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2010-26220

  • FR Doc 2010-26220[Federal Register: October 18, 2010 (Volume 75, Number 200)]

    [Proposed Rules]

    [Page 63732-63753]

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

    [DOCID:fr18oc10-22]

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    COMMODITY FUTURES TRADING COMMISSION

    17 CFR Parts 1, 37, 38, 39, and 40

    RIN 3038-AD01

    Requirements for Derivatives Clearing Organizations, Designated

    Contract Markets, and Swap Execution Facilities Regarding the

    Mitigation of Conflicts of Interest

    AGENCY: Commodity Futures Trading Commission.

    ACTION: Notice of proposed rulemaking.

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

    hereby proposes rules to implement new statutory provisions enacted by

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

    Act (the ``Dodd-Frank Act''). Specifically, the proposed rules

    contained herein impose new requirements on derivatives clearing

    organizations (``DCOs''), designated contract markets (``DCMs''), and

    swap execution facilities (``SEFs'') with respect to mitigation of

    conflicts of interest.

    DATES: Submit comments on or before November 17, 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: dcodcmsefGovernance@cftc.gov.

    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.

    FOR FURTHER INFORMATION CONTACT: Nancy Liao Schnabel, Special Counsel,

    Division of Clearing and Intermediary Oversight (DCIO), at 202-418-5344

    or nschnabel@cftc.gov; Lois Gregory, Assistant Deputy Director for

    Market Review, the Division of Market Oversight (DMO), at 202-418-5569

    or lgregory@cftc.gov; Andrea Musalem, Special Counsel, DCIO, at 202-

    418-5167 or amusalem@cftc.gov; Jordan O'Regan, Attorney-Advisor, DCIO,

    at 202-418-5984 or joregan@cftc.gov; Cody Alvarez, Attorney-Advisor,

    DMO, at 202-418-5404 or calvarez@cftc.gov; Dana Brown, Law Clerk, DMO,

    at 202-418-5093 or dbrown@cftc.gov; Jolanta Sterbenz, Counsel, Office

    of the General Counsel, at 202-418-6639 or jsterbenz@cftc.gov; David

    Reiffen, Senior Economist, Office of the Chief Economist, at 202-418-

    5602 or dreiffen@cftc.gov; or Alicia Lewis, Attorney-Advisor, DCIO, at

    202-418-5862 or alewis@cftc.gov; in each case, also at the Commodity

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

    NW., Washington, DC 20581.

    SUPPLEMENTARY INFORMATION:

    I. Background

    On July 21, 2010, President Obama signed the Dodd-Frank Act.\1\

    Title VII of the Dodd-Frank Act \2\ amended the Commodity Exchange Act

    (``CEA'') \3\ to establish a comprehensive new regulatory framework for

    swaps and certain security-based swaps. The legislation was enacted to

    reduce risk, increase transparency, and promote market integrity within

    the financial system by, among other things: (i) Providing for the

    registration and comprehensive regulation of swap dealers and major

    swap participants; \4\ (ii) imposing mandatory clearing and trade

    execution requirements on clearable swap contracts; (iii) creating

    robust recordkeeping and real-time reporting regimes; and (iv)

    enhancing the rulemaking and enforcement authorities of the Commission

    with respect to, among others, all registered entities and

    intermediaries subject to the oversight of the Commission.

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    \1\ See Dodd-Frank Act, Pub. L. 111-203, 124 Stat. 1376 (2010).

    The text of the Dodd-Frank Act may be accessed at http://

    www.cftc.gov./LawRegulation/OTCDERIVATIVES/index.htm.

    \2\ Pursuant to Section 701 of the Dodd-Frank Act, Title VII may

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

    2010.''

    \3\ 7 U.S.C. 1 et seq.

    \4\ In this release, the terms ``swap dealer'' and ``major swap

    participant'' shall have the meanings set forth in Section 721(a) of

    the Dodd-Frank Act, which added Sections 1a(49) and (33) of the CEA.

    However, Section 721(c) of the Dodd-Frank Act directs the Commission

    to promulgate rules to further define, among other terms, ``swap

    dealer'' and ``major swap participant.'' The Commission is in the

    process of this rulemaking. See, e.g., http://www.cftc.gov/

    LawRegulation/OTCDerivatives/OTC_2_Definitions.html. The

    Commission anticipates that such rulemaking will be completed by the

    statutory deadline of July 15, 2011.

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    In order to ensure the proper implementation of the comprehensive

    new regulatory framework, especially with respect to (ii) above, the

    Dodd-Frank Act requires \5\ the Commission to promulgate rules to

    mitigate conflicts of interest in the operation of certain DCOs, DCMs,

    and SEFs. First, Section 726(a) of the Dodd-Frank Act specifically

    empowers the Commission to adopt ``numerical limits * * * on control''

    or ``voting rights'' that enumerated entities \6\ may hold with respect

    to such DCOs, DCMs, and SEFs. Second, Section 726(b) of the Dodd-Frank

    Act directs the Commission to determine the manner in which its rules

    may be deemed necessary or

    [[Page 63733]]

    appropriate to improve the governance of certain DCOs, DCMs, or SEFs or

    to mitigate systemic risk, promote competition, or mitigate conflicts

    of interest in connection with the interaction between swap dealers and

    major swap participants, on the one hand, and such DCOs, DCMs, and

    SEFs. Finally, Section 726(c) of the Dodd-Frank Act directs the

    Commission to consider the manner in which its rules address conflicts

    of interest in the abovementioned interaction arising from equity

    ownership, voting structure, or other governance arrangements of the

    relevant DCOs, DCMs, and SEFs. The Commission must complete a

    rulemaking under Section 726 of the Dodd-Frank Act within 180 days

    after enactment--i.e., by January 14, 2011.\7\

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    \5\ See the following colloquy between Representative Stephen

    Lynch and Representative Barney Frank on the language that became

    Section 726 of the Dodd-Frank Act:

    Madam Speaker, for the purpose of a colloquy, I would like to

    engage with the chairman of the committee and the drafter of this

    legislation. I congratulate him on the great work he has done on

    this reform bill.

    Mr. Chairman, I want to call your attention to sections 726 and

    765 of the bill. These two provisions require the CFTC and the SEC

    to conduct rulemakings to eliminate the conflicts of interest

    arising from the control of clearing and trading facilities by

    entities such as swap dealers and major swap participants.

    This problem arises because, right now, 95 percent of all of the

    clearinghouses in this country are owned by just five banks. So,

    while we are relying on the clearinghouses to reduce systemic risk,

    we have the banks now owning the clearinghouses.

    The question I have is regarding the intent of the conferees in

    retaining subsection B of these provisions. It could be loosely

    construed to leave it up to the agencies whether or not to adopt

    rules.

    Mr. Chairman, do you agree that my reading of sections 726 and

    765 affirmatively require these agencies to adopt strong conflict of

    interest rules on control and governance of clearing and trading

    facilities?

    Mr. FRANK of Massachusetts. If the gentleman would yield to me,

    he has been a leader in this important area, and he is a careful

    lawyer and understands that just saving a principle isn't enough.

    You've got to make sure it is carried out. Dealing with a conflict

    of interest that he has been a leader in identifying is essential if

    this is going to work. So I completely agree with him. Yes, we mean

    both of those subsections, and it is a mandatory rulemaking.

    I will say to my neighbor from Massachusetts that we will be

    monitoring this carefully. They can expect oversight hearings

    because, yes, this is definitely a mandate to them to adopt rules to

    deal with what would be a blatant conflict of interest in the

    efficacy rules, and we intend to follow that closely.

    156 Cong. Rec. H5217 (2010).

    \6\ The ``enumerated entities'' include: (i) Bank holding

    companies with over $50,000,000,000 in total consolidated assets;

    (ii) a nonbank financial company supervised by the Board of

    Governors of the Federal Reserve System; (iii) an affiliate of (i)

    or (ii); (iv) a swap dealer; (v) a major swap participant; or (vi)

    an associated person of (iv) or (v).

    \7\ In adopting rules to implement Section 726 of the Dodd-Frank

    Act, the Commission is also implementing Section 725(d) of the Dodd-

    Frank Act. The latter states: ``[t]he Commodity Futures Trading

    Commission shall adopt rules mitigating conflicts of interest in

    connection with the conduct of business by a swap dealer or a major

    swap participant with a derivatives clearing organization, board of

    trade, or a swap execution facility that clears or trades swaps in

    which the swap dealer or major swap participant has a material debt

    or material equity investment.''

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    In carrying out Section 726 of the Dodd-Frank Act,\8\ the

    Commission identifies in Section II below the following potential

    conflicts of interest:

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    \8\ Although the Commission is proposing the rules contained

    herein to specifically carry out Section 726 of the Dodd-Frank Act

    (as well as Section 725(d) of the Dodd-Frank Act), the Commission

    notes that it has additional authority to propose such rules under

    Sections 735(b), 735(c), and 733 of the Dodd-Frank Act. See infra

    note 17 for a more extensive description of Sections 735(b), 735(c),

    and 733 of the Dodd-Frank Act.

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    Conflicts of interest that a DCO may confront when

    determining (i) whether a swap contract is capable of being cleared,

    (ii) the minimum criteria that an entity must meet in order to become a

    swap clearing member, and (iii) whether a particular entity satisfies

    such criteria; \9\ and

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    \9\ The Commission requests comment as to whether DCOs, like

    DCMs and SEFs, have (or potentially may have) other conflicts of

    interest that implicate the balance between advancement of

    commercial interests and fulfillment of self-regulatory

    responsibilities.

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    Conflicts of interest that a DCM or SEF may confront in

    balancing advancement of commercial interests and fulfillment of self-

    regulatory responsibilities.

    The Commission proposes in Section III below (i) structural governance

    requirements and (ii) limits on the ownership of voting equity and the

    exercise of voting power, and describes, in each case, the manner in

    which such proposals may mitigate conflicts of interest in the

    operation of a DCO, DCM, or SEF.\10\

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    \10\ Commission regulations (the ``Regulations'') referred to

    herein are found at 17 CFR Ch. 1.

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    In general, the proposed rules include strengthened versions of the

    acceptable practices that the Commission previously adopted for the DCM

    core principle on conflicts of interest.\11\ The proposed rules impose

    structural governance requirements and limits on the ownership of

    voting equity and the exercise of voting power. They impose specific

    composition requirements on DCO, DCM, or SEF Boards of Directors and

    require each DCO, DCM, or SEF to have a nominating committee and one or

    more disciplinary panels. Each DCO must have a risk management

    committee and each DCM or SEF must have a regulatory oversight

    committee and a membership or participation committee, subject to

    specific composition requirements.

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    \11\ See, generally, ``Conflicts of Interest in Self-Regulation

    and Self-Regulatory Organizations,'' 74 FR 18982 (April 27, 2009)

    (which defined ``public director''); 72 FR 6936 (Feb. 14, 2007)

    (which adopted final acceptable practices for the DCM core

    principle) (the ``DCM Conflicts of Interest Release''); 71 FR 38740

    (July 7, 2006) (which proposed acceptable practices for the DCM core

    principle).

    Currently, DCM core principle 15 addresses conflicts of

    interest. See 7 U.S.C. 7(d)(15). The Dodd-Frank Act has redesignated

    DCM core principle 15 as DCM core principle 16, but has left the

    actual language of the principle substantively unchanged.

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    The proposed rules limit DCM or SEF members (and related persons)

    from beneficially owning more than twenty (20) percent of any class of

    voting equity in the registered entity or from directly or indirectly

    voting an interest exceeding twenty (20) percent of the voting power of

    any class of equity interest in the registered entity. With respect to

    a DCO only, the proposed rules require a DCO to choose one of two

    alternative limits on the ownership of voting equity or the exercise of

    voting power. Under the first alternative, no individual member may

    beneficially own more than twenty (20) percent of any class of voting

    equity in the DCO or directly or indirectly vote an interest exceeding

    twenty (20) percent of the voting power of any class of equity interest

    in the DCO. In addition, the enumerated entities, whether or not they

    are DCO members, may not collectively own on a beneficial basis more

    than forty (40) percent of any class of voting equity in a DCO, or

    directly or indirectly vote an interest exceeding forty (40) percent of

    the voting power of any class of equity interest in the DCO.

    Under the second alternative, no DCO member or enumerated entity,

    regardless of whether it is a DCO member, may own more than five (5)

    percent of any class of voting equity in the DCO or directly or

    indirectly vote an interest exceeding five (5) percent of the voting

    power of any class of equity interest in the DCO.

    Notwithstanding the foregoing, the proposed rules recognize that

    circumstances may exist where neither alternative would be appropriate

    for a DCO. Consequently, the proposed rules provide a procedure for the

    DCO to apply for, and the Commission to grant, a waiver of the limits

    specified in the first and second alternative.

    The proposed rules reflect consultation with staff of the following

    agencies: (i) The Securities and Exchange Commission (the ``SEC'');

    \12\ (ii) the Board of Governors of the Federal Reserve, (iii) the

    Office of the Comptroller of the Currency; (iv) the Federal Deposit

    Insurance Corporation; and (v) the Treasury Department. Staff from each

    of these agencies has provided verbal and/or written comments, and the

    proposed rules incorporate elements of the comments provided. The

    proposed rules have been further informed by (i) the joint roundtable

    that Commission and SEC staff conducted on August 20, 2010 (the

    ``Roundtable'') \13\ and (ii) public comments posted to the Web site of

    the Commission.\14\ Finally, mindful of the importance of international

    harmonization,\15\ the proposed rules incorporate certain elements of:

    (i) The Proposal for a Regulation of the European Parliament and of the

    Council on OTC Derivatives, Central Counterparties, and Trade

    Depositories (the ``European Commission Proposal''); \16\ and (ii) the

    latest draft of the Principles for Financial Market Infrastructures,

    which would ultimately be reviewed by the Committee on Payment and

    Settlement Systems of the Bank for International Settlements and the

    Technical Committee of the

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    International Organization of Securities Commissions.

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    \12\ Section 765 of the Dodd-Frank Act requires the SEC to

    promulgate rules to mitigate conflicts of interest in the operation

    of (i) a clearing agency that clears security-based swaps, (ii) a

    security-based swap execution facility, or (iii) a national

    securities exchange that posts or makes available for trading

    security-based swaps.

    \13\ The transcript from the roundtable (the ``Roundtable Tr.'')

    is available at: http://www.cftc.gov/ucm/groups/public/@newsroom/

    documents/file/derivative9sub082010.pdf.

    \14\ Such comments are available at: http://www.cftc.gov/

    LawRegulation/DoddFrankAct/OTC_9_DCOGovernance.html.

    \15\ Currently, the Commission regulates certain entities based

    outside of the United States (e.g., LCH.Clearnet Limited and ICE

    Clear Europe Limited (``ICE Clear Europe''), each of which is based

    in the United Kingdom).

    \16\ COM(2010) 484/5.

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    The Commission anticipates conducting at least one other rulemaking

    that may impose requirements on DCOs, DCMs, and SEFs with respect to

    governance and mitigation of conflicts of interest.\17\ The Commission

    expects to finish such rulemaking by the statutory deadline of July 15,

    2011.

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    \17\ Such rulemaking would implement Sections 735(b) and 725(c)

    of the Dodd-Frank Act, which amends Sections 5(d) and 5b(c) of the

    CEA to add new core principles, or to supplement existing core

    principles, regarding the governance of DCMs and DCOs, and the

    mitigation of conflicts of interest in the operation of such

    entities. Such core principles would apply to all DCMs and DCOs,

    regardless of whether they clear or list swap contracts or only

    commodity futures or options. Such rulemaking would also implement

    Section 733 of the Dodd-Frank Act, which inserts new Section 5h of

    the CEA to create a registration category for SEFs, and to impose

    core principles that include the mitigation of conflicts of

    interest. The Commission is considering the proposals set forth

    below, among others, with respect to the second rulemaking: (1)

    Requiring each DCO, DCM, or SEF to have a regulatory program to (i)

    identify, on an ongoing basis, existing and potential conflicts of

    interest, and (ii) to make decisions in the event of such conflict;

    (2) mandating that each DCO, DCM, or SEF (i) prescribe limits on use

    of non-public information, and (ii) afford transparency with respect

    to governance arrangements; (3) requiring each DCO, DCM, or SEF to

    report to the Commission whenever (i) the Board of Directors rejects

    a recommendation or supersedes an action of the DCM or SEF

    Regulatory Oversight Committee, DCM or SEF Membership or

    Participation Committee, or DCO Risk Management Committee, as

    applicable, or (ii) the DCO Risk Management Committee rejects or

    supersedes an action of the DCO Risk Management Subcommittee, if

    applicable; (4) mandating minimum governance fitness standards for

    DCO and DCM members and participants; and (5) prescribing minimum

    standards regarding (i) DCM consideration of market participant

    views and (ii) the diversity of DCM Board of Directors, if the DCM

    is publicly-listed.

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    The Commission requests comment on all aspects of this release.

    II. Conflicts of Interest

    As mentioned above, Title VII of the Dodd-Frank Act amended the CEA

    to establish a comprehensive new framework for swaps and security-based

    swaps. This framework imposes mandatory clearing and trade execution

    requirements with respect to clearable swap contracts. Some market

    participants, investor advocates, and academics have expressed a

    concern that the enumerated entities have economic incentives to

    minimize the number of swap contracts subject to mandatory clearing and

    trading. They contend that control of a DCO by the enumerated entities,

    whether through ownership or otherwise, constitutes the primary means

    for keeping swap contracts out of the mandatory clearing requirement,

    and therefore also out of the trading requirement. The Commission

    addresses these arguments below. The Commission also examines the

    contention that sustained competition between DCMs or SEFs with respect

    to the same swap contracts may exacerbate certain structural conflicts

    of interest, as the DCM Conflicts of Interest Release defines such

    term.\18\

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    \18\ According to the DCM Conflicts of Interest Release, ``[t]he

    presence of potentially conflicting demands within a single entity--

    regulatory authority coupled with commercial incentives to misuse

    such authority--constitutes the new structural conflict of interest

    addressed by the acceptable practices adopted herein.'' 72 FR at

    6937.

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    a. DCOs

    In general, in the commodity futures and options markets, the DCM

    decides which contracts to list, whereas the DCO manages the risk of

    guaranteeing such contracts. Clearing members exercise significant

    control over the manner in which a DCO manages risk, whether the

    members own the DCO or not.\19\ Based on Commission experience, such

    control has generally permitted the DCO to serve the purposes of the

    CEA, especially with respect to ``ensur[ing] the financial integrity of

    all transactions subject to [the CEA] and the avoidance of systemic

    risk.'' \20\ Clearing members contribute substantial financial

    resources to the DCO default or guarantee fund. If a clearing member

    defaults, and the DCO holds insufficient performance bond from such

    member to cover its losses, then the DCO would access the default or

    guarantee fund. Thus, the DCO spreads its losses across all clearing

    members. This mechanism creates an incentive for each clearing member

    to ensure that (i) other clearing members meet certain financial

    requirements and (ii) the DCO adopt a conservative approach towards

    risk management, especially in determining whether a particular

    contract would be acceptable for clearing.

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    \19\ The CME Group, Inc. (the ``CME Group''), a publicly-listed

    corporation, wholly owns the Chicago Mercantile Exchange, Inc.

    (``CME''). However, CME Clearing House, a division of CME, has a

    Risk Committee that is composed of: (i) Two members of the CME Board

    of Directors; (ii) five clearing member representatives; and (iii)

    two additional individuals, one of whom cannot be a clearing member

    representative. See CME Rule 403.A, available at: http://

    www.cmegroup.com/rulebook/CME/I/4/03.html.

    \20\ See Section 3(b) of the CEA, 7 U.S.C. 5(b).

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    This same mechanism also creates a disincentive for clearing

    members to act collectively (i) to exclude other entities from becoming

    clearing members or (ii) to bar a DCO from accepting new commodity

    futures or options contracts. After all, each new clearing member must

    contribute to the default or guarantee fund. Such contribution would

    result in a pro rata decrease in the potential exposure of each other

    clearing member to a default. Moreover, clearing members generally had

    little incentive to prevent the DCO from accepting a particular

    contract, absent a risk-based objection. In fact, the more different

    types of contracts that a DCO accepts, the more the intermediation

    services that such clearing member offers would likely be in demand.

    The regulated market structure that the Dodd-Frank Act contemplates

    for swap contracts is, in many ways, the mirror image of the market

    structure for commodity futures and option contracts. Currently, most

    swap contracts are privately negotiated between two parties, and are

    generally not cleared.\21\ Section 723 of the Dodd-Frank Act requires:

    (i) Swap contracts meeting certain criteria to be cleared with a DCO;

    and (ii) such contracts to be executed on a DCM or SEF (unless no DCM

    or SEF lists such contracts). Therefore, a DCO has unprecedented

    influence over the manner in which a swap contract can be executed.

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    \21\ See, e.g., Darrel Duffie, Ada Li, Theo Lubke, ``Policy

    Perspectives on OTC Derivatives Market Infrastructure,'' Federal

    Reserve Bank of New York Staff Report No. 424, dated January 2010,

    as revised March 2010 (the ``FRBNY Staff Report''). According to

    Section II of the FRBNY Staff Report, ``[a]n over-the-counter trade

    is privately negotiated between the buyer and seller.'' According to

    Section VII(A)(i) of the FRBNY Staff Report, ``[o]nly some types of

    OTC derivatives are now cleared. These include, for example, certain

    actively traded credit derivatives, some common forms of interest-

    rate swaps, and some energy derivatives. Of these `eligible' types

    of OTC derivatives, those for which clearing has been set up, not

    all positions are actually cleared; the decision of which positions

    to clear has to this point been left to the discretion of market

    participants.''

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    Certain market participants and academics believe that Section 723

    of the Dodd-Frank Act does not introduce any new incentives for

    clearing members to act collectively (i) to exclude other entities from

    becoming clearing members or (ii) to bar a DCO from accepting new

    contracts. First, they argue that clearing does not make a bilateral

    swap contract less profitable.\22\ Second, they contend that, because

    clearing does not impact the profitability of a bilateral swap

    contract, swap clearing members that are

    [[Page 63735]]

    enumerated entities have specific, risk-based justifications for (i)

    setting membership criteria that exclude certain entities \23\ and (ii)

    determining that certain swap contracts cannot be cleared.\24\ Third,

    they assert that such swap clearing members must have the right to

    cause the DCO to act on such justifications, since ultimately, the

    capital of such clearing members (i.e., their contributions to the

    default or guarantee fund) may be accessed if a fellow clearing member

    defaults.\25\

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    \22\ See, e.g., Comments from James Hill, Managing Director and

    Global Credit Derivatives Officer, Morgan Stanley, representing the

    Securities Industry and Financial Markets Association (``Hill'')

    (``I think there's a bit of a misconception that somehow clearing

    makes trades less profitable. That's clearly not the case. In fact,

    I think most of the large systemically important participants in

    this market prefer clearing. And I think that's not just a

    statement; there is significant anecdotal evidence to support that

    perhaps the most important of which is LCH''), Roundtable Tr. at 21-

    22.

    \23\ See, e.g., Comments from Hill (``as a general rule, the

    clearing member needs to be able to absorb losses, a default by

    another clearing member, number one; and, number two, they need to

    be able to absorb the economic transaction risk in the portfolio of

    a defaulting member * * * And so the way these clearinghouses set up

    their risk, you know, their admission or their membership criteria,

    is both of those things. So, A, they have to have a capital base

    sufficient to absorb losses and add in more capital to the

    clearinghouse if a member defaults. And B, they have to be able to

    in a situation where a clearing member has defaulted, which is

    probably the time of most economic stress, you know, in the economy,

    be able to take down the economic transaction risk of the swaps that

    were otherwise, the defaulting member was otherwise a party to,

    those trades need to be allocated among the surviving clearing

    members * * * And so the way these clearinghouses developed their

    criteria is they look at both of those prongs and they set

    thresholds to make sure that the members who are admitted can do

    those things. Because, remember, if you admit a member who can't do

    both of those things, then what happens is the clearinghouse will

    have insufficient capital in a situation where a member has

    defaulted, which is the time of the highest economic stress''),

    Roundtable Tr. at 28 to 29.

    \24\ See, e.g., Comments from Hill (``In evaluating what trades

    should be cleared, there's a balance that needs to be struck between

    the goal of increasing clearing, obviously, but, B, you don't want

    to put trades in the clearinghouse that can't be appropriately risk-

    managed. So if you put trades in the clearinghouse that are illiquid

    and can't be valued properly, what will happen is when a clearing

    member defaults, there will be insufficient collateral with respect

    to that trade because it wasn't properly valued in the

    clearinghouse, and the surviving clearing members will be stressed

    from an economic perspective in taking positions the value of which

    cannot be readily ascertained. So it's critical that only trades

    that can be appropriately risk-managed be put into the

    clearinghouse. And I think what you'll see is that most of the

    clearinghouses look to their clearing members to help them valuate

    which trades are appropriate from a clearing perspective, and that

    is completely consistent with the economic incentives because the

    clearing members are the ones who have the overwhelming

    preponderance of the capital in the clearinghouse. So it's their

    capital that's at risk. They should certainly have a say in helping

    the clearinghouse evaluate which trades are acceptable for clearing

    and which trades are too risky or can't be valued, or are too

    illiquid or not standardized and, therefore, shouldn't be

    cleared''), Roundtable Tr. at 43 to 45.

    \25\ Id. See, also, e.g., Comments from Lee Olesky, Chief

    Executive Officer and Co-Founder, TradeWeb (``Olesky'') (``And I

    second Mr. Hill's comments. I think that it's very important that

    the people who bear the risk and supply the capital should have a

    substantial voice in how that risk gets managed, and that includes

    what contracts are accepted for clearing''), Roundtable Tr. at 46.

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    Others do not agree. They maintain that certain enumerated entities

    are active in the over-the-counter swap markets \26\ and that they earn

    significant revenues from this line of business.\27\ Such entities may

    experience substantial decreases in revenues if swap contracts were

    required to be (i) cleared with a DCO and (ii) executed on a DCM or

    SEF.\28\ Therefore, some contend that such entities may have an

    incentive to represent that certain swap contracts do not meet the

    mandatory clearing criteria under Section 723 of the Dodd-Frank

    Act.\29\ Such swap contracts would also not be subject to the trading

    requirement under Section 723 of the Dodd-Frank Act.

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

    \26\ For example, according to the Office of the Comptroller of

    the Currency (``OCC''), as of the second quarter of 2009, U.S.

    commercial banks held derivatives with $203.5 trillion in notional

    value. Of that $203.5 trillion, the top five commercial banks held

    approximately $197 trillion. The top five commercial banks were: (i)

    JPMorgan Chase Bank N.A.; (ii) Goldman Sachs Bank USA; (iii) Bank of

    America N.A.; (iv) Citibank N.A.; and (v) Wells Fargo Bank N.A. The

    sixth commercial bank, holding approximately $3 trillion, was HSBC

    Bank USA N.A. See OCC's Quarterly Report on Bank Trading and

    Derivatives Activities, Second Quarter 2009.

    \27\ Id. (stating that ``U.S. commercial banks reported revenues

    of $5.2 billion trading cash and derivative instruments in the

    second quarter of 2009, compared to a record $9.8 billion in the

    first quarter'').

    \28\ According to Section VI of the FRBNY Staff Report, ``[e]ven

    after an OTC derivatives product has achieved relatively active

    trading, and would be suitable for exchange trading, dealers have an

    incentive to maintain the wider bid-ask spreads that they can obtain

    in the OTC market relative to the spreads that might apply to the

    same product on an exchange, where buyers and sellers can more

    directly compete for the same trade. Further, exchanges are more

    likely to match ultimate buyers to sellers, reducing the fraction of

    trades intermediated by dealers. Thus, from the viewpoint of their

    profits, dealers may prefer to reduce the migration of derivatives

    trading from the OTC market to central exchanges.''

    \29\ See, e.g., Comments of Heather Slavkin, Senior Legal and

    Policy Advisor, Office of Investment, AFL-CIO (``Slavkin'') (``If

    there's an interest among the people who own the clearinghouse, or a

    conflict of interest that would create incentives for them to also

    favor, you know, [not] allowing certain types of swaps to clear

    because they may be more profitable for the institution generally if

    they remain over the counter, then that can create perverse

    incentives to maintain the OTC, nontransparent, systemically risky

    markets when the goal needs to be to prevent those conflicts of

    interest to ensure that anything that can be cleared does, in fact,

    clear''), Roundtable Tr. at 21; Comments of Darrell Duffie, Dean

    Witter Distinguished Professor of Finance at the Graduate School of

    Business, Stanford University (``Duffie'') (``We talked earlier

    about how the members of the clearinghouse should determine what

    gets traded, and we also have conflicts of interest arising from the

    incentives of the dealers to profit from bid versus ask on products

    that are not traded on swap execution facilities. So the interaction

    effect here is effectively if one gets cleared as one gets traded on

    a swap execution facility, then we want to be very careful that the

    members of a central clearing counterparty that determine what gets

    cleared and, therefore, have control over what gets traded on swap

    execution facilities are the members that have, you know, the right

    social incentives to create competition''); Comments of Michael

    Greenberger, Professor, University of Maryland School of Law

    (``Greenberger'') (``If you have one clearinghouse dominated by the

    major swaps dealers, they have several conflicting incentives. One

    is, I reject the idea that somehow they do not want to keep a large

    and vibrant over-the-counter market. We're told that clearing is

    very profitable. If it was that profitable, where were these people

    when we were aggressively arguing for mandatory clearing and

    exchange trading? They were on the opposite side of that. The

    transaction fees and the spreads still make an unregulated market

    very, very profitable, probably more profitable than the profits

    that would derive from clearing. So, if you have the swaps dealers

    in control of a clearing facility, they have that incentive''),

    Roundtable Tr. at 111.

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

    Although Section 723 of the Dodd-Frank Act grants the Commission

    ultimate authority to determine whether a swap contract must be cleared

    with a DCO, it also anticipates that the Commission would consider the

    risk assessment of DCOs. Currently, DCOs that clear large volumes of

    swap contracts tend to have swap clearing members that consist

    exclusively of enumerated entities.\30\ Therefore, some argue that the

    risk assessment of such DCOs may be compromised.\31\

    [[Page 63736]]

    Moreover, some contend that the swap clearing members of such DCOs may

    exclude non-enumerated entities from becoming clearing members, because

    non-enumerated entities may influence risk assessments of DCOs in favor

    of clearing more swap contracts.\32\ Some market participants maintain

    that such practices may have systemic implications.\33\

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

    \30\ For example, as of July 2, 2010, ICE Clear Europe cleared

    approximately $3.3 trillion in European credit default swap

    (``CDS'') indices and an additional $501 billion in European CDS

    single-name instruments. See ``ICE Surpasses $10 Trillion Milestone

    in Global CDS Clearing,'' available at:

    http:[sol][sol]ir.theice.com/releasedetail.cfm?ReleaseID=485527.

    As of September 20, 2010, all CDS clearing members of ICE Clear

    Europe are banks, bank holding companies, or affiliates thereof.

    Such members are: (i) Banc of America N.A.; (ii) Barclays Bank PLC;

    (iii) BNP Paribas; (iv) Citigroup Global Markets Limited; (v) Credit

    Suisse International; (vi) Deutsche Bank AG; (vii) Goldman Sachs

    International; (viii) HSBC Bank PLC; (ix) JPMorgan Chase Bank, N.A.;

    (x) Morgan Stanley Capital Services, Inc.; (xi) Nomura International

    PLC; (xii) Soci[eacute]t[eacute] G[eacute]n[eacute]rale; (xiii) The

    Royal Bank of Scotland PLC; (xiv) UBS AG, London Branch; and (xv)

    UniCredit Bank AG. See ICE Clear Europe, Clearing Members, available

    at: https:[sol][sol]www.theice.com/publicdocs/clear_europe/ICE_

    Clear_Europe_Clearing_Member_List.pdf, and the release updating

    such list, available at https:[sol][sol]www.theice.com/publicdocs/

    clear_europe/circulars/C10080.pdf.

    ICE Trust U.S. LLC (``ICE Trust''), an affiliate of ICE Clear

    Europe, cleared approximately $6 billion in North American CDS

    indices and $272 billion in North American single-name indices. The

    CDS clearing members of ICE Clear Europe and ICE Trust generally

    overlap (counting affiliated entities), except that Merrill Lynch

    International is a clearing member of ICE Trust and

    Soci[eacute]t[eacute] G[eacute]n[eacute]rale and UniCredit Bank AG

    are not. See ICE Trust, Participant List, available at:

    https:[sol][sol]www.theice.com/publicdocs/ice_trust/ICE_Trust_

    Participant_List.pdf. ICE Trust is currently not a DCO.

    \31\ See note 29 above. See, also, Comments from Slavkin (``I

    think that there's the risk that anything that could be made to

    appear to be something that is a bilateral * * * contract, you could

    have the spurious customization issues, if there's the opportunity

    to get additional profits within the big dealer banks, and those

    same dealer banks are running and controlling the clearinghouses,

    then, you know, the potential for spurious customization becomes a

    real issue and becomes a possibility''), Roundtable Tr. at 40.

    In addition to noting that the enumerated entities may have

    incentives to influence DCO risk assessments in favor of considering

    fewer contracts to be suitable for mandatory clearing, certain

    academics have observed that, for those contracts that nonetheless

    are cleared, the enumerated entities may have incentives to lower

    risk management standards. See, e.g., Comments from Greenberger (``*

    * * yes, certain products will be cleared because they are

    profitable and [the enumerated entities] may over calculate and be

    over enthused about clearing things that are too risky''),

    Roundtable Tr. at 112. For example, the enumerated entities may not

    accurately calculate the amount of performance bond and/or guarantee

    or default fund contributions necessary to clear a particular swap

    contract.

    \32\ See, e.g., Comments from Jason Kastner, Vice Chairman,

    Swaps and Derivatives Markets (``Kastner'') (``Let me give you a

    specific example. One of the members of this SDMA currently clears

    13 percent of the business at a large exchange in Chicago. That

    large, independent FCM is clearly qualified to become a swap

    clearing member. But because of various conflicts of interest, the

    risk committee of said exchange is precluding that firm, which is

    clearly qualified and has the capital, from becoming a swap clearing

    member * * * this goes back to the governance point and transparency

    about who's making that decision and why, because a lot of times

    what happens is people will swallow themselves in the cloak of risk

    management or financial stability or whatever really to make an

    anti-competitive stand. In other words, you can never say that you

    don't want to let somebody in. But you could probably find an excuse

    or a reason in the interest of systematic--you know, systemic

    stability and the rest of it to put an asterisk on the application

    or just delay it for awhile''), Roundtable Tr. at 90-91.

    See, also, infra note 67 on the potential non-availability of

    arrangements whereby a non-clearing futures commission merchant may

    present a customer trade to a swap clearing member for clearing with

    a DCO.

    \33\ In Lessening Systemic Risk: Removing Final Hurdles to

    Clearing OTC Derivatives, the Swaps and Derivatives Market

    Association states: ``[r]estricted access leads to reduced clearing

    which leads to systemic risk.''

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

    The framers of the Dodd-Frank Act observe that the clearing of swap

    contracts constitutes a key means for managing systemic risk, because

    clearing removes the type of interconnectedness between financial

    institutions that contributed to the financial crisis resulting from

    the failure and bankruptcy of firms such as Bear Stearns, Lehman

    Brothers, and AIG.\34\ Therefore, it is important to mitigate potential

    conflicts of interest that may prevent clearable swap contracts from

    becoming subject to mandatory clearing. At the same time, the

    Commission recognizes that the safety and soundness of a DCO should not

    be compromised. A DCO must not only have the ability to appropriately

    manage the risk associated with each and every contract that it

    guarantees, it must be able to decline accepting contracts for clearing

    if they pose unacceptable risks. In addition, DCO members must have

    input in setting membership criteria, because they bear the risk of

    loss in the event of member default. Nevertheless, the Commission does

    not believe that (i) subjecting more swap contracts to mandatory

    clearing is incompatible with (ii) DCO safety and soundness.\35\

    Rather, the Commission intends to ensure, through the proposed rules

    below, that a DCO takes action to achieve both (i) and (ii), and that

    the private, competitive interests of certain DCO members do not

    capture DCO risk assessments.

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

    \34\ See, e.g., the letter from Senators Christopher Dodd and

    Blanche Lincoln, respective chairs of the Senate Banking and

    Agriculture Committee, to Representatives Barney Frank and Collin

    Peterson, respective chairs of the House Financial Services and

    Agriculture Committees, dated June 30, 2010 (stating that ``Congress

    determined that clearing is at the heart of reform--bringing

    transactions and counterparties into a robust, conservative and

    transparent risk management framework'').

    \35\ Certain Roundtable participants agree. See Comments from

    Duffie (``I don't think there's a conflict between the incentives

    for competition, increasing competition in this market on the one

    hand and the incentives for improving financial stability on the

    other, or I don't think there's a problem between those two. You can

    * * * have both. The incentives to watch for on competition are that

    we've got enough access by multiple market * * * participants, and

    that the oligopolistic nature of the market is, to some extent,

    watched carefully by regulators''), Roundtable Tr. at 104.

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

    b. DCMs and SEFs

    The main function of a DCM, as well as a SEF, is to provide a

    facility for: (i) The discovery of prices; and (ii) the execution of

    transactions. However, in order to obtain and maintain a license to

    perform such a function, each DCM and SEF must fulfill self-regulatory

    obligations under the CEA and the Dodd-Frank Act.\36\ Therefore,

    although each DCM or SEF \37\ is a commercial enterprise, the fact that

    each entity has self-regulatory obligations means that each entity ``is

    not simply a corporation, but a corporation charged with the public

    trust.'' \38\ Section 3(b) of the CEA confers on the Commission the

    responsibility for ensuring that each DCM or SEF appropriately

    prioritizes its self-regulatory obligations. Such obligations include

    appropriately implementing the comprehensive new framework that the

    Dodd-Frank Act sets forth, as well as meeting existing requirements

    under the CEA.

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

    \36\ Section 3(a) of the CEA defines the ``national public

    interest'' that transactions in commodity futures and options and

    swaps serve. It states, ``[t]he transactions subject to this Act are

    entered into regularly in interstate and international commerce and

    are affected with a national public interest by providing a means

    for managing and assuming price risks, discovering prices, or

    disseminating pricing information through trading in liquid, fair

    and financially secure trading facilities.'' 7 U.S.C. 5(a). The

    importance of transactions in commodity futures and options, as well

    as swaps, forms the basis for Commission regulation of DCMs and

    SEFs.

    Section 3(b) of the CEA describes the system of regulation that

    Congress has directed the Commission to implement to achieve the

    abovementioned purposes. It states: ``[i]t is the purpose of this

    chapter to serve the public interests * * * through a system of

    effective self-regulation of trading facilities, clearing systems,

    market participants and market professionals under the oversight of

    the Commission.'' 7 U.S.C. 5(a). The Commission has interpreted the

    ``self-regulation'' referenced in Section 3(b) of the CEA as

    encompassing both (i) the registered entity ensuring that members

    meet applicable statutory requirements, and (ii) the registered

    entity having systems to ensure that it continues to meet applicable

    statutory requirements. For example, as the Commission previously

    stated in the DCM Conflicts of Interest Release, ``Core Principle 15

    requires DCMs to maintain systems to minimize structural conflicts

    of interest inherent in self-regulation, as well as individual

    conflicts of interest faced by particular persons. The acceptable

    practices are rationally related to the purposes of Core Principle

    15.'' 72 FR at 6937, 6940.

    \37\ As mentioned above, the SEF is a new registration category

    that the Dodd-Frank Act created. Therefore, the Commission has never

    opined as to whether a SEF is a ``self-regulatory organization''

    within the meaning of Regulation 1.3(ee). However, a SEF has self-

    regulatory obligations under the Dodd-Frank Act, as the Commission

    has interpreted such obligations in the DCM Conflicts of Interest

    Release. For example, to the extent that a SEF determines that it

    must impose requirements on members in order to comport with a core

    principle (e.g., with respect to position limits), a SEF must

    monitor member compliance with such requirement, and must have the

    authority and ability to enforce such requirement. See Section

    5h(f)(2)(A) of the CEA, as added by Section 733 of the Dodd-Frank

    Act.

    \38\ Preamble to proposed acceptable practices on ``Conflicts of

    Interest in Self-Regulation and Self-Regulatory Organizations,'' 71

    FR 38740, 38741 (July 7, 2006).

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

    As the DCM Conflicts of Interest Release notes, increased

    competition may exacerbate conflicts of interest, causing a DCM to (i)

    prioritize commercial interests over self-regulatory responsibilities;

    \39\ and (ii) restrict access or impose burdens on access in a

    discriminatory manner.\40\

    [[Page 63737]]

    The Dodd-Frank Act attempts to create conditions favorable to sustained

    competition between DCMs and SEFs with respect to the same swap

    contract. For example, the Dodd-Frank Act contemplates that either a

    DCM or a SEF may list swap contracts.\41\ It also contemplates that

    multiple DCMs or SEFs may list the same swap contract, and that such

    swap contracts may be offset at the same DCO.\42\ Also, in requiring

    certain swap contracts to be listed on a DCM or SEF,\43\ the Dodd-Frank

    Act may encourage competition between standardized swap contracts and

    commodity futures and options.\44\

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

    \39\ See, generally, the DCM Conflicts of Interest Release.

    \40\ See, infra note 67 for a specific example of DCM or SEF

    restrictions or burdens on access. Also, clauses (i) and (ii) are

    not mutually exclusive. As the DCM Conflicts of Interest Release

    notes, ``[s]elf-regulation's traditional conflict--that members will

    fail to police their peers with sufficient zeal--has been joined by

    the possibility that competing DCMs could abuse their regulatory

    authority to gain competitive advantage or to satisfy commercial

    imperatives.'' 72 FR at 6938. In its Concept Release Concerning

    Self-Regulation, the SEC identified one method that national

    securities exchanges have used to gain a competitive advantage:

    ``abus[ing] SRO status by overregulating members that operate

    markets that compete with the SROs.'' Release No. 34-50700 (Nov. 18,

    2004), 69 FR 71256 (Dec. 8, 2004).

    Also, similar to the incentives that the enumerated entities may

    have with respect to the mandatory clearing requirement, if the

    enumerated entities control a DCM or SEF, they may cause such DCM or

    SEF to not list a swap contract for trading, if it would be more

    profitable to keep such contract bilaterally negotiated. However,

    the Commission notes that nothing would prevent another DCM or SEF

    from listing such contract, and that Section 723 of the Dodd-Frank

    Act would require that a DCO clearing such contract provide non-

    discriminatory access to such DCM or SEF.

    \41\ See Section 2(h)(8) of the CEA, as added by Section 723 of

    the Dodd-Frank Act.

    \42\ See Section 2(h)(1)(B) of the CEA, as added by Section 733

    of the Dodd-Frank Act. Whereas DCMs have competed in the past, and

    are currently competing, to list commodity futures and options

    contracts with the same economic terms and conditions, such

    contracts have not been, and currently are not, fungible. In other

    words, such contracts cannot be offset in the same DCO.

    \43\ See Section 2(h)(8) of the CEA, as added by Section 723 of

    the Dodd-Frank Act.

    \44\ For example, two DCMs (i.e., the NASDAQ OMX Futures

    Exchange and CME), as well as one exempt board of trade (i.e., Eris

    Exchange), offer interest rate futures products. Currently, interest

    rate swap contracts constitute a large percentage of the bilateral

    swaps market. See, e.g., OCC's Quarterly Report on Bank Trading and

    Derivatives Activities, First Quarter 2010, Executive Summary,

    available at: http:[sol][sol]www.occ.treas.gov/ftp/release/2010-

    71a.pdf. (stating that ``[d]erivative contracts remain concentrated

    in interest rate products, which comprise 84% of total derivative

    notional values'').

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

    Such sustained competition, if it occurs,\45\ would constitute an

    increase to the competition that most DCMs currently face with respect

    to commodity futures and options. As described below, the Commission

    intends to ensure through the proposed rules that each DCM or SEF

    implements appropriate systems to manage such conflicts.

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

    \45\ As discussed above, whether such competition occurs depends

    in part on the manner in which Section 723 of the Dodd-Frank Act is

    implemented.

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

    c. Questions on Conflicts of Interest

    The Commission seeks comment on the questions set forth below on

    potential conflicts of interest.

    Has the release correctly identified the conflicts of

    interest that a DCO, DCM, or SEF may confront?

    Has the release accurately specified the possible effects

    of such conflicts of interest on DCO, DCM, or SEF operations? What are

    other possible effects?

    What other conflicts of interest may exist? What are the

    effects of such conflicts?

    III. Mitigation of Conflicts of Interest

    To mitigate, on a prophylactic basis, the conflicts of interest

    identified above, the Commission sets forth below proposed (i)

    structural governance requirements and (ii) limits on the ownership of

    voting equity and the exercise of voting power. As explained in greater

    detail below, the Commission views (ii) as a method of enhancing (i),

    in that (ii) limits the influence that certain shareholders may exert

    over the DCO, DCM, or SEF Board of Directors. The Commission believes

    that such influence may affect, among other things, the independent

    perspective of public directors. The Commission does not believe that

    stricter structural governance requirements (e.g., a higher percentage

    of public directors) justify more lenient limits on the ownership of

    voting equity and the exercise of voting power, or vice versa. However,

    the Commission requests comment on the proper relationship between such

    requirements and limits. The Commission also requests comment on

    whether both (i) structural governance requirements and (ii) limits on

    the ownership of voting equity and the exercise of voting power are

    necessary or appropriate to mitigate the conflicts of interest

    described in Section II, or whether one or the other (or neither) would

    be effective.

    In applying such requirements and limits, the Commission does not

    propose to distinguish between DCMs and SEFs listing swap contracts. As

    mentioned above, such DCMs and SEFs may experience sustained

    competition with respect to the same swap contract, and therefore would

    face the same pressures on self-regulation. Additionally, the

    Commission does not propose to distinguish between (i) DCMs listing

    swap contracts and (ii) DCMs listing only commodity futures and

    options. As mentioned above, clearable swap contracts may share

    sufficiently similar characteristics with certain commodity futures and

    options as to compete with respect to execution. Therefore, a DCM

    listing only commodity futures and options may face competition from a

    SEF with fewer self-regulatory requirements, in the same manner as a

    DCM listing swap contracts. Given that the same conflicts of interest

    \46\ may concern both types of DCM, it would appear that the same (i)

    structural governance requirements and (ii) limits on the ownership of

    voting equity and the exercise of voting power should apply.

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

    \46\ Namely, (i) prioritizing commercial interests over self-

    regulatory responsibilities and (ii) restricting access or imposing

    burdens on access in a discriminatory manner, in each case, because

    of increased competition.

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

    In addition, the Commission does not propose to distinguish between

    (i) DCOs clearing swap contracts and (ii) DCOs clearing only commodity

    futures and options. Certain standardized swap contracts have

    sufficiently similar risk profiles to commodity futures and options

    that the Commission has, on occasion, permitted such products to be

    commingled and margined within the segregated customer account under

    Section 4d of the CEA.\47\ If the Commission applied differential (i)

    structural governance requirements and (ii) limits on the ownership of

    voting equity and the exercise of voting power, the Commission risks

    creating an incentive for regulatory arbitrage between the two types of

    DCO.

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

    \47\ 7 U.S.C. 6d.

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

    The Commission requests comment on holding the two types of (i)

    DCMs and (ii) DCOs to the same requirements regarding the mitigation of

    conflicts of interest. The Commission also requests comment on holding

    DCMs and SEFs listing swap contracts to the same requirements. The

    Commission is specifically interested in the costs and benefits of its

    approach.

    a. Structural Governance Requirements

    i. Independence

    In general, the structural governance requirements mitigate

    conflicts of interest at a DCO, DCM, or SEF by introducing a

    perspective independent of competitive, commercial, or industry

    considerations to the deliberations of governing bodies (i.e., the

    Board of Directors and committees). Such independent perspective would

    more likely encompass regulatory considerations, and to accord such

    considerations proper weight. Such independent perspective also would

    more likely contemplate the manner in which a decision might affect all

    constituencies, as opposed to concentrating on the manner in which a

    decision affects the interests of one constituency.\48\

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

    \48\ See, e.g., the DCM Conflicts of Interest Release (stating

    that ``the public interest will be furthered if the boards and

    executive committees of all DCMs are at least 35% public. Such

    boards and committees will gain an independent perspective that is

    best provided by directors with no current industry ties or other

    relationships which may pose a conflict of interest. These public

    directors, representing over one-third of their boards, will

    approach their responsibilities without the conflicting demands

    faced by industry insiders. They will be free to consider both the

    needs of the DCM and of its regulatory mission, and may best

    appreciate the manner in which vigorous, impartial, and effective

    self-regulation will serve the interests of the DCM and the public

    at large. Furthermore, boards of directors that are at least 35%

    public will help to promote widespread confidence in the integrity

    of U.S. futures markets and self-regulation''). 72 FR 6946.

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

    [[Page 63738]]

    In the DCM Conflicts of Interest Release, the Commission emphasized

    the importance of independent decision-makers in protecting DCM self-

    regulatory functions from DCM commercial interests and that of its

    constituencies. However, the Commission notes that participants in the

    Roundtable raised the possibility that conflicts of interest may also

    be mitigated by providing for fair representation of all constituencies

    in the governance of a DCO, DCM, or SEF.\49\ Theoretically, all

    constituencies would act in their own commercial, competitive, or

    industry interests, but no one interest would dominate. The Commission

    specifically requests comment regarding whether fair representation

    would be preferable to, or would complement, director independence in

    mitigating the DCO, DCM, and SEF conflicts of interest described in

    Section II. The Commission would particularly welcome factual examples.

    The Commission also requests comment on how the proposed structural

    governance requirements should change if the Commission adopts a fair

    representation standard as either an alternative to, or a complement

    of, rules emphasizing an independent perspective.

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

    \49\ See, e.g., Comment from Hal Scott, Nomura Professor of

    International Financial Systems and Director of Program on

    International Financial Systems, Harvard Law School (``Scott'')

    (``When I spoke, I was saying I opposed ownership restrictions, I

    was not talking about voting restrictions which I think is a

    different issue, and the way I would put it is not a voting

    restriction. I would turn it around to a duty of fair

    representation, which the SEC is quite familiar with, and is applied

    to their regulated entities which ensures that the users, more

    broadly defined of the exchange. And maybe if you translated this

    into the clearinghouse, the users, but not necessarily the members

    of the clearinghouse, would have representation in terms of

    governance * * * Independent directors, to me, are most needed with

    public companies as under SOX when there was a broad duty to

    shareholders. But I think what's needed in this context is more the

    expert, and we heard before that it's very important that people

    that know what they're doing have input into those, and clearly

    major users of these clearinghouses, that is customers who clear

    through a member. Major hedge funds, for instance, have a lot of

    expertise, okay, in these areas, they're big traders * * *''),

    Roundtable Tr. at 130-131; Richard Prager, Managing Director, Global

    Head of Fixed Income Trading, Blackrock (``as the [sole] fiduciary

    on this panel * * * we would be in support of a very inclusive

    participation and governance with teeth''), Roundtable Tr. at 131-

    132; Lynn Martin, Chief Operating Officer, NYSE Liffe U.S. (``You

    may be aware that NYSE Euronext's U.S. Future Exchange--NYSE Life

    U.S., is a semi-neutralized structure whereby we balance the views

    of both the independence criteria as required by core principle 15

    in the CFTC-DCM requirements, as well as the views of NYSE Euronext

    and our external investor firms' views, such that no one board

    action may be enacted based on the views of any one of those

    constituents * * * So, it's our belief that a more balanced board

    structure, a more balanced governance structure, is the proper way

    to handle or potentially mitigate conflicts of interest''),

    Roundtable Tr. at 121.

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

    ii. Board Requirements

    1. Composition

    As the DCM Conflicts of Interest Release states, ``the governing

    board * * * is [the] ultimate decision maker and therefore the logical

    place to begin to address conflicts.'' \50\ The Commission proposes (i)

    maintaining the requirement that DCM Boards of Directors be composed of

    at least 35 percent ``public directors'' \51\ and (ii) extending this

    requirement to SEF and DCO Boards of Directors. In the DCM Conflicts of

    Interest Release, the Commission stated that the 35 percent requirement

    struck an appropriate balance between (i) the need to minimize

    conflicts of interest in DCM decision-making processes with (ii) the

    need for expertise and efficiency in such processes. Such rationale

    would appear to apply to SEF and DCO Boards of Directors as well.\52\

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

    \50\ 72 FR at 6940.

    \51\ See Section III(a)(iv) of this release for more detail

    regarding the definition of ``public director.''

    The Commission notes that such percentage harmonizes with

    Article 25(2) of the European Commission Proposal, which requires a

    central counterparty (``CCP'') to have ``a board of which at least

    one third, but no less than two, of its members are independent.''

    \52\ 72 FR at 6946.

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

    In addition to the 35 percent composition requirement, the

    Commission proposes specifying that DCO, DCM, and SEF Boards of

    Directors may not have less than two public directors. Such a

    requirement is also contained in the European Commission Proposal.\53\

    As the Commission has observed that most DCO and DCM Boards of

    Directors contain more than three members, the Commission does not

    believe that such a requirement imposes additional burden. However, the

    Commission welcomes comment on this proposal.

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

    \53\ See Article 25(2) of the European Commission Proposal.

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

    In order to prevent evasion of the abovementioned composition

    requirements through corporate structuring or internal reorganization,

    the Commission proposes extending the composition requirements to any

    committee of the Board of Directors that may exercise delegated

    authority with respect to the management of a DCO, DCM, or SEF.

    Further, the Commission proposes prohibiting a DCO, DCM, or SEF from

    permitting itself to be operated \54\ by another entity, unless such

    entity agrees to comport with such requirements in the same manner as

    the DCO, DCM, or SEF.

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

    \54\ The proposed rule defines ``operate'' as ``the direct

    exercise of control (including through the exercise of veto power)

    over the day-to-day business operations of'' a DCO, DCM, or SEF ``by

    the sole or majority shareholder of such registered entity, either

    through the ownership of voting equity, by contract, or otherwise.

    The term `operate' shall not prohibit an entity, acting as the sole

    or majority shareholder of such registered entity, from exercising

    its rights as a shareholder under any contract, agreement, or other

    legal obligation.''

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

    The Commission would like to clarify that it does not intend to

    extend the abovementioned composition requirements to an entity that

    does not exert active and recurrent control over the operations of a

    DCO, DCM, or SEF. Consequently, the Commission proposes to deem an

    entity to ``operate'' a DCO, DCM, or SEF only if it engages in ``the

    direct exercise of control (including through the exercise of veto

    power) over the day-to-day business operations'' of the registered

    entity.

    In addition to the abovementioned composition requirements, the

    Commission proposes prohibiting a DCO, DCM, or SEF from permitting

    itself to be operated by an entity unless such entity agrees to subject

    (i) its officers, directors, employees, and agents to Commission

    authority, and (ii) its books and records to Commission inspection and

    copying. The Commission believes that such proposals are necessary to

    ensure effective audits of DCO, DCM, or SEF operations, given the

    corporate structure of the DCO, DCM, or SEF.

    2. Questions on Composition

    The Commission seeks comment on the questions set forth below on

    DCO, DCM, and SEF Boards of Directors composition requirements:

    Would such composition requirements be equally valid in

    mitigating conflicts of interest concerning a privately-held DCO, DCM,

    and SEF, as opposed to a publicly-held DCO, DCM, and SEF?

    As mentioned above, would providing for fair

    representation on DCO, DCM, or SEF Boards of Directors be preferable

    to, or complementary to, mandating specific percentages of

    [[Page 63739]]

    public directors? Also, if the main purpose of the 35 percent

    composition requirement is to introduce an independent perspective into

    DCO, DCM, and SEF governance, would requiring one or two public

    directors be sufficient, regardless of the size of the DCO, DCM, or SEF

    Board of Directors?

    As mentioned above, the Commission is seeking to mitigate

    potential conflicts of interest that may influence a DCO regarding (i)

    whether a swap contract is capable of being cleared, (ii) the minimum

    criteria that an entity must meet in order to become a swap clearing

    member, and (iii) whether a particular entity satisfies such criteria.

    Because the DCO Board of Directors would make ultimate decisions

    implicating (i), (ii), and (iii), is the 35 percent composition

    requirement sufficient to ensure that the private, competitive

    interests of certain DCO members do not capture DCO risk assessments

    with respect to both products and membership? Or should the Commission

    increase the required percentage of public directors to 51 percent? Or

    is there a number less than 51 percent but greater than 35 percent that

    would be more appropriate?

    As described above, the Dodd-Frank Act envisions (i) a DCM

    competing with a SEF to list the same swap contract, and (ii) a DCM

    listing a commodity futures or options contract that competes with a

    swap contract listed on a SEF. In both cases, a DCM would be competing

    against an entity with lesser self-regulatory obligations. Such

    competition may place increased stress on the manner in which the DCM

    aims to satisfy its self-regulatory responsibilities. In light of such

    stress, is the 35 percent composition requirement still sufficient to

    protect the DCM self-regulatory function?

    As referenced above, the Dodd-Frank Act anticipates that a

    SEF would face a more competitive environment at inception than a DCM

    currently listing commodity futures and options. As the DCM Conflicts

    of Interest Release notes, increased competition may be detrimental to

    self-regulation. Therefore, is the 35 percent composition requirement

    appropriate to ensure that a SEF discharges its self-regulatory

    functions in the first instance?

    3. Substantive Requirements

    In addition to the abovementioned composition requirements, the

    Commission proposes the substantive requirements set forth below, which

    aim to enhance the accountability of the DCO, DCM, or SEF Board of

    Directors to the Commission regarding the manner in which such Board of

    Directors causes the DCO, DCM, or SEF to discharge all statutory,

    regulatory, or self-regulatory responsibilities under the Dodd-Frank

    Act and the existing CEA.

    The roles and responsibilities of a DCO, DCM, or SEF Board

    of Directors must be clearly articulated, especially in respect of the

    manner in which such Board of Directors ensures that the DCO, DCM, or

    SEF complies with all statutory, regulatory, and self-regulatory

    responsibilities under the Dodd-Frank Act and the existing CEA.

    A DCO, DCM, or SEF Board of Directors shall review its

    performance and that of its individual members annually. It should

    consider periodically using external faciliators for such reviews.

    A DCO, DCM, or SEF must have procedures to remove a member

    from the Board of Directors, where the conduct of such member is likely

    to be prejudicial to the sound and prudent management of the DCO, DCM,

    or SEF.

    Because of the highly specialized nature of DCO, DCM, or SEF

    operation, the Commission proposes requiring that each member of a DCO,

    DCM, or SEF Board of Directors have sufficient expertise, where

    applicable, in financial services, risk management, and clearing

    services. Roundtable participants generally agreed that a DCO, DCM, or

    SEF Board of Directors must have sufficient expertise.\55\

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

    \55\ See, e.g., Comments from Slavkin (``I think having real

    experts on the boards of directors is a very important issue. We all

    saw situations in the last several years where there were boards

    that were two-thirds independent and made really stupid decisions

    about risk management. So, we need to make sure that there are

    people on those boards of directors that really understand the risks

    that exist within a clearinghouse and are prepared to perceive

    potential risks that may arise in the system down the road and

    address them. So they also need to have the personalities to stand

    up to a board of directors that may be entrenched and have their own

    interests that may differ from those that are in the best interests

    of the systemic stability''), Roundtable Tr. at 77; Comments from

    Johnathan Short, Senior Vice President, General Counsel and

    Corporate Secretary, the IntercontinentalExchange, Inc. (``I mean,

    she's right, but I just want to point out that there really is a

    tension there, because some of the people who are best qualified to

    assess risk in a given market are the people that some parts of

    the--you know, of the market are complaining about is controlling

    clearinghouses and controlling key infrastructure''), Roundtable Tr.

    at 78; Comments from William H. Navin, Executive Vice President and

    General Counsel, Options Clearing Corporation (``I would second

    those remarks. Our experience has been that we've benefited greatly

    from the expertise of industry directors, and I think it would be

    throwing the baby out with the bathwater if substantial restrictions

    on industry governance were to be enacted''), Roundtable Tr. at 78;

    Comments from Greenberger (``I do agree with what has been said,

    that you need experts on the board. What I disagree with is that all

    expertise comes from five swaps dealers or it all comes from people

    who work for banks. There are academics, former regulators, and, you

    know, other participants in the market who have talked today about

    their need for open and fair access. I think that kind of diversity

    on the board is important''), Roundtable Tr. at 164.

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

    To ensure that members of a DCO, DCM, or SEF Board of Directors are

    not incented to accord undue consideration to the commercial interests

    of a DCO, DCM, or SEF in relation to regulatory interests, the

    Commission proposes to prohibit linking the compensation of public

    directors and other non-executive members of the Board of Directors to

    the business performance of the DCO, DCM, or SEF.

    The abovementioned substantive requirements are in accord with

    certain provisions in the European Commission Proposal.\56\

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

    \56\ See Article 25 of the European Commission Proposal.

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

    4. Questions on Substantive Requirements

    The Commission seeks comment on the questions set forth below on

    the substantive requirements applicable to a DCO, DCM, or SEF Board of

    Directors:

    What substantive requirements, other than those identified

    above, should the Commission consider imposing on a DCO, DCM, or SEF

    Board of Directors to mitigate the potential conflicts of interest

    described in Section II, as well as any potential conflicts of interest

    not specified herein? For example, should the Commission consider any

    additional requirements related to (i) the fiduciary duties that a DCO,

    DCM, or SEF Board of Directors may owe or (ii) policies or charters

    that the DCO, DCM, or SEF Board of Directors may adopt?

    iii. Committees

    1. Requirements for Each DCO, DCM, and SEF

    a. Nominating Committee

    As stated above, the structural governance requirements contained

    herein focus on mitigating conflicts of interest through introducing a

    perspective independent of competitive, commercial, or industry

    considerations to the deliberations of DCO, DCM, and SEF governing

    bodies. Public director composition requirements are not, in and of

    themselves, sufficient to ensure the representation of such independent

    perspective. The Commission also must protect the integrity of the

    process by which the DCO, DCM, or SEF selects public directors.\57\

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

    \57\ See, e.g., Comments from Rick McVey, Chief Executive

    Officer, MarketAxess (``McVey'') (``I personally think that one of

    the most important areas to focus on is the governance and

    nominating committee. How do people get on these boards? And if

    there is a requirement that that process be independent I think you

    would get both qualified people that are going to look after the

    best interest of the company, and you would get better independence

    on these boards''), Roundtable Tr. at 150.

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

    [[Page 63740]]

    To this end, the Commission proposes requiring each DCO, DCM, or

    SEF to have a Nominating Committee. The role of the Nominating

    Committee would be to: (i) Identify individuals qualified to serve on

    the Board of Directors, consistent with the criteria that the Board of

    Directors require and any composition requirement that the Commission

    promulgates; and (ii) administer a process for the nomination of

    individuals to the Board of Directors. The Commission proposes that (i)

    public directors comprise at least 51 percent of the Nominating

    Committee, and (ii) a public director chair the Nominating Committee.

    b. Disciplinary Panels

    As stated above, each DCM and SEF must fulfill self-regulatory

    obligations under the CEA and the Dodd-Frank Act. Also, each DCO has

    certain self-regulatory obligations.\58\ The Commission proposes

    requiring each DCO, DCM, or SEF to have one or more disciplinary

    panels.\59\ The role of such disciplinary panels would be to conduct

    hearings, render decisions, and impose sanctions with respect to

    disciplinary matters.

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

    \58\ For example, to the extent that a DCO determines that it

    must impose requirements on members in order to comport with a core

    principle or other regulatory requirement (e.g., limits on ownership

    and voting power), a DCO must monitor member compliance with such

    requirement, and must have the authority and ability to enforce such

    requirement. See Section 5b(c)(2)(H) of the CEA, as added by Section

    725(c) of the Dodd-Frank Act.

    \59\ The Commission understands that DCOs currently may not have

    disciplinary panels, but that the Risk Management Committee of a DCO

    may perform the functions of such panel. Therefore, consistent with

    current practice, the Commission proposes to permit the DCO Board of

    Directors to delegate to the Risk Management Committee the

    performance of such functions. If the Board of Directors so

    delegates, (i) the DCO would no longer need to maintain a

    disciplinary panel, but (ii) the composition requirements applicable

    to a disciplinary panel would be extended to any committee (or

    similar body) to which a decision of the Risk Management Committee

    may be appealed.

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

    The Commission believes that it is imperative for each DCO, DCM, or

    SEF to exercise its disciplinary authority in an impartial manner. In

    the DCM Conflicts of Interest Release, the Commission acknowledged the

    value of fair representation in maintaining such impartiality.\60\ To

    ensure that fair representation results in impartiality, the Commission

    proposes (i) maintaining the requirement that each DCM adopt rules that

    would preclude any group or class of participants from dominating or

    exercising disproportionate influence on the disciplinary panel, and

    (ii) extending such requirement to each DCO or SEF. The Commission also

    proposes mandating that each DCO, DCM, or SEF adopt rules that would

    prohibit any member of a disciplinary panel from participating in

    deliberations or voting on any matter in which the member knowingly has

    a financial interest.

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

    \60\ See 72 FR at 6952 (stating that ``fair disciplinary

    procedures, with minimal conflicts of interest, require disciplinary

    bodies that represent a diversity of perspectives and

    experiences'').

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

    In the DCM Conflicts of Interest Release, the Commission also

    acknowledged the importance of an independent perspective.\61\ The

    Commission proposes retaining and strengthening the role that such

    perspective plays in DCO, DCM, or SEF disciplinary processes. First,

    the Commission proposes (i) maintaining the requirement that each DCM

    disciplinary panel include at least one ``public participant,'' \62\

    and (ii) extending such requirement to each DCO or SEF disciplinary

    panel. Second, the Commission proposes requiring that the chair of each

    disciplinary panel be a public participant.

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

    \61\ Id. (stating that ``[t]he presence of at least one public

    person on disciplinary bodies * * * provides an outside voice and

    helps to ensure that the public's interests are represented and

    protected. This approach is consistent with the Commission's overall

    objective of ensuring an appropriate level of public representation

    at every level of DCM decision making, while simultaneously

    calibrating the required number of public persons to the nature and

    responsibility of the decision-making body in question'').

    \62\ Id. at 6957. In the proposed rules, a ``Public

    Participant'' is defined as an entity that meets the bright-line

    materiality tests in the definition of ``Public Director.''

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

    2. Requirements for Each DCO Only

    a. Risk Management Committee (and Subcommittee)

    The central purpose of a DCO is to guarantee the performance of

    each derivatives contract that it clears. In order to fulfill such

    guarantee, each DCO must appropriately manage the risks associated with

    such contract. In general, a DCO convokes a committee to oversee risk

    management. The Commission proposes to require each DCO to have a Risk

    Management Committee.

    Swap contracts, as well as commodity futures and options, are

    complex instruments. Managing the risks of such instruments requires

    expertise. In general, clearing members constitute the main source of

    such expertise, as they (i) routinely execute trades in such

    instruments and (ii) have experience in managing risks posed by

    customer trades. Because of the lack of a centralized market for swap

    contracts, swap clearing members also perform the function of (i)

    pricing a swap contract and (ii) participating in an auction to

    liquidate the swap contract in the event of member default.

    However, as discussed above, swap clearing members at DCOs that

    currently clear large volumes of swap contracts are exclusively

    enumerated entities. Some have argued that the enumerated entities have

    an incentive to influence DCO risk assessments regarding (i) whether a

    swap contract is capable of being cleared, (ii) the appropriate

    membership criteria for a swap clearing member, and (iii) whether a

    particular entity meets such criteria. Therefore, the Commission must

    carefully consider the composition of the Risk Management Committee, in

    order to achieve (i) the increased clearing of swap contracts that the

    Dodd-Frank Act contemplates without compromising (ii) DCO safety and

    soundness.

    The Commission proposes a three-pronged approach to mitigating the

    potential conflict of interest identified above, while still ensuring

    that the Risk Management Committee retains sufficient expertise. First,

    the Commission proposes requiring that 35 percent of the Risk

    Management Committee be composed of public directors, with sufficient

    expertise in, among other things, clearing services.\63\ Second, the

    Commission proposes requiring that 10 percent of the Risk Management

    Committee be composed of customers of clearing members, who also

    routinely execute swap contracts (as well as commodity futures and

    options) and who have experience in using pricing models for such

    contracts (if only to ensure that they receive a fair price from the

    enumerated entities).\64\ Because customers benefit from a wider pool

    of swap clearing members and greater competition between such members,

    customers have an incentive to ensure that the membership criteria of a

    DCO are risk-based, and do not reflect the private, competitive

    interests of the enumerated entities. Third, the Commission proposes to

    permit a DCO Risk Management Committee to delegate to a subcommittee

    (the ``Risk

    [[Page 63741]]

    Management Subcommittee'') the responsibility to: (i) Determine the

    standards and requirements for initial and continuing clearing

    membership eligibility; (ii) approve or deny (or review approvals or

    denials of) clearing membership applications; and (iii) determine

    products eligible for clearing. If the Risk Management Committee

    effects such a delegation, then it would free itself of the composition

    requirements. The decisions of the Risk Management Subcommittee would

    be subject to review by the Risk Management Committee. Therefore, if

    the Risk Management Committee determines that a particular decision by

    the Risk Management Subcommittee is overly risky, then the Risk

    Management Committee may overrule that decision.\65\

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

    \63\ See Comments from Greenberger, supra note 55, regarding the

    availability of such public directors.

    \64\ See, generally, supra note 55.

    Because customers do not contribute to the DCO default fund,

    customers may have less capital at stake than clearing members if a

    DCO improperly measures risk. Therefore, the Commission believes

    that 10 percent representation would ensure that customers have

    adequate voice on the DCO Risk Management Committee, without

    adversely impacting the risk assessments of such committee.

    \65\ The Commission is contemplating requiring the DCO to report

    to the Commission whenever the Risk Management Committee overrules

    the Risk Management Subcommittee, or whenever the Board of Directors

    overrules the Risk Management Committee. If the Commission decides

    to propose such requirement, it would be included in the second

    rulemaking that the Commission contemplates finishing on governance

    and mitigation of conflicts of interest. See supra note 17.

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

    In order to prevent evasion of the above-mentioned composition

    requirements through internal reorganization, the Commission proposes

    to prohibit:

    A decision of the Risk Management Subcommittee from being

    subject to the approval of, or otherwise restricted or limited by, a

    body other than the DCO Board of Directors or the DCO Risk Management

    Committee, including, without limitation, any advisory committee; and

    Certain decisions of the Risk Management Committee \66\

    from being subject to the approval of, or otherwise restricted or

    limited by, a body other than the DCO Board of Directors, including,

    without limitation, any advisory committee.

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

    \66\ I.e., any decision pertaining to (i) whether a swap

    contract is capable of being cleared, (ii) the appropriate

    membership criteria for a swap clearing member, and (iii) whether a

    particular entity meets such criteria.

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

    The Commission requests comment on its three-pronged approach,

    including any alternatives to such approach. The Commission also

    requests comment on (i) the specific percentages set forth above, and

    (ii) the prohibitions on certain bodies approving of, or otherwise

    restricting or limiting, the decisions of the Risk Management Committee

    (or Risk Management Subcommittee, as applicable).

    3. Requirements for Each DCM or SEF Only

    a. Membership or Participation Committee

    As mentioned above, increased competition may exacerbate conflicts

    of interest, causing a DCM or SEF to (i) prioritize commercial

    interests over self-regulatory responsibilities; and (ii) restrict

    access or impose burdens on access in a discriminatory manner.

    Roundtable participants identified a specific example of (ii), where

    swap clearing members may seek to limit access to SEF execution and

    pricing to customers executing through such members.\67\ The rationale

    of such example would apply to a DCM as well. To protect decisions

    regarding access from DCM or SEF commercial interests, or the interests

    of the enumerated entities, the Commission proposes requiring a DCM or

    SEF to have a Membership or Participation Committee, composed of

    thirty-five percent public directors.\68\ Such committee would have the

    responsibility to: (i) Determine the standards and requirements for

    initial and continuing membership or participation eligibility; (ii)

    review appeals of staff denials of membership or participation

    applications; and (iii) approve rules that would result in different

    categories or classes of members or participants receiving disparate

    access. The Commission proposes prohibiting the Membership or

    Participation Committee from upholding any staff denial if the relevant

    application meets the standards and requirements that such committee

    sets forth. Further, the Commission proposes prohibiting the Membership

    or Participation Committee from restricting access or imposing burdens

    on access in a discriminatory manner, within each category or class of

    members or participants or between similarly situated categories or

    classes of members or participants. Nothing in this preamble is meant

    to prohibit the Commission from issuing substantive proposals regarding

    access to a DCM or SEF in any subsequent proposed rulemaking.

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

    \67\ See, e.g., Comments from Kastner (``I'll take the ball for

    a second with the SEFs. The same principles that apply to DCOs in

    terms of open access--also if you carefully apply to SEFs, anybody

    who is able to get a clearing account at a qualified swap clearing

    member or FCM to use the, you know, futures analog, anybody that

    wants to trade on a SEF, the SEF should not have any barriers to

    entry.''), Roundtable Tr. at 52, (``The point is if you have a firm

    who is doing customer business and wants to engage in an interest

    rate swap with an end user who is not a clearing member, that they

    should be able to execute that trade with the end user and then give

    up to a clearing member.''), Roundtable Tr. at 84; Comments from

    William DeLeon, Executive Vice President, Global Head of Portfolio

    Risk Management, PIMCO (``You know, that concept of using a SEF, I

    think it should be free and open access * * *. The issue is that

    there needs to be a guarantee that when you access a SEF, that when

    you do a trade, that there is someone who is guarantee that that is

    a good trade. So whether that means that there's a market maker * *

    * or if that means that there's a DCM or an FCM or someone who's

    going to guarantee that they're going to stand behind * * * unknown

    clients * * * ''), Roundtable Tr. at 56.

    \68\ The Commission acknowledges that a DCM may have already

    assigned the functions of a Membership or Participation Committee to

    other governing bodies. Therefore, the proposed rules permit the DCM

    Board of Directors to delegate the performance of the functions of

    the Membership or Participation Committee to one or more other

    committees, provided that each such committee meets the applicable

    composition requirements. If the Board of Directors chooses to so

    delegate, the registered swap execution facility would no longer

    need to maintain a Membership or Participation Committee.

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

    b. Regulatory Oversight Committee

    In the DCM Conflicts of Interest Release, the Commission emphasized

    the importance of a DCM Regulatory Oversight Committee (``ROC''):

    Properly functioning ROCs should be robust oversight bodies

    capable of firmly representing the interests of vigorous, impartial,

    and effective self-regulation. ROCs should also represent the

    interests and needs of regulatory officers and staff; the resource

    needs of regulatory functions; and the independence of regulatory

    decisions. In this manner, ROCs will insulate DCM self-regulatory

    functions, decisions, and personnel from improper influence, both

    internal and external.\69\

    \69\ See 72 FR 6950, 6951.

    The Commission also underscored the importance of the DCM ROC being

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

    composed of 100 percent public directors:

    The Commission strongly believes that new structural conflicts

    of interest within self-regulation require an appropriate response

    within DCMs. The Commission further believes that ROCs, consisting

    exclusively of public directors, are a vital element of any such

    response * * *. ROCs make no direct commercial decisions, and

    therefore, have no need for industry directors as members. The

    public directors serving on ROCs are a buffer between self-

    regulation and those who could bring improper influence to bear upon

    it.\70\

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

    \70\ Id. at 6951.

    The Commission proposes (i) maintaining the requirement that DCMs

    have a ROC composed of only public directors, and (ii) extending such

    requirement to SEFs, which also have self-regulatory obligations.

    However, the Commission recognizes that SEFs--but not DCMs--must have a

    chief compliance officer (i) to monitor SEF adherence to statutory,

    regulatory, and

    [[Page 63742]]

    self-regulatory requirements and (ii) to resolve conflicts of interest

    that may impede such adherence. The chief compliance officer must

    report to the SEF Board of Directors (or similar governing body) or the

    senior SEF officer.\71\ Since the Dodd-Frank Act charges the SEF Board

    of Directors (or similar governing body) or the senior SEF officer with

    the responsibility for overseeing the chief compliance officer

    (including with respect to the resolution of conflicts of interest),

    the Commission requests comment on whether requiring a SEF to also have

    a ROC is necessary.

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

    \71\ See Section 5h(f)(15) of the CEA, as added by Section 733

    of the Dodd-Frank Act.

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

    iv. Definition of Public Director

    The proposed rules include a definition of ``public director'' that

    makes several modifications to the definition of ``public director''

    that the Commission adopted in 2009.\72\ Such modifications bring

    several aspects of the definition in line with the definition of

    ``independent director'' that the SEC proposed in 2004.\73\ Since the

    Commission is currently, or will in the future, be regulating some of

    the same entities as the SEC,\74\ the modifications to the definition

    of ``public director'' are intended to allow for greater harmonization

    with the SEC and currently accepted practices.\75\

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

    \72\ See, generally, 74 FR 18982 (April 27, 2009).

    \73\ See 69 FR 71127 (December 8, 2004) (the ``SEC 2004

    Release'').

    \74\ E.g., the Options Clearing Corporation, or a SEF that lists

    both CDS indices and single-name CDS contracts.

    \75\ See, e.g., the listing standards of NYSE Euronext or NASDAQ

    OMX.

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

    First, the proposed rules include a new bright-line test that

    prohibits any director that is an officer of another entity, which

    entity has a compensation committee, on which any officer of the

    registered entity serves, from being a public director. This test is a

    part of the independence tests of most listing standards and prevents a

    public director from having a financial relationship that would likely

    impair his independence. In light of the obvious conflicts that could

    arise as a result of such a financial relationship, the Commission

    proposes that this additional bright-line test be included in the

    definition of ``public director.''

    Second, the proposed rules would preclude directors that are

    employees of members of DCOs, DCMs, and SEFs from being public

    directors. The proposed rules would also preclude a director, or an

    entity with which the director is an employee, from being a public

    director if certain payments are made to such director. In 2009, the

    Commission moved the evaluation of employment relationships from the

    bright-line test to an analysis under the overarching materiality

    standard. The Commission is re-evaluating such move in light of current

    concerns regarding further protecting regulatory functions from

    directors that are conflicted due to industry ties. The Commission

    notes that CBOE Futures Exchange, LLC (``CFE'') submitted a comment

    letter to this effect in 2009. In particular, CFE expressed concern

    that, as a result of the removal of employment relationships from the

    bright-line tests, all required public directors could be member

    employees.\76\ At the time, the Commission felt that such a situation

    would be incompatible with the overarching materiality test, even if

    such prohibition against employment was not included in the bright-line

    test. The Commission seeks comments regarding the re-insertion of

    employment relationships in the bright-line tests.

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

    \76\ CFE Comment Letter at 2.

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

    Third, the proposed ``public director'' definition includes an

    expanded definition of ``immediate family'' that includes certain

    family members, whether by blood, marriage or adoption, and also

    includes any person residing in the home of the director or his

    immediate family. Such change attempts to harmonize the ``public

    director'' definition with the SEC 2004 Release and currently accepted

    practices.

    Finally, the Commission notes that the proposed rules retain the

    one-year look-back period. The Commission seeks comment as to whether

    such period should be increased, given (i) current concerns regarding

    further protecting regulatory functions from directors that are

    conflicted due to industry ties, and (ii) the goal of achieving harmony

    with the SEC and currently accepted practices.

    v. Questions on Committees and the Definition of Public Director

    In addition to any questions that the Commission may have posed

    above, the Commission seeks comment on the following questions

    regarding DCO, DCM, or SEF committees, and the attendant composition

    requirements, as well as the definition of public director:

    Is each of the committees or panels specified above

    necessary or appropriate for the mitigation of the conflicts of

    interest described in Section II, or of any conflict of interest not

    identified herein? If so, are the composition requirements applicable

    to such committees necessary or appropriate to effect such mitigation?

    What other ways should the Commission consider defining

    ``public director''? Are there other circumstances that the Commission

    should include in the bright-line materiality tests? Are there

    circumstances that the Commission should remove from such tests?

    b. Ownership and Voting Limits

    As mentioned above, the structural governance requirements mitigate

    DCO, DCM, or SEF conflicts of interest by introducing a perspective

    independent of competitive, commercial, or industry considerations to

    the deliberations of governing bodies. The Commission believes that

    limits on ownership of voting equity and the exercise of voting rights

    would enhance the structural governance requirements.\77\ In general,

    individuals are compensated for service on the Board of Directors (and

    the committees thereof). Voting shareholders elect, directly or

    indirectly, members of the Board of Directors. Such members serve as

    fiduciaries to all shareholders under state law. Therefore, to ensure

    that DCO, DCM, or SEF public directors maintain their independent

    perspective (rather than solely representing the competitive,

    commercial, or industry considerations of shareholders), the Commission

    believes that limits on ownership of voting equity and the exercise of

    voting rights are necessary.\78\

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

    \77\ The Commission proposes not to limit non-voting equity. In

    general, a shareholder would have direct influence over a DCO, DCM,

    or SEF Board of Directors only if the shareholder has the ability to

    exercise voting rights with respect to, e.g., election,

    compensation, or removal of directors. However, the Commission notes

    that certain Roundtable participants disagree. See, e.g., Comments

    from Slavkin (``I actually disagree with what the gentleman from JP

    Morgan said when he said that he doesn't think that having an

    economic stake without having a voting interest is a concern. I

    think most of us can imagine a situation where someone owns 5

    percent of our company and asks us to do something. I don't think it

    matters if that person gets to vote for the board of directors, that

    person has real influence regardless of whether it's formal

    influence, there is going to be influence over the decision making,

    there's going to be influence over the strategy and innovation and

    the trajectory of the institution in general, so I do think we need

    to look at ownership restrictions related to voting interests as

    well as related to economic interests even when they're not tied to

    actual voting shares''), Roundtable Tr. at 153. The Commission

    requests comment on whether limits on non-voting equity would be

    appropriate to the mitigation of conflicts of interest.

    \78\ Certain Roundtable Participants agree. See, e.g., Comments

    from Slavkin (``What I'm hearing from the people who support

    governance as opposed to real caps on ownership is an argument in

    favor of the status quo, and I think that when Congressman Brown--

    I'm sorry, when Congressman Lynch proposed this amendment that was

    passed in the House legislation, and when Senator Brown proposed,

    you know, the Lynch Light version that was passed by the entire

    Congress, their intention was to create real change in recognition

    of the fact that the current system is broken. It doesn't work.

    That's why we're all sitting around this table today. Governance is

    a valuable tool, it's not the only tool, and I think it's our

    responsibility to try to examine other options and I think that the

    ownership cap is a real valuable tool that can be used to mitigate

    the problems that exist in the current system''), Roundtable Tr. at

    124 to 125.

    The European Commission Proposal explicitly rejects ownership

    limitations. See Section 4.3.4 of the European Commission Proposal

    (stating that structural governance requirements ``are considered

    more effective in addressing any potential conflicts of interest

    that may limit the capacity of CCPs to clear, than any other form of

    regulation which may have undesirable consequence on market

    structures (e.g., limitation of ownership, which would need to

    extend also to so-called vertical structures in which exchanges own

    a CCP)'').

    However, the European Commission Proposal explicitly preserves

    the power of the regulator to refuse authorization of a CCP ``where,

    it is not satisfied as to the suitability of the shareholders or

    members that have qualifying holdings in the CCP, taking into

    account the need to ensure the sound and prudent management of a

    CCP.'' See Article 28(2) of the European Commission Proposal.

    Further, the European Commission Proposal permits the regulator to

    terminate authorization of a CCP where ``shareholders or members,

    whether direct or indirect, * * * exercise an influence which is

    likely to be prejudicial to the sound and prudent management of the

    CCP.'' See Article 28(1) and (4) of the European Commission

    Proposal.

    The Commission requests comment as to whether a reservation of

    power similar to that contained in the European Commission Proposal

    would complement the limits on ownership of voting equity and the

    exercise of voting power described above.

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

    [[Page 63743]]

    i. DCOs

    According to the DCM Conflicts of Interest Release, ``[t]oday's

    DCMs * * * are vibrant commercial enterprises competing globally in an

    industry whose ownership structures, business models, trading

    practices, and products are evolving rapidly.'' \79\ The same

    evolution, and the diversity in ownership structures that it engenders,

    may be observed in DCOs. Therefore, in acknowledgement of the different

    DCO ownership structures that currently or may in the future exist, the

    Commission proposes that a DCO choose between one of two alternative

    limitations on ownership of voting equity and the exercise of voting

    rights. However, the Commission recognizes that circumstances may exist

    where neither alternative may be appropriate. Consequently, the

    Commission also proposes a waiver procedure.

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

    \79\ 72 FR at 6938.

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

    1. First Alternative

    For the first alternative, the Commission proposes a combination of

    a single-member limitation and an aggregate limitation (the ``First

    Alternative'').

    a. Single-Member Limitation

    First, the Commission proposes requiring a 20 percent limitation on

    the voting equity that any single member (and related persons) \80\ may

    own.\81\ Economic research suggests that holding 20 percent voting

    equity of an entity may be sufficient for exerting control over an

    entity,\82\ especially if that entity has otherwise diffuse

    ownership.\83\

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

    \80\ The Commission requests comment on whether the definitions

    of ``related person'' in the proposed rules are under or over-

    inclusive.

    \81\ Ruben Lee, The Governance of Financial Infrastructure,

    Oxford Finance Group, at 256 (January 2010) (stating that

    ``[m]andatory ownership constraints may prevent a single firm from

    exercising undue influence over a market institution that is also an

    SRO'').

    \82\ See, generally, e.g., Bae, K-H., J-K and J-M Kang (2002).

    ``Tunneling or value added? Evidence from mergers by Korean business

    groups'', Journal of Finance 57, pp. 2695-2740; Barclay, M. and C.

    Holderness (1989) ``Private benefits from control of public

    corporations'', Journal of Financial Economics 25, pp. 371-395;

    Barclay, M. and C. Holderness (1991) ``Negotiated block trades and

    corporate control'', Journal of Finance 46, pp. 861-878; Barclay, M.

    and C. Holderness and D. Sheehan (2001) ``The block pricing

    puzzle'', Working Paper; Cheung,Y-L, P.R. Rao and A. Stouraitis

    (2006) ``Tunneling, propping, and expropriation: evidence from

    connected party transactions in Hong Kong'', Journal of Financial

    Economics 82, pp. 343-386; Claessens, S., S. Djankov, L.H.P. Lang

    (2000) ``The separation of ownership and control in East Asian

    corporations'', Journal of Financial Economics 58, pp. 81-112; Dyck,

    A and L. Zingales (2004) ``Private benefits of control: An

    international comparison'', Journal of Finance 59, pp. 537-600;

    Faccio, M., L.H.P Lang, and L. Young (2001) ``Dividends and

    expropriation'', American Economic Review 91, 54-78; and Morck, R.,

    D. Wolfenzon, and B. Yeung (2005) ``Corporate governance, economic

    entrenchment, and growth'', Journal of Economic Literature, 43, pp.

    655-72.

    The 20 percent limitation also accords with the proposals in the

    SEC 2004 Release. See 69 FR at 71143-44.

    \83\ As mentioned above, CME, for example, is wholly-owned by

    CME Group. However, CME Group is a publicly-listed company with

    diffuse ownership.

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

    As described above, based on Commission experience, control of a

    DCO by members collectively has generally permitted the DCO to serve

    the purposes of the CEA. However, such description does not necessarily

    hold true if, for example, the DCO has demutualized but one member

    retains sufficient voting ownership to dominate the DCO.\84\ Such

    domination may result in the DCO relaxing risk management standards

    with respect to that member, but imposing more stringent standards on

    others.

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

    \84\ Comments from Greenberger (``if we want governance with

    teeth, governance with teeth will have ownership limitations. You

    can talk about fair representation, board governance, the fact of

    the matter is, and I think this will bear its way out in the

    comments to you, that does not protect fair and open access * *

    *''), Roundtable Tr. 135.

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

    Given the increased importance of the DCO in managing systemic

    risk, the Commission believes that limiting the amount of voting equity

    that any one member may own is appropriate to ensure impartiality in

    risk assessment, especially in a DCO with otherwise diffuse ownership.

    To prevent evasion of the 20 percent limitation, the Commission

    proposes requiring an identical limit on voting rights; and if the DCO

    is a subsidiary, extending the limitation to the shareholders of its

    direct or indirect parent. If any parent is publicly-listed, then that

    parent would have to comply with shareholder voting requirements

    promulgated by the SEC or the exchange on which the parent is listed.

    b. Aggregate Limitation

    Further, the Commission proposes a 40 percent limitation on the

    voting equity that the enumerated entities (and their related persons)

    may own in the aggregate, regardless of whether such entities are DCO

    members.\85\ As mentioned above, some market participants, investor

    advocates, and academics have argued that the enumerated entities may

    have commercial incentives to influence DCO risk assessments regarding

    (i) whether a swap contract is capable of being cleared, (ii) the

    appropriate membership criteria for a swap clearing member, and (iii)

    whether a particular entity meets such criteria. The enumerated

    entities may directly influence such assessments through participation

    on the Risk Management Committee as clearing members, or indirectly

    influence such assessments as voting shareholders. In general, the

    Commission believes that the enumerated entities would attempt to

    influence such assessments as voting shareholders only if the DCO has a

    mutualized structure with concentrated ownership.\86\ In such a

    structure, the percentage necessary for control would be higher than

    the abovementioned 20 percent, which is sufficient for a diffuse

    ownership structure.

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

    \85\ Cf. The Lynch Amendment, which prohibited certain

    ``restricted owners'' from collectively acquiring more than 20

    percent of the voting equity in a DCO.

    \86\ See, generally, Barclay, M. and C. Holderness (1989)

    ``Private benefits from control of public corporations'', Journal of

    Financial Economics 25, pp. 371-395. The premise of this paper is

    that (i) buyers of equity blocks in a publicly-traded corporation

    appear, on average, to pay a premium above market price, and (ii)

    such premium reflects the value to the buyer of being able to

    influence the decisions of the corporation in a way that is

    privately profitable, but not profitable to other shareholders. In

    general, the Commission believes that, if a DCO has diffuse

    ownership, the outlay that an enumerated entity would need to make

    to influence DCO risk assessments as a voting shareholder would

    likely exceed the outlay necessary to obtain the same amount of

    influence through other means.

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

    In counterweight to the commercial incentives that the enumerated

    entities may have to influence DCO risk assessments regarding (i),

    (ii), and (iii)

    [[Page 63744]]

    above, the Commission acknowledges that the enumerated entities have

    the capital and expertise necessary to manage the risks of clearing

    swap contracts.\87\ Therefore, the Commission believes that a 40

    percent aggregate limitation is appropriate, assuming that the DCO has

    a mutualized structure with concentrated ownership, because it permits

    the enumerated entities to influence, directly or indirectly, but not

    control, DCO risk assessments.

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

    \87\ See, e.g., Comments from Jeremy Barnum, Managing Director,

    J.P. Morgan (``Barnum'') (``So, on the question of--on the question

    of ownership of clearinghouses and expertise and the Lynch

    amendment, the--it is very appealing in principle to imagine that

    these systemically important financial players into which we are

    putting much more risk, could somehow be entirely free of the

    nefarious influence of the evil dealers who contributed to the

    crisis to quote Mr. Greenberger. But, unfortunately, they are, in

    fact, the market participants who need to use the clearinghouses''),

    Roundtable Tr. at 115; Comments from Olesky (``I think it's really

    important to recognize--for all of us to recognize--that market

    participants really engender many market facilities. And in my

    experience in the investment of capital and the knowledge about a

    particular space has led directly to innovations and advances both

    with Tradeweb and another company I was with, BrokerTech; exchanges;

    clearing corps. If you go back in history, those are the folks that

    have the capital to support this innovation and the knowledge and

    experience to move it forward. And while it's easy to sort of be

    critical of that group, I think it's also important not to cut off

    that flow of capital into innovative organizations that are really

    groups of market participants that are investing in these types of

    mechanisms * * * Tradeweb was started in 1997 with the internet with

    a group of banks. We had four banks initially. Then we sold 100

    percent of the company in 2004 and we weren't owned by any banks for

    4 years. Then we had another investment back in, and we had a

    minority stake by some banks. I think we really have to separate out

    the ownership argument from the governance argument, because it's

    critical to be able to access that capital for entrepreneurs and for

    innovators when they're trying to build these mechanisms''),

    Roundtable Tr. at 60 to 61.

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

    In conjunction with the 40 percent aggregate limitation, the

    Commission proposes requiring a majority vote for the passage of any

    shareholder resolution; and if the DCO is a subsidiary, extending the

    aggregate limitation and the requirement for a majority vote to the

    shareholders of its direct or indirect parent. If any parent is

    publicly-listed, then that parent would have to comply with shareholder

    voting requirements promulgated by the SEC or the exchange on which the

    parent is listed.

    2. Second Alternative

    For the second alternative, the Commission proposes a 5 percent

    limitation on the voting equity that any DCO member or enumerated

    entity (whether or not such entity is a DCO member), and the related

    persons thereof in each case, may own (the ``Second Alternative'').

    Such a limitation effectively ensures that neither a DCO member nor an

    enumerated entity would have sufficient power, in a concentrated or

    diffuse ownership structure, to exert undue influence, as a voting

    shareholder, over DCO operations (including with respect to risk

    assessments regarding (i), (ii), and (iii) above). Certain Roundtable

    participants favor a similar approach.\88\

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

    \88\ See, e.g., Comments of Roger Liddell, Chief Executive

    Officer, LCH.Clearnet Group (``Liddell'') (``To go back to the

    question, I think with established organizations, then I think the

    concept of some combination of ownership limits and voting caps

    actually does make sense. For example, in the [LCH] clearinghouse,

    we've got a 5 percent voting cap and have done for many years. And

    the reason for that was to take away any incentive for anyone to

    build up a stake greater than that so that we would be highly

    unlikely to ever have less than 20 shareholders. That works well for

    us''), Roundtable Tr. at 118 to 119.

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

    To prevent evasion of the 5 percent limitation, the Commission

    proposes requiring an identical limit on voting rights; and if the DCO

    is a subsidiary, extending the limitation to the shareholders of its

    direct or indirect parent. If any parent is publicly-listed, then that

    parent would have to comply with shareholder voting requirements

    promulgated by the SEC or the exchange on which the parent is listed.

    3. Waiver

    As mentioned above, the Commission believes that there may be

    circumstances where the imposition of rigid limitations on ownership or

    voting rights may not be appropriate for certain DCO ownership

    structures. To provide flexibility, a DCO may request that the

    Commission waive individual and/or aggregate ownership or voting rights

    limitations by any entity for a reasonable period of time.

    The Commission may grant the requested waiver if it determines that

    ownership or voting rights limitations are not necessary or appropriate

    to:

    Improve the governance of the DCO;

    Mitigate systemic risk;

    Promote competition;

    Mitigate conflicts of interest in connection with a swap

    dealer's or major swap participant's conduct of business with the DCO

    with respect to fair and open access and participation and product

    eligibility; and

    Otherwise accomplish the purposes of the Act.

    The Commission may, at any time, revoke the waiver. Upon such

    revocation, or at the expiration of the waiver period, any such DCO

    shall require divestiture of any relevant entity's ownership or voting

    rights percentages to an individual and/or aggregate level that is

    consistent with the First or Second Alternative, or such other level

    that the Commission deems appropriate based on the foregoing factors as

    set forth in Section 726(b) of the Dodd-Frank Act.

    4. Questions on the First and Second Alternatives and the Waiver

    The Commission seeks comment on the questions set forth below on

    the First and Second Alternatives, as well as the Waiver:

    a. First and Second Alternatives

    Are the First and Second Alternatives effective for

    mitigating, on a prophylactic basis, conflicts of interest arising from

    the control that (i) one member may exert as a dominant voting

    shareholder of a DCO and (ii) the enumerated entities may collectively

    exert as voting shareholders of a DCO (specifically with respect to the

    DCO risk assessments referenced above)? What methods, other than the

    First and Second Alternatives, should the Commission consider to

    mitigate such conflicts of interest? What are the advantages and

    disadvantages of such methods?

    Under what circumstances would the First and Second

    Alternatives not be appropriate for a DCO? For example, should the

    First and Second Alternatives apply equally to established DCOs and

    start-up DCOs? \89\

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

    \89\ See, e.g., Comments from Olesky, supra note 87; Comments

    from Liddell (``However, to pick upon the point that Lee Olesky made

    before, I think you have to be a little bit careful in how you treat

    entrepreneurials or starter ventures because most of the successful

    starter ventures have started with a relatively small number of

    banks sharing an interest in creating something which then becomes a

    lot bigger''), Roundtable Tr. at 119.

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

    Are the percentages that the Commission specifies in the

    First and Second Alternatives effective for mitigating conflicts of

    interest arising from the control that (i) one member may exert as a

    dominant voting shareholder of a DCO and (ii) the enumerated entities

    may collectively exert as voting shareholders of a DCO? If not, what

    alternative percentages should the Commission consider to achieve such

    mitigation?

    Would the First and Second Alternatives be effective to

    mitigate any potential conflicts of interest not discussed herein? If

    not, then what other equity ownership and voting limits should the

    Commission consider?

    Should the limits in the First and Second Alternatives

    only apply to clearing members, and not enumerated entities that are

    not clearing members? Should the limits in the First and Second

    Alternatives apply only to

    [[Page 63745]]

    DCOs, and not to their parent companies?

    b. Waiver

    The Commission seeks comment on (i) the circumstances

    which may require an alternative ownership structure for a DCO, (ii)

    the types of alternative ownership structures of DCOs that may require

    flexibility in setting ownership or voting rights levels consistent

    with achieving the goal of Section 726 of the Dodd-Frank Act to

    mitigate conflicts of interest, and (iii) the appropriate means to

    provide such flexibility to the Commission during the DCO application

    process if such an organization were to adopt an alternative structure.

    ii. DCMs or SEFs

    The Commission proposes a 20 percent limitation on the voting

    equity that any single member (and related persons) may own in a DCM or

    SEF. As mentioned above, economic research suggests that holding 20

    percent voting equity of an entity would be sufficient for control,

    especially if such entity has otherwise diffuse ownership. Such a

    limitation would prevent any one member of a DCM or SEF from dominating

    the decision-making process. The Commission also proposes an identical

    limitation on voting rights; and if the DCM or SEF is a subsidiary,

    extending the limitation to the shareholders of its direct or indirect

    parent. If any parent is publicly-listed, then that parent would have

    to comply with shareholder voting requirements promulgated by the SEC

    or the exchange on which the parent is listed.

    The Commission, however, does not propose imposing a limitation on

    the voting equity that the enumerated entities may own in the

    aggregate. As mentioned above, the Dodd-Frank Act specifically attempts

    to encourage sustained competition between multiple DCMs and SEFs over

    listing the same swap contract. Based on comments from Roundtable

    participants, the enumerated entities would be the most likely source

    of funding for a new DCM or SEF.\90\ In this instance, the Commission

    believes that the benefits of sustained competition between new DCMs

    and SEFs outweigh the incremental benefit of better governance through

    limitations on the aggregate influence of the enumerated entities.\91\

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

    \90\ See, e.g., Comments of McVey (``I think when it comes to

    ownership we have to realize that we are embarking on a major

    transformation of OTC markets and all of these entities are going to

    need capital to provide the market efficiencies that we're all

    seeking to achieve. And rightly or wrongly, historically a

    tremendous amount of the capital for clearing, e-trading, data and

    affirmation hubs, has come from the dealer community, and I think it

    would be very dangerous to cut off an important source of capital

    that can lead to some of the market improvements that we're all

    seeking to achieve''), Roundtable Tr. at 121 to 122.

    \91\ See, generally, Comments of Barnum (``The traditional

    vertically integrated exchange model for futures works beautifully

    in a whole range of respects for those products from the perspective

    of liquidity and systemic risk, but it has a couple problems. It

    is--it does seem to create some natural monopoly properties. You can

    debate whether they're severe enough to warrant action or not and

    that's one of the kinds of tensions that needs to be balanced. In

    addition, they work very well for the types of products that

    naturally attract liquidity on exchanges. The whole premise of this

    is that we're pushing a whole new set of products with different

    liquidity characteristics into central counterparties. That means

    that you cannot apply exactly the same framework. There are new

    challenges that are being introduced. They create tensions. And

    those tensions need to be looked at rationally in a continuum

    framework that balances different social goods against each

    other''), Roundtable Tr. at 116 to 117.

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

    1. Questions on DCM or SEF Limits on Ownership and Voting Power

    The Commission seeks comment on the questions set forth below on

    the DCM or SEF limits on ownership and voting power:

    Are the single-member limits on ownership and voting power

    effective for mitigating, on a prophylactic basis, the conflicts of

    interest that Section II identifies? What methods, other than such

    limits, should the Commission consider to mitigate such conflicts of

    interest? What are the advantages and disadvantages of such methods?

    Should the Commission also consider instituting a waiver

    procedure for DCMs and SEFs with respect to the single-member

    limitation?

    Should the single-member limitation be extended to the

    parent company of a DCM or SEF?

    IV. Effectiveness and Transition Period

    As noted above, the Commission is contemplating rulemakings on

    further defining certain entities implicated by the proposed rules

    (e.g., swap dealers, major swap participants, and swap execution

    facilities). The Commission anticipates that such rulemakings would be

    completed by the statutory deadline of July 15, 2011. Therefore, the

    Commission is proposing a staggered effective date for the final rules

    on mitigation of conflicts of interest. Any portion of the final rules

    implicating entities subject to further definition would not become

    effective until sixty (60) days after July 15, 2011. Portions of the

    final rules not involving such entities would become effective sixty

    (60) days after the Federal Register publication of the final rules.

    Although the Commission proposes that the final rules become

    effective within the time periods specified above, consistent with the

    DCM Conflicts of Interest Release, the Commission will permit each

    existing DCO, DCM, and SEF to phase-in implementation of the final

    rules over two (2) years or two regularly-scheduled Board of Directors

    elections. The Commission expects, however, all new DCO, DCM, and SEF

    applicants to fully comply with the final rules.

    The Commission requests comment on the (i) timing of effectiveness

    for the final rules, and (ii) the length of the phase-in implementation

    period. The Commission further requests comment on whether new DCO,

    DCM, and SEF applicants should have to demonstrate compliance with the

    final rules to receive registration.

    V. Numbering

    As the proposed rules constitute amendments or additions to

    Regulation Parts 1, 37, 38, 39, and 40, the Commission anticipates that

    the numbering of such proposed rules will change upon completion of

    other rulemakings concerning such parts.

    VI. Related Matters

    a. Regulatory Flexibility Act

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

    proposing rules, consider the impact of those rules on ``small

    entities.'' \92\ The term ``small entity'' has the same meaning as the

    term ``small business'' under the RFA \93\ and the term ``small

    business'' generally has the same meaning as the term ``small business

    concern'' under section 3 of the Small Business Act.\94\

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

    \92\ 5 U.S.C. 601 et seq.

    \93\ 5 U.S.C. 601(6).

    \94\ A ``small business concern'' is generally defined as one

    which is independently owned and operated and which is not dominant

    in its field of operation. 15 U.S.C. 632.

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

    The proposed rules detailed in this release would only affect DCOs,

    DCMs, and SEFs. The Commission has previously determined that DCOs \95\

    and DCMs \96\ are not ``small entities'' for purposes of the RFA. In

    contrast, SEFs constitute a new category of registrant that the Dodd-

    Frank Act created. Accordingly, the Commission has not addressed the

    question of whether SEFs are, in fact, ``small entities'' for purposes

    of the RFA.

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

    \95\ 66 FR 45604, 45609 (August 29, 2001).

    \96\ 47 FR 18618, 18619 (April 30, 1982).

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

    The Dodd-Frank Act defines a SEF to mean a trading system or

    platform in which multiple participants have the

    [[Page 63746]]

    ability to execute or trade swaps by accepting bids and offers made by

    multiple participants in the facility or system, through any means of

    interstate commerce, including any trading facility that facilitates

    the execution of swaps between persons and is not a designated contract

    market.\97\ The Commission is hereby proposing that SEFs not be

    considered to be ``small entities'' for essentially the same reasons

    that DCMs and DCOs have previously been determined not to be small

    entities. These reasons include the fact that the Commission designates

    a contract market or registers a derivatives clearing organization only

    when it meets specific criteria including expenditure of sufficient

    resources to establish and maintain adequate self-regulatory programs.

    Likewise, the Commission will register an entity as a SEF only after it

    has met specific criteria including the expenditure of sufficient

    resources to establish and maintain an adequate self-regulatory

    program.\98\ Accordingly, the Commission does not expect the rules, as

    proposed herein, to have a significant impact on a substantial number

    of small entities. Therefore, the Chairman, on behalf of the

    Commission, hereby certifies, pursuant to 5 U.S.C. 605(b), that the

    proposed amendments will not have a significant economic impact on a

    substantial number of small entities. The Commission invites the public

    to comment on whether SEFs covered by these rules should be considered

    small entities for purposes of the RFA.

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

    \97\ See Section 721 of the Dodd-Frank Act. The Commission

    anticipates proposing regulations that would further specify those

    entities that must register as a SEF. The Commission does not

    believe that such proposals would alter its determination that a SEF

    is not a ``small entity'' for purposes of the RFA.

    \98\ See Core Principle 2 applicable to SEFs under Section 733

    of the Dodd-Frank Act.

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

    b. Paperwork Reduction Act

    The Paperwork Reduction Act (``PRA'') \99\ imposes certain

    requirements on Federal agencies in connection with their conducting or

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

    proposed rules do not require a new collection of information on the

    part of any entities that would be subject to the proposed rules.

    Accordingly, for purposes of the PRA, the Commission certifies that the

    proposed rules, if promulgated in final form, would not impose any new

    reporting or recordkeeping requirements.

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

    \99\ 44 U.S.C. 3501 et seq.

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

    c. Cost-Benefit Analysis

    Section 15(a) of the CEA \100\ requires that the Commission, before

    promulgating a regulation or issuing an order, to consider the costs

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

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

    regulation or to determine whether the benefits of the regulation

    outweigh its costs. Rather, Section 15(a) of the CEA simply requires

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

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

    \100\ 7 U.S.C. 19(a).

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

    Section 15(a) of the CEA 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 and

    competition; (3) financial integrity of the futures markets and price

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

    interest considerations. Accordingly, the Commission could, in its

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

    and could determine that, notwithstanding its costs, a particular

    regulation was necessary or appropriate to protect the public interest

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

    purposes of the Act.

    The Commission has evaluated the costs and benefits of the proposed

    rules, in light of the specific provisions of Section 15(a) of the CEA,

    as follows:

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

    rules concern governance and conflicts of interest and seek to improve

    governance arrangements to prevent conflicts of interest that if not

    addressed, would serve the interests of one group of constituents over

    other groups, including other market participants and the public. The

    proposed rules require governance arrangements that allow the

    registered entities to better serve the public interest.

    2. Efficiency and competition. The proposed rules provide for the

    identification and mitigation of conflicts of interest, which improves

    efficiency in decision-making and increases fair access to clearing and

    markets which improves competition.

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

    proposed rules facilitate transparency in governance which, in turn,

    facilitates transparency in matters governed including increased fair

    access to clearing and trading which, in turn, facilitates price

    discovery. This decreases risk which, in turn, increases financial

    integrity.

    4. Sound risk management practices. The proposed rules provide for

    participation in decision-making by those who share in the risk

    presented by the operation of the registered entity. The governance

    arrangements provided by the proposed rules provide for a balance among

    different interests (including the public interest) so that risks

    presented by one group's interests will not dominate decision-making in

    the organization. This balance should prevent excess risk associated

    with any one group's interests from affecting operations.

    5. Other public interest considerations. The proposed rules provide

    for governance arrangements for DCOs, DCMs, and SEFs, as well as

    methods of mitigating the presence of conflicts of interest, that

    should, for the reasons, cited above, operate in the best interests of

    the public.

    Accordingly, after considering the five factors enumerated above,

    the Commission has determined to propose the regulations set forth

    below. The Commission invites public comment on its evaluation of the

    costs and benefits of the proposed rules. Specifically, commenters are

    invited to submit data quantifying the costs and benefits of the

    proposed rules with their comment letters.

    VII. Text of Proposed Rules

    List of Subjects

    17 CFR Part 1

    Definitions, Directors, Committees.

    17 CFR Part 37

    Swap execution facility, Conflict of Interest, Membership, Access,

    Voting, Ownership.

    17 CFR Part 38

    Designated contract markets, Conflict of interest, Membership,

    Access, Voting, Ownership.

    17 CFR Part 39

    Registered clearing organization, Conflict of interest, Membership,

    Access, Voting, Ownership.

    17 CFR Part 40

    Governance, Directors, Committees, Conflict of interest.

    For the reasons stated in this release, the Commission hereby

    amends 17 CFR parts 1, 37, 38, 39, and 40 as follows:

    PART 1--GENERAL REGULATIONS UNDER THE COMMODITY EXCHANGE ACT

    1. Revise the authority citation for part 1 to read as follows:

    [[Page 63747]]

    Authority: 7 U.S.C. 1a, 2, 2a, 4, 4a, 6, 6a, 6b, 6c, 6d, 6e, 6f,

    6h, 6i, 6j, 6k, 6l, 6m, 6n, 60, 6p, 7, 7a, 7b, 8, 9, 12, 12c, 13a,

    13a-1, 16, 16a, 19, 21, 23, and 24 and Sec. 726, Pub. L. 111-203,

    124 Stat. 1376.

    2. Section 1.3 is amended by adding paragraphs (zz) through (aaa)

    to read as follows:

    Sec. 1.3 Definitions

    (zz) Board of Directors. This term means the Board of Directors or

    Board of Governors of a company or organization, or equivalent

    governing body.

    (aaa) Disciplinary Panel. This term shall be as defined in Sec.

    40.9(c)(3)(i).

    (bbb) Executive Committee. This term shall mean a committee of the

    Board of Directors that may exercise the authority delegated to it by

    the Board of Directors with respect to the management of the company or

    organization.

    (ccc) Public Director. This term means a member of the Board of

    Directors (each, a ``director'') of a registered derivatives clearing

    organization (as defined in Section 1a(15) of the Act), a board of

    trade designated as a contract market pursuant to Section 5 of the Act,

    or a registered swap execution facility (as defined in Section 1a(50)

    of the Act), as applicable, who has been found, by the Board of

    Directors of the registered entity, on the record, to have no material

    relationship with such registered entity. The Board of Directors must

    make such finding upon the nomination or appointment of the director

    and as often as necessary in light of all circumstances relevant to

    such director, but in no case less than annually.

    (1) For purposes of this definition, a ``material relationship'' is

    one that reasonably could affect the independent judgment or decision-

    making of the director. In making the finding specified in paragraph

    (ccc) of this section, the Board of Directors need not consider

    previous service as a director of the registered entity to constitute a

    ``material relationship.'' Circumstances in which a director shall be

    considered to have a ``material relationship'' with the registered

    entity include, but are not limited to, the following:

    (i) Such director is an officer or an employee of the registered

    entity, or an officer or an employee of its affiliate. In this context,

    ``affiliate'' includes parents or subsidiaries of the registered entity

    or entities that share a common parent with the registered entity;

    (ii) Such director is a member of the registered entity, or a

    director, an officer, or an employee of a member. In this context,

    ``member'' is defined according to Section 1a(34) of the Act and any

    regulation promulgated thereunder, including, without limitation,

    Sec. Sec. 1.3(c) and (q) of this chapter and any successor provisions;

    (iii) Such director is an officer of another entity, which entity

    has a compensation committee (or similar body) on which any officer of

    the registered entity serves;

    (iv) Such director, or an entity with which the director is a

    partner, an officer, an employee, or a director, receives more than

    $100,000 in combined annual payments for legal, accounting, or

    consulting services from the registered entity, any affiliate thereof

    (as defined in paragraph (ccc)(1)(i) of this section), any member of

    the registered entity (as defined in paragraph (ccc)(1)(ii) of this

    section), or any affiliate of such member. Compensation for services as

    a director of the registered entity or as a director of an affiliate

    thereof does not count toward the $100,000 payment limit, nor does

    deferred compensation for services rendered prior to becoming a

    director of the registered entity, so long as such compensation is in

    no way contingent, conditioned, or revocable; or

    (v) Notwithstanding paragraph (ccc)(1)(iv) of this section, in the

    case of a public director that is a member of the Regulatory Oversight

    Committee, the Risk Management Committee (or any subcommittee thereof),

    or the Membership or Participation Committee (or any committee serving

    a similar function), such director (other than in the capacity of a

    member of such committee, any other committee, or the Board of

    Directors, in each case, of the registered entity), accepts, directly

    or indirectly, any consulting, advisory, or other compensatory fee from

    the registered entity, any affiliate thereof (as defined in paragraph

    (ccc)(1)(i) of this section), any member of the registered entity (as

    defined in paragraph (ccc)(1)(ii) of this section), or any affiliate of

    such member, other than deferred compensation for service rendered

    prior to becoming a member of the Regulatory Oversight Committee, the

    Risk Management Committee (or any subcommittee thereof), or the

    Membership or Participation Committee (or any committee serving a

    similar function), provided that such compensation is in no way

    contingent, conditioned, or revocable.

    (vi) Any of the relationships set forth in paragraphs (ccc)(1)(i)

    through (ccc)(1)(v) of this section apply to the ``immediate family''

    of such director, i.e., spouse, parents, children, and siblings, in

    each case, whether by blood, marriage, or adoption, or any person

    residing in the home of the director or that of his or her ``immediate

    family.''

    (2) All of the disqualifying circumstances described in paragraph

    (ccc)(1)(i) through (ccc)(1)(v) of this section shall be subject to a

    one-year look back.

    (3) A public director of any registered entity specified in

    paragraph (ccc) of this section may also serve as a public director of

    an affiliate of the registered entity (as defined in paragraph

    (ccc)(1)(i) of this section) if he or she otherwise meets the

    requirements in paragraph (ccc)(1)(i) through (ccc)(1)(v) of this

    section.

    (ddd) Membership or Participation Committee. This term shall be as

    defined in Sec. 37.19(c)(1)(i), with respect to a registered swap

    execution facility, and Sec. 38.851(c)(1)(i), with respect to a

    designated contract market.

    (eee) Nominating Committee. This term shall be as defined in Sec.

    40.9(c)(1)(i).

    (fff) Regulatory Oversight Committee. This term shall be as defined

    in Sec. 37.19(b)(1), with respect to a registered swap execution

    facility, and Sec. 38.851(b)(1), with respect to a designated contract

    market.

    (ggg) Risk Management Committee. This term shall be as defined in

    Sec. 39.13(g)(1).

    PART 37--SWAP EXECUTION FACILITIES

    3. Revise the authority citation for part 37 to read as follows:

    Authority: Sec. 726, Pub. L. 111-203, 124 Stat. 1376.

    4. Revise the heading to Part 37 to read as set forth above.

    5. Add Sec. 37.19 to read as follows:

    Sec. 37.19 Conflicts of Interest.

    (a) General. The swap execution facility shall:

    (1) Establish and enforce rules to minimize conflicts of interest

    in its decision-making process; and

    (2) Establish a process for resolving the conflicts of interest.

    Nothing in this section shall supersede any requirement applicable to

    the registered swap execution facility under Sec. 40.9 of this

    chapter.

    (b) Regulatory Oversight Committee.

    (1) General. A registered swap execution facility shall have a

    regulatory oversight committee (the ``Regulatory Oversight

    Committee''), which shall:

    (i) Monitor the regulatory program of the registered entity for

    sufficiency, effectiveness, and independence;

    (ii) Oversee all facets of the regulatory program, including:

    (A) Trade practice and market surveillance; audits, examinations,

    and

    [[Page 63748]]

    other regulatory responsibilities with respect to members (including

    ensuring compliance with, if applicable, financial integrity, financial

    reporting, sales practice, recordkeeping, and other requirements); and

    the conduct of investigations;

    (B) Reviewing the size and allocation of the regulatory budget and

    resources, and the number, hiring, termination, and compensation of

    regulatory personnel;

    (C) Reviewing the performance of the Chief Compliance Officer (as

    referenced in Section 5h(f)(15) of the Act) and making recommendations

    with respect to such performance to the Board of Directors;

    (D) Recommending changes that would ensure fair, vigorous, and

    effective regulation; and

    (E) Reviewing all regulatory proposals prior to implementation and

    advising the Board of Directors as to whether and how such changes may

    impact regulation.

    (2) Reporting. The Regulatory Oversight Committee shall report to

    the Board of Directors of the registered swap execution facility.

    (3) Composition. The Regulatory Oversight Committee shall be

    composed entirely of Public Directors.

    (4) Delegation. The Regulatory Oversight Committee shall oversee

    the regulatory program of the registered swap execution facility on

    behalf of the Board of Directors. The Board of Directors shall delegate

    sufficient authority, dedicate sufficient resources, and allow

    sufficient time for the Regulatory Oversight Committee to fulfill its

    mandate.

    (c) Membership or Participation.

    (1) Committee.

    (i) General. A registered swap execution facility shall have a

    membership or participation committee (the ``Membership or

    Participation Committee''), which shall, at a minimum, perform the

    following functions:

    (A) Determine the standards and requirements for initial and

    continuing membership or participation eligibility;

    (B) Review appeals of staff denials of membership or participation

    applications; and

    (C) Approve rules that would result in different categories or

    classes of members or participants receiving disparate access to the

    registered swap execution facility.

    (ii) Reporting. The Membership or Participation Committee shall

    report to the Board of Directors of the registered swap execution

    facility.

    (iii) Composition. The Membership or Participation Committee shall

    be composed of thirty-five percent Public Directors.

    (iv) Delegation. The Board of Directors may choose to delegate the

    performance of the functions of the Membership or Participation

    Committee to one or more other committees, provided that each such

    committee meets the composition requirements set forth in paragraph

    (c)(1)(iii) of this section. If the Board of Directors chooses to so

    delegate, the registered swap execution facility would no longer need

    to maintain a Membership or Participation Committee.

    (2) Access.

    (i) In reviewing appeals of staff denials of membership or

    participation applications, the Membership or Participation Committee

    (or entity performing the functions of such committee) shall not uphold

    any staff denial if the relevant application meets the standards and

    requirements that such committee sets forth.

    (ii) The Membership or Participation Committee (or entity

    performing the functions of such committee) shall not, and shall not

    permit the registered swap execution facility to, restrict access or

    impose burdens on access in a discriminatory manner, within each

    category or class of members or participants or between similarly-

    situated categories or classes of members or participants.

    (d) Limits on Voting Equity Ownership and the Exercise of Voting

    Power.

    (1) Definitions. For purposes of this Sec. 37.19(d):

    (i) Related Persons means, with respect to any member of a

    registered swap execution facility:

    (A) Any person that, directly or indirectly, is a parent or

    subsidiary of, or shares a common parent with, such member;

    (B) Any partner, director, officer, or other employee of such

    member;

    (C) Any immediate family member of such member, or any immediate

    family member of such member's spouse, in each case, who has the same

    home as such member; or

    (D) Any immediate family member of the persons enumerated in

    paragraph (d)(1)(i)(B) of this section, or any immediate family member

    of such person's spouse, in each case, who has the same home as such

    person.

    (2) Limits. A registered swap execution facility shall not permit

    any member, together with any Related Persons of such member, to:

    (i) Beneficially own, directly or indirectly, more than twenty

    percent of any class of equity interest of the registered swap

    execution facility entitled to vote; or

    (ii) Directly or indirectly vote, cause the vote of, give any

    consent or proxy with respect to the voting of, or enter into any

    shareholder agreement regarding the voting of, any interest in the

    registered swap execution facility that exceeds twenty percent of the

    voting power of any class of equity interest of the registered swap

    execution facility.

    (3) Parent Companies. If the registered swap execution facility is

    a subsidiary, paragraph (d)(2) of this section shall apply to its

    parent, whether direct or indirect, in the same manner as it applies to

    the registered swap execution facility. If any parent is publicly-

    listed on a domestic exchange, then such parent must follow the voting

    requirements promulgated by the Securities and Exchange Commission or

    the entity on which such parent is listed.

    (4) Remediation. A registered swap execution facility must have

    rules addressing the manner in which it would remediate any breach of

    the limits set forth in paragraph (d)(2) of this section. Such rules

    must specify, at a minimum:

    (i) The manner in which the registered swap execution facility

    would redeem any equity interest that a member or a Related Person

    purchased in excess of the limits set forth in paragraph (d)(2) of this

    section;

    (ii) The manner in which the registered swap execution facility

    would disregard any votes cast in excess of such limits; and

    (iii) The manner in which the registered swap execution facility

    would cause any breach of such limits to be reported to the Chief

    Compliance Officer (as referenced in Section 5h(f)(15) of the Act).

    PART 38--DESIGNATED CONTRACT MARKETS

    6. Revise the authority citation for part 38 to read as follows:

    Authority: 7 U.S.C. 2, 5, 6, 6c, 7, 7a-2 and 12a and Sec. 726,

    Pub. L. 111-203, 124 Stat. 1376.

    7. Section 38.1 is amended by adding a new sentence to the end of

    the section to read as follows:

    Sec. 38.1 Scope.

    * * * Nothing in this Part 38 shall apply to a board of trade

    designated as a contract market pursuant to Section 5f of the Act.

    8. Add Sec. 38.851 to read as follows:

    Sec. 38.851 Conflicts of interest.

    (a) General. A designated contract market shall establish and

    enforce rules

    [[Page 63749]]

    to minimize conflicts of interest in its decision-making process and

    establish a process for resolving any conflicts of interest. Nothing in

    this section shall supersede any requirement applicable to the

    designated contract market under Sec. 40.9 of this chapter.

    (b) Regulatory Oversight Committee.

    (1) General. A designated contract market shall have a regulatory

    oversight committee (``Regulatory Oversight Committee''), which shall:

    (i) Monitor the regulatory program of the registered entity for

    sufficiency, effectiveness, and independence;

    (ii) Oversee all facets of the regulatory program, including:

    (A) Trade practice and market surveillance; audits, examinations,

    and other regulatory responsibilities with respect to members

    (including ensuring compliance with, if applicable, financial

    integrity, financial reporting, sales practice, recordkeeping, and

    other requirements); and the conduct of investigations;

    (B) Reviewing the size and allocation of the regulatory budget and

    resources, and the number, hiring, termination, and compensation of

    regulatory personnel;

    (C) Supervising the chief regulatory officer of the designated

    contract market, who will report directly to the Regulatory Oversight

    Committee;

    (D) Recommending changes that would ensure fair, vigorous, and

    effective regulation; and

    (E) Reviewing all regulatory proposals prior to implementation and

    advising the Board of Directors as to whether and how such changes may

    impact regulation.

    (2) Reporting. The Regulatory Oversight Committee shall report to

    the Board of Directors of the designated contract market.

    (3) Composition. The Regulatory Oversight Committee shall be

    composed entirely of Public Directors.

    (4) Delegation. The Regulatory Oversight Committee shall oversee

    the regulatory program of the designated contract market on behalf of

    the Board of Directors. The Board of Directors shall delegate

    sufficient authority, dedicate sufficient resources, and allow

    sufficient time for the Regulatory Oversight Committee to fulfill its

    mandate.

    (c) Membership or Participation.

    (1) Committee.

    (i) General. A designated contract market shall have a membership

    or participation committee (``Membership or Participation Committee''),

    which shall, at a minimum, perform the following functions:

    (A) Determine the standards and requirements for initial and

    continuing membership or participation eligibility;

    (B) Review appeals of staff denials of membership or participation

    applications; and

    (C) Approve rules that would result in different categories or

    classes of members or participants receiving disparate access to the

    designated contract market.

    (ii) Reporting. The Membership or Participation Committee shall

    report to the Board of Directors of the designated contract market.

    (iii) Composition. The Membership or Participation Committee shall

    be composed of thirty-five percent Public Directors.

    (iv) Delegation. The Board of Directors may choose to delegate the

    performance of the functions of the Membership or Participation

    Committee to one or more other committees, provided that each such

    committee meets the composition requirements set forth in paragraph

    (c)(1)(iii) of this section. If the Board of Directors chooses to so

    delegate, the registered swap execution facility would no longer need

    to maintain a Membership or Participation Committee.

    (2) Access.

    (i) In reviewing appeals of staff denials of membership or

    participation applications, the Membership or Participation Committee

    (or entity performing the functions of such committee) shall not uphold

    any staff denial if the relevant application meets the standards and

    requirements that such committee sets forth.

    (ii) The Membership or Participation Committee (or entity

    performing the functions of such committee) shall not, and shall not

    permit the registered swap execution facility to, restrict access or

    impose burdens on access in a discriminatory manner, within each

    category or class of members or participants or between similarly-

    situated categories or classes of members or participants.

    (d) Limits on Voting Equity Ownership and the Exercise of Voting

    Power.

    (1) Definitions. For purposes of this Sec. 38.851(d):

    (i) Related Persons means, with respect to any member of a

    designated contract market:

    (A) Any person that, directly or indirectly, is a parent or

    subsidiary of, or shares a common parent with, such member;

    (B) Any partner, director, officer, or other employee of such

    member;

    (C) Any immediate family member of such member, or any immediate

    family member of such member's spouse, in each case, who has the same

    home as such member; or

    (D) Any immediate family member of the persons enumerated in

    paragraph (d)(1)(i)(B) of this section, or any immediate family member

    of such person's spouse, in each case, who has the same home as such

    person.

    (2) Limits. A designated contract market shall not permit any

    member, together with any Related Persons of such member, to:

    (i) Beneficially own, directly or indirectly, more than twenty

    percent of any class of equity interest of the designated contract

    market entitled to vote; or

    (ii) Directly or indirectly vote, cause the vote of, give any

    consent or proxy with respect to the voting of, or enter into any

    shareholder agreement regarding the voting of, any interest in the

    designated contract market that exceeds twenty percent of the voting

    power of any class of equity interest of the designated contract

    market.

    (3) Parent Companies. If the designated contract market is a

    subsidiary, paragraph (d)(2) of this section shall apply to its parent,

    whether direct or indirect, in the same manner as it applies to the

    designated contract market. If any parent is publicly-listed on a

    domestic exchange, then such parent must follow the voting requirements

    promulgated by the Securities and Exchange Commission or the entity on

    which such parent is listed.

    (4) Remediation. A designated contract market must have rules

    addressing the manner in which it would remediate any breach of the

    limits set forth in paragraph (d)(2) of this section. Such rules must

    specify, at a minimum:

    (i) The manner in which the designated contract market would redeem

    any equity interest that a member or a Related Person purchased in

    excess of the limits set forth in paragraph (d)(2) of this section;

    (ii) The manner in which the designated contract market would

    disregard any votes cast in excess of such limits; and

    (iii) The manner in which the designated contract market would

    cause any breach of such limits to be reported to the chief regulatory

    officer.

    PART 39--DERIVATIVES CLEARING ORGANIZATIONS

    9. Revise the authority citation for part 39 read as follows:

    Authority: 7 U.S.C. 7b and Sec. 726, Pub. L. 111-203, 124 Stat.

    1376.

    10. Add Sec. 39.13 to read as follows:

    [[Page 63750]]

    Sec. 39.13 Risk Management.

    (a) through (g) [Reserved]

    (g) Risk Management Committee.

    (1) General. A derivatives clearing organization shall have a risk

    management committee (the ``Risk Management Committee''), which shall,

    at a minimum, perform the following functions:

    (i) Advise the Board of Directors on significant changes to the

    derivatives clearing organization's risk model and default procedures;

    (ii) Determine the standards and requirements for initial and

    continuing clearing membership eligibility;

    (iii) Approve or deny (or review approvals or denials of) clearing

    membership applications;

    (iv) Determine products eligible for clearing; and

    (v) Review the performance of the Chief Compliance Officer (as

    referenced in Section 5b(i) of the Act) and make recommendations with

    respect to such performance to the Board of Directors.

    (2) Reporting. The Risk Management Committee shall report to the

    Board of Directors of the derivatives clearing organization.

    (3) Composition.

    (i) The Risk Management Committee shall be composed of at least

    thirty-five percent Public Directors of a derivatives clearing

    organization and at least ten percent representatives of customers. In

    this context, a ``customer'' means any customer of a clearing member,

    including, without limitation:

    (A) Any ``customer'' or ``commodity customer'' within the meaning

    of Sec. 1.3(k) of this chapter;

    (B) Any ``foreign futures or foreign options customer'' within the

    meaning of Sec. 30.1(c) of this chapter; and

    (C) Any customer entering into a cleared swap (as defined in

    Section 1a(7) of the Act).

    (ii) The remaining members of such Risk Management Committee (or

    subcommittee thereof as described in paragraph (g)(5) of this section)

    may be, in the discretion of the derivatives clearing organization,

    representatives of clearing members. No such member shall be an

    employee of the derivatives clearing organization.

    (iii) The Chairman of the Risk Management Committee (or

    subcommittee thereof as described in paragraph (g)(5) of this section)

    shall be a Public Director.

    (4) Meetings. The Risk Management Committee shall hold regular

    meetings. The Committee may invite employees of the derivatives

    clearing organization to attend its meetings in a non-voting capacity.

    (5) Delegation. The Risk Management Committee may delegate, in

    writing, the performance of the functions enumerated in paragraph

    (g)(1)(ii) to (iv) of this section to a subcommittee, provided that

    such subcommittee meets the composition requirements set forth in

    paragraph (g)(3) of this section. If the Risk Management Committee

    chooses to so delegate, then it would no longer be subject to such

    composition requirements.

    (6) Discretion.

    (i) No decision of a subcommittee with delegated authority under

    paragraph (g)(5) of this section, pertaining to the functions

    enumerated in paragraph (g)(1)(ii) to (iv) of this section, may be

    subject to the approval of, or otherwise restricted or limited by, a

    body other than the Board of Directors or the Risk Management Committee

    of the derivatives clearing organization, including, without

    limitation, any advisory committee.

    (ii) No decision of the Risk Management Committee pertaining to the

    functions enumerated in paragraph (g)(1)(ii) to (iv) of this section,

    may be subject to the approval of, or otherwise restricted or limited

    by, a body other than the Board of Directors of the derivatives

    clearing organization, including, without limitation, any advisory

    committee.

    11. Add Sec. 39.25 to read as follows:

    Sec. 39.25 Conflicts of interest.

    (a) General. (1) A derivatives clearing organization shall

    establish and enforce rules to minimize conflicts of interest in its

    decision-making process and establish a process for resolving any

    conflicts of interest.

    (2) Governance arrangements for derivatives clearing organizations

    should be clear and transparent and be designed to promote the safety

    and efficiency of the derivatives clearing organization, to support the

    stability of the broader financial system and other relevant public

    interest considerations, and to support the objectives of relevant

    stakeholders.

    (3) Nothing in this section shall supersede any requirement

    applicable to the derivatives clearing organization under Sec. 40.9 of

    this chapter.

    (b) Limits on Voting Equity Ownership and the Exercise of Voting

    Power.

    (1) Definitions. For purposes of this Sec. 39.25(b):

    (i) Affiliate means any person that, directly or indirectly,

    controls, is controlled by, or is under common control with, another

    person.

    (ii) Enumerated Entities means:

    (A) A bank holding company (as defined in Section 2 of the Bank

    Holding Company Act of 1956 (12 U.S.C. 1841)) with total consolidated

    assets of $50,000,000,000 or more,

    (B) A nonbank financial company (as defined in Section 102 of the

    Dodd-Frank Wall Street Reform and Consumer Protection Act) supervised

    by the Board of Governors of the Federal Reserve System,

    (C) An Affiliate of such bank holding company or nonbank financial

    company,

    (D) A swap dealer (as defined in Section 1a(49) of the Act and any

    regulations promulgated thereunder),

    (E) A major swap participant (as defined in Section 1a(33) of the

    Act and any regulations promulgated thereunder), and

    (F) An associated person of a swap dealer or major swap participant

    (as defined in Section 1a(3) of the Act and any regulations promulgated

    thereunder).

    (iii) Related Persons means, with respect to any person:

    (A) An Affiliate of such person;

    (B) Any partner, director, officer, or other employee of such

    person;

    (C) Any immediate family member of such person, or any immediate

    family member of such person's spouse, in each case, who has the same

    home as such person; or

    (D) Any immediate family member of the persons enumerated in

    paragraph (b)(1)(iii)(B) of this section, or any immediate family

    member of such person's spouse, in each case, who has the same home as

    such person.

    (2) Limits. A derivatives clearing organization shall choose to

    comport with either paragraph (b)(2)(i) or (b)(2)(ii) of this section:

    (i)(A) The derivatives clearing organization shall not permit any

    member, together with any Related Persons of such member, to:

    (1) Beneficially own, directly or indirectly, more than twenty

    percent of any class of equity interest of the derivatives clearing

    organization entitled to vote; or

    (2) Directly or indirectly vote, cause the vote of, give any

    consent or proxy with respect to the voting of, or enter into any

    shareholder agreement regarding the voting of, any interest in the

    derivatives clearing organization that exceeds twenty percent of the

    voting power of any class of equity interest of the derivatives

    clearing organization.

    (B) Additionally, a derivatives clearing organization shall not

    permit the Enumerated Entities (whether or not they are clearing

    members), together with any Related Persons of such Enumerated

    Entities, to collectively:

    (1) Own, on a beneficial basis, directly or indirectly, more than

    forty percent of

    [[Page 63751]]

    any class of equity interest of the derivatives clearing organization

    entitled to vote; or

    (2) Directly or indirectly vote, cause the vote of, give any

    consent or proxy with respect to the voting of, or enter into any

    shareholder agreement regarding the voting of, any interest in the

    derivatives clearing organization that exceeds forty percent of the

    voting power of any class of equity interest of the derivatives

    clearing organization.

    (C) The derivatives clearing organization shall ensure that no

    resolution or similar measure on which the Enumerated Entities are

    entitled to vote shall be passed by less than a majority of all

    outstanding equity interests similarly entitled to vote.

    (ii) The derivatives clearing organization shall not permit any

    member or any Enumerated Entity (whether or not such entity is a

    member), together with any Related Persons in each case thereof, to:

    (A) Beneficially own, directly or indirectly, more than five

    percent of any class of equity interest of the derivatives clearing

    organization entitled to vote; or

    (B) Directly or indirectly vote, cause the vote of, give any

    consent or proxy with respect to the voting of, or enter into any

    shareholder agreement regarding the voting of, any interest in the

    derivatives clearing organization that exceeds five percent of the

    voting power of any class of equity interest of the derivatives

    clearing organization.

    (3) Waiver.

    (i) A derivatives clearing organization may request that the

    Commission waive the requirements set forth in paragraph (b)(2) of this

    section.

    (ii)(A) The Commission may grant a waiver for a period of time that

    it deems reasonable if, upon a showing by a derivatives clearing

    organization, the Commission determines that, with respect to the

    derivatives clearing organization, the requirements set forth in

    paragraph (b)(2) of this section are not necessary or appropriate to:

    (1) Improve the governance of the derivatives clearing

    organization;

    (2) Mitigate systemic risk;

    (3) Promote competition;

    (4) Mitigate conflicts of interest in connection with a swap dealer

    or major swap participant's conduct of business with the derivatives

    clearing organization, including with respect to Section 2(h)(1)(B) and

    Section 5b(c)(2)(c) of the Act; and

    (5) Otherwise accomplish the purposes of the Act.

    (B) The Commission may, at any time, revoke the waiver upon its own

    motion. Upon such revocation, or at the expiration of the waiver

    period, the derivatives clearing organization shall require all equity

    holders to comport, through divestiture or other means, with the

    requirements set forth in paragraph (b)(2) of this section.

    (4) Parent Companies. If the derivatives clearing organization is a

    subsidiary, paragraph (b)(2) of this section shall apply to its parent,

    whether direct or indirect, in the same manner as it applies to the

    derivatives clearing organization. If any parent is publicly listed on

    a domestic exchange, then such parent must follow the voting

    requirements promulgated by the Securities and Exchange Commission or

    the entity on which such parent is listed.

    (5) Remediation. A derivatives clearing organization must have

    rules addressing the manner in which it would remediate any breach of

    the limits set forth in paragraph (b)(2) of this section. Such rules

    must specify, at a minimum:

    (i) The manner in which the derivatives clearing organization would

    redeem any equity interest that a member, the Enumerated Entities, or a

    Related Person in each case thereof, purchased in excess of the limits

    set forth in paragraph (b)(2) of this section;

    (ii) The manner in which the derivatives clearing organization

    would disregard any votes cast in excess of such limits; and

    (iii) The manner in which the derivatives clearing organization

    would cause any breach of such limits to be reported to the Chief

    Compliance Officer (as referenced in Section 5b(i) of the Act).

    PART 40--PROVISIONS COMMON TO REGISTERED ENTITIES

    1. Revise the authority citation for part 40 to read as follows:

    Authority: 7 U.S.C. 1a, 2, 5, 6, 7, 7a, 8, and 12a, and Sec.

    726, Pub. L. 111-203, 124 Stat. 1376.

    2. Add Sec. 40.9 to read as follows:

    Sec. 40.9 Governance.

    (a) General. (1) Nothing in this section shall apply to a board of

    trade designated as a contract market pursuant to Section 5f of the

    Act.

    (2) Capitalized terms not defined herein shall have the meanings

    assigned to them in Sec. 1.3 of this chapter.

    (3) Nothing in this section shall supersede any requirement

    applicable to the registered entity under Parts 37, 38, or 39 of this

    chapter.

    (b) The Board of Directors.

    (1) General.

    (i) The Board of Directors of a registered derivatives clearing

    organization, a designated contract market, or a registered swap

    execution facility shall be composed of at least thirty-five percent,

    but no less than two, Public Directors.

    (ii) The roles and responsibilities of such Board of Directors must

    be clearly articulated, especially in respect of the manner in which

    the Board of Directors ensures that a registered entity referenced in

    paragraph (b)(1)(i) of this section complies with all statutory,

    regulatory, and self-regulatory responsibilities under the Act and the

    regulations promulgated thereunder.

    (2) Parent Companies.

    (i) For purposes of paragraph (b)(2) of this section, ``operate''

    shall mean the direct exercise of control (including through the

    exercise of veto power) over the day-to-day business operations of a

    registered entity specified in paragraph (b)(1)(i) of this section by

    the sole or majority shareholder of such registered entity, whether

    through the ownership of voting equity, by contract, or otherwise. The

    term ``operate'' shall not prohibit an entity, acting as the sole or

    majority shareholder of such registered entity, from exercising its

    rights as a shareholder under any contract, agreement, or other legal

    obligation.

    (ii) A registered entity specified in paragraph (b)(1)(i) of this

    section shall not permit itself to be operated by any entity unless

    such entity agrees that:

    (A) Paragraph (b)(1) of this section shall apply to such entity in

    the same manner as it applies to the registered entity;

    (B) The officers, directors, employees, and agents of such entity

    shall be deemed to be the officers, directors, employees, and agents of

    the registered entity, and shall thereby be subject to the authority of

    the Commission pursuant to the Act and the regulations promulgated

    thereunder; and

    (C) Any books and records of such entity relating to such operation

    shall be deemed to be the books and records of the registered entity

    for purposes of the Act and the regulations promulgated thereunder.

    Such books and records shall be subject at all times to inspection and

    copying by the Commission, regardless of whether such books and records

    contain confidential information, as long as such entity operates the

    registered entity.

    (3) Expertise. The members of the Board of Directors, including

    Public Directors, of each registered entity specified in paragraph

    (b)(1)(i) of this section, shall be of sufficiently good repute and,

    where applicable, have sufficient expertise in financial services, risk

    management, and clearing services.

    [[Page 63752]]

    (4) Compensation. The compensation of the Public Directors and

    other non-executive members of the Board of Directors of a registered

    entity specified in paragraph (b)(1)(i) of this section shall not be

    linked to the business performance of such registered entity.

    (5) Annual Self-Review. The Board of Directors of a registered

    entity specified in paragraph (b)(1)(i) of this section shall review

    its performance and that of its individual members annually. It should

    consider periodically using external facilitators for such reviews.

    (6) Board Member Removal. A registered entity specified in

    paragraph (b)(1)(i) of this section shall have procedures to remove a

    member from the Board of Directors, where the conduct of such member is

    likely to be prejudicial to the sound and prudent management of the

    registered entity.

    (c) Committees and Panels.

    (1) Nominating Committee.

    (i) General. Each registered derivatives clearing organization,

    designated contract market, or registered swap execution facility must

    have a nominating committee (``Nominating Committee''), which shall, at

    a minimum:

    (A) identify individuals qualified to serve on the Board of

    Directors, consistent with criteria approved by the Board of Directors,

    and with the composition requirements set forth in this section; and

    (B) Administer a process for the nomination of individuals to the

    Board of Directors.

    (ii) Reporting. The Nominating Committee shall report to the Board

    of Directors of the registered entity.

    (iii) Composition. The Nominating Committee shall be composed of at

    least fifty-one percent Public Directors. The chair of the Nominating

    Committee shall be a Public Director.

    (2) Executive Committee. Any Executive Committee of a registered

    derivatives clearing organization, designated contract market, or

    registered swap execution facility shall be composed of at least

    thirty-five percent, but no less than two, Public Directors.

    (3) Disciplinary Panels.

    (i) General. Each registered derivatives clearing organization,

    designated contract market, or registered swap execution facility must

    have one or more disciplinary panels (each, a ``Disciplinary Panel''),

    each of which shall be responsible for conducting hearings, rendering

    decisions, and imposing sanctions with respect to disciplinary matters.

    (ii) Composition. Each Disciplinary Panel shall include at least

    one person who would not be disqualified from serving as a Public

    Director by Sec. 1.3(ccc)(1)(i)-(vi) and (2) of this chapter (a

    ``Public Participant''). Such Public Participant shall chair each

    Disciplinary Panel. In addition, any registered entity specified in

    paragraph (c)(3)(i) of this section shall adopt rules that would, at a

    minimum:

    (A) Further preclude any group or class of participants from

    dominating or exercising disproportionate influence on a Disciplinary

    Panel and

    (B) Prohibit any member of a Disciplinary Panel from participating

    in deliberations or voting on any matter in which the member has a

    financial interest.

    (iii) Appeals. If the rules of the registered entity provide that

    the decision of a Disciplinary Panel may be appealed to another

    committee of the Board of Directors (or similar body), then such

    committee must also include at least one Public Participant, and such

    Public Participant must chair the committee.

    (iv) Exception. Notwithstanding the foregoing, paragraphs

    (c)(3)(ii) through (c)(3)(iii) of this section do not apply to a

    Disciplinary Panel convened for cases solely involving decorum or

    attire.

    (v) Delegation. With respect to a registered derivatives clearing

    organization, the Board of Directors may delegate to the Risk

    Management Committee the performance of the functions of the

    Disciplinary Panel. If the Board of Directors so delegates:

    (A) The registered derivatives clearing organization need no longer

    maintain a Disciplinary Panel, but

    (B) Paragraph (c)(3)(iii) of this section would still apply to any

    committee (or similar body) to which a decision of the Risk Management

    Committee may be appealed.

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

    David A. Stawick,

    Secretary of the Commission.

    Concurring Statement of Commissioner Scott D. O'Malia

    October 1, 2010 Public Meeting

    I concur in the Commission's proposal of rules pursuant to

    Section 726 of the Dodd-Frank Act (the ``Act''). However, I have a

    number of concerns associated with the prescriptiveness of the

    proposed conflict of interest rules. I believe, given the goals of

    the Act, it is appropriate to consider more flexible ownership

    structures and voting rights levels as well as the availability of

    waivers for derivatives clearing organizations (``DCOs'').

    Ownership and Voting Limits on DCOs

    A main goal of the Act is to mitigate systemic risk in the U.S.

    financial system by imposing a mandatory clearing requirement on

    swaps. Additionally, the business of clearing is serious and

    financially complex. I am concerned that the proposed rules may not

    properly consider the effect on mitigation of systemic risk,

    competition, and capital formation in the DCO space, or afford the

    Commission with the necessary flexibility to achieve those outcomes.

    Given that the Commission has yet to consider any new DCO

    applications under the Act, it is extremely unwise to conduct an

    experiment with the ownership structure of DCOs.

    Second, a stated goal of the Act was to provide all market

    participants with fair, open, and non-discriminatory access to DCOs.

    To achieve that end, Congress included Open Access and Participant

    and Product Eligibility provisions in the Act.\101\ Each provision

    addresses and attempts to eliminate the potential for clearing

    entities to use ownership control to obstruct market participants

    from gaining access to a DCO. Rather than utilizing the limited and

    inflexible ownership caps in the proposed rules, I believe that the

    open access and eligibility provisions will be more effective in

    achieving the Act's goals of fair, open, and non-discriminatory

    access to DCOs.

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

    \101\ Section 2(h)(1)(B) and Section 5b(c)(2)(c) of the Act.

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

    Third, an overarching goal of the Act is the international

    harmonization of financial regulation. I believe that it's

    especially important for the Commission to harmonize its rules with

    those of foreign regulators in order to prevent regulatory

    arbitrage. With that said, the European Commission released

    (September 15, 2010) a proposal on financial reform which does not

    place individual or aggregate ownership limits on DCOs under

    European Union jurisdiction.

    For the aforementioned reasons, I am in favor of a more flexible

    approach to limitations on DCO ownership and voting rights,

    including the availability of a full waiver for individual and

    aggregate ownership or voting limits on swap dealers or major swap

    participants that hold or desire to hold debt or equity positions in

    DCOs.

    Public Directors

    I fully support the Commission's decision to require a

    registered entity to have its board of directors and certain other

    committees composed of thirty-five percent (35%) public directors.

    This standard is consistent with the Commission's previous core

    principle 15 for designated contract markets (``DCMs''). The

    Commission thoroughly vetted this percentage with the public in a

    recent rulemaking and it concluded that having a board of directors

    for DCMs composed of thirty-five percent (35%) public directors was

    neither overly burdensome nor cost prohibitive. Today's proposed

    rulemaking also raises the question as to whether it is desirable to

    expand the existing rule from thirty-five percent (35%) up to fifty-

    one percent (51%) for DCMs, DCOs, and swap execution facilities. I

    am interested to know how this proposal would enhance the governance

    of the existing board structures of certain registered entities, and

    more specifically, how it would expand the clearing and risk

    management expertise of a DCO.

    [[Page 63753]]

    I strongly encourage the public to closely analyze the language

    of each proposed rule and to provide the Commission with

    constructive and detailed comments on each of them. In particular, I

    am interested to know (i) what effect the Commission's proposed

    rules on voting and ownership limitations will have on competition,

    raising capital, and managing risk, and (ii) whether or not the open

    access and eligibility provisions in Sections 2(h)(1)(B) and

    5b(c)(2)(c) of the Act would be a more effective method for the

    Commission to expand access to clearing, rather than placing limits

    on the voting and ownership of DCOs.

    Proposed Requirements for Derivatives Clearing Organizations,

    Designated Contract Markets, and Swap Execution Facilities Regarding

    the Mitigation of Conflicts of Interest

    Commissioner Jill E. Sommers, Dissenting

    The Commission is voting today on a proposal to implement two

    sections of the Dodd-Frank Act regarding the governance of CFTC

    regulated trading venues and clearinghouses that trade or clear

    swaps and how to mitigate conflicts of interest that may arise in

    connection with ownership interests that certain entities may have

    in these registrants. Specifically, Section 725(d) of the Act

    directs the Commission to:

    Adopt rules mitigating conflicts of interest in connection with

    the conduct of business by a swap dealer or a major swap participant

    with at [DCO], [DCM], or a [SEF] that clears or trades swaps in

    which the swap dealer or major swap participant has a material debt

    or material equity investment.

    Section 726 of the Act provides that the Commission shall adopt

    rules which ``may'' include numerical limits on the degree of

    control or voting rights that certain enumerated entities may

    possess with respect to DCOs, DCMs and SEFs if the Commission

    determines, after a review:

    That such rules are necessary or appropriate to improve the

    governance of, or to mitigate systemic risk, promote competition, or

    mitigate conflicts of interest in connection with a swap dealer or

    major swap participant's conduct of business with, a [DCO], [DCM],

    or [SEF] that clears or posts swaps or makes swaps available for

    trading and in which such swap dealer or major swap participant has

    a material debt or equity investment.

    I recognize that these provisions direct the Commission to adopt

    strong governance rules to mitigate conflicts of interest in

    connection with the interaction between swap dealers and major swap

    participants and DCOs, DCMs and SEFs in which they have a material

    debt or equity investment. In my opinion, however, the voting equity

    restrictions being proposed are not necessary or appropriate to

    mitigate the perceived conflicts and in fact, may do more harm than

    good to the emerging marketplace for trading and clearing swaps.

    In 2009, after more than two years of study, the Commission

    finalized acceptable practices to provide a safe harbor for

    complying with Core Principle 15 for DCMs dealing with conflicts of

    interest. I support making those acceptable practices mandatory for

    DCMs, DCOs and SEFs, as augmented by some of the additional

    provisions being proposed today, such as the Risk Management

    Committee for DCOs. I believe that strong governance rules, coupled

    with the Commission's ultimate authority to determine which swaps

    must be cleared, under Section 723 of Dodd-Frank, is sufficient to

    ensure that swaps that should be listed for trading and cleared will

    be listed for trading and cleared.

    I have grave concerns that the proposed limitations on voting

    equity, especially those proposed for enumerated entities in the

    aggregate with respect to DCOs, may stifle competition by preventing

    new DCMs, DCOs and SEFs that trade or clear swaps from being formed.

    The Commission recognizes in the preamble to the proposal that the

    enumerated entities will be the most likely source of funding for

    new DCMs and SEFs and thus chose not to propose the aggregate limits

    for trading venues. I believe the same logic applies with even

    greater force for DCOs. I am equally concerned that a number of

    recent entrants into the swaps trading and clearing space will

    potentially be required to disband their operations if they are

    unable to attract the required amount of non-voting equity within

    the two-year/two board election cycles proposed. I also note that

    the European Commission explicitly rejected ownership limitations in

    its proposal for regulating OTC derivatives announced September 15th

    because such limitations may have negative consequences for market

    structures. I agree. And I hope that we will be mindful of global

    consistency as we move forward. The marketplace for trading and

    clearing swaps is in its infancy. I strongly believe that the

    limitations the Commission is proposing will have the effect of

    inhibiting emerging competition rather than promoting it. I

    therefore cannot support today's proposal.

    [FR Doc. 2010-26220 Filed 10-15-10; 8:45 am]

    BILLING CODE P

    Last Updated: October 18, 2010



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