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2011-690

  • Federal Register, Volume 76 Issue 13 (Thursday, January 20, 2011)[Federal Register Volume 76, Number 13 (Thursday, January 20, 2011)]

    [Proposed Rules]

    [Pages 3698-3742]

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

    [FR Doc No: 2011-690]

    [[Page 3697]]

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    Part II

    Commodity Futures Trading Commission

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    17 CFR Part 39

    Risk Management Requirements for Derivatives Clearing Organizations;

    Proposed Rule

    Federal Register / Vol. 76 , No. 13 / Thursday, January 20, 2011 /

    Proposed Rules

    [[Page 3698]]

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    COMMODITY FUTURES TRADING COMMISSION

    17 CFR Part 39

    RIN 3038-AC98

    Risk Management Requirements for Derivatives Clearing

    Organizations

    AGENCY: Commodity Futures Trading Commission.

    ACTION: Notice of proposed rulemaking.

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    SUMMARY: The Commodity Futures Trading Commission (Commission) is

    proposing regulations to implement Title VII and Title VIII of the

    Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank

    Act). Proposed regulations would establish the regulatory standards for

    compliance with derivatives clearing organization (DCO) Core Principles

    C (Participant and Product Eligibility), D (Risk Management), E

    (Settlement Procedures), F (Treatment of Funds), G (Default Rules and

    Procedures), and I (System Safeguards). For DCOs that are designated by

    the Financial Stability Oversight Council as systemically important

    DCOs (SIDCOs), the Commission is proposing heightened standards in the

    area of system safeguards supporting business continuity and disaster

    recovery and a provision that would implement the Commission's special

    enforcement authority over SIDCOs. The Commission also is proposing

    certain additional amendments including replacement of the current part

    39 appendix A, Application Guidance and Compliance With Core

    Principles, with an application form for entities seeking to register

    as DCOs, technical amendments to reorganize part 39 of the Commission's

    regulations, and amendments to supplement reporting and public

    information requirements proposed in a previous rulemaking.

    DATES: Submit comments on or before March 21, 2011.

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

    the following methods:

    Agency Web site, via its Comments Online process: http://comments.cftc.gov. Follow the instructions for submitting comments

    through the Web site.

    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.

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

    Follow the instructions for submitting comments.

    Please submit comments by only one method.

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

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

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

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

    information that may be exempt from disclosure under the Freedom of

    Information Act (FOIA), a petition for confidential treatment of the

    exempt information may be submitted according to the procedures

    established in Sec. 145.9 of the Commission's regulations.\1\ The

    Commission reserves the right, but shall have no obligation, to review,

    pre-screen, filter, redact, refuse, or remove any or all of your

    submission from http://www.cftc.gov that it may deem to be

    inappropriate for publication, such as obscene language. All

    submissions that have been redacted or removed that contain comments on

    the merits of the rulemaking will be retained in the public comment

    file and will be considered as required under the Administrative

    Procedure Act and other applicable laws, and may be accessible under

    FOIA.

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

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

    at http://www.cftc.gov.

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

    418-5480, jlawton@cftc.gov; Phyllis P. Dietz, Associate Director, 202-

    418-5449, pdietz@cftc.gov, Robert B. Wasserman, Associate Director,

    202-418-5092, rwasserman@cftc.gov (System Safeguards); and Jonathan

    Lave, Special Counsel, 202-418-5983, jlave@cftc.gov, Division of

    Clearing and Intermediary Oversight, Commodity Futures Trading

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

    DC 20581; and Julie A. Mohr, Associate Director, 312-596-0568,

    jmohr@cftc.gov; and Anne C. Polaski, Special Counsel, 312-596-0575,

    apolaski@cftc.gov, Division of Clearing and Intermediary Oversight,

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

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    Illinois 60661.

    SUPPLEMENTARY INFORMATION:

    Table of Contents

    I. Background

    A. Title VII of the Dodd-Frank Act

    B. Title VIII of the Dodd-Frank Act

    C. Dodd-Frank Act rulemaking initiative

    II. Discussion

    A. Registration procedures

    B. Implementation of DCO core principles

    1. Participant and product eligibility

    (a) Participant eligibility

    (i) Fair and open access

    (ii) Financial resources

    (iii) Operational requirements

    (iv) Monitoring, reporting, and enforcement

    (b) Product eligibility

    2. Risk management

    (a) General

    (b) Risk management framework

    (c) Chief risk officer

    (d) Measurement of credit exposure

    (e) Limitation of exposure to potential losses from defaults

    (f) Margin requirements

    (i) General

    (ii) Methodology and coverage

    (iii) Independent validation

    (iv) Spread margins

    (v) Price data

    (vi) Daily review and back tests

    (vii) Customer margin

    (1) Gross margin for customer accounts

    (2) Customer initial margin requirements

    (3) Withdrawal of customer initial margin

    (viii) Time deadlines

    (g) Other risk control mechanisms

    (i) Risk limits

    (ii) Large trader reports

    (iii) Stress tests

    (iv) Portfolio compression

    (v) Clearing members' risk management policies and procedures

    (vi) Additional authority

    3. Settlement procedures

    (a) Daily settlements

    (b) Settlement banks

    (c) Settlement finality

    (d) Recordkeeping

    (e) Netting arrangements

    (f) Physical delivery

    4. Treatment of funds

    (a) Required standards and procedures

    (b) Segregation of funds and assets

    (c) Holding of funds and assets

    (i) Types of assets

    (ii) Valuation

    (iii) Haircuts

    (iv) Concentration limits

    (v) Pledged assets

    (d) Permissible investments

    5. Default rules and procedures

    (a) General

    (b) Default management plan

    (c) Default procedures

    (d) Insolvency of a clearing member

    6. System safeguards

    (a) General

    (i) Definitions

    (ii) Program of risk analysis

    (iii) Elements of program

    (iv) Standards for program

    (v) Business continuity and disaster recovery

    (vi) Location of resources; outsourcing

    (vii) Notification of Commission staff; recordkeeping

    (viii) Testing

    (ix) Coordination of business continuity and disaster recovery

    plan

    (b) SIDCOs

    (i) Determining which DCOs will be subject to enhanced BC-DR

    obligations

    [[Page 3699]]

    (ii) Recovery time objective

    (iii) Geographic diversity

    (iv) Testing

    (v) Effective date

    7. Special enforcement authority over SIDCOs

    C. Additional amendments

    1. Technical amendments to reorganize part 39

    2. Supplemental provisions for proposed Sec. 39.19

    3. Technical amendments to proposed Sec. 39.21

    III. Effective Date

    IV. Section 4(c)

    V. Related Matters

    A. Regulatory Flexibility Act

    B. Paperwork Reduction Act

    C. Cost-benefit analysis

    I. Background

    A. Title VII of the Dodd-Frank Act

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

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

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

    risk, increase transparency, and promote market integrity within the

    financial system by, among other things: (1) Providing for the

    registration and comprehensive regulation of swap dealers and major

    swap participants; (2) imposing clearing and trade execution

    requirements on standardized derivative products; (3) creating rigorous

    recordkeeping and real-time reporting regimes; and (4) enhancing the

    Commission's rulemaking and enforcement authorities with respect to all

    registered entities and intermediaries subject to the Commission's

    oversight.

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

    Act, 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.

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

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

    2010.''

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

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

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

    to be registered and to maintain registration as a DCO.

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

    Modernization Act of 2000 (CFMA).\5\ The Commission did not adopt

    implementing rules and regulations, but instead promulgated guidance

    for DCOs on compliance with the core principles.\6\ Under section

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

    confirmed that the Commission may adopt implementing rules and

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

    the CEA.\7\

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    \5\ See Commodity Futures Modernization Act of 2000, Pub. L.

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

    \6\ See 17 CFR part 39, app. A.

    \7\ Section 8a(5) of the CEA authorizes the Commission to

    promulgate such regulations ``as, in the judgment of the Commission,

    are reasonably necessary to effectuate any of the provisions or to

    accomplish any of the purposes of [the CEA].'' 7 U.S.C. 12a(5).

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    The Commission continues to believe that each DCO should be

    afforded an appropriate level of discretion in determining how to

    operate its business within the statutory framework. At the same time,

    the Commission recognizes that specific, bright-line regulations may be

    necessary in order to facilitate DCO compliance with a given core

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

    clearing system. Accordingly, in developing the proposed regulations,

    the Commission has endeavored to strike an appropriate balance between

    establishing general prudential standards and prescriptive

    requirements.

    In this notice of proposed rulemaking, the Commission proposes to

    adopt regulations to implement six DCO core principles. Those core

    principles, all of which were amended by the Dodd-Frank Act, are C

    (Participant and Product Eligibility), D (Risk Management), E

    (Settlement Procedures), F (Treatment of Funds), G (Default Rules and

    Procedures), and I (System Safeguards).

    B. Title VIII of the Dodd-Frank Act

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

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

    promote financial stability. Section 804 authorizes the Financial

    Stability Oversight Council (Council) to designate entities involved in

    clearing and settlement as systemically important.\8\

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    \8\ See Advance Notice of Proposed Rulemaking Regarding

    Authority to Designate Financial Market Utilities as Systemically

    Important, available at http://www.treasury.gov/initiatives/Pages/FSOC-index.aspx.

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

    prescribe regulations for those DCOs that the Council has determined

    are systemically important. The Commission is proposing to adopt

    enhanced requirements for SIDCOs regarding system safeguards for

    business continuity and disaster recovery in proposed Sec. 39.30.

    Section 807(c) of the Dodd-Frank Act provides the Commission with

    special enforcement authority over SIDCOs, which the Commission is

    proposing to implement in proposed Sec. 39.31.

    C. Dodd-Frank Act Rulemaking Initiative

    This proposed rulemaking is the last in a series of proposed

    rulemakings issued for the purpose of implementing the DCO core

    principles.\9\ Through the proposed regulations, the Commission seeks

    to enhance legal certainty for DCOs, clearing members, and market

    participants by providing a regulatory framework to support DCO risk

    management practices overall and, in turn, strengthen the financial

    integrity of the futures markets and swap markets subject to Commission

    oversight.

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    \9\ See e.g., 75 FR 78185 (Dec. 15, 2010) (Core Principles J,

    Reporting; K, Recordkeeping; L, Public Information; and M,

    Information Sharing); 75 FR 77576 (Dec. 13, 2010) (Core Principles

    A, Compliance; H, Rule Enforcement; N, Antitrust Considerations; and

    R, Legal Risk); 75 FR 63732 (Oct. 18, 2010) (Core Principle P,

    Conflicts of Interest); and 75 FR 63113 (Oct. 14, 2010) (Core

    Principle B, Financial Resources).

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    With this in mind, the Commission also is proposing to establish

    greater uniformity and transparency in the DCO application process by

    adopting a registration application form that will facilitate greater

    efficiency and consistency in processing submissions. The Commission is

    further proposing certain technical amendments to update and conform

    provisions of part 39 to the CEA, as amended by the Dodd-Frank Act.

    The Commission requests comment on all aspects of the rules

    proposed herein, as well as comment on the specific provisions and

    issues highlighted in the discussion below.

    II. Discussion

    A. Registration Procedures

    As proposed in an earlier notice of proposed rulemaking, the

    Commission intends to continue to voluntarily apply a 180-day time

    frame for review of DCO registration applications, but eliminate the

    90-day expedited review period for such applications.\10\ Related to

    this, the Commission is now proposing additional revisions to the

    requirements for DCO registration in order to clarify the application

    submission and review process and to achieve greater efficiency for

    both applicants and the Commission.

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    \10\ See 75 FR at 77586. Although the CEA does not require the

    Commission to review DCO applications within a prescribed time

    period or subject to any prescribed procedures, the Commission

    adopted a 90-day expedited review period and, in the alternative,

    the 180-day time period and procedures specified in section 6(a) of

    the CEA for review of applications for designation of a contract

    market.

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    The Commission is proposing to revise appendix A to part 39,

    ``Application Guidance and Compliance With Core Principles,'' by

    removing the current content and substituting in its

    [[Page 3700]]

    place Form DCO, which would be comprised of two parts: (i) An

    application cover sheet for basic information about the DCO applicant,

    its ownership structure, officers, and application contact information,

    and (ii) instructions for a series of accompanying exhibits that would

    contain information demonstrating compliance with each of the DCO core

    principles. An application for DCO registration would consist of the

    completed Form DCO, including all applicable exhibits, and any

    supplemental information submitted to the Commission.\11\

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    \11\ In separate rulemakings, the Commission is proposing

    applications for designation as a contract market and registration

    as a swap execution facility. This approach is similar to the SEC's

    use of the Form CA for securities clearing agency applications,

    available at https://www.sec.gov.

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    The Commission's objective in adopting an application form is to

    streamline the DCO registration process, having learned from experience

    that the general guidance contained in the current appendix A does not

    provide sufficiently specific instructions to applicants. As a result,

    the registration process has been prolonged in some cases because of

    the need for Commission staff to provide applicants with additional

    guidance about the nature of the information that is required in order

    for the Commission to conclude that the applicant has demonstrated its

    ability to comply with the core principles.

    The Commission proposes to amend Sec. 39.3(d), ``Guidance for

    applicants and registrants,'' and redesignate it as Sec. 39.3(a)(2).

    The amended provision would state that any person seeking to register

    as a DCO would be required to submit a completed Form DCO as provided

    in appendix A to part 39, including all applicable exhibits. Use of the

    Form DCO also would be required for amendments to a pending application

    or requests for an amendment to an existing DCO registration. Section

    39.3(a)(2) would clarify that an applicant, upon its own initiative,

    could file additional information that might be necessary or helpful to

    the Commission in processing the application. The Commission strongly

    encourages prospective applicants to submit any additional information

    that could be useful to the Commission.

    The proposed appendix A containing the Form DCO is set forth in

    this notice of proposed rulemaking. The Commission requests comment on

    the potential benefits and disadvantages of requiring the use of a

    standardized application. In addition, the Commission requests comment

    on the content of the proposed application including specific exhibits.

    Proposed Sec. 39.3(a)(3) would clarify that the filing of a

    completed Form DCO would be a minimum requirement and would not create

    a presumption that the application is materially complete \12\ or that

    supplemental information will not be required by the Commission. At any

    time during the application review process, the Commission may request

    that the applicant submit supplemental information in order for the

    Commission to process the application.

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    \12\ Section 6(a) of the CEA, 7 U.S.C. 8(a), provides that the

    Commission must approve or deny an application for designation of a

    contract market within 180 days of the filing of the application.

    However, ``[i]f the Commission notifies the person that its

    application is materially incomplete and specifies the deficiencies

    in the application, the running of the 180-day period shall be

    stayed from the time of such notification until the application is

    resubmitted in completed form.''

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    Under proposed Sec. 39.3(a)(4), an applicant would be required to

    promptly amend its Form DCO if it discovered a material omission or

    error, or if there is a material change in any information already

    provided to the Commission.

    Proposed Sec. 39.3(a)(5) would largely incorporate applicable

    language of Sec. 40.8(a), which identifies those parts of a DCO

    application that are available to the public.\13\ Those parts are: the

    first page of the cover sheet, proposed rules (Exhibit A-1), the

    applicant's regulatory compliance chart (Exhibit A-2), a narrative

    summary of the applicant's proposed clearing activities (Exhibit A-3),

    documents establishing the applicant's legal status (Exhibit A-8),

    documents setting forth the applicant's corporate and governance

    structure (Exhibits A-7 and Q), and any other part of the application

    not covered by a request for confidential treatment subject to FOIA and

    filed in accordance with the requirements of Sec. 145.9 of the

    Commission's regulations.\14\ The Commission notes that it expects to

    continue its practice of posting DCO applications on its Web site for a

    public comment period (typically 30 days).

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    \13\ See 75 FR 67282 (Nov. 2, 2010) (provisions common to

    registered entities).

    \14\ See 5 U.S.C. 552 and Sec. 145.9 of the Commission's

    regulations (regarding petitions for confidential treatment of

    information submitted to the Commission).

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    Proposed Sec. 39.3(b)(1) would stay the running of the 180-day

    review period if an application was materially incomplete, consistent

    with the Commission's authority with respect to the designation of a

    contract market under section 6(a) of the CEA. The delegation provision

    of current Sec. 39.3(g) would be redesignated as paragraph (b)(2).

    This provision authorizes the Director of the Division of Clearing and

    Intermediary Oversight or the Director's designee, with the concurrence

    of the General Counsel or the General Counsel's designee, to notify an

    applicant that the application is materially incomplete and the running

    of the 180-day period is stayed.

    The Commission requests comment on all aspects of the proposed

    amendments to Sec. 39.3, including the costs associated with the

    application process and possible means for streamlining the process

    further.

    B. Implementation of DCO Core Principles

    1. Participant and Product Eligibility

    Core Principle C, as amended by the Dodd-Frank Act,\15\ requires

    each DCO to establish appropriate admission and continuing eligibility

    standards for members of, and participants in, the DCO,\16\ including

    sufficient financial resources and operational capacity to meet the

    obligations arising from participation. Core Principle C further

    requires that such participation and membership requirements be

    objective, be publicly disclosed, and permit fair and open access. Core

    Principle C also requires that each DCO establish and implement

    procedures to verify compliance with each participation and membership

    requirement, on an ongoing basis. With respect to product eligibility,

    Core Principle C requires that each DCO establish appropriate standards

    for determining the eligibility of agreements, contracts, or

    transactions submitted to the DCO for clearing.\17\ The Commission is

    proposing to adopt

    [[Page 3701]]

    Sec. 39.12 to establish requirements that a DCO would have to meet in

    order to comply with Core Principle C.

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    \15\ Section 5b(c)(2)(C) of the CEA; 7 U.S.C. 7a-1(c)(2)(C)

    (Core Principle C).

    \16\ Core Principle C, as well as the other core principles that

    are discussed herein, refer to ``members of, and participants in'' a

    DCO. The Commission interprets this phrase to mean persons with

    clearing privileges, and has used the term ``clearing member'' in

    describing the requirements of each core principle and in the text

    of the proposed regulations described herein. In a separate notice

    of proposed rulemaking, the Commission has proposed to amend the

    definition of ``clearing member'' in Sec. 1.3(c) to mean ``any

    person that has clearing privileges such that it can process, clear

    and settle trades through a derivatives clearing organization on

    behalf of itself or others. The derivatives clearing organization

    need not be organized as a membership organization.'' See 75 FR at

    77585.

    \17\ Prior to amendment by the Dodd-Frank Act, Core Principle C

    provided that

    [t]he applicant shall establish--

    (i) appropriate admission and continuing eligibility standards

    (including appropriate minimum financial requirements) for members

    of and participants in the organization; and

    (ii) appropriate standards for determining eligibility of

    agreements, contracts, or transactions submitted to the applicant.

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    (a) Participant eligibility.

    As noted above, Core Principle C requires that a DCO's admission

    and continuing eligibility standards for clearing members must be

    objective and publicly disclosed.\18\ Proposed Sec. 39.12(a) would

    codify these requirements, and would make clear that such requirements

    must be risk-based.

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    \18\ Section 5b(c)(2)(C)(iii) of the CEA; 7 U.S.C. 7a-

    1(c)(2)(C)(iii) (Core Principle C).

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    (i) Fair and open access.

    Core Principle C mandates that participation requirements must

    ``permit fair and open access.'' \19\ It also mandates that clearing

    members must have ``sufficient financial resources and operational

    capacity to meet obligations arising from participation in the

    derivatives clearing organization.'' \20\ Although there is potential

    for tension between these goals, the Commission believes that they can

    be harmonized. Proposed Sec. 39.12 is designed to ensure that

    participation requirements do not unreasonably restrict any entity from

    becoming a clearing member while, at the same time, limiting risk to

    the DCO and its clearing members. The Commission believes that more

    widespread participation could reduce the concentration of clearing

    member portfolios and diversify risk. It could also increase

    competition by allowing more entities to become clearing members.

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    \19\ Id.

    \20\ Id.

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    Proposed Sec. 39.12(a)(1) would require a DCO to establish

    participation requirements that permit fair and open access. To achieve

    fair and open access, proposed Sec. 39.12(a)(1)(i) would prohibit a

    DCO from adopting a particular restrictive participation requirement if

    it could adopt a less restrictive requirement that would not materially

    increase risk to the DCO or its clearing members.

    Proposed Sec. 39.12(a)(1)(ii) would require a DCO to permit a

    market participant to become a clearing member if it met the DCO's

    participation requirements. Proposed Sec. 39.12(a)(1)(iii) would

    prohibit participation requirements that have the effect of excluding

    or limiting clearing membership of certain types of market participants

    unless the DCO can demonstrate that the restriction is necessary to

    address credit risk or deficiencies in the participants' operational

    capabilities that would prevent them from fulfilling their obligations

    as clearing members. Section 39.12(a)(1)(iv) would prohibit a DCO from

    requiring that clearing members must be swap dealers. Section

    39.12(a)(1)(v) would prohibit a DCO from requiring that clearing

    members maintain a swap portfolio of any particular size, or that

    clearing members meet a swap transaction volume threshold.

    The access and participation requirements discussed above meet or

    exceed international recommendations.\21\

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    \21\ In November 2004, the Task Force on Securities Settlement

    Systems, jointly established by the Committee on Payment and

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

    countries and the Technical Committee of the International

    Organization of Securities Commissions (IOSCO), issued

    Recommendations for Central Counterparties. CPSS & Technical Comm.

    of IOSCO Recommendations for Central Counterparties, CPSS Publ'n No.

    64 (Nov. 2004), available at http://www.bis.org/publ/cpss64.pdf

    (CPSS-IOSCO Recommendations). CPSS-IOSCO Recommendation 2 provides,

    in part, that ``[a] CCP's participation requirements should be

    objective, publicly disclosed, and permit fair and open access.''

    The CPSS-IOSCO Recommendations further state that

    [t]o avoid discriminating against classes of participants and

    introducing competitive distortions, participation requirements

    should be objective and avoid limiting competition through

    unnecessarily restrictive criteria, thereby permitting fair and open

    access within the scope of services offered by the CCP. [footnote

    omitted] Participation requirements that limit access on grounds

    other than risks should be avoided.

    (CPSS-IOSCO Recommendations, pg. 16). The Commission notes that

    CPSS and IOSCO are currently reviewing the CPSS-IOSCO

    Recommendations, which may be revised.

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    (ii) Financial resources.

    Core Principle C mandates that participation requirements must

    ensure that clearing members have ``sufficient financial resources and

    operational capacity to meet obligations arising from participation in

    the [DCO].'' \22\ Proposed Sec. 39.12(a)(2)(i) would require a DCO to

    establish participation requirements that require clearing members to

    have access to sufficient financial resources to meet obligations

    arising from participation in the DCO in extreme but plausible market

    conditions. The financial resources could include a clearing member's

    capital, a guarantee from a clearing member's parent, or a credit

    facility funding arrangement. The proposed regulation would further

    specify that, for purposes of proposed Sec. 39.12(a)(2), ``capital''

    would mean adjusted net capital as defined in Sec. 1.17 of the

    Commission's regulations, for futures commission merchants (FCMs), and

    net capital as defined in SEC rule 15c3-1, for broker-dealers, or any

    similar risk adjusted capital calculation for all other prospective

    clearing members.

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    \22\ Section 5b(c)(2)(C)(i)(I) of the CEA; 7 U.S.C. 7a-

    1(c)(2)(C)(i)(I).

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    The Commission invites comment regarding whether a guarantee or a

    credit facility funding arrangement is sufficiently reliable and liquid

    such that it should be considered as a resource that would be available

    to meet obligations arising from participation in a DCO in extreme but

    plausible market conditions.

    Proposed Sec. 39.12(a)(2)(ii) would require a DCO to establish

    capital requirements that are based on objective, transparent, and

    commonly accepted standards that appropriately match capital to risk.

    The proposed regulation would require capital requirements to be

    scalable so that they are proportional to the risks posed by clearing

    members.

    With respect to persons that seek clearing membership in order to

    clear swaps, proposed Sec. 39.12(a)(2)(iii) would specify that a DCO

    is not permitted to set a minimum capital requirement of more than $50

    million.

    If the capital requirement is satisfied by a prospective clearing

    member, the DCO is prohibited from making a determination that the

    prospective clearing member does not satisfy its scalable capital

    requirements. Proposed Sec. Sec. 39.12(a)(2)(ii) and 39.12(a)(2)(iii),

    considered together, would require a DCO to admit any person to

    clearing membership for the purpose of clearing swaps, if the person

    had $50 million in capital, but would permit a DCO to require each

    clearing member to hold capital proportional to its risk exposure.\23\

    Thus, if a clearing member's risk exposure were to increase in a non-

    linear manner, the DCO could increase the clearing member's

    corresponding scalable capital requirement in a non-linear manner.

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    \23\ Conversely, as discussed, infra, in section II.B.2.g.i,

    proposed Sec. 39.13(h)(1)(i) would require a DCO to impose risk

    limits on a clearing member to prevent a clearing member from

    carrying positions where the risk exposure of those positions

    exceeded a threshold specified by the DCO relative to the financial

    resources of the clearing member, the DCO, or both.

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

    The Commission requests comment on whether establishing a capital

    threshold is an effective approach to promoting fair and open access.

    If it is, the Commission further requests views on whether the $50

    million figure is an appropriate amount and, if not, what alternative

    amount might be more appropriate.

    (iii) Operational requirements.

    Proposed Sec. 39.12(a)(3) would require a DCO to establish

    participation requirements that ensure that clearing members have

    adequate operational

    [[Page 3702]]

    capacity to meet obligations arising from participation in the DCO. The

    requirements would have to include, at a minimum, the ability to

    process expected volumes and values of transactions cleared by the

    clearing member within required time frames, including at peak times

    and on peak days; the ability to fulfill collateral, payment, and

    delivery obligations imposed by the DCO; and the ability to participate

    in default management activities under the rules of the DCO and in

    accordance with Sec. 39.16 of the Commission's regulations.

    (iv) Monitoring, reporting, and enforcement.

    Strong participation requirements will not limit risk if clearing

    members do not satisfy the requirements on an ongoing basis.

    Accordingly, Core Principle C requires each DCO to ``establish and

    implement procedures to verify, on an ongoing basis, the compliance of

    each participation and membership requirement of the derivatives

    clearing organization.'' \24\ Proposed Sec. 39.12(a)(4) would codify

    this requirement.

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

    \24\ See section 5b(c)(2)(C)(ii) of the CEA; 7 U.S.C. 7a-

    1(c)(2)(C)(ii). Based on context, the Commission interprets the

    phrase ``compliance of each participation and membership

    requirement'' to mean compliance ``with'' each participation and

    membership requirement.

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

    A DCO cannot effectively monitor clearing members if it is not

    adequately informed about their financial status. Proposed Sec.

    39.12(a)(5) would address this concern. Specifically, proposed Sec.

    39.12(a)(5)(i) would require a DCO to require all of its clearing

    members, including non-FCMs, to file periodic financial reports with

    the DCO that contain any financial information that the DCO determines

    is necessary to assess whether participation requirements are met on an

    ongoing basis. A DCO would have to require its clearing members that

    are FCMs to file the financial reports that are specified in Sec. 1.10

    of the Commission's regulations with the DCO. The proposed regulation

    also would require a DCO to review these financial reports for risk

    management purposes. Proposed Sec. 39.12(a)(5)(i) would further

    require a DCO to require its clearing members that are not FCMs to make

    the periodic financial reports that they file with the DCO available to

    the Commission upon the Commission's request. Proposed Sec.

    39.12(a)(5)(ii) would require a DCO to adopt rules that require a

    clearing member to provide to the DCO, in a timely manner, information

    that concerns any financial or business developments that could

    materially affect the clearing member's ability to continue to comply

    with participation requirements.

    Finally, proposed Sec. 39.12(a)(6) would require a DCO to have the

    ability to enforce compliance with its participation requirements. In

    particular, the DCO would be required to establish procedures for the

    suspension and orderly removal of clearing members that no longer meet

    the DCO's participation requirements.

    (b) Product eligibility.

    Core Principle C requires each DCO to establish ``appropriate

    standards for determining the eligibility of agreements, contracts, or

    transactions submitted to the [DCO] for clearing.'' \25\ Proposed Sec.

    39.12(b)(1) would require a DCO to establish appropriate requirements

    for determining the eligibility of agreements, contracts, or

    transactions submitted to the DCO for clearing, taking into account the

    DCO's ability to manage the risks associated with such agreements,

    contracts, or transactions. Factors to be considered in determining

    product eligibility would include, but would not be limited to: (i)

    trading volume; (ii) liquidity; (iii) availability of reliable prices;

    (iv) ability of market participants to use portfolio compression \26\

    with respect to a particular swap product; (v) ability of the DCO and

    clearing members to gain access to the relevant market for purposes of

    creating and liquidating positions; (vi) ability of the DCO to measure

    risk for purposes of setting margin requirements; and (vii) operational

    capacity of the DCO and clearing members to address any unique risk

    characteristics of a product.

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

    \25\ Section 5b(c)(2)(C)(i)(II) of the CEA; 7 U.S.C. 7a-

    1(c)(2)(C)(i)(II).

    \26\ Portfolio compression is a mechanism by which superfluous

    transactions among two or more counterparties are compressed,

    terminated and replaced with a smaller number of transactions of

    decreased notional principal value in an effort to reduce the risk,

    cost, and inefficiency of maintaining unnecessary transactions on

    the counterparties' books.

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

    Section 2(h)(1)(B) of the CEA requires a DCO to adopt rules

    providing that all swaps with the same terms and conditions submitted

    to the DCO for clearing are economically equivalent within the DCO and

    may be offset with each other within the DCO. Section 2(h)(1)(B)

    further requires a DCO to provide for non-discriminatory clearing of a

    swap executed bilaterally or on or subject to the rules of an

    unaffiliated designated contract market (DCM) or swap execution

    facility (SEF). Proposed Sec. 39.12(b)(2) would codify these

    requirements in the Commission's regulations.

    Proposed Sec. 39.12(b)(3) would require a DCO to select contract

    unit sizes that maximize liquidity, open access, and risk management.

    To the extent appropriate to further these objectives, the proposed

    regulation would require a DCO to select contract units for clearing

    purposes that may be smaller than the contract units in which trades

    submitted for clearing were executed. The contract unit size of a

    particular swap executed bilaterally may reflect the immediate

    circumstances of the two parties to the transaction. Once submitted for

    clearing, it may be possible to split the trade into smaller units

    without compromising the interests of the two original parties. Smaller

    units can promote liquidity by permitting more parties to trade the

    product, facilitate open access by permitting more clearing members to

    clear the product, and aid risk management by enabling a DCO, in the

    event of a default, to have more potential counterparties for

    liquidation.

    Finally, proposed Sec. 39.12(b)(4) would require each DCO that

    clears swaps to have rules stating that upon acceptance of a swap by

    the DCO for clearing, (i) the original swap is extinguished, (ii) it is

    replaced by equal and opposite swaps between clearing members and the

    DCO, (iii) all terms of the cleared swaps must conform to templates

    established under DCO rules, and (iv) if a swap is cleared by a

    clearing member on behalf of a customer, all terms of the swap, as

    carried in the customer account on the books of the clearing member,

    must conform to the terms of the cleared swap established under the

    DCO's rules.

    The purpose of this provision is to encourage the standardization

    of swaps and to avoid any differences between the terms of a swap as

    carried at the DCO level and as carried at the clearing member level.

    Any such differences would raise both customer protection and systemic

    risk concerns. From a customer protection standpoint, if the terms of

    the swap at the customer level differ from those at the clearing level,

    then the customer position cannot really be said to have been cleared.

    If the customer position differs from the cleared position, the

    customer may not receive the full transparency and liquidity benefits

    of clearing. Similarly, from a systemic perspective, any differences

    could diminish overall price discovery and liquidity. Standardizing the

    terms of a swap upon clearing would facilitate trading and promote the

    mitigation of risk for all participants in the swap markets.

    Furthermore, standardization would support the requirement in section

    2(h)(1)(B) of the CEA and proposed Sec. 39.12(b)(2) that a DCO must

    adopt rules providing that all swaps with the same terms and conditions

    submitted to the DCO are

    [[Page 3703]]

    economically equivalent within the DCO and may be offset with each

    other.

    2. Risk Management Requirements

    Core Principle D, as amended by the Dodd-Frank Act,\27\ requires

    each DCO to ensure that it possesses the ability to manage the risks

    associated with discharging the responsibilities of the DCO through the

    use of appropriate tools and procedures. It further requires each DCO

    to measure its credit exposures to each clearing member not less than

    once during each business day and to monitor each such exposure

    periodically during the business day. Core Principle D also requires

    each DCO to limit its exposure to potential losses from defaults by

    clearing members, through margin requirements and other risk control

    mechanisms, to ensure that its operations would not be disrupted and

    that nondefaulting clearing members would not be exposed to losses that

    nondefaulting clearing members cannot anticipate or control. Finally,

    Core Principle D requires that the margin that the DCO requires from

    each clearing member must be sufficient to cover potential exposures in

    normal market conditions and that each model and parameter used in

    setting such margin requirements must be risk-based and reviewed on a

    regular basis.\28\ The Commission is proposing to adopt Sec. 39.13 to

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

    with Core Principle D.

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

    \27\ Section 5b(c)(2)(D) of the CEA; 7 U.S.C. 7a-1(c)(2)(D)

    (Core Principle D).

    \28\ Prior to amendment by the Dodd-Frank Act, Core Principle D

    provided that ``[t]he applicant shall have the ability to manage the

    risks associated with discharging the responsibilities of a

    derivatives clearing organization through the use of appropriate

    tools and procedures.''

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

    (a) General.

    Proposed Sec. 39.13(a) would require a DCO to ensure that it

    possesses the ability to manage the risks associated with discharging

    its responsibilities through the use of appropriate tools and

    procedures. The specific requirements that are addressed in the

    remainder of proposed Sec. 39.13, in addition to margin requirements,

    describe various tools and procedures that the Commission believes are

    necessary to ensure that DCOs are able to effectively manage the risks

    that are inherent in their roles as central counterparties. Many of

    those requirements reflect the current practices of most or all DCOs,

    and others may describe enhancements that would assist existing and new

    DCOs in mitigating their risks as they assume new responsibilities in

    connection with the clearing of swaps.

    (b) Risk management framework.

    Proposed Sec. 39.13(b) would require a DCO to establish and

    maintain written policies, procedures, and controls, approved by its

    Board of Directors, which establish an appropriate risk management

    framework that, at a minimum, clearly identifies and documents the

    range of risks to which the DCO is exposed, addresses the monitoring

    and management of the entirety of those risks, and provides a mechanism

    for internal audit. Those risks may include, but are not limited to,

    legal risk, credit risk, liquidity risk, custody and investment risk,

    concentration risk, default risk, operational risk, market risk, and

    business risk. A DCO would be required to regularly review its risk

    management framework and update it as necessary.

    The Commission believes that a DCO should adopt a comprehensive and

    documented risk management framework that addresses all of the various

    types of risks to which it is exposed, including the manner in which

    they may relate to each other. A DCO's risk management framework should

    be subject to the approval of its Board of Directors, as the Board is

    ultimately responsible for managing a DCO's risks. The Commission is

    proposing to leave it to the discretion of each DCO to determine the

    frequency with which it reviews its risk management framework as long

    as it is reviewed on a regular basis.

    (c) Chief risk officer.

    Proposed Sec. 39.13(c) would require a DCO to have a chief risk

    officer who would be responsible for the implementation of the risk

    management framework and for making appropriate recommendations

    regarding the DCO's risk management functions to the DCO's Risk

    Management Committee or Board of Directors, as applicable. In a

    separate rulemaking, the Commission has proposed to adopt Sec.

    39.13(d) to require DCOs to have a Risk Management Committee with

    defined composition requirements and specified minimum functions.\29\

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

    \29\ See 75 FR at 63750. In that proposed rulemaking, the

    provisions relating to the Risk Management Committee were designated

    as Sec. 39.13(g). In the final rulemaking, the provisions will be

    redesignated as Sec. 39.13(d).

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

    DCOs generally have a chief risk officer or an individual who

    performs such a function, and the Commission believes this is a ``best

    practice.'' Although Core Principle D does not specifically require a

    DCO to have a chief risk officer, the Commission believes that given

    the importance of the risk management function, each DCO should have a

    member of senior management who is responsible for overseeing the

    implementation of the DCO's comprehensive risk management framework and

    making appropriate recommendations regarding risk management issues to

    the DCO's Risk Management Committee (for matters within its

    jurisdiction) or directly to the Board.

    The CEA, as amended by the Dodd-Frank Act, requires a DCO to have a

    chief compliance officer with defined responsibilities.\30\ These

    requirements have been addressed in a separate rulemaking.\31\ Given

    the importance of the risk management function and the comprehensive

    nature of the responsibilities of the chief compliance officer as

    defined in the statute, the Commission expects that the chief risk

    officer and the chief compliance officer would be two different

    individuals.

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

    \30\ See section 5b(i) of the CEA; 7 U.S.C. 7a-1(i).

    \31\ 75 FR at 77587.

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

    (d) Measurement of credit exposure.

    Proposed Sec. 39.13(e) would require a DCO to measure and monitor

    its credit exposures to its clearing members. The proposed regulation

    uses the term ``credit exposure'' in order to be consistent with the

    statutory language of Core Principle D. In this context, ``credit

    exposure'' does not refer to an extension of credit by the DCO to a

    clearing member. Rather, it refers to any amounts that a clearing

    member would owe to a DCO if the clearing member were to default in its

    obligations to the DCO. It includes both current exposures and

    potential future exposures.

    Specifically, Sec. 39.13(e) would require a DCO to: (1) Measure

    its credit exposure to each clearing member and mark to market such

    clearing member's open positions at least once each business day; and

    (2) monitor its credit exposure to each clearing member periodically

    during each business day. Proposed Sec. 39.13(e) goes hand in hand

    with proposed Sec. 39.14(b), which addresses daily settlements based

    on a DCO's measurement of its credit exposures to its clearing

    members.\32\

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

    \32\ See infra section II.B.3.a of this notice.

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

    (e) Limitation of exposure to potential losses from defaults.

    Proposed Sec. 39.13(f) would require a DCO, through margin

    requirements and other risk control mechanisms, to limit its exposure

    to potential losses from defaults by its clearing members to ensure

    that: (1) Its operations would not be disrupted; and (2) nondefaulting

    clearing members would not be exposed to losses that nondefaulting

    clearing members cannot anticipate or control. The language of proposed

    Sec. 39.13(f) is virtually identical to the language in

    [[Page 3704]]

    section 5b(c)(2)(D)(iii) of the CEA, as amended by the Dodd-Frank Act.

    (f) Margin requirements.

    (i) General.

    As specified in section 5b(c)(2)(D)(iv) of the CEA, proposed Sec.

    39.13(g)(1) would require that the initial margin that a DCO requires

    from each clearing member must be sufficient to cover potential

    exposures in normal market conditions and that each model and parameter

    used in setting initial margin requirements must be risk-based and

    reviewed on a regular basis.\33\ The Commission has not defined

    ``normal market conditions'' in the proposed regulation. Current

    international recommendations define ``normal market conditions'' as

    ``price movements that produce changes in exposures that are expected

    to breach margin requirements or other risk control mechanisms only 1%

    of the time, that is, on average on only one trading day out of 100.''

    \34\ The Commission invites comment regarding whether a definition of

    ``normal market conditions'' should be included in the proposed

    regulation and, if so, how normal market conditions should be defined.

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

    \33\ The Commission has proposed to define ``initial margin'' as

    ``money, securities, or property posted by a party to a futures,

    option, or swap as performance bond to cover potential future

    exposures arising from changes in the market value of the

    position.'' See 75 FR at 77585 (proposing Sec. 1.3(lll)).

    \34\ CPSS-IOSCO Recommendations, pg. 21.

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

    (ii) Methodology and coverage.

    Proposed Sec. 39.13(g)(2) would set forth requirements regarding

    margin methodology and coverage. First, it would require a DCO to

    establish initial margin requirements that are commensurate with the

    risks of each product or portfolio, including any unique

    characteristics of, or risks associated with, particular products or

    portfolios. In particular, proposed 39.13(g)(2)(i) would require a DCO

    that clears credit default swaps (CDS) to appropriately address jump-

    to-default risk in setting initial margins.\35\ With the exception of

    jump-to-default risk, the Commission has not defined specific risks

    that a DCO should consider in light of the fact that such risks would

    be product-specific and portfolio-specific. In addition, there may be

    risks that might apply to products or portfolios that are cleared in

    the future that cannot be anticipated at this time. The Commission

    invites comment regarding whether there are specific risks that should

    be identified and addressed in the proposed regulation in addition to

    jump-to-default risk.

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

    \35\ Jump-to-default risk refers to the possibility that a CDS

    portfolio with large net sales of protection on an underlying

    reference entity could experience significant losses over a very

    short period of time following an unexpected event of default by the

    reference entity.

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

    Proposed Sec. 39.13(g)(2)(ii) would require a DCO to use margin

    models that generate initial margin requirements sufficient to cover

    the DCO's potential future exposures to clearing members based on price

    movements in the interval between the last collection of variation

    margin \36\ and the time within which the DCO estimates that it would

    be able to liquidate a defaulting clearing member's positions

    (liquidation time). A DCO would be required to use a liquidation time

    that is a minimum of five business days for cleared swaps that are not

    executed on a DCM, whether the swaps are carried in a customer account

    subject to section 4d(a) or 4d(f) of the CEA, or a house account.\37\ A

    DCO would be required to use a liquidation time that is a minimum of

    one business day for all other products that it clears, although it

    would be required to use longer liquidation times, if appropriate,

    based on the unique characteristics of particular products or

    portfolios.

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

    \36\ The Commission has proposed to define ``variation margin''

    as ``a payment made by a party to a futures, option, or swap to

    cover the current exposure arising from changes in the market value

    of the position since the trade was executed or the previous time

    the position was marked to market.'' See 75 FR at 77585 (proposing

    Sec. 1.3(ooo)).

    \37\ See infra section II.B.4.b of this notice, discussing

    commingling of customer futures and cleared swaps positions.

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

    A minimum of one business day is the current standard that DCOs

    generally apply to futures and options on futures contracts. The

    Commission believes that a minimum of five business days is appropriate

    for cleared swaps that are not executed on a DCM in that such a time

    period may be necessary to close out swap positions in a cost-effective

    manner.\38\ Several clearing organizations currently use a five-day

    liquidation time in determining margin requirements for certain cleared

    swaps. The Commission invites comment regarding whether the minimum

    liquidation times specified in proposed Sec. 39.13(g)(2)(ii) are

    appropriate, or whether there are minimum liquidation times that are

    more appropriate.

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

    \38\ Pursuant to section(s) 4(c) and/or 4d of the CEA, the

    Commission has previously issued several orders allowing funds

    margining cleared swaps to be commingled with funds margining

    futures and options on futures. In those orders, the Commission

    permitted such swaps to be margined using liquidation times that

    were less than five business days. See, e.g., 74 FR 12316 (Mar. 24,

    2009) (corn, wheat and soybean swaps); 73 FR 77015 (Dec. 18, 2008)

    (coffee, sugar and cocoa swaps); and Order of the Commodity Futures

    Trading Commission, dated Sep. 26, 2008, entitled ``Treatment of

    Funds Held in Connection with the Clearing of Over-the-Counter

    Products by The Chicago Mercantile Exchange,'' available at http://www.cftc.gov/stellent/groups/public/@requestsandactions/documents/ifdocs/cbot4dorder9-26-08.pdf (ethanol swaps). The Commission

    intends to grandfather the swaps subject to previously issued

    orders, such that the relevant liquidation time periods for those

    swaps would continue to be governed by the terms of the orders.

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

    Proposed Sec. 39.13(g)(2)(iii) would require that the actual

    coverage of the initial margin requirements produced by a DCO's margin

    models, along with projected measures of the models' performance, would

    have to meet a confidence level of at least 99%, based on data from an

    appropriate historic time period with respect to: (A) Each product that

    is margined on a product basis; (B) each spread within or between

    products for which there is a defined spread margin rate, as described

    in proposed Sec. 39.13(g)(3); (C) each account held by a clearing

    member at the DCO, by customer origin and house origin, and (D) each

    swap portfolio, by beneficial owner. These requirements meet or exceed

    international recommendations.\39\

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

    \39\ For example, on September 15, 2010, the European Commission

    (EC) proposed the European Market Infrastructure Regulation (EMIR),

    available at http://ec.europa.eu/internal_market/financial-markets/docs/derivatives/20100915_proposal_en.pdf, ``to ensure

    implementation of the G20 commitments to clear standardized

    derivatives [which can be accessed at http://www.g20.org/Documents/pittsburgh_summit_leaders_statement_250909.pdf], and that

    Central Counterparties (CCPs) comply with high prudential standards

    * * *,'' among other things, and expressed its intent to be

    consistent with the Dodd-Frank Act. (EMIR, pg. 2-3). The EMIR

    requires that margins ``* * * shall be sufficient to cover losses

    that result from at least 99 per cent of the exposures movements

    over an appropriate time horizon . * * *'' (EMIR, Article 39,

    paragraph 1, pg. 46).

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

    The Commission recognizes that while some DCOs generally apply a

    99% confidence level to some or all products that they clear, other

    DCOs apply a confidence level of between 95% and 99% with respect to

    certain products. In addition, certain DCOs may achieve an average

    confidence level of 99% across all products that they clear, although

    not every product may meet the 99% confidence level. The Commission

    invites comment regarding whether a confidence level of 99% is

    appropriate with respect to all applicable products, spreads, accounts,

    and swap portfolios.\40\

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

    \40\ For example, the CPSS-IOSCO Recommendations state that

    ``[m]argin requirements for new and low-volume products might be set

    at a lower coverage level [than the major products cleared by a CCP]

    if the potential losses resulting from such products are minimal.''

    (CPSS-IOSCO Recommendations, pg. 23).

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

    Proposed Sec. 39.13(g)(2)(iv) does not specify the historic time

    period that a DCO would have to use when calculating a 99% confidence

    level for any particular product, account, or portfolio. Rather, it

    would permit each

    [[Page 3705]]

    DCO to exercise its discretion with respect to the appropriate time

    periods that should be used in each instance, based on the

    characteristics, including volatility patterns, as applicable, of the

    products, spreads, accounts, or portfolios.

    (iii) Independent validation.

    Historically, many U.S. DCOs have used Chicago Mercantile

    Exchange's (CME) proprietary risk-based portfolio margining system,

    Standard Portfolio Analysis of Risk[supreg] (SPAN) as the basis for

    their margin models for futures and options. However, there is at least

    one other margin model that is currently being used for futures and

    options, and there are also multiple margin models that DCOs are using

    for swaps that are currently cleared. As DCOs begin to clear additional

    swaps it can be anticipated that they will develop new margin models to

    address the risks of particular products.

    Proposed Sec. 39.13(g)(3) would require that, on a regular basis,

    a DCO's systems for generating initial margin requirements, including

    the DCO's theoretical models, would have to be reviewed and validated

    by a qualified and independent party. A validation should include a

    comprehensive analysis to ensure that such systems and models achieve

    their intended goals. Although the proposed regulation does not define

    the term ``regular basis,'' the Commission would expect that, at a

    minimum, a DCO would obtain such an independent validation prior to

    implementation of a new margin model and when making any significant

    change to a model that is in use by the DCO. Significant changes would

    be those that could materially affect the nature or level of risks to

    which a DCO would be exposed. The Commission would expect a DCO to

    obtain an independent validation prior to any significant change that

    would relax risk management standards. However, if a DCO needed to

    adopt a significant change in an expedited manner to enhance risk

    protections, the Commission would expect the DCO to obtain an

    independent validation promptly after the change was made.

    The Commission has not proposed a definition of the term

    ``qualified and independent party.'' The Commission invites comment

    regarding whether a qualified and independent party must be a third

    party or whether there may be circumstances under which an employee of

    the relevant DCO could be considered to be independent.

    (iv) Spread margins.

    Proposed Sec. 39.13(g)(4)(i) would permit a DCO to allow

    reductions in initial margin requirements for related positions (spread

    margins), if the price risks with respect to such positions were

    significantly and reliably correlated. Under the proposed regulation,

    the price risks of different positions would only be considered to be

    reliably correlated if there was a theoretical basis for the

    correlation in addition to an exhibited statistical correlation. A non-

    exclusive list of possible theoretical bases includes the following:

    (A) The products on which the positions are based are complements of,

    or substitutes for, each other; (B) one product is a significant input

    into the other product(s); (C) the products share a significant common

    input; or (D) the prices of the products are influenced by common

    external factors. An example of such an external factor might be

    interest rates. An offset may not be based solely on the fact that the

    prices of certain products have exhibited a statistical correlation in

    the past. The DCO would be required to be able to articulate a

    theoretical explanation for such a correlation. The Commission requests

    comment regarding the appropriateness of requiring a theoretical basis

    for the correlation between related positions before reductions in

    initial margin requirements would be permitted.

    Proposed Sec. 39.13(g)(4)(ii) would require a DCO to regularly

    review its spread margins and the correlations on which they are based.

    (v) Price data.

    Proposed Sec. 39.13(g)(5) would require a DCO to have a reliable

    source of timely price data to measure its credit exposure accurately,

    and to have written procedures and sound valuation models for

    addressing circumstances where pricing data is not readily available or

    reliable. Both initial margin and variation margin calculations require

    timely and reliable price data to be effective. DCOs should rely on

    prices from continuous, transparent, and liquid markets, wherever

    possible. It may be difficult to determine current market prices for

    certain over-the-counter (OTC) products if there is no continuous

    liquid market or if bid-ask spreads are volatile. In these

    circumstances, DCOs would need to ensure that they would be able to

    measure their credit exposures accurately through the use of sound

    valuation models. The nature of such valuation models would necessarily

    depend on the particular products and the source of any relevant

    pricing data.

    (vi) Daily review and back tests.

    Daily review and periodic back testing are essential to enable a

    DCO to ensure that its margin models continue to provide adequate

    coverage of the DCO's risk exposures to its clearing members. Proposed

    Sec. 39.13(g)(6) would require a DCO to determine the adequacy of its

    initial margin requirements for each product, on a daily basis, with

    respect to those products that are margined on a product basis.

    Proposed Sec. 39.13(g)(7) would require a DCO to conduct certain back

    tests. The Commission has proposed to define ``back test'' in a

    separate rulemaking, as ``a test that compares a derivatives clearing

    organization's initial margin requirements with historical price

    changes to determine the extent of actual margin coverage.'' \41\ Thus,

    the back tests required by proposed Sec. 39.13(g)(7), which would

    require a comparison of initial margin requirements with historical

    price changes, are distinguished from the daily review required by

    proposed Sec. 39.13(g)(6), which would require a determination of

    whether a margin breach had occurred on the particular day under

    review. For purposes of proposed Sec. 39.13(g)(7)(i) and (ii),

    proposed Sec. 39.13(g)(7) specifies that, in conducting back tests, a

    DCO would be required to use historical price change data based on a

    time period that is equivalent in length to the historic time period

    used by the applicable margin model for establishing the minimum 99%

    confidence level or a longer time period. The applicable time period is

    separately specified for the back tests required by proposed Sec.

    39.13(g)(7)(iii), as discussed below.

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

    \41\ See 75 FR at 77585 (proposing definitions in Sec. 39.1(b),

    to be redesignated as Sec. 39.2).

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

    Proposed Sec. 39.13(g)(7)(i) would require a DCO, on a daily

    basis, to conduct back tests with respect to products that are

    experiencing significant market volatility. Specifically, a DCO would

    be required to test the adequacy of its initial margin requirements and

    its spread margin requirements for such products that are margined on a

    product basis.

    Proposed Sec. 39.13(g)(7)(ii) would require a DCO, on at least a

    monthly basis, to conduct back tests to test the adequacy of its

    initial margin requirements and spread margin requirements for each

    product that is margined on a product basis. The Commission requests

    comment regarding whether initial margin requirements for all products

    should be subject to back tests on a monthly basis or whether some

    other time period, such as quarterly, would be sufficient to meet

    prudent risk management standards.

    Proposed Sec. 39.13(g)(7)(iii) would require a DCO, on at least a

    monthly basis, to conduct back tests to test the adequacy of its

    initial margin

    [[Page 3706]]

    requirements for each clearing member's accounts, by customer origin

    and house origin, and each swap portfolio, by beneficial owner, over at

    least the previous 30 days. The Commission has proposed that the

    initial margin requirements for such clearing member accounts and swap

    portfolios must be compared to 30 days of historical data since the

    composition of such accounts and swap portfolios may change on a daily

    basis. The Commission anticipates that back tests with respect to such

    accounts and portfolios would involve a review of the initial margin

    requirements for each account and portfolio as it existed on each day

    during the 30-day period. The Commission requests comment regarding

    whether initial margin requirements for all clearing members' accounts,

    by origin, and swap portfolios, by beneficial owner, should be subject

    to back tests on a monthly basis or whether some other time period,

    such as quarterly (based on the previous quarter's historical data),

    would be sufficient to meet prudent risk management standards.

    (vii) Customer margin.

    Proposed Sec. 39.13(g)(8) addresses three different proposed

    requirements regarding customer margin, including the collection of

    gross margin for customer accounts, customer initial margin levels, and

    withdrawals of customer initial margin.\42\

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

    \42\ The Commission has proposed to define ``customer initial

    margin'' as ``initial margin posted by a customer with a futures

    commission merchant, or by a non-clearing futures commission

    merchant with a clearing member.'' See 75 FR at 77585 (proposing

    Sec. 1.3(kkk)).

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

    (1) Gross margin for customer accounts.

    Proposed Sec. 39.13(g)(8)(i) would require a DCO to collect

    initial margin on a gross basis for each clearing member's customer

    account equal to the sum of the initial margin amounts that would be

    required by the DCO for each individual customer within that account if

    each individual customer were a clearing member. A DCO would not be

    permitted to net positions of different customers against one another,

    but it could collect initial margin for its clearing members' house

    accounts on a net basis.

    The Commission recognizes that gross margining of customer accounts

    would be a change from current margin practices at certain DCOs.

    However, the Commission believes that gross margining of customer

    accounts would more appropriately address the risks posed to a DCO by

    its clearing members' customers than margining all of a particular

    clearing member's customer accounts on a net basis. Gross margining

    would increase the financial resources available to a DCO in the event

    of a customer default. Moreover, with respect to cleared swaps, the

    requirement for gross margining of customers' portfolios supports the

    requirement in proposed Sec. 39.13(g)(2)(iii) that a DCO would have to

    margin each swap portfolio at a minimum 99% confidence level.

    The Commission recently proposed a new Sec. 39.19(c)(1)(iv) under

    which a DCO would be required, on a daily basis, to report the end-of-

    day positions for each clearing member, by origin.\43\ In connection

    with the proposed Sec. 39.13(g)(8)(i) requirement for DCOs to collect

    initial margin for customer accounts on a gross basis, the Commission

    is proposing to amend proposed Sec. 39.19(c)(1)(iv) to additionally

    require a DCO, for the customer origin, to report the gross positions

    of each beneficial owner.

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

    \43\ See 75 FR at 78195.

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

    (2) Customer initial margin requirements.

    Proposed Sec. 39.13(g)(8)(ii) would require a DCO to require its

    clearing members to collect customer initial margin from their

    customers for non-hedge positions at a level that is greater than 100%

    of the DCO's initial margin requirements with respect to each product

    and swap portfolio. Such a cushion would enable clearing members to

    deposit additional margin with a DCO on behalf of their customers, as

    necessitated by adverse market movements, without the need for the

    clearing members to make frequent margin calls to their customers.

    Historically, DCMs have mandated the amounts of customer initial

    margin and maintenance margin that their FCM members must collect from

    their customers.\44\ DCMs typically impose customer initial margin

    requirements that are higher, by a specified percentage, than the

    initial margin requirements imposed upon clearing FCMs by the relevant

    DCO, and maintenance margin requirements that are equivalent to the

    DCO's initial margin requirements. Customer initial margin requirements

    have typically been between 125% and 140% of a DCO's initial margin

    requirements.

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

    \44\ ``Maintenance margin'' refers to an amount that must be

    maintained on deposit at all times. If the equity in a customer's

    account drops below the level of maintenance margin because of

    adverse price movement, the FCM must issue a margin call to restore

    the customer's equity to the customer initial margin level.

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

    The Commission believes that DCOs should determine how much margin

    their FCM clearing members must collect from their customers because a

    DCO must ensure that its clearing members are able to meet their

    obligations to the DCO. Moreover, although it may be appropriate for a

    DCM to determine the customer initial margin requirements for non-

    clearing FCM members of the DCM, with respect to products traded on the

    DCM, a DCO may be the only entity in a position to assume any

    responsibility for setting customer initial margin requirements for

    cleared swaps that may be traded on SEFs or executed bilaterally.

    Proposed Sec. 39.13(g)(8)(ii) would permit a DCO to have

    reasonable discretion in determining the percentage by which customer

    initial margins would have to exceed the DCO's initial margin

    requirements with respect to particular products or swap portfolios. A

    DCO would be familiar with the risk characteristics of particular

    products and swap portfolios that it clears, which should enable it to

    determine the extent of the cushion that a clearing member should have

    with respect to customer initial margins. However, under the proposed

    regulation, the Commission may review such percentage levels and

    require different percentage levels, but not specific margin amounts,

    if the Commission deems the levels insufficient to protect the

    financial integrity of the clearing members or the DCO.

    The customer initial margin requirement set forth in proposed Sec.

    39.13(g)(8)(ii) would only apply with respect to customers' non-hedge

    positions. Hedge margins are typically equal to maintenance margins.

    (3) Withdrawal of customer initial margin.

    Proposed Sec. 39.13(g)(8)(iii) would require a DCO to require its

    clearing members to prohibit their customers from withdrawing funds

    from their accounts with such clearing members unless the net

    liquidating value plus the margin deposits remaining in the customer's

    account after the withdrawal would be sufficient to meet the customer

    initial margin requirements with respect to the products or portfolios

    in the customer's account, which were cleared by the DCO. This is

    consistent with the definition of ``Margin Funds Available for

    Disbursement'' in the Margins Handbook prepared by the Joint Audit

    Committee \45\ and, therefore, codifies current practices.

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

    \45\ See http;//www.nfa.futures.org/NFA-compliance/publication-library/margins-handbook.pdf.

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

    (viii) Time deadlines.

    [[Page 3707]]

    Proposed Sec. 39.13(g)(9) would require a DCO to establish and

    enforce time deadlines for initial and variation margin payments. If

    margin payments are not made on time, DCOs and clearing members face

    uncollateralized risk.

    (g) Other Risk Control Mechanisms

    (i) Risk limits.

    Proposed Sec. 39.13(h)(1)(i) would require a DCO to impose risk

    limits on each clearing member, by customer origin and house origin, in

    order to prevent a clearing member from carrying positions where the

    risk exposure of those positions exceeds a threshold set by the DCO

    relative to the clearing member's financial resources, the DCO's

    financial resources, or both. The DCO would have reasonable discretion

    in determining: (A) the method of computing risk exposure; (B) the

    applicable threshold(s); and (C) the applicable financial resources,

    provided however, that the ratio of exposure to capital would have to

    remain the same across all capital levels. The Commission could review

    any of these determinations and require different methods, thresholds,

    or financial resources, as appropriate.

    Proposed Sec. 39.13(h)(1)(ii) would allow a DCO to permit a

    clearing member to exceed the threshold(s) applied pursuant to

    paragraph (h)(1)(i) provided that the DCO required the clearing member

    to post additional initial margin that the DCO deemed sufficient to

    appropriately eliminate excessive risk exposure at the clearing member.

    The Commission could review the amount of additional initial margin and

    require a different amount, as appropriate.

    (ii) Large trader reports.

    Proposed Sec. 39.13(h)(2) would require a DCO to obtain from its

    clearing members, copies of all reports that such clearing members were

    required to file with the Commission pursuant to part 17 of the

    Commission's regulations, i.e., large trader reports. A DCO would be

    required to obtain such reports directly from the relevant reporting

    market if the reporting market exclusively listed self-cleared

    contracts, and were therefore required to file such reports on behalf

    of clearing members, pursuant to Sec. 17.00(i).

    Proposed Sec. 39.13(h)(2) would require a DCO to review the large

    trader reports that it received from its clearing members, or reporting

    markets, as applicable, on a daily basis to ascertain the risk of the

    overall portfolio of each large trader. A DCO would be required to

    review large trader positions for each large trader, across all

    clearing members carrying an account for the large trader. A DCO would

    also be required to take additional actions with respect to such

    clearing members in order to address any risks posed by a large trader,

    when appropriate. Such actions would include actions specified in

    proposed Sec. 39.13(h)(6), as discussed in section II.B.2(g)(vi)

    below.

    (iii) Stress tests.

    Proposed Sec. 39.13(h)(3) would require a DCO to conduct certain

    daily and weekly stress tests. The Commission has proposed to define

    ``stress test'' in a separate rulemaking, as ``a test that compares the

    impact of a potential price move, change in option volatility, or

    change in other inputs that affect the value of a position, to the

    financial resources of a derivatives clearing organization, clearing

    member, or large trader, to determine the adequacy of such financial

    resources.'' \46\ The Commission has not proposed a definition of

    financial resources in this context, although it would be expected to

    include, at a minimum, margin on deposit, and with respect to a

    clearing member, its capital.

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

    \46\ See 75 FR at 77585-86 (proposing definitions in Sec.

    39.1(b), to be redesignated as Sec. 39.2).

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

    Proposed Sec. 39.13(h)(3) would require a DCO to conduct certain

    types of stress tests with respect to certain large traders on a daily

    basis and with respect to all clearing member accounts and swap

    portfolios on at least a weekly basis.

    Proposed Sec. 39.13(h)(3)(i) would require a DCO to conduct daily

    stress tests with respect to each large trader who poses significant

    risk to a clearing member or the DCO in the event of default, including

    positions at all clearing members carrying accounts for the large

    trader. The DCO would have reasonable discretion in determining which

    traders to test and the methodology used to conduct the stress tests.

    However, the Commission could review the selection of accounts and the

    methodology and require changes, as appropriate.

    Proposed Sec. 39.13(h)(3)(ii) would require a DCO to conduct

    stress tests, at least once a week with respect to each account held by

    a clearing member at the DCO, by customer origin and house origin, and

    each swap portfolio, by beneficial owner, under extreme but plausible

    market conditions. The DCO would have reasonable discretion in

    determining the methodology used to conduct these stress tests.

    However, the Commission may review the methodology and require any

    appropriate changes. The Commission requests comment regarding whether

    all clearing member accounts, by origin, and all swap portfolios should

    be subject to such stress tests on a weekly basis or whether some other

    time period, such as monthly, would be sufficient to meet prudent risk

    management standards.

    (iv) Portfolio compression.

    Proposed Sec. 39.13(h)(4)(i) would require a DCO to offer

    multilateral portfolio compression exercises, on a regular basis, for

    its clearing members that clear swaps, to the extent that such

    exercises are appropriate for those swaps that it clears. The

    Commission has not specified the frequency with which DCOs must offer

    multilateral portfolio compression exercises in proposed Sec.

    39.13(h)(4)(i), other than to state that they would have to be offered

    on a regular basis. The Commission requests comment regarding whether

    such exercises should be offered monthly, quarterly, or another

    frequency. In addition, the Commission requests comment regarding

    whether the frequency of such exercises should vary for different

    categories of swaps.

    Under proposed Sec. 39.13(h)(4)(ii), a DCO must require its

    clearing members to participate in all multilateral portfolio

    compression exercises offered by the DCO, to the extent that any swap

    in the applicable portfolio is eligible for inclusion in the exercise,

    unless including the swap would be reasonably likely to significantly

    increase the risk exposure of the clearing member. Proposed Sec.

    39.13(h)(4)(iii) would permit a DCO to allow clearing members

    participating in such exercises to set risk tolerance limits for their

    portfolios, provided that the clearing member could not set such risk

    tolerances at an unreasonable level or use such risk tolerances to

    evade the requirements of proposed Sec. 39.13(h)(4).

    (v) Clearing members' risk management policies and procedures.

    The Commission believes that in order for a DCO to adequately

    manage its own risks, it must ensure that its clearing members also

    have adequate risk management policies and procedures. In order to do

    this, a DCO must have the authority to obtain documents and information

    from its clearing members regarding such policies and procedures, and

    must review their implementation on a periodic basis.

    Proposed Sec. 39.13(h)(5) would impose several requirements upon

    DCOs relating to their clearing members' risk management policies and

    procedures. Specifically, a DCO must adopt rules that: (a) Require its

    clearing members to maintain current written risk management policies

    and procedures; (b) ensure that the DCO has the authority to request

    and obtain information and documents from its

    [[Page 3708]]

    clearing members regarding their risk management policies, procedures,

    and practices, including, but not limited to, information and documents

    relating to the liquidity of their financial resources and their

    settlement procedures; and (c) require its clearing members to make

    information and documents regarding their risk management policies,

    procedures, and practices available to the Commission upon the

    Commission's request. In addition, a DCO would be required to review

    the risk management policies, procedures, and practices of each of its

    clearing members on a periodic basis and document such reviews.

    Proposed Sec. 39.13(h)(5) does not define how DCOs would have to

    conduct clearing member risk management reviews, and has not specified

    a required frequency of such reviews except to state that they would

    have to be conducted on a periodic basis. The Commission invites

    comment regarding whether it should require that a DCO must conduct

    risk reviews of its clearing members on an annual basis or within some

    other time frame. The Commission also requests comment regarding

    whether the Commission should require that such reviews be conducted in

    a particular manner, e.g., whether there must be an on-site visit or

    whether any particular testing should be required. In addition, the

    Commission invites comment regarding whether, and to what extent, a DCO

    should be permitted to vary the method and depth of such reviews based

    upon the nature, risk profiles, or other regulatory supervision of

    particular clearing members.

    The risk management reviews contemplated by proposed Sec.

    39.13(h)(5) would also support DCOs' compliance with Core Principle C

    and proposed Sec. 39.12, by providing a means for the DCO and the

    Commission to ensure that clearing members continue to meet

    participation requirements relating to risk management.

    (vi) Additional authority.

    Proposed Sec. 39.13(h)(6) would require a DCO to take additional

    actions with respect to particular clearing members, when appropriate,

    based on the application of objective and prudent risk management

    standards. Such actions would include, but would not be limited to: (i)

    Imposing enhanced capital requirements; (ii) imposing enhanced margin

    requirements; (iii) imposing position limits; (iv) prohibiting an

    increase in positions; (v) requiring a reduction of positions; (vi)

    liquidating or transferring positions; and (vii) suspending or revoking

    clearing membership. The Commission believes that a DCO should have the

    authority to take any of the specified actions or other appropriate

    actions, and should take such actions, when necessary to address risks

    posed to the DCO by particular clearing members or their customers.

    However, a DCO would have the discretion to determine when to take

    additional actions, and what actions to take, based on its exercise of

    objective and prudent risk management standards.

    3. Settlement Procedures

    Core Principle E, as amended by the Dodd-Frank Act,\47\ requires a

    DCO to: (a) Complete money settlements on a timely basis, but not less

    frequently than once each business day; (b) employ money settlement

    arrangements to eliminate or strictly limit its exposure to settlement

    bank risks (including credit and liquidity risks from the use of banks

    to effect money settlements); (c) ensure that money settlements are

    final when effected; (d) maintain an accurate record of the flow of

    funds associated with money settlements; (e) possess the ability to

    comply with the terms and conditions of any permitted netting or offset

    arrangement with another clearing organization; (f) establish rules

    that clearly state each obligation of the DCO with respect to physical

    deliveries; and (g) ensure that it identifies and manages each risk

    arising from any of its obligations with respect to physical

    deliveries.\48\ The Commission is proposing to adopt Sec. 39.14 to

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

    with Core Principle E.

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

    \47\ Section 5b(c)(2)(E) of the CEA; 7 U.S.C. 7a-1(c)(2)(E)

    (Core Principle E).

    \48\ Prior to amendment by the Dodd-Frank Act, Core Principle E

    provided that [t]he applicant shall have the ability to--

    (i) complete settlements on a timely basis under varying

    circumstances;

    (ii) maintain an adequate record of the flow of funds associated

    with each transaction that the applicant clears; and

    (iii) comply with the terms and conditions of any permitted

    netting or offset arrangements with other clearing organizations.

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

    Proposed Sec. 39.14(a) would define ``settlement'' and

    ``settlement bank'' for purposes of Sec. 39.14. In particular,

    ``settlement'' is defined in proposed Sec. 39.14(a)(1) to include: (i)

    Payment and receipt of variation margin for futures, options and swap

    positions; (ii) payment and receipt of option premiums; (iii) deposit

    and withdrawal of initial margin for futures, options and swap

    positions; (iv) all payments due in final settlement of futures,

    options and swap positions on the final settlement date with respect to

    such positions; and (v) all other cash flows collected from or paid to

    each clearing member, including but not limited to, payments related to

    swaps such as coupon amounts. ``Settlement bank'' is defined in

    proposed Sec. 39.14(a)(2) as ``a bank that maintains an account either

    for the [DCO] or for any of its clearing members, which is used for the

    purpose of transferring funds and receiving transfers of funds in

    connection with settlements with the [DCO].''

    (a) Daily settlements.

    The daily settlement of financial obligations arising from the

    addition of new positions and price changes with respect to all open

    positions is an essential element of the clearing process at a DCO.

    Proposed Sec. 39.14(b) would require a DCO to effect a settlement with

    each clearing member at least once each business day, and to have the

    authority and operational capacity to effect a settlement with each

    clearing member, on an intraday basis, either routinely, when

    thresholds specified by the DCO were breached, or in times of extreme

    market volatility.

    Proposed Sec. 39.14(b) would permit DCOs to exercise their

    discretion regarding whether they would effect routine intraday

    settlements or whether they would settle positions on an intraday basis

    only when certain thresholds were breached or in times of extreme

    market volatility. Moreover, a DCO would have the discretion to

    establish any relevant thresholds and to define extreme market

    volatility in the context of the products and portfolios that it

    clears. These provisions are consistent with international

    recommendations.\49\

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

    \49\ See CPSS-IOSCO Recommendations, pg. 21; EMIR, Article 39,

    paragraph 3, pg. 46.

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

    (b) Settlement banks.

    A DCO generally requires its clearing members to effect settlement

    through one of a specified set of settlement banks. In addition, a DCO

    itself often has a lead, concentration, or central settlement bank.

    Proposed Sec. 39.14(c) would set forth three specific requirements

    in furtherance of the general requirement that DCOs must employ

    settlement arrangements to eliminate or strictly limit their exposure

    to settlement bank risks. First, proposed Sec. 39.14(c)(1) would

    require a DCO to have documented criteria for those banks that it would

    use, and that it would permit its clearing members to use, as

    settlement banks, including criteria addressing the capitalization,

    creditworthiness, access to liquidity, operational reliability, and

    regulation or supervision of such banks. Second, proposed Sec.

    39.14(c)(2) would require a DCO to monitor each approved

    [[Page 3709]]

    settlement bank on an ongoing basis to ensure that it continues to meet

    the documented criteria. Finally, proposed Sec. 39.14(c)(3) would

    require a DCO to monitor the full range and concentration of its

    exposures to its own and its clearing members' settlement banks \50\

    and assess its own and its clearing members' potential losses and

    liquidity pressures in the event that the settlement bank with the

    largest share of settlement activity were to fail. If action were

    reasonably necessary in order to eliminate or strictly limit exposures

    to settlement banks, a DCO would be required to: (i) Maintain

    settlement accounts at additional settlement banks; (ii) approve

    additional settlement banks for use by its clearing members; (iii)

    impose concentration limits with respect to its own or its clearing

    members' settlement banks; and/or (iv) take any other appropriate

    actions. The determination of whether any such actions were necessary

    would be left to the discretion of the DCO in the first instance, but

    such determination would have to be reasonable.

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

    \50\ A DCO may have multiple exposures to a settlement bank,

    e.g., if the bank is also a clearing member or extends a credit

    facility funding arrangement to the DCO.

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

    (c) Settlement finality.

    Proposed Sec. 39.14(d) would require that a DCO must ensure that

    settlement fund transfers are irrevocable and unconditional when the

    DCO's accounts are debited or credited. In addition, the proposed

    regulation would require that a DCO's legal agreements with its

    settlement banks would have to state clearly when settlement fund

    transfers would occur and a DCO would have to routinely confirm that

    its settlement banks were effecting fund transfers as and when required

    by those legal agreements.

    (d) Recordkeeping.

    Proposed Sec. 39.14(e) would incorporate Core Principle E's

    requirement that a DCO must maintain an accurate record of the flow of

    funds associated with each settlement.\51\

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

    \51\ Section 5b(c)(2)(E)(iv) of the CEA; 7 U.S.C. 7a-

    1(c)(2)(E)(iv).

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

    (e) Netting arrangements.

    Proposed Sec. 39.14(f) would incorporate Core Principle E's

    requirement that a DCO must possess the ability to comply with each

    term and condition of any permitted netting or offset arrangement with

    any other clearing organization.\52\

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

    \52\ Section 5b(c)(2)(E)(v) of the CEA; 7 U.S.C. 7a-

    1(c)(2)(E)(v).

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

    (f) Physical delivery.

    Proposed Sec. 39.14(g) would set forth requirements with respect

    to contracts, agreements, and transactions that are settled by physical

    transfers of the underlying instruments or commodities. In particular,

    the proposed regulation would require a DCO to establish rules clearly

    stating each obligation that the DCO has assumed with respect to

    physical deliveries, including whether it has an obligation to make or

    receive delivery of a physical instrument or commodity, or whether it

    indemnifies clearing members for losses incurred in the delivery

    process, and to ensure that the risks of each such obligation are

    identified and managed. Proposed Sec. 39.14(g) would not require DCOs

    to assume any particular obligations in connection with physical

    deliveries, in recognition of the fact that DCOs would need to

    determine what, if any, obligations to assume on a product-specific

    basis, in the exercise of prudent risk management standards.

    4. Treatment of Funds

    Core Principle F, as amended by the Dodd-Frank Act,\53\ requires a

    DCO to:(a) Establish standards and procedures that are designed to

    protect and ensure the safety of its clearing members' funds and

    assets; (b) hold such funds and assets in a manner by which to minimize

    the risk of loss or of delay in the DCO's access to the assets and

    funds; and (c) only invest such funds and assets in instruments with

    minimal credit, market, and liquidity risks.\54\ The Commission is

    proposing to adopt Sec. 39.15 to establish requirements that a DCO

    would have to meet in order to comply with Core Principle F.

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

    \53\ Section 5b(c)(2)(F) of the CEA; 7 U.S.C. 7a-1(c)(2)(F)

    (Core Principle F).

    \54\ Prior to amendment by the Dodd-Frank Act, Core Principle F

    provided that ``[t]he applicant shall have standards and procedures

    designed to protect and ensure the safety of member and participant

    funds.''

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

    (a) Required standards and procedures.

    Proposed Sec. 39.15(a) would require a DCO to establish standards

    and procedures that are designed to protect and ensure the safety of

    funds and assets belonging to clearing members and their customers.\55\

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

    \55\ Such ``assets'' would include any securities or property

    that clearing members deposit with a DCO in order to satisfy initial

    margin obligations, which are also sometimes referred to as

    ``collateral.'' Proposed Sec. 39.15 uses the term ``assets'' rather

    than ``securities or property'' or ``collateral'' in order to be

    consistent with the statutory language.

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

    (b) Segregation of funds and assets.

    Proposed Sec. 39.15(b)(1) would require a DCO to comply with the

    segregation requirements of section 4d of the CEA and Commission

    regulations thereunder, or any other applicable Commission regulation

    or order requiring that customer funds and assets be segregated, set

    aside, or held in a separate account. The Commission has included this

    language because it is an essential element of the standards and

    procedures described in proposed Sec. 39.15(a). However, proposed

    Sec. 39.15(b)(1) would not impose any new requirements on DCOs that

    are in addition to those required by section 4d of the CEA and those

    that are currently required, or may in the future be required, by

    applicable Commission regulations or orders.

    Proposed Sec. 39.15(b)(2)(i) would permit a DCO to commingle, and

    a DCO to permit clearing member FCMs to commingle, customer positions

    in futures, options on futures, and swaps, and any money, securities,

    or property received to margin, guarantee, or secure such positions, in

    an account subject to the requirements of section 4d(f) of the CEA

    (cleared swap account), pursuant to DCO rules that have been approved

    by the Commission under Sec. 40.5 of the Commission's regulations. The

    proposed regulation would establish minimum informational requirements

    for such rule submissions, consistent with the informational

    requirements the Commission has previously imposed upon petitioners

    requesting orders under section 4d of the CEA.

    The rule filing would have to be submitted electronically to the

    Commission, in the form and manner required by the Commission, and

    would have to include, at a minimum, the following: (A) An

    identification of the futures, options on futures, and swaps that would

    be commingled, including contract specifications or the criteria that

    would be used to define eligible futures, options on futures, and

    swaps; (B) an analysis of the risk characteristics of the eligible

    products; (C) a description of whether the swaps would be executed

    bilaterally and/or executed on a DCM and/or a SEF; (D) an analysis of

    the liquidity of the respective markets for the futures, options on

    futures, and swaps that would be commingled, the ability of clearing

    members and the DCO to offset or mitigate the risks of such products in

    a timely manner, without compromising the financial integrity of the

    account, and, as appropriate, proposed means for addressing

    insufficient liquidity; (E) an analysis of the availability of reliable

    prices for each of the eligible products; (F) a description of the

    financial, operational, and managerial standards or requirements for

    clearing members that would be permitted to commingle the eligible

    products; (G) a description of the systems and procedures that would be

    used by the DCO to oversee such clearing members' risk management of

    the commingled positions; (H) a

    [[Page 3710]]

    description of the financial resources of the DCO, including the

    composition and availability of a guaranty fund with respect to the

    commingled products; (I) a description and analysis of the margin

    methodology that would be applied to the commingled products, including

    any margin reduction applied to correlated positions, and any

    applicable margin rules with respect to both clearing members and

    customers; \56\ (J) an analysis of the ability of the DCO to manage a

    potential default with respect to any of the commingled products; (K) a

    discussion of the procedures that the DCO would follow if a clearing

    member defaulted, and the procedures that a clearing member would

    follow if a customer defaulted, with respect to any of the commingled

    products; and (L) a description of the arrangements for obtaining daily

    position data from each beneficial owner of the commingled products.

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

    \56\ See supra section II.B.2.f.ii of this notice, discussing

    the minimum liquidation time of five business days for margining

    cleared swaps that are not executed on a DCM.

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

    Proposed Sec. 39.15(b)(2)(ii) addresses situations where customer

    positions in futures, options on futures, and cleared swaps could be

    carried in a futures account subject to section 4d(a) of the CEA. In

    recent years, the Commission, in its discretion, has issued orders

    permitting cleared swaps to be carried in a futures account, on a case-

    by-case basis.\57\ Proposed Sec. 39.15(b)(2)(ii) would incorporate the

    informational requirements of proposed Sec. 39.15(b)(2)(i), but would

    still require that the Commission issue an order granting permission to

    commingle customer positions in futures, options on futures, and swaps

    in a futures account.

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

    \57\ See supra n.38.

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

    Proposed Sec. 39.15(b)(2)(iii)(A) would provide that the

    Commission may request additional information in support of a rule

    submission and it may approve the rules in accordance with Sec.

    40.5.\58\ Proposed Sec. 39.15(b)(2)(iii)(B) would provide that the

    Commission may request additional information in support of a petition

    and it may issue an order under section 4d of the CEA in its

    discretion.

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

    \58\ Rules submitted for prior approval would be approved unless

    the rule is inconsistent with the CEA or the Commission's

    regulations. See section 5c(c)(5) of the CEA; 7 U.S.C. 7a-2(c)(5);

    and 75 FR at 67295.

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

    In the case of a rule approval under Sec. 39.15(b)(2)(i), as well

    as the issuance of an order under Sec. 39.15(b)(2)(ii), the Commission

    would take action pursuant to section 4d of the CEA (permitting

    commingling) and section 4(c) of the CEA (exempting the DCO and

    clearing members from the requirement to hold customer positions in a

    particular account, as applicable, 4d(a) or 4d(f)).\59\

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

    \59\ 7 U.S.C. 6(c). See infra section IV. (further discussing

    the 4(c) exemption and requesting comment).

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

    The Commission requests comment on whether it should take the same

    approach (rule submission or petition for an order) with respect to the

    futures account and the cleared swap account and, if so, what that

    approach should be. In addition, the Commission requests comment on

    whether the enumerated informational requirements fully capture the

    relevant considerations for making a determination on either rule

    approval or the granting of an order, and whether the Commission's

    analysis should take into consideration the type of account in which

    the positions would be carried, the particular type of products that

    would be involved, or the financial resources of the clearing members

    that would hold such accounts. The Commission further requests comment

    on what, if any, additional or heightened requirements should be

    imposed to manage the increased risks introduced to a futures account

    that also holds cleared swaps.

    (c) Holding of funds and assets.

    Proposed Sec. 39.15(c) would require that a DCO must hold funds

    and assets belonging to clearing members and their customers in a

    manner that minimizes the risk of loss or of delay in the DCO's access

    to those funds and assets. In furtherance of this objective, the

    Commission has proposed certain requirements addressing types of assets

    that a DCO may accept, the valuation of such assets, applicable

    haircuts, concentration limits, and requirements that would apply if

    assets were pledged to a DCO but were held in the name of a clearing

    member, as described below.

    (i) Types of assets.

    Proposed Sec. 39.15(c)(1) would require a DCO to limit the assets

    it accepts as initial margin to those that have minimal credit, market,

    and liquidity risks. The proposed regulation would also state that a

    DCO may not accept letters of credit as initial margin. The Commission

    has not specified the assets that a DCO may accept, and with the

    exception of letters of credit, it has not specified the assets that a

    DCO may not accept. In general, proposed Sec. 39.15(c)(1) would set

    forth the criteria of minimal credit, market, and liquidity risks and

    would leave it to the discretion of each DCO to determine which assets

    the DCO would accept, subject to their meeting those criteria. The

    Commission has proposed to prohibit the acceptance of letters of credit

    because they are unfunded financial resources with respect to which

    funds might be unavailable when most needed. The Commission expects

    that DCOs would continue their current practice of re-evaluating the

    types of assets that they would accept as initial margin as

    necessitated by changes in market conditions that could affect the

    credit, market, and liquidity risks of those assets.

    (ii) Valuation.

    Proposed Sec. 39.15(c)(2) would require a DCO to use prudent

    valuation practices to value assets posted as initial margin on a daily

    basis. The Commission has not specified what such valuation practices

    should entail, as the nature of the valuations would depend on the

    nature of the particular assets. However, whatever method would be used

    to determine the value of margin assets, it is crucial that such assets

    be valued daily, because a DCO cannot evaluate the adequacy of margin

    coverage on a daily basis without knowing the value of the assets that

    are components of the margin on deposit. Such daily valuation of margin

    assets is currently the standard practice of DCOs.

    (iii) Haircuts.

    Proposed Sec. 39.15(c)(3) would require a DCO to apply appropriate

    reductions in value to reflect the market and credit risk of the assets

    that it accepts in satisfaction of initial margin obligations. Such

    reductions are known as haircuts, and DCOs currently apply haircuts to

    the margin assets that they accept as initial margin. Haircuts are

    designed to mitigate the potential future exposure that could result

    from potential changes in the value of particular assets.

    Haircut levels would be dependent on the nature of the particular

    assets. DCOs would be required to calculate their haircuts taking into

    account stressed market conditions. Incorporating stressed market

    conditions into the calculation of haircuts can limit the effects of

    procyclicality, which refers to changes that are positively correlated

    with business or credit cycle fluctuations and that may cause or

    exacerbate financial instability.\60\ In

    [[Page 3711]]

    addition, the proposed regulation would require a DCO to evaluate the

    appropriateness of its haircuts on at least a quarterly basis.

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

    \60\ While changes in collateral values tend to be procyclical,

    collateral arrangements can increase procyclicality if haircut

    levels fall during periods of low-market stress and increase during

    periods of high-market stress. For example, in a stressed market, if

    a DCO required the posting of additional collateral due to both the

    decline of asset prices and an increase in haircut levels, it could

    exacerbate market stress and drive down asset prices further,

    resulting in additional collateral requirements. This cycle could

    exert further downward pressure on asset prices in already stressed

    markets. To limit the effects of this procyclicality, a DCO should

    establish stable and conservative haircuts that are calibrated to

    include periods of stressed market conditions.

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

    (iv) Concentration limits.

    Proposed Sec. 39.15(c)(4) would require a DCO to apply appropriate

    limitations on the concentration of assets posted as initial margin, as

    necessary, in order to ensure the DCO's ability to liquidate those

    assets quickly with minimal adverse price effects. Any concentration

    limits would be set by the DCO, in its discretion, depending on the

    nature of the assets. The proposed regulation would require a DCO to

    evaluate the appropriateness of its concentration limits, on at least a

    monthly basis.

    (v) Pledged assets.

    Some DCOs permit their clearing members to pledge assets for

    initial margin while retaining those assets in accounts in the names of

    the pledging clearing members. Proposed Sec. 39.15(c)(5) would require

    that if such pledged assets were held in an account in the name of a

    clearing member, the DCO would have to ensure that the assets were

    unencumbered and that the pledge had been validly created and validly

    perfected in the relevant jurisdiction, in order to ensure that the DCO

    had immediate access to those assets.

    (d) Permissible investments.

    Proposed Sec. 39.15(d) would require that clearing members' funds

    and assets that are invested by a DCO must be held in instruments with

    minimal credit, market, and liquidity risks.\61\ The proposed

    regulation further adds that any investment of customer funds or assets

    by a DCO would have to comply with Sec. 1.25 of the Commission's

    regulations, which itself is designed to ensure that such investments

    would be subject to minimal credit, market, and liquidity risks.

    Moreover, the proposed regulation would apply the limitations contained

    in Sec. 1.25 to all customer funds and assets, whether they were the

    funds and assets of futures and options customers subject to the

    segregation requirements of section 4d(a) of the CEA, or the funds and

    assets of swaps customers subject to the segregation requirements of

    section 4d(f) of the CEA.

    The proposed regulation does not enumerate the specific instruments

    in which DCOs may invest clearing members' own funds and assets,

    leaving it to the discretion of each DCO to determine which instruments

    have minimal credit, market, and liquidity risks. As regards those

    assets that DCOs would accept as initial margin, the Commission expects

    that DCOs would continue their current practice of re-evaluating the

    instruments in which they would invest clearing members' own funds and

    assets, as necessitated by changes in market conditions that could

    affect the credit, market, and liquidity risks of those instruments.

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

    \61\ IOSCO Recommendation 7 (custody and investment risks) also

    states, in part, that ``[a]ssets invested by a CCP should be held in

    instruments with minimal credit, market, and liquidity risks.''

    (CPSS-IOSCO Recommendations, pg. 31).

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

    5. Default Rules and Procedures

    Core Principle G, as amended by the Dodd-Frank Act,\62\ requires

    each DCO to have rules and procedures designed to allow for the

    efficient, fair, and safe management of events during which clearing

    members become insolvent or otherwise default on their obligations to

    the DCO. In addition, Core Principle G requires each DCO to clearly

    state its default procedures, make its default rules publicly

    available, and ensure that it may take timely action to contain losses

    and liquidity pressures and to continue meeting its obligations.\63\

    The Commission is proposing to adopt Sec. 39.16 to establish

    requirements that a DCO would have to meet in order to comply with Core

    Principle G.

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

    \62\ Section 5b(c)(2)(G) of the CEA; 7 U.S.C. 7a-1(c)(2)(G)

    (Core Principle G).

    \63\ Prior to amendment by the Dodd-Frank Act, Core Principle G

    provided that ``[t]he applicant shall have rules and procedures

    designed to allow for efficient, fair, and safe management of events

    when members or participants become insolvent or otherwise default

    on their obligations to the derivatives clearing organization.''

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

    (a) General.

    It is essential that DCOs have clearly defined and effective

    default management rules and procedures in order to protect the

    defaulting clearing members' customers, non-defaulting clearing

    members, and the DCO, to the extent possible. Proposed Sec. 39.16(a)

    would require DCOs to adopt rules and procedures designed to allow for

    the efficient, fair, and safe management of events during which

    clearing members become insolvent or default on the obligations of such

    clearing members to the DCO.\64\ Existing DCOs have rules and

    procedures to address possible defaults.

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

    \64\ Core Principle G specifically refers to events during which

    clearing members ``(I) become insolvent; or (II) otherwise default *

    * *.'' However, it is possible that a clearing member could become

    insolvent and not default on its obligations to the DCO. For

    example, the insolvency could be a consequence of a clearing

    member's meeting all such obligations. Nevertheless, the Commission

    believes that a clearing member should be required to follow certain

    procedures, beginning with notifying the DCO, if it becomes subject

    to a bankruptcy petition, receivership proceeding, or the

    equivalent, and such proposed requirements are contained in proposed

    Sec. 39.16(d), discussed infra in section II.B.5.d.

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

    (b) Default management plan.

    Proposed Sec. 39.16(b) would require a DCO to maintain a current

    written default management plan that delineates the roles and

    responsibilities of its Board of Directors, its Risk Management

    Committee, any other committee that has responsibilities for default

    management, and the DCO's management, in addressing a default,

    including any necessary coordination with, or notification of, other

    entities and regulators. The proposed regulation would also require the

    default management plan to address any differences in procedures with

    respect to highly liquid contracts (such as certain futures) and less

    liquid contracts (such as certain swaps). In addition, proposed Sec.

    39.16(b) would require a DCO to conduct and document a test of its

    default management plan on at least an annual basis.

    (c) Default procedures.

    Proposed Sec. 39.16(c)(1) would require a DCO to adopt procedures

    that would permit the DCO to take timely action to contain losses and

    liquidity pressures and to continue meeting its obligations in the

    event of a default on the obligations of a clearing member to the

    DCO.\65\

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

    \65\ Similarly, IOSCO Recommendation 6 (Default procedures)

    states that ``[a] CCP's default procedures should be clearly stated,

    and they should ensure that the CCP can take timely action to

    contain losses and liquidity pressures and to continue meeting its

    obligations.'' (CPSS-IOSCO Recommendations, pg. 27).

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

    Proposed Sec. 39.16(c)(2) would require a DCO to include certain

    identified procedures in its default rules. In particular, proposed

    Sec. 39.16(c)(2)(i) would require a DCO to set forth its definition of

    a default. Proposed Sec. 39.16(c)(2)(ii) would require a DCO to set

    forth the actions that it is able to take upon a default, which must

    include the prompt transfer, liquidation, or hedging of the customer or

    proprietary positions of the defaulting clearing member, as applicable.

    Proposed Sec. 39.16(c)(2)(ii) would further state that such procedures

    could also include, in the DCO's discretion, the auctioning or

    allocation of such positions to other clearing members. Proposed Sec.

    39.16(c)(2)(iii) would require a DCO to include in its default rules

    any obligations that the DCO imposed on its clearing members to

    participate in auctions, or to accept allocations, of a defaulting

    clearing member's positions, and specifically would provide that any

    allocation would have to be proportional to the size of the

    participating or accepting clearing member's positions at the DCO. For

    example, certain DCO rules currently address the DCO's authority to

    auction a defaulting clearing member's

    [[Page 3712]]

    swaps to other clearing members that participate in the market for that

    category of swaps.

    Proposed Sec. 39.16(c)(2)(iv) would require that a DCO's default

    rules address the sequence in which the funds and assets of the

    defaulting clearing member and the financial resources maintained by

    the DCO would be applied in the event of a default. The proposed

    regulation would not specify the sequence in which a DCO would be

    required to apply its own resources or those of the defaulting clearing

    member, but it would set forth two related requirements.

    First, proposed Sec. 39.16(c)(2)(v) would require that a DCO's

    default rules contain a provision that customer margin posted by a

    defaulting clearing member could not be applied in the event of a

    proprietary default. This is consistent with the segregation

    requirements of section 4d of the CEA and Sec. 1.20 of the

    Commission's regulations.

    Second, proposed Sec. 39.16(c)(2)(vi) would require that a DCO's

    default rules contain a provision that proprietary margins posted by a

    defaulting clearing member would have to be applied in the event of a

    customer default, if the relevant customer margin were insufficient to

    cover the shortfall. This is consistent with Sec. 190.08(a)(ii)(J),

    which defines customer property to include the trading accounts of an

    FCM, to the extent that other enumerated customer property is

    insufficient to satisfy all claims of public customers in the

    bankruptcy of the FCM.

    Proposed Sec. 39.16(c)(3) would incorporate the Core Principle G

    requirement that a DCO must make its default rules publicly

    available,\66\ and it cross-references proposed Sec. 39.21, which has

    been proposed in a separate rulemaking and which also addresses this

    requirement.\67\

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

    \66\ See section 5b(c)(2)(G)(ii)(II) of the CEA; 7 U.S.C. 7a-

    1(c)(2)(G)(ii)(II).

    \67\ See 75 FR at 78197.

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

    (d) Insolvency of a clearing member.

    Proposed Sec. 39.16(d) would set forth specific procedures that a

    DCO would have to require its clearing members to follow, and that a

    DCO itself would have to follow, if a clearing member became the

    subject of a bankruptcy petition (either voluntary or involuntary), a

    receivership proceeding, or an equivalent proceeding, e.g., a foreign

    liquidation proceeding. The Commission believes that such procedures

    would be necessary in order to provide for ``the efficient, fair, and

    safe management of events'' when a clearing member becomes insolvent,

    as required by Core Principle G.

    Proposed Sec. 39.16(d)(1) would require a DCO to adopt rules that

    would require a clearing member to provide prompt notice to the DCO of

    such a petition or proceeding. Proposed Sec. 39.13(d)(2) would require

    a DCO to review the clearing member's continuing eligibility for

    clearing membership upon receiving such notice. Proposed Sec.

    39.16(d)(3) would require a DCO to take any appropriate action, in its

    discretion, with respect to the clearing member or its positions,

    including but not limited to liquidation or transfer of positions, and

    suspension or revocation of clearing membership. Proposed Sec.

    39.16(d)(2) does not outline specific review procedures, and Sec.

    39.16(d)(3) would leave it to the discretion of the DCO to determine

    whether any particular action were appropriate with respect to the

    clearing member.

    6. System Safeguards

    Core Principle I, as amended by the Dodd-Frank Act,\68\ requires

    each DCO to establish and maintain a program of risk analysis and

    oversight to identify and minimize sources of operational risk through

    the development of appropriate controls and procedures, and automated

    systems that are reliable, secure, and have adequate scalable capacity.

    Core Principle I also requires each DCO to establish and maintain

    emergency procedures, backup facilities, and a plan for disaster

    recovery that allows for the timely recovery and resumption of

    operations of, and the fulfillment of each obligation and

    responsibility of, the DCO. Finally, Core Principle I requires each DCO

    to periodically conduct tests to verify that its backup resources are

    sufficient to ensure daily processing, clearing, and settlement.\69\

    The Commission is proposing to adopt Sec. 39.18 to establish

    requirements that a DCO would have to meet in order to comply with Core

    Principle I.

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

    \68\ Section 5b(c)(2)(I) of the CEA; 7 U.S.C. 7a-1(c)(2)(I)

    (Core Principle I).

    \69\ Prior to amendment by the Dodd-Frank Act, Core Principle I

    provided that

    [t]he applicant shall demonstrate that the applicant (i) has

    established and will maintain a program of oversight and risk

    analysis to ensure that the automated systems of the applicant

    function properly and have adequate capacity and security; and (ii)

    has established and will maintain emergency procedures, and a plan

    for disaster recovery, and will periodically test backup facilities

    sufficient to ensure daily processing, clearing, and settlement of

    transactions.

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

    (a) General.

    Proposed Sec. 39.18 would codify the requirements of Core

    Principle I and would establish additional standards for a DCO's

    business continuity and disaster recovery procedures. On July 14,

    2010,\70\ the Commission published proposed regulations regarding

    business continuity and disaster recovery applicable to DCOs and DCMs.

    After consideration of the provisions of the Dodd-Frank Act, the

    Commission has determined to re-propose the provisions concerning DCOs.

    The Commission appreciates the comments made with respect to those

    earlier proposed regulations, and has taken them into account in

    developing the proposed regulations described below.

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

    \70\ See 75 FR 42633 (July 22, 2010) (July Proposal).

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

    (i) Definitions.

    Proposed Sec. 39.18(a) would set forth relevant definitions for

    the system safeguards provisions applicable to DCOs set forth in Sec.

    39.18 and the modified system safeguards provisions applicable to

    SIDCOs set forth in Sec. 39.30, including ``recovery time objective''

    (the time period, after disruption, within which a DCO should be able

    to achieve recovery and resumption of clearing activities) (RTO),

    ``relevant area'' (the geographic area within which a DCO has necessary

    resources, as well as adjacent communities), and ``wide-scale

    disruption'' (an event that causes severe disruption of critical

    infrastructure, or an evacuation or unavailability of the population,

    in a relevant area).\71\

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

    \71\ The Commission may consider, in a future rulemaking,

    placing an expanded version of these definitions (to include, e.g.,

    recovery time objectives with respect to DCMs and other registered

    entities) in part 1, and, as appropriate, incorporating those

    definitions by reference in part 39 of its regulations.

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

    (ii) Program of risk analysis.

    Because automated systems play a central and critical role in

    today's electronic financial market environment, oversight of core

    principle compliance by DCOs with respect to automated systems is an

    essential part of effective clearing oversight. Sophisticated computer

    systems are crucial to a DCO's ability to meet its obligations and

    responsibilities. Safeguarding the reliability, security, and capacity

    of such systems is also essential to mitigation of systemic risk for

    the nation's financial sector as a whole.

    Proposed Sec. 39.18(b) would require that a DCO maintain a program

    of risk analysis and oversight with respect to its operations and

    automated systems to identify and minimize sources of operational risk,

    establish and maintain resources that allow for the fulfillment of the

    DCO's obligations and responsibilities in light of those risks, and

    verify that those resources are

    [[Page 3713]]

    adequate to ensure daily processing, clearing, and settlement.

    (iii) Elements of program.

    Proposed Sec. 39.18(c) would require that the program of risk

    analysis and oversight address each of six categories: information

    security, business continuity and disaster recovery (BC-DR), capacity

    and performance planning, systems operations, systems development and

    quality assurance, and physical security and environmental controls.

    (iv) Standards for program.

    DCO compliance with generally accepted standards and best practices

    with respect to the development, operation, reliability, security, and

    capacity of automated systems can reduce the frequency and severity of

    automated system security breaches or functional failures, thereby

    augmenting efforts to mitigate systemic risk. Accordingly, proposed

    Sec. 39.18(d) would require that a DCO follow generally accepted

    standards and industry best practices with respect to the development,

    operation, reliability, security, and capacity of automated systems.

    (v) Business continuity and disaster recovery.

    Proposed Sec. 39.18 (e) would require that a DCO maintain a BC-DR

    plan, procedures, and physical (e.g., buildings, generators, and

    related physical infrastructure), technological (e.g., computers,

    replacement parts, and software), and personnel resources (e.g.,

    trained employees or other committed human resources) sufficient to

    enable timely recovery and resumption of operations, and fulfillment of

    responsibilities (e.g., daily processing, clearing and settlement of

    transactions cleared) of the DCO following a disruption. The required

    recovery time objective would be no later than the next business day.

    As noted below, proposed Sec. 39.30 would set a more stringent RTO for

    SIDCOs.

    (vi) Location of resources; outsourcing.

    Proposed Sec. 39.18(f) would clarify that a DCO could maintain the

    resources required pursuant to Sec. 39.18(e) on its own or through an

    outsourcing arrangement with another DCO or other service provider.

    Proposed Sec. 39.18(f)(i) would provide that an outsourcing DCO would

    retain complete liability for any failure to meet the specified

    responsibilities, and must employ personnel with the expertise

    necessary to enable the DCO to supervise the service provider. Proposed

    Sec. 39.18(f)(ii) would require that testing include all of the DCO's

    own and outsourced resources, and verify that such resources will work

    effectively together.

    In response to the July Proposal, a number of commenters expressed

    concern that it was impractical for DCOs to have all key job functions

    fully duplicated. The proposed regulation clarifies that a DCO may

    maintain such functions on its own (including, e.g., through cross-

    training) or through written outsourcing arrangements, including with

    another DCO.

    The Commission seeks comment on whether these provisions governing

    outsourcing are appropriate, and whether the clarifications concerning

    the retention of responsibility and the necessity for integrated

    testing should be expanded to cover all functions of a DCO.

    (vii) Notification of Commission staff; recordkeeping.

    Proposed Sec. 39.18(g) would require each DCO to notify Commission

    staff of various exceptional events, such as technology malfunctions,

    system security-related incidents, or targeted threats. The proposed

    regulation attempts to achieve a reasonable balance, requiring

    notification only of such events that materially impair, or create a

    significant likelihood of material impairment, of automated system

    operation, reliability, security, or capacity. The proposed regulation

    would also require notification of any activation of the DCO's BC-DR

    plan.

    Proposed Sec. 39.18(h) would require a DCO to give Commission

    staff timely advance notice of planned changes, either changes to

    automated systems that are likely to have a significant impact on such

    systems, or changes to the DCO's program of risk analysis and

    oversight.

    Proposed Sec. 39.18(i) would require a DCO to maintain current

    copies of its business continuity plan and other emergency procedures,

    its assessments of its operational risks, and records of testing

    protocols and results; to provide copies of such records to Commission

    staff pursuant to Sec. 1.31; and to provide other documents requested

    by Commission staff for the purpose of maintaining a current profile of

    the DCO's automated systems.

    (viii) Testing.

    Proposed Sec. 39.18(j) would require a DCO to conduct regular,

    periodic, objective testing and review of its automated systems to

    ensure that they are reliable, secure, and have adequate scalable

    capacity, and of its BC-DR capabilities, using testing protocols

    adequate to ensure that the DCO's backup resources are sufficient to

    meet the RTO specified in Sec. 39.18(e). The testing would be required

    to be conducted by qualified, independent professionals. While such

    professionals could include employees of the DCO, they could not be

    persons responsible for development or operation of the systems or

    capabilities being tested.

    Reports setting forth the protocols for, and results of, such tests

    would be required to be communicated to, and reviewed by, senior

    management of the DCO. Because tests that result in few or no

    exceptions raise the possibility of an insufficiently rigorous

    protocol, such results would be required to be subject to more

    searching review.

    (ix) Coordination of business continuity and disaster recovery

    plans.

    Proposed Sec. 39.18(k) would require each DCO, to the extent

    practicable, to coordinate its BC-DR plan with those of its clearing

    members, to initiate coordinated testing of such plans, and to take

    into account in its own BC-DR plan the BC-DR plans of its providers of

    essential services, including telecommunications, power, and water.

    (b) SIDCOs.

    (i) Determining which DCOs will be subject to enhanced BC-DR

    obligations.

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

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

    promulgates higher standards pursuant to Title VIII of the Dodd-Frank

    Act.

    Unlike the July Proposal,\72\ these proposed regulations do not

    provide a means for the Commission to determine which DCOs are ``core

    clearing and settlement organizations.'' In light of the provisions of

    section 804 of the Dodd-Frank Act for designation of systemically

    important clearing or settlement activities, the Commission proposes to

    avoid duplication by applying the enhanced BC-DR obligations described

    below to SIDCOs.

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

    \72\ See id. at 42639 (proposed appendix E to part 40--Guidance

    on Critical Financial Market and Core Clearing and Settlement

    Organization Determination).

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

    (ii) Recovery time objective.

    Proposed Sec. 39.30(a) would set an RTO for SIDCOs of recovery no

    later than two hours following the disruption, for any disruption

    including a wide-scale disruption,\73\ in light of the important

    [[Page 3714]]

    role that SIDCOs play in the financial system. The term ``wide-scale

    disruption'' is defined in proposed Sec. 39.18(a).

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

    \73\ See Interagency Paper on Sound Practices To Strengthen the

    Resilience of the U.S. Financial System, 68 FR 17809, 17812 (Apr.

    11, 2003) (White Paper) which states

    ``core clearing and settlement organizations are necessary to

    the completion of most transactions in critical markets;

    accordingly, they must recover and resume their critical functions

    in order for other market participants to process pending

    transactions and complete large-value payments. It also is

    reasonable to assume that there will be firms that play significant

    roles and other market participants in locations not affected by a

    particular disruption that will need to clear and settle pending

    transactions in critical markets. Therefore, core clearing and

    settlement organizations should plan both to recover and resume

    their processing and other activities that support critical markets.

    In light of the large volume and value of transactions/payments that

    are cleared and settled on a daily basis, failure to complete the

    clearing and settlement of pending transactions within the business

    day could create systemic liquidity dislocations, as well as

    exacerbate credit and market risk for critical markets. Therefore,

    core clearing and settlement organizations should develop the

    capacity to recover and resume clearing and settlement activities

    within the business day on which the disruption occurs with the

    overall goal of achieving recovery and resumption within two hours

    after an event''

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

    (iii) Geographic diversity.

    Because of the importance of SIDCOs to the financial system, and

    the fact that a wide-scale disruption may cause the physical or

    technological resources that are located within the relevant area, or

    personnel who live or work within the relevant area, to be temporarily

    or permanently unavailable, proposed Sec. 39.30(b) would require each

    SIDCO to maintain geographic dispersal of physical and technological

    resources and personnel.

    Physical and technological resources must, pursuant to proposed

    Sec. 39.30(b)(1), be located outside the relevant area of the

    infrastructure the entity normally relies upon to conduct activities

    necessary to the clearance and settlement of existing and new

    contracts, and the SIDCO could not rely on the same critical

    transportation, telecommunications, power, water, or other critical

    infrastructure components the entity normally relies upon for such

    activities. Moreover, proposed Sec. 39.30(b)(2) would require

    personnel, sufficient to enable the SIDCO to meet the recovery time

    objective after interruption of normal clearing by a wide-scale

    disruption affecting the relevant area, who live and work outside that

    relevant area.

    While these proposed requirements would likely lead to a

    considerable expense, the Commission believes that the systemic

    importance of SIDCOs carries with it a responsibility to be reliably

    available on a near-continuous basis, to fulfill their obligations.

    Moreover, to provide an opportunity to meet this responsibility in a

    flexible manner, proposed Sec. 39.30(b)(3) would make it explicit that

    the outsourcing provisions of proposed Sec. 39.18(f) would apply to

    these resource requirements.

    (iv) Testing.

    Proposed Sec. 39.30(c) would require each SIDCO to conduct

    regular, periodic tests of its business continuity and disaster

    recovery plans and resources and its capacity to achieve the required

    recovery time objective in the event of a wide-scale disruption, and

    would state that the provisions of proposed Sec. 39.18(j), concerning

    testing by DCOs, would apply. Moreover, with respect to outsourcing,

    proposed Sec. 39.18(f)(2)(ii) would provide that the testing

    referenced in proposed Sec. 39.30(c) ``shall include all [of the

    DCO's] own and outsourced resources, and shall verify that all such

    resources will work effectively together.''

    (v) Effective date.

    A number of commenters on the July Proposal suggested that the

    establishment of geographically diverse capabilities would require an

    extended implementation period, such as 24 months. The Commission

    observes with approval, however, that a number of potential SIDCOs

    already have geographic dispersal of certain resources, and/or are

    already working to achieving such dispersal. Accordingly, the

    Commission proposes an effective date for the SIDCO requirements of the

    later of one year from the effective date of these regulations, or July

    30, 2012. Moreover, Sec. 39.30(d) provides that proposed Sec. 39.30

    will apply to a DCO no earlier than one year after such DCO is

    designated as systemically important.

    7. Special Enforcement Authority Over SIDCOs

    Under section 807(c) of the Dodd-Frank Act, for purposes of

    enforcing the provisions of Title VIII, a SIDCO is subject to, and the

    Commission has authority under the provisions of subsections (b)

    through (n) of section 8 of, the Federal Deposit Insurance Act \74\ in

    the same manner and to the same extent as if the SIDCO were an insured

    depository institution and the Commission were the appropriate Federal

    banking agency for such insured depository institution. This special

    authority is codified in proposed Sec. 39.31.

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

    \74\ 12 U.S.C. 1818.

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

    C. Additional Amendments

    1. Technical Amendments To Reorganize Part 39

    The Commission is proposing to reorganize part 39 into three

    subparts. Subpart A would contain general provisions applicable to all

    DCOs including definitions, procedures for DCO registration, and

    procedures for implementation of DCO rules and clearing new products.

    Subpart B would contain the regulations that codify and implement the

    DCO core principles. The regulations in subpart B would apply to all

    DCOs except to the extent that a DCO is a SIDCO and there are

    superseding provisions in subpart C. Subpart C would contain

    regulations that apply only to SIDCOs. As proposed, for purposes of

    clarity, each subpart would have an introductory section stating the

    scope of the subpart.\75\

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

    \75\ See proposed subpart A, Sec. 39.1; proposed subpart B,

    Sec. 39.9; and proposed subpart C, Sec. 39.28.

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

    The Commission is proposing to amend Sec. 39.1 to update the

    citation to the definition of the term ``derivatives clearing

    organization'' and to restate the scope of part 39 to reflect the

    reorganization of part 39 into subparts A, B, and C.

    The Commission is additionally proposing to remove Sec. 39.2,

    which exempts DCOs from all Commission regulations except those

    explicitly enumerated in the exemption.\76\ The Commission believes

    that this exemption is inconsistent with the regulatory approach

    established by the Dodd-Frank Act. Moreover, a preliminary review

    indicates that by eliminating the exemption, DCOs would be subject to

    only one additional regulation of significance, Sec. 1.49

    (denomination of customer funds and location of depositories).\77\

    Section 1.49 was promulgated after Sec. 39.2 was adopted. It is

    noteworthy that, notwithstanding Sec. 39.2, the Commission and the

    industry have proceeded as if the requirements of Sec. 1.49 applied to

    DCOs. The absence of a reference in Sec. 39.2 to Sec. 1.49 in the

    exemption was an oversight. This situation points out the unintended

    consequences of attempting to carve out ``reverse'' exemptions in this

    manner, and the Commission believes it is a better regulatory policy to

    amend the terms of inapplicable regulations or rescind them, as

    appropriate, rather than attempt to maintain an up-to-date list of

    applicable regulations.

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

    \76\ Section 39.2 provides, in relevant part, as follows:

    A derivatives clearing organization and the clearing of

    agreements, contracts and transactions on a derivatives clearing

    organization are exempt from all Commission regulations except for

    the requirements of this part 39, Sec. Sec. 1.3, 1.12(f)(1), 1.20,

    1.24, 1.25, 1.26, 1.27, 1.29, 1.31, 1.36, 1.38(b), part 40 and part

    190 of this chapter, and as applicable to the agreement, contract,

    or transaction cleared, parts 15 through 18 of this chapter.

    \77\ The other provisions relate to governance and conflicts of

    interest issues, and may be superseded by pending rules. See Sec.

    1.59 (activities of self-regulatory organization employees,

    governing board members, committee members, and consultants); Sec.

    1.63 (service on self-regulatory organization governing boards or

    committees by persons with disciplinary histories); and Sec. 1.69

    (voting by interested members of self-regulatory organization

    governing boards and various committees).

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

    [[Page 3715]]

    In place of the exemption, the Commission proposes to insert the

    definitions proposed as Sec. 39.1(b) in an earlier proposed

    rulemaking.\78\ Section 39.1(a), as proposed in the earlier rulemaking,

    would be redesignated as Sec. 39.1.\79\

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

    \78\ See 75 FR at 77585-86.

    \79\ Id.

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

    2. Supplemental Provisions for Proposed Sec. 39.19

    The Commission recently proposed a new Sec. 39.19(c) which would

    require certain reports to be made by a DCO to the Commission.\80\

    Where the primary reporting requirement would be specified elsewhere in

    the Commission's regulations, the Commission intends to cross-reference

    these requirements in Sec. 39.19. The following are recently proposed

    reporting requirements for which the Commission proposes to add a

    cross-reference in proposed Sec. 39.19:

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

    \80\ See 75 FR at 78194.

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

    (1) The Commission recently proposed a new Sec. 39.24(b)(4) which

    would require each DCO to collect and verify certain information

    related to governance fitness standards and provide that information to

    the Commission on an annual basis.\81\ By this notice, the Commission

    is proposing a new Sec. 39.19(c)(3)(iii) \82\ under which a DCO would

    be required to satisfy the annual reporting requirements of Sec.

    39.24(b)(4). The Commission also is proposing to amend proposed Sec.

    39.24(b)(4) to require the report to be submitted in accordance with

    the requirements of proposed Sec. 39.19(c)(3)(iv) (which would require

    the report to be filed not more than 90 days after the end of the DCO's

    fiscal year).

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

    \81\ See 76 FR 722, 736 (Jan. 6, 2011).

    \82\ The Commission is proposing to redesignate what is

    currently proposed as Sec. 39.19(c)(3)(iii) as Sec.

    39.19(c)(3)(iv). This proposed regulation currently states:

    The reports required by this paragraph (c)(3) shall be submitted

    concurrently to the Commission not more than 90 days after the end

    of the derivatives clearing organization's fiscal year; provided

    that, a derivatives clearing organization may request from the

    Commission an extension of time to submit either report, provided

    the derivatives clearing organization's failure to submit the report

    in a timely manner could not be avoided without unreasonable effort

    or expense. Extensions of the deadline will be granted at the

    discretion of the Commission.

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

    (2) The Commission recently proposed a new Sec. 39.25(b) under

    which a DCO would be required to submit a report to the Commission in

    the event that the Board of Directors of a DCO rejects a recommendation

    or supersedes an action of the Risk Management Committee, or the Risk

    Management Committee rejects a recommendation or supersedes an action

    of its subcommittee.\83\ The report would have to include the following

    details: (i) The recommendation or action of the Risk Management

    Committee (or subcommittee thereof); (ii) the rationale for such

    recommendation or action; (iii) the rationale of the Board of Directors

    (or the Risk Management Committee, if applicable) for rejecting such

    recommendation or superseding such action; and (iv) the course of

    action that the Board of Directors (or the Risk Management Committee,

    if applicable) decided to take contrary to such recommendation or

    action. By this notice, the Commission is proposing a new Sec.

    39.19(c)(4)(xvi) under which a DCO would be required to report to the

    Commission as required by Sec. 39.25(b). The Commission also is

    proposing to amend proposed Sec. 39.25(b) to require the report to be

    submitted to the Commission within 30 days of such a rejection or

    supersession.

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

    \83\ See supra n.81.

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

    (3) The Commission also recently proposed a new Sec.

    40.9(b)(1)(iii) under which a DCO (as well as other registered

    entities) would have to submit to the Commission, within 30 days after

    the election of its Board of Directors, certain information regarding

    the Board of Directors.\84\ By this notice, the Commission is proposing

    a new Sec. 39.19(c)(4)(xvii) under which a DCO would have to submit to

    the Commission a report in accordance with the requirements of proposed

    Sec. 40.9(b)(1)(iii).

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

    \84\ Id.

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

    (4) In this notice, the Commission is proposing that a DCO notify

    staff of the Division of Clearing and Intermediary Oversight of certain

    exceptional events and certain planned changes related to system

    safeguards (Core Principle I).\85\ The Commission is proposing a new

    Sec. 39.19(c)(4)(xviii) under which a DCO would be required to notify

    staff of the Division of Clearing and Intermediary Oversight of

    exceptional events related to system safeguards in accordance with

    proposed Sec. 39.18(g) and of planned changes related to system

    safeguards in accordance with proposed Sec. 39.18(h).

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

    \85\ See supra, section II.B.6.a.vii.

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

    3. Technical Amendments to Proposed Sec. 39.21

    The Commission recently proposed a new Sec. 39.24(a)(2) which

    would require each DCO to make available to the public and to the

    relevant authorities, including the Commission, a description of the

    manner in which its governance arrangements permit the consideration of

    the views of its owners, whether voting or non-voting, and its

    participants, including, without limitation, clearing members and

    customers.\86\ The Commission also recently proposed Sec. 40.9(d)

    which would require a DCO (as well as other registered entities) to, at

    a minimum, make certain information available to the public and

    relevant authorities, including the Commission.\87\

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

    \86\ See 76 FR at 735.

    \87\ Id. at 736.

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

    The Commission also recently proposed a new Sec. 39.21(c) which

    lists certain information a DCO would be required to disclose publicly

    and to the Commission.\88\ By this notice, the Commission is proposing

    to amend proposed Sec. 39.21(c) to cross-reference the transparency

    requirements of proposed Sec. Sec. 39.24(a)(2) and 40.9(d).

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

    \88\ See 75 FR at 78197.

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

    III. Effective Date

    The Commission is proposing that the requirements proposed in this

    notice become effective 180 days from the date the final rules are

    published in the Federal Register, with the exception of (1) the system

    safeguard requirements that would be applicable to SIDCOs, set forth in

    proposed Sec. 39.30, for which the proposed effective date is

    discussed in section II.B.6(b)(v) above, and (2) the provisions of

    Sec. 39.15(b)(2) relating to the commingling of customer futures,

    options on futures, and swaps positions, which would become effective

    30 days after the date of publication of the final rules. The

    provisions relating to commingling of customer funds do not require

    additional time for planning and implementation because they relate to

    a voluntary action on the part of a DCO.

    The Commission believes that a period of 180 days would give DCOs

    adequate time to implement any additional technology and enhanced

    procedures that may be necessary to fulfill the proposed requirements

    related to participant and product eligibility, risk management,

    settlement procedures, treatment of funds, default rules and

    procedures, and system safeguards (insofar as they would apply to all

    DCOs). The Commission requests comment on whether 180 days is an

    appropriate time frame for compliance with these proposed rules. The

    Commission further requests comment on possible alternative effective

    dates and the basis for any such alternative dates.

    IV. Section 4(c)

    Section 4(c) of the CEA provides that, in order to promote

    responsible

    [[Page 3716]]

    economic or financial innovation and fair competition, the Commission,

    by rule, regulation or order, after notice and opportunity for hearing,

    may exempt any agreement, contract, or transaction, or class thereof,

    including any person or class of persons offering, entering into,

    rendering advice or rendering other services with respect to, the

    agreement, contract, or transaction, from the contract market

    designation requirement of section 4(a) of the CEA, or any other

    provision of the CEA other than certain enumerated provisions, if the

    Commission determines that the exemption would be consistent with the

    public interest.\89\

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

    \89\ 7 U.S.C. 6(c).

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

    Proposed Sec. Sec. 39.15(b)(2)(i) and 39.15(b)(2)(ii) would be

    promulgated under Core Principle F, which sets forth requirements for

    treatment of funds by a DCO.\90\ Proper treatment of customer funds

    requires, among other things, segregation of customer money, securities

    and property received to margin, guarantee, or secure positions in

    futures or options on futures, in an account subject to section 4d(a)

    of the CEA (i.e., a futures account), and segregation of customer

    money, securities and property received to margin, guarantee, or secure

    positions in cleared swaps, in an account subject to section 4d(f) of

    the CEA (i.e., a cleared swap account). Customer funds required to be

    held in a futures account cannot be commingled with non-customer funds

    and cannot be held in an account other than an account subject to

    section 4d(a), absent Commission approval in the form of a rule,

    regulation or order. Section 4d(f) of the CEA mirrors these limitations

    as applied to customer positions in cleared swaps.

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

    \90\ Section 5b(c)(2)(F) of the CEA; 7 U.S.C. 7a-1(c)(2)(F).

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

    In proposing a regulation that would permit futures and options on

    futures to be carried in a cleared swap account if the Commission

    approves DCO rules providing for such treatment of funds, and in

    proposing a regulation that would permit cleared swap positions to be

    carried in a futures account if the Commission issues an order

    permitting such treatment of funds, the Commission is exercising its

    authority to grant an exemption under section 4(c) of the CEA. In this

    regard, the DCO and its clearing members would be exempt from complying

    with the segregation requirements of section 4d(a) when holding

    customer segregated funds in a cleared swap account subject to section

    4d(f) of the CEA, instead of a futures account; and similarly, the DCO

    and its clearing members would be exempt from complying with the

    segregation requirements of section 4d(f) when holding customer funds

    related to cleared swap positions in a futures account subject to

    section 4d(a) of the CEA, instead of a cleared swap account.

    While this rule-based exemption would streamline the approval

    process for commingling customer positions in futures, options on

    futures, and cleared swaps, the Commission would still conduct a case-

    by case analysis when permitting cleared swaps to be carried in a

    futures account, in keeping with its past practice in issuing orders

    under section 4d. The Commission believes that there can be benefits to

    commingling customer positions in futures, options on futures, and

    cleared swaps, primarily in the area of greater capital efficiency due

    to margin reductions for correlated positions. The Commission views

    this form of portfolio margining as a positive step toward financial

    innovation within a framework of responsible oversight, and it believes

    that the public can benefit from such innovation.

    In light of the foregoing, the Commission believes that the

    adoption of proposed Sec. Sec. 39.15(b)(2)(i) and 39.15(b)(2)(ii)

    would promote responsible economic and financial innovation and fair

    competition, and would be consistent with the ``public interest,'' as

    that term is used in section 4(c) of the CEA.

    The Commission solicits public comment on whether the proposed

    regulation satisfies the requirements for exemption under section 4(c)

    of the CEA.

    V. Related Matters

    A. Regulatory Flexibility Act

    The Regulatory Flexibility Act (RFA) requires that agencies

    consider whether the rules they propose will have a significant

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

    provide a regulatory flexibility analysis respecting the impact.\91\

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

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

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

    Commission in evaluating the impact of its regulations on small

    entities in accordance with the RFA.\92\ The Commission has previously

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

    RFA.\93\ Accordingly, the Chairman, on behalf of the Commission, hereby

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

    have a significant economic impact on a substantial number of small

    entities.

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

    \91\ 5 U.S.C. 601 et seq.

    \92\ 47 FR 18618 (Apr. 30, 1982).

    \93\ See 66 FR 45605, 45609 (Aug. 29, 2001).

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

    B. Paperwork Reduction Act

    The Paperwork Reduction Act (``PRA'') \94\ imposes certain

    requirements on Federal agencies in connection with their conducting or

    sponsoring any collection of information as defined by the PRA. An

    agency may not conduct or sponsor, and a person is not required to

    respond to, a collection of information unless it displays a currently

    valid control number. OMB has not yet assigned a control number to the

    new collection.

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

    \94\ 44 U.S.C. 3501 et seq.

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

    This proposed rulemaking would result in new collection of

    information requirements within the meaning of the PRA. The Commission

    therefore is submitting this proposal to the Office of Management and

    Budget (``OMB'') for review. If adopted, responses to this collection

    of information would be mandatory.

    The Commission will protect proprietary information according to

    FOIA and 17 CFR part 145, ``Commission Records and Information.'' In

    addition, section 8(a)(1) of the CEA strictly prohibits the Commission,

    unless specifically authorized by the CEA, from making public ``data

    and information that would separately disclose the business

    transactions or market positions of any person and trade secrets or

    names of customers.'' The Commission also is required to protect

    certain information contained in a government system of records

    according to the Privacy Act of 1974, 5 U.S.C. 552a.

    1. Information Provided by Reporting Entities/Persons

    The proposed regulations would require each respondent to maintain

    records of all activities related to its business as a DCO, including

    all information required to be created, generated, or reported under

    part 39, including but not limited to the results of and methodology

    used for all tests, reviews, and calculations.

    The Commission staff estimates this would result in a total of one

    response per respondent on an annual basis and that respondents could

    expend up to $500 annually, based on an hourly rate of $10, to comply

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

    of $6,000 per annum (12 respondents x $500).

    [[Page 3717]]

    The proposed regulations also would require the submission of an

    application form by entities seeking to register as DCOs. The applicant

    burden is estimated to take, on average, approximately 400 hours, with

    an hourly rate ranging from $75-$400, for a total estimated cost of

    $100,000 per application. These estimates include the time needed to

    review instructions and to develop, acquire, install, and utilize

    technology and systems for the purposes of collecting, validating, and

    verifying information. Staff estimates that three entities will seek to

    register as a DCO on an annual basis.

    2. Information Collection Comments

    The Commission invites the public and other Federal agencies to

    comment on any aspect of the reporting and recordkeeping burdens

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

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

    collection of information is necessary for the proper performance of

    the functions of the Commission, including whether the information will

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

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

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

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

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

    including through the use of automated collection techniques or other

    forms of information technology.

    Comments may be submitted directly to the Office of Information and

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

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

    of submitted comments so that all comments can be summarized and

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

    this notice of proposed rulemaking for comment submission instructions

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

    collections of information discussed above may be obtained by visiting

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

    collection of information between 30 and 60 days after publication of

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

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

    publication.

    C. Cost-Benefit Analysis

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

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

    CEA. By its terms, section 15(a) does not require the Commission to

    quantify the costs and benefits of a rule or to determine whether the

    benefits of the rulemaking outweigh its costs; rather, it requires that

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

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

    be evaluated in light of five broad areas of market and public concern:

    (1) Protection of market participants and the public; (2) efficiency,

    competitiveness, and financial integrity of futures markets; (3) price

    discovery; (4) sound risk management practices; and (5) other public

    interest considerations. The Commission may in its discretion give

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

    discretion determine that, notwithstanding its costs, a particular

    regulation is necessary or appropriate to protect the public interest

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

    purposes of the CEA.

    Summary of proposed requirements. The proposed regulations would

    implement the participant and product eligibility, risk management,

    settlement procedures, treatment of funds, default procedures and

    system safeguards core principles for DCOs and would adopt an

    application form for DCO registration under the CEA, as amended by the

    Dodd-Frank Act.

    Costs. With respect to costs, the Commission has determined that

    the costs to market participants and the public if these regulations

    are not adopted are substantial. Significantly, without these

    regulations to ensure that DCOs fully comply with the core principles

    of participant and product eligibility, risk management, settlement

    procedures, treatment of funds, default procedures and system

    safeguards, sound risk management and the financial integrity of the

    futures and swap markets would not be enhanced, to the detriment of

    market participants and the public.

    The Commission has also determined that the costs of the new

    reporting requirements imposed on DCOs will consist primarily of

    recordkeeping requirements, which the Commission estimates will cost

    DCOs $500 annually. For purposes of this rulemaking, the estimated

    reporting and recordkeeping costs do not include other costs addressed

    by other rulemakings. However, the costs do take into account the costs

    of implementing certain reporting requirements which many DCOs already

    have in place, and thus, the actual costs to many DCOs may be far less

    than the Commission's estimates.

    Benefits. With respect to benefits, the Commission has determined

    that the benefits of the proposed rules are many and substantial. DCO

    registration applications will be processed transparently and

    efficiently, making clearing services available to the futures and swap

    markets in order to protect the integrity of these markets through the

    sound risk management practices associated with clearing and the

    efficiency that competition between clearinghouses will foster. The

    protection of market participants, financial integrity of the markets,

    and sound risk management will further be promoted by the compliance of

    each DCO with the rules and standards that are being adopted to

    implement the core principles, notably those associated with

    participant and product eligibility, risk management, settlement

    procedures, treatment of funds, default procedures and system

    safeguards.

    The Commission has also determined that the recordkeeping

    requirements allow for making certain records available for Commission

    inspection, which helps further the goals of the reporting requirements

    and is necessary for the Commission to effectively monitor a DCO's

    financial integrity and compliance with the CEA and Commission

    regulations.

    Public Comment. The Commission invites public comment on its cost-

    benefit considerations. Commenters are also invited to submit any data

    or other information that they may have quantifying or qualifying the

    costs and benefits of the proposal with their comment letters.

    List of Subjects in 17 CFR Part 39

    Commodity futures, Participant and product eligibility, Risk

    management, Settlement procedures, Treatment of funds, Default rules

    and procedures, System safeguards, Enforcement authority application

    form.

    In light of the foregoing, the Commission hereby proposes to amend

    part 39 of Title 17 of the Code of Federal Regulations as follows:

    PART 39--DERIVATIVES CLEARING ORGANIZATIONS

    1. Revise the authority citation for part 39 to read as follows:

    Authority: 7 USC 2, 5, 6, 6d, 7a-1, 7a-2, and 7b as amended by

    the Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub.

    L. 111-203, 124 Stat. 1376.

    [[Page 3718]]

    Subpart A--General Provisions Applicable to Derivatives Clearing

    Organizations

    2. Designate existing Sec. Sec. 39.1 through 39.7 as subpart A and

    add a subpart heading to read as set forth above.

    3. Revise Sec. 39.1 to read as follows:

    Sec. 39.1 Scope.

    The provisions of this subpart A apply to any derivatives clearing

    organization, as defined under section 1a(15) of the Act and Sec.

    1.3(d) of this chapter, which is registered or deemed to be registered

    with the Commission as a derivatives clearing organization, is required

    to register as such with the Commission pursuant to section 5b(a) of

    the Act, or which voluntarily registers as such with the Commission

    pursuant to section 5b(b) or otherwise.

    4. Revise Sec. 39.2 to read as follows:

    Sec. 39.2 Definitions.

    For the purposes of this part,

    Back test means a test that compares a derivatives clearing

    organization's initial margin requirements with historical price

    changes to determine the extent of actual margin coverage.

    Compliance policies and procedures means all policies, procedures,

    codes, including a code of ethics, safeguards, rules, programs, and

    internal controls that are required to be adopted or established by a

    derivatives clearing organization pursuant to the Act, Commission

    regulations, or orders, or that otherwise facilitate compliance with

    the Act and Commission regulations.

    Customer account or customer origin means a clearing member's

    account held on behalf of customers, as defined in Sec. 1.3(k) of this

    chapter. A customer account is also a futures account, as that term is

    defined by Sec. 1.3(vv) of this chapter.

    House account or house origin means a clearing member's combined

    proprietary accounts, as defined in Sec. 1.3(y) of this chapter.

    Key personnel means derivatives clearing organization personnel who

    play a significant role in the operations of the derivatives clearing

    organization, the provision of clearing and settlement services, risk

    management, or oversight of compliance with the Act and Commission

    regulations and orders. Key personnel include, but are not limited to,

    those persons who are or perform the functions of any of the following:

    chief executive officer; president; Chief compliance officer; chief

    operating officer; Chief risk officer; chief financial officer; chief

    technology officer; and emergency contacts or persons who are

    responsible for business continuity or disaster recovery planning or

    program execution.

    Stress test means a test that compares the impact of a potential

    price move, change in option volatility, or change in other inputs that

    affect the value of a position, to the financial resources of a

    derivatives clearing organization, clearing member, or large trader, to

    determine the adequacy of such financial resources.

    Systemically important derivatives clearing organization means a

    financial market utility that is a derivatives clearing organization

    registered under section 5b of the Act (7 U.S.C. 7a-1), which has been

    designated by the Financial Stability Oversight Council to be

    systemically important.

    5. Amend Sec. 39.3 by revising paragraphs (a)(2), (a)(3), (b),

    (c), (d) and (e) and by adding paragraphs (a)(4) and (a)(5) to read as

    follows:

    Sec. 39.3 Procedures for registration.

    (a) * * *

    (2) Application. Any person seeking to register as a derivatives

    clearing organization, any applicant amending its pending application,

    or any registered derivatives clearing organization seeking to amend

    its order of registration (applicant), shall submit to the Commission a

    completed Form DCO, which shall include a cover sheet, all applicable

    exhibits, and any supplemental materials, including amendments thereto,

    as provided in appendix A to this part 39 (application). The Commission

    will not commence processing an application unless the applicant has

    filed the application as required by this section. Failure to file a

    completed application will preclude the Commission from determining

    that an application is materially complete, as provided in section 6(a)

    of the Act. Upon its own initiative, an applicant may file with its

    completed application additional information that may be necessary or

    helpful to the Commission in processing the application.

    (3) Submission of supplemental information. The filing of a

    completed application is a minimum requirement and does not create a

    presumption that the application is materially complete or that

    supplemental information will not be required. At any time during the

    application review process, the Commission may request that the

    applicant submit supplemental information in order for the Commission

    to process the application. The applicant shall file electronically

    such supplemental information with the Secretary of the Commission in

    the form and manner provided by the Commission.

    (4) Application amendments. An applicant shall promptly amend its

    application if it discovers a material omission or error, or if there

    is a material change in the information provided to the Commission in

    the application or other information provided in connection with the

    application.

    (5) Public information. The following sections of all applications

    to become a registered derivatives clearing organization will be

    public: first page of the Form DCO cover sheet, proposed rules,

    regulatory compliance chart, narrative summary of proposed clearing

    activities, documents establishing the applicant's legal status,

    documents setting forth the applicant's corporate and governance

    structure, and any other part of the application not covered by a

    request for confidential treatment, subject to Sec. 145.9 of this

    chapter.

    (b) Stay of application review. (1) The Commission may stay the

    running of the 180-day review period if an application is materially

    incomplete, in accordance with section 6(a) of the Act.

    (2) Delegation of authority. (i) The Commission hereby delegates,

    until it orders otherwise, to the Director of the Division of Clearing

    and Intermediary Oversight or the Director's designee, with the

    concurrence of the General Counsel or the General Counsel's designee,

    the authority to notify an applicant seeking registration under section

    6(a) of the Act that the application is materially incomplete and the

    running of the 180-day period is stayed.

    (ii) The Director of the Division of Clearing and Intermediary

    Oversight may submit to the Commission for its consideration any matter

    which has been delegated in this paragraph.

    (iii) Nothing in this paragraph prohibits the Commission, at its

    election, from exercising the authority delegated in paragraph

    (b)(2)(i) of this section.

    (c) Withdrawal of application for registration. An applicant for

    registration may withdraw its application submitted pursuant to

    paragraph (a) of this section by filing electronically such a request

    with the Secretary of the Commission in the form and manner provided by

    the Commission. Withdrawal of an application for registration shall not

    affect any action taken or to be taken by the Commission based upon

    actions, activities, or events occurring during the time that the

    application for registration was pending with the Commission.

    [[Page 3719]]

    (d) Reinstatement of dormant registration. Before listing or

    relisting products for clearing, a dormant registered derivatives

    clearing organization as defined in Sec. 40.1 of this chapter must

    reinstate its registration under the procedures of paragraph (a) of

    this section; provided, however, that an application for reinstatement

    may rely upon previously submitted materials that still pertain to, and

    accurately describe, current conditions.

    (e) Request for vacation of registration. A registered derivatives

    clearing organization may vacate its registration under section 7 of

    the Act by filing electronically such a request with the Secretary of

    the Commission in the form and manner provided by the Commission.

    Vacation of registration shall not affect any action taken or to be

    taken by the Commission based upon actions, activities or events

    occurring during the time that the entity was registered by the

    Commission.

    * * * * *

    Sec. 39.7 [Redesignated as Sec. 39.8]

    6. Redesignate Sec. 39.7 as Sec. 39.8.

    Sec. 39.6 [Redesignated as Sec. 39.7]

    7. Redesignate Sec. 39.6 as Sec. 39.7.

    8. Add subpart B to read as follows:

    Subpart B--Compliance with Core Principles

    Sec.

    39.9 Scope.

    39.10 [Reserved]

    39.11 [Reserved]

    39.12 Participant and product eligibility.

    39.13 Risk management.

    39.14 Settlement procedures.

    39.15 Treatment of funds.

    39.16 Default rules and procedures.

    39.17 [Reserved]

    39.18 System safeguards.

    39.19 Reporting.

    39.20 [Reserved]

    39.21 Public information.

    39.22 [Reserved]

    39.23 [Reserved]

    39.24 Governance fitness standards.

    39.25 Conflicts of interest.

    Subpart B--Compliance with Core Principles

    Sec. 39.9 Scope.

    Except as otherwise provided with respect to systemically important

    derivatives clearing organizations subject to subpart C of this part,

    the provisions of this subpart B apply to any derivatives clearing

    organization, as defined under section 1a(15) of the Act and Sec.

    1.3(d) of this chapter, which is registered or deemed to be registered

    with the Commission as a derivatives clearing organization, is required

    to register as such with the Commission pursuant to section 5b(a) of

    the Act, or which voluntarily registers as such with the Commission

    pursuant to section 5b(b) or otherwise.

    Sec. 39.10 [Reserved]

    Sec. 39.11 [Reserved]

    Sec. 39.12 Participant and product eligibility.

    (a) Participant eligibility. A derivatives clearing organization

    shall establish appropriate admission and continuing participation

    requirements for clearing members of the derivatives clearing

    organization that are objective, publicly disclosed, and risk-based.

    (1) Fair and open access for participation. The participation

    requirements shall permit fair and open access;

    (i) A derivatives clearing organization shall not adopt restrictive

    clearing member standards if less restrictive requirements that would

    not materially increase risk to the derivatives clearing organization

    or clearing members could be adopted;

    (ii) A derivatives clearing organization shall allow all market

    participants who satisfy participation requirements to become clearing

    members;

    (iii) A derivatives clearing organization shall not exclude or

    limit clearing membership of certain types of market participants

    unless the derivatives clearing organization can demonstrate that the

    restriction is necessary to address credit risk or deficiencies in the

    participants' operational capabilities that would prevent them from

    fulfilling their obligations as clearing members.

    (iv) A derivatives clearing organization shall not require that

    clearing members must be swap dealers.

    (v) A derivatives clearing organization shall not require that

    clearing members maintain a swap portfolio of any particular size, or

    that clearing members meet a swap transaction volume threshold.

    (2) Financial resources. (i) The participation requirements shall

    require clearing members to have access to sufficient financial

    resources to meet obligations arising from participation in the

    derivatives clearing organization in extreme but plausible market

    conditions. The financial resources may include, but are not limited

    to, a clearing member's capital, a guarantee from the clearing member's

    parent, or a credit facility funding arrangement. For purposes of this

    paragraph, ``capital'' means adjusted net capital as defined in Sec.

    1.17 of this chapter, for futures commission merchants, and net capital

    as defined in Sec. 15c3-1 of this title, for broker-dealers, or any

    similar risk adjusted capital calculation for all other prospective

    clearing members.

    (ii) The participation requirements shall set forth capital

    requirements that are based on objective, transparent, and commonly

    accepted standards that appropriately match capital to risk. Capital

    requirements shall be scalable so that they are proportional to the

    risks posed by clearing members.

    (iii) A derivatives clearing organization shall not set a minimum

    capital requirement of more than $50 million for any person that seeks

    to become a clearing member in order to clear swaps.

    (3) Operational requirements. The participation requirements shall

    require clearing members to have adequate operational capacity to meet

    obligations arising from participation in the derivatives clearing

    organization. The requirements shall include, but are not limited to:

    the ability to process expected volumes and values of transactions

    cleared by a clearing member within required time frames, including at

    peak times and on peak days; the ability to fulfill collateral,

    payment, and delivery obligations imposed by the derivatives clearing

    organization; and the ability to participate in default management

    activities under the rules of the derivatives clearing organization and

    in accordance with Sec. 39.16 of this part.

    (4) Monitoring. A derivatives clearing organization shall establish

    and implement procedures to verify, on an ongoing basis, the compliance

    of each clearing member with each participation requirement of the

    derivatives clearing organization.

    (5) Reporting. (i) A derivatives clearing organization shall

    require all clearing members, including those that are not futures

    commission merchants, to file periodic financial reports with the

    derivatives clearing organization which contain any financial

    information that the derivatives clearing organization determines is

    necessary to assess whether participation requirements are met on an

    ongoing basis. A derivatives clearing organization shall require

    clearing members that are futures commission merchants to file the

    financial reports that are specified in Sec. 1.10 of this chapter with

    the derivatives clearing organization. The derivatives clearing

    organization shall review all such financial reports for risk

    management purposes. A derivatives clearing organization shall also

    require clearing members that are not futures commission merchants to

    make such periodic financial reports available to

    [[Page 3720]]

    the Commission upon the Commission's request.

    (ii) A derivatives clearing organization shall adopt rules that

    require clearing members to provide to the derivatives clearing

    organization, in a timely manner, information that concerns any

    financial or business developments that may materially affect the

    clearing members' ability to continue to comply with participation

    requirements.

    (6) Enforcement. A derivatives clearing organization shall have the

    ability to enforce compliance with its participation requirements and

    shall establish procedures for the suspension and orderly removal of

    clearing members that no longer meet the requirements.

    (b) Product eligibility. (1) A derivatives clearing organization

    shall establish appropriate requirements for determining the

    eligibility of agreements, contracts, or transactions submitted to the

    derivatives clearing organization for clearing, taking into account the

    derivatives clearing organization's ability to manage the risks

    associated with such agreements, contracts, or transactions. Factors to

    be considered in determining product eligibility include, but are not

    limited to:

    (i) Trading volume;

    (ii) Liquidity;

    (iii) Availability of reliable prices;

    (iv) Ability of market participants to use portfolio compression

    with respect to a particular swap product;

    (v) Ability of the derivatives clearing organization and clearing

    members to gain access to the relevant market for purposes of creating

    and liquidating positions;

    (vi) Ability of the derivatives clearing organization to measure

    risk for purposes of setting margin requirements; and

    (vii) Operational capacity of the derivatives clearing organization

    and clearing members to address any unique risk characteristics of a

    product.

    (2) A derivatives clearing organization shall adopt rules providing

    that all swaps with the same terms and conditions submitted to the

    derivatives clearing organization for clearing are economically

    equivalent within the derivatives clearing organization and may be

    offset with each other within the derivatives clearing organization. A

    derivatives clearing organization shall also provide for non-

    discriminatory clearing of a swap executed bilaterally or on or subject

    to the rules of an unaffiliated designated contract market or swap

    execution facility.

    (3) A derivatives clearing organization shall select contract unit

    sizes that maximize liquidity, open access, and risk management. To the

    extent appropriate to further these objectives, a derivatives clearing

    organization shall select contract units for clearing purposes that are

    smaller than the contract units in which trades submitted for clearing

    were executed.

    (4) A derivatives clearing organization that clears swaps shall

    have rules providing that, upon acceptance of a swap by the derivatives

    clearing organization for clearing:

    (i) The original swap is extinguished;

    (ii) The original swap is replaced by equal and opposite swaps

    between clearing members and the derivatives clearing organization;

    (iii) All terms of the cleared swaps must conform to templates

    established under derivatives clearing organization rules; and

    (iv) If a swap is cleared by a clearing member on behalf of a

    customer, all terms of the swap, as carried in the customer account on

    the books of the clearing member, must conform to the terms of the

    cleared swap established under the derivatives clearing organization's

    rules.

    Sec. 39.13 Risk management.

    (a) In general. A derivatives clearing organization shall ensure

    that it possesses the ability to manage the risks associated with

    discharging the responsibilities of the derivatives clearing

    organization through the use of appropriate tools and procedures.

    (b) Documentation requirement. A derivatives clearing organization

    shall establish and maintain written policies, procedures, and

    controls, approved by its Board of Directors, which establish an

    appropriate risk management framework that, at a minimum, clearly

    identifies and documents the range of risks to which the derivatives

    clearing organization is exposed, addresses the monitoring and

    management of the entirety of those risks, and provides a mechanism for

    internal audit. The risk management framework shall be regularly

    reviewed and updated as necessary.

    (c) Chief risk officer. A derivatives clearing organization shall

    have a chief risk officer who shall be responsible for implementing the

    risk management framework, including the procedures, policies and

    controls described in paragraph (b) of this section, and for making

    appropriate recommendations to the derivatives clearing organization's

    Risk Management Committee or Board of Directors, as applicable,

    regarding the derivatives clearing organization's risk management

    functions.

    (d) [Reserved]

    (e) Measurement of credit exposure. A derivatives clearing

    organization shall:

    (1) Measure its credit exposure to each clearing member and mark to

    market such clearing member's open positions at least once each

    business day; and

    (2) Monitor its credit exposure to each clearing member

    periodically during each business day.

    (f) Limitation of exposure to potential losses from defaults. A

    derivatives clearing organization, through margin requirements and

    other risk control mechanisms, shall limit its exposure to potential

    losses from defaults by its clearing members to ensure that:

    (1) The operations of the derivatives clearing organization would

    not be disrupted; and

    (2) Non-defaulting clearing members would not be exposed to losses

    that nondefaulting clearing members cannot anticipate or control.

    (g) Margin requirements--(1) In general. The initial margin that a

    derivatives clearing organization requires from each clearing member

    shall be sufficient to cover potential exposures in normal market

    conditions. Each model and parameter used in setting initial margin

    requirements shall be risk-based and reviewed on a regular basis.

    (2) Methodology and coverage. (i) A derivatives clearing

    organization shall establish initial margin requirements that are

    commensurate with the risks of each product and portfolio, including

    any unique characteristics of, or risks associated with, particular

    products or portfolios. A derivatives clearing organization that clears

    credit default swaps shall appropriately address jump-to-default risk

    in setting initial margins.

    (ii) A derivatives clearing organization shall use models that

    generate initial margin requirements sufficient to cover the

    derivatives clearing organization's potential future exposures to

    clearing members based on price movements in the interval between the

    last collection of variation margin and the time within which the

    derivatives clearing organization estimates that it would be able to

    liquidate a defaulting clearing member's positions (liquidation time);

    provided, however, that a derivatives clearing organization shall use a

    liquidation time that is a minimum of five business days for cleared

    swaps that are not executed on a designated contract market, whether

    the swaps are carried in a customer account subject to section 4d(a) or

    4d(f) of the Act, or carried in a house account, and a liquidation time

    that is a minimum of one business day for all other products that it

    clears, and shall use longer

    [[Page 3721]]

    liquidation times, if appropriate, based on the unique characteristics

    of particular products or portfolios.

    (iii) The actual coverage of the initial margin requirements

    produced by such models, along with projected measures of the models'

    performance, shall meet an established confidence level of at least

    99%, based on data from an appropriate historic time period, for:

    (A) Each product (that is margined on a product basis);

    (B) Each spread within or between products for which there is a

    defined spread margin rate, as described in paragraph (g)(4) of this

    section;

    (C) Each account held by a clearing member at the DCO, by customer

    origin and house origin; and

    (D) Each swap portfolio, by beneficial owner.

    (iv) A derivatives clearing organization shall determine the

    appropriate historic time period based on the characteristics,

    including volatility patterns, as applicable, of each product, spread,

    account, or portfolio.

    (3) Independent validation. A derivatives clearing organization's

    systems for generating initial margin requirements, including its

    theoretical models, must be reviewed and validated by a qualified and

    independent party, on a regular basis.

    (4) Spread margins. (i) A derivatives clearing organization may

    allow reductions in initial margin requirements for related positions

    (spread margins) if the price risks with respect to such positions are

    significantly and reliably correlated. The price risks of different

    positions will only be considered to be reliably correlated if there is

    a theoretical basis for the correlation in addition to an exhibited

    statistical correlation. That theoretical basis may include, but is not

    limited to, the following:

    (A) The products on which the positions are based are complements

    of, or substitutes for, each other;

    (B) One product is a significant input into the other product(s);

    (C) The products share a significant common input; or

    (D) The prices of the products are influenced by common external

    factors.

    (ii) A derivatives clearing organization shall regularly review its

    spread margins and the correlations on which they are based.

    (5) Price data. A derivatives clearing organization shall have a

    reliable source of timely price data in order to measure the

    derivatives clearing organization's credit exposure accurately. A

    derivatives clearing organization shall also have written procedures

    and sound valuation models for addressing circumstances where pricing

    data is not readily available or reliable.

    (6) Daily review. On a daily basis, a derivatives clearing

    organization shall determine the adequacy of its initial margin

    requirements for each product (that is margined on a product basis).

    (7) Back tests. A derivatives clearing organization shall conduct

    back tests, as defined in Sec. 39.2 of this part, using historical

    price changes based on a time period that is equivalent in length to

    the historic time period used by the applicable margin model for

    establishing the confidence level described in paragraph (g)(2) of this

    section or a longer time period, unless another time period is

    specified by this paragraph.

    (i) On a daily basis, a derivatives clearing organization shall

    conduct back tests with respect to products that are experiencing

    significant market volatility, to test the adequacy of its initial

    margin requirements and spread margin requirements for such products

    that are margined on a product basis.

    (ii) On at least a monthly basis, a derivatives clearing

    organization shall conduct back tests to test the adequacy of its

    initial margin requirements and spread margin requirements for each

    product that is margined on a product basis.

    (iii) On at least a monthly basis, a derivatives clearing

    organization shall conduct back tests to test the adequacy of its

    initial margin requirements for each account held by a clearing member

    at the DCO, by origin, house and customer, and each swap portfolio, by

    beneficial owner, over at least the previous 30 days.

    (8) Customer margin--(i) Gross margin. A derivatives clearing

    organization shall collect initial margin on a gross basis for each

    clearing member's customer account equal to the sum of the initial

    margin amounts that would be required by the derivatives clearing

    organization for each individual customer within that account if each

    individual customer were a clearing member. A derivatives clearing

    organization may not net positions of different customers against one

    another. A derivatives clearing organization may collect initial margin

    for its clearing members' house accounts on a net basis.

    (ii) Customer initial margin requirements. A derivatives clearing

    organization shall require its clearing members to collect customer

    initial margin, as defined in Sec. 1.3 of this chapter, from their

    customers, for non-hedge positions, at a level that is greater than

    100% of the derivatives clearing organization's initial margin

    requirements with respect to each product and swap portfolio. The

    derivatives clearing organization shall have reasonable discretion in

    determining the percentage by which customer initial margins must

    exceed the derivatives clearing organization's initial margin

    requirements with respect to particular products or swap portfolios.

    The Commission may review such percentage levels and require different

    percentage levels if the Commission deems the levels insufficient to

    protect the financial integrity of the clearing members or the

    derivatives clearing organization.

    (iii) Withdrawal of customer initial margin. A derivatives clearing

    organization shall require its clearing members to ensure that their

    customers do not withdraw funds from their accounts with such clearing

    members unless the net liquidating value plus the margin deposits

    remaining in a customer's account after such withdrawal are sufficient

    to meet the customer initial margin requirements with respect to all

    products and swap portfolios held in such customer's account which are

    cleared by the derivatives clearing organization.

    (9) Time deadlines. A derivatives clearing organization shall

    establish and enforce time deadlines for initial and variation margin

    payments to the derivatives clearing organization.

    (h) Other risk control mechanisms--(1) Risk limits. (i) A

    derivatives clearing organization shall impose risk limits on each

    clearing member, by customer origin and house origin, in order to

    prevent a clearing member from carrying positions for which the risk

    exposure exceeds a specified threshold relative to the clearing

    member's and/or the derivatives clearing organization's financial

    resources. The derivatives clearing organization shall have reasonable

    discretion in determining:

    (A) The method of computing risk exposure;

    (B) The applicable threshold(s); and

    (C) The applicable financial resources under this provision;

    provided however, that the ratio of exposure to capital must remain the

    same across all capital levels. The Commission may review such methods,

    thresholds, and financial resources and require the application of

    different methods, thresholds, or financial resources, as appropriate.

    (ii) A derivatives clearing organization may permit a clearing

    member to exceed the threshold(s) applied pursuant to paragraph

    (h)(1)(i) of this section provided that the derivatives clearing

    organization requires the clearing member to post additional initial

    margin that the derivatives clearing organization deems sufficient to

    [[Page 3722]]

    appropriately eliminate excessive risk exposure at the clearing member.

    The Commission may review the amount of additional initial margin and

    require a different amount of additional initial margin, as

    appropriate.

    (2) Large trader reports. A derivatives clearing organization shall

    obtain from its clearing members, copies of all reports that are

    required to be filed with the Commission by such clearing members

    pursuant to part 17 of this chapter. With respect to exclusively self-

    cleared contracts, a derivatives clearing organization shall obtain

    from the relevant reporting market, copies of all reports that are

    required to be filed with the Commission on behalf of such clearing

    members by the relevant reporting market, pursuant to Sec. 17.00(i) of

    this chapter. A derivatives clearing organization shall review such

    reports on a daily basis to ascertain the risk of the overall portfolio

    of each large trader, including positions at all clearing members

    carrying accounts for each such large trader, and shall take additional

    actions with respect to such clearing members, when appropriate, as

    specified in paragraph (h)(6) of this section, in order to address any

    risks posed by any such large trader.

    (3) Stress tests. A derivatives clearing organization shall conduct

    stress tests, as defined in Sec. 39.2 of this part, as follows:

    (i) On a daily basis, a derivatives clearing organization shall

    conduct stress tests with respect to each large trader who poses

    significant risk to a clearing member or the derivatives clearing

    organization, including positions at all clearing members carrying

    accounts for each such large trader. The derivatives clearing

    organization shall have reasonable discretion in determining which

    traders to test and the methodology used to conduct such stress tests.

    The Commission may review the selection of accounts and the methodology

    and require changes, as appropriate.

    (ii) On at least a weekly basis, a derivatives clearing

    organization shall conduct stress tests with respect to each clearing

    member account, by customer origin and house origin, and each swap

    portfolio, by beneficial owner, under extreme but plausible market

    conditions. The derivatives clearing organization shall have reasonable

    discretion in determining the methodology used to conduct such stress

    tests. The Commission may review the methodology and require changes,

    as appropriate.

    (4) Portfolio compression. (i) A derivatives clearing organization

    shall offer multilateral portfolio compression exercises, on a regular

    basis, for its clearing members that clear swaps, to the extent that

    such exercises are appropriate for those swaps that it clears.

    (ii) A derivatives clearing organization shall require its clearing

    members to participate in all such exercises, to the extent that any

    swap in the applicable portfolio is eligible for inclusion in the

    exercise, unless including the swap would be reasonably likely to

    significantly increase the risk exposure of the clearing member.

    (iii) A derivatives clearing organization may permit clearing

    members participating in compression exercises to set risk tolerance

    limits for their portfolios, provided that the clearing members do not

    set such risk tolerances at an unreasonable level or use such risk

    tolerances to evade the requirements of this paragraph.

    (5) Clearing members' risk management policies and procedures. (i)

    A derivatives clearing organization shall adopt rules that:

    (A) Require its clearing members to maintain current written risk

    management policies and procedures;

    (B) Ensure that it has the authority to request and obtain

    information and documents from its clearing members regarding their

    risk management policies, procedures, and practices, including, but not

    limited to, information and documents relating to the liquidity of

    their financial resources and their settlement procedures; and

    (C) Require its clearing members to make information and documents

    regarding their risk management policies, procedures, and practices

    available to the Commission upon the Commission's request.

    (ii) A derivatives clearing organization shall review the risk

    management policies, procedures, and practices of each of its clearing

    members on a periodic basis and document such reviews.

    (6) Additional authority. A derivatives clearing organization shall

    take additional actions with respect to particular clearing members,

    when appropriate, based on the application of objective and prudent

    risk management standards including, but not limited to:

    (i) Imposing enhanced capital requirements;

    (ii) Imposing enhanced margin requirements;

    (iii) Imposing position limits;

    (iv) Prohibiting an increase in positions;

    (v) Requiring a reduction of positions;

    (vi) Liquidating or transferring positions; and

    (vii) Suspending or revoking clearing membership.

    Sec. 39.14 Settlement procedures.

    (a) Definitions--(1) Settlement. For purposes of this section,

    ``settlement'' means:

    (i) Payment and receipt of variation margin for futures, options,

    and swap positions;

    (ii) Payment and receipt of option premiums;

    (iii) Deposit and withdrawal of initial margin for futures,

    options, and swap positions;

    (iv) All payments due in final settlement of futures, options, and

    swap positions on the final settlement date with respect to such

    positions; and

    (v) All other cash flows collected from or paid to each clearing

    member, including but not limited to, payments related to swaps such as

    coupon amounts.

    (2) Settlement bank. For purposes of this section, ``settlement

    bank'' means a bank that maintains an account either for the

    derivatives clearing organization or for any of its clearing members,

    which is used for the purpose of transferring funds and receiving

    transfers of funds in connection with settlements with the derivatives

    clearing organization.

    (b) Daily settlements. A derivatives clearing organization shall

    effect a settlement with each clearing member at least once each

    business day, and shall have the authority and operational capacity to

    effect a settlement with each clearing member, on an intraday basis,

    either routinely, when thresholds specified by the derivatives clearing

    organization are breached, or in times of extreme market volatility.

    (c) Settlement banks. A derivatives clearing organization shall

    employ settlement arrangements that eliminate or strictly limit its

    exposure to settlement bank risks, including the credit and liquidity

    risks arising from the use of such banks to effect settlements with its

    clearing members.

    (1) A derivatives clearing organization shall have documented

    criteria with respect to those banks that are acceptable settlement

    banks for the derivatives clearing organization and its clearing

    members, including criteria addressing the capitalization,

    creditworthiness, access to liquidity, operational reliability, and

    regulation or supervision of such banks.

    (2) A derivatives clearing organization shall monitor each approved

    settlement bank on an ongoing basis to ensure that such bank continues

    to meet the criteria established pursuant to paragraph (c)(1) of this

    section.

    [[Page 3723]]

    (3) A derivatives clearing organization shall monitor the full

    range and concentration of its exposures to its own and its clearing

    members' settlement banks and assess its own and its clearing members'

    potential losses and liquidity pressures in the event that the

    settlement bank with the largest share of settlement activity were to

    fail. A derivatives clearing organization shall:

    (i) Maintain settlement accounts at additional settlement banks;

    (ii) Approve additional settlement banks for use by its clearing

    members;

    (iii) Impose concentration limits with respect to its own or its

    clearing members' settlement banks; and/or

    (iv) Take any other appropriate actions, if any such actions are

    reasonably necessary in order to eliminate or strictly limit such

    exposures.

    (d) Settlement finality. A derivatives clearing organization shall

    ensure that settlements are final when effected by ensuring that

    settlement fund transfers are irrevocable and unconditional when the

    derivatives clearing organization's accounts are debited or credited. A

    derivatives clearing organization's legal agreements with its

    settlement banks shall state clearly when settlement fund transfers

    will occur and a derivatives clearing organization shall routinely

    confirm that its settlement banks are effecting fund transfers as and

    when required by such legal agreements.

    (e) Recordkeeping. A derivatives clearing organization shall

    maintain an accurate record of the flow of funds associated with each

    settlement.

    (f) Netting arrangements. A derivatives clearing organization shall

    possess the ability to comply with each term and condition of any

    permitted netting or offset arrangement with any other clearing

    organization.

    (g) Physical delivery. With respect to contracts, agreements, and

    transactions that are settled by physical transfers of the underlying

    instruments or commodities, a derivatives clearing organization shall:

    (1) Establish rules that clearly state each obligation that the

    derivatives clearing organization has assumed with respect to physical

    deliveries, including whether it has an obligation to make or receive

    delivery of a physical instrument or commodity, or whether it

    indemnifies clearing members for losses incurred in the delivery

    process; and

    (2) Ensure that the risks of each such obligation are identified

    and managed.

    Sec. 39.15 Treatment of funds.

    (a) Required standards and procedures. A derivatives clearing

    organization shall establish standards and procedures that are designed

    to protect and ensure the safety of funds and assets belonging to

    clearing members and their customers.

    (b) Segregation of funds and assets--(1) Segregation. A derivatives

    clearing organization shall comply with the segregation requirements of

    section 4d of the Act and Commission regulations thereunder, or any

    other applicable Commission regulation or order requiring that customer

    funds and assets be segregated, set aside, or held in a separate

    account.

    (2) Commingling of futures, options on futures, and swaps

    positions--(i) Cleared swap account. In order for a derivatives

    clearing organization and its clearing members to commingle customer

    positions in futures, options on futures, and swaps, and any money,

    securities, or property received to margin, guarantee or secure such

    positions, in an account subject to the requirements of section 4d(f)

    of the Act, the derivatives clearing organization shall file rules for

    Commission approval pursuant to Sec. 40.5 of this chapter. Such rule

    submission shall include, at a minimum, the following:

    (A) An identification of the futures, options on futures, and swaps

    that would be commingled, including contract specifications or the

    criteria that would be used to define eligible futures, options on

    futures, and swaps;

    (B) An analysis of the risk characteristics of the eligible

    products;

    (C) A description of whether the swaps would be executed

    bilaterally and/or executed on a designated contract market and/or a

    swap execution facility;

    (D) An analysis of the liquidity of the respective markets for the

    futures, options on futures, and swaps that would be commingled, the

    ability of clearing members and the derivatives clearing organization

    to offset or mitigate the risk of such futures, options on futures, and

    swaps in a timely manner, without compromising the financial integrity

    of the account, and, as appropriate, proposed means for addressing

    insufficient liquidity;

    (E) An analysis of the availability of reliable prices for each of

    the eligible products;

    (F) A description of the financial, operational, and managerial

    standards or requirements for clearing members that would be permitted

    to commingle such futures, options on futures, and swaps;

    (G) A description of the systems and procedures that would be used

    by the derivatives clearing organization to oversee such clearing

    members' risk management of any such commingled positions;

    (H) A description of the financial resources of the derivatives

    clearing organization, including the composition and availability of a

    guaranty fund with respect to the futures, options on futures, and

    swaps that would be commingled;

    (I) A description and analysis of the margin methodology that would

    be applied to the commingled futures, options on futures, and swaps,

    including any margin reduction applied to correlated positions, and any

    applicable margin rules with respect to both clearing members and

    customers;

    (J) An analysis of the ability of the derivatives clearing

    organization to manage a potential default with respect to any of the

    futures, options on futures, or swaps that would be commingled;

    (K) A discussion of the procedures that the derivatives clearing

    organization would follow if a clearing member defaulted, and the

    procedures that a clearing member would follow if a customer defaulted,

    with respect to any of the commingled futures, options on futures, or

    swaps in the account; and

    (L) A description of the arrangements for obtaining daily position

    data from each beneficial owner of futures, options on futures, and

    swaps in the account.

    (ii) Futures account. In order for a derivatives clearing

    organization and its clearing members to commingle customer positions

    in futures, options on futures, and swaps, and any money, securities,

    or property received to margin, guarantee or secure such positions, in

    an account subject to the requirements of section 4d(a) of the Act, the

    derivatives clearing organization shall file with the Commission a

    petition for an order pursuant to section 4d(a) of the Act. Such

    petition shall include, at a minimum, the information required under

    paragraph (b)(2)(i) of this section.

    (iii) Commission action. (A) The Commission may request additional

    information in support of a rule submission filed under paragraph

    (b)(i) of this section, and may grant approval of such rules in

    accordance with Sec. 40.5 of this chapter.

    (B) The Commission may request additional information in support of

    a petition filed under paragraph (b)(ii) of this section, and may issue

    an order under section 4d of the Act in its discretion.

    (c) Holding of funds and assets. A derivatives clearing

    organization shall hold funds and assets belonging to clearing members

    and their customers in a manner which minimizes the risk

    [[Page 3724]]

    of loss or of delay in the access by the derivatives clearing

    organization to such funds and assets.

    (1) Types of assets. A derivatives clearing organization shall

    limit the assets it accepts as initial margin to those that are have

    minimal credit, market, and liquidity risks. A derivatives clearing

    organization may not accept letters of credit as initial margin.

    (2) Valuation. A derivatives clearing organization shall use

    prudent valuation practices to value assets posted as initial margin on

    a daily basis.

    (3) Haircuts. A derivatives clearing organization shall apply

    appropriate reductions in value to reflect market and credit risk

    (haircuts), including in stressed market conditions, to the assets that

    it accepts in satisfaction of initial margin obligations, and shall

    evaluate the appropriateness of such haircuts on at least a quarterly

    basis.

    (4) Concentration limits. A derivatives clearing organization shall

    apply appropriate limitations on the concentration of assets posted as

    initial margin, as necessary, in order to ensure its ability to

    liquidate such assets quickly, with minimal adverse price effects, and

    shall evaluate the appropriateness of any such concentration limits, on

    at least a monthly basis.

    (5) Pledged assets. If a derivatives clearing organization permits

    its clearing members to pledge assets for initial margin while

    retaining such assets in accounts in the names of such clearing

    members, the derivatives clearing organization shall ensure that such

    assets are unencumbered and that such a pledge has been validly created

    and validly perfected in the relevant jurisdiction.

    (d) Permitted investments. Funds and assets belonging to clearing

    members and their customers that are invested by a derivatives clearing

    organization shall be held in instruments with minimal credit, market,

    and liquidity risks. Any investment of customer funds or assets by a

    derivatives clearing organization shall comply with Sec. 1.25 of this

    part, as if all such funds and assets comprise customer funds subject

    to segregation pursuant to section 4d(a) of the Act and Commission

    regulations thereunder.

    Sec. 39.16 Default rules and procedures.

    (a) In general. A derivatives clearing organization shall adopt

    rules and procedures designed to allow for the efficient, fair, and

    safe management of events during which clearing members become

    insolvent or default on the obligations of such clearing members to the

    derivatives clearing organization.

    (b) Default management plan. A derivatives clearing organization

    shall maintain a current written default management plan that

    delineates the roles and responsibilities of its Board of Directors,

    its Risk Management Committee, any other committee that has

    responsibilities for default management, and the derivatives clearing

    organization's management, in addressing a default, including any

    necessary coordination with, or notification of, other entities and

    regulators. Such plan shall address any differences in procedures with

    respect to highly liquid contracts (such as certain futures) and less

    liquid contracts (such as certain swaps). A derivatives clearing

    organization shall conduct and document a test of its default

    management plan on at least an annual basis.

    (c) Default procedures. (1) A derivatives clearing organization

    shall adopt procedures that would permit the derivatives clearing

    organization to take timely action to contain losses and liquidity

    pressures and to continue meeting its obligations in the event of a

    default on the obligations of a clearing member to the derivatives

    clearing organization.

    (2) A derivatives clearing organization shall adopt rules that set

    forth its default procedures, including:

    (i) The derivatives clearing organization's definition of a

    default;

    (ii) The actions that the derivatives clearing organization may

    take upon a default, which shall include the prompt transfer,

    liquidation, or hedging of the customer or proprietary positions of the

    defaulting clearing member, as applicable, and which may include, in

    the discretion of the derivatives clearing organization, the auctioning

    or allocation of such positions to other clearing members;

    (iii) Any obligations that the derivatives clearing organization

    imposes on its clearing members to participate in auctions, or to

    accept allocations, of a defaulting clearing member's positions,

    provided that any allocation shall be proportional to the size of the

    participating or accepting clearing member's positions at the

    derivatives clearing organization;

    (iv) The sequence in which the funds and assets of the defaulting

    clearing member and the financial resources maintained by the

    derivatives clearing organization would be applied in the event of a

    default;

    (v) A provision that customer margin posted by a defaulting

    clearing member shall not be applied in the event of a proprietary

    default;

    (vi) A provision that proprietary margins posted by a defaulting

    clearing member shall be applied in the event of a customer default, if

    the relevant customer margin is insufficient to cover the shortfall;

    and

    (3) A derivatives clearing organization shall make its default

    rules publicly available as provided in Sec. 39.21 of this part.

    (d) Insolvency of a clearing member.

    (1) A derivatives clearing organization shall adopt rules that

    require a clearing member to provide prompt notice to the derivatives

    clearing organization if it becomes the subject of a bankruptcy

    petition, receivership proceeding, or the equivalent;

    (2) Upon receipt of such notice, a derivatives clearing

    organization shall review the continuing eligibility of the clearing

    member for clearing membership; and

    (3) Upon receipt of such notice, a derivatives clearing

    organization shall take any appropriate action, in its discretion, with

    respect to such clearing member or its positions, including but not

    limited to liquidation or transfer of positions, and suspension or

    revocation of clearing membership.

    Sec. 39.17 [Reserved]

    Sec. 39.18 System safeguards.

    (a) Definitions. For purposes of this section and of Sec. 39.30 of

    this part:

    Relevant area means the metropolitan or other geographic area

    within which a derivatives clearing organization has physical

    infrastructure or personnel necessary for it to conduct activities

    necessary to the clearance and settlement of existing and new

    contracts. The term ``relevant area'' also includes communities

    economically integrated with, adjacent to, or within normal commuting

    distance of that metropolitan or other geographic area.

    Recovery time objective means the time period within which an

    entity should be able to achieve recovery and resumption of clearing

    and settlement of existing and new contracts, after those capabilities

    become temporarily inoperable for any reason up to or including a wide-

    scale disruption.

    Wide-scale disruption means an event that causes a severe

    disruption or destruction of transportation, telecommunications, power,

    water, or other critical infrastructure components in a relevant area,

    or an event that results in an evacuation or unavailability of the

    population in a relevant area.

    (b) In general--(1) Program of risk analysis. Each derivatives

    clearing organization shall establish and

    [[Page 3725]]

    maintain a program of risk analysis and oversight with respect to its

    operations and automated systems to identify and minimize sources of

    operational risk through:

    (i) The development of appropriate controls and procedures; and

    (ii) The development of automated systems that are reliable,

    secure, and have adequate scalable capacity.

    (2) Resources. Each derivatives clearing organization shall

    establish and maintain resources that allow for the fulfillment of each

    obligation and responsibility of the derivatives clearing organization

    in light of the risks identified pursuant to paragraph (b)(1) of this

    section.

    (3) Verification of adequacy. Each derivatives clearing

    organization shall periodically verify that resources described in

    paragraph (b)(2) are adequate to ensure daily processing, clearing, and

    settlement.

    (c) Elements of program. A derivatives clearing organization's

    program of risk analysis and oversight with respect to its operations

    and automated systems, as described in paragraph (b) of this section,

    shall address each of the following categories of risk analysis and

    oversight:

    (1) Information security;

    (2) Business continuity and disaster recovery planning and

    resources;

    (3) Capacity and performance planning;

    (4) Systems operations;

    (5) Systems development and quality assurance; and

    (6) Physical security and environmental controls.

    (d) Standards for program. In addressing the categories of risk

    analysis and oversight required under paragraph (c) of this section, a

    derivatives clearing organization shall follow generally accepted

    standards and industry best practices with respect to the development,

    operation, reliability, security, and capacity of automated systems.

    (e) Business continuity and disaster recovery--(1) Plan and

    resources. A derivatives clearing organization shall maintain a

    business continuity and disaster recovery plan, emergency procedures,

    and physical, technological, and personnel resources sufficient to

    enable the timely recovery and resumption of operations and the

    fulfillment of each obligation and responsibility of the derivatives

    clearing organization following any disruption of its operations.

    (2) Responsibilities and obligations. The responsibilities and

    obligations described in paragraph (e)(1) shall include, without

    limitation, daily processing, clearing, and settlement of transactions

    cleared.

    (3) Recovery time objective. The derivatives clearing

    organization's business continuity and disaster recovery plan described

    in paragraph (e)(1) of this section shall have the objective of, and

    the physical, technological, and personnel resources described therein

    shall be sufficient to, enable the derivatives clearing organization to

    resume daily processing, clearing, and settlement no later than the

    next business day following the disruption.

    (f) Location of resources; outsourcing. A derivatives clearing

    organization may maintain the resources required under paragraph (e)(1)

    of this section either:

    (1) Using its own employees as personnel, and property that it

    owns, licenses, or leases (own resources); or

    (2) Through written contractual arrangements with another

    derivatives clearing organization or other service provider

    (outsourcing).

    (i) Retention of responsibility. A derivatives clearing

    organization that enters into such a contractual arrangement shall

    retain complete liability for any failure to meet the responsibilities

    specified in paragraph (e) of this section, although it is free to seek

    indemnification from the service provider. The outsourcing derivatives

    clearing organization must employ personnel with the expertise

    necessary to enable it to supervise the service provider's delivery of

    the services.

    (ii) Testing. The testing referred to in paragraph (j) of this

    Sec. 39.18 and Sec. 39.30(c) of this part shall include all own and

    outsourced resources, and shall verify that all such resources will

    work effectively together.

    (g) Notice of exceptional events. A derivatives clearing

    organization shall notify staff of the Division of Clearing and

    Intermediary Oversight promptly of:

    (1) Any hardware or software malfunction, cyber security incident,

    or targeted threat that materially impairs, or creates a significant

    likelihood of material impairment, of automated system operation,

    reliability, security, or capacity; or

    (2) Any activation of the derivatives clearing organization's

    business continuity and disaster recovery plan.

    (h) Notice of planned changes. A derivatives clearing organization

    shall give staff of the Division of Clearing and Intermediary Oversight

    timely advance notice of all:

    (1) Planned changes to automated systems that are likely to have a

    significant impact on the reliability, security, or adequate scalable

    capacity of such systems; and

    (2) Planned changes to the derivatives clearing organization's

    program of risk analysis and oversight.

    (i) Recordkeeping. A derivatives clearing organization shall

    maintain, and provide to Commission staff promptly upon request,

    pursuant to Sec. 1.31 of this chapter, current copies of its business

    continuity plan and other emergency procedures, its assessments of its

    operational risks, and records of testing protocols and results, and

    shall provide any other documents requested by Commission staff for the

    purpose of maintaining a current profile of the derivatives clearing

    organization's automated systems.

    (j) Testing--(1) Purpose of testing. A derivatives clearing

    organization shall conduct regular, periodic, and objective testing and

    review of:

    (i) Its automated systems to ensure that they are reliable, secure,

    and have adequate scalable capacity; and

    (ii) Its business continuity and disaster recovery capabilities,

    using testing protocols adequate to ensure that the derivatives

    clearing organization's backup resources are sufficient to meet the

    requirements of paragraph (e) of this section.

    (2) Conduct of testing. Testing shall be conducted by qualified,

    independent professionals. Such qualified independent professionals may

    be independent contractors or employees of the derivatives clearing

    organization, but shall not be persons responsible for development or

    operation of the systems or capabilities being tested.

    (3) Reporting and review. Reports setting forth the protocols for,

    and results of, such tests shall be communicated to, and reviewed by,

    senior management of the derivatives clearing organization. Protocols

    of tests which result in few or no exceptions shall be subject to more

    searching review.

    (k) Coordination of business continuity and disaster recovery

    plans. A derivatives clearing organization shall, to the extent

    practicable:

    (1) Coordinate its business continuity and disaster recovery plan

    with those of its clearing members, in a manner adequate to enable

    effective resumption of daily processing, clearing, and settlement

    following a disruption;

    (2) Initiate and coordinate periodic, synchronized testing of its

    business continuity and disaster recovery plan and the plans of its

    clearing members; and

    (3) Ensure that its business continuity and disaster recovery plan

    takes into account the plans of its providers of essential services,

    including telecommunications, power, and water.

    [[Page 3726]]

    Sec. 39.19 Reporting.

    (a) [Reserved]

    (b) [Reserved]

    (c) (1) [Reserved]

    (i) [Reserved]

    (ii) [Reserved]

    (iii) [Reserved]

    (iv) End-of-day positions for each clearing member, by customer

    origin and house origin.

    (2) [Reserved]

    (3)(i) [Reserved]

    (ii) [Reserved]

    (iii) The annual verification required by Sec. 39.24(b)(4) of this

    part.

    (iv) Time of report. The reports required by this paragraph (c)(3)

    shall be submitted concurrently to the Commission not more than 90 days

    after the end of the derivatives clearing organization's fiscal year;

    provided that, a derivatives clearing organization may request from the

    Commission an extension of time to submit either report, provided the

    derivatives clearing organization's failure to submit the report in a

    timely manner could not be avoided without unreasonable effort or

    expense. Extensions of the deadline will be granted at the discretion

    of the Commission.

    (4) (i)-(xv) [Reserved]

    (xvi) Action of Board of Directors or Risk Management Committee. A

    report when (A) the Board of Directors of a derivatives clearing

    organization rejects a recommendation or supersedes an action of the

    Risk Management Committee; or

    (B) The Risk Management Committee rejects a recommendation or

    supersedes an action of its subcommittee, as required by Sec. 39.25(b)

    of this part.

    (xvii) Election of Board of Directors. A report after each election

    of its Board of Directors in accordance with Sec. 40.9(b)(1)(iii) of

    this chapter.

    (xviii) System safeguards. A report of (A) exceptional events as

    required by Sec. 39.18(g) of this part; or

    (B) Planned changes as required by Sec. 39.18(h) of this part.

    Sec. 39.20 [Reserved]

    Sec. 39.21 Public information.

    (a) [Reserved]

    (b) [Reserved]

    (c)(1)-(5) [Reserved]

    (6) The derivatives clearing organization's rules and procedures

    for defaults in accordance with Sec. 39.16 of this part;

    (7) Governance and conflicts of interest in accordance with Sec.

    39.24(a)(2) of this part and Sec. 40.9(d) of this chapter; and

    (8) Any other matter that is relevant to participation in the

    clearing and settlement activities of the derivatives clearing

    organization.

    Sec. 39.22 [Reserved]

    Sec. 39.23 [Reserved]

    Sec. 39.24 Governance fitness standards.

    (a) [Reserved]

    (b)(1)-(3) [Reserved]

    (4) Verification. Each derivatives clearing organization must

    collect and verify information that supports compliance with the

    standards in paragraphs (b)(2) and (3) of this section, and provide

    that information to the Commission on an annual basis in accordance

    with the requirements of Sec. 39.19(c)(3)(iv) of this part. Such

    information may take the form of a certification based on verifiable

    information, an affidavit from the general counsel of the derivatives

    clearing organization, registration information, or other

    substantiating information.

    Sec. 39.25 Conflicts of interest.

    (a) [Reserved]

    (b) Reporting to the Commission. In the event that:

    (1) The Board of Directors of a derivatives clearing organization

    rejects a recommendation or supersedes an action of the Risk Management

    Committee, or

    (2) The Risk Management Committee rejects a recommendation or

    supersedes an action of its subcommittee (as described in Sec.

    39.13(d)(5) of this part), the derivatives clearing organization shall

    submit a written report to the Commission within 30 days of such a

    rejection or supersession detailing:

    (i) The recommendation or action of the Risk Management Committee

    (or subcommittee thereof);

    (ii) The rationale for such recommendation or action;

    (iii) The rationale of the Board of Directors (or the Risk

    Management Committee, if applicable) for rejecting such recommendation

    or superseding such action; and

    (iv) The course of action that the Board of Directors (or the Risk

    Management Committee, if applicable) decided to take contrary to such

    recommendation or action.

    9. Add subpart C to read as follows:

    Subpart C--Provisions applicable to systemically important derivatives

    clearing organizations.

    Sec.

    39.28 Scope.

    39.29 [Reserved]

    39.30 System safeguards.

    30.31 Special enforcement authority.

    Subpart C--Provisions applicable to systemically important

    derivatives clearing organizations.

    Sec. 39.28 Scope.

    (a) The provisions of this subpart C apply to any derivatives

    clearing organization, as defined in section 1a(15) of the Act and

    Sec. 1.3(d) of this chapter,

    (1) Which is registered or deemed to be registered with the

    Commission as a derivatives clearing organization, is required to

    register as such with the Commission pursuant to section 5b(a) of the

    Act, or which voluntarily registers as such with the Commission

    pursuant to section 5b(b) or otherwise; and

    (2) Which is a systemically important derivatives clearing

    organization as defined in Sec. 39.2 of this part.

    (b) A systemically important derivatives clearing organization is

    subject to the provisions of subparts A and B of this part 39 except to

    the extent different requirements are imposed by provisions of this

    subpart C.

    (c) A systemically important derivatives clearing organization

    shall provide notice to the Commission in advance of any proposed

    change to its rules, procedures, or operations that could materially

    affect the nature or level of risks presented by the systemically

    important derivatives clearing organization, in accordance with the

    requirements of Sec. 40.10 of this chapter.

    Sec. 39.29 [Reserved]

    Sec. 39.30 System safeguards.

    (a) Notwithstanding Sec. 39.18(e)(3) of this part, the business

    continuity and disaster recovery plan described in Sec. 39.18(e)(1)

    for each systemically important derivatives clearing organization shall

    have the objective of enabling, and the physical, technological, and

    personnel resources described in Sec. 39.18(e)(1) shall be sufficient

    to enable, the derivatives clearing organization to recover its

    operations and resume daily processing, clearing, and settlement no

    later than two hours following the disruption, for any disruption

    including a wide-scale disruption.

    (b) To ensure its ability to achieve the recovery time objective

    specified in paragraph (a) of this section in the event of a wide-scale

    disruption, each systemically important derivatives clearing

    organization must maintain a degree of geographic dispersal of

    physical, technological and personnel resources consistent with the

    following:

    (1) Physical and technological resources, sufficient to enable the

    entity

    [[Page 3727]]

    to meet the recovery time objective after interruption of normal

    clearing by a wide-scale disruption, must be located outside the

    relevant area of the infrastructure the entity normally relies upon to

    conduct activities necessary to the clearance and settlement of

    existing and new contracts, and must not rely on the same critical

    transportation, telecommunications, power, water, or other critical

    infrastructure components the entity normally relies upon for such

    activities;

    (2) Personnel, sufficient to enable the entity to meet the recovery

    time objective after interruption of normal clearing by a wide-scale

    disruption affecting the relevant area in which the personnel the

    entity normally relies upon to engage in such activities are located,

    must live and work outside that relevant area;

    (3) The provisions of Sec. 39.18(f) of this part shall apply to

    these resource requirements.

    (c) Each systemically important derivatives clearing organization

    must conduct regular, periodic tests of its business continuity and

    disaster recovery plans and resources and its capacity to achieve the

    required recovery time objective in the event of a wide-scale

    disruption. The provisions of Sec. 39.18(j) of this part apply to such

    testing.

    (d) The requirements of this section shall apply to a derivatives

    clearing organization not earlier than one year after such derivatives

    clearing organization is designated as systemically important.

    Sec. 39.31 Special enforcement authority.

    For purposes of enforcing the provisions of Title VIII of the Dodd-

    Frank Act, a systemically important derivatives clearing organization

    shall be subject to, and the Commission has authority under the

    provisions of subsections (b) through (n) of section 8 of, the Federal

    Deposit Insurance Act (12 U.S.C. 1818) in the same manner and to the

    same extent as if the systemically important derivatives clearing

    organization were an insured depository institution and the Commission

    were the appropriate Federal banking agency for such insured depository

    institution.

    10. Revise appendix A to read as follows:

    Appendix A to Part 39--Form DCO Derivatives Clearing Organization

    Application for Registration

    BILLING CODE 6351-01-P

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    BILLING CODE 6351-01-C

    Description of Exhibits

    Exhibit A--General Information/Compliance

    Attach as Exhibit A-1, a regulatory compliance chart

    setting forth each Core Principle and providing citations to the

    Applicant's relevant rules, policies, and procedures that address

    each Core Principle, and a brief summary of the manner in which

    Applicant will comply with each Core Principle.

    Attach as Exhibit A-2, a current copy of Applicant's

    rulebook. The rulebook must consist of all the rules necessary to

    carry out Applicant's role as a derivatives clearing organization.

    Applicant must certify that its rules constitute a binding agreement

    between Applicant and its clearing members and, in addition to the

    separate clearing member agreements, establish rights and

    obligations between Applicant and its clearing members.

    Attach as Exhibit A-3, a narrative summary of

    Applicant's proposed clearing activities including (i) the

    anticipated start date of clearing products (or, if Applicant is

    already clearing products, the anticipated start date of activities

    for which Applicant is seeking an amendment to its registration) and

    (ii) a description of the scope of Applicant's proposed clearing

    activities (e.g., clearing for a designated contract market;

    clearing for a swap execution facility; clearing over-the-counter

    (``OTC'') products).

    Attach as Exhibit A-4, a detailed business plan setting

    forth, at a minimum, the nature of and rationale for Applicant's

    activities as a derivatives clearing organization, the context in

    which it is beginning or expanding its activities, and the nature,

    terms, and conditions of the products it will clear.

    Attach as Exhibit A-5, a list of the names of any

    person (i) who owns 5% or more of Applicant's stock or other

    ownership or equity interests; or (ii) who, either directly or

    indirectly, through agreement or otherwise, may control or direct

    the management or policies of Applicant. Provide as part of Exhibit

    A-5 the full name and address of each such person, indicate the

    person's ownership percentage, and attach a copy of the agreement

    or, if there is no agreement, an explanation of the basis upon which

    such person exercises or may exercise such control or direction.

    Attach as Exhibit A-6, a list of Applicant's current

    officers, directors, governors, general partners, LLC managers, and

    members of all standing committees (including any committee

    referenced in Section (a)(2) of Exhibit P herein), as applicable, or

    persons performing functions similar to any of the foregoing,

    indicating for each:

    a. Name and Title (with respect to a director, such title must

    include participation on any committee of Applicant);

    b. Phone number (both work and mobile) and e-mail contact

    information;

    c. Dates of commencement and, if appropriate, termination of

    present term of office or position;

    d. Length of time each such person has held the same office or

    position;

    e. Brief description of the business experience of each person

    over the last ten years;

    f. Any other current business affiliations in the financial

    services industry;

    g. If such person is not an employee of Applicant, list any

    compensation paid to the person as a result of his or her position

    at Applicant. For a director, describe any performance-based

    compensation;

    h. A certification for each such person that the individual

    would not be disqualified under Section 8a(2) of the Act or Sec.

    1.63; and

    i. With respect to a director, whether such director is a public

    director or a clearing member customer, and the basis for such a

    determination as to the director's status.

    If another entity ``operates'' Applicant, attach for such entity

    all of the items indicated in Exhibit A-6. For this purpose, the

    term ``operate'' shall be as defined in Sec. 40.9(b)(2)

    Attach as Exhibit A-7, a diagram of the entire

    corporate organizational structure of Applicant including the legal

    name of all entities within the organizational structure and the

    applicable percentage ownership among affiliated entities.

    Additionally, provide (i) a list of all jurisdictions in which

    Applicant or its affiliated entities are doing business; (iii) the

    registration status of Applicant and its affiliated entities,

    including pending applications or exemption requests and whether any

    applications or exemptions have been denied (e.g., country,

    regulator, registration category, date of registration or request

    for exemption, date of denial, if applicable); and (ii) the address

    for

    [[Page 3736]]

    legal service of process for Applicant (which cannot be a post

    office box) for each applicable jurisdiction.

    Attach as Exhibit A-8, a copy of the constituent

    documents, articles of incorporation or association with all

    amendments thereto, partnership or limited liability agreements, and

    existing bylaws, operating agreement, and rules or instruments

    corresponding thereto, of Applicant. Provide a certificate of good

    standing or its equivalent for Applicant for each jurisdiction in

    which Applicant is doing business, including any foreign

    jurisdiction, dated within one month of the date of the Form DCO.

    Attach as Exhibit A-9, a brief description of any

    material pending legal proceeding(s) or governmental

    investigation(s) to which Applicant or any of its affiliates is a

    party or is subject, or to which any of its or their property is at

    issue. Include the name of the court or agency where the

    proceeding(s) is pending, the date(s) instituted, the principal

    parties involved, a description of the factual allegations in the

    complaint(s), the laws that were allegedly violated, and the relief

    sought. Include similar information as to any such proceeding(s) or

    any investigation known to be contemplated by any governmental

    agency.

    If Applicant intends to use the services of an outside

    service provider (including services of its clearing members or

    market participants), to enable Applicant to comply with any of the

    Core Principles, Applicant must submit as Exhibit A-10 all

    agreements entered into or to be entered into between Applicant and

    the outside service provider, and identify (1) the services that

    will be provided; (2) the staff who will provide the services; and

    (3) the Core Principles addressed by such arrangement. If a

    submitted agreement is not final and executed, the Applicant must

    submit evidence that constitutes reasonable assurance that such

    services will be provided as soon as operations require.

    Attach as Exhibit A-11, documentation that demonstrates

    compliance with the Chief Compliance Officer (``CCO'') requirements

    set forth in Sec. 39.10(c), including but not limited to:

    a. Evidence of the designation of an individual to serve as

    Applicant's CCO with full responsibility and authority to develop

    and enforce appropriate compliance policies and procedures;

    b. A description of the background and skills of the person

    designated as the CCO and a certification that the individual would

    not be disqualified under Section 8a(2) of the Act or Sec. 1.63;

    c. To whom the CCO reports (i.e., the senior officer or the

    Board of Directors);

    d. Any plan of communication or regular or special meetings

    between the CCO and the Board of Directors or senior officer as

    appropriate;

    e. A job description setting forth the CCO's duties;

    f. Procedures for the remediation of noncompliance issues; and

    g. A copy of Applicant's Compliance Manual (including a code of

    ethics and conflict of interest policy).

    Exhibit B--Financial Resources

    Attach as Exhibit B, documents that demonstrate

    compliance with the financial resources requirements set forth in

    Sec. 39.11, including but not limited to:

    a. General--Provide as Exhibit B-1:

    (1) The most recent set of audited financial statements of

    Applicant or of its parent company, including the balance sheet,

    income statement, statement of cash flows, notes to the financial

    statements, and accountant's opinion;

    (2) If the audited financial statements are not dated within 1

    month of the date of filing of the Form DCO, Applicant must provide

    a set of unaudited financial statements current within 1 month of

    the date of filing of the Form DCO;

    (3) If Applicant does not have audited financial statements,

    Applicant must provide a balance sheet as of a date within 1 month

    of the date of filing of the Form DCO and an income statement and

    statement of cash flows reflecting the period since Applicant's

    formation and a date that is within 1 month of the date of filing of

    the Form DCO. These statements must be accompanied by an independent

    certified public accountant's review report; and

    (4) Evidence of ability to satisfy the requirements of Exhibits

    B-2 and B-3 below which may include (i) pro forma financial

    statements setting forth all projections and assumptions used

    therein, and (ii) a narrative description of how Applicant will fund

    its financial resources obligations on the first day of its

    operation as a derivatives clearing organization.

    b. Default Resources--Provide as Exhibit B-2:

    (1) A calculation of the financial resources needed to enable

    Applicant to meet its requirements under Sec. 39.11(a)(1).

    Applicant must provide hypothetical default scenarios designed to

    reflect a variety of market conditions, and the assumptions and

    variables underlying the scenarios must be explained. All results of

    the analysis must be included. This calculation requires a start-up

    enterprise to estimate its largest anticipated financial exposure. A

    start-up must be able to explain the basis for its estimate;

    (2) Proof of unencumbered assets sufficient to satisfy Sec.

    39.11(a)(1). This may be demonstrated by a copy of a bank balance

    statement(s) in the name of Applicant and may be combined with the

    types of financial resources set forth in Sec. 39.11(b)(1). If

    relying on Sec. 39.11(b)(1)(vi), such other resources must be

    thoroughly explained. If relying on Sec. 39.11(b)(1)(ii) and/or

    (vi), Applicant cannot also count these assets when demonstrating

    its compliance with its operating resources requirement under Sec.

    39.11(a)(2) and Applicant must detail the amounts or percentages of

    such assets that apply to each financial resource requirement;

    (3) A demonstration that Applicant can perform the monthly

    calculations required by Sec. 39.11(c)(1);

    (4) A demonstration that Applicant's financial resources are

    sufficiently liquid as required by Sec. 39.11(e)(1);

    (5) A demonstration of how Applicant will be able to maintain,

    at all times, the level of resources required by Sec. 39.11(a)(1);

    and

    (6) A demonstration of how default resources financial

    information will be updated and reported to clearing members and the

    public under Sec. 39.21, and to the Commission as required by Sec.

    39.11(f)(1) and Sec. 39.19.

    c. Operating Resources--Provide as Exhibit B-3:

    (1) A calculation of the financial resources needed to enable

    Applicant to meet its requirements under Sec. 39.11(a)(2);

    (2) Proof of assets sufficient to satisfy the amount required

    under Sec. 39.11(a)(2). This may be demonstrated by a copy of a

    bank balance statement(s) in the name of Applicant and may be

    combined with the types of financial resources set forth in Sec.

    39.11(b)(2). If relying on Sec. 39.11(b)(2)(ii), such other

    resources must be thoroughly explained. If relying on Sec.

    39.11(b)(2)(i) or (ii), Applicant cannot also count these assets

    when demonstrating its compliance with meeting its default resources

    requirement under Sec. 39.11(a)(1) and Applicant must detail the

    amounts or percentages of such assets that apply to each financial

    resource requirement;

    (3) Proof of adequate physical infrastructure to carry out

    business operations, which includes an office(s) (separate from any

    personal dwelling) with a U.S. street address (not merely a post

    office box number) that has electricity, HVAC, and running water and

    meets all local building and fire codes. This location must be the

    same as the principal executive offices address identified on the

    cover sheet of the Form DCO;

    (4) Proof of adequate technological systems necessary to carry

    out operations including properly working computers, networks,

    appropriate software, telephones, fax machines, Internet access, and

    photocopiers;

    (5) A calculation pursuant to Sec. 39.11(c)(2), including the

    total projected operating costs for Applicant's first year of

    operation, calculated on a monthly basis with an explanation of the

    basis for calculating each cost and a discussion of the type,

    nature, and number of the various costs included;

    (6) A demonstration that Applicant's financial resources are

    sufficiently liquid and unencumbered, as required by Sec.

    39.11(e)(2);

    (7) A demonstration of how Applicant will maintain, at all

    times, the level of resources required by Sec. 39.11(a)(2) with an

    explanation of asset valuation methodology and calculation of

    projected revenue, if applicable; and

    (8) A demonstration of how operating resources financial

    information will be updated and reported to clearing members and the

    public under Sec. 39.21, and to the Commission as required by Sec.

    39.11(f)(1) and Sec. 39.19.

    d. Human Resources--Provide as Exhibit B-4:

    (1) An organizational chart showing Applicant's current and

    planned staff by position and title, including key personnel (as

    such term is defined in Sec. 39.2) and, if applicable, managerial

    staff reporting to key personnel.

    (2) A discussion and description of the staffing requirements

    needed to fulfill all operations and associated functions, tasks,

    [[Page 3737]]

    services, and areas of supervision necessary to operate Applicant on

    a day-to-day basis; and

    (3) The names and qualifications of individuals who are key

    personnel or other managerial staff who will carry out the

    operations and associated functions, tasks, services, and

    supervision needed to run the Applicant on day-to-day basis. In

    particular, Applicant must identify such individuals who are

    responsible for risk management, treasury, clearing operations and

    compliance (and specify whether each such person is an employee or

    consultant/agent).

    Exhibit C--Participant and Product Eligibility

    Attach as Exhibit C, documents that demonstrate

    compliance with the participant and product eligibility requirements

    set forth in Sec. 39.12 of the Commission's regulations, including

    but not limited to:

    a. Participant Eligibility--Provide as Exhibit C-1, an

    explanation of the requirements for becoming a clearing member and

    how those requirements satisfy Sec. 39.12 and, where applicable,

    support Applicant's compliance with other Core Principles. Applicant

    must address how its participant eligibility requirements comply

    with the core principles and regulations thereunder for financial

    resources, risk management and operational capacity. The explanation

    also must include:

    (1) A final version of the membership agreement between

    Applicant and its clearing members that sets forth the full scope of

    respective rights and obligations;

    (2) A discussion of how Applicant will monitor for and enforce

    compliance with its eligibility criteria, especially minimum

    financial requirements;

    (3) An explanation of how the eligibility criteria are objective

    and allow for fair and open access to Applicant. Applicant must

    include an explanation of the differences between various classes of

    membership or participation that might be based on different levels

    of capital and/or creditworthiness. Applicant must also include

    information about whether any differences exist in how Applicant

    will monitor and enforce the obligations of its various clearing

    members including any differences in access, privilege, margin

    levels, position limits, or other controls;

    (4) If Applicant allows intermediation, Applicant must describe

    the requirements applicable to those who may act as intermediaries

    on behalf of customers or other market participants;

    (5) A description of the program for monitoring the financial

    status of the clearing members on an ongoing basis;

    (6) The procedures that Applicant will follow in the event of

    the bankruptcy or insolvency of a clearing member, which did not

    result in a default to Applicant;

    (7) A description of whether and how Applicant would adjust

    clearing member participation under continuing eligibility criteria

    based on the financial, risk, or operational status of a clearing

    member;

    (8) A discussion of whether Applicant's clearing members will be

    required to be registered with the Commission; and

    (9) A list of current or prospective clearing members. If a

    current or prospective clearing member is a Commission registrant,

    Applicant must identify the member's designated self-regulatory

    organization.

    b. Product Eligibility--Provide as Exhibit C-2, an explanation

    of the criteria for instruments acceptable for clearing including:

    (1) The regulatory status of each market on which a contract to

    be cleared by Applicant is traded (e.g., DCM, SEF, not a registered

    market), and whether the market for which Applicant clears intends

    to join the Joint Audit Committee. For OTC agreements, contracts, or

    transactions not traded on a registered market, Applicant must

    describe the nature of the OTC market and its interest in having the

    particular OTC agreement, contract, or transaction cleared;

    (2) The criteria, and the factors considered in establishing the

    criteria, for determining the types of products that will be

    cleared;

    (3) An explanation of how the criteria for deciding what

    products to clear take into account the different risks inherent in

    clearing different agreements, contracts, or transactions and how

    those criteria affect maintenance of assets to support the guarantee

    function in varying risk environments;

    (4) A precise list of all the agreements, contracts, or

    transactions to be covered by Applicant's registration order,

    including the terms and conditions of all agreements, contracts, or

    transactions;

    (5) A forecast of expected volume and open interest at the

    outset of clearing operations, after six months, and after one year

    of operation; and

    (6) The mechanics of clearing the contract, such as reliance on

    exchange for physical, exchange for swap, or other substitution

    activity; whether the contracts are matched prior to submission for

    clearing or after submission; and other aspects of clearing

    mechanics that are relevant to understanding the products that would

    be eligible for clearing.

    Exhibit D--Risk Management

    Attach as Exhibit D, documents that demonstrate

    compliance with the risk management requirements set forth in Sec.

    39.13 of the Commission's regulations, including but not limited to:

    a. Risk Management Framework--Provide as Exhibit D-1, a copy of

    Applicant's written policies, procedures, and controls, as approved

    by Applicant's Board of Directors, that establish Applicant's risk

    management framework as required by Sec. 39.13(b). Applicant must

    also provide a description of the composition and responsibilities

    of Applicant's Risk Management Committee.

    b. Measuring Risk--Provide as Exhibit D-2, a narrative

    explanation of how Applicant has projected and will continue to

    measure its counterparty risk exposure, including:

    (1) A description of the risk-based margin calculation

    methodology;

    (2) The assumptions upon which the methodology was designed,

    including the risk analysis tools and procedures employed in the

    design process;

    (3) An explanation as to why a particular methodology was chosen

    over other methodologies that might have been suitable, including a

    comparison of margin levels calculated using other margin

    methodologies;

    (4) A demonstration of the margin methodology as applied to real

    or hypothetical clearing scenarios;

    (5) A description of the data sources for inputs used in the

    methodology, e.g. historical price data reflecting market volatility

    over various periods of time;

    (6) A description of the sources of price data for the

    measurement of current exposures and the valuation models for

    addressing circumstances where pricing data is not readily available

    or reliable;

    (7) The frequency and circumstances under which the margin

    methodology will be reviewed and the criteria for deciding how often

    to review and whether to modify a margin methodology;

    (8) An independent validation of Applicant's systems for

    generating initial margin requirements, including its theoretical

    models;

    (9) The frequency of measuring counterparty risk exposures (mark

    to market), whether counterparty risk exposures are routinely

    measured on an intraday basis, whether Applicant has the operational

    capacity to measure counterparty risk exposures on an intraday

    basis, and the circumstances under which Applicant would conduct a

    non-routine intraday measurement of counterparty risk exposures;

    (10) Preliminary forecasts regarding future counterparty risk

    exposure and assumptions upon which such forecasts of exposure are

    based;

    (11) A description of any systems or software that Applicant

    will require clearing members to use in order to margin their

    positions in their internal bookkeeping systems, and whether and

    under what terms and conditions Applicant will provide such systems

    or software to clearing members; and

    (12) A description of the extent to which counterparty risk can

    be offset through the clearing process (i.e., the limitations, if

    any, on Applicant's duty to fulfill its obligations as the buyer to

    every seller and the seller to every buyer).

    c. Limiting Risk--Provide as Exhibit D-3, a narrative discussion

    addressing the specifics of Applicant's clearing activities,

    including:

    (1) How Applicant will collect financial information about its

    clearing members and other traders or market participants, monitor

    price movements, and mark to market, on a daily basis, the products

    and/or portfolios it clears;

    (2) How Applicant will monitor accounts carried by clearing

    members, the accumulation of positions by clearing members and other

    market participants, and compliance with position limits; and how it

    will use large trader information;

    (3) How Applicant will determine variation margin levels and

    outstanding initial margin due;

    (4) How Applicant will identify unusually large pays on a

    proactive basis before they occur;

    (5) Whether and how Applicant will compare price moves and

    position information to historical patterns and to the

    [[Page 3738]]

    financial information collected from its clearing members; how it

    will identify unusually large pays on a daily basis;

    (6) How Applicant will use various risk tools and procedures

    such as: (i) value-at-risk calculations; (ii) stress testing; (iii)

    back testing; and/or (iv) other risk management tools and

    procedures;

    (7) How Applicant will communicate with clearing members,

    settlement banks, other derivatives clearing organizations,

    designated contract markets, swap execution facilities, major swap

    participants, swap data repositories, and other entities in

    emergency situations or circumstance that might require immediate

    action by the Applicant;

    (8) How Applicant will monitor risk outside business hours;

    (9) How Applicant will review its clearing members' risk

    management practices;

    (10) Whether Applicant will impose credit limits and/or employ

    other risk filters (such as automatic system denial of entry of

    trades under certain conditions);

    (11) Plans for handling ``extreme market volatility'' and how

    Applicant defines that term;

    (12) An explanation of how Applicant will be able to offset

    positions in order to manage risk including: (i) ensuring both

    Applicant and clearing members have the operational capacity to do

    so; and (ii) liquidity of the relevant market, especially with

    regard to OTC products and OTC markets;

    (13) Plans for managing accounts that are ``too big'' to

    liquidate and for conducting ``what if'' analyses on these accounts;

    (14) If options are involved, how Applicant will manage the

    different and more complex risk presented by these products;

    (15) If Applicant intends to clear swaps, whether and how often

    Applicant will offer multilateral portfolio compression exercises

    for its clearing members; and

    (16) If Applicant intends to clear credit default swaps, how

    Applicant will manage the unique risks associated with clearing

    these products, such as jump-to-default risk.

    d. Existence of collateral (funds and assets) to apply to losses

    resulting from realized risk--Provide as Exhibit D-4:

    (1) An explanation of the factors, process, and methodology used

    for calculating and setting required collateral levels, the required

    inputs, the appropriateness of those inputs, and an illustrative

    example;

    (2) An analysis supporting the sufficiency of Applicant's

    collateral levels for capturing all or most price moves that may

    take place in one settlement cycle;

    (3) A description of how Applicant will value open positions and

    collateral assets;

    (4) A description and explanation of the forms of assets allowed

    as collateral, why they are acceptable, and whether there are any

    haircuts or concentration limits on certain kinds of assets,

    including how often any such haircuts and concentration limits are

    reviewed;

    (5) An explanation of how and when Applicant will collect

    collateral, whether and under what circumstances it will collect

    collateral on an intraday basis, and what will happen if collateral

    is not received in a timely manner. Include a proposed collateral

    collection schedule based on changes in market positions and

    collateral values; and

    (6) If options are involved, a full explanation of how it will

    manage the associated risk through the use of collateral including,

    if applicable, a discussion of its option pricing model, how it

    establishes its implied volatility scan range, and other matters

    related to the complex matter of managing the risk associated with

    the clearing of option contracts.

    Exhibit E--Settlement Procedures

    Attach as Exhibit E, documents that demonstrate

    compliance with the settlement procedures requirements set forth in

    Sec. 39.14 of the Commission's regulations, including but not

    limited to:

    a. Settlement--Provide as Exhibit E-1, a full description of the

    daily process of settling financial obligations on all open

    positions being cleared. This must include:

    (1) Procedures for completing settlements on a timely basis

    during normal market conditions (and no less frequently than once

    each business day);

    (2) Procedures for completing settlements on a timely basis in

    varying market circumstances including in the event of a default by

    the clearing member creating the largest financial exposure for

    Applicant in extreme but plausible market conditions;

    (3) A description of how contracts will be marked to market on

    at least a daily basis;

    (4) Identification of the settlement banks used by Applicant

    (including identification of the lead settlement bank, if

    applicable) and a copy of Applicant's settlement bank agreement(s).

    Such settlement bank agreements must (i) outline daily cash

    settlement procedures, (ii) state clearly when settlement fund

    transfers will occur, (iii) provide procedures for settlements on

    bank holidays when the markets are open, and (iv) ensure that

    settlements are final when effected;

    (5) Identification of settlement banks that Applicant will allow

    its clearing members to use for margin calls and variation

    settlements;

    (6) A description of the criteria and review process used by

    Applicant when selecting settlement banks; procedures for monitoring

    the continued appropriateness of all settlement banks including a

    description of how Applicant monitors its concentration risk or

    exposure to each settlement bank;

    (7) The specific means by which settlement instructions are

    communicated from Applicant to the settlement bank(s);

    (8) A timetable showing the flow of funds associated with the

    settlement of products for a 24-hour period or such other settlement

    timeframe specified by a particular product; this may be presented

    in the form of a chart, as in the following example:

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    [GRAPHIC] [TIFF OMITTED] TP20JA11.026

    (9) A description of what happens in the event that there are

    insufficient funds in a clearing member's settlement account;

    (10) An explanation of how and when Applicant will collect

    variation margin, whether and under what circumstances it will

    collect variation margin on an intraday basis, what will happen if

    variation margin is not received in a timely manner, and a proposed

    variation margin collection schedule based on changes in market

    prices;

    (11) All the information above, to the extent relevant, for any

    products cleared that may be denominated in a foreign currency; and

    (12) With respect to physical settlements, identify Applicant's

    rules that clearly state each obligation of Applicant with respect

    to physical deliveries, and explain how Applicant intends to

    identify and manage risks arising from physical settlement.

    b. Recordkeeping--Provide as Exhibit E-2, a full description of

    the following:

    (1) The nature and quality of the information collected

    concerning the flow of funds involved in clearing and settlement;

    and

    (2) How such information will be recorded, maintained, and

    accessed.

    c. Interfaces with other clearing organizations--Provide as

    Exhibit E-3, a description of Applicant's relationships with other

    derivatives clearing organizations, clearing agencies, financial

    market utilities or foreign entities that perform similar functions

    including how compliance with the terms and conditions of agreements

    or arrangements with such other entities will be satisfied, e.g.,

    any netting or offset arrangements, cross-margining, portfolio

    margining, linkage, common banking, common clearing programs or

    limited guaranty agreements or arrangements.

    Exhibit F--Treatment of Funds

    Attach as Exhibit F, documents that demonstrate

    compliance with the treatment of funds requirements set forth in

    Sec. 39.15 of the Commission's regulations, including but not

    limited to:

    a. Safe custody--Provide as Exhibit F-1, documents that

    demonstrate:

    (1) How Applicant will ensure the safekeeping of funds and

    collateral in depositories and how Applicant will minimize the risk

    of loss or of delay in accessing such funds and collateral;

    (2) The depositories that will hold the funds and collateral and

    any written agreements between or among such depositories, Applicant

    or its clearing members regarding the legal status of the funds and

    collateral and the specific conditions or prerequisites for movement

    of the funds and collateral; and

    (3) How Applicant will limit the concentration of risk in

    depositories where funds and collateral are deposited.

    b. Segregation of customer and proprietary funds--Provide as

    Exhibit F-2, documents that demonstrate:

    (1) The appropriate segregation of customer funds and associated

    acknowledgement documentation; and

    (2) Requirements or restrictions regarding commingling customer

    funds with proprietary funds, obligating customer funds for any

    purpose other than to purchase, clear, and settle the products

    Applicant is clearing, procedures regarding customer funds which are

    subject to cross-margin or similar agreements, and any other aspects

    of customer fund segregation.

    c. Investment standards--Provide as Exhibit F-3, documents that

    demonstrate:

    (1) How customer funds would be invested in instruments with

    minimal credit, market, and liquidity risks, and in compliance with

    the requirements of Sec. 1.25; and

    (2) How Applicant will obtain and keep associated records and

    data regarding the details of such investments.

    [[Page 3740]]

    Exhibit G--Default Rules and Procedures

    Attach as Exhibit G, documents that demonstrate

    compliance with the default rules and procedures requirements set

    forth in Sec. 39.16 of the Commission's regulations, including but

    not limited to:

    a. Default Management Plan--Applicant must provide a copy of its

    written default management plan which must contain all of the

    information required by Sec. 39.16(b), along with Applicant's most

    recently documented results of a test of its default management

    plan.

    b. Definition of default--Applicant must describe or otherwise

    document:

    (1) The events (activities, lapses, or situations) that will

    constitute a clearing member default;

    (2) What action Applicant can take upon a default and how

    Applicant will otherwise enforce the rules applicable in the event

    of default, including the steps and the sequence of the steps that

    will be followed. Identify whether a Default Management Committee

    exists and, if so, its role in the default process; and

    (3) An example of a hypothetical default scenario and the

    results of the default management process used in the scenario.

    c. Remedial action--Applicant must describe or otherwise

    document:

    (1) The authority and methods by which Applicant may take

    appropriate action in the event of the default of a clearing member

    which may include, among other things, liquidating positions,

    hedging, auctioning, allocating (including any obligations of

    clearing members to participate in auctions or to accept

    allocations), and transferring of customer accounts to another

    clearing member (including an explanation of the movement of

    positions and collateral on deposit); and

    (2) Actions taken by a clearing member or other events that

    would put a clearing member on Applicant's ``watch list'' or similar

    device.

    d. Process to address shortfalls--Applicant must describe or

    otherwise document:

    (1) Procedures for the prompt application of Applicant and/or

    clearing member financial resources to address monetary shortfalls

    resulting from a default;

    (2) How Applicant will make publicly available its default rules

    including a description of the priority of application of financial

    resources in the event of default (i.e., the ``waterfall''); and

    (3) How Applicant will take timely action to contain losses and

    liquidity pressures and to continue to meet each obligation of

    Applicant.

    e. Use of cross-margin programs--Describe or otherwise document,

    as applicable, how cross-margining programs will provide for fair

    and efficient means of covering losses in the event of a default of

    any clearing member participating in the program.

    f. Customer priority rule--Describe or otherwise document rules

    and procedures regarding priority of customer accounts over

    proprietary accounts of defaulting clearing members and, where

    applicable, specifically in the context of specialized margin

    reduction programs such as cross-margining or common banking

    arrangements with other derivatives clearing organizations, clearing

    agencies, financial market utilities or foreign entities that

    perform similar functions.

    Exhibit H--Rule Enforcement

    Attach as Exhibit H, documents that demonstrate

    compliance with the rule enforcement requirements set forth in Sec.

    39.17 of the Commission's regulations, including but not limited to:

    a. Surveillance--Describe or otherwise document arrangements and

    resources for the effective monitoring and enforcement of compliance

    with Applicant's rules and the resolution of disputes.

    b. Enforcement--Applicant must describe or otherwise document:

    (1) Arrangements and resources for the effective enforcement of

    rules and authority and ability to discipline and limit or suspend a

    member's activities pursuant to clear and fair standards;

    (2) Arrangements for enforcing compliance with its rules and

    addressing instances of non-compliance, including: Disciplinary

    tools such as limiting, suspending, or terminating a clearing

    member's access or member privileges;

    (3) How Applicant will address situations related to, but which

    may not constitute an event of default, such as a clearing member's

    failure to comply with certain rules or to maintain eligibility

    standards, or actions taken by other regulatory bodies;

    (4) The standards and any procedural protections Applicant will

    follow in imposing any such enforcement measure; and

    (5) Processes for reporting to the Commission Applicant's rule

    enforcement activities and possible sanctions that could be imposed

    against clearing members.

    c. Dispute resolution--Describe or otherwise document

    arrangements and resources for resolution of disputes between

    customers and clearing members, and between clearing members.

    Exhibit I--System Safeguards

    Attach as Exhibit I, documents that demonstrate

    compliance with the system safeguards requirements set forth in

    Sec. 39.18 of the Commission's regulations, including but not

    limited to:

    a. A description of Applicant's program of risk analysis and

    oversight with respect to its operations and automated systems. This

    program must be designed to ensure daily processing, clearing, and

    settlement of transactions and address each of the following

    categories of risk:

    (1) Information security;

    (2) Business continuity-disaster recovery planning and

    resources;

    (3) Capacity and performance planning;

    (4) Systems operations;

    (5) Systems development and quality assurance; and

    (6) Physical security and environmental controls.

    b. An explanation of how Applicant will establish and maintain

    resources that allow for the fulfillment of its program of risk

    analysis and oversight with respect to its operations and automated

    systems, and a description of such resources, including:

    (1) A description of how Applicant will periodically verify that

    its resources are adequate to ensure daily processing, clearing, and

    settlement;

    (2) A demonstration that Applicant's automated systems are

    reliable, secure, and have (and will continue to have) adequate

    scalable capacity;

    (3) A description of the physical, technological and personnel

    resources and procedures used by Applicant as part of its business

    continuity and disaster recovery plan, and support for the

    conclusion that these resources are sufficient to enable the

    Applicant to resume daily processing, clearing and settlement no

    later than the next business day following a disruption; and

    (4) A statement identifying which such resources are Applicant's

    own resources and which are provided by a service provider

    (outsourced). For resources that are outsourced, provide (i) all

    contracts governing the outsourcing arrangements, including all

    schedules and other supplemental materials, and (ii) a demonstration

    that Applicant employs personnel with the expertise necessary to

    enable them to supervise the service provider's delivery of the

    services.

    c. An explanation of how Applicant will ensure the proper

    functioning of its systems, including its program for the periodic

    objective testing and review of its systems and back-up facilities

    (including all of its own and outsourced resources), and

    verification that all such resources will work effectively together;

    d. Identification of the persons conducting the testing,

    including information as to their qualifications and independence;

    e. A description of Applicant's emergency procedures, including

    a copy of its written plan for business continuity and disaster

    recovery and a description of how Applicant will coordinate its

    business continuity and disaster recovery plan (including testing)

    with those of its clearing members and providers of essential

    services such as telecommunications, power and water; and

    f. A description of how Applicant will report exceptional events

    and planned changes to the Commission as required by Sec. Sec.

    39.18(g) and 39.18(h).

    Exhibit J--Reporting

    Attach as Exhibit J, documents that demonstrate

    compliance with the reporting requirements set forth in Sec. 39.19

    of the Commission's regulations including but not limited to:

    a. How Applicant will make available to Commission staff all the

    information Commission staff need in order to carry out effective

    oversight. This must include a discussion of what will be made

    available on a routine basis, how often it will be made available,

    and the method of its transmission. The same items must be addressed

    for information it will make available on a non-routine basis and

    what events would precipitate the generation of such data or

    information. Applicant must also address the manner in which any

    information will be made available to clearing members, customers,

    market participants and/or the general public. If not part of an

    initial application, Applicant must provide a representation that it

    will provide the

    [[Page 3741]]

    following when initially generated or when content changes occur:

    (1) A list of current members/market participants;

    (2) A list of all products currently eligible for clearing;

    (3) The initial margin collection schedule;

    (4) Information on any disciplinary actions (such as

    suspensions, etc.);

    (5) Information concerning any physical or other emergencies;

    (6) All information concerning any default by a member and the

    impact of the default on Applicant's financial resources;

    (7) A copy of any examination/evaluation/compliance report of

    any regulatory body other than the Commission that oversees

    Applicant;

    (8) A copy of any internal examination/evaluation/compliance

    reports such as, but not limited to, those related to stress testing

    and systems testing;

    (9) Key personnel that have particular knowledge of the

    market(s) for which Applicant clears and any changes in those

    personnel, especially those to be contacted in case of market

    volatility or to respond to inquiries and emergencies;

    (10) Copies of audited financial statements of Applicant; and

    (11) Information regarding counterparties and their positions,

    stress test results, internal governance, legal proceedings, and

    other clearing activities.

    b. Forms or templates to be used to satisfy the daily,

    quarterly, annual, and event-specific reporting requirements

    specified in Sec. 39.19(c) of the Commission's regulations.

    Exhibit K--Recordkeeping

    Attach as Exhibit K, documents that demonstrate

    compliance with the recordkeeping requirements set forth in Sec.

    39.20 of the Commission's regulations including but not limited to:

    a. Applicant's recordkeeping and record retention policies and

    procedures;

    b. The different activities related to the entity as a

    derivatives clearing organization for which it must maintain

    records;

    c. The manner in which records relating to swaps and swap data

    are gathered and maintained; and

    d. How Applicant will satisfy the performance standards of Sec.

    1.31 as applicable to derivatives clearing organizations, including:

    (1) What ``full'' or ``complete'' will encompass with respect to

    each type of book or record that will be maintained;

    (2) The form and manner in which books or records will be

    compiled and maintained with respect to each type of activity for

    which such books or records will be kept;

    (3) Confirmation that books and records will be open to

    inspection by any representative of the Commission or of the U.S.

    Department of Justice;

    (4) How long books and records will be readily available and how

    they will be made readily available during the first two years; and

    (5) How long books and records will be maintained (and

    confirmation that, in any event, they will be maintained as required

    in Sec. 1.31).

    Exhibit L--Public Information

    Attach as Exhibit L, documents that demonstrate

    compliance with the public information requirements set forth in

    Sec. 39.21 of the Commission's regulations including but not

    limited to:

    a. Applicant's procedures for making its rulebook, a list of all

    current clearing members, and the information listed in Sec.

    39.21(c) readily available to the general public, in a timely

    manner, by posting such information on Applicant's Web site no later

    than the business day following the day to which the information

    pertains;

    b. Any other information routinely made available to the public

    by Applicant;

    c. How Applicant will make information available to clearing

    members and market participants in order to allow such persons to

    become familiar with Applicant's procedures before participating in

    clearing operations; and

    d. How clearing members will be informed of their specific

    rights and obligations preceding a default and upon a default, and

    of the specific rights, options and obligations of Applicant

    preceding and upon a clearing member's default.

    Exhibit M--Information Sharing

    Attach as Exhibit M, documents that demonstrate

    compliance with the information sharing requirements set forth in

    Sec. 39.22 of the Commission's regulations, including but not

    limited to:

    a. The appropriate and applicable information sharing agreements

    to which Applicant is, or intends to be, a party including any

    domestic or international information-sharing agreements or

    arrangements, whether formal or informal, which involve or relate to

    Applicant's operations, especially as it relates to measuring and

    addressing counterparty risk;

    b. A description of the types of information expected to be

    shared and how that information will be shared;

    c. An explanation as to how information obtained pursuant to any

    information-sharing agreements or arrangements would be used to

    further the objectives of Applicant's risk management program and

    any of its surveillance programs including financial surveillance

    and continuing eligibility of its clearing members; and

    d. An explanation as to how Applicant expects to obtain accurate

    information pursuant to the information-sharing agreement or

    arrangement and the mechanisms or procedures which would allow for

    timely use and application of all information.

    Exhibit N--Antitrust Considerations

    Attach as Exhibit N, documents that demonstrate

    compliance with the antitrust considerations requirements set forth

    in Sec. 39.23 of the Commission's regulations, including but not

    limited to policies or procedures to ensure compliance with the

    antitrust considerations requirements.

    Exhibit O--Governance Fitness Standards

    Attach as Exhibit O, documents that demonstrate

    compliance with the governance fitness standards requirements set

    forth in Sec. 39.24 of the Commission's regulations, including but

    not limited to:

    a. The manner in which its governance arrangements permit

    consideration of the views of Applicant's owners, whether voting or

    non-voting, and its participants (clearing members and customers)

    including (i) the general method by which Applicant will learn of

    the views of Applicant's owners, other than through their exercise

    of voting power, or the views of participants, other than through

    representation on the Board of Directors or any committee of

    Applicant, and (ii) the manner in which Applicant will consider such

    views;

    b. The fitness standards applicable to members of the Board of

    Directors, members of any Disciplinary Panel, members of any

    Disciplinary Committee, clearing members, any individual or entity

    with direct access to settlement or clearing activities, and any

    party affiliated with any of the above individuals or entities, as

    well as natural persons who, directly or indirectly, own greater

    than 10% of any one class of equity interest in Applicant; including

    a description or other documentation explaining how Applicant will

    collect and verify information that supports compliance with the

    fitness standards; and

    c. The manner in which Applicant will condition clearing member

    access and other direct access to its settlement and clearing

    activities on agreement to be subject to the jurisdiction of

    Applicant.

    Exhibit P--Conflicts of Interest

    Attach as Exhibit P, documents that demonstrate

    compliance with the conflicts of interest requirements set forth in

    Sec. Sec. 39.13(d), 39.25, and 40.9 of the Commission's

    regulations, including but not limited to:

    a. A copy of:

    (1) The charter (or mission statement) of Applicant (if not

    attached as Exhibit A-8).

    (2) The charter (or mission statement) of Applicant's Board of

    Directors, each committee with a composition requirement (including

    any Executive Committee), as well as each other committee that has

    the authority to amend or constrain actions of Applicant's Board of

    Directors (if not attached as Exhibit A-8).

    (3) If another entity ``operates'' the Applicant, the charter

    (or mission statement) of such entity's Board of Directors (if not

    attached as Exhibit A-8); and a description of the manner in which

    the Applicant will ensure that the entity complies with Sec.

    40.9(b)(2)(ii)(B) and (C) (Officers and Directors; Books and

    Records).

    (4) An internal organizational chart showing the lines of

    responsibility and accountability for each operational unit.

    b. Describe or otherwise document:

    (1) Applicant's rules and procedures for ensuring compliance

    with the requirements of Sec. 39.25(b) (including ensuring parent

    compliance with Sec. 39.25(b)(4)), including through remediation as

    detailed in Sec. 39.25(b)(5);

    (2) Applicant's nominations process for the Board of Directors

    and the process for assigning members of the Board of Directors or

    other persons to any committee referenced in item a.(2) above;

    1. The manner in which the Board of Directors reviews its

    performance and the

    [[Page 3742]]

    performance of its members on an annual basis; and

    2. The procedures for removing a member of the Board of

    Directors, including where the conduct of such member is likely to

    be prejudicial to the sound and prudent management of Applicant;

    (3) The composition of its Nominating Committee, including the

    number or percentage of public directors, and the identity of the

    Chairman of the Committee;

    (4) The composition of any Executive Committee, including the

    number or percentage of public directors;

    (5) The composition of the Risk Management Committee, including

    the number or percentage of public directors, the number or

    percentage of customer representatives, and the identity of the

    Chairman of the committee;

    1. Whether the Risk Management Committee is an executive

    committee or an advisory committee; and

    2. Whether the Risk Management Committee has delegated certain

    functions to the Risk Management Subcommittee, including a

    description or other documentation of the functions so delegated;

    (6) The form of report to be used in reporting to the Commission

    those instances in which the Board rejects a recommendation or

    supersedes an action of the Risk Management Committee, or the Risk

    Management Committee rejects a recommendation or supersedes an

    action of its subcommittee;

    (7) The manner in which Applicant will ensure compliance with

    Sec. 39.13(d)(6) (Discretion); and the manner in which Applicant

    will ensure compliance with Sec. 40.9(c)(ii)(A) and (B)

    (Prohibition on Domination of and Recusal Procedures with respect to

    the Disciplinary Panel), and Sec. 40.9(c)(iii) (Appeals), including

    whether the Board of Directors has delegated the functions of the

    Disciplinary Panel to any other committee;

    (8) The manner in which Applicant will record and summarize

    ``significant decisions,'' as such term is described in Sec.

    40.9(d);

    (9) The manner in which Applicant will ensure that all

    information required under Sec. 40.9(d) is current, accurate,

    clear, and readily accessible to both the Commission and the public;

    (10) Any written procedures that Applicant intends to adopt to

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

    interest;

    (11) Applicant's process for making fair and non-biased

    decisions in the event of a conflict of interest; and

    (12) Applicant's written policies or procedures on safeguarding

    non-public information, and the manner in which such policies or

    procedures fulfill the minimum standards set forth in Sec.

    40.9(f)(2).

    Exhibit Q--Composition of Governing Boards

    Attach as Exhibit Q, documents that demonstrate

    compliance with the composition of governing boards requirements set

    forth in Sec. 39.26, including but not limited to documentation

    describing the composition of Applicant's Board of Directors,

    including the number or percentage of public directors and customer

    representatives.

    Exhibit R--Legal Risk Considerations

    Attach as Exhibit R, documents that demonstrate

    compliance with the legal risk considerations requirements set forth

    in Sec. 39.27 of the Commission's regulations, including but not

    limited to:

    a. A discussion of how Applicant operates pursuant to a well-

    founded, transparent, and enforceable legal framework that addresses

    each aspect of the activities of Applicant. The framework must

    provide for Applicant to act as a counterparty, including, as

    applicable:

    (1) Novation;

    (2) Netting arrangements;

    (3) Applicant's interest in collateral (including margin);

    (4) The steps that Applicant can take to address a default of a

    clearing member, including but not limited to, the unimpeded ability

    to liquidate collateral and close out or transfer positions in a

    timely manner;

    (5) Finality of settlement and funds transfers that are

    irrevocable and unconditional when effected (when Applicant's

    accounts are debited and credited); and

    (6) Other significant aspects of Applicant's operations, risk

    management procedures, and related requirements.

    b. If Applicant provides, or will provide, clearing services

    outside the United States, Applicant must (i) provide a memorandum

    from local counsel analyzing insolvency issues in the foreign

    jurisdiction where Applicant is based and (ii) describe or otherwise

    document:

    (1) How Applicant has identified and addressed any conflict of

    law issues;

    (2) Which jurisdiction's law is intended to apply to each aspect

    of Applicant's operations;

    (3) The enforceability of Applicant's choice of law in relevant

    jurisdictions; and

    (4) That its rules, procedures, and products are enforceable in

    all relevant jurisdictions.

    Issued in Washington, DC, on December 16, 2010, by the

    Commission.

    Sauntia S. Warfield,

    Assistant Secretary of the Commission.

    Appendices to Risk Management Requirements for Derivatives Clearing

    Organizations--Commission Voting Summary and Statements of

    Commissioners

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

    Federal Regulations.

    Appendix 1--Commission Voting Summary

    On this matter, Chairman Gensler and Commissioners Dunn,

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

    Commissioner voted in the negative.

    Appendix 2--Statement of Chairman Gary Gensler

    I support the proposed rulemaking for risk management

    requirements for derivatives clearing organizations (DCOs). The

    proposal establishes robust risk management standards, which is

    particularly important as more swaps are moved into central

    clearinghouses. The proposed rule meets or exceeds international

    standards and recommendations. It establishes methodologies for

    clearinghouses to set margin with regard to swaps contracts.

    The proposed regulations will enhance legal certainty for DCOs,

    clearing members and market participants by providing a regulatory

    framework to support DCO risk management practices. This will help

    strengthen the financial integrity of the futures and swap markets.

    The proposed participant eligibility requirements will promote fair

    and open access to clearing. Importantly, the proposal addresses

    rules of how a futures commission merchant can become a member of a

    swaps clearinghouse. The proposal promotes more inclusiveness while

    allowing the clearinghouses to scale a member's participation and

    risk based upon its capital.

    The proposal would establish a registration application form to

    bring about greater uniformity and transparency in the DCO

    application process and facilitate greater efficiency and

    consistency in processing submissions.

    [FR Doc. 2011-690 Filed 1-19-11; 8:45 am]

    BILLING CODE 6351-01-P

    Last Updated: January 20, 2011



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