FR Doc 2010-7742[Federal Register: April 6, 2010 (Volume 75, Number 65)]
[Rules and Regulations]
[Page 17297-17303]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr06ap10-4]
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COMMODITY FUTURES TRADING COMMISSION
17 CFR Part 190
RIN 3038-AC94
Account Class
AGENCY: Commodity Futures Trading Commission.
ACTION: Final rules.
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SUMMARY: The Commodity Futures Trading Commission (the ``Commission'')
is amending its regulations (the ``Regulations'') \1\ to create a sixth
and separate ``account class,'' \2\ applicable only to the bankruptcy
of a commodity broker that is a futures commission merchant (``FCM''),
for positions in cleared over-the-counter (``OTC'') derivatives (and
money, securities, and/or other property margining, guaranteeing, or
securing such positions).
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\1\ The regulations of the Commission can be found at 17 CFR
Chapter 1.
\2\ In general, the concept of ``account class'' governs the
manner in which the trustee calculates the net equity (i.e., claims
against the estate) and the allowed net equity (i.e., pro rata share
of the estate) for each customer of a commodity broker in
bankruptcy.
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Further, the Commission is amending the Regulations to codify the
appropriate allocation, in a bankruptcy of any commodity broker, of
positions in commodity contracts of one account class (and the money,
securities, and/or other property margining, guaranteeing, or securing
such positions), which, pursuant to an order issued by the Commission
under Section 4d of the Commodity Exchange Act (the ``Act''),\3\ are
commingled with positions in commodity contracts of the futures account
class (and the money, securities, and/or other property margining,
guaranteeing, or securing such positions).
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\3\ The Act can be found at 7 U.S.C. 1-23.
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DATES: Effective Date: The final rules are effective as of May 6, 2010.
FOR FURTHER INFORMATION CONTACT: Robert B. Wasserman, Associate
Director, Division of Clearing and Intermediary Oversight, 202-418-
5092, [email protected]; or Nancy Schnabel, Special Counsel, Division
of Clearing and Intermediary Oversight, 202-418-5344,
[email protected]; Commodity Futures Trading Commission, Three
Lafayette Centre, 1155 21st Street, NW., Washington, DC 20581.
SUPPLEMENTARY INFORMATION:
I. Background
On August 13, 2009, the Commission published a Notice of Proposed
Rulemaking, which contained the following three proposals (the
``Notice'').\4\ First, the Notice proposed amending Regulation
190.01(a), as well as adding new Regulation 190.01(oo), to create a
sixth and separate account class, applicable only to the bankruptcy of
a commodity broker that is an FCM, for positions in ``cleared OTC
derivatives'' (and money, securities, and/or other property margining,
guaranteeing, or securing such positions).\5\ Second, the Notice
proposed further amending Regulation 190.01(a) to codify the
appropriate allocation, in a bankruptcy of any commodity broker, of
positions in commodity contracts of one account class (and relevant
collateral), which, pursuant to an order issued by the Commission under
Section 4d of the Act \6\ (a ``Section 4d Order''), are commingled with
positions in commodity contracts of the futures account class (and
relevant collateral). Third, the Notice proposed making certain
conforming amendments to Regulation 190.07(b)(2)(viii) and Form 4
(Proof of Claim) in Appendix A to Regulation Part 190 (Bankruptcy
Forms).
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\4\ 74 FR 40794 (August 13, 2009).
\5\ The Notice proposed defining ``cleared OTC derivatives'' as:
Positions in commodity contracts that have not been entered into
or traded on a contract market (as such term is defined in Sec.
1.3(h) of this chapter) or on a derivatives transaction execution
facility (within the meaning of Section 5a of the Act), but which
nevertheless are submitted by a commodity broker that is a futures
commission merchant (as such term is defined in Sec. 1.3(p) of this
chapter) for clearing by a clearing organization (as such term is
defined in this section), along with the money, securities, and/or
other property margining, guaranteeing, or securing such positions,
which are required to be segregated, in accordance with a rule,
regulation, or order issued by the Commission, or which are required
to be held in a separate account for cleared OTC derivatives only,
in accordance with the rules or bylaws of a clearing organization
(as such term is defined in this section).
Id. at 40799.
\6\ 7 U.S.C. 6d.
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Although, as mentioned above, the Notice proposed creating a new
account class for positions in cleared OTC derivatives (and relevant
collateral), the Notice declined to propose substantive requirements,
applicable prior to the bankruptcy of a commodity broker that is an
FCM, for the treatment of such positions (and relevant collateral).
Rather, the Notice stated that ``the Commission proposes to define
`cleared OTC derivatives' in such a manner as to specify the sources
from which such substantive requirements may
[[Page 17298]]
originate.'' \7\ According to the Notice, the rules or bylaws of a DCO
constitute one such source.
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\7\ 74 FR at 40796.
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The public comment period on the Notice ended on September 14,
2009. The Commission received four comments \8\ during the comment
period: (i) One from an alternative investment industry trade
association; \9\ (ii) one from a futures industry trade association;
\10\ (iii) one from the holding company of four designated contract
markets (each, a ``DCM'') and three DCOs; \11\ and (iv) one from a
DCM.\12\
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\8\ For purposes of this release, a comment letter is referenced
by (i) its author, (ii) its file number (as shown in the comment
file associated with the Notice on the Commission's Web site), and
(iii) the page (if applicable). The comment file associated with the
Notice is available at http://www.cftc.gov/lawandregulation/
federalregister/federalregistercomments/2009/09-009.html.
\9\ The Managed Funds Association (representing the global
alternative investment industry) (``MFA'') (CL01).
\10\ The Futures Industry Association (representing the
commodity futures and options industry) (``FIA'') (CL02).
\11\ The CME Group, Inc. (the holding company for: (i) The
Chicago Mercantile Exchange Inc. (``CME'') and CME Clearing, a
division of CME; (ii) the Board of Trade of the City of Chicago,
Inc. and its clearing house; (iii) the New York Mercantile Exchange,
Inc. and its clearing house; and (iv) the Commodity Exchange, Inc.)
(``The CME Group'') (CL03).
\12\ ELX Futures, L.P. (``ELX'') (CL04).
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Collectively, the comments raise the following five concerns with
the Notice:
The Commission may not have authority to promulgate the
proposed amendments in the Notice;
The Commission should make the proposed account class for
cleared OTC derivatives applicable to the bankruptcy of a commodity
broker that is a DCO, not simply to the bankruptcy of a commodity
broker that is an FCM;
The Commission should change the definition of cleared OTC
derivatives in the Notice to better comport with the definition of
``cleared-only contracts'' \13\ in the Interpretative Statement that
the Commission issued on September 26, 2008 (the ``Statement on Cleared
OTC Derivatives''); \14\
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\13\ In the Statement on Cleared OTC Derivatives, the Commission
defined ``cleared-only contracts'' as those contracts that
``although not executed or traded on a Designated Contract Market or
a Derivatives Transaction Execution Facility, are subsequently
submitted for clearing through a Futures Commission Merchant * * *
to a Derivatives Clearing Organization.'' 73 FR 65514 (November 4,
2008).
\14\ Id.
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The Commission should establish objective standards for
issuing Section 4d Orders; and
The Commission should specify substantive requirements
with respect to the treatment of positions in cleared OTC derivatives
(and money, securities, and/or other property margining, guaranteeing,
or securing such positions), if a DCO requires such positions (and
relevant collateral) to be held in a separate account for cleared OTC
derivatives.
The Commission will address below each of the five concerns in
turn.
II. Concern That the Commission Does Not Have Authority To Promulgate
the Proposed Amendments in the Notice
A. Rationale for Concern
Two commenters stated that certain participants in the OTC
derivatives markets have questioned the authority of the Commission to
promulgate the proposed amendments in the Notice. In support of their
respective statements, both commenters referenced the Report to the
Supervisors of the Major OTC Derivatives Dealers on the Proposals of
Centralized CDS Clearing Solutions for the Segregation and Portability
of Customer CDS Positions and Related Margin, dated June 30, 2009 (the
``Segregation and Portability Report'').\15\ One commenter quotes from
a portion of the Segregation and Portability Report, which states that
there exists a ``not insignificant'' risk that a court administering
the bankruptcy of a commodity broker would disagree with the Statement
on Cleared OTC Derivatives.\16\ In the Statement on Cleared OTC
Derivatives, the Commission determined (i) that cleared-only contracts
constituted ``commodity contracts'' \17\ within the meaning of
Subchapter IV of Chapter 7 of the Bankruptcy Code (``Subchapter
IV''),\18\ and (ii) that, therefore, customer positions in cleared-only
contracts that, pursuant to a Section 4d Order, are commingled with
customer positions in futures contracts should be afforded all
protections available under Subchapter IV and Regulation Part 190 in
the event of the bankruptcy of a commodity broker that is an FCM. For
the reasons explained below, the Commission does not believe that the
commenters' concerns are well founded.
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\15\ The Segregation and Portability Report is available at
http://www.newyorkfed.org/newsevents/news/markets/2009/
an090713.html.
According to the MFA, the Segregation and Portability Report
states that ``there is uncertainty as to the proposition that
cleared OTC derivatives contracts constitute `commodity contracts',
thereby receiving account class protections under the [Act] and the
Bankruptcy Code.'' See MFA CL01 at 3.
According to the FIA, the Segregation and Portability Report
``concludes that there are reasonable arguments that cleared OTC
derivatives may be viewed as `commodity contracts' for purposes of
Subchapter IV and Part 190. However, `the risk of a contrary
conclusion is not insignificant.' [Emphasis supplied.]'' See FIA
CL02 at 6.
\16\ Id. The FIA also quotes from another portion of the
Segregation and Portability Report, which states:
We believe there is a significant possibility (in a worst-case
scenario) that the proposition that cleared [credit default swap]
contracts constitute ``commodity contracts'' within the meaning of
the Bankruptcy Code may be challenged * * * In addition, we also
believe that any challenge to the proposition that [credit default
swaps] constitute ``commodity contracts'' would likely result in
significant delay for customers seeking the return of margin through
the insolvent FCM.
Id.
To properly contextualize these expressed concerns, the
Commission makes two observations.
First, while the Segregation and Portability Report repeatedly
makes portentous statements concerning the ``not insignificant''
risk that a court might find that cleared-only contracts (as the
Statement on Cleared OTC Derivatives defines such term) are not
commodity contracts, the Segregation and Portability Report cites
neither to statutory language nor to case law that might be relied
upon to support such a conclusion. Indeed, the Report fails to
specify any analytical basis for its concerns.
Second, the Segregation and Portability Report's discussion of
timing concerns in this context is somewhat incongruous, given that
the report contains the following description of its own scope:
We do not principally focus on timing issues in this Report--
e.g., when customers will be able to recover their margin. Although
we note certain instances in which timing concerns may be
particularly relevant, our primary focus is on whether customers
will be able to recover their margin. Timing issues are critical to
the analysis of any CCP's customer protection framework. However, we
do not focus on them in this Report because of their inherently
complex and unpredictable nature.
See the Segregation and Portability Report at 3. In any event,
the prosaic observation that the conclusions of the Statement on
Cleared OTC Derivatives may be the subject of a challenge, and that
such a challenge might take time to resolve, provides no reason for
rejecting the proposals contained in the Notice that are based on
those conclusions.
\17\ 11 U.S.C. 761(4)(A).
\18\ 11 U.S.C. Chapter 7, Subchapter IV.
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B. ``Commodity Contract'' Definition
In both the Statement on Cleared OTC Derivatives and the Notice,
the Commission relied on clear statutory authority that the Commodity
Futures Modernization Act of 2000 (the ``CFMA'') \19\ introduced in the
Act and in Subchapter IV to conclude that cleared OTC derivatives are
``commodity contracts'' within the meaning of Section 761(4)(A) of the
Bankruptcy Code.\20\ The CFMA created the opportunity for OTC
derivatives to be cleared.\21\ The CFMA also extended Subchapter IV to
cleared OTC derivatives. Section 761(4)(A) of the Bankruptcy Code
defines ``commodity contract,'' with respect to an FCM, as a ``contract
for the purchase or sale of a commodity for future delivery on, or
subject to the rules of, a contract market
[[Page 17299]]
or board of trade.'' \22\ Section 112(c)(6) of the CFMA amended the
definition of ``contract market'' in Section 761(7) of the Bankruptcy
Code to include reference to a ``registered entity.'' \23\ It also
amended Section 761(8) of the Bankruptcy Code to incorporate by
reference the definition of ``registered entity'' in the Act.\24\
Section 1a(29) of the Act defines a ``registered entity'' to include
``(iii) a derivatives clearing organization registered under Section 5b
* * *''.\25\
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\19\ Appendix E of Public Law 106-554, 114 Stat. 2763 (2000).
\20\ See supra note 17.
\21\ See, e.g., Sections 2(d), (e), and (g) of the Act (7 U.S.C.
2(d), (e), (g)).
\22\ See supra note 17.
\23\ 11 U.S.C. 761(7).
\24\ 11 U.S.C. 761(8).
\25\ 7 U.S.C. 1a(29).
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Therefore, the Commission believes that the CFMA permitted cleared
OTC derivatives, which are subject to the rules of a DCO, to become
``commodity contracts,'' with respect to an FCM, within the meaning of
Section 761(4) of the Bankruptcy Code.\26\ The Commission further
believes that a court administering the bankruptcy of an FCM would
consider the abovementioned CFMA interpretation to be a ``reasonable''
``construction of a statutory scheme'' that the Commission has been
``entrusted to administer'' under Chevron U.S.A. Inc. v. Natural
Resources Defense Council, Inc., et al., 467 U.S. 837, 844 (1984).\27\
Indeed, the Segregation and Portability Report states: ``Ultimately, we
believe a court is likely to conclude that [credit default swaps] are
`commodity contracts' (on account of which [credit default swap]
clearing customers are `customers' within the meaning of the Bankruptcy
Code) * * *''.\28\
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\26\ See supra note 17.
\27\ As mentioned above, ``account class'' governs the manner in
which the trustee calculates the net equity (i.e., claims against
the estate) and the allowed net equity (i.e., pro rata share of the
estate) for each customer of a commodity broker in bankruptcy. As
the NPRM states, ``[t]he Commission is empowered by Section 20 of
the Commodity Exchange Act * * * (i) to define the `net equity' of a
customer of a commodity broker in bankruptcy, and (ii) to prescribe,
by rule or regulation, the procedures for calculating such `net
equity.' '' See 74 FR at 40795. The Commission is exercising its
powers under Section 20 of the Act in determining whether cleared
OTC derivatives could, with respect to an FCM that is a commodity
broker, constitute a sixth and separate account class. The plain
language of the Bankruptcy Code recognizes the authority of the
Commission to make such determination. For example, Section 761(17)
of the Bankruptcy Code subjects the definition of ``net equity,'' in
the case of a commodity broker, to such ``rules and regulations as
the Commission promulgates under the Act.'' Moreover, the
legislative history of the 1978 amendments to the Bankruptcy Code
supports the authority of the Commission. Cf. H.R. Rep. No. 95-595
(1977) (stating that ``a final distinction [between Subchapter III
of Title 7 of the Bankruptcy Code (11 U.S.C., Title 7, Subchapter
III) and Subchapter IV] concerns the creation of a rule-making power
in the Commodity Futures Trading Commission to carry out the
provisions * * * The bill contains such a rule-making power with
respect to * * * net equity * * * The rule-making power was
requested by the CFTC and is appropriate in light of the germinal
state of regulation in this area'').
\28\ The Segregation and Portability Report does note that
``this outcome is not at all certain.'' See the Segregation and
Portability Report at 35. However, the Segregation and Portability
Report also observes that, in the event that a court administering
the bankruptcy of a commodity broker disagrees with the
determination of the Commission that cleared-only contracts (as the
Statement on Cleared OTC Derivatives defines such term) constitute
``commodity contracts'' under Subchapter IV, ``if the [commodity
broker] segregates assets solely for the cleared [credit default
swap] customers, then the cleared [credit default swap] customers'
interest in those assets may be superior to any interest of the
commodities customers or unsecured creditors of the [commodity
broker] * * *''. See the Segregation and Portability Report at 37.
Therefore, the Segregation and Portability Report appears to imply
that the creation, in the event of the bankruptcy of a commodity
broker that is an FCM, of a separate account class for customer
positions in cleared OTC derivatives (and money, securities, and/or
other property margining, guaranteeing, or securing such positions),
as the Notice proposed, may benefit customers, even if a court does
not accord such positions (and relevant collateral) full protection
under Subchapter IV and Regulation Part 190.
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C. Support for Legislative Changes
One commenter notes that the Commission proposed to Congress on
August 17, 2009 certain amendments to the Bankruptcy Code that would
achieve the same effect as the amendments proposed in the Notice. The
commenter then speculated that the Commission may have been motivated
to make such proposal because it believed that it otherwise lacks
authority to promulgate the proposed amendments in the Notice.\29\ Such
speculation is mistaken. As stated above, the Commission believes that
cleared OTC derivatives are ``commodity contracts'' within the meaning
of Section 761(4)(A) of the Bankruptcy Code.\30\ The commenter
references proposals that Chairman Gary Gensler made to Congress. These
proposals included the abovementioned amendments to the Bankruptcy Code
in order to clarify the status of swaps, in the context of the
improvements to regulation of over-the-counter derivatives markets that
the Administration proposed \31\ and other, more extensive changes to
the Bankruptcy Code. The proposal that Congress make explicit what the
CFMA left implicit does not mean that the interpretation of the
existing statute that the Commission has advanced is not
reasonable.\32\
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\29\ As mentioned above, according to the FIA, the Segregation
and Portability Report ``concludes that there are reasonable
arguments that cleared OTC derivatives may be viewed as `commodity
contracts' for purposes of Subchapter IV and Part 190. However, `the
risk of a contrary conclusion is not insignificant.' [Emphasis
supplied.]'' The FIA then further observes:
The Commission may have reached the same conclusion. In its
August 17, 2009 recommendations to Congress, the Commission has
proposed amendments to the Bankruptcy Code that amend the definition
of a ``contract market'' to remove the reference to ``registered
entity,'' which is currently the Commission's basis for finding that
cleared-only derivatives contracts are ``commodity contracts'' under
the Bankruptcy Code. Instead, the Commission recommends that the
definition of a ``commodity contract'' be amended to include a
``swap that is submitted to a derivatives clearing organization for
clearing'' by a ``swap clearer'' (as defined). The broad definition
of a ``swap'' in the Bankruptcy Code would encompass all cleared OTC
derivatives contracts.
See FIA CL02 at 6-7.
\30\ See supra note 17.
\31\ Such proposals are available at http://
financialstability.gov/docs/regulatoryreform/titleVII.pdf.
\32\ See United States v. Sepulveda, 115 F.3d 882, 885 (11th
Cir. 1997) (quoting Hawkins v. United States, 30 F.3d 1077, 1082
(9th Cir. 1994)) (stating that ``Congress may, however, `amend a
statute to clarify existing law * * *' Thus, an amendment to a
statute does not necessarily indicate that the unamended statute
meant the opposite.'' See also Wesson v. United States, 48 F.3d 894,
900-901 (5th Cir. 1995); Fowler v. Unified School District No. 259,
Sedgwick County, Kansas, 128 F.3d 1431 (10th Cir. 1997)).
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III. Recommendation That the Commission Extend the Application of the
Proposed Account Class for Cleared OTC Derivatives
One commenter recommends that the Commission extend the application
of the account class for cleared OTC derivatives, as proposed in the
Notice, to the bankruptcy of a commodity broker that is a DCO, rather
than limit such application to the bankruptcy of a commodity broker
that is an FCM. That commenter argues that the absence of such an
extension would cause confusion, in the event of a DCO bankruptcy,
regarding the treatment of the money, securities, and/or other property
that the DCO holds to margin, guarantee, or secure positions in cleared
OTC derivatives belonging to customers of DCO members.\33\
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\33\ Specifically, The CME Group states:
If, as proposed by the Commission, an FCM were to utilize a
separate account for customers' cleared OTC derivatives in the
absence of a 4d order, the DCO must also maintain a similar account
for holding such positions and their accompanying margins. If the
cleared OTC derivatives account class will not apply in the unlikely
event of a DCO bankruptcy, then it is unclear what account class
would apply to the funds in the DCO's separate account for those OTC
derivatives that it clears on behalf of its clearing FCMs'
customers.
See The CME Group CL03 at 3.
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While sympathetic to these arguments, the Commission continues to
believe that a DCO bankruptcy would be sui generis.\34\ Therefore, the
[[Page 17300]]
Commission believes that the best approach, at present, would be to
limit the application of the account class for cleared OTC derivatives
to the bankruptcy of a commodity broker that is an FCM.
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\34\ The proposing release to Regulation Part 190 states:
The Commission is proposing that all open commodity contracts,
even those in a deliverable position, be liquidated in the event of
a clearing organization bankruptcy because it would be highly
unlikely that an exchange could maintain a properly functioning
futures market in the event of the collapse of its clearing
organization. The Commission has proposed no other rules with
respect to the operation of clearing organization debtors * * *
Because the bankruptcy of a clearing organization would be unique,
the Commission is not proposing a general rule in this regard. The
potential for disruption of the Markets, and of the nation's economy
as a whole, in the case of a clearing organization bankruptcy,
together with the desirability of the Commission's active
participation in developing a means of meeting such an emergency,
has disposed the Commission to take a case-by-case approach with
respect to clearing organizations.
See 46 FR 57535, 57545 (November 24, 1981).
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IV. Recommendation That the Commission Change the Proposed Definition
of Cleared OTC Derivatives
One commenter recommends that the Commission change the definition
of cleared OTC derivatives, as proposed in the Notice,\35\ to better
comport with the definition of cleared-only contracts in the Statement
on Cleared OTC Derivatives.\36\ Specifically, the commenter notes that
the definition of cleared OTC derivatives proposed in the Notice
appears to require that an FCM actually submit a contract for clearing.
In contrast, the definition of cleared-only contracts in the Statement
on Cleared OTC Derivatives only requires that a contract is submitted
through an FCM for clearing.\37\ The commenter states that, if the
Commission adopts the recommendation, the Commission would render
patent that it ``does not intend to prohibit clearing FCMs from
authorizing their customers to directly enter their transactions into
the clearing system, in order to meet the definition of cleared OTC
derivatives, as long as the transactions are cleared through an FCM.''
\38\ The Commission agrees with this commenter, and has modified, in
this release, the definition of cleared OTC derivatives proposed in the
Notice in accordance with the recommendation from this commenter.
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\35\ See supra note 5.
\36\ See supra note 13.
\37\ See The CME Group CL03 at 5.
\38\ Id.
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Another commenter poses two questions about the definition of
cleared OTC derivatives proposed in the Notice.\39\ All such questions
appear related to whether the Commission may deem a contract listed for
trading on a contract market (as Regulation 1.3(h) defines such term)
to have been executed OTC, if such contract fails to reach a certain
liquidity threshold on the contract market. The Commission believes
that the definition of cleared OTC derivatives, as proposed in the
Notice (i.e., proposed Regulation 190.01(oo)), plainly limits such term
to contracts that ``have not been entered into or traded on a contract
market (as such term is defined in Sec. 1.3(h) of this chapter) * *
*.'' Regulation 1.3(h), in turn, defines ``contract market'' in terms
of a board of trade's designation as a DCM, not in terms of the
liquidity of any particular contract.
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\39\ Specifically, ELX asks:
``What constitutes a `cleared only' contract? If an OTC
derivative is offered for exchange trading (thus losing the moniker
OTC derivative) but fails to trade, or trades fewer than 100
contracts per day, is it considered cleared only?''
``How much time will a contract be given to reach a
liquidity threshold before being deemed `cleared only' and required
to be placed in a new account class?''
See ELX CL04 at 2.
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V. Recommendations That the Commission Establish Objective Standards
for Section 4d Orders
Two commenters recommend that the Commission propose objective
standards for determining which cleared OTC derivatives would be
eligible for a Section 4d Order.\40\ The first commenter states that
``it would be beneficial to DCOs and the Commission if the Commission
were to adopt standards that would define the requirements that must be
met for a cleared OTC derivative to qualify for 4d treatment.'' \41\ In
contrast, the second commenter states that the Commission must propose
such objective standards ``[i]n order to assure that `cleared OTC
derivatives' customers receive the benefits intended'' by the proposed
rules contained in the Notice.\42\ The second commenter contends that,
without such standards, customers with positions (and money,
securities, and/or other property margining, guaranteeing, or securing
such positions) in the account class for cleared OTC derivatives may
argue, in the bankruptcy of a commodity broker that is an FCM, that:
(i) Such positions share certain characteristics with positions in the
futures account class; and (ii) thus such customers ``should have
access to the same pool of assets, i.e., the futures account.'' \43\
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\40\ A Section 4d Order would permit positions in a cleared OTC
derivative (and relevant collateral) to be included in the futures
account class rather than another account class (e.g., the account
class for cleared OTC derivatives).
\41\ See The CME Group CL03 at 7.
\42\ See FIA CL02 at 3.
\43\ Id. at 3-5.
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The proposed regulations contained in the Notice (i.e., the
proposed amendment to Regulation 190.01(a)) unambiguously state that
``positions in commodity contracts of one account class (and the money,
securities, and/or other property margining, guaranteeing, or securing
such positions)'' would be treated, in the bankruptcy of any commodity
broker, ``as being held in the futures account class'' only if,
``pursuant to a Commission order,'' such positions are ``commingled
with positions in commodity contracts of the futures account class (and
the money, securities, and/or other property margining, guaranteeing,
or securing such positions).'' \44\ Pursuant to that plain language, in
the bankruptcy of a commodity broker, the decisive factor as to whether
a position in a cleared OTC derivative contract (and relevant
collateral) would be treated as belonging to the futures account class
is whether the Commission has issued a Section 4d Order covering such
contract, not whether the Commission should have or could have issued
such a Section 4d Order.\45\
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\44\ 74 FR at 40798-99.
\45\ To enhance clarity on this point, the reference in the
definition of cleared OTC derivatives, as proposed in the Notice, to
positions (and relevant collateral) that are ``segregated * * * in
accordance with a rule, regulation, or order issued by the
Commission,'' see id. at 40799, has been changed in this release to
a reference to positions (and relevant collateral) that are
``segregated or set aside * * * in accordance with a rule,
regulation, or order issued by the Commission.'' Also, Regulation
190.01(a), as proposed in the Notice, has been changed to include
the following emphasized language: ``Provided, further, that, if
positions in commodity contracts that would otherwise belong to one
account class (and the money, securities, and/or other property
margining, guaranteeing, or securing such positions), are, pursuant
to a Commission order, commingled with positions in commodity
contracts of the futures account class (and the money, securities,
and/or other property margining, guaranteeing, or securing such
positions), then the former positions (and the relevant money,
securities, and/or other property) shall be treated, for purposes of
this part, as being held in an account of the futures account
class.''
In making the abovementioned changes, the Commission intends to
remove any possible doubt that:
OTC derivatives subject to a Section 4d Order
(including from inception) are ``cleared OTC derivatives'' within
the meaning of Regulation 190.01(oo), but that such derivatives
shall be treated, pursuant to Regulation 190.01(a), as belonging to
the futures account class and not the cleared OTC derivative account
class; and
OTC derivatives not subject to a Section 4d Order may
become ``cleared OTC derivatives'' within the meaning of Regulation
190.01(oo), but that such derivatives shall be treated, pursuant to
Regulation 190.01(a), as belonging to the cleared OTC derivative
account class and not the futures account class.
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It is outside the purview of this release to propose objective
standards for determining which cleared OTC derivative contracts would
be eligible
[[Page 17301]]
for a Section 4d Order. For the abovementioned reasons, such standards
are not necessary to effectuate the purposes of the proposed rules
contained in the Notice (including the proposed amendment to Regulation
190.01(a)).\46\
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\46\ As the Notice states: ``The Commission is proposing [to
create an account class for cleared OTC derivatives] at this time
because of increased interest among DCOs in clearing OTC
derivatives, and the need to enhance certainty regarding the
treatment of cleared OTC derivatives in the bankruptcy of a
commodity broker in bankruptcy.'' 74 FR at 40796.
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A third commenter poses questions pertaining to the operation of
the futures account class after the Commission establishes a separate
account class for cleared OTC derivatives.\47\ In answer to such
questions, the Commission makes the following three observations.
First, the Commission will continue to review petitions for Section 4d
Orders and will approve such petitions in appropriate cases. Second,
the only effect of this release on contracts (and relevant collateral)
that, pursuant to a previously issued Section 4d Order, are permitted
to be commingled with contracts (and relevant collateral) of the
futures account class, is to codify the Statement on Cleared OTC
Derivatives and the Interpretative Statement that the Commission issued
on November 30, 2004 (the ``Statement on Commingling Foreign Futures
Positions''),\48\ which, in each case, provides that such contracts
(and relevant collateral) are to be treated as part of the futures
account class. This release does not in any way vitiate any previously
issued Section 4d Order. Finally, in the absence of an appropriate
order, the Commission does not intend to permit positions in the
futures account class and positions in the separate account class for
cleared OTC derivatives to be margined as a single portfolio.
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\47\ Specifically, ELX asks:
``[W]hether the DCO will be permitted to cross margin
the new account class envisioned by the Proposed Rules against
related products in different account classes * * *''
``Will 4d exemptions still be granted after the new
account class is created?''
``What will be the status of previously granted 4d
exemptions, and will they be grandfathered or required to be
transferred into the new account class?''
ELX CL04 at 2.
\48\ The Statement on Cleared OTC Derivatives can be found at 73
FR 65514 (November 4, 2008). The Statement on Commingling Foreign
Futures Positions can be found at 69 FR 69510 (November 30, 2004).
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VI. Recommendation That the Commission Establish Rules for the
Treatment of Positions in Cleared OTC Derivatives (and Relevant
Collateral)
In the Notice, the Commission stated that it ``[did] not intend to
specify substantive requirements for the treatment of cleared OTC
derivatives (and the money, securities, and/or other property
margining, guaranteeing, or securing such derivatives). Rather, the
Commission propose[d] to define `cleared OTC derivatives' in such a
manner as to specify the sources from which such substantive
requirements may originate.'' As the Notice indicates, a DCO rule or
bylaw constitutes one possible source for such substantive
requirements. Because different DCOs may adopt different substantive
requirements, such DCOs may afford varying levels of protection to
positions in cleared OTC derivatives (and relevant collateral).\49\
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\49\ As The CME Group accurately observed, the proposed
definition of ``cleared OTC derivatives'' in the Notice would
permit, for example, ``one DCO [to] model its rule on the
requirements for 4d segregated accounts which limit the instruments
in which such funds may be invested to those set forth in Regulation
1.25,'' and ``another DCO [to] use Regulation 30.7 requirements as
its guide, and choose not to specify permissible investments.'' The
CME Group CL03 at 6.
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Two commenters disagree with such approach. They recommend that the
Commission specify substantive requirements with respect to the
treatment of positions in cleared OTC derivatives (and relevant
collateral), if the DCO requires such positions (and relevant
collateral) to be held in a separate account for cleared OTC
derivatives.\50\ One commenter observes:
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\50\ FIA states: ``In adopting these standards, the Commission
should also provide guidance regarding the treatment of funds
deposited to margin `cleared OTC derivatives.' '' FIA CL02 at 4.
In addition, The CME Group states:
Given that the Commission's goal is to ensure that customers
clearing OTC derivatives receive bankruptcy protection, and in the
interest of providing consistency in the safeguards for OTC customer
positions and margins, the Commission should define the minimum
requirements that must apply to cleared OTC derivatives accounts for
transactions that are cleared through any DCO with respect to those
areas that the Commission has already addressed for 4d accounts,
including permitted investments, recordkeeping, and acknowledgement
letters. The CME Group CL03 at 6-7.
Depending on how much the requirements for cleared OTC
derivatives accounts vary among DCOs, FCMs could find themselves in
the position of having to maintain multiple cleared OTC derivatives
accounts with respect to different DCOs. Moreover, under the
Commission proposal, all cleared OTC derivatives accounts are
considered to be part of the same account class, even if the
accounts relate to multiple DCOs with varying requirements for such
accounts. Therefore, the available funds in the cleared OTC
derivatives account class could be diluted for customers of a
bankrupt FCM who hold OTC derivatives cleared by a DCO with more
stringent requirements because the account class also contains the
margins of customers who hold OTC derivatives cleared by a DCO with
less stringent requirements.\51\
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\51\ See The CME Group CL03 at 6.
The Commission does not disagree with the recommendations of the
two commenters, and has directed staff to recommend for the
Commission's consideration proposals that would impose substantive
requirements with respect to the treatment of positions in cleared OTC
derivatives (and relevant collateral).
The Commission has decided to promulgate the final rules contained
in this release, without waiting to propose the abovementioned
requirements, because the Commission believes that it is important, in
light of recent market events (including disruptions in global credit
markets), to enhance certainty, as soon as possible, with respect to
the protections available under Subchapter IV and Regulation Part 190
to positions in cleared OTC derivatives (and relevant collateral),
however the FCM and the DCO treat such collateral. Moreover, the
Commission believes that it is important to enhance certainty, as soon
as possible, regarding the treatment, in a bankruptcy of any commodity
broker, of customers with positions (and relevant collateral) subject
to a Section 4d Order. Therefore, for the avoidance of doubt, the
Commission clarifies that, after the final rules become effective, a
position in an OTC derivative (and relevant collateral) that a customer
clears through an FCM with a DCO, which position (and collateral) is
not subject to a Section 4d Order, would be considered part of the
cleared OTC derivative account class, as soon as, but only after, a DCO
rule or bylaw that requires such positions (and relevant collateral) to
be held in a separate account for cleared OTC derivatives becomes
effective, either through self-certification or approval by the
Commission.\52\ Such rule or bylaw need not specify any particular
treatment of such positions (and relevant collateral) at this time in
order for such positions to be considered within the OTC derivative
account class.
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\52\ See Regulations 40.5 and 40.6 (17 CFR 40.5, 40.6).
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[[Page 17302]]
VII. Related Matters
A. Regulatory Flexibility Act
The Regulatory Flexibility Act (``RFA'') \53\ requires Federal
agencies, in promulgating regulations, to consider the impact of those
regulations on small businesses. The final rules promulgated in this
release will affect only FCMs and DCOs. The Commission has previously
established certain definitions of ``small entities'' to be used by the
Commission in evaluating the impact of its regulations in accordance
with the RFA.\54\ The Commission has previously determined that FCMs
\55\ and DCOs \56\ are not small entities for the purpose of the RFA.
Accordingly, pursuant to 5 U.S.C. 605(b), the Chairman, on behalf of
the Commission, certifies that the final rules promulgated herein will
not have a significant impact on a substantial number of small
entities.
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\53\ 5 U.S.C. 601 et seq.
\54\ 47 FR 18618 (April 30, 1982).
\55\ Id. at 18619.
\56\ 66 FR 45604, 45609 (August 29, 2001).
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B. Paperwork Reduction Act
The Paperwork Reduction Act of 1995 (``PRA'') \57\ imposes certain
requirements on Federal agencies in connection with their conducting or
sponsoring any ``collection of information'' as defined by the PRA. The
final rules promulgated in this release do not require the new
collection of information on the part of DCOs or FCMs. Accordingly, for
purposes of the PRA, the Commission certifies that the final rules
promulgated in this release would not impose any new reporting or
recordkeeping requirements.
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\57\ 44 U.S.C. 3501-3520.
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C. Cost-Benefit Analysis
Section 15(a) of the Act requires that the Commission, before
promulgating a regulation under the Act or issuing an order, consider
the costs and benefits of its action. By its terms, Section 15(a) of
the Act does not require the Commission to quantify the costs and
benefits of a new regulation or determine whether the benefits of the
regulation outweigh its costs. Rather, Section 15(a) of the Act simply
requires the Commission to ``consider the costs and benefits'' of its
action.
Section 15(a) of the Act further specifies that costs and benefits
shall be evaluated in light of the following considerations: (1)
Protection of market participants and the public; (2) efficiency,
competitiveness, and financial integrity of futures markets; (3) price
discovery; (4) sound risk management practices; and (5) other public
interest considerations. Accordingly, the Commission could, in its
discretion, give greater weight to any one of the five considerations
and could determine that, notwithstanding its costs, a particular
regulation was necessary or appropriate to protect the public interest
or to effectuate any of the provisions or to accomplish any of the
purposes of the Act.
The Commission has evaluated the costs and benefits of the final
rules promulgated in this release in light of (i) the comments that it
has received on the Notice and (ii) the specific considerations
identified in Section 15(a) of the Act, as follows:
1. Protection of Market Participants and the Public
The final rules promulgated in this release would benefit FCMs and
DCOs, as well as customers of the futures and options markets, by
providing greater certainty, (i) in a bankruptcy of a commodity broker
that is an FCM, regarding the treatment of cleared OTC derivatives, and
(ii) in a bankruptcy of any commodity broker, regarding the allocation
of positions in commodity contracts (and relevant money, securities,
and/or other property) of one account class that are commingled in an
FCM or DCO account, pursuant to a Section 4d Order, with positions in
commodity contracts (and relevant money, securities, and/or other
property) of the futures account class.
2. Efficiency and Competition
The final rules promulgated in this release are not expected to
have an effect on efficiency or competition.
3. Financial Integrity of Futures Markets and Price Discovery
The final rules promulgated in this release would enhance the
protection, in the bankruptcy of a commodity broker that is an FCM, of
customers with positions in cleared OTC derivatives by providing an
account class in which to hold such positions (and relevant money,
securities, and/or other property). Further, the final rules would
enhance certainty regarding the treatment, in a bankruptcy of any
commodity broker, of customers with positions (and relevant money,
securities, and/or other property) subject to a Section 4d Order, by
removing concerns regarding whether the Statement on Cleared OTC
Derivatives, as well as the Statement on Commingling Foreign Futures
Positions, would be limited to the specific factual patterns addressed
therein. Thus, the final rules would contribute to the financial
integrity of the futures and options markets as a whole.
4. Sound Risk Management Practices
The final rules promulgated in this release would reinforce the
sound risk management practices already required of FCMs and DCOs, by
(i) providing an account class, in the bankruptcy of a commodity broker
that is an FCM, in which to hold positions in cleared OTC derivatives
(and relevant money, securities, and/or other property), and (ii)
providing certainty to FCMs and DCOs regarding the allocation between
account classes, in a bankruptcy of any commodity broker, of customer
positions (and relevant money, securities, and/or other property)
subject to a Section 4d Order.
5. Other Public Considerations
Recent market events, including disruptions in global credit
markets, render it prudent to enhance certainty regarding the treatment
of customer positions (and relevant money, securities, and/or other
property) in a commodity broker bankruptcy.
Accordingly, after considering the five factors enumerated in the
Act, the Commission has determined to promulgate the final rules as set
forth below.
List of Subjects in 17 CFR Part 190
Bankruptcy, Brokers, Commodity futures.
0
For the reasons stated in the preamble, the Commission hereby amends 17
CFR part 190 as follows:
PART 190--BANKRUPTCY
0
1. The authority citation for part 190 continues to read as follows:
Authority: 7 U.S.C. 1a, 2, 4a, 6c, 6d, 6g, 7a, 12, 19, and 24,
and 11 U.S.C. 362, 546, 548, 556, and 761-766, unless otherwise
noted.
0
2. In Sec. 190.01, revise paragraph (a) and add paragraph (oo) to read
as follows:
Sec. 190.01 Definitions.
* * * * *
(a) Account class means each of the following types of customer
accounts which must be recognized as a separate class of account by the
trustee: futures accounts, foreign futures accounts, leverage accounts,
commodity option accounts, delivery accounts as defined in Sec.
190.05(a)(2), and, only with respect to the bankruptcy of a commodity
broker that is a futures commission merchant, cleared OTC derivatives
accounts; Provided, however, That to the extent that the equity
balance, as defined in Sec. 190.07, of a customer in a
[[Page 17303]]
commodity option, as defined in Sec. 1.3(hh) of this chapter, may be
commingled with the equity balance of such customer in any domestic
commodity futures contract pursuant to regulations under the Act, the
aggregate shall be treated for purposes of this part as being held in a
futures account; Provided, further, that, if positions in commodity
contracts that would otherwise belong to one account class (and the
money, securities, and/or other property margining, guaranteeing, or
securing such positions), are, pursuant to a Commission order,
commingled with positions in commodity contracts of the futures account
class (and the money, securities, and/or other property margining,
guaranteeing, or securing such positions), then the former positions
(and the relevant money, securities, and/or other property) shall be
treated, for purposes of this part, as being held in an account of the
futures account class.
* * * * *
(oo) Cleared OTC derivatives shall mean positions in commodity
contracts that have not been entered into or traded on a contract
market (as such term is defined in Sec. 1.3(h) of this chapter) or on
a derivatives transaction execution facility (within the meaning of
Section 5a of the Act), but which nevertheless are submitted through a
commodity broker that is a futures commission merchant (as such term is
defined in Sec. 1.3(p) of this chapter) for clearing by a clearing
organization (as such term is defined in this section), along with the
money, securities, and/or other property margining, guaranteeing, or
securing such positions, which are required to be segregated or set
aside, in accordance with a rule, regulation, or order issued by the
Commission, or which are required to be held in a separate account for
cleared OTC derivatives only, in accordance with the rules or bylaws of
a clearing organization (as such term is defined in this section).
0
4. In Sec. 190.07, revise paragraph (b)(2)(viii) to read as follows:
Sec. 190.07 Calculation of allowed net equity.
(b) * * *
(2) * * *
(viii) Subject to paragraph (b)(2)(ix) of this section, the futures
accounts, leverage accounts, options accounts, foreign futures
accounts, and cleared OTC derivatives accounts of the same person shall
not be deemed to be held in separate capacities: Provided, however,
That such accounts may be aggregated only in accordance with paragraph
(b)(3) of this section.
* * * * *
0
5. Amend ``bankruptcy appendix form 4--proof of claim'' in Appendix A
to Part 190 by revising paragraph a in section III to read as follows:
Appendix A to Part 190--Bankruptcy Forms
* * * * *
bankruptcy appendix form 4--proof of claim
* * * * *
III. * * *
a. Whether the account is a futures, foreign futures, leverage,
option (if an option account, specify whether exchange-traded or
dealer), ``delivery'' account, or, only with respect to a bankruptcy
of a commodity broker that is a futures commission merchant, a
cleared OTC derivatives account. A ``delivery'' account is one which
contains only documents of title, commodities, cash, or other
property identified to the claimant and deposited for the purposes
of making or taking delivery on a commodity underlying a commodity
contract or for payment of the strike price upon exercise of an
option.
Issued in Washington, DC, on March 31, 2010, by the Commission.
David A. Stawick,
Secretary of the Commission.
[FR Doc. 2010-7742 Filed 4-5-10; 8:45 am]
BILLING CODE P
Last Updated: April 6, 2010