2011-27536

Federal Register, Volume 76 Issue 216 (Tuesday, November 8, 2011)[Federal Register Volume 76, Number 216 (Tuesday, November 8, 2011)]

[Rules and Regulations]

[Pages 69334-69480]

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

[FR Doc No: 2011-27536]

[[Page 69333]]

Vol. 76

Tuesday,

No. 216

November 8, 2011

Part II

Commodity Futures Trading Commission

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17 CFR Parts 1, 21, 39 et al.

Derivatives Clearing Organization General Provisions and Core

Principles; Final Rule

Federal Register / Vol. 76 , No. 216 / Tuesday, November 8, 2011 /

Rules and Regulations

[[Page 69334]]

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COMMODITY FUTURES TRADING COMMISSION

17 CFR Parts 1, 21, 39, and 140

RIN 3038-AC98

Derivatives Clearing Organization General Provisions and Core

Principles

AGENCY: Commodity Futures Trading Commission.

ACTION: Final rule.

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SUMMARY: The Commodity Futures Trading Commission (Commission) is

adopting final regulations to implement certain provisions of Title VII

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

Protection Act (Dodd-Frank Act) governing derivatives clearing

organization (DCO) activities. More specifically, the regulations

establish the regulatory standards for compliance with DCO Core

Principles A (Compliance), B (Financial Resources), C (Participant and

Product Eligibility), D (Risk Management), E (Settlement Procedures), F

(Treatment of Funds), G (Default Rules and Procedures), H (Rule

Enforcement), I (System Safeguards), J (Reporting), K (Recordkeeping),

L (Public Information), M (Information Sharing), N (Antitrust

Considerations), and R (Legal Risk) set forth in Section 5b of the

Commodity Exchange Act (CEA). The Commission also is updating and

adding related definitions; adopting implementing rules for DCO chief

compliance officers (CCOs); revising procedures for DCO applications

including the required use of a new Form DCO; adopting procedural rules

applicable to the transfer of a DCO registration; and adding

requirements for approval of DCO rules establishing a portfolio

margining program for customer accounts carried by a futures commission

merchant (FCM) that is also registered as a securities broker-dealer

(FCM/BD). In addition, the Commission is adopting certain technical

amendments to parts 21 and 39, and is adopting certain delegation

provisions under part 140.

DATES: The rules will become effective January 9, 2012. DCOs must

comply with Sec. Sec. 39.11; 39.12; 39.13 (except for 39.13(g)(8)(i));

and 39.14 by May 7, 2012; with Sec. Sec. 39.10(c); 39.13(g)(8)(i);

39.18; 39.19; and 39.20 by November 8, 2012; and all other provisions

of these rules by January 9, 2012.

FOR FURTHER INFORMATION CONTACT: Phyllis P. Dietz, Deputy Director,

(202) 418-5449, [email protected]; John C. Lawton, Deputy Director, (202)

418-5480, [email protected]; Robert B. Wasserman, Chief Counsel, (202)

418-5092, [email protected]; Eileen A. Donovan, Associate Director,

(202) 418-5096, [email protected]; Jonathan Lave, Special Counsel,

(202) 418-5983, [email protected], Division of Clearing and Risk; and

Jacob Preiserowicz, Special Counsel, (202) 418-5432,

[email protected], Division of Swap Dealer and Intermediary

Oversight, Commodity Futures Trading Commission, Three Lafayette

Centre, 1155 21st Street NW., Washington, DC 20581; and Julie A. Mohr,

Deputy Director, (312) 596-0568, [email protected]; and Anne C. Polaski,

Special Counsel, (312) 596-0575, [email protected], Division of

Clearing and Risk, Commodity Futures Trading Commission, 525 West

Monroe Street, Chicago, 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. Regulatory Framework for DCOs

II. Part 1 Amendments--Definitions

III. Part 39 Amendments--General Provisions

A. Scope

B. Definitions

C. Procedures for Registration

D. Procedures for Implementing DCO Rules and Clearing New

Products

E. Reorganization of Part 39

F. Technical Amendments

IV. Part 39 Amendments--Core Principles

A. Compliance with Core Principles

B. Financial Resources

C. Participant and Product Eligibility

D. Risk Management

E. Settlement Procedures

F. Treatment of Funds

G. Default Rules and Procedures

H. Rule Enforcement

I. System Safeguards

J. Reporting

K. Recordkeeping

L. Public Information

M. Information Sharing

N. Antitrust Considerations

O. Legal Risk Considerations

P. Special Enforcement Authority for SIDCOs

V. Part 140 Amendments--Delegations of Authority

VI. Effective Dates

VII. Section 4(c)

VIII. Consideration of Costs and Benefits

IX. Related Matters

A. Regulatory Flexibility Act

B. Paperwork Reduction Act

I. Background

A. Title VII of the Dodd-Frank Act

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

Title VII of the Dodd-Frank Act \2\ amended the CEA \3\ to establish a

comprehensive statutory 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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\1\ See Dodd-Frank Wall Street Reform and Consumer Protection

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

Dodd-Frank Act may be accessed at http://www.cftc.gov/LawRegulation/OTCDERIVATIVES/index.htm.

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

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

2010.''

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

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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

in order 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).\4\ The Commission did not adopt

implementing rules and regulations, but instead promulgated guidance

for DCOs on compliance with the core principles.\5\ Under Section

5b(c)(2) of the CEA, 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.\6\

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\4\ See Commodity Futures Modernization Act of 2000, Public Law

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

\5\ See 66 FR 45604 (Aug. 29, 2001) (adopting 17 CFR part 39,

app. A).

\6\ 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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In light of Congress's explicit affirmation of the Commission's

authority to adopt regulations to implement the core principles, the

Commission has chosen to adopt regulations (which have the force of

law) rather than guidance (which does not have the force of law). By

issuing regulations, the Commission expects to increase legal certainty

for DCOs, clearing members, and market participants, and prevent DCOs

from lowering risk management standards for competitive reasons and

taking on more risk than is prudent. The imposition of legally

enforceable standards provides

[[Page 69335]]

assurance to market participants and the public that DCOs are meeting

minimum risk management standards. This can serve to increase market

confidence which, in turn, can increase open interest and free up

resources that market participants might otherwise hold in order to

compensate for weaker DCO risk management practices. Regulatory

standards also can reduce search costs that market participants would

otherwise incur in determining that DCOs are managing risk effectively.

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 (FSOC) to designate entities involved in

clearing and settlement as systemically important.\7\

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\7\ See 76 FR 44763 (July 27, 2011) (FSOC authority to designate

financial market utilities as systemically important; final rule).

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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 (SIDCOs). The Commission proposed heightened

requirements for SIDCO financial resources and system safeguards for

business continuity and disaster recovery.

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

special enforcement authority over SIDCOs, which the Commission

proposed to codify in its regulations.

C. Regulatory Framework for DCOs

The Commission, now responsible for regulating swaps markets as

well as futures markets, has undertaken an unprecedented rulemaking

initiative to implement the Dodd-Frank Act. As part of this initiative,

the Commission has issued a series of eight proposed rulemakings that,

together, would establish a comprehensive regulatory framework for the

clearing and settlement activities of DCOs. Through these proposed

regulations, the Commission sought to enhance legal certainty for DCOs,

clearing members, and market participants, to strengthen the risk

management practices of DCOs, and to promote financial integrity for

swaps and futures markets.

In this notice of final rulemaking, the Commission is adopting

regulations to implement 15 DCO core principles: A (Compliance), B

(Financial Resources), C (Participant and Product Eligibility),\8\ D

(Risk Management), E (Settlement Procedures), F (Treatment of Funds), G

(Default Rules and Procedures), H (Rule Enforcement), I (System

Safeguards), J (Reporting), K (Recordkeeping), L (Public Information),

M (Information Sharing), N (Antitrust Considerations), and R (Legal

Risk).\9\ In addition, the Commission is adopting regulations to

implement the CCO provisions of Section 725 of the Dodd-Frank Act.\10\

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\8\ The Commission is reserving for a future final rulemaking

certain proposed amendments relating to participant and product

eligibility. See 76 FR 13101 (Mar. 10, 2011) (requirements for

processing, clearing, and transfer of customer positions (Straight-

Through Processing)); and 76 FR 45730 (Aug. 1, 2011) (customer

clearing documentation and timing of acceptance for clearing

(Customer Clearing)).

\9\ The Commission is reserving for a future final rulemaking

regulations to implement DCO Core Principles O (Governance Fitness

Standards) and Q (Composition of Governing Boards) (76 FR 722 (Jan.

6, 2011) (Governance)); and Core Principle P (Conflicts of Interest)

(75 FR 63732 (Oct. 18, 2010) (Conflicts of Interest)).

\10\ See Section 5b(i) of the CEA, 7 U.S.C 7a-1(i).

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The final rules adopted herein were proposed in five separate

notices of proposed rulemaking.\11\ Each proposed rulemaking was

subject to an initial 60-day public comment period and a re-opened

comment period of 30 days.\12\ After the second comment period ended,

the Commission informed the public that it would continue to accept and

consider late comments and did so until August 25, 2011. The Commission

received a total of approximately 119 comment letters directed

specifically at the proposed rules, in addition to many other comments

applicable to the Dodd-Frank Act rulemaking initiative more

generally.\13\ The Chairman and Commissioners, as well as Commission

staff, participated in numerous meetings with representatives of DCOs,

FCMs, trade associations, public interest groups, traders, and other

interested parties. In addition, the Commission has consulted with

other U.S. financial regulators including the Board of Governors of the

Federal Reserve System and Securities and Exchange Commission (SEC).

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\11\ See 76 FR 13101 (Mar. 10, 2011) (Straight-Through

Processing); 76 FR 3698 (Jan. 20, 2011) (Core Principles C, D, E, F,

G, and I (Risk Management)); 75 FR 78185 (Dec. 15, 2010) (Core

Principles J, K, L, and M (Information Management)); 75 FR 77576

(Dec. 13, 2010) (Core Principles A, H, N, and R (General

Regulations)); and 75 FR 63113 (Oct. 14, 2010) (Core Principle B

(Financial Resources)).

\12\ See 76 FR 25274 (May 4, 2011) (extending or re-opening

comment periods for multiple Dodd-Frank proposed rulemakings); see

also 76 FR 16587 (Mar. 24, 2011) (re-opening 30-day comment period

for reporting requirement with clause omitted in the notice of

proposed rulemaking).

\13\ Comment files for each proposed rulemaking can be found on

the Commission Web site, www.cftc.gov.

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The Commission is mindful of the benefits of harmonizing its

regulatory framework with that of its counterparts in foreign

countries. The Commission has therefore monitored global advisory,

legislative, and regulatory proposals, and has consulted with foreign

regulators in developing the proposed and final regulations for DCOs.

The Commission is of the view that each DCO should be afforded an

appropriate level of discretion in determining how to operate its

business within the legal framework established by the CEA, as amended

by the Dodd-Frank Act. At the same time, the Commission recognizes that

specific, bright-line regulations may be necessary to facilitate DCO

compliance with a given core principle and, ultimately, to protect the

integrity of the U.S. derivatives clearing system. Accordingly, in

developing the proposed regulations and in finalizing the regulations

adopted herein, taking into consideration public comments and views

expressed by U.S. and foreign regulators, the Commission has endeavored

to strike an appropriate balance between establishing general

prudential standards and specific requirements.

In determining the scope and content of the final rules, the

Commission has taken into account concerns raised by commenters

regarding the implications of specific rules for smaller versus larger

DCOs, DCOs that do not clear customer positions versus those with a

traditional customer model, clearinghouses that are registered as both

a DCO and a securities clearing agency, and clearinghouses that operate

in foreign jurisdictions as well as in the United States. The

Commission addresses these issues in its discussion of specific rule

provisions, below.

The Commission has carefully considered the costs and benefits

associated with each proposed rule, with particular attention to public

comments. For the reasons discussed in this notice of final rulemaking,

in the analyses of specific rule provisions as well as in the formal

cost-benefit analysis, the Commission has determined that the final

rules appropriately balance the costs and benefits associated with

oversight and supervision of DCOs pursuant to the CEA, as amended by

the Dodd-Frank Act.

The Commission is herein adopting regulations to implement the core

principles applicable to DCOs, to implement CCO requirements

established under the Dodd-Frank Act, and to update the regulatory

framework for DCOs to reflect standards and practices that have evolved

over the past decade since the enactment of the

[[Page 69336]]

CFMA. The Commission is largely adopting final rules as proposed,

although there are a number of proposed provisions that, upon further

consideration in light of comments received, the Commission has

determined to either revise or decline to adopt. In the discussion

below, the Commission highlights topics of particular interest to

commenters and discusses comment letters that are representative of the

views expressed on those topics. The discussion does not explicitly

respond to every comment submitted; rather, it addresses the most

significant issues raised by the proposed rulemakings and it analyzes

those issues in the context of specific comments.

The final rules include a number of technical revisions to the

proposed rule text, intended variously to clarify certain provisions,

standardize terminology within part 39, conform terminology to that

used in other parts of the Commission's rules, and more precisely state

regulatory standards and requirements. These are non-substantive

changes. For example, the proposed DCO rules used the terms

``contract'' and ``product'' interchangeably, and some provisions used

the statutory language ``contracts, agreements and transactions'' to

refer to the products subject to Commission regulation. In the final

rules adopted herein, the Commission has revised the terminology to

uniformly refer to ``products,'' which encompasses contracts,

agreements, and transactions, except where the language of the rule

codifies statutory language. In those cases, the rule text is

unchanged.

For easy reference and for purposes of clarification, in this

notice of final rulemaking the Commission is publishing the complete

part 39 as currently adopted. This means that certain longstanding

rules that are not being amended (e.g., Sec. 39.8 (formerly designated

as Sec. 39.7, fraud in connection with the clearing of transactions of

a DCO), and rules recently adopted (Sec. 39.5, review of swaps for

Commission determination on clearing requirement) are being re-

published along with the newly-adopted rules. Rules that have been

proposed but not yet adopted in final form are identified in part 39 as

``reserved.''

II. Part 1 Amendments--Definitions

The Commission proposed to amend the definitions of ``clearing

member,'' ``clearing organization,'' and ``customer'' found in Sec.

1.3 of its regulations to conform the definitions with the terminology

and substantive provisions of the CEA, as amended by the Dodd-Frank

Act. The Commission also proposed to add to Sec. 1.3, definitions for

``clearing initial margin,'' ``customer initial margin,'' ``initial

margin,'' ``margin call,'' ``spread margin,'' and ``variation margin.''

ISDA commented that the margin definitions are appropriate for

futures and cleared derivatives, but less readily applicable in the

uncleared OTC derivatives context. It suggested that the definitions

should expressly provide that they apply only to cleared transactions.

The Commission notes that some of the definitions by their terms

already apply only to cleared trades, e.g., ``clearing initial

margin.'' Other terms, however, have applicability to both cleared and

uncleared trades, e.g., ``initial margin.'' \14\

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\14\ See Section 4s of the CEA, 7 U.S.C. 6s.

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The Commission proposed to define ``spread margin'' as ``reduced

initial margin that takes into account correlations between certain

related positions held in a single account.'' Better Markets commented

that the definition of ``spread margin'' omits key characteristics of

netting initial margin which are needed to precisely define spread

margin. Better Markets proposed to define it as ``initial margin

relating to two positions in a single account that has been reduced

from the aggregate initial margin otherwise applicable to the two

positions by application of an algorithm that measures statistical

correlations between the historic price movements of the two

positions.'' The Commission is adopting the definition of ``spread

margin'' as proposed because it believes that Better Markets'

definition adds unnecessary details that could have the unintended

effect of imposing substantive margin methodology requirements in a

definition.

In light of proposed rulemakings issued after the Commission

proposed the definition of ``customer; commodity customer; swap

customer,'' the Commission is making certain technical

modifications.\15\ First, instead of placing the definition in Sec.

1.3, which serves as the general definition section for all of the

Commission's regulations, this definition is being moved to Sec. 39.2,

which sets forth definitions applicable only to regulations found in

part 39 or as otherwise explicitly provided. This accommodates the need

for further consideration of other proposals before a global definition

is adopted, while satisfying the need for a definition for purposes of

part 39 as adopted herein. Second, the Commission has made certain

technical changes to the rule text in connection with the definition's

redesignation in 39.2 and to conform phraseology when incorporating by

reference definitions that appear in the CEA and Sec. 1.3. These

changes include limiting the term to ``customer,'' because the terms

``commodity customer'' and ``swap customer'' are not used in Part 39.

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\15\ See 76 FR 33818 (June 9, 2011) (Protection of Cleared Swaps

Customer Contracts and Collateral; Conforming Amendments to the

Commodity Broker Bankruptcy Provisions); 76 FR 33066 (June 7, 2011)

(Adaptation of Regulations to Incorporate Swaps).

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The Commission is adopting the other definitions as proposed.

III. Part 39 Amendments--General Provisions

A. Scope--Sec. 39.1

As originally proposed, Sec. 39.1 included an updated statement of

scope and definitions applicable to other provisions in part 39. The

Commission later revised proposed Sec. 39.1 to include only the

statement of scope. The Commission did not receive any comments on the

statement of scope, which was updated to include references to the

definition of ``derivatives clearing organization'' in newly-renumbered

Section 1(a)(15) of the CEA and Sec. 1.3(d) of the Commission's

regulations. The Commission is adopting Sec. 39.1 as proposed.

B. Definitions--Sec. 39.2

The Commission proposed definitions of the terms ``back test,''

``compliance policies and procedures,'' ``customer account '' or

``customer origin,'' ``house account'' or ``house origin,'' ``key

personnel,'' ``stress test,'' and ``systemically important derivatives

clearing organization.'' The definitions set forth in proposed Sec.

39.2 would apply specifically to provisions contained in part 39 and

such other rules as may explicitly cross-reference these definitions.

The Commission is adopting the definitions as proposed, with the

exceptions discussed below.

CME Group, Inc. (CME) commented that the proposed definition of

``compliance policies and procedures'' was too broad. That definition

was proposed as an adjunct to the proposed rules for a DCO's CCO. The

Commission is not adopting a definition of ``compliance policies and

procedures,'' as it has concluded that a DCO's compliance policies and

procedures will likely encompass a limited, self-evident body of

documents, and a regulatory definition could invite more scrutiny than

is necessary or helpful to the DCO or the Commission.

The Commission proposed to define ``stress test'' as ``a test that

compares the impact of a potential price move, change

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in option volatility, or change in other inputs that affect the value

of a position, to the financial resources of a [DCO], clearing member,

or large trader to determine the adequacy of such financial

resources.'' Better Markets, Inc. (Better Markets) expressed the view

that a stress test can only be useful if it tests unprecedented

circumstances of illiquidity, and that basing the test on historic

price data would make it meaningless. In response to this comment, the

Commission is modifying the definition in one respect. The word

``extreme'' is being inserted after the word ``potential'' to make

clear that a stress test does not include typical events. The

Commission further addresses Better Markets' concerns in its discussion

of stress tests in Sec. 39.13(h)(3).\16\

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\16\ See discussion of stress tests in section IV.D.7.c, below.

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The Commission proposed to define the term ``systemically important

derivatives clearing organization'' to mean ``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.''

The Options Clearing Corporation (OCC) submitted a comment on this

definition in connection with the Commission's proposed Sec. 40.10

(special certification procedures for submission of certain risk-

related rules by SIDCOs).\17\ OCC pointed out that, under this proposed

definition, a DCO could be a SIDCO even if the Commission were not its

Supervisory Agency pursuant to Section 803(8) of the Dodd-Frank Act.

The Commission, recognizing that some DCOs like OCC may be regulated by

more than one federal agency, is adopting a revised definition to

clarify that the term ``systemically important derivatives clearing

organization'' means a ``financial market utility that is a derivatives

clearing organization registered under Section 5b of the Act, which has

been designated by the Financial Stability Oversight Council to be

systemically important and for which the Commission acts as the

Supervisory Agency pursuant to Section 803(8) of the Dodd-Frank Wall

Street Reform and Consumer Protection Act.'' \18\

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\17\ See 76 FR 44776 at 44783-84 (July 27, 2011) (Provisions

Common to Registered Entities; final rule).

\18\ See id. for further discussion of this topic.

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The Commission also is making a technical change to the definition

of ``customer account or customer origin.'' The proposed definition

would provide, in part, that ``[a] customer account is also a futures

account, as that term is defined by Sec. 1.3(vv) of this chapter.'' The

Commission is removing this reference and defining ``customer account

or customer origin'' to mean ``a clearing member account held on behalf

of customers, as that term is defined in this section, and which is

subject to section 4d(a) or section 4d(f) of the Act.'' This clarifies

that the term encompasses both customer futures accounts and customer

cleared swaps accounts, respectively.

Similarly, the Commission is making a technical revision to the

term ``house account or house origin'' to delete the proposed reference

to proprietary accounts, which are currently defined in Sec. 1.3(y)

only in terms of futures and options (not swaps). The term ``house

account or house origin'' is now defined as a ``clearing member account

which is not subject to section 4d(a) or 4d(f) of the Act.''

In connection with the proposal to adopt a definitions section

designated as Sec. 39.2, the Commission proposed to rescind the

existing Sec. 39.2, which exempted DCOs from all Commission

regulations except those explicitly enumerated in the exemption. This

action would result in clarifying the applicability of Sec. 1.49

(denomination of customer funds and location of depositories) to DCOs

and, insofar as the rule exempted DCOs from regulations relating to DCO

governance and conflicts of interest, those regulations are expected to

themselves be replaced by rules to implement DCO Core Principles O

(Governance Fitness Standards), P (Conflicts of Interest), and Q

(Composition of Governing Boards).\19\ The Commission did not receive

any comments on the proposed rescission of the exemption provided by

existing Sec. 39.2 and is herein rescinding that exemption, as

proposed.

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\19\ See 76 FR 722 (Jan. 6, 2011) (Governance); and 75 FR 63732

(Oct. 18, 2010) (Conflicts of Interest).

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C. Procedures for Registration as a DCO--Sec. 39.3

The Commission proposed several revisions to its procedures for DCO

registration, including the elimination of the 90-day expedited review

period and the required use of an application form, proposed Form DCO.

The Commission is adopting Sec. 39.3 as proposed, and is adopting the

Form DCO with the revisions discussed below.

1. Form DCO

The Commission proposed to revise appendix A to part 39,

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

removing the existing guidance and substituting the Form DCO in its

place. An application for DCO registration would consist of the

completed Form DCO, which would include all applicable exhibits, and

any supplemental information submitted to the Commission.

CME commented that the proposed Form DCO would require the

applicant to create and submit to the Commission a large number of

documents. It questioned why certain documents were necessary and

whether Commission staff would be able to meaningfully review all of

the materials within the 180-day timeframe contemplated in the proposed

regulations.

The Commission is adopting the Form DCO as proposed, except for the

modifications discussed below. The Commission notes that the Form DCO

standardizes and clarifies the information that the Commission has

required from DCO applicants in the past and the Form DCO Exhibit

Instructions, in an effort to reduce the burden on applicants, state

that ``If any Exhibit requires information that is related to, or may

be duplicative of, information required to be included in another

Exhibit, Applicant may summarize such information and provide a cross-

reference to the Exhibit that contains the required information.''

Based on the Commission's experience with the DCO registration process

over the past decade, it believes that its staff can meaningfully

review the required information within the 180-day time frame. In

addition, the Commission believes that by standardizing informational

requirements, the Form DCO will allow the Commission to process

applications more quickly and efficiently. This will benefit applicants

as well as free Commission staff to handle other regulatory matters.

CME specifically questioned whether, as part of the Form DCO cover

sheet, applicants should be required to identify and list ``all outside

service providers and consultants, including accountants and legal

counsel.'' This comment mischaracterizes the information required by

the Form DCO, which requires contact information for enumerated outside

service providers (Certified Public Accountant, legal counsel, records

storage or management, business continuity/disaster recovery) and

``other'' outside service providers ``such as consultants, providing

services related to this application.'' Such contact information is

helpful to the Commission staff in processing the application and

making a determination as to whether the applicant has obtained the

services it needs to effectively

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operate as a DCO.\20\ Nonetheless, in response to CME's comments and in

order to clarify the scope of requesting contact information for ``any

other outside service providers,'' the Commission has decided to revise

section 12.e. of the Form DCO cover sheet to provide for contact

information for any ``Professional consultant providing services

related to this application.''

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\20\ This requirement focuses on outside services ``related to

this application.'' Similarly, if the applicant intends to use the

services of an outside service provider (including services of its

clearing members or market participants), to enable it to comply

with any of the core principles, the applicant must submit as

exhibit A-10 all agreements entered into or to be entered into

between the 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. This exhibit does not require that the applicant

submit information and documentation related to all outside service

providers. Rather, the requirement is directed at contractual

arrangements related to compliance with the core principles, i.e.,

the DCO's core business functions.

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CME commented that proposed exhibit A-1, which would require the

applicant to produce a chart demonstrating in detail how its rules,

procedures, and policies address each DCO core principle, is not

necessary. The Commission believes exhibit A-1 is necessary because it

will provide a clear picture of which rules, procedures, and policies

address each DCO core principle. The chart will greatly assist

Commission staff in tracking and evaluating the materials supplied by

the applicant and should reduce the need for staff to seek follow-up

clarifications from the applicant. Again, this will also reduce the

costs to the applicant.

CME commented that the Commission has not explained its reasons for

requiring an applicant to supply ``telephone numbers, mobile phone

numbers and email addresses of all officers, managers, and directors of

the DCO,'' as provided in proposed exhibit A-6. The Commission notes

that the exhibit A-6 instructions request contact and other information

for ``current officers, directors, governors, general partners, LLC

managers, and members of all standing committees.'' The exhibit is not

directed at ``all managers'' or ``all directors,'' but rather at those

persons who are in key decision-making positions (for example, key

personnel, directors serving on a board of directors and a manager or

managing member of a DCO organized in the form of a limited liability

corporation). The purpose of obtaining contact information is to enable

the Commission to start building an emergency contact database.

CME commented that proposed exhibit A-7 would require the applicant

to list all jurisdictions where the applicant and its affiliates are

doing business, and the registration status of the applicant and its

affiliates. CME questioned the Commission's need for such information

with respect to affiliates of the applicant. The Commission believes

that such information is necessary because it allows the Commission to

develop a more complete understanding of the applicant's entire

corporate organizational structure including potential financial

commitments and regulatory obligations of the applicant's affiliates

inclusive of its parent organization.

CME commented that proposed exhibit B-3, which would require the

applicant to provide proof that each of its physical locations meets

all building and fire codes, and that it has running water and a

heating, ventilation and air conditioning system, and adequate office

technology, is not necessary. The Commission believes that it is

important for an applicant to demonstrate that it has a physical

presence capable of supporting clearing and settlement services and is

not a ``shoestring'' operation. Typically, Commission staff will

conduct a site visit to an applicant's headquarters and other

facilities, and one of the purposes of such visits is to evaluate the

suitability of the applicant's physical facilities. Site visits,

however, are conducted after a DCO application is deemed to be

materially complete, and there are instances when it might not be

feasible to conduct a site visit. Accordingly, at a minimum, a

narrative statement discussing the applicant's physical facilities and

office technology must be submitted to the Commission as part of the

application package so that staff can complete its initial review for

``adequate * * * operational resources'' under Core Principle B.

In response to CME's comments, the Commission has decided to revise

exhibit B-3 to require the following:

(3) A narrative statement demonstrating the adequacy of

Applicant's physical infrastructure to carry out business

operations, which includes a principal executive office (separate

from any personal dwelling) with a U.S. street address (not merely a

post office box number). For its principal executive office and

other facilities Applicant plans to occupy in carrying out its DCO

functions, a description of the space (e.g., location and square

footage), use of the space (e.g., executive office, data center),

and the basis for Applicant's right to occupy the space (e.g.,

lease, agreement with parent company to share leased space).

(4) A narrative statement demonstrating the adequacy of the

technological systems necessary to carry out Applicant's business

operations, including a description of Applicant's information

technology and telecommunications systems and a timetable for full

operability.

CME questioned the value of proposed exhibits C-1(9) and C-2(5),

which would, respectively, require an applicant to provide a list of

current and prospective clearing members, and to forecast expected

volumes and open interest at launch date, six months, and one year

thereafter. The Commission believes that this information is important

because it would enable the Commission to understand the nature and

level of the DCO's expected start-up activities and to appropriately

evaluate whether the applicant has adequate resources to manage the

expected volume of business.

CME questioned the benefits of what it termed the ``incredibly

burdensome'' requirements of proposed exhibit D-2(b)(3), which would

require an applicant to explain why a particular margin methodology was

chosen over other potentially suitable methodologies, and to include a

comparison of margin levels that would have been generated by using

such other potential methodologies. To address CME's comment, the

Commission is revising exhibit D-2(b)(3) to require an explanation of

whether other margining methodologies were considered and, if so,

explain why they were not chosen. This information will be sufficient

in the first instance and, when evaluating an applicant's proposed

margin methodology, Commission staff can request additional information

if needed to complete its review for compliance with Core Principle D

and Sec. 39.13 (risk management).

The Commission proposed to require use of the Form DCO by a

registered DCO when requesting an amendment to its DCO registration

order. CME and Minneapolis Grain Exchange, Inc. (MGEX) suggested that

the Form DCO be modified so that a currently registered DCO would not

have to expend as much time and resources to complete an amendment

request as a new applicant for DCO registration, unless there are

extenuating circumstances. In response to this suggestion, the

Commission is revising the Form DCO General Instructions to clarify

that if the Form DCO is being filed as an amendment to a pending

application for registration or for the purpose of amending an existing

registration order, the applicant need only submit the information and

exhibits relevant to the application

[[Page 69339]]

amendment or request for an amended registration order.

CME also noted that a DCO applicant would be required to represent

that its Form DCO submission is true, correct, and complete. It

suggested that the Commission modify this language so that the

applicant is required to certify that, ``to the best of its

knowledge,'' its Form DCO submission is true, correct, and complete

``in all material respects.'' The Commission is revising the language

as suggested by CME, in recognition of the fact that some of the

information contained in the exhibits may have been provided by third

parties and there is a limit to the reach of an applicant's due

diligence with respect to such information.

In addition to the above changes, the Commission has made non-

substantive editorial changes to the Form DCO for purposes of internal

consistency and conformity with the Form SDR for swap data repositories

(SDRs) and proposed Form DCM and Form SEF for designated contract

markets (DCMs) and swap execution facilities (SEFs), respectively.\21\

The Commission also has made changes to Form DCO to remove references

to proposed regulations that remain pending.\22\

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\21\ See 76 FR 54538 (Sept. 1, 2011) (SDRs: Registration

Standards, Duties and Core Principles; final rule); 75 FR 80572

(Dec. 22, 2010) (Core Principles and Other Requirements for

Designated Contract Markets); 76 FR 1214 (Jan. 7, 2011) (Core

Principles and Other Requirements for Swap Execution Facilities).

\22\ For example, the Commission has removed the specific cross-

references located in exhibit P to Form DCO to the proposed

conflicts of interest rules, 75 FR 63732 (Oct. 18, 2010) (Conflicts

of Interest), and replaced such references with a description of the

required information. When the Commission finalizes such proposed

rules, the Commission intends to make technical changes to the Form

DCO to include cross-references to such final rules where, in the

opinion of the Commission, doing so will facilitate compliance with

the Form DCO, the CEA and/or Commission regulations.

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2. Request for Transfer of Registration and Open Interest--Sec.

39.3(h)

The Commission proposed Sec. 39.3(h) to clarify the procedures

that a DCO must follow when requesting the transfer of its DCO

registration and positions comprising open interest for clearing and

settlement, in anticipation of a corporation change.\23\ The Commission

received a comment from OCC suggesting that a request to transfer a

DCO's registration and open interest should be published in the Federal

Register for public comment.

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\23\ As a technical matter, the Commission is removing proposed

Sec. 39.3(g)(1) and adopting proposed Sec. 39.3(h) as Sec.

39.3(f); proposed Sec. 39.3(g)(1) was a typographical error which

repeats a delegation of authority already provided by Sec.

39.3(b)(2)(i).

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The Commission recognizes the value of public comment, but it has

determined not to formalize the public comment process through

publication in the Federal Register. This procedure could unnecessarily

delay the review process and completion of the transfer, and the

Commission believes that posting the request on its Web site, which it

currently does for DCO registration applications, will provide an

opportunity for public comment without potential delay.

3. Technical Amendments

The Commission proposed a set of technical amendments to Sec. 39.3

to update filing procedures, to conform various provisions to reflect

the elimination of the 90-day expedited review period for DCO

applications, and to correct terminology in the delegation provisions

of Sec. 39.3(g). The Commission did not receive any comments on the

proposed technical amendments and the Commission is adopting the

amendments as proposed.

D. Procedures for Implementing DCO Rules and Clearing New Products--

Sec. 39.4

1. Acceptance of Certain New Products for Clearing--Sec. 39.4(c)(2)

The Commission proposed a technical amendment to existing Sec.

39.4(c)(2), which would require a DCO to certify to the Commission the

terms and conditions of new over-the-counter (OTC) products that it

intended to clear. The Commission proposed removing the reference to

new products ``not traded on a designated contract market or a

registered derivatives transaction execution facility'' and inserting a

reference to new products ``not traded on a designated contract market

or a registered swap execution facility.'' The proposed provision would

retain the reference to filing the terms and conditions of the new

product ``pursuant to the procedures of Sec. 40.2 of this chapter.''

Since proposing that technical amendment, the Commission has

adopted a new Sec. 39.5 (review of swaps for Commission determination

on clearing requirement) \24\ and revisions to Sec. 40.2 (listing

products for trading by certification).\25\ As a result, a DCO seeking

to clear new products that are not traded on a designated contract

market or swap execution facility must submit to the Commission the

terms and conditions of the product pursuant to the procedures of Sec.

39.5, not Sec. 40.2. The Commission is therefore adopting a technical

revision to conform Sec. 39.4(c)(2) to the current procedural

requirements.

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\24\ See 76 FR 44464, at 44473-44474 (July 26, 2011) (Process

for Review of Swaps for Mandatory Clearing; final rule).

\25\ See 76 FR 44776 (July 27, 2011) (Provisions Common to

Registered Entities; final rule).

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2. Holding Securities in a Futures Portfolio Margining Account--Sec.

39.4(e)

The CEA, as amended by Section 713 of the Dodd-Frank Act, permits,

pursuant to an exemption, rule or regulation, futures and options on

futures to be held in a portfolio margining account that is carried as

a securities account and approved by the SEC.\26\ Reciprocally, the

Securities Exchange Act of 1934 (SEA), as amended by Section 713 of the

Dodd-Frank Act, permits, pursuant to an exemption, rule, or regulation,

cash and securities to be held in a portfolio margining account that is

carried as a futures account and approved by the Commission.\27\ Those

provisions of the CEA and SEA further require consultation between the

Commission and the SEC in drafting implementing regulations. As a first

step toward meeting this goal, proposed Sec. 39.4(e) would establish

the procedural requirements applicable to a DCO seeking approval for a

futures portfolio margining account program.

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\26\ Section 4d(h) of the CEA, 7 U.S.C. 6d(h).

\27\ Section 15(c)(3)(C) of the SEA, 15 U.S.C. 78o(c)(3).

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OCC, Newedge USA, LLC (Newedge), New York Portfolio Clearing, LLC

(NYPC), and MetLife Inc. urged the Commission to propose rules that

would permit portfolio margining, not just establish procedural

requirements. The Commission agrees that it should propose substantive

portfolio margining rules, but it must move forward on proposing

substantive rules with the SEC's participation.

Accordingly, the Commission is adopting the procedural requirements

as proposed and anticipates consulting with the SEC in the future to

determine the substantive requirements it would impose in approving a

futures portfolio margining program and, additionally, in granting an

exemption under Section 4(c) of the CEA to permit futures and options

on futures to be held in a securities portfolio margining account. The

Dodd-Frank Act does not set a deadline for these actions, and the

Commission believes that it is important to give this matter due

consideration, both in terms of consultation with the SEC and, more

broadly, in obtaining industry views on the topic before

[[Page 69340]]

proposing substantive regulations or other guidance.

E. Reorganization of Part 39

With the adoption of regulations relating to implementation of the

core principles and other provisions of the Dodd-Frank Act, the

Commission is reorganizing part 39 of its regulations into two

subparts, with a new appendix.

Subpart A, ``General Provisions Applicable to Derivatives Clearing

Organizations'' contains Sec. Sec. 39.1 through 39.8, which are

general provisions including procedural requirements for DCO

applications and other activities such as transfer of a DCO

registration, clearing of new products, and submission of swaps for a

mandatory clearing determination. Subpart A also includes pre-existing

provisions regarding enforceability and fraud in connection with

clearing transactions on a DCO.\28\ Subpart B, ``Compliance with Core

Principles,'' contains Sec. Sec. 39.9 through 39.27, which are rules

that implement the core principles under Section 5b of the CEA, as

amended by the Dodd-Frank Act.

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\28\ As part of the reorganization of Part 39, Sec. 39.6

(Enforceability) is being redesignated as Sec. 39.7 and Sec. 39.7

(Fraud in connection with the clearing of transactions on a

derivatives clearing organization) is being redesignated as Sec.

39.8.

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As discussed above, the Commission is replacing appendix A

``Application Guidance and Compliance with Core Principles,'' with a

new appendix to part 39, ``Form DCO Derivatives Clearing Organization

Application for Registration.''

F. Technical Amendments

With the objective of listing all DCO reporting requirements in a

new Sec. 39.19, the Commission proposed redesignating Sec. 39.5(a)

and (b) (information relating to DCOs) as proposed Sec. Sec.

39.19(c)(5)(i) and (ii), respectively, in substantially the same form.

The Commission also proposed removing Sec. 39.5(c) (large trader

reporting by DCOs), redesignating Sec. 39.5(d) (special calls) as

Sec. 21.04 (and current Sec. 21.04 as Sec. 21.05), and adding Sec.

21.06, which would delegate authority under Sec. 21.04 to the Director

of the Division of Clearing and Risk.

The Commission did not receive any comments on these proposals.

Therefore, the Commission is adopting these revisions as proposed,

except for non-substantive changes to Sec. Sec. 39.19(c)(5)(i) and

(c)(5)(ii) to clarify the language.\29\

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\29\ After these technical amendments were proposed, the

Commission adopted a final rule governing the process for review of

swaps for mandatory clearing. That rule was designated as Sec.

39.5, and the former Sec. 39.5 was redesignated as Sec. 39.8. See

76 FR at 44473 (July 26, 2011) (Process for Review of Swaps for

Mandatory Clearing; final rule). In connection with adoption of the

technical amendments described above, the provisions regarding fraud

in connection with the clearing of transactions on a DCO (former

Sec. 39.7) are now redesignated as Sec. 39.8.

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IV. Part 39 Amendments--Compliance With Core Principles

Proposed Sec. 39.9 would establish the scope of the rules

contained in subpart B of part 39, stating that all provisions of

subpart B apply to DCOs. The Commission did not receive any comments on

the statement of scope, and the Commission is adopting Sec. 39.9 as

proposed.

A. Core Principle A--Compliance With Core Principles--Sec. 39.10

1. Core Principle A

Core Principle A,\30\ as amended by the Dodd-Frank Act, requires a

DCO to comply with each core principle set forth in Section 5b(c)(2) of

the CEA and any requirement that the Commission may impose by rule or

regulation pursuant to Section 8a(5) of the CEA. Core Principle A also

provides a DCO with reasonable discretion to establish the manner by

which it complies with each core principle. Proposed Sec. Sec.

39.10(a) and 39.10(b) would codify these provisions, respectively. The

Commission received no comments on these proposed rules and is adopting

the rules as proposed.

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\30\ Section 5b(c)(2)(A) of the CEA, 7 U.S.C. 7a-1(c)(2)(A).

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2. Designation of a Chief Compliance Officer--Sec. 39.10(c)(1)

Section 725(b) of the Dodd-Frank Act added a new paragraph (i) to

Section 5b of the CEA to require each DCO to designate an individual as

its CCO, responsible for the DCO's compliance with the CEA and

Commission regulations and the filing of an annual compliance

report.\31\ In proposed Sec. 39.10(c), the Commission set forth

implementing requirements that would largely track the language of

Section 5b(i).

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\31\ See Section 5b(i) of the CEA; 7 U.S.C. 7a-1(b)(i).

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Under the introductory provision of proposed Sec. 39.10(c)(1),

each DCO would be required to appoint a CCO with ``the full

responsibility and authority to develop and enforce in consultation

with the board of directors or the senior officer, appropriate

compliance policies and procedures, as defined in Sec. 39.1(b), to

fulfill the duties set forth in the Act and Commission regulations.''

As previously noted, the Commission is not adopting the definition of

``compliance policies and procedures'' included in proposed Sec.

39.1(b).

CME commented that the text of the Dodd-Frank Act does not require

a CCO to ``enforce'' compliance policies and procedures and it

suggested that Sec. 39.10 should not do so. According to CME, it is

important to separate the functions of monitoring and advising on

compliance issues from what it considers ``senior management

functions'' of enforcing and supervising compliance policies.

The Commission believes that Congress intended that the CCO have

the full responsibility and authority to enforce compliance in

consultation with the board of directors or the senior officer. Given

the specified duties of the CCO set forth in Section 5b(i)(2), the

Commission finds ample support for this interpretation and is adopting

the rule as proposed.

First, one definition of the term ``enforce'' is ``to ensure

observance of laws and rules,'' \32\ and among the CCO duties set forth

by the Dodd-Frank Act is the requirement that the CCO ``ensure

compliance.'' \33\ Second, Section 5b(i)(2)(C) requires a CCO to

``resolve any conflicts of interest that may arise'' in consultation

with the board of the DCO or the senior officer of the DCO. This duty

clearly indicates that the CCO is more than just an advisor to

management and must have the ability to enforce compliance with the CEA

and Commission regulations. The authority to resolve conflicts of

interest is more an enforcement function than an audit function.

Finally, Section 5b(i)(2)(D) requires the CCO to ``be responsible for

administering each policy.''

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\32\ See http://www.websters-online-dictionary.org/definitions/enforce.

\33\ See Section 5b(i)(2)(E) of the CEA, 7 U.S.C. 7a-

1(b)(i)(2)(E), which requires the CCO to ``ensure compliance with

this Act (including regulations) relating to agreements, contracts,

or transactions, including each rule prescribed by the Commission

under this section.''

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While the CEA does not explicitly use the word ``enforce,'' the

Commission believes that the use of this word in Sec. 39.10(c)(1) is

appropriate to capture the meaning of Section 5b(i)(2)(C), i.e., that

CCOs must have the authority to fulfill their statutory and regulatory

obligations. Moreover, it is consistent with the statutory directive

for the CCO to ensure compliance with the CEA. These considerations are

particularly important given that the CCO of a DCO has unique

responsibilities in connection with the DCO's critical role in

providing financial integrity to derivatives markets. In particular, a

CCO must have the ability to effectively address rules and practices

that could compromise compliance with fair and open access requirements

(Core Principle C), risk management

[[Page 69341]]

requirements (Core Principle D), and financial resource requirements

(Core Principle B).

The Commission, however, recognizes that the term ``enforce'' could

imply that the DCO's CCO must have direct supervisory authority over

employees not otherwise in his or her direct chain of command, or that

the CCO has independent authority to discipline employees or terminate

employment to facilitate compliance with the CEA and the Commission's

regulations. To avoid confusion, the Commission herein clarifies that

the term ``enforce,'' as used in Sec. 39.10(c)(1), is not intended to

include the authority to supervise employees not in the CCO's direct

chain of command, or the authority to terminate employment or

discipline employees for conduct that results in noncompliance. The

Commission notes that a DCO is not precluded from conferring such

authority on its CCO; however, such action would be at the DCO's

discretion and is not required by Sec. 39.10(c)(1).\34\

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\34\ See further discussion of a CCO's duties in section IV.A.7,

below.

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3. Individuals Qualifying To Serve as a CCO--Sec. 39.10(c)(1)(i)

Proposed Sec. 39.10(c)(1)(i) would require a DCO to designate an

individual with the background and skills appropriate for fulfilling

the responsibilities of the CCO position. The Commission asked whether

additional qualifications should be imposed and, in particular, whether

the Commission should restrict the CCO position from being held by an

attorney who represents the DCO or its board of directors, such as an

in-house or general counsel. The Commission explained that the

rationale for such a restriction would be based on concern that the

interests of representing the DCO's board of directors or management

could be in conflict with the duties of the CCO. Related to this, the

Commission specifically sought comment on whether there is a need for a

regulation requiring the DCO to insulate a CCO from undue pressure and

coercion. It further asked if it is necessary to adopt rules to address

the potential conflict between and among compliance interests,

commercial interests, and ownership interests of a DCO and, if there is

no need for such rules, requested comment on how such potential

conflicts would be addressed.

CME, OCC, MGEX, and the Kansas City Board of Trade Clearing

Corporation (KCC) commented that additional restrictions should not be

imposed. MGEX commented that smaller DCOs will need to maximize the

utility of each employee. It also argued that there is little risk if a

CCO serves as in-house counsel because attorneys have additional

ethical duties which can complement the duties and obligations of a

CCO. According to MGEX, if a conflict arose, the attorney could step

out of one or both of the roles.

Better Markets commented that there is potential conflict between a

CCO and in-house counsel because in-house counsel is an advocate for

the DCO or its board of directors regarding any controversy that may

relate to regulatory compliance, while a CCO's duty is to ensure

compliance. It suggested that the Commission prohibit a CCO from

serving as in-house counsel.

The Commission is adopting Sec. 39.10(c)(1)(i) as proposed. The

Commission has considered prohibiting a CCO from working in the DCO's

legal department or serving as general counsel, consistent with the

Commission's approach to the CCO of an SDR.\35\ However, in response to

public comments and in light of the fact that all currently registered

DCOs have some form of compliance program already in place, with one or

more staff members assigned to carry out compliance officer functions,

the Commission has determined that the potential costs of hiring

additional staff to satisfy such requirement could result in imposing

an unnecessary burden on DCOs, particularly smaller ones. The

Commission recognizes, however, that a conflict of interest could

compromise a CCO's ability to effectively fulfill his or her

responsibilities as a CCO. The Commission therefore expects that as

soon as any conflict of interest becomes apparent, a DCO would

immediately implement a back-up plan for reassignment or other measures

to address the conflict and ensure that the CCO's duties can be

performed without compromise.

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\35\ See 76 FR 54538 (Sept. 1, 2011) (SDRs: Registration

Standards, Duties and Core Principles; final rule).

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MGEX and KCC also recommended that the Commission should permit the

Chief Regulatory Officer to function as the CCO. Presumably, the

commenters are referring to circumstances in which a DCO (which

typically would not have a Chief Regulatory Officer) is also registered

as a DCM (which typically would have a Chief Regulatory Officer). The

Commission notes that the rule does not prohibit the person serving as

CCO from also serving as the Chief Regulatory Officer.

4. CCO Reporting Structure--Sec. 39.10(c)(1)(ii)

Section 5b(i)(2)(A) of the CEA requires that a CCO report directly

to the board of directors or the senior officer of the DCO.\36\

Proposed Sec. 39.10(c)(1)(ii) would codify this requirement. The

proposed rule also would require the board of directors or the senior

officer to approve the compensation of the CCO.

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\36\ 7 U.S.C. 7a-1(i)(2)(A).

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In the notice of proposed rulemaking, the Commission sought comment

as to the degree of flexibility that should be provided in the

reporting structure of the CCO. Specifically, the Commission requested

comment on: (i) Whether it would be more appropriate for a CCO to

report to the senior officer or the board of directors; (ii) as between

the senior officer or board of directors, which generally is a stronger

advocate of compliance matters within an organization; and (iii)

whether the proposed rules allow for sufficient flexibility with regard

to a DCO's business structure.

CME, MGEX, and KCC commented that the proposed rules would provide

DCOs with the appropriate degree of flexibility. CME, however, believes

it would be ``logical'' for a CCO to report to the senior officer, and

that the board of directors should oversee implementation of compliance

policies and ensure that compliance issues are resolved effectively and

expeditiously by the senior officer with the assistance of the CCO.

MGEX noted that each DCO may have a different business and reporting

structure and believes that rigid rules may hinder the effectiveness

and independence of the CCO.

Better Markets observed that, in the past, businesses have placed

financial interests over other considerations like risk management and

have created a climate where people were unwilling to speak out against

financial considerations for fear of being fired. Better Markets

suggested that there should be a strong reporting and working

relationship between the CCO and independent directors, and suggested

that independent directors have sole responsibility to designate or

terminate the CCO and to set compensation levels for the CCO.

The Commission is adopting Sec. 39.10(c)(1)(ii) as proposed,

declining to prescribe whether the CCO can only report to the board of

directors or to the senior officer. The Commission appreciates Better

Markets' concern that a CCO who reports to the senior officer may be

swayed by financial

[[Page 69342]]

considerations. However, the Dodd-Frank Act permits alternative

reporting structures and the Commission has not been presented with a

compelling reason to conclude that the structure and operations of a

DCO require the imposition of this limitation on the ability of a DCO's

board and management to establish lines of authority appropriate to the

particular DCO.

CME asked the Commission to clarify that the term ``senior

officer'' may apply to the senior officer of a division that is engaged

in clearing activities. The Commission notes that Section 5b(i)(2)(A)

of the CEA requires a CCO to ``report directly to the board or to the

senior officer of the derivatives clearing organization.'' If the

division engaged in clearing activities is the registered DCO, then the

senior officer of that division would be the ``senior officer'' for

purposes of this provision.

Finally, Better Markets suggested that compliance should be

addressed on an entire-group basis by a senior CCO. According to Better

Markets, a single senior CCO should have overall responsibility for

each affiliated and controlled entity, even if the individual entities

within the group have CCOs. The final rules do not require a business

organization to have a ``senior'' CCO as Better Markets suggested. The

Commission believes this would be overly prescriptive and that a DCO

should have the flexibility to manage compliance functions across

divisions or affiliates to accommodate its particular organizational

structure.

5. Annual Compliance Meeting--Sec. 39.10(c)(1)(iii)

Proposed Sec. 39.10(c)(1)(iii) would require a CCO to meet with

the board of directors or the senior officer at least once a year to

discuss the effectiveness of the DCO's compliance policies and

procedures, as well as the administration of those policies and

procedures by the CCO. Better Markets suggested that a CCO meet with

the board of directors at least quarterly. No comments were received on

the proposed topics to be discussed at the annual meeting.

The Commission is adopting Sec. 39.10(c)(1)(iii) in modified form.

The final rule retains the requirement that the CCO meet with the board

of directors or senior officer annually, but eliminates the required

topics to be discussed at the meeting. As the Commission noted in the

notice of proposed rulemaking, the requirement for an annual discussion

would not preclude the board of directors or the senior officer from

meeting with the CCO more frequently. While more frequent communication

between the CCO and the DCO's board or senior officer may be desirable,

the Commission has concluded that adopting requirements to that effect

would be overly prescriptive. Similarly, upon further consideration,

the Commission has concluded that the purpose of the meeting should be

self-evident (i.e., compliance) and it is not necessary for the

Commission, by regulation, to prescribe the business that must be

conducted at that meeting.

6. Change in the Designation of the CCO--Sec. 39.10(c)(1)(iv)

Proposed Sec. 39.10(c)(1)(iv) would require that a change in the

designation of the individual serving as the CCO be reported to the

Commission, in accordance with the requirements of proposed Sec.

39.19(c)(4)(xi). The Commission received no comments on the proposed

rule and is adopting the provision as proposed.\37\

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\37\ See discussion in section IV.J.5.h. (The Commission is

adopting proposed Sec. 39.19(c)(4)(xi) as a renumbered Sec.

39.19(c)(4)(ix)).

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7. Duties of the CCO--Sec. 39.10(c)(2)

Section 5b(i)(2) of the CEA, added by Section 725(a) of the Dodd-

Frank Act, sets forth the duties of a CCO,\38\ and proposed Sec.

39.10(c)(2) would codify those enumerated duties in paragraphs

(c)(2)(i)-(vii).

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\38\ 7 U.S.C. 7a-1(i)(2).

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The Commission received comments on the CCO's duties from CME, KCC,

and OCC. In general, the commenters expressed the view that the

proposed regulations are too broad because they improperly provide the

CCO with what CME calls ``senior management functions'' like enforcing

and supervising compliance policies. Instead, the commenters believe

that the role of a CCO is only to serve as an auditor who monitors

compliance and informs senior management of noncompliance. The

Commission has carefully considered the comments and is adopting the

rule as proposed, except as discussed below.

CME acknowledged that proposed Sec. 39.10(c)(2)(ii) mirrors the

language in the Dodd-Frank Act. However, CME believes that Congress did

not intend to mean ``resolve'' in the executive or managerial sense

such that the CCO alone would examine the facts and determine and

affect the course of action. CME believes that Congress intended the

CCO to identify, advise, and escalate, as appropriate, and to assist

senior management in resolving conflicts of interest.

KCC also believes that the board of directors or senior officer

should resolve any conflict of interest in consultation with the CCO.

KCC commented that compliance policies and procedures should be

administered by DCO staff and not by the CCO. According to KCC, a DCO's

staff is most familiar with the day-to-day operations of the DCO and is

in the best position to manage the policies and procedures. KCC

believes that a CCO's role should be that of oversight of the DCO's

compliance program and filing an annual report.

The Commission disagrees with assertions that a CCO should only

assist senior management in resolving conflicts of interest or that the

board or senior management should resolve conflicts of interest in

consultation with the CCO. Section 5b(i)(2)(C) of the CEA states that a

CCO shall ``in consultation with the board of the derivatives clearing

organization, a body performing a function similar to the board of the

derivatives clearing organization, or the senior officer of the

derivatives clearing organization, resolve any conflicts of interest

that may arise.'' Given this express statutory direction, the

Commission is not revising the proposed rule.

The Commission points out that a CCO's duty to administer

compliance policies and procedures is set forth in Section 5b(i)(2)(D)

of the CEA. It requires a CCO to ``be responsible for administering

each policy and procedure that is required to be established pursuant

to this section.'' By administering compliance policies and procedures,

a CCO is not required to perform staff functions that have compliance

implications. Rather, the CCO is responsible for oversight of such

functions.

The Commission is revising Sec. 39.10(c)(2)(iii) to require a CCO

to have the duty of ``[e]stablishing and administering written policies

and procedures reasonably designed to prevent violation of the Act.''

This does not change the substance of the requirement or alter the

implementation of the statutory standard, as it is consistent with

Sec. 39.10(c)(1) which requires a CCO to ``develop * * * appropriate

policies and procedures * * * to fulfill the duties set forth in the

Act and Commission regulations.'' The Commission believes that the

revised language eliminates the possibility of ambiguity and prevents

too narrow a reading of the reference to policies and procedures that

are ``required'' under the CEA.

CME described as ``impracticable'' the proposed standard that a CCO

must ''ensure'' a DCO's compliance and

[[Page 69343]]

suggested that an appropriate and ``achievable'' standard would be to

require a CCO to put in place measures ``reasonably designed to ensure

compliance'' with the CEA and Commission regulations.

The Commission is revising Sec. 39.10(c)(2)(iv) in response to

CME's comment. Although Section 5b(i)(2)(E) of the CEA requires a CCO

to ``ensure'' compliance, the Commission agrees that a CCO cannot fully

guarantee compliance because, as a practical matter, he or she will

have to rely to some extent on information provided by other DCO

employees or representatives of the DCO's service providers.

Accordingly, Sec. 39.10(c)(2)(iv) is being modified to include as a

duty of the CCO, ``[t]aking reasonable steps to ensure compliance with

the Act and Commission regulations * * * '' (added text in italics).

The Commission believes that this revision addresses CME's concern

while retaining the emphasis on the CCO's actions rather than focusing

on the nature of measures put in place by the CCO.\39\

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\39\ See also 76 FR at 54584 (Sept. 1, 2011) (SDRs: Registration

Standards, Duties and Core Principles; final rule) (adopting Sec.

49.22(d)(4), which applies this standard to the CCO of an SDR).

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CME recommended that the Commission revise proposed Sec.

39.10(c)(2)(vi) to require a CCO to ``[e]stablish[] appropriate

procedures [for] the handling, management response, remediation,

retesting, and closing of noncompliance issues,'' and to eliminate the

requirement that a CCO ``follow[]'' such procedures. According to CME,

this is a function of senior management and Congress did not intend for

a CCO to exercise senior management functions. OCC agrees with CME.

Specifically, CME suggested that proposed Sec. 39.10(c)(2)(vi) be

modified to eliminate the requirement that a CCO ``follow'' appropriate

procedures because following procedures is a function of senior

management. However, a CCO's performance of this ``senior management''

function is explicitly set forth in Section 5b(i)(2)(G) of the CEA,

which states that ``[t]he chief compliance officer shall * * *

establish and follow appropriate procedures for the handling,

management response, remediation, retesting, and closing of

noncompliance issues.'' The Commission does not believe that CME has

provided a persuasive basis for its suggested modification of Sec.

39.10(c)(2)(vi), and the Commission is adopting the provision as

proposed.

Finally, the Commission, on its own initiative, is revising Sec.

39.10(c)(2)(vii) to eliminate the requirement that a CCO establish a

compliance manual. While having a compliance manual is a good practice,

incorporating this requirement into a regulation may be overly

prescriptive and the Commission has concluded that a DCO should have

discretion as to the vehicles through which it will carry out its

compliance program.

8. Annual Report--Sec. 39.10(c)(3)

Section 5b(i)(3) of the CEA, added by Section 725(b) of the Dodd-

Frank Act, requires a CCO to prepare an annual report that describes

the DCO's compliance with the CEA, regulations promulgated under the

CEA, and each policy and procedure of the DCO, including the code of

ethics and conflicts of interest policies.\40\ Implementation of these

statutory requirements was addressed at proposed Sec. 39.10(c)(3)(i),

(c)(3)(ii)(A), and (c)(3)(v) and (v).

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\40\ 7 U.S.C. 7a-1(i)(3).

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With respect to proposed Sec. 39.10(c)(3)(i), CME suggested that

the Commission eliminate it and KCC commented that the requirement for

a DCO to show compliance with respect to the CEA and Commission

regulations is ambiguous and overreaching. KCC also suggested that the

scope of the annual report should not go beyond reviewing the DCO core

principles and identifying the compliance policies and procedures that

are in place to satisfy the core principles.

Although paragraph (i) mirrors the language and requirements set

forth in Section 5b(i)(3)(A)(i) of the CEA, to address CME's and KCC's

comments, the Commission has decided to revise the language of

Sec. Sec. 39.10(c)(3)(i) and (ii) to avoid submission of duplicative

information and to clarify the scope of the annual report content

requirements without altering the nature of the information that must

be included in the report pursuant to the CEA. Final Sec. 39.10

(c)(3)(i) requires that the annual report ``[c]ontain a description of

the derivatives clearing organization's written policies and

procedures, including the code of ethics and conflict of interest

policies.'' Final Sec. 39.10 (c)(3)(ii) requires that the report ''

[r]eview each core principle and applicable Commission regulations, and

with respect to each: (A) Identify the compliance policies and

procedures that are designed to ensure compliance with the core

principle.'' The Commission notes that by specifying ``written''

policies and procedures, the rule more precisely establishes the scope

of Sec. 39.10(c)(3)(i).

Proposed Sec. Sec. 39.10(c)(3)(iii) and (c)(3)(iv) would require

that the annual report list any material changes to compliance policies

and procedures since the last annual report and describe the DCO's

financial, managerial, and operational resources for compliance with

the Act and Commission regulations, respectively. The Commission did

not receive any comments on these provisions and is adopting Sec. Sec.

39.10(c)(3)(iii) and (c)(3)(iv) as proposed.

Proposed Sec. 39.10(c)(3)(v) would require that the annual report

``[d]escribe any material compliance matters, including incidents of

noncompliance, since the date of the last annual report and describe

the corresponding action taken.'' CME suggested that the provision be

revised to require that the annual report identify only material

compliance issues that were not properly addressed by the DCO.

The Commission is adopting Sec. 39.10(c)(3)(v) as proposed because

receiving such information will enable the Commission to assess whether

the DCO is addressing compliance matters effectively. It also will

enable the Commission to become aware of possible future compliance

issues across DCOs and to proactively identify best practices. An

annual report that identifies only material compliance issues would not

provide sufficient information.

Finally, the Commission on its own initiative is not adopting

proposed Sec. 39.10(c)(3)(vi) because information of this nature is

not essential to the Commission's evaluation of the DCO's compliance

program and, if it is relevant to a material compliance matter, it will

be provided to the Commission pursuant to Sec. 39.10(c)(3)(v).

9. Submission of Annual Report to the Commission--Sec. 39.10(c)(4)

Proposed Sec. 39.10(c)(4) would set forth the requirements for

submitting an annual report to the Commission. Except as noted below,

the Commission is adopting the rule as proposed.

Better Markets suggested that the Commission change proposed Sec.

39.10(c)(4)(i) to require a CCO to present the finalized annual report

to the board of directors and executive management prior to its

submission to the Commission. Better Markets also suggested that the

independent directors as well as the entire board should be required to

review and approve the report in its entirety and to detail any

disagreement with any portion. In

[[Page 69344]]

addition, Better Markets commented that a CCO should be required to

file the report with the Commission, either as approved or with

statements of disagreement.

The Commission is not revising proposed Sec. 39.10(c)(4)(i) per

Better Markets' suggestion. The Commission believes that a DCO should

have the flexibility to determine whether the annual report will be

provided to the board of directors, the senior officer, or both. The

Commission also is not requiring the board of directors to approve or

submit comments on the report given that the board of directors might

not have sufficient information to approve or disagree with the report.

In addition, there is a risk that the board might try to influence the

CCO to change the report if it were required to express approval. The

Commission notes that the rules do not prohibit the board, any of its

members, or the senior officer from approving or disagreeing with

aspects of the annual report.

Proposed Sec. 39.10(c)(4)(ii) would require that the annual report

include a certification by the CCO that, to the best of his or her

knowledge and reasonable belief, and under penalty of law, the annual

report is accurate and complete. CME commented that the Commission

should require the DCO's senior officer, and not the CCO, to make the

necessary certification in the annual compliance report. According to

CME, ``the best way to achieve the goal of a robust effective

compliance program, and to close the loop on creating a culture of

compliance, is to require the registrant's senior officer--and not the

CCO--to complete the required certification.''

KCC commented that a CCO should not have to certify ``under penalty

of law'' that the annual report is accurate and complete, and a CCO

should certify instead that to the best of his or her knowledge and

belief the annual report is accurate and complete.

The Commission is adopting Sec. 39.10(c)(4)(ii) as proposed. The

CEA requires (1) the CCO to sign the annual report and (2) that the

annual report contain a certification that, under penalty of law, the

compliance report is accurate and complete.\41\ Accordingly, the

Commission believes the regulation accurately reflects Congressional

intent.

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\41\ See Section 5b(i)(3)(B)(ii) of the CEA, 7 U.S.C. 7a-

1(i)(3)(B)(ii).

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10. Annual Report Confidentiality

CME suggested that Commission regulations should expressly state

that annual reports are confidential documents that are not subject to

public disclosure by listing annual reports as a specifically exempt

item in part 145 of the Commission's regulations. The Commission has

not proposed and is not adopting CME's proposal, which would provide

blanket confidentiality to all annual reports submitted by CCOs of

DCOs, even though the Commission may determine that there is

information contained in a report that should be public. Accordingly, a

DCO must petition for confidential treatment of its annual report under

Sec. 145.9 if it wants the Commission to determine that a particular

annual report should be subject to confidentiality.

11. Insulating the CCO From Undue Influence

The notice of proposed rulemaking solicited comments as to whether

the Commission should adopt regulations that require a DCO to insulate

its CCO from undue pressure and coercion. CME commented that the

current regulations are sufficient to protect a CCO from undue

influence and it does not believe additional regulations are necessary.

The Commission agrees with CME and is not adopting such regulations.

12. Recordkeeping--Sec. 39.10(c)(5)

Proposed Sec. 39.10(c)(5) would require a DCO to maintain: (i) A

copy of the policies and procedures adopted in furtherance of

compliance with the CEA and Commission regulations; (ii) copies of

materials, including written reports provided to the board of directors

or the senior officer in connection with review of the annual report;

and (iii) any records relevant to the DCO's annual report, including

work papers and financial data. The DCO would be required to maintain

these records in accordance with Sec. 1.31 and proposed Sec. 39.20.

The Commission did not receive any comment letters discussing proposed

Sec. 39.10(c)(5). The Commission has adopted Sec. 39.10(c)(5) as

proposed, except that the Commission has modified Sec. 39.10(c)(5)(A)

to refer to ``all compliance policies and procedures'' rather than

``the compliance policies and procedures, as defined in Sec. 39.1(b)''

in light of the Commission's decision not to adopt a definition of

compliance policies and procedures, as discussed in section III.B,

above.

B. Core Principle B--Financial Resources--Sec. 39.11

Core Principle B,\42\ as amended by the Dodd-Frank Act, requires a

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

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

its clearing members notwithstanding a default by the clearing member

creating the largest financial exposure for the DCO in extreme but

plausible market conditions and to cover its operating costs for a

period one year, as calculated on a rolling basis. Proposed Sec. 39.11

would codify these requirements. The Commission received a total of 18

comments on the proposed regulations. The Commission considered each of

these comments in formulating the final regulations discussed below.

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\42\ Section 5b(c)(2)(B) of the CEA, 7 U.S.C. 7a-1(c)(2)(B).

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1. Amount of Financial Resources Required--Sec. Sec. 39.11(a) and

39.11(b)(3)

Proposed Sec. 39.11(a)(1) would require a DCO to maintain

sufficient financial resources to meet its financial obligations to its

clearing members notwithstanding a default by the clearing member

creating the largest financial exposure for the DCO in extreme but

plausible market conditions, and proposed Sec. 39.11(a)(2) would

require a DCO to maintain sufficient financial resources to cover its

operating costs for at least one year, calculated on a rolling basis.

Proposed Sec. 39.11(b)(3) would allow a DCO to allocate a financial

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

proposed Sec. 39.11(a)(1) or proposed Sec. 39.11(a)(2), but not both,

and only to the extent that use of that financial resource is not

otherwise limited by the CEA, Commission regulations, the DCO's rules,

or any contractual arrangements to which the DCO is a party.

The Futures Industry Association (FIA) recommended that all DCOs be

required to maintain resources sufficient to withstand the default of

the two clearing members representing the largest financial exposure to

the DCO, but that the Commission give DCOs reasonable time to come into

compliance with the enhanced requirement.

The International Swaps and Derivatives Association (ISDA) also

suggested that, in the clearing of certain OTC derivatives such as

eligible credit default swaps and interest rate swaps, a DCO should

have sufficient financial resources that, at a minimum, enable it to

withstand a potential default by two of its largest clearing members,

as measured by the two clearing members with the largest obligations to

the DCO in extreme but plausible market conditions. ISDA further

suggested, however, that this heightened financial resource level may

not be appropriate for all other OTC or other derivatives products, and

offered to work with the Commission to determine the

[[Page 69345]]

appropriate standard for derivatives in other asset classes.

Similarly, Mr. Chris Barnard recommended that consideration be

given to differentiating risk, and therefore resource requirements by

broad derivative/product class, or at least by exchange-traded and OTC

derivative types.

Better Markets suggested that the default rate used in the stress

test for DCOs should be the larger of (1) the member representing the

largest exposure to the DCO, and (2) the members constituting at least

25 percent of the exposures in aggregate to the DCO. Americans for

Financial Reform (AFR) stated that the calculation in proposed Sec.

39.11(a)(1) should be based on risk exposure as well as number of

defaults.

LCH.Clearnet Group Limited (LCH) concurred with all the provisions

set forth by the Commission under proposed Sec. 39.11(a). NYPC also

expressed support for proposed Sec. Sec. 39.11(a)(1) and 39.11(a)(2).

The Commission is adopting Sec. 39.11(a) as proposed. Section

39.11(a) is consistent with Core Principle B as amended by the Dodd-

Frank Act. As the Commission noted in its notice of proposed

rulemaking, Sec. 39.11(a)(1) is also consistent with the Bank for

International Settlements' Committee on Payment and Settlement Systems

and the Technical Committee of the International Organization of

Securities Commissions (CPSS-IOSCO) Recommendations for Central

Counterparties (CCPs), issued in 2004 (2004 CPSS-IOSCO

Recommendations).\43\ The Commission recognizes that those

recommendations eventually will be replaced by the Principles for

Financial Market Infrastructures (FMIs), which are currently being

developed by CPSS and IOSCO and are expected to be finalized in

2012.\44\ For financial resources requirements for CCPs, CPSS and IOSCO

are considering three alternatives: (1) A ``cover one'' minimum

requirement for all CCPs; (2) a ``cover two'' minimum requirement for

all CCPs; and (3) either a ``cover one'' or a ``cover two'' minimum

requirement for a particular CCP, depending upon the risk and other

characteristics of the particular products it clears, the markets it

serves, and the number and type of participants it has.\45\ The

Commission may reconsider Sec. 39.11(a)(1) once CPSS and IOSCO have

finished their work.

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\43\ See Bank for International Settlements' Committee on

Payment and Settlement Systems and Technical Committee of the

International Organization of Securities Commissions,

``Recommendations for Central Counterparties,'' CPSS Publ'n No. 64

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

\44\ See Bank for International Settlements' Committee on

Payment and Settlement Systems and Technical Committee of the

International Organization of Securities Commissions, ``Principles

for financial market infrastructures: Consultative report,'' CPSS

Publ'n No. 94 (March 2011), available at http://www.bis.org/publ/cpss94.pdf (CPSS-IOSCO Consultative Report).

\45\ CPSS-IOSCO Consultative Report, Principle 4: Credit Risk,

at 30.

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MGEX noted that proposed Sec. 39.11(b)(3) would prohibit a DCO

from using a financial resource for both default and operating cost

purposes. While MGEX agreed this seems a logical approach to take to

avoid counting an asset's value for two different purposes, MGEX stated

that there are practical implications to consider. As a DCM and DCO,

MGEX keeps one basic set of financial records that are compliant with

various accounting standards. MGEX recommended that the Commission's

proposal should not be interpreted to require a DCO to formally divide

some assets and accounts. The Commission confirms that Sec.

39.11(b)(3) does not require a DCO to formally divide its assets or

accounts. The Commission is adopting Sec. 39.11(b)(3) as proposed.

2. Treatment of Affiliated Clearing Members--Sec. 39.11(a)(1)

Proposed Sec. 39.11(a) would state, in part: ``A [DCO] shall

maintain financial resources sufficient to cover its exposures with a

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

compliance with the core principles set out in Section 5b of the [CEA]

* * * Financial resources shall be considered sufficient if their

value, at a minimum, exceeds the total amount that would: (1) Enable

the [DCO] to meet its financial obligations to its clearing members

notwithstanding a default by the clearing member creating the largest

financial exposure for the [DCO] in extreme but plausible market

conditions; Provided that if a clearing member controls another

clearing member or is under common control with another clearing

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

clearing member for purposes of this provision * * * ''

In the notice of proposed rulemaking, the Commission stated:

``There may be some instances in which one clearing member controls

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

control with another clearing member. The Commission proposes to treat

such affiliated clearing members as a single entity for purposes of

determining the largest financial exposure because the default of one

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

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

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

with separate capital requirements, separate guaranty fund obligations,

and separate potential assessment liability, the Commission requests

comment on whether a different approach might be warranted.''

CME noted that it treats affiliated clearing members as separate

entities, with separate capital requirements, separate guaranty fund

obligations, and separate potential assessment liability. While CME

acknowledged that the default of one affiliate may impact the ability

of another affiliated clearing member to meet its financial obligations

to the DCO, CME suggested that circumstances may exist in which a

clearing member is sufficiently independent to continue operating

notwithstanding a default by an affiliate. CME rules allow, but do not

require, emergency action to be taken against a clearing member based

upon the financial or operational condition of an affiliate (whether or

not that affiliate is also a clearing member). CME urged the Commission

to take a similar approach by revising the language of proposed Sec.

39.11(a) to state that ``if a clearing member controls another clearing

member or is under common control with another clearing member, the

affiliated clearing members may be deemed to be a single clearing

member * * *.''

LCH agreed with the Commission's proposed requirement that the DCO

must treat any clearing member, either controlled by another clearing

member or under common control with another clearing member, as a

single clearing member for the purposes of Sec. 39.11(a)(1).

The Commission is adopting Sec. 39.11(a)(1) as proposed. The

Commission believes this treatment appropriately addresses the

potential risks of affiliates. The Commission notes that aggregating

the potential losses of affiliated clearing members for purposes of

this calculation would provide more coverage in the event of a default.

3. Operating Costs--Sec. 39.11(a)(2)

Proposed Sec. 39.11(a)(2) would require a DCO to maintain

sufficient financial resources to cover its operating costs for at

least one year, calculated on a rolling basis.

OCC commented that while the statutory requirement that a DCO have

one year of operating costs, based on a rolling period, may be a

reasonable

[[Page 69346]]

standard to ensure that a DCO is not forced out of business while there

is still open interest in the contracts it clears, the requirement

should be calculated based on essential operating expenses for the

rolling period. According to OCC, an appropriate wind-down budget would

include projected revenues during the wind-down and would not include

expenses associated with activities having value only to a DCO that

intends to remain in business (e.g., product development, technological

enhancements, lobbying activities, investor education, etc.).

ISDA stated that it is appropriate that a DCO hold equity capital

sufficient to cover its operating costs and likely exit costs during

any liquidation and this capital should be separate from any DCO equity

contribution to the required default resources.

Eurex Clearing AG (Eurex) agreed that having a requirement for

operating resources is reasonable, especially in view of the

flexibility implied in the Commission's proposed rules for types of

financial resources, but cautioned that the one-year time frame may be

unnecessarily long.

FIA supported this aspect of the Commission's proposal, including

the requirement that a DCO not be permitted to ``double-count'' its

resources to cover both this and the default resources requirement.

The Commission is adopting Sec. 39.11(a)(2) as proposed. The

Commission notes that the language in Sec. 39.11(a)(2) is virtually

identical to that of Core Principle B.

4. Types of Financial Resources--Sec. 39.11(b)

Proposed Sec. 39.11(b)(1) lists the types of financial resources

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

proposed Sec. 39.11(a)(1): (1) The margin of the defaulting clearing

member; (2) The DCO's own capital; (3) the guaranty fund deposits of

the defaulting clearing member and non-defaulting clearing members; (4)

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

assessments for additional guaranty fund contributions on non-

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

deemed acceptable by the Commission. Proposed Sec. 39.11(b)(2) lists

the types of financial resources that would be available to a DCO to

satisfy the requirements of proposed Sec. 39.11(a)(2): (1) The DCO's

own capital and (2) any other financial resource deemed acceptable by

the Commission.

In the notice of proposed rulemaking, the Commission noted that a

DCO would be able to request an informal interpretation from Commission

staff on whether or not a particular financial resource may be

acceptable to the Commission. The Commission also invited commenters to

recommend particular financial resources for inclusion in the final

regulation.

ISDA encouraged the Commission to give prudent consideration to the

use of standby letters of credit as an additional financial resource,

given that many letter-of-credit issuing banks will be an affiliate of

a clearing member.

Natural Gas Exchange Inc. (NGX) requested that the Commission

consider the acceptability of letters of credit as an asset of the

guaranty fund and clarify in the final rule that letters of credit are

acceptable as an asset of the guaranty fund if subject to certain

safeguards. NGX also requested that the Commission make clear in the

final regulation that it will interpret proposed Sec. Sec.

39.11(b)(1)(vi) and 39.11(b)(2)(ii) broadly so as to permit a

demonstration, on a case-by-case basis, that a DCO meets the overall

policies of the regulation through a specific mix of financial

resources.

Mr. Barnard recommended splitting the types of financial resources

permitted under proposed Sec. 39.11(b)(1) into two classes: Class A

would consist of the financial resources listed in paragraphs (b)(i)

through (b)(iii), and would be required to make up the significant part

of the total financial resources, and class B would consist of the

financial resources listed in paragraphs (b)(iv) through (b)(vi), on

which larger prudential haircuts would be required. MGEX suggested that

proposed Sec. 39.11(b)(2) should retain the ability for a DCO to

provide its explanation and methodology for including a particular

financial resource. MGEX further suggested that the list of potential

financial resources should be broad and not pruned too quickly,

particularly by initial regulation.

Eurex commented that the Commission's proposed list of financial

resources in proposed Sec. 39.11(b)(1) is appropriate.

The Commission is adopting Sec. 39.11(b) as proposed, except for a

technical amendment to clarify the scope of the use of margin as a

financial resource to cover a default. As proposed, the Commission is

not including letters of credit as an acceptable financial resource

because they are only a promise by a bank to pay and not an asset that

can be sold.\46\ However, both Sec. 39.11(b)(1) and Sec. 39.11(b)(2)

permit ``any other financial resource deemed acceptable by the

Commission,'' which means that the Commission could evaluate the use of

letters of credit on a case-by-case basis.\47\

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\46\ The Commission recognizes that assessment powers are also a

promise to pay, but as the Commission noted in the notice of

proposed rulemaking, a clearing member may have a strong financial

incentive to pay an assessment. If a clearing member failed to pay

its assessment obligation, that failure would be treated as a

default and the clearing member would be subject to liquidation of

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

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

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

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

size and profitability of its positions and the margin on deposit

relative to the size of the assessment.

\47\ See discussion of the prohibition on accepting letters of

credit as initial margin in section IV.F.5, below.

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The Commission also received inquiries from a few DCOs as to

whether the Commission would deem projected revenue an acceptable

financial resource to satisfy the requirements of Sec. 39.11(a)(2).

The Commission expects that projected revenue generally would be deemed

acceptable for established DCOs that can demonstrate a historical

record of revenue, but not for DCO applicants or relatively new DCOs

with no such record.

With respect to any financial resource that is not enumerated in

Sec. 39.11(b) and for which a DCO seeks a determination as to its

acceptability based on the DCO's particular circumstances, DCO staff

should contact Commission staff prior to submitting the DCO's quarterly

financial resources report.

The Commission is modifying Sec. 39.11(b)(1)(i) to more precisely

reflect the fact that the use of margin as a financial resource

available to satisfy the requirements of paragraph (a)(1) is subject to

limitations imposed by the Commission and a DCO, e.g., relating to the

use of customer margin to cover a default. As proposed, Sec.

39.11(b)(1)(i) would permit the use of ``[m]argin of a defaulting

clearing member.'' The provision now refers to ``[m]argin to the extent

permitted under parts 1, 22, and 190 of this chapter and under the

rules of the derivatives clearing organization.''

5. Capital Requirement

Proposed Sec. Sec. 39.11(b)(1) and (b)(2) list the DCO's own

capital as a type of financial resource that would be available to a

DCO to satisfy the requirements of proposed Sec. Sec. 39.11(a)(1) and

(a)(2), respectively. In the notice of proposed rulemaking, the

Commission noted that Commission regulations do not prescribe capital

requirements for DCOs. The Commission invited

[[Page 69347]]

comment on whether it should consider adopting such requirements and if

so, what those requirements should be.

J.P. Morgan Chase & Co. (J.P. Morgan) commented that if a DCO

enumerates its own capital as part of its waterfall, that DCO should be

required to provide sufficient assurances that the capital will be

available to meet those obligations and will not be reallocated to

serve other purposes at the DCO's discretion. In a separate comment

letter on the proposed risk management requirements for DCOs, J.P.

Morgan offered its support for regulations that would require a DCO to

retain in a segregated deposit account, on a rolling basis, 50 percent

of its earnings from the previous 4 years. In addition, J.P. Morgan

stated that it would be appropriate for at least 50 percent of the

retained earnings to have a first loss position. J.P. Morgan also

recommended that the DCO contribution be subject to a minimum floor of

$50 million.

Mr. Michael Greenberger recommended that the Commission require

DCOs to set aside a reasonable amount of capital, equal to an average

size of one contract for that DCO, so that a DCO would have sufficient

financial resources to absorb a default. In addition, Mr. Greenberger

suggested that capital requirements for DCOs must require that the

DCOs' capital be highly liquid so that a DCO can cure a default in a

timely manner.

Eurex noted that clearing organizations exhibit a variety of

organizational and capital structures and suggested the Commission

should allow DCOs to determine their own mixes of protective measures,

which might include the DCO's own capital. Nevertheless, Eurex

expressed support for an initial capital requirement of $25 million for

DCOs.

OCC commented that an equity capital requirement for DCOs is not

appropriate because DCOs rely primarily on member-supplied resources,

such as clearing fund deposits and margin, to meet their obligations.

According to OCC, most, if not all, DCOs have little capital in

relation to their obligations. OCC suggested that the critical question

from a safeness and soundness standpoint is whether DCOs have adequate

financial resources, not the form in which such resources are held.

CME stated that the financial resources requirements contained in

Core Principle B are better suited to achieve the goal of ensuring

adequate capitalization of DCOs, and that further capital requirements

would be unnecessary and essentially duplicative.

KCC commented that, with proposed Sec. 39.11(a)(1) requiring a DCO

to maintain sufficient financial resources to meets its financial

obligations, a separate capital requirement would be redundant. KCC

also stated that onerous capital requirements placed on DCOs could have

an anti-competitive effect.

NYPC cautioned that mandating that DCOs hold specific forms or

amounts of capital could have a chilling effect on competition, at odds

with the principles of the CEA by potentially shutting out various

forms of organizational structures for DCOs. NYPC noted that Core

Principle B requires that DCOs maintain sufficient financial resources

to perform their functions as central counterparties in compliance with

the CEA. NYPC suggested that whether such financial resources are

derived from a DCO's own capital or other financial resources deemed

acceptable to the Commission should be inconsequential to the extent

such statutorily prescribed functions are fulfilled.

MGEX stated that it does not support adopting specific capital

requirements for DCOs. MGEX noted that the proposed regulation already

requires a DCO to be able to withstand the default of its largest

clearing member in extreme but plausible market conditions. MGEX

further noted that a DCO's capital is only one element of the financial

resources necessary to cover that risk, and suggested that a DCO should

be able to determine how it best needs to allocate that risk among its

various financial resources.

The Commission is not adopting a capital requirement for DCOs at

this time. The Commission believes that it is appropriate to provide

flexibility to DCOs in designing their financial resources structure so

long as the aggregate amount is sufficient. The Commission notes,

however, that one of the principles in the CPSS-IOSCO Consultative

Report would require an FMI to ``hold sufficiently liquid net assets

funded by equity to cover potential general business losses so that it

can continue providing services as a going concern.'' \48\ CPSS and

IOSCO are considering, and requesting comment on, the establishment of

a specific minimum quantitative requirement for liquid net assets

funded by equity. If such a requirement is established, the Commission

may consider a similar requirement for DCOs at that time.

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\48\ See CPSS-IOSCO Consultative Report, Principle 15: General

Business Risk, at 70.

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6. Assessments--Sec. Sec. 39.11(b)(1)(v) and 39.11(d)(2)

Proposed Sec. 39.11(b)(1)(v) would list ``potential assessments

for additional guaranty fund contributions, if permitted by the [DCO]'s

rules'' as a type of financial resource that would be available to a

DCO to satisfy the requirements of proposed Sec. 39.11(a)(1). Proposed

Sec. 39.11(d)(2) would require a DCO: (i) To have rules requiring that

its clearing members have the ability to meet an assessment within the

time frame of a normal variation settlement cycle; (ii) to monitor, on

a continual basis, the financial and operational capacity of its

clearing members to meet potential assessments; (iii) to apply a 30

percent haircut to the value of potential assessments; and (iv) to only

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

percent of its default resources requirement. The Commission requested

comment on whether these limits and requirements are appropriate and,

more generally, whether assessment powers should be considered to be a

financial resource available to satisfy the requirements of proposed

Sec. 39.11(a)(1).

With regard to proposed Sec. Sec. 39.11(d)(2)(i) and (ii), OCC

commented that the requirement that clearing members be able to meet an

assessment within the time frame of a normal variation settlement cycle

is an aggressive but appropriate standard that its clearing members

would be able to meet in most circumstances, but that DCOs should have

discretion to extend this deadline on a case-by-case basis where

appropriate to avoid severe strains on clearing member liquidity in

unusual circumstances. OCC objected to the requirement that DCOs must

monitor ``on a continual basis'' a clearing member's ability to meet

potential assessments, which OCC claimed is overly burdensome and

difficult to administer. OCC suggested that a monthly review is

reasonable and adequate.

NYPC requested that the Commission clarify how the requirement of

proposed Sec. 39.11(d)(2)(i) would be imposed on DCOs that conduct

both end-of-day and intraday settlements each business day. In order to

ensure that a uniform standard is applied across clearing members of

all DCOs, whether the DCO conducts one or two settlements per business

day, NYPC recommended that the Commission clarify that a DCO's rules

should require clearing members to have the ability to meet an

assessment within one business day.

With regard to proposed Sec. 39.11(d)(2)(ii), NYPC requested that

[[Page 69348]]

the Commission provide guidance as to how it expects DCOs to determine

whether a clearing member has the capacity to meet a potential

assessment. In addition, NYPC expressed concern that the ``continual''

monitoring of clearing members' ability to meet potential assessments,

which NYPC believes implies daily or even real-time monitoring, would

be extremely difficult, if not impossible, to administer. NYPC

suggested that it would be reasonable and more practicable for the

Commission to require that monitoring of clearing members' ability to

meet potential assessments be included as a mandatory component of the

periodic financial reviews of clearing members that DCOs already

conduct in the ordinary course of business.

In response to these comments, the Commission is revising Sec.

39.11(d)(2)(i) to read as follows (added text in italics): ``The

derivatives clearing organization shall have rules requiring that its

clearing members have the ability to meet an assessment within the time

frame of a normal end-of-day variation settlement cycle.'' In response

to OCC's comment, the Commission notes that Sec. 39.11(d)(2)(i)

requires a DCO to have rules requiring that its clearing members have

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

end-of-day variation settlement cycle, but would permit a DCO, in its

discretion, to provide some flexibility to clearing members as to

timing.

In addition, the requirement in Sec. 39.11(d)(2)(ii) that a DCO

must monitor the financial and operational capacity of its clearing

members to meet potential assessments ``on a continual basis'' was

intended to mean only that the DCO must perform such monitoring often

enough to enable it to become aware of any potential problems in a

timely manner. To eliminate possible ambiguity, the Commission is

revising the final rule by removing the phrase ``on a continual

basis.'' Thus, Sec. 39.11(d)(2)(ii) establishes a standard whereby a

DCO must monitor its clearing members, but the DCO can meet the

standard through the exercise of its judgment in response to particular

circumstances, e.g., a DCO might have reason to evaluate certain

clearing members on a daily basis and evaluate others only as part of

routine, periodic financial reviews.

With regard to proposed Sec. Sec. 39.11(d)(2)(iii), FIA commented

that the 30 percent haircut and 20 percent cap are reasonable and

prudent safeguards, sufficient to ensure that a DCO does not unduly

rely on its assessment power. J.P. Morgan supported the proposal and

also recommended that regulators adopt a risk-based analysis to

determine the likelihood that a clearing member will be able to meet

its assessment obligations across all DCOs. Mr. Greenberger, citing

J.P. Morgan's comments, agreed that it is absolutely critical that the

Commission promulgate rules that would determine a clearing member's

risk of default and its availability of financial resources across all

clearinghouses. Similarly, ISDA suggested that the Commission evaluate

the potential impact of multiple assessments from different DCOs on the

same clearing member or affiliate group in a short time-frame.

CME suggested that a DCO should be required to completely exclude

the potential defaulting firm's assessment liability in calculating its

available assessment resources. CME also commented that, in light of

the requirements of proposed Sec. Sec. 39.11(d)(2)(i) and (ii), and

the fact that a clearing member that failed to pay an assessment would

itself be in default to the DCO, it does not believe that a further

haircut on assessments is necessary, and it is aware of no valid reason

to cap the use of assessments at 20 percent as proposed.

KCC noted that the inclusion of assessment powers as financial

resources is necessary for it to meet its obligations in the unlikely

event of a default. KCC agreed that a reasonable haircut on the value

of a DCO's assessment power may be a prudent measure, but stated that

the proposed limits are unreasonable and excessive and seem arbitrary.

KCC suggested that a better approach would be for the DCO to be allowed

the latitude to determine clearing member assessment haircuts on an

individual basis, based on each clearing member's financial

capabilities.

MGEX recommended that the Commission allow each DCO to provide its

methodology and support for why any assessment might be considered a

financial resource and how much. MGEX stated that the 30 percent

haircut and 20 percent cap seem arbitrary and prescriptive. MGEX stated

that the DCO should have the discretion to determine an appropriate

haircut based on the clearing member's liquidity.

Better Markets commented that the proposed haircuts for assessments

are inadequate. According to Better Markets, it would be far more

prudent to require funding of risk that can be anticipated in stress

tests and rely on assessments as a financial resource only for

conditions that are not anticipated in stress tests.

LCH recommended that potential assessments not be allowed to

satisfy the requirements of proposed Sec. 39.11(a)(1) because, in

LCH's view, it is of the utmost importance that a DCO's resources

following a clearing member default be immediately and unconditionally

available. LCH suggested that assessments should be allowed as part of

the DCO's ``waterfall'' of protections, but should not be taken into

account to meet the specific test outlined under proposed Sec.

39.11(a)(1).

AFR urged the Commission to prohibit DCOs from including assessment

powers in their calculation of financial resources because it is

unclear, in a time of broad market distress, whether a DCO's members

would be willing and able to pay their assessments.

The Commission is adopting Sec. 39.11(d)(2)(iii) as proposed. In

view of the wide range of comments on this issue, the Commission

believes the rule strikes an appropriate balance. The 30 percent

haircut recognizes that the defaulting firm, which by definition will

not be paying an assessment, might represent a significant segment of

the DCO's total risk. The 20 percent cap recognizes that given the

contingent nature of assessments, they should only be relied upon as a

last resort. In response to ISDA's comment, the Commission expects that

as part of the evaluation of a clearing member's risk profile, a DCO

would take into consideration the potential exposure of the clearing

member at other DCOs, to the extent that it is able to obtain such

information, including the possibility of assessments. The Commission

notes, in response to MGEX's and KCC's comments, that a DCO may

determine clearing member assessment haircuts on an individual basis

because Sec. 39.11(d)(2)(iii) only requires a 30 percent haircut on an

aggregate basis.

7. Computation of the Financial Resources Requirement--Sec.

39.11(c)(1)

Proposed Sec. 39.11(c)(1) would require a DCO to perform stress

testing on a monthly basis in order to make a reasonable calculation of

the financial resources it needs to meet the requirements of proposed

Sec. 39.11(a)(1). The DCO would have reasonable discretion in

determining the methodology used to make the calculation, but would be

required to take into account both historical data and hypothetical

situations. In the notice of proposed rulemaking, the Commission

requested comment on whether monthly tests are appropriate.

MGEX commented that monthly reporting seems reasonable as it

already

[[Page 69349]]

performs stress tests on a routine basis. MGEX further commented that

allowing DCOs discretion in selecting stress test scenarios is

appropriate.

CME suggested that annual stress testing would suffice for

operating costs because operating costs are generally static. With

regard to default coverage, CME suggested that stress testing should be

done no less than monthly.

LCH expressed concern over the requirement that the DCO perform

stress testing only on a monthly basis. In LCH's view, stress testing

should be carried out by the DCO on at least a daily basis, and LCH

strongly urged the Commission to amend its proposal accordingly. LCH

suggested that monthly stress testing is inadequate, as experience has

shown that market conditions and member positions can change rapidly

during periods of market turmoil.

ISDA suggested that reverse stress tests \49\ should be required

for determining the size of the financial resources package and that

there should be public disclosure of the stress tests and their

results.

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

\49\ Reverse stress tests are stress tests that require a firm

to assess scenarios and circumstances that would render its business

model unviable, thereby identifying potential business

vulnerabilities. Reverse stress testing starts from an outcome of

business failure and identifies circumstances where this might

occur. This is different from general stress testing, which tests

for outcomes arising from changes in circumstances. See http://www.fsa.gov.uk/pages/About/What/International/stress_testing/firm_s/reverse_stress_testing/index.shtml.

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

Mr. Barnard agreed that stress testing should be carried out at

least monthly, and suggested that back testing should be carried out

daily. Mr. Barnard also suggested that the Commission specifically

refer to reverse stress testing in proposed Sec. 39.11(c)(1) because,

in his view, it is a useful tool for managing expectations and for

helping the DCO to anticipate financial resources requirements in

extreme conditions.

FIA recommended that the Commission make clear its expectation that

the DCOs will, at a minimum: (1) Conduct a range of stress tests that

reflect the DCO's product mix; (2) include the most volatile periods

that have been experienced by the markets for which the DCO provides

clearing services; (3) take into account the distribution of cleared

positions between clearing members and their customers; and (4) test

for unanticipated levels of volatility and for breakdowns in

correlations within and across product classes.

Mr. Greenberger recommended that historical market data that led up

to the passage of the Dodd-Frank Act be taken into account in

determining market conditions that could be defined as extreme but

plausible.

Better Markets commented that the passive role of the Commission in

measuring the financial requirements for a DCO is inappropriate in

light of the importance of this function. Better Markets proposed that

the methodology, the historical data set, and the hypothetical

scenarios be: (1) Jointly developed by the DCO and the Commission and

(2) reviewed whenever ordered by the Commission, but no less frequently

than quarterly. Better Markets also recommended that the Commission

explicitly recognize the importance of illiquidity in developing

hypothetical scenarios.

AFR stated that it is critical that the Commission play a central

role in establishing the standards by which DCOs will measure their

exposure to future risks. AFR urged the Commission to define minimal

standards that will ensure that DCO stress tests are stringent and

incorporate realistic metrics of worst-case scenarios that DCOs may

experience.

The Commission is adopting Sec. 39.11(c)(1) as proposed. The

Commission believes it is appropriate to allow the DCO discretion in

designing stress tests because stress testing is an exercise that

inherently entails the exercise of judgment at various stages.

Furthermore, Sec. 39.11(c)(1) allows the Commission to evaluate the

testing and require changes as appropriate. In response to the LCH

comment, the Commission notes that there is a distinction between the

type of stress testing carried out under this rule for the purpose of

sizing the overall financial resource package and the type of stress

testing carried out under Sec. 39.13(h)(3) for the purpose of

ascertaining the risks that may be posed to the DCO by individual

traders and clearing members. The former is a comprehensive test across

all clearing members and all products with the goal of identifying the

firms posing the greatest risk to the DCO and quantifying that risk.

The regulations would require such testing to be completed monthly. The

latter is targeted testing addressing the specific risks of specific

positions at specific firms. The regulations would require such testing

to be completed on either a daily or weekly basis, as described in

Sec. 39.13(h)(3).\50\

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\50\ See discussion of Sec. 39.13(h)(3) in section IV.D.7.c,

below.

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8. Valuation of Financial Resources--Sec. 39.11(d)(1)

Proposed Sec. 39.11(d)(1) would require a DCO, no less frequently

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

resource used to meet its obligations under proposed Sec. 39.11(a).

When valuing a financial resource, a DCO would be required to reduce

the value, as appropriate, to reflect any market or credit risk

specific to that particular resource, i.e., apply a haircut. The

Commission would permit each DCO to exercise its discretion in

determining the applicable haircuts. However, the haircuts would have

to be evaluated on a monthly basis, would be subject to Commission

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

OCC suggested that the proposed regulations should be modified or

interpreted to accommodate the use of a true portfolio margining model

that values collateral based on its relationship to an overall

portfolio in lieu of applying fixed haircuts on margin collateral.

ISDA stated that it would support an appropriate haircut for

default insurance, potential assessments, and possibly other financial

resources deemed acceptable by the Commission, as determined by the

Commission upon review of the relevant DCO.

FIA expressed reservations about the ability of a DCO to be paid

promptly under the terms of a default insurance policy. FIA therefore

recommended that default insurance coverage be subjected to a 30

percent haircut and a 20 percent cap, similar to the policies that the

Commission has proposed to apply to a DCO's assessment power.

In discussions with Commission staff, Federal Reserve and Federal

Reserve Bank of New York staff suggested that the liquidity of a

financial resource should be an additional factor in determining an

appropriate haircut. Considerations should include whether it is easy

to value the financial resource (e.g., whether the pricing is

transparent) and whether the financial resource could be divested in a

short time period under normal market conditions. The Commission agrees

that liquidity is an important factor in valuing financial resources.

Accordingly, the Commission is revising Sec. 39.11(d)(1) to read

as follows (added text in italics): ``At appropriate intervals, but not

less than monthly, a derivatives clearing organization shall compute

the current market value of each financial resource used to meet its

obligations under paragraph (a) of this section. Reductions in value to

reflect

[[Page 69350]]

credit, market, and liquidity risks (haircuts) shall be applied as

appropriate and evaluated on a monthly basis.'' In response to OCC's

comments, the Commission notes that Sec. 39.11(d)(1) does not prohibit

the valuation method described by OCC in its comment letter.

The Commission believes Sec. 39.11(d)(1) takes a balanced approach

by permitting a DCO to exercise its discretion in determining

applicable haircuts for each of its financial resources but making

those haircuts subject to Commission review and approval. Section

39.11(d)(1) requires a DCO to perform such valuations no less

frequently than monthly, which means the Commission would expect a DCO

to perform such valuations more frequently when appropriate, such as

during periods of market volatility.

9. Liquidity of Financial Resources--Sec. 39.11(e)

Proposed Sec. 39.11(e)(1) would require a DCO to have financial

resources sufficiently liquid to enable the DCO to fulfill its

obligations as a central counterparty during a one-day settlement

cycle, including sufficient capital in the form of cash to meet the

average daily settlement variation pay per clearing member over the

last fiscal quarter. The DCO would be permitted to take into account a

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

the remainder of the liquidity requirement. In the notice of proposed

rulemaking, the Commission requested comment on whether the liquidity

requirement should cover more than a one-day cycle. The Commission also

requested comment on what standards might be applicable to lines of

credit--e.g., should the Commission require that there be a diversified

set of providers, or that a line of credit have same-day drawing

rights?

Proposed Sec. 39.11(e)(2) would require a DCO to maintain

unencumbered liquid financial assets in the form of cash or highly

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

be permitted to take into account a committed line of credit or similar

facility to satisfy this requirement.

Proposed Sec. 39.11(e)(3) would require that: (i) Assets in a

guaranty fund have minimal credit, market, and liquidity risks and be

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

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

risk, and (iii) letters of credit not be a permissible asset for a

guaranty fund.

OCC recommended that the proposed regulations be modified or

interpreted to provide DCOs some flexibility in determining the means

of managing their ``cash'' liquidity needs by allowing DCOs to use

secured credit facilities and tri-party repo facilities in addition to

cash held in demand deposit accounts to satisfy the cash requirement.

OCC observed that permitting these alternatives would allow a DCO to

hold a significant portion of its financial resources in the form of

U.S. Treasuries, with the ability to convert the Treasuries to cash as

needed. According to OCC, cash must generally be held at banks, which

presents a credit risk.

NGX suggested that immediately accessible bank lines of credit

should be acceptable to cover the cash requirement where the underlying

commodity is itself traded in a liquid market.

CME suggested the phrase ``average daily settlement variation pay

per clearing member over the last fiscal quarter'' in proposed Sec.

39.11(e)(1) is somewhat ambiguous. CME assumed that the Commission

intended to refer to the average daily variation pay for a single

clearing member, not the average daily settlement variation pay for all

clearing members.

CME also commented that the Commission's approach is not warranted

given the potential amount of cash at issue and the reliability of

liquidity facilities for short-term cash needs. CME suggested that the

Commission revise the last sentence of proposed Sec. 39.11(e)(1) to

read as follows: ``If any portion of such financial resources is not

sufficiently liquid, the derivatives clearing organization may take

into account a committed line of credit or similar facility for

purposes of meeting these requirements.''

In response to the Commission's request for comment on what

standards might be applicable to a liquidity facility, CME stated that

reviews and evaluations by Commission staff during regular DCO audits

are a sufficient check on the adequacy and soundness of a committed

line of credit, and that the Commission should not attempt to prescribe

the terms and conditions of a DCO's liquidity facility.

KCC found the language in proposed Sec. 39.11(e) to be ambiguous.

KCC interpreted the average daily settlement variation pay per clearing

member over the last fiscal quarter to mean the cumulative average of

the pay-ins per each clearing member divided by the number of clearing

members. In KCC's view, a line of credit with same-day drawing rights

should be considered as liquid as cash and therefore should be allowed

to be used by the DCO to fulfill its financial obligations during a

one-day settlement cycle. KCC commented that the liquidity requirement

should cover no more than one day of market price movement.

LCH was unclear on what the Commission intends to mean in proposed

Sec. 39.11(e)(1) by requiring that the DCO should allocate financial

resources to meet the requirements of Sec. 39.11(a)(1) and fulfill its

arising obligations during a ``one-day settlement cycle.'' LCH

suggested that the requirement instead should be that the DCO is

obliged to fulfill its arising obligations ``as they fall due.''

Additionally, LCH suggested that the requirement that the DCO must have

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

settlement variation pay per clearing member over the last fiscal

quarter'' is insufficient. LCH recommended that this requirement be

replaced by a test that the DCO can meet its liquidity requirements

``following the default of the clearing member(s) creating the largest

liquidity requirement under stressed market conditions over the

quarter.''

Mr. Greenberger suggested that the standards for a committed line

of credit or similar facility must be narrowly and strictly defined, so

that the party can easily use such highly liquid line of credit or

similar facility. Mr. Greenberger further suggested that greater

participation by clearing members in a committed line of credit or a

similar instrument at times of market distress would not provide

necessary liquidity but rather would increase systemic risk.

Eurex noted that proposed Sec. 39.11(e) requires DCOs to monitor

the liquidity of assets and agreed that low-credit risk, highly liquid

assets should comprise guaranty funds and that this rule would serve

important purposes.

FIA recommended that the Commission clarify that the cash

requirement is intended to measure the average (and not the aggregate)

clearing member variation margin requirement. FIA further recommended

that the Commission permit a DCO to satisfy this requirement through

the use of cash or cash equivalents, including U.S. government

securities and repurchase agreements involving highly liquid securities

if such repurchase agreement matures within one business day or is

reversible upon demand. FIA additionally recommended that this aspect

of the Commission's proposal be modified to clarify that DCOs are

permitted to satisfy the liquidity requirement through the

establishment of committed repo facilities. FIA supported allowing a

DCO to obtain a

[[Page 69351]]

committed line of credit or similar credit facility to cover the

remainder of its default resources requirement, but recommended that

this proposal be strengthened by the diversification of credit

providers, with concentration limits of 25 percent per provider.

MGEX commented that proposed Sec. 39.11(e)(1) requires some

clarity. MGEX interpreted it to mean that a DCO must have cash that

will cover the average of all the clearing members' average daily

settlement variation pays, which to MGEX would seem a logical and

practical application. Rather than adopting multiple liquidity

requirements (i.e., cash, clearing member default coverage, six months'

worth of operating expenses), MGEX suggested the process could be

simplified to address the most relevant, which appeared to MGEX to be

the clearing member default coverage. In addition, MGEX recommended

that proposed Sec. 39.11(e) should permit combining and then totaling

its liquidity of financial resources as a single-entity DCO/DCM.

AFR stated that DCOs should be required to have sufficient cash to

fulfill their obligations for 10 business days and that lines of credit

should not count toward liquidity requirements.

NYPC commented that, to the extent the proposed requirement is

intended to exclude cash equivalents, such as U.S. Treasury securities,

the standard is inappropriate. NYPC recommended that the Commission

allow DCOs to satisfy their liquidity needs through the use of any

combination of cash held in demand deposit accounts, bank accounts

meeting the requirements of CFTC Interpretative Letter 03-31,\51\ and

secured credit facilities and repurchase agreements that allow DCOs to

convert U.S. Treasury securities and other high quality collateral into

cash on a same-day basis.

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\51\ CFTC Interpretative Letter 03-31 concerned a bank that

requested an interpretation that a trust deposit account product it

developed would be acceptable for the deposit of customer segregated

funds in accordance with Commission Regulation 1.20. Based on an

analysis of the account, staff of the Commission's Division of

Clearing and Intermediary Oversight issued an interpretation that

the account would be acceptable as a deposit location because the

account would be properly titled and covered by appropriate

acknowledgements by the bank, and the funds in the account would at

all times be immediately available for withdrawal on demand.

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In response to the comments, the Commission is revising Sec.

39.11(e)(1) to provide greater clarity. In addition, the Commission is

modifying the ``cash'' requirement to include ``U.S. Treasury

obligations and high quality, liquid, general obligations of a

sovereign nation.'' This conforms the requirement to existing liquidity

practices and, in particular, it accommodates acceptable practices of

foreign-based DCOs. However, the Commission is not including bank lines

of credit as an acceptable financial resource for meeting the ``cash''

requirement because they are only a promise by the bank to pay and not

an asset that can be sold. The Commission is revising Sec. 39.11(e)(1)

by deleting the following language: ``The derivatives clearing

organization shall have sufficient capital in the form of cash to meet

the average daily settlement pay per clearing member over the last

fiscal quarter. If any portion of the remainder of the financial

resources is not sufficiently liquid, the derivatives clearing

organization may take into account a committed line of credit or

similar facility for the purpose of meeting this requirement.''

The Commission is replacing the deleted language with the

following: ``[(ii)] The derivatives clearing organization shall

maintain cash, U.S. Treasury obligations, or high quality, liquid,

general obligations of a sovereign nation, in an amount greater than or

equal to an amount calculated as follows: (A) Calculate the average

daily settlement pay for each clearing member over the last fiscal

quarter; (B) Calculate the sum of those average daily settlement pays;

and (C) Using that sum, calculate the average of its clearing members'

average pays. (iii) The derivatives clearing organization may take into

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

of meeting the remainder of the requirement under paragraph (e)(1)(ii)

of this section.''

The Commission notes that, in the CPSS-IOSCO Consultative Report,

CPSS and IOSCO are considering a minimum liquidity requirement for CCPs

that would be either: (1) A ``cover one'' minimum requirement for all

CCPs; (2) a ``cover two'' minimum requirement for all CCPs; or (3) a

``cover one'' or ``cover two'' minimum requirement for an individual

CCP, depending on the particular risk and other characteristics of the

particular products that it clears, the markets it serves, and the

number and type of participants it has.\52\ The Commission might

revisit the issue after CPSS and IOSCO determine what standard they

will adopt.

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\52\ See CPSS-IOSCO Consultative Report, Principle 7: Liquidity

Risk, at 46.

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10. Reporting Requirements--Sec. 39.11(f)

Proposed Sec. 39.11(f) would require a DCO to report to the

Commission, at the end of each fiscal quarter or at any time upon

Commission request: (i) The amount of financial resources necessary to

meet the requirements set forth in the regulation; and (ii) the value

of each financial resource available to meet those requirements. The

DCO would be required to include with its report a financial statement

(including the balance sheet, income statement, and statement of cash

flows) of the DCO or its parent company. A DCO would have 17 business

days from the end of the fiscal quarter to file its report, but would

also be able to request an extension of time from the Commission.

NYPC suggested that, in light of the scope of information required

to be submitted in the quarterly report (i.e., information regarding

default risk financial resources and operating financial resources),

the Commission should require that such reports be filed not later than

30 calendar days, rather than 17 business days, following the end of

the DCO's fiscal quarter.

ISDA suggested that a DCO seeking an extension of the 17-day

reporting deadline should be required to request the extension at least

seven business days before the deadline.

KCC noted that it does not prepare a statement of cash flows on a

monthly basis, only on an annual basis as part of its audited financial

statements. KCC commented that a monthly profit/loss statement is

sufficient for determining its financial operating needs.

MGEX suggested the Commission should consider a DCO's privacy

concerns when permitting reasonable discretion in the data the DCO

provides in the monthly reports required by the proposed regulations.

MGEX stated that some detail as to projected revenue and expenses must

remain proprietary if it involves potential business opportunities or

other strategic business decisions, and that DCOs have a legitimate

concern that confidential financial information could be subject to

Freedom of Information Act requests.

The Commission is adopting Sec. 39.11(f) as proposed. The

Commission notes that the 17-business-day filing deadline is consistent

with the deadline imposed on FCMs for the filing of monthly financial

reports under Sec. 1.10(b). Moreover, a DCO may request an extension

if it is unable to meet the deadline. The Commission does not believe

it is appropriate to require a DCO to request an extension at least

seven business days before the deadline, because a DCO may not know

that far in advance that it will be unable to meet the deadline. With

regard to the confidentiality of the information contained in the

reports, the Commission notes that Core Principle L

[[Page 69352]]

and Sec. 39.21(c)(4) require a DCO to publicly disclose the size and

composition of the financial resources package available in the event

of a clearing member default. A DCO may request confidential treatment

under Sec. 145.9 for other information submitted to the Commission

under these regulations.

11. SIDCOs--Sec. 39.29

Proposed Sec. 39.29(a) would require a SIDCO to maintain

sufficient financial resources to meet its financial obligations to its

clearing members notwithstanding a default by the two clearing members

creating the largest combined financial exposure for the SIDCO in

extreme but plausible market conditions. Proposed Sec. 39.29(b) would

require that a SIDCO not count the value of assessments to meet the

obligations arising from a default by the clearing member creating the

single largest financial exposure and only count the value of

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

the obligations arising from a default by the clearing member creating

the second largest financial exposure. The Commission believes that it

would be premature to take action regarding Sec. 39.29 at this time.

The FSOC has not yet designated any DCOs as systemically important. As

previously noted, the CPSS-IOSCO Principles for Financial Market

Infrastructures, which are expected to be finalized in 2012, will

address minimum financial resources requirements for CCPs. Similarly,

certain foreign regulators, including the European Union, are also

considering requirements in this area for the CCPs they regulate. The

Commission is concerned that SIDCOs would be put at a competitive

disadvantage if they are forced to comply with these requirements

before non-U.S. CCPs are subject to comparable standards. The

Commission is closely monitoring developments on this issue and is

prepared to revisit the issue if the European Union or other foreign

regulators move closer to implementation. Moreover, because it may be

some time before any DCO is designated a SIDCO, the Commission believes

it would be prudent to reconsider the regulation of SIDCOs in light of

developments that may occur in the interim. The Commission expects to

consider all the proposed rules relating to SIDCOs together.

C. Core Principle C--Participant and Product Eligibility--Sec. 39.12

1. Participant Eligibility

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

each DCO to establish appropriate admission and continuing eligibility

standards for members of, and participants in, the DCO,\54\ 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. Proposed Sec. 39.12(a) would codify

these requirements and establish the minimum requirements that a DCO

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

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

\54\ 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. The Commission is also

amending the definition of ``clearing member'' in Sec. 1.3(c),

adopted herein, 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.''

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Although there is potential tension between the goals of ``fair and

open access'' and ``sufficient financial resources and operational

capacity to meet obligations arising from participation in the

derivatives clearing organization,'' the Commission believes the rules

that it is adopting herein strike an appropriate balance. The

Commission has crafted the provisions of Sec. 39.12 and related rules,

e.g., the risk management requirements, to establish a regulatory

framework that it believes can ensure that a DCO's 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 expects that more widespread

participation will reduce the concentration of clearing member

portfolios, thereby diversifying risk, increasing market liquidity, and

increasing competition among clearing members.

a. Fair and Open Access--Sec. 39.12(a)(1)

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

appropriate admission and continuing participation requirements for

clearing members of the DCO, which are objective, publicly disclosed,

and risk-based. Proposed Sec. 39.12(a)(1) would require a DCO to have

participation requirements that permit fair and open access, setting

forth specific standards.

The Managed Funds Association (MFA), BlackRock, Inc. (BlackRock),

State Street Corporation (State Street), and the Committee on Capital

Markets Regulation (CCMR) supported the proposed rules. J.P. Morgan,

ISDA, and FIA expressed support for the fair and open access provisions

as long as there is prudent risk management.

According to MFA, more inclusive DCO participation requirements

would benefit DCOs and the markets by: (1) Reducing DCO concentration

risk; (2) increasing diversity of market participants involved in DCO

governance; (3) enhancing competition in the provision of clearing

services; and (4) lowering overall costs for non-clearing members.

State Street agreed that more widespread participation could increase

competition by allowing more entities to become clearing members.

Blackrock commented that the proposed rule would allow a diverse group

of entities to become clearing members, which would increase

competition, promote more inclusive DCO participation requirements, and

lower costs to customers of clearing members.

Each of the provisions of Sec. 39.12(a)(1) are discussed below.

b. Less Restrictive Standards--Sec. 39.12(a)(1)(i)

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. BlackRock, the Swaps & Derivatives Market Association

(SDMA), CME, LCH, Citadel, and CCMR supported the proposed rule. CCMR

commented that the proposed rule would help to encourage an open

marketplace.

KCC, ICE, and MGEX did not support the proposed rule. According to

KCC, the test is highly subjective and would be difficult to implement

in practice. ICE commented that the proposal would require a DCO to

dilute current prudent risk management practices. MGEX commented that

the proposed rule

[[Page 69353]]

would require DCOs to consider only objective, hard number risk

factors, which would force DCOs to bear other risks such as financial

fraud convictions. MGEX suggested that the Commission should provide

DCOs with latitude when determining the risks to which it will expose

itself.

The Commission is adopting Sec. 39.12(a)(1)(i) as proposed, except

for the addition of clarifying language to provide that a DCO shall not

adopt restrictive clearing member standards if less restrictive

requirements ``that achieve the same objective and'' that would not

materially increase risk to the derivatives clearing organization or

clearing members could be adopted. The rule balances the dual

Congressional mandate to provide for fair and open access while

ensuring that such increased access does not materially increase risk.

Because the rule does not require a DCO to provide access that

materially increases risk to the DCO or clearing members, the

Commission does not agree with ICE that the rule will subject a DCO to

increased risk.

The Commission does not agree with KCC that the rule will be highly

subjective or difficult to implement in practice. The rule provides a

DCO with discretion to balance restrictions on participation with

legitimate risk management concerns and, in this regard, a DCO is in

the best position in the first instance to determine the optimal

balance. Only in circumstances where there is a question as to the

impact of the rule would the Commission ask a DCO to justify the

balance that the DCO has struck.

In response to MGEX's comment, the Commission notes that the rule

does not require a DCO to rely solely on objective, hard number risk

factors. The rule permits a DCO to rely on both qualitative and

quantitative analyses, providing each DCO with latitude to determine

how it can facilitate open access while determining the risks to which

it will expose itself.

Except for certain bright-line participation requirements (e.g.,

capital requirements for clearing members), the Commission has not

provided more specific guidance as to what participant eligibility

requirements are permissible under Core Principle C. Such a

clarification would only serve to limit a DCO's flexibility to

formulate participation requirements.

The Commission encourages each DCO to conduct a self-assessment to

make sure that it can provide reasoned support to justify a conclusion

that its rules do not violate the ``less restrictive'' standard

contained in Sec. 39.12(a)(1)(i). Such an analysis should take into

consideration the interaction of this provision with the other

provisions of Sec. 39.12(a).

c. Clearing Member Qualification--Sec. 39.12(a)(1)(ii)

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

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

participation requirements. SDMA, LCH, and CCMR supported the proposed

rule. According to CCMR, the proposed rule would help to encourage an

open marketplace.

KCC commented that the proposed rule is not workable because a DCO

may not have the operational capacity to admit all applicants that

satisfy the DCO's membership requirements. KCC proposed that the

regulation clarify that a DCO may set limits on the number of market

participants that may be admitted in light of the DCO's own operational

constraints.

The Commission is adopting Sec. 39.12(a)(1)(ii) as proposed. The

Commission is concerned that permitting a DCO to set a limit on the

number of market participants that may become clearing members could

enable a DCO to evade the open access requirement imposed by Core

Principle C. If a DCO were able to demonstrate that operational

constraints prevented it from admitting additional clearing members,

the DCO could petition the Commission for an exemption.

d. Non-Discriminatory Treatment--Sec. 39.12(a)(1)(iii)

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. LCH

and SDMA supported the proposed rule. CME commented that in addition to

credit risk and deficiencies in operational capabilities, legal risk

should be included in the text of this regulation as a basis upon which

a DCO may exclude or limit clearing membership of certain types of

participants.

KCC did not support the proposed rule, commenting that a DCO's

right to exclude or place limitation on certain clearing members should

not be subject to ex-post determinations as to the necessity of such

restrictions, as the DCO itself is in the best position to monitor the

risks posed by the activities of its clearing members. According to

KCC, the proposed rule would limit the risk management capabilities of

a DCO, and DCOs should be accorded flexibility in their assessments of

the operational capabilities of potential clearing members.

The Commission is adopting Sec. 39.12(a)(1)(iii) as proposed.

CME's concerns regarding heightened legal risk, such as the inability

to attach property of a foreign clearing member under foreign law, are

encompassed within the ``credit risk'' consideration. The Commission

expects that most, if not all, bases for membership exclusion or

limitation will fall within either financial or operational

considerations. In addition, the Commission does not believe the rule

would limit a DCO's risk management capabilities as KCC suggested

because it would not prevent a DCO from excluding or limiting certain

types of market participants from clearing if such participation would

introduce genuine risk that cannot be adequately managed by the DCO.

The Commission expects that DCOs will review their existing

participation requirements for compliance with this rule.

e. Prohibition of Swap Dealer Requirement--Sec. 39.12(a)(1)(iv)

Proposed Sec. 39.12(a)(1)(iv) would prohibit a DCO from requiring

that clearing members be swap dealers. LCH commented that, in the event

of default, it relies on non-defaulting clearing members to hedge the

defaulting member's swap portfolio; to provide liquidity for such

hedging; to bid on hedged portfolios; and, in extreme circumstances, to

accept a forced allocation of swaps, which could be a risky, unhedged

swaps portfolio. LCH commented that a clearing member who is not a swap

dealer may not be able to participate in a DCO's default management

process.

The Commission is adopting Sec. 39.12(a)(1)(iv) as proposed. It is

important to note that the regulation would not preclude participation

by swap dealers (on which LCH currently relies). It simply requires

that a DCO provide clearing access to other entities that could also

participate in a DCO's default management process, even if to a lesser

extent. Broader access is supported by other Commission regulations,

e.g., Sec. 39.12(a)(3), which mandates that a DCO require its clearing

members to have adequate operational capacity to participate in default

management activities; Sec. 39.12(b)(5), which requires a DCO to

select contract units for clearing purposes that maximize liquidity,

facilitate

[[Page 69354]]

transparency in pricing, promote open access, and allow for effective

risk management; and Sec. 39.16(c)(2)(iii), which permits a DCO to

require its clearing members to accept an allocation, provided that any

allocation must be proportional to the size of the clearing member's

positions at the DCO. Thus, a DCO should be able to establish

participation requirements that allow it to rely on non-defaulting

clearing members to hedge a defaulting member's swap portfolio, to

provide liquidity for such hedging, to bid on hedged portfolios, and to

accept a forced allocation of swaps.

f. Prohibition of Swap Portfolio or Swap Transaction Volume

Requirements--Sec. 39.12(a)(1)(v)

Proposed Sec. 39.12(a)(1)(v) would prohibit a DCO from requiring

clearing members to maintain a swap portfolio of any particular size,

or that clearing members meet a swap transaction volume threshold.

According to State Street, such requirements are intended to

systematically favor membership for financial institutions that are

also substantial dealers in swaps. They do not take into account the

risk management capabilities of many DCO members such as State Street,

which are able to closely monitor risk exposures and effectively

liquidate exposures through networks of interdealer relationships. The

Commission believes that such requirements would have the effect of

permitting only large swap dealers to provide clearing services. This

would be inconsistent with Core Principle C. Accordingly, the

Commission is adopting Sec. 39.12(a)(1)(v) as proposed.

g. Financial Resources--Sec. 39.12(a)(2)(i)

Core Principle C mandates that each DCO must ensure that its

clearing members have ``sufficient financial resources and operational

capacity to meet obligations arising from participation in the [DCO].''

\55\ 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.

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\55\ 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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CME commented that it supports the inclusion of parent guarantees

and credit facility funding arrangements as acceptable financial

resources for clearing members, provided that each DCO retains the

flexibility to determine the particular terms and conditions of such

arrangements. LCH, however, commented that credit facilities or funding

arrangements should not be allowed for the purposes of fulfilling

financial participation requirements. According to LCH, all clearing

members' resources should be immediately and unconditionally available.

ISDA also commented that a credit facility funding arrangement from an

unaffiliated entity should not be available to satisfy clearing member

financial resource requirements. ISDA did not believe that such funding

would be reliable.

MGEX commented that testing for extreme but plausible market

conditions would have minimal value because the test would be based on

historical records or it would be based on future assumptions that are

based on static conditions. MGEX believes that the proposed rule would

require a DCO to devise tests for clearing members to use and would

require a DCO to conduct the tests and provide the results to clearing

members. MGEX commented that this specific rule seems unnecessary

because DCOs have other methods to address risk, like increasing and

decreasing margin. It noted further that it already requires clearing

members to be in good financial standing, which includes minimum

capital requirements and a requirement to provide a parent guarantee in

certain circumstances.

The Commission is adopting Sec. 39.12(a)(2)(i) with the

modification described below. Per CME's comment, the rule provides a

DCO with the flexibility to determine what constitutes sufficient

financial resources to meet obligations arising from participation in

the DCO in extreme but plausible market conditions, and to determine

what financial resources are available to a clearing member to satisfy

this requirement.

Regarding the comments of LCH and ISDA, the rule does not require a

DCO to allow clearing members to use a credit facility funding

arrangement to meet financial resource requirements. Because such

arrangements can serve as an important source of liquidity for clearing

members, the Commission has not prohibited their possible use to

satisfy clearing member financial resource requirements. The Commission

is modifying Sec. 39.12(a)(2)(i) to clarify a DCO's discretion, by

rephrasing the second sentence to read as follows: ``A derivatives

clearing organization may permit such financial resources to include,

without limitation, a clearing member's capital, a guarantee from the

clearing member's parent, or a credit facility funding arrangement.''

To address concerns about reliability, a DCO can consider requiring

that a credit facility funding arrangement be supported by multiple

lenders.

Finally, the Commission does not believe that MGEX's comment

provides a basis for revising the proposed rule. As an initial matter,

Core Principle C requires each DCO to establish participation standards

that require a clearing member to have sufficient financial resources

to meet obligations arising from participation in the DCO. Core

Principle B requires a DCO to maintain financial resources that would

enable it to meet its financial obligations in ``extreme but

plausible'' market conditions. The Commission believes that it is

appropriate for a DCO to subject its clearing members to a comparable

financial standard to support its own compliance with statutory

requirements. A DCO would have discretion in setting the terms of any

tests to determine whether clearing members' financial resources are

sufficient to meet their obligations in extreme but plausible market

conditions.

h. Capital Requirements Must Match Capital to Risk--Sec.

39.12(a)(2)(ii)

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, which appropriately match capital to risk.

The capital requirements also would have to be scalable so that they

are proportional to the risks posed by clearing members.

J.P. Morgan, MFA, ISDA, State Street, SDMA, Citadel LLC (Citadel),

Better Markets, and FIA supported the proposed rule. According to

Better Markets, the proposed rule is an important change of practices

that will open DCO membership to more market participants while

protecting the risk management system. FIA commented that a DCO, when

it sets capital requirements, should take into account a clearing

member's risk-derived exposures and its potential assessment

obligations at each clearing organization of which it is a member. FIA

recommended that a DCO should allow an FCM to clear positions in

proportion to its capital net of those other risk-derived exposures and

assessment obligations.

The Commission is adopting Sec. 39.12(a)(2)(ii) as proposed, with

one modification. In response to a comment from staff of the Federal

Reserve and the Federal Reserve Bank of New York, the

[[Page 69355]]

Commission is deleting the phrase ``so that they are proportional''

from the rule. This is to make clear that a DCO should take into

account nonlinear risk. In response to FIA's comment, the Commission

notes that in setting scalable requirements, a DCO should take into

consideration risks that a clearing member carries as a result of

positions cleared at other DCOs, to the extent that it is able to

obtain such information.

i. Minimum Capital Requirement--Sec. 39.12(a)(2)(iii)

Proposed Sec. 39.12(a)(2)(iii) would prohibit a DCO from setting a

minimum capital requirement of more than $50 million for any person

that seeks to become a clearing member in order to clear swaps.

Pierpont Securities LLC (Pierpont), Better Markets, SDMA, Newedge, MFA,

Citadel, and Jefferies & Company (Jefferies) supported the proposed

rule.

Jefferies commented that the proposed rule would allow it to

participate more actively in the swap market. Jefferies believes that

taken together, the provisions of proposed Sec. 39.12(a) provide a DCO

with more than sufficient authority to assure the financial integrity

and efficient operation of its swaps clearing activities.

Newedge commented that the proposed rule should not increase risk

to a DCO because a DCO can mitigate risk by, among other things,

imposing position limits, stricter margin requirements, or stricter

default deposit requirements on lesser capitalized clearing members.

Newedge proposed that the Commission prohibit DCOs from imposing a

requirement that clearing members have an internal trading desk capable

of liquidating or hedging a defaulting clearing member's positions. It

said that there is no need for such a requirement because a non-

defaulting member can handle a default event in a variety of ways,

including having a contingent default manager. Newedge noted that under

proposed Sec. 39.16(c)(2)(iii), any obligation of a clearing member to

participate in an auction, or to accept the allocation of a defaulting

clearing member's positions, would be proportionate to the size of the

clearing member's own position at the DCO. Thus, a clearing member

should be able to hedge an allocated position and carry the position

over time without having to take a substantial charge to its capital.

MFA commented that the threshold should not impose additional risk

on a DCO because a DCO could ensure the safety of itself and clearing

members by scaling each clearing member's net capital obligation in

proportion to that clearing member's risk exposure. MFA expressed

concern that a DCO could comply with the $50 million net capital

requirement but impose a non-risk-based and excessive threshold

guaranty fund contribution requirement that would unnecessarily exclude

clearing members. MFA proposed that the regulations require that such

scaling be determined by objective, risk-based methodologies that are

based on reasonable stress and default scenarios, and the tests be

consistently applied to all clearing members, without use of ``tiers''

that could have discriminatory or anti-competitive effects.

J.P. Morgan, the U.K. Financial Services Authority (FSA), CME, KCC,

ISDA, IntercontinentalExchange, Inc. (ICE), State Street, Federal Home

Loan Banks (FHLBanks), the Securities Industry and Financial Markets

Association (SIFMA), and LCH expressed the view that the proposed rule

could increase risk and the probability of default, and require DCOs to

accept members who might not be able to participate in the default

management process. FSA, KCC, and CME commented that a DCO must have

reasonable discretion to determine the appropriate capital requirements

for its clearing members based upon the DCO's analysis of the

particular characteristics of the swaps that it clears.

J.P. Morgan, however, commented that a cap on a member's minimum

capital requirement would not impact the systemic stability of a DCO as

long as: (1) Clearing members clear house and client business in

proportion to their available capital; (2) DCOs employ real-time risk

management processes to ensure compliance with this principle; (3) DCOs

hold a sufficient amount of margin and funded default guarantee funds;

and (4) the Commission monitors clearing members to ensure that they

are able to meet their financial obligations with respect to all DCOs

of which they are members.

LCH and ISDA commented that the lower threshold could increase risk

because a $50 million threshold would allow a clearing member to meet

the eligibility requirements of multiple DCOs.

LCH, CME, and FSA commented that the smaller firms may be unable to

participate in the default management process. LCH and ISDA also

commented that members should not be able to outsource default

management to third parties because they may not be sufficiently

reliable in times of stress.

In addition, according to ISDA, there could be conflict-of-interest

issues because the unaffiliated third party would not have ``skin in

the game.'' As a result, through the actions of the unaffiliated third

party, a clearing member could be assigned an unsuitable part of a

defaulting clearing member's proprietary portfolio and/or at a sub-

optimal valuation and/or wrongly accept customer positions from the

defaulting clearing member. This conflict-of-interest concern is

exacerbated where the entity to whom the default management obligations

are outsourced is a ``competing'' clearing member in the same DCO.

State Street and SDMA, however, commented that clearing members

should be permitted to enter into committed arrangements with non-

affiliated firms to perform default management functions. According to

SDMA, there is no evidence to suggest that a legal arrangement with a

third-party dealer somehow lessens the integrity to the system.

Assuming the legal and financial arrangements between such firms are

sufficiently strong to ensure performance when needed, State Street

commented that there is no appreciable difference between the default

management capacity of the traditional dealer-affiliated clearing

member and a non-dealer clearing member outsourcing certain functions

to a non-affiliate.

Finally, SIFMA commented that the appropriate minimum capital

requirement would be $300 million, while ISDA commented that if the

Commission cannot monitor risk across all DCOs, a $1 billion capital

requirement would be appropriate.

After carefully considering the comments, the Commission is

adopting Sec. 39.12(a)(2)(iii) as proposed. The Commission believes,

as noted in numerous comments, that the rule will increase the number

of firms clearing swaps, which will make markets more competitive,

increase liquidity, reduce concentration, and reduce systemic risk. The

Commission also believes that, as explained below, the $50 million

threshold will not significantly increase risk or lead to admission of

clearing members who are unable to meaningfully and responsibly

participate in the clearing process.

As an initial matter, the Commission emphasizes that the $50

million threshold is not arbitrary. That number was arrived at by

reviewing the capital of registered FCMs.\56\ This amount

[[Page 69356]]

captures firms that the Commission believes have the financial,

operational, and staffing resources to participate in clearing swaps

without posing an unacceptable level of risk to a DCO. This capital

threshold is considered to be appropriate, particularly in light of

other proposed rules (such as scaling capital and risk exposure and

breaking down large swap positions into smaller units for more

diversified allocation in the event of a clearing member default).

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\56\ See transcript of December 16, 2010 Commission meeting at

77-81 available at www.cftc.gov (discussing $50 million threshold;

Commission staff stating that of 126 FCMs, 63 currently have capital

above $50 million and most FCMs with capital below that amount are

not clearing members).

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The Commission considered whether to increase the capital threshold

to $300 million as proposed by SIFMA or $1 billion as proposed by ISDA.

The Commission analyzed the reduction in the number of firms that would

be eligible to clear at CME, ICE Clear US, KCC, MGEX, and OCC using

these thresholds. As set forth in the table below, depending on the

basis used to measure capital, a capital threshold of $300 million

would reduce the number of firms able to clear by 38-51 percent. A

capital threshold of $1 billion would reduce the number of firms able

to clear by 62-65 percent. The Commission believes that this reduction

in participation would be contrary to the Congressional mandate for

open access to clearing.\57\

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\57\ Clearing FCM and non-clearing FCM data for adjusted net

capital and excess net capital was provided by FCM registrants and

is available on the Commission Web site. The other data is non-

public. Ownership equity data was provided by FCM registrants

through the monthly financial statements that are submitted to the

Commission. The data from the monthly financial statements reside in

the Commission's RSR Express system, and all data for clearing non-

FCMs was provided by the DCOs to the Commission's Risk Surveillance

Group during the course of its routine oversight activities.

[GRAPHIC] [TIFF OMITTED] TR08NO11.000

The Commission does not believe that the rule will increase risk.

Section 39.12(a)(2)(ii) requires DCOs to impose capital requirements

that are scalable to the risks posed by clearing members. Accordingly,

a small clearing member should not be able to expose a DCO to

significant risk even if it is able to clear at multiple DCOs because

its exposure at each DCO would be limited. DCOs that participate in the

Shared Market Information System (SHAMIS) will be able to see a

clearing member's pays and collects across participating DCOs, and a

DCO also could on its own initiative require clearing members to

directly report their clearing activity at other DCOs. The Commission

also will be able to monitor clearing member exposure by means of DCO

end-of-day reporting under the reporting requirements of Sec.

39.19(c)(1)(i), which the Commission is adopting herein. It will also

be able to monitor the financial strength of clearing members that are

registrants pursuant to financial reporting requirements.

In addition, the Commission is adopting other rules that will

reinforce a DCO's oversight of its clearing members. In this regard,

Sec. 39.12(a)(4) requires a DCO to verify, on an ongoing basis, the

compliance of each clearing member with each participation requirement;

Sec. 39.12(a)(5) requires a DCO to require all clearing members to

file periodic financial statements and timely information that concerns

any financial or business developments that may materially affect the

clearing members' ability to continue to comply with participation

requirements; and Sec. 39.13(h)(5) further requires a DCO to adopt

rules that require clearing members to maintain current risk management

policies and procedures and requires a DCO to review such policies and

procedures on a periodic basis. The Commission also has proposed

requirements for clearing member risk management.\58\

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\58\ See 76 FR 45724 (Aug. 1, 2011) (Clearing Member Risk

Management).

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

The Commission does not believe that the $50 million threshold

would lead to a DCO having to admit clearing members that are unable to

participate in the default management process. As discussed above, the

regulation does not preclude highly-capitalized entities (such as swap

dealers) from participating in a DCO as clearing members. Thus, the

addition of smaller clearing members does not eliminate the role that

larger clearing members can play in default management--it merely

spreads the risk.

The Commission wishes to emphasize that it will review DCO

membership rules as a package in light of all of the provisions of

Sec. 39.12(a). Thus, a DCO may not circumvent Sec. 39.12(a)(2)(iii)

by enacting some additional financial requirement that effectively

renders the $50 million threshold meaningless for some potential

clearing members. Such an arrangement would violate Sec.

39.12(a)(1)(i) (less restrictive alternatives), or Sec.

39.12(a)(1)(iii) (exclusion of certain types of firms).

As discussed below, under Sec. 39.12(a)(3), a DCO's participation

requirements must include provisions for adequate operational capacity.

This requirement should be read in conjunction with Sec.

39.12(a)(1)(i), which prohibits restrictive clearing member standards

if less restrictive standards could be adopted; Sec. 39.12(a)(1)(iii),

which prohibits DCOs from excluding certain types of market

participants from clearing membership if they can fulfill the

obligations of clearing membership; and Sec. 39.16(c)(2)(iii), which

permits a DCO to require a clearing member to participate in an auction

or to accept allocations of a defaulting clearing member's customer or

house positions, provided the allocated positions are proportional to

the size of the clearing member's positions at the DCO and are

permitted to be outsourced to a qualified third party subject to

safeguards imposed by the DCO.

Several commenters discussed the use of outsourcing to satisfy

default management obligations. The Commission believes that open

access to clearing and effective risk management need not be viewed as

conflicting goals. Subject to appropriate safeguards, outsourcing of

certain obligations can be an effective means of harmonizing these

goals. For example, a small clearing member might have less ability to

contribute meaningfully to a DCO's

[[Page 69357]]

auction process acting on its own than if an entity with greater

expertise in the relevant markets acted in its place.

Therefore, the Commission believes that it would be inconsistent

with Sec. 39.12(a)(1)(i) and Sec. 39.12(a)(1)(iii) for a DCO to

prohibit outsourcing. Accordingly, as discussed below, the Commission

is adopting revised default procedure rules to require a DCO to permit

outsourcing to qualified third parties of obligations to participate in

auctions or in allocations, subject to appropriate safeguards imposed

by the DCO.\59\

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\59\ See discussion of revised Sec. 39.16(c)(2)(iii) in section

IV.G.4, below.

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Finally, the Commission has determined that it will not permit a

DCO to require members to post a minimum amount of liquid margin or

default guarantee contributions, or to participate in a liquidity

facility per J.P. Morgan's suggestion. The Commission believes that the

rules are sufficient to ensure that each member has adequate resources

to withstand another member's default and such requirements could be

used by a DCO to evade the open access to clearing intended by the

Dodd-Frank Act.

j. Operational Requirements--Sec. 39.12(a)(3)

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

clearing members to have adequate operational capacity to meet their

obligations arising from participation in the DCO. The requirements

would include, but not be 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 DCO; and the ability to participate in default

management activities under the rules of the DCO and in accordance with

proposed Sec. 39.16.

LCH, FIA, Jefferies, and SDMA commented that the Commission has

correctly identified the operational requirements. Jefferies commented

that demonstrating sufficient operational capacity is more important

than capital considerations. According to SDMA, these operational

requirements are directly related to the core business of the clearing

member and provide the services needed and relied upon by the DCO to

clear trades. SDMA also believes that DCOs should be prohibited from

imposing operational requirements that are not part of a clearing

member's core business because they create discriminatory barriers to

clearing, and it points to the following as examples of discriminatory

operational eligibility requirements: Clearing members must (1) Have

both execution and clearing capabilities; (2) provide end-of-day prices

to mark its positions; and (3) have extensive experience in clearing

swaps or ``sophistication.''

J.P. Morgan and FIA commented that a DCO must ensure that each

member has risk management resources to assist the DCO in its risk

management process, and FIA suggested that the final rules add

appropriate risk management requirements as a participant eligibility

criterion, or make clear that nothing in the proposed rules is intended

to prevent a DCO from adopting such requirements.

ISDA commented that the ability to bid for portfolios of other

clearing members of the DCO is critically important. According to ISDA,

an appropriate risk management framework for a clearing member may be

broadly categorized as follows: (1) Board and senior management

oversight; (2) organizational structure; and (3) strong systems and

procedures for controlling, monitoring and reporting risk.

Finally, State Street commented that a clearing member must be able

to demonstrate it can carry out its obligations to a DCO under a

default scenario. That demonstration could include having the capacity

to trade swaps using experienced swap traders, and the ability to

execute transactions in the market by having appropriate trading

relationships. A clearing member must also demonstrate an ability to

monitor positions, calculate potential losses and market risk, perform

stress tests, and maintain liquidity, among numerous other

requirements.

The Commission is adopting Sec. 39.12(a)(3) as proposed. The

Commission believes that the rule correctly identifies the necessary

operational requirements and is concerned that the heightened

operational requirements suggested by some commenters could allow a DCO

to evade the open access to DCO clearing intended by the Dodd-Frank

Act. The Commission emphasizes that under the rule, any operational

requirements must be necessary to meet clearing obligations. In

addition, the Commission is adopting Sec. 39.13(h)(5) herein, which

requires a DCO to adopt rules requiring clearing members to maintain

current written risk management policies and procedures.\60\ The

Commission has also proposed rules requiring clearing members that are

FCMs (proposed Sec. 1.73) and swap dealers and major swap participants

(proposed Sec. 23.609) to engage in specific risk management

activities.\61\

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\60\ See discussion of Sec. 39.13(h)(5) in section IV.D.7.e,

below.

\61\ See 76 FR at 45729-45730 (Aug. 1, 2011) (Clearing Member

Risk Management).

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k. Monitoring, Reporting, and Enforcement--Sec. 39.12(a)(4)

Core Principle C requires each DCO to ``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.'' \62\ Proposed Sec. 39.12(a)(4) would codify

these requirements.

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

\62\ See Section 5b(c)(2)(C)(ii) of the CEA; 7 U.S.C. 7a-

1(c)(2)(C)(ii).

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

OCC supported the proposed rule ``if interpreted reasonably.'' J.P.

Morgan commented that a clearing member may have committed to

additional unfunded assessments at more than one clearinghouse and

proposes that the Commission and DCOs monitor clearing members to

ensure that they have sufficient liquid resources to support the

business they clear at each DCO. According to J.P. Morgan, a DCO should

monitor exposures against risk-based position limits on a real-time

basis.

The Commission is adopting Sec. 39.12(a)(4) as proposed. In

response to J.P. Morgan's comments, the Commission notes that in

monitoring firms, a DCO should take into consideration risks that the

firm faces outside of that DCO. The Commission further notes that it is

not prescribing the means by which DCOs should monitor compliance.

l. Reporting Requirements--Sec. 39.12(a)(5)

Proposed Sec. 39.12(a)(5)(i) would mandate that a DCO require all

clearing members, including those that are not FCMs, to file with the

DCO periodic financial reports containing any financial information

that the DCO determines is necessary to assess whether participation

requirements are met on an ongoing basis. The proposed rule also would

mandate that a DCO require 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, and would require the DCO to review all such

financial reports for risk management purposes. Proposed Sec.

39.12(a)(5)(i) would also 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

[[Page 69358]]

request. Proposed Sec. 39.12(a)(5)(ii) would mandate that a DCO adopt

rules that require clearing members to provide to the DCO, 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.

LCH commented that a DCO based outside the U.S. may have clearing

members that are not subject to the Commission's jurisdiction and would

be regulated in their home jurisdiction. LCH proposed this provision be

revised such that only FCMs and U.S.-based members that are not FCMs

are required to provide this information to the Commission upon

request. According to LCH, all other members should be required to

submit the information to the DCO only or to their equivalent local

regulator.

LCH and MGEX commented that proposed Sec. 39.12(a)(5)(ii) would be

more appropriately imposed on clearing members themselves, rather than

on the DCO. KCC suggested that the Commission should evaluate its

statutory authority to enact the proposed rule. MGEX commented that the

proposed rules appear to require clearing members to report to each DCO

with which they clear, which would create an additional, duplicative

burden on clearing members. MGEX suggested that the Commission regulate

the clearing members directly. As an alternative, MGEX proposed a new

industry group similar to the Joint Audit Committee (JAC) in which each

DCO would be represented and participate in developing an overall risk

management program that would be used in fulfilling the new proposed

requirements.

The Commission is adopting Sec. 39.12(a)(5) with modifications to

(1) provide that the financial information provided by non-FCM clearing

members may be submitted by the clearing members to the Commission

pursuant to DCO rules or may be submitted to the Commission by the DCO,

in either case, upon the Commission's request; and (2) eliminate the

proposed requirement that the DCO must review clearing members'

financial reports for risk management purposes.

The rule is intended to address circumstances where the Commission

must obtain information in the possession of a clearing member. The

Commission anticipates such requests will be few in number. However,

when those occasions arise, the Commission must be able to obtain the

information as expeditiously as possible. The rule addresses this need

by allowing the Commission to obtain the information directly from the

source and to minimize the burden on DCOs. In response to the comments,

the Commission is revising the rule to provide that a DCO may either

provide the requested information directly to the Commission or require

clearing members to provide the information to the Commission.

The Commission is eliminating the requirement that the DCO must

review clearing members' financial reports for risk management

purposes. Upon further consideration, the Commission has concluded that

although a DCO may review such financial reports for several reasons,

including risk management and to ensure that clearing members continue

to meet participation requirements, it is not necessary to be

prescriptive in this regard.

In response to MGEX suggestion of a new industry group, Commission

staff is considering such a step.

The Commission is making certain technical revisions to Sec.

39.12(a)(5) in connection with these changes.

m. Enforcement of Participation Requirements--Sec. 39.12(a)(6)

Proposed Sec. 39.12(a)(6) would require a DCO to enforce

compliance with its participation requirements and establish procedures

for the suspension and orderly removal of clearing members that no

longer meet the requirements. MGEX commented that the proposed rule

goes beyond the language of the Dodd-Frank Act.

The Commission is adopting Sec. 39.12(a)(6) as proposed. A DCO

must have the ability to enforce compliance with its participation

requirements or its clearing members may not satisfy these

requirements. A DCO also must have procedures for the suspension and

orderly removal of clearing members that no longer meet the

requirements. Otherwise, the enforcement process may not be orderly and

could introduce additional risk to the DCO. This requirement

complements Sec. 39.17, adopted herein, which implements Core

Principle H (Rule Enforcement).\63\

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\63\ See discussion of Sec. 39.17 in section IV.H, below.

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2. 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. Proposed Sec. 39.12(b)

would codify these requirements.

a. General Comments

Citadel and MFA supported the proposed rules. To ensure non-

discriminatory clearing, Citadel and MFA recommended the Commission

make explicit that a DCO must provide highly standardized mechanisms

and procedures for establishing connectivity with SEFs and any other

permitted trading venue. According to Citadel, these mechanisms and

procedures must be objective, commercially reasonable, publicly

available, and treat all applicant execution facilities in an unbiased

manner. Citadel and MFA also proposed that the rules mandate that a DCO

keep the clearing acceptance process anonymous (i.e., without the

customer's clearing member knowing the identity of the customer's

executing counterparty).

The Commission agrees that a DCO must provide mechanisms for

establishing connectivity with SEFs and DCMs, which would provide

executing counterparties with fair and open access. The Commission has

proposed rules addressing this issue.\64\ The Commission also has

proposed rules that address the anonymity issue.\65\

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\64\ See 76 FR 13101 (Mar. 10, 2011) (Straight-Through

Processing).

\65\ See 76 FR 45730 (Aug. 1, 2011) (Customer Clearing).

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b. Products Eligible for Clearing--Sec. 39.12(b)(1)

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: (1) Trading volume; (2) liquidity; (3) availability of reliable

prices; (4) ability of market participants to use portfolio compression

with respect to a particular swap product; (5) ability of the DCO and

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

creating and liquidating positions; (6) ability of the DCO to measure

risk for purposes of setting margin requirements; and (7) operational

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

characteristics of a product.\66\

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\66\ As proposed, Sec. 39.12(b)(1)(vii) referred to addressing

any ``unique'' risk characteristics of a product. The Commission is

revising this provision in the final rule to refer to any

``unusual'' risk characteristics to clarify that such

characteristics are not limited to those that are one of a kind.

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OCC noted that the factors to be considered are already among the

factors that a DCO would naturally consider and that OCC in fact

considers, and it suggested that the application of

[[Page 69359]]

this new rule be limited to swaps. OCC also noted that the trading

volume of new products is often unknown and unpredictable and suggested

that factor not be a barrier to accepting a product for clearing.

MGEX commented that the proposed rule considers legitimate factors,

but mandating that a DCO establish eligibility requirements is not

necessary, other than requirements for the contract size of swaps. Like

OCC, MGEX noted that DCOs already use these factors as part of their

sound business judgment in making these types of decisions. MGEX

recommended that the Commission issue suggested guidelines or core

principles and, on an as-needed basis, request that a DCO file with the

Commission the rationale supporting its conclusion that a contract

qualifies for clearing.

LCH expressed concerns with proposed Sec. 39.12(b)(1)(iv) and

commented that compression services have been developed only when swap

markets are relatively large and well-established, and the introduction

of cleared facilities has largely pre-dated the introduction of

compression services. According to LCH, making swap clearing contingent

on swap portfolio compression may have the effect of permitting fewer

swaps to be cleared. LCH proposed that the Commission encourage the use

of compression services where suitable and available, but not constrain

the ability of a DCO to clear a given swap based on the availability of

such services.

LCH also commented that it is imperative that a DCO have the

ability to ``transfer,'' ``auction,'' or ``allocate'' cleared swaps.

LCH proposed that the factor listed in proposed Sec. 39.12(b)(1)(v),

the ``[a]bility of the [DCO] and clearing members to gain access to the

relevant market for purposes of creating and liquidating positions'' be

modified to reflect these additional actions.

The Commission agrees with LCH that a DCO must have the ability to

``transfer,'' ``auction,'' or ``allocate'' cleared swaps and it is

revising Sec. 39.12(b)(1)(v) to incorporate LCH's suggestion.\67\ The

Commission is otherwise adopting Section 39.12(b)(1) as proposed. The

Commission believes that setting forth the minimum factors that all

DCOs must consider when determining contract eligibility is necessary

to prevent a DCO from seeking to clear transactions that present an

unacceptable level of risk. The Commission also believes that OCC's and

LCH's concerns are unfounded. The rule provides factors to be

considered and does not prohibit a DCO from accepting a product for

clearing if it does not satisfy one of the factors. Finally, the

Commission is declining to limit the rule to swaps because it believes

the eligibility factors are applicable to all products cleared by a

DCO. The Commission is also declining to issue suggested guidelines or

core principles, or to request that a DCO file with the Commission the

rationale for why a contract qualifies for clearing. The Commission

believes that Sec. 39.12(b)(1) is not burdensome because, as MGEX and

OCC commented, these factors are already considered by DCOs. In

contrast, filing rationales on an as-needed basis could be burdensome

to the DCO and the Commission, and would not serve to mitigate risk

more effectively.

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\67\ This is also consistent with Sec. 39.16(c)(2)(ii), adopted

herein and discussed in section IV.G.4, below, which requires a DCO

to adopt rules that set forth the actions that a DCO may take in the

event of a default, which must include the prompt transfer,

liquidation, or hedging of the defaulting clearing member's

positions, and which may include the auctioning or allocation of

such positions to other clearing members.

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c. Economic Equivalence--Sec. 39.12(b)(2)

Proposed Sec. 39.12(b)(2) would require a DCO to adopt rules

providing that all swaps with the same terms and conditions (as defined

by templates established under DCO rules) submitted to the DCO for

clearing are economically equivalent within the DCO and may be offset

with each other within the DCO.

ISDA, CME, and FIA commented that the term ``template'' is

inappropriate. According to ISDA, ``template'' has no clear meaning,

and it assumes that the term refers to the contract specifications

currently used by a variety of futures facilities. ISDA noted that the

development of specific templates for swap transactions is a mixed

business/technological project that requires significant discussion

involving each DCO and its market participants. It suggested that the

Commission's regulations guide the meaning of ``template'' to achieve

as much individual transactional variability as possible within the

transaction or range of transactions that a template may cover.

CME commented that references to ``templates'' are confusing

because swap dealers generally maintain standard templates for

documenting their trading relationships, and their counterparties

frequently negotiate changes to those templates. According to CME, a

DCO does not define the templates used by OTC participants, and DCO

rules do not function as templates from which counterparties may

negotiate. Rather, a DCO sets forth in its rulebook the product

specifications of each contract it accepts for clearing, including

swaps. CME suggested that the Commission revise Sec. 39.12(b)(2) to

state as follows (change in italics): ``A [DCO] shall adopt rules

providing that all swaps with the same terms and conditions, as defined

by product specifications established under [DCO] rules, submitted to

the [DCO] for clearing are economically equivalent within the [DCO] and

may be offset with each other within the [DCO].''

FIA requested that Commission confirm that economically equivalent

swaps must have the same cash flows, values, and liquidation dates. FIA

also suggested that terms and conditions of such templates--for

example, events of default--should also be consistent with market

practice.

Finally, KCC commented that the proposed rule is redundant because

Chapter 21 of the KCC rulebook already defines the terms and conditions

for swaps that KCC will clear.

The Commission is revising Sec. 39.12(b)(2) as suggested by CME to

substitute the phrase ``product specifications'' for the word

``templates.'' As noted above, some commenters found the use of the

word ``templates'' confusing. The Commission's intent was to ensure

that a DCO sets the specifications for cleared products. The Commission

is otherwise adopting the rule as proposed.

In response to FIA, the Commission confirms that it regards cash

flows, values, and liquidation dates as terms and conditions

encompassed by this rule. The Commission, however, declines to require

that terms and conditions be consistent with market practice. The

Commission believes that a DCO should have the flexibility to determine

whether to conform terms and conditions to market practice.

d. Non-Discriminatory Treatment of Swaps--Sec. 39.12(b)(3)

Proposed Sec. 39.12(b)(3) would require a DCO to provide for non-

discriminatory clearing of a swap executed bilaterally or on or subject

to the rules of an unaffiliated SEF or DCM. FIA and MFA commented in

support of the proposed rule.

OCC suggested that it should not be deemed a violation of Sec.

39.12(b)(3) for a DCO to require a SEF or DCM desiring to transmit

swaps to the DCO for clearing to enter into a non-exclusive clearing

agreement on non-discriminatory terms similar to those offered by the

DCO to other SEFs or DCMs for clearing of similar products. OCC

believes that such agreements are

[[Page 69360]]

necessary and appropriate for purposes of addressing matters between

the parties such as information sharing and furnishing price data by

the exchange to the DCO.

LCH suggested that the Commission clarify that ``non-

discriminatory'' includes costs, technology, and other related

considerations. LCH also suggested that the Commission impose the

reverse requirements on execution venues such as DCMs and SEFs, so that

those venues are also required to provide trade feeds to DCOs on a non-

discriminatory basis.

The Commission is adopting Sec. 39.12(b)(3) as proposed. In

response to OCC, the Commission notes that the rule does not prohibit a

DCO from requiring a SEF or DCM desiring to transmit swaps to the DCO

for clearing to enter into a non-exclusive clearing agreement on non-

discriminatory terms similar to those offered by the DCO to other SEFs

or DCMs for clearing of similar products. The Commission agrees that

such agreements are necessary and appropriate for purposes of

addressing matters between the parties such as information sharing and

furnishing price data by the exchange to the DCO. The Commission notes

that it expects DCOs to review clearing agreements for compliance with

Sec. 39.12(b)(3), the open access requirements of Core Principle C,

and any relevant requirements of other core principles.

In response to LCH's comment, the Commission notes that the

requirement applies to the factors LCH enumerated. The Commission also

notes that LCH's suggestion regarding trading venues is outside the

scope of this rulemaking

e. Prohibition on Requirement That Executing Party Is a Clearing

Member--Sec. 39.12(b)(4)

Proposed Sec. 39.12(b)(4) would prohibit a DCO from requiring one

of the original executing parties to be a clearing member in order for

a contract, agreement, or transaction to be eligible for clearing.

CME concurred with the Commission's analysis and fully supported

the proposed regulation. FIA, Citadel, and MFA also supported the

proposed regulation.

MFA suggested strengthening the proposed rule. According to MFA,

when a non-clearing member trades with another non-clearing member, the

clearing process should be identical and as prompt as when one of the

parties is a clearing member, so long as the transaction satisfies the

relevant DCO's rules, requirements, and standards otherwise applicable

to such trades. MFA believes that providing this parity would allow new

liquidity providers to efficiently and effectively enter into and

compete within the market.

MFA also suggested that the Commission revise the proposed rule to

prohibit a DCO from adopting rules or engaging in conduct that is

prejudicial to non-clearing members as compared to clearing members

with respect to eligibility or the timing of clearing or processing of

trades generally. The Commission has addressed this issue in the

recently proposed rules on clearing documentation.\68\

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\68\ See 76 FR 45730 (Aug. 1, 2011) (Customer Clearing).

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

ISDA commented that rules barring trades that don't involve a

clearing member as a party are inappropriate in established DCOs, but

new DCOs may need to roll out products and procedures in a contained

way. According to ISDA, ``initial decisions on which market

constituencies should have access to clearing must be the subject of

legitimate, reasoned decision-making by each DCO with regard to its

ability to properly serve each constituency and each constituency's

readiness to participate in a cleared market.''

Finally, NGX commented that if the proposed rule were applied to a

non-intermediated DCO such as NGX, the rule would require a fundamental

restructuring of the manner in which the DCO admits members, guarantees

trades, and provides risk management. DCOs like NGX require all

participants to become clearing participants at the DCO, and they do

not clear contracts that involve non-clearing participants.

The Commission is adopting Sec. 39.12(b)(4) as proposed. In

response to the comments of ISDA and NGX, the Commission notes that

some DCOs currently have only direct participants, i.e., participants

that do not offer client clearing. NGX, for example, provides direct

access to commercial end users who clear for themselves. The Commission

notes that, consistent with principles of open access, a DCO must have

rules in place to offer client clearing promptly if an FCM or a

customer requests access. However, from a cost-benefit perspective, the

Commission would expect that any DCO investment in building systems

would be proportionate to evidence of demand for the service.

Finally, in a separate rulemaking, the Commission has proposed

rules that address MFA's suggestion that trades between indirect

clearing members should have parity with trades between clearing

members.\69\

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\69\ See 76 FR 45730 (Aug. 1, 2011) (Customer Clearing).

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f. Product Standardization--Sec. 39.12(b)(5)

Proposed Sec. 39.12(b)(5) would require a DCO to select contract

unit sizes and other product terms and conditions that maximize

liquidity, facilitate transparency in pricing, promote open access, and

allow for effective risk management.\70\ To the extent appropriate to

further these objectives, a DCO would be required to select contract

units for clearing purposes that were smaller than the contract units

in which trades submitted for clearing were executed. \71\

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

\70\ See 76 FR 13101 (Mar. 10, 2011) (Straight-Through

Processing).

\71\ Id.

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

ISDA supported the goals identified by the Commission; however, it

commented that ``unit size'' is not a meaningful concept in swap

transactions because contract size is not standardized. According to

ISDA, the only meaningful size limit is the smallest unit of relevant

currency or relevant underlying. ISDA suggested that the Commission

avoid focusing on ``unit size'' and instead articulate its ultimate

objectives, as it has, leaving DCOs with the discretion to set suitable

terms and conditions to further those objectives.

FIA did not support the requirement that a DCO select contract unit

sizes because FIA does not believe that the swap market has evolved to

the point where DCOs can do this. FIA also does not believe the market

is at a point where it would be appropriate for a DCO to establish

templates regarding the terms and conditions of standardized swaps

eligible for clearing. FIA believes that requiring swaps to fit within

artificial, prescribed templates would be disruptive to the market and

would not benefit customers. FIA, however, would support a requirement

that DCOs study this matter and submit a report to the Commission on

the feasibility of establishing templates regarding the terms and

conditions of standardized swaps as soon as practicable.

Finally, LCH commented that it is not appropriate to require a DCO

to select contract units for clearing purposes that are smaller than

the contract units in which trades submitted for clearing were

executed. According to LCH, a DCO clearing swaps should be able to

accept such swaps in any size, and swaps submitted for clearing should

not

[[Page 69361]]

be broken down into sub-units. LCH suggested that the Commission strike

Sec. 39.12(b)(5) and that any rules addressing average size of

exposure traded in the swap markets be addressed in rules pertaining to

trading and execution venues.

The Commission is adopting Sec. 39.12(b)(5) as proposed. The

Commission believes that standardizing products, including swaps, by

requiring a DCO to determine product terms and conditions, including

product size, will increase liquidity, lower prices, and increase

participation. In addition, standardized products should make it easier

for members to accept a forced allocation in the event of bankruptcy.

The Commission recognizes that standardized products may create

basis risk for some hedge positions. However, this circumstance has

long existed in the futures markets. The Commission believes that the

benefits of standardization, such as competitive pricing, liquid

markets, and open access, outweigh the costs of imperfect hedging.

In response to LCH, the Commission notes that the product 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. The Commission notes that under the rule, DCOs retain some

discretion in determining how best to promote liquidity, facilitate

open access, and aid risk management.

g. Novation--Sec. 39.12(b)(6)

Proposed Sec. 39.12(b)(6) would require a DCO that clears swaps to

have rules providing that upon acceptance of a swap: (i) The original

swap is extinguished; (ii) the original swap is replaced by equal and

opposite swaps between clearing members and the DCO; (iii) the terms of

the cleared swaps 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.

Newedge supported this rule, in particular, the requirement for

standardization.

CME, FIA, and ICE commented that the proposed rule appears to

presume the use of a ``principal'' model for all cleared swaps, even

those swaps cleared on behalf of customers. CME noted that at CME, an

FCM clearing customer business acts as an agent for undisclosed

principals (i.e., the FCM's customers) vis-a-vis CME and guarantees its

customers' performance to CME. CME suggested that in order to preserve

the agency model for customer-cleared swaps, the Commission should

adopt a revised Sec. 39.12(b)(6)(ii) to provide that, upon acceptance

of a swap for clearing, ``the original swap is replaced by equal and

opposite swaps with the DCO.'' As previously noted, CME also commented

that the use of the term ``template'' is confusing. It suggested that

the Commission revise Sec. 39.12(b)(6)(iii) to state: ``All terms of

the cleared swaps must conform to product specifications established

under [DCO] rules.''

FIA commented that the proposed rule would conflict with the FCMs'

position that, with respect to customer positions, FCMs are acting as

agent, and not as principal, for customers in executing and clearing

swaps (and futures) on behalf of customers. FIA suggested that the

proposed rule be revised to confirm that, in clearing swaps on behalf

of customers, a clearing member shall be deemed a guarantor and agent

of a cleared swap and not a principal.

ICE noted that U.S. futures markets may clear on an open offer

basis, which allows straight-through processing. ICE commented that the

Commission should not preclude open offer clearing of swaps by

requiring the underlying swap to be novated.

Finally, LCH suggested that the Commission revise the rule so that

the obligation would fall on the clearing member rather than the DCO

because the provisions relate to the clearing member's books and

records, not the DCO's.

The Commission is adopting Sec. 39.12(b)(6) with modifications to

clarify its intended meaning. In response to the comments from CME,

FIA, and ICE, the Commission is revising Sec. 39.12(b)(6)(ii) to

provide that a DCO that clears swaps must have rules providing that,

upon acceptance of a swap by the DCO for clearing, ``[t]he original

swap is replaced by an equal and opposite swap between the derivatives

clearing organization and each clearing member acting as principal for

a house trade or acting as agent for a customer trade.''

In response to the comment from CME, the Commission is revising

Sec. 39.12(b)(6)(iii) to substitute the phrase ``product

specifications'' for the word ``templates.'' This is consistent with

the change to Sec. 39.12(b)(2), discussed above.

In response to the comment by ICE, the Commission notes that ``open

offer'' systems are acceptable under the rule. Effectively, under an

open offer system there is no ``original'' swap between executing

parties that needs to be novated; the swap that is created upon

execution is between the DCO and the clearing member, acting either as

principal or agent.

Finally, with regard to LCH's comment, the Commission believes that

it is proper for the requirement to fall on the DCO. The DCO is the

central counterparty and is responsible for the transaction going

forward.

h. Confirmation of Terms--Sec. 39.12(b)(8)

Proposed Sec. 39.12(b)(8) would require a DCO to have rules that

provide that all swaps submitted to the DCO for clearing must include

written documentation that memorializes all of the terms of the

transaction and legally supersedes any previous agreement.\72\ The

confirmation of all terms of the transaction would be required to take

place at the same time as the swap is accepted for clearing.

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\72\ This provision was originally designated as Sec.

39.12(b)(7)(v) in 76 FR 13101 (Mar. 10, 2011) (Straight-Through

Processing). It was later proposed to be renumbered as Sec.

39.12(b)(8) in 76 FR 45730 (Aug. 1, 2011) (Customer Clearing).

Section 39.12(b)(7), as currently proposed (76 FR at 13110), will be

addressed in a separate final rulemaking.

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CME suggested that the Commission revise the proposed regulation to

require a DCO to ``provide each clearing member carrying a cleared swap

with a definitive record of the terms of the agreement, which will

serve as a confirmation of the swap.''

ISDA commented that it is not clear what efficiencies the proposed

rule would achieve for the parties to the swap in confirming through a

DCO. It suggested that the Commission be less prescriptive and

recognize that the act of clearing a swap transaction through a DCO in

and of itself should produce a definitive written record, tailored to

the particular category of swap transaction by the DCO and its market

constituency, which fulfills the Commission's objective of facilitating

the timely processing and confirmation of swaps not executed on a SEF

or a DCM.

FIA requested that the Commission clarify the obligations of the

parties under this proposed rule. According to FIA, the rule appears to

place

[[Page 69362]]

responsibility on the parties to the swap to submit a written

confirmation of the terms of the transaction to the DCO, which, upon

acceptance by the DCO, will supersede any prior documents and serve as

the confirmation of the trade. However, the notice of proposed

rulemaking places responsibility on the DCO, explaining that the

proposed rule ``would require that DCOs accepting a swap for clearing

provide the counterparties with a definitive written record of the

terms of their agreement, which will serve as a confirmation of the

swap.'' Further, the proposed rule appears to apply to all swaps

submitted for clearing, but the notice of proposed rulemaking appears

to limit the requirement to swaps not executed on a SEF or DCM, noting

that swaps executed on a SEF or DCM are confirmed upon execution.\73\

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\73\ The notice of proposed rulemaking states: ``Proposed Sec.

39.12(b)(7)(v) would require that DCOs accepting a swap for clearing

provide the counterparties with a definitive written record of the

terms of their agreement, which will serve as a confirmation of the

swap.'' 76 FR at 13105-13106 (Mar. 10, 2011) (Straight-Through

Processing).

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OCC commented that the terms and conditions applicable to a cleared

swap would already be specified in the DCO rules or product

specifications, and it does not think it is necessary for a DCO to

provide a confirmation that is similar in form to detailed trade

documentation such as an ISDA Master Agreement. OCC believes that the

term ``written documentation'' should be interpreted broadly to mean

any documentation that sufficiently memorialized the agreement of the

counterparties with respect to the terms of a swap, which may consist

of a confirmation (electronic or otherwise) that confirms the values

agreed upon for terms that can be varied by the parties.

MarkitSERV noted that the proposed rule would require a

confirmation of all terms of the transaction at the time the swap is

accepted for clearing, and commented that the rule is unclear as to

whether, when a swap is to be submitted for clearing, confirmation

would ever be required of the pre-clearing initial transaction between

the original counterparties. In contrast, the Commission has elsewhere

stated that it expects a DCO to require pre-clearing transactions to be

confirmed before clearing.\74\ MarkitSERV also noted that when a

transaction is not rapidly accepted for clearing the parties will still

be responsible for confirming the transaction under Commission

regulations. It recommended that the Commission clarify that when a

transaction is not accepted for clearing within the time frame

established for mandatory confirmation the parties should be permitted

to satisfy their confirmation obligations by confirming the transaction

prior to clearing.

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\74\ See 75 FR 81519, at 81521 (Dec. 28, 2010) (Confirmation,

Portfolio Reconciliation, and Portfolio Compression Requirements for

Swap Dealers and Major Swap Participants) (``if a swap is executed

bilaterally, but subsequently submitted to a DCO for clearing, the

DCO will require a definitive written record of all terms to the

counterparties' agreement prior to novation by the DCO'').

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The Commission is adopting Sec. 39.12(b)(8) in modified form to

read as set forth in the regulatory text of this final rule.

The change to the heading is responsive to the comment by FIA that

it was unclear whether the rule applied to all cleared swaps or only to

those that are executed bilaterally. Regardless of the execution venue,

confirmation of a cleared swap is ultimately provided by the DCO. In

the case of a trading facility with a central limit order book,

execution and acceptance for clearing are simultaneous and confirmation

occurs at that time. In all other cases, there is an interim time

between execution and acceptance, or rejection, for clearing.

The Commission notes that applicable confirmation requirements may

depend on the length of time between execution and acceptance or

rejection for clearing. For example, if a trade executed on a SEF is

accepted for clearing within seconds, the DCO notification would serve

as the single confirmation. But, if a trade is executed bilaterally and

later submitted for clearing, there may need to be an initial bilateral

confirmation that is later superseded by the clearing confirmation.

The changes to the text are responsive to the comments of FIA, CME,

ISDA, OCC, and MarkitSERV. As FIA pointed out, the proposed rule text

seems to place the confirmation obligation on the submitting parties,

while the discussion in the notice of proposed rulemaking places it on

the DCO. Consistent with the language in the discussion and the

recommendations of FIA, CME, and ISDA, the revised rule clarifies that

DCOs provide confirmations of cleared trades. This interpretation was

implicit in the proposal given that the second sentence of the rule

provides that confirmation takes place when the trade ``is accepted''

for clearing.

D. Core Principle D--Risk Management--Sec. 39.13

Core Principle D, \75\ as amended by the Dodd-Frank Act, 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 non-defaulting clearing members would not be exposed to losses

that non-defaulting clearing members cannot anticipate or control.

Finally, Core Principle D provides that a DCO must require margin from

each clearing member 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. The Commission proposed to adopt Sec. 39.13 to establish

requirements that a DCO would have to meet in order to comply with Core

Principle D.

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\75\ Section 5b(c)(2)(D) of the CEA, 7 U.S.C. 7a-1(c)(2)(D).

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1. General--Sec. 39.13(a)

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 Commission did not receive any comments on proposed

Sec. 39.13(a) and is adopting Sec. 39.13(a) as proposed.

2. Risk Management Framework--Sec. 39.13(b)

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. In addition, proposed Sec. 39.13(b) would require

a DCO to regularly review its risk management framework and update it

as necessary.

Mr. Barnard recommended that the Commission comprehensively and

explicitly address all elements that make up a risk management

framework, including organizational structure, governance, risk

functions, internal controls, compliance, internal audit,

[[Page 69363]]

and legal functions.\76\ In particular, with respect to organizational

structure, Mr. Barnard noted that reporting lines and the allocation of

responsibilities and authority within a DCO should be clear, complete,

well-defined and enforced.

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\76\ Mr. Barnard also recommended that the Commission focus more

on operational risk and the role of reporting and public

disclosures. With respect to operational risk, the Commission notes

that it is adopting Sec. 39.18 herein, which addresses system

safeguards, and which is discussed in section I, below. Reporting

and public information are addressed in Sec. Sec. 39.19 and 39.21,

respectively, also adopted herein, which are discussed in sections J

and L, respectively, below.

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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 and the manner in which they may

relate to each other. The Commission believes that a written risk

policy is important because it will help to ensure the DCO has

carefully considered its risk management framework, and it will provide

guidance to DCO management, staff, and market participants. It will

also allow the Commission to assess the DCO's risk management framework

more efficiently. The risks to be addressed 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. However, the Commission does not

believe that it is necessary to explicitly list such risks in the final

rule.

MGEX commented that the documentary and procedural requirements of

proposed Sec. 39.13(b) would impose heavy costs and turn the goal of

practical risk management into one of paperwork compliance, and that

while having a framework containing all the various policies can be

beneficial for DCOs, the development and implementation of such

policies must be flexible and left to each DCO. The Commission notes

that DCOs generally already have certain written risk management

policies, procedures and controls, although the substance, level of

detail, and integration of each DCO's documentation of such policies,

procedures and controls may vary. The Commission believes that Sec.

39.13(b) provides DCOs with the appropriate amount of flexibility with

regard to the documentation of their risk management frameworks,

without imposing significant additional costs upon DCOs.

OCC noted that its risk management policies are highly complex and

are embodied in multiple separate written documents, and much of its

day-to-day operations are related to risk management. OCC stated that

the Commission should make it clear that the proposal would not require

the board to approve every document related to risk management, as it

would be burdensome and would inappropriately require the board to

micro-manage the day-to-day functions of a DCO. OCC indicated that it

does not believe that the function of the committee that is responsible

for the oversight of its risk management activities would be enhanced

by the creation of additional written policies, procedures, and

controls.

The Commission recognizes that many of the day-to-day functions of

a DCO are related to risk management, and Sec. 39.13(b) is not

intended to require that a DCO's board must approve every document at a

DCO that addresses risk management issues nor is it intended to require

that a DCO's board must approve every day-to-day decision regarding the

implementation of the DCO's risk management framework.

CME and ICE took the position that a DCO's Risk Management

Committee should have the authority to approve the written policies,

procedures, and controls that establish a DCO's risk management

framework, noting that this would be consistent with proposed Sec.

39.13(c), which would require a DCO's Chief Risk Officer to make

appropriate recommendations to the DCO's Risk Management Committee or

board of directors, as applicable, regarding the DCO's risk management

function.

The Commission believes that a DCO's risk management framework

should be subject to the approval of its board of directors. The

Commission recognizes that a DCO's Risk Management Committee may play a

crucial role in the development of the risk management policies of a

DCO. However, the board has the ultimate responsibility for the

management of the DCO's risks. Requiring board approval of a DCO's risk

management framework is also consistent with proposed international

standards.\77\

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\77\ See CPSS-IOSCO Consultative Report, Principle 2:

Governance, Key Consideration 5, at 23.

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In addition, a requirement that a DCO's board approve its risk

management framework is consistent with Sec. 39.13(c), which permits a

DCO's Chief Risk Officer to make appropriate recommendations to the

DCO's Risk Management Committee regarding the DCO's risk management

functions. Although the board would approve the framework, it could

delegate defined decision-making authority to the Risk Management

Committee in connection with the implementation of the framework. The

Commission is adopting Sec. 39.13(b) as proposed.

3. Chief Risk Officer--Sec. 39.13(c)

Proposed Sec. 39.13(c) would require a DCO to have a Chief Risk

Officer (CRO) 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.\78\

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\78\ See 75 FR at 63750 (Oct. 18, 2010) (Conflicts of Interest).

In that proposed rulemaking, the provisions relating to the Risk

Management Committee were designated as Sec. 39.13(g). In the final

rulemaking with respect to that proposal, those provisions will be

redesignated as Sec. 39.13(d).

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Better Markets commented that the proposal should provide

substantive parameters for a CRO and that the CRO rules applicable to

FCMs should be applied to DCOs. Mr. Greenberger indicated that the CRO

of a DCO should be subject to the same rules regarding reporting and

independence as the CROs of other registered entities.

The Commission does not believe that it is necessary to further

define the responsibilities of a DCO's CRO in the final rule. The

Commission notes that it has not proposed any rules regarding a CRO for

FCMs or any other registered entities, as suggested by Better Markets

and Mr. Greenberger.\79\

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\79\ However, the Commission has proposed rules regarding a CCO

for futures commission merchants, swap dealers, and major swap

participants, at 75 FR 70881 (Nov. 19, 2010) (Designation of a Chief

Compliance Officer; Required Compliance Policies; and Annual Report

of a Futures Commission Merchant, Swap Dealer, or Major Swap

Participant), with respect to which Better Markets filed a comment

letter.

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As noted in the notice of proposed rulemaking, given the importance

of the risk management function and the comprehensive nature of the

responsibilities of a DCO's CCO, which are governed by Sec. 39.10, as

adopted in this rulemaking, the Commission expects that a DCO's CRO and

its CCO would be two different individuals. The Commission is adopting

Sec. 39.13(c) as proposed.

4. Measurement of Credit Exposure--Sec. 39.13(e)

Proposed 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

[[Page 69364]]

day; and (2) monitor its credit exposure to each clearing member

periodically during each business day. Proposed Sec. 39.13(e) was a

prerequisite for proposed Sec. 39.14(b), which would address daily

settlements based on a DCO's measurement of its credit exposures to its

clearing members.

LCH commented that a DCO should be required to measure its credit

exposures ``several times each business day'' and that a DCO should be

obliged to recalculate initial and variation margin requirements more

than once each business day. By contrast, OCC requested that the

Commission clarify that the proposed requirement that a DCO monitor its

credit exposure to each clearing member periodically during each

business day would not require a DCO to update clearing member

positions on an intra-day basis for purposes of monitoring risk, which

would not be practical, and that intra-day monitoring of credit

exposures based on periodic revaluation of beginning-of-day positions

would be sufficient to comply with the proposed rule.

The Commission does not believe that a DCO should be required to

mark each clearing member's open positions to market and recalculate

initial and variation margin requirements more than once each business

day, and notes that the requirement that a DCO monitor its credit

exposure to each clearing member periodically during each business day

could be satisfied through intra-day monitoring of credit exposures

based on periodic revaluation of beginning-of-day positions as

suggested by OCC.

However, as discussed in section IV.E.2, below, Sec. 39.14(b)

requires 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

are breached, or in times of extreme market volatility. Therefore, in

order to comply with Sec. 39.14(b), a DCO would be required to have

the authority and operational capacity to mark each clearing member's

open positions to market and recalculate initial and variation margin

requirements, on an intraday basis, under the circumstances defined in

Sec. 39.14(b).

The Commission is adopting Sec. 39.13(e) as proposed, except that

the Commission is making a technical revision by replacing the phrase

``such clearing member's open positions'' with the phrase ``such

clearing member's open house and customer positions'' to eliminate

possible ambiguity and to clarify the Commission's intent to reflect

current industry practice and include both house and customer

positions, not just house positions. The Commission notes that Sec.

39.13(e) is consistent with international recommendations.\80\

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\80\ See CPSS-IOSCO Consultative Report, Principle 6: Margin,

Key Consideration 4, at 40.

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5. Limitation of Exposure to Potential Losses From Defaults--Sec.

39.13(f)

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) non-defaulting

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 Section

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

FIA supported the proposal and MGEX stated that it appeared

reasonable if applied appropriately. FIA acknowledged that clearing

members understand and accept that they are subject to losses in the

event of a default of another clearing member but noted that these

potential losses must be measurable and subject to a reasonable cap

over a period of simultaneous or multiple defaults. MGEX suggested that

the Commission adopt an interpretation that each clearing member, by

becoming a clearing member, can reasonably anticipate that another

clearing member may potentially default and that a DCO can apply its

rules accordingly.

The Commission believes that every clearing member is aware that

another clearing member may default. The Commission also notes that the

potential losses resulting from such a default will be mitigated to the

extent that a DCO is bound to comply with the CEA, Commission

regulations, and its own rules, particularly with regard to financial

resources and default rules and procedures.

KCC commented that there would appear to be little cost/benefit

justification for duplicating the statutory language of the core

principle in the form of a rule.\81\ The Commission believes that

codifying provisions of the CEA does not impose an additional cost on a

DCO because a DCO must satisfy such requirements to comply with the

law. At the same time, the Commission believes that codifying this

statutory provision provides a DCO with a single location in which to

identify the minimum standards necessary to fulfill the requirements of

Core Principle D. The Commission is adopting Sec. 39.13(f) as

proposed.

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\81\ See Section 5b(c)(2)(D)(iii) of the CEA, 7 U.S.C. 7a-

1(c)(2)(D)(iii).

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6. Margin Requirements--Sec. 39.13(g)

a. General

Several commenters made general comments about margin requirements

that did not address specific provisions of proposed Sec. 39.13(g).

The Commission has summarized those comments, and responded to those

comments, below.

KCC expressed its belief that the Commission's detailed proposed

margin requirements are not consistent with the Dodd-Frank Act's

changes to the CEA, which simply require that a DCO's margin models and

parameters must be ``risk-based.'' The Commission notes that Section

5b(c)(2) of the CEA, as amended by the Dodd-Frank Act, requires a DCO

to comply with the statutory core principles ``and any requirement that

the Commission may impose by rule or regulation pursuant to section

8a(5).'' As noted in section I.A, above, legally enforceable standards

set forth in regulations serve to increase legal certainty, prevent

DCOs from lowering risk management standards for competitive reasons,

and increase market confidence. These goals are especially important

with respect to margin, which is one of the key tools used by DCOs in

managing risk. Therefore, the Commission believes it is appropriate to

impose more detailed margin requirements than those contained in the

statutory language of Core Principle D.

ISDA urged the Commission to adopt rules requiring DCOs to adopt

risk methodologies that would reduce the impact that customer account

risk has on the size of default fund contributions. ISDA noted that

this would enable DCOs to better guaranty the portability of client

portfolios, but would increase risk to the DCO; however, ISDA stated

that this increased risk could be addressed by increasing the risk

margin of the customer account. The Commission has not proposed and is

not adopting such rules. The Commission believes that a DCO should have

reasonable discretion to determine how it will calculate the amounts of

any default fund contributions that it may require from its clearing

members, and the extent to which customer risk will be a factor in such

calculations.

MFA and Citadel stated that it is important that a DCO's process

for setting initial margin be transparent in order to give all market

participants

[[Page 69365]]

certainty as to the margin they can expect the DCO to assess.

Therefore, MFA and Citadel urged the Commission to adopt final rules

that would require a DCO to make available to all market participants,

at no cost, a margin calculation utility, so that they would be able to

replicate the calculation of the margin that the DCO would assess.

The Commission notes that it is adopting Sec. Sec. 39.21(c)(3) and

(d) herein, which require a DCO to disclose information concerning its

margin-setting methodology on its Web site. However, the Commission is

not requiring a DCO to provide a margin calculation utility to market

participants free of cost, although the Commission notes that some DCOs

have chosen to do so.\82\ The Commission believes that whether a DCO

will provide a margin calculation utility to market participants, and

whether and how much it might charge for such a utility, is a business

decision that should be left to the discretion of a DCO.

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\82\ See e.g., http://www.cmegroup.com/clearing/cme-core-cme-clearing-online-risk-engine.html and https://www.theice.com/publicdocs/ice_trust/ICE_Margin_Simulation_Calculator_Training_Presentation.pdf.

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The FHLBanks indicated that it may be appropriate, in some

circumstances, for a DCO to waive its initial margin requirements with

respect to certain highly creditworthy customers of a clearing member.

Therefore, the FHLBanks urged the Commission to grant DCOs discretion

to waive initial margin requirements when doing so would not pose risk

to the DCO or its clearing members. In light of the fact that the Dodd-

Frank Act requires the removal of reliance on credit ratings, the

FHLBanks recommended that the Commission adopt alternative criteria by

which a DCO could exercise such discretionary waivers, or alternatively

grant DCOs discretion to establish their own criteria, subject to

Commission approval, or to guidelines established by the Commission in

the final rule.

The Commission has not proposed a rule that would permit it to

grant DCOs the discretion to waive initial margin requirements and it

is not adopting such a rule, as requested by the FHLBanks. Even if

there were an objective way to define highly creditworthy customers,

the Commission does not believe that permitting such waivers would

constitute prudent risk management.

b. Amount of Initial Margin Required--Sec. 39.13(g)(1)

Proposed Sec. 39.13(g)(1) would require that the initial margin

\83\ 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. The Commission invited

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.

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\83\ The term ``initial margin'' is now defined in Sec.

1.3(lll), adopted herein.

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MFA, BlackRock, and Citadel expressed their support for the

proposal. CME and OCC commented that the Commission should not define

normal market conditions, while ISDA stated that the Commission should

define normal market conditions. The Commission noted in the notice of

proposed rulemaking that the 2004 CPSS-IOSCO Recommendations defined

``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 percent of the time, that is, on average

on only one trading day out of 100.'' \84\ The CPSS-IOSCO Consultative

Report was published subsequent to the issuance of proposed Sec.

39.13(g)(1). The CPSS-IOSCO Consultative Report replaced the concept of

``normal market conditions'' with a proposed requirement that

``[i]nitial margin should meet an established single-tailed confidence

level of at least 99 percent for each product that is margined on a

product basis, each spread within or between products for which

portfolio margining is permitted, and for each clearing member's

portfolio losses.'' \85\ The Commission had also proposed similar

requirements for a 99 percent confidence level in proposed Sec.

39.13(g)(2)(iii), discussed below. Therefore, in adopting Sec.

39.13(g)(1), the Commission is declining to adopt the proposed explicit

requirement that initial margin must be sufficient to cover potential

exposures in normal market conditions, in order to avoid any ambiguity

over the meaning of ``normal market conditions.''

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\84\ See 2004 CPSS-IOSCO Recommendations at 21.

\85\ See CPSS-IOSCO Consultative Report, Principle 6: Margin,

Key Consideration 3, at 40.

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FIA recommended that parameters used in setting initial margin

requirements should be reviewed monthly and models should be reviewed

annually and on an ad hoc basis if substantive changes are made,

whereas OCC took the position that the Commission should permit a DCO

to use its reasonable discretion in determining what constitutes a

``regular basis'' for reviewing margin models and parameters. The

Commission has determined not to specify the appropriate frequency of

review, as it may differ based on the characteristics of particular

products and markets, and the nature of the margin models and

parameters that apply to those products and markets. However, although

Sec. 39.13(g)(1) would permit a DCO to exercise its discretion in

determining how often it should review its margin models and

parameters, the Commission would apply a reasonableness standard in

determining whether the frequency of reviews conducted by a particular

DCO was appropriate.

Moreover, as discussed in section IV.D.6.d, below, Sec.

39.13(g)(3) requires that a DCO's systems for generating initial margin

requirements, including the DCO's theoretical models, must be reviewed

and validated by a qualified and independent party, on a regular basis.

As the Commission noted in the notice of proposed rulemaking, the

Commission would expect a DCO to obtain 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. This express expectation

would address FIA's suggestion that a DCO should be required to review

its margin models on an ad hoc basis if substantive changes are made.

For the reasons discussed, the Commission is adopting Sec. 39.13(g)(1)

with the modification described above.

c. Methodology and Coverage

(1) General--Sec. 39.13(g)(2)(i)

Proposed Sec. 39.13(g)(2)(i) would require a DCO to 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.\86\ In

particular, proposed Sec. 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.\87\ The Commission

[[Page 69366]]

invited comment regarding whether there are specific risks that should

be identified and addressed in the proposed regulation in addition to

jump-to-default risk.

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\86\ As proposed, Sec. 39.13(g)(2)(i) referred to addressing

any ``unique'' characteristics of, or risks associated with,

particular products or portfolios. The Commission is revising this

provision in the final rule to refer to any ``unusual''

characteristics of, or risks associated with, particular products or

portfolios to clarify that such characteristics or risks are not

limited to those that are one of a kind. See also n. 66, above.

\87\ In the notice of proposed rulemaking, the Commission

defined jump-to-default risk as referring 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.

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CME and Nadex, Inc. (Nadex) expressed the opinion that it would not

be beneficial to attempt to identify additional specific risks that a

DCO must address in determining initial margins and LCH commented that

the reference to jump-to-default risk should either be removed or

amended to cover all other products that are subject to jump-to-default

risk. The Commission agrees with CME and Nadex that it is not necessary

to identify additional specific risks in the regulation, and also

agrees with LCH that the reference to jump-to-default risk should

generally apply to any product that may be subject to such risk.

Therefore, the Commission is adopting a revised Sec. 39.13(g)(2)(i)

that eliminates the specific reference to CDS. The Commission has also

added the phrase ``or similar jump risk.'' This is intended to address

the possibility of a large payment obligation in a product accumulating

in a very short period of time following an extreme market event.

(2) Liquidation Time--Sec. 39.13(g)(2)(ii)

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 \88\ and the time within which the DCO estimates that it would

be able to liquidate a defaulting clearing member's positions

(liquidation time). As proposed, a DCO would have to use a liquidation

time that is a minimum of five business days for cleared swaps that

were not executed on a DCM, and 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. The Commission invited comment regarding whether the

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

were appropriate, or whether there were minimum liquidation times that

were more appropriate.

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\88\ The term ``variation margin'' is now defined in Sec.

1.3(ooo), adopted herein.

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LCH suggested that ``or transfer'' should be inserted after

``liquidate'' in the proposed rule and that an appropriate liquidation

period should be a period that would be sufficient to enable a DCO to

adequately hedge or close out a defaulting member's risk. The

Commission does not believe that it is appropriate to add ``or

transfer,'' or to interpret the liquidation period to include the time

that would be sufficient to hedge a defaulting clearing member's

positions. In a worst-case scenario, a DCO would need to liquidate a

defaulting clearing member's positions, and the time it would take to

do so should be the relevant consideration in setting initial margin

requirements.

ISDA commented that a DCO should continually monitor the risk

associated with concentration in participants' positions, and if a DCO

determines that a participant's cleared portfolio is so large that it

could not be liquidated within the liquidation period assumed in the

DCO's default management plan, the DCO should have the discretion to

include an extra charge for concentration risk in the initial margin

requirements of that participant. FIA made similar comments but

suggested that prudent risk management should require the imposition of

concentration margin in appropriate circumstances. FIA further noted

that when a DCO imposes concentration margin on a clearing member, the

additional margin should be included in the DCO's minimum margin

calculations for any customers of the clearing member that generate the

increased risk.

Although the regulations adopted by the Commission herein do not

specifically address concentration margin as described by ISDA and FIA,

they do not limit a DCO's discretion to impose extra charges on its

clearing members for concentration risk. It should also be noted that

Sec. 39.13(h)(6), adopted herein,\89\ requires 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, which actions may include imposing enhanced

margin requirements.

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\89\ See discussion of Sec. 39.13(h)(6)(ii) in section

IV.D.7.f, below.

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Numerous commenters objected to the proposed difference in

requirements that would subject swaps that were either executed

bilaterally or executed on a SEF to a minimum five-day liquidation

time, while permitting equivalent swaps that were executed on a DCM to

be subject to a minimum one-day liquidation time. Commenters variously

argued that the proposed one-day/five-day distinction for swap

transactions depending on the venue of execution would: (1) Be

inconsistent with the open access provisions of Section 2(h)(1)(B) of

the CEA \90\ and/or proposed Sec. 39.12(b)(2) \91\ (GFI Group Inc.

(GFI), VMAC, LCC (VMAC), BlackRock, Wholesale Markets Brokers'

Association, Americas (WMBAA), and FX Alliance Inc. (FXall)); (2) be

inconsistent with Congressional intent, expressed in Section 731 of the

Dodd-Frank Act,\92\ which recognizes a difference in risk between

cleared and uncleared swaps that could be addressed by differential

margin requirements, but does not differentiate between the risk of

swaps executed on a DCM and those executed on a SEF (Asset Management

Group of the Securities Industry and Financial Markets Association

(AMG)); (3) discriminate against trades not executed on DCMs by

requiring DCOs to impose higher margin requirements for swaps that are

executed on SEFs than for swaps that are executed on DCMs (GFI, VMAC,

MarketAxess Corporation (MarketAxess), WMBAA, Tradeweb Markets LLC

(Tradeweb), Nodal Exchange, LLC (Nodal), and FXall); (4) raise the cost

of clearing for swaps traded on a SEF (National Energy Marketers

Association (NEM), NGX, and BlackRock); \93\ (5) put SEFs at a

competitive disadvantage to DCMs (GFI, MarketAxess, and BlackRock); (6)

artificially restrict the ability of market participants, including

asset managers, to select the best means of execution for their swap

transactions (BlackRock); (7) penalize market participants that desire

to effect swap transactions on a SEF rather than a DCM (WMBAA and

Tradeweb); (8) undermine the goal of the Dodd-Frank Act to promote

trading of swaps on SEFs (Tradeweb and FXall); (9) potentially create

detrimental arbitrage between standardized swaps traded on a SEF and

futures contracts with the same terms and conditions traded on a DCM

(Nodal); (10) impose onerous and unnecessary administrative costs on

DCOs, which would likely be passed on to clearing members and their

customers (VMAC and BlackRock); (11) create a disincentive for DCOs to

practice appropriate default management ``drills'' to reduce the

[[Page 69367]]

liquidation time of portfolios of swaps (ISDA); (12) remove the

incentive for DCOs to detail, practice and leverage clearing member

expertise in default management (FIA); (13) discourage voluntary

clearing (NGX); and (14) require DCOs and clearing members to manage

margin calls and netting based on the execution platform for the

relevant swaps (VMAC and BlackRock).

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\90\ See Section 2(h)(1)(B) of the CEA, 7 U.S.C. 2(h)(1)(B).

\91\ See discussion of Sec. 39.12(b)(2) in section IV.C.2.c,

above.

\92\ Section 731 of the Dodd-Frank Act amended the CEA to insert

Section 4s. See Section 4s(e)(3)(A)(ii) of the CEA, 7 U.S.C.

6s(e)(3)(A)(ii).

\93\ NGX estimated that the impact of transitioning from its

current two-day requirement to a five-day requirement for all of the

energy products that it clears would lead to an approximate 60

percent increase in initial margins.

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In addition, a number of commenters argued that there was no basis

for concluding that swaps executed on a SEF would be less liquid than

swaps executed on a DCM (GFI, WMBAA, NGX, MarketAxess, AMG, and FXall).

BlackRock recommended that the Commission require a DCO to use a

consistent liquidation time for cleared swaps that are executed on SEFs

and DCMs.

Commenters variously contended that a liquidation time of five

business days may be excessive for some swaps (CME and Citadel \94\), a

one-day liquidation period is too short (LCH), a one-day liquidation

period is appropriate for swaps executed on a DCM or a SEF (AMG), and a

two-day liquidation period is appropriate for cleared swaps (NGX).

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\94\ Citadel further commented that excessive margin

requirements relative to risk exposure could adversely affect market

liquidity and deter clearing.

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Various commenters encouraged the Commission to permit a DCO to

determine the appropriate liquidation time for all products that it

clears based on the unique characteristics and liquidity of each

relevant product or portfolio (CME, MFA, ISDA, LCH, NYPC, NGX, FIA,\95\

Nadex, Citadel, and FXall) or to grant DCOs such discretion subject to

a one-day minimum for all products, including cleared swaps (GFI, VMAC,

MarketAxess, Nodal, WMBAA, and Tradeweb).

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\95\ FIA also commented that liquidation times should be set at

times appropriate to manage the liquidation of the vast majority of

the portfolios carried by a DCO's clearing members, and not

necessarily that of the largest clearing member.

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FIA and ISDA commented that the appropriate liquidation time should

be derived from a DCO's default management plan and the results of its

periodic testing of such plan. FIA further stated that a DCO should

adjust its minimum margin requirements if its periodic testing of its

default management plan demonstrates that a defaulting clearing

member's positions could be resolved in a shorter period of time.

Similarly, NGX stated that the Commission should permit a DCO to

demonstrate through back testing and stress testing that a particular

type of cleared transaction should be subject to a shorter liquidation

time.

MFA and Citadel recommended that if the Commission were to mandate

minimum liquidation times in the final rules, it should allow DCOs to

apply for exemptions for specific groups of swaps if market conditions

prove that such minimum liquidation times are excessive. Citadel

further recommended that the Commission make it explicit that the

Commission may re-evaluate and, if necessary, re-calibrate such minimum

liquidation times as markets evolve.

The Commission is persuaded by the views expressed by numerous

commenters that requiring different minimum liquidation times for

cleared swaps that are executed on a DCM and equivalent cleared swaps

that are executed on a SEF could have negative consequences. Therefore,

after further consideration, the Commission has determined not to

mandate different minimum liquidation times for cleared swaps based on

their venue of execution, and has further determined that the same

minimum liquidation time should be used with respect to cleared swaps

that are executed bilaterally. This approach is consistent with the

open access requirements of Section 2(h)(1)(B) of the CEA and Sec.

39.12(b)(2), adopted herein.

The Commission also acknowledges the concerns expressed by

commenters that a five-day liquidation period may be excessive for some

swaps. For example, for a number of years, CME and ICE have

successfully cleared swaps based on physical commodities using a one-

day liquidation time.\96\ By contrast, as noted in the notice of

proposed rulemaking, several DCOs currently use a five-day liquidation

time in determining margin requirements for certain swaps based on

financial instruments.\97\ These differences reflect differences in the

risk characteristics of the products.

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\96\ NYMEX, now CME, has cleared OTC swaps generally with a one

day liquidation time since 2002. CME currently offers more than

1,000 products for clearing through its ClearPort system.

\97\ In particular, ICE Clear Credit LLC and CME use a five-day

liquidation time for credit default swaps and LCH and CME use a

five-day liquidation time for interest rate swaps.

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The Commission has carefully considered whether it should prescribe

any liquidation time or, alternatively, permit each DCO to exercise its

discretion in applying liquidation times based on the risk profile of

particular products or portfolios. In this regard, the Commission notes

that even without a specified minimum liquidation time, under Sections

5b(c)(2)(D) and 8a(7)(D) of the CEA, the Commission can require a DCO

to adjust its margin methodology if it determines that the current

margin levels for a product or portfolio are inadequate based on back

testing or current market volatility.

Weighing the advantages and drawbacks of the alternatives, the

Commission believes that a bright-line requirement, with a provision

for making exceptions, will best serve the public interest. While a DCO

will still have considerable latitude in setting risk-based margin

levels, the Commission has determined that establishing a minimum

liquidation time will provide legal certainty for an evolving

marketplace, will offer a practical means for assuring that the

thousands of different swaps that are going to be cleared subject to

the Commission's oversight will have prudent minimum margin

requirements, and will prevent a potential ``race to the bottom'' by

competing DCOs. Moreover, given the large number of swaps already

cleared, this alleviates the need for the Commission, with its limited

staff resources, to evaluate immediately the liquidation time for each

swap that is cleared.\98\

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\98\ E.g., the 950,000 trades in LCH's SwapClear have an

aggregate notional principal amount of over $295 trillion. Source:

http://www.lch.com/swaps/swapclear_for_clearing_members/.

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Taking into account these considerations, and in response to the

comments, the Commission is adopting Sec. 39.13(g)(2)(ii) with a

number of modifications. First, the final rule requires a DCO to use

the same liquidation time for a product whether it is executed on a

DCM, a SEF, or bilaterally. This addresses the competitive concerns

raised by numerous commenters and recognizes that once a swap is

cleared, its risk profile is not affected by the method by which it was

executed.\99\

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\99\ See Section 2(h)(1)(B) of the CEA and Sec. 39.12(b)(2),

adopted herein (swaps submitted to a DCO with the same terms and

conditions are economically equivalent within the DCO and may be

offset with each other within the DCO).

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Second, the final rule provides that the minimum liquidation time

for swaps based on certain physical commodities, i.e., agricultural

commodities,\100\ energy, and metals, is one day. For all other swaps,

the minimum liquidation time is five days. This distinction is based on

the differing risk characteristics of these product groups and is

consistent with existing requirements that reflect the risk assessments

DCOs have made over the course of their experience clearing these types

of swaps. The longer liquidation time, currently five days for credit

default swaps at ICE Clear Credit, LLC, and CME, and for interest rate

[[Page 69368]]

swaps at LCH and CME, is based on their assessment of the higher risk

associated with these products.\101\ Contributing factors include a

concentration of positions among clearing members, the number and

variety of products listed, the complexity of the portfolios, the long-

dated expiration time for many swaps, and the challenges of the

liquidation process in the event of a default.\102\

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\100\ See 76 FR 41048 (July 13, 2011) (Agricultural Commodity

Definition; final rule).

\101\ See e.g., Cleared OTC Interest Rate Swaps at 7 (Aug.

2011), available at http://www.cmegroup.com/clearing/cme-core-cme-clearing-online-risk-engine.html; ICE Clear Credit Clearing Rules,

Schedule 401 (Jul. 16, 2011) available at https://www.theice.com/publicdocs/clear_credit/ICE_Clear_Credit_Rules.pdf.

\102\ The liquidation of the Lehman interest rate swap portfolio

in the fall of 2008 demonstrates that the actual liquidation time

for a swap portfolio could be longer than 5 days. Between September

15, 2008 (the day Lehman Bros. Holdings declared bankruptcy) and

October 3, 2008, LCH and ``OTCDerivnet,'' an interest rate

derivatives forum of major market dealers, wound down the cleared

OTC interest rate swap positions of Lehman Bros. Special Financing

Inc. (LBSFI). This portfolio had a notional value of $9 trillion and

consisted of 66,390 trades across 5 major currencies. LCH and

OTCDerivnet competitively auctioned off LBSFI's five hedge currency

portfolios to their members between September 24 and October 3,

2008. The margin held by LCH proved sufficient to cover the costs

incurred. Source: LCH Press Release of October 8, 2008, available

at: http://www.lchclearnet.com/Images/2008-10-08%20SwapClear%20default_tcm6-46506.pdf.

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Third, to provide further flexibility, the Commission is adding a

provision specifying that, by order, the Commission may provide for a

different minimum liquidation time for particular products or

portfolios. As markets evolve, it may become appropriate to ease the

requirement for certain swaps subject to the five-day minimum.

Conversely, analysis may reveal that for other products or portfolios

the five-day or one-day minimum is insufficient. The Commission

believes that in light of the novelty, complexity, and potential

magnitude of the risk posed by financial swaps, prudential

considerations dictate that this type of fine-tuning should be used in

appropriate circumstances. Such an order could be granted upon the

Commission's initiative or in response to a petition from a DCO.

In this regard, the Commission emphasizes that it is retaining the

proposed requirement that a DCO must use longer liquidation times, if

appropriate, based on the specific characteristics of particular

products or portfolios.\103\ Such longer liquidation times may be based

on a DCO's testing of its default management plan. If a DCO determines

that a longer liquidation time is appropriate for a particular swap,

the Commission would expect that the DCO would use the same longer

liquidation time for the equivalent swaps that it clears, whether the

swaps are executed on a DCM, a SEF, or bilaterally. Among the factors

that DCOs should consider in establishing minimum liquidation times

are: (i) Average daily trading volume in a product; (ii) average daily

open interest in a product; (iii) concentration of open interest; (iv)

availability of a predictable basis relationship with a highly liquid

product; and (v) availability of multiple market participants in

related markets to take on positions in the market in question. The

Commission would also consider these factors in determining whether a

particular liquidation time was appropriate.

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\103\ As proposed, Sec. 39.13(g)(2)(ii) referred to the

``unique'' characteristics of particular products or portfolios. The

Commission is revising this phrase in the final rule to refer to the

``specific'' characteristics of a particular product or portfolio to

clarify that such characteristics are not limited to those that are

one of a kind.

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The Commission is adopting Sec. 39.13(g)(2)(ii) revised to read as

set forth in the regulatory text of this final rule.\104\

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\104\ In a technical revision, the Commission has eliminated the

phrase, ``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,'' because it is superfluous.

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(3) Confidence Level--Sec. 39.13(g)(2)(iii)

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 percent, 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,\105\

and (D) each swap portfolio, by beneficial owner. The Commission

invited comment regarding whether a confidence level of 99 percent is

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

and swap portfolios.

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\105\ The terms ``customer account or customer origin'' and

``house account or house origin'' are now defined in Sec. 39.2,

adopted herein.

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Alice Corporation supported the proposed 99 percent confidence

level, especially for new swaps and swaps with non-linear

characteristics. ISDA commented that the proposed 99 percent confidence

level is appropriate given current levels of mutualization in a DCO

default fund and mutualization in omnibus client accounts.\106\ MGEX

stated that it did not oppose the proposed 99 percent confidence level

for each account held by a clearing member at a DCO, by customer origin

and house origin.\107\

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\106\ ISDA contended that if there were a requirement to have

individualized client accounts, the appropriate confidence level

should be higher than 99 percent because the funds available to a

DCO to manage a client account default would be reduced.

\107\ MGEX requested that the Commission clarify that this

proposed requirement applies to the net account of each clearing

member and not the underlying accounts at each clearing member. The

Commission did not intend proposed Sec. 39.13(g)(2)(iii)(C), which

would refer to ``[e]ach account held by a clearing member at the

DCO, by customer origin and house origin * * *, '' to apply to

individual customer accounts by beneficial owner. However, the

Commission notes that Sec. 39.13(g)(2)(iii)(D), as proposed and as

adopted herein, applies the 99 percent confidence level requirement

to ``[e]ach swap portfolio, by beneficial owner.''

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FIA opposed the proposed 99 percent requirement because it sets an

artificial floor that may remove the incentive for DCOs to conduct the

rigorous analysis necessary to establish an appropriate confidence

level. FIA further stated that if a different regulatory scheme than

loss mutualization for the protection of customer funds were to be

adopted for cleared swaps, a much higher level of confidence may be

required.

CME, Nadex, KCC,\108\ and Citadel took the position that the

Commission should not prescribe a specific confidence level, but should

instead continue to give each DCO the discretion to determine the

appropriate confidence levels. CME and Nadex noted that one or more of

the following factors could be considered by a DCO in determining the

appropriate confidence levels: the particular characteristics of the

products and portfolios it clears, the depth of the underlying markets,

the existence of multiple venues trading similar products on which a

defaulting clearing member's portfolio could be liquidated or hedged,

the duration of the products, the size of the DCO and its systemic

importance, its customer base, or its other risk management tools.

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\108\ KCC also expressed its belief that ultra-high confidence

level modeling does not protect against risk as well as direct

margin intervention by the DCO in the case of significant market

movements, such as retaining the right to review recent price

movements to re-establish margins at a higher level and retaining

the right to demand special margin from certain clearing members.

The Commission believes that a DCO should retain the right to take

such actions in addition to, rather than instead of, using a 99

percent confidence level, as required by Sec. 39.13(g)(2)(iii). For

example, Sec. 39.13(h)(6)(ii), discussed below, requires a DCO to

take additional actions with respect to particular clearing members,

when appropriate, including imposing enhanced margin requirements.

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The Commission does not agree such discretion is appropriate and

has

[[Page 69369]]

determined to establish a minimum confidence level. The Commission

believes that a minimum confidence level will provide legal certainty

for an evolving marketplace, will offer a practical means for assuring

market participants that the thousands of different products that are

going to be cleared subject to the Commission's oversight will have

prudent minimum margin requirements, and will prevent a potential

``race to the bottom'' by competing DCOs. Moreover, given the large

number of products already cleared, this alleviates the need for the

Commission, with its limited staff resources, to evaluate immediately

the confidence level requirements for each product that is cleared.

The Commission is adopting the proposed minimum 99 percent

confidence level. This is consistent with proposed international

standards.\109\ Moreover, given the potential costs of default, the

Commission agrees with those commenters who stated that a 99 percent

level is appropriate. An individual DCO may determine to set a higher

confidence level, in its discretion.

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\109\ See CPSS-IOSCO Consultative Report, Principle 6: Margin,

Key Consideration 3, at 40. In addition, 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, at 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, at 46).

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NASDAQ OMX Commodities Clearing Company (NOCC) supported an

approach that would allow DCOs to set margin requirements for new and

low-volume products at a lower coverage level if the potential losses

resulting from such products are minimal. According to NOCC, this would

allow DCOs to include more products and market participants by

attracting them at an early stage without materially increasing the

risk of the DCO.

VMAC suggested that the Commission add to the requirement that

initial margin levels must be based upon ``an established confidence

level of at least 99 percent,'' language that states ``or, subject to

specific authorization from the CFTC, a lower confidence level.'' In

particular, VMAC commented that although a DCO should be required to

demonstrate that the given confidence level results in an initial

margin amount which is sufficient to allow the DCO to fully discharge

its obligations upon a clearing member default, a DCO should not be

required to collect margin substantially in excess of its obligations

to clearing members in a default scenario.

The Commission is not modifying the language of Sec.

39.13(g)(2)(iii) in a manner that would permit DCOs to set margin

requirements at a lower coverage level for new and low-volume products,

as recommended by NOCC, or provide for a lower confidence level subject

to specific Commission authorization, as suggested by VMAC. In the

notice of proposed rulemaking, the Commission noted that the 2004 CPSS-

IOSCO Recommendations stated 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.'' \110\ However, the CPSS-IOSCO Consultative

Report, which was issued subsequent to the Commission's proposed rules,

does not contain similar language. The Commission believes that it is

prudent to apply the same standard to all products.

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\110\ See 2004 CPSS-IOSCO Recommendations at 23.

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OCC and NYPC encouraged the Commission to modify its proposal to

make clear that, when swaps are commingled in either a Section 4d(a)

futures account or a Section 4d(f) cleared swaps account, pursuant to

Sec. 39.15(b)(2),\111\ the 99 percent test need not be separately

applied to the swaps positions alone. The Commission agrees with OCC

and NYPC that if swaps and futures are held in the same customer

account pursuant to rules approved by the Commission or a 4d order

issued by the Commission, as specified in Sec. 39.15(b)(2), the 99

percent test would apply to the entire commingled account, and not just

the swap positions, under Sec. 39.13(g)(2)(iii)(D). Therefore, the

Commission is modifying Sec. 39.13(g)(2)(iii)(D) to add ``including

any portfolio containing futures and/or options and held in a

commingled account pursuant to Sec. 39.15(b)(2) of this part,'' after

``[e]ach swap portfolio.'' The Commission is making similar

modifications in Sec. 39.13(g)(7) with respect to back testing

requirements, which are discussed in section IV.D.6.g, below.

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\111\ See discussion of Sec. 39.15(b)(2), adopted herein, in

section IV.F.3, below.

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OCC also requested that the Commission clarify that, in the case of

a margin system that calculates margin for all positions in an account

on the basis of the net risk of those positions based upon historical

price correlations rather than on a product or a pre-defined spread

basis, the 99 percent confidence level would be applied only on an

account-by-account basis, and not to individual products, product

groups, or specified spread positions. NYPC made a similar request,

stating that its historical Value at Risk (VaR)-based margin model

calculates initial margin requirements at the portfolio level, rather

than on a product or spread basis.

The Commission notes that, as proposed, Sec. 39.13(g)(2)(iii)(A)

would require the application of the 99 percent confidence level to

``[e]ach product (that is margined on a product basis)'' and Sec.

39.13(g)(2)(iii)(B) would require the application of the 99 percent

confidence level to ``[e]ach spread within or between products for

which there is a defined spread margin rate * * *.'' The Commission's

intent was that Sec. Sec. 39.13(g)(2)(iii)(A) and (B) would apply to

products and pre-defined spreads under margin models that calculate

initial margin requirements on a product and pre-defined spread basis,

respectively. Further, with respect to margin models that do not

calculate margin on a product or pre-defined spread basis, the 99

percent requirement would apply with respect to each account held by a

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

and to each swap portfolio, by beneficial owner, pursuant to Sec. Sec.

39.13(g)(2)(iii)(C) and (D), respectively.\112\

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\112\ For purposes of clarification, certain references to

customer origin in Sec. Sec. 39.13 and 39.19 have been replaced

with references to ``each customer origin'' to clarify the

distinction between customer positions in futures and options

segregated pursuant to Section 4d(a) of the CEA, and customer

positions in swaps segregated pursuant to Section 4d(f) of the CEA.

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In order to clarify the Commission's intent, the Commission is

adopting Sec. 39.13(g)(2)(iii)(A) to read as follows: ``[e]ach product

for which the derivatives clearing organization uses a product-based

margin methodology,'' while striking ``(that is margined on a product

basis).'' In addition, the Commission is adopting Sec.

39.13(g)(2)(iii)(B) to read as follows: ``[e]ach spread within or

between products for which there is a defined spread margin rate,''

while striking ``as described in paragraph (g)(4) of this section.''

LCH commented that the Commission's approach to setting margin

based on products and spreads, while appropriate for futures, is not

[[Page 69370]]

suitable or sufficient for swaps. LCH proposed that the key requirement

for swaps should be for the DCO to ensure that it has enough margin and

guarantee funds to cover its exposures, and for the DCO to prove this

on an individual client and clearing member basis. The Commission did

not intend to suggest that swaps should be margined pursuant to a

product-based margin methodology, nor that they should be subject to

defined spread margin rates. The Commission recognizes that swaps are

often margined on a portfolio basis and specifically addressed swap

portfolios in Sec. 39.13(g)(2)(iii)(D). The Commission would also like

to clarify that a 99 percent confidence level, as applied to swap

portfolios, means that each portfolio is covered 99 percent of the

time, and not that a collection of portfolios is covered 99 percent of

the time on an aggregate basis.

The Commission is adopting Sec. 39.13(g)(2)(iii) with the

modifications described above.

(4) Appropriate Historic Time Period--Sec. 39.13(g)(2)(iv)

Proposed Sec. 39.13(g)(2)(iv) would require each DCO to determine

the appropriate historic time period of data that it would use for

establishing the 99 percent confidence level based on the

characteristics, including volatility patterns, as applicable, of each

product, spread, account, or portfolio.

LCH recommended that the Commission define the ``historic time

period'' as a minimum of one calendar year in order to provide for

adequate historical observations. The Commission believes that a DCO

should be permitted to exercise its discretion with respect to the

appropriate time periods that should be used, based on the

characteristics, including volatility patterns, as applicable, of the

relevant products, spreads, accounts, or portfolios. The Commission

also notes that proposed international standards do not specify a

historic time period that would be appropriate in all circumstances,

recognizing that either a shorter or a longer historic time period may

be appropriate based on the volatility patterns of a particular

product.\113\ The Commission expects that DCOs would include periods of

significant financial stress. Therefore, the Commission is adopting

Sec. 39.13(g)(2)(iv) as proposed.

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\113\ See CPSS-IOSCO Consultative Report, Principle 6: Margin,

Explanatory Note 3.6.7, at 43.

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d. Independent Validation--Sec. 39.13(g)(3)

Proposed Sec. 39.13(g)(3) would require that a DCO's systems for

generating initial margin requirements, including the DCO's theoretical

models, must be reviewed and validated by a qualified and independent

party, on a regular basis. The Commission invited comment regarding

whether a qualified and independent party must be a third party or

whether there may be circumstances under which an employee of a DCO

could be considered to be independent.

In the notice of proposed rulemaking, the Commission explained that

a validation should include a comprehensive analysis to ensure that

such systems and models achieve their intended goals. The Commission

also noted that, although the proposed regulation did not define the

meaning of ``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 was in use by the DCO.\114\ The Commission

further stated that significant changes would be those that could

materially affect the nature or level of risks to which a DCO would be

exposed, and that the Commission would expect a DCO to obtain an

independent validation prior to any significant change that would relax

risk management standards. However, the Commission noted that 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.

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\114\ The Commission also notes that the CPSS-IOSCO Consultative

Report recommends that a CCP's initial margin models should be

independently validated at least on a yearly basis. CPSS-IOSCO

Consultative Report, Principle 6: Margin, Explanatory Note 3.6.8, at

43. The Commission is not requiring an annual validation at this

time, although it may revisit this issue in the future.

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CME, OCC, MGEX, and KCC all expressed the view that an employee of

a DCO could be independent in appropriate circumstances. CME commented

that permitting employees of a DCO to conduct the required reviews

would be consistent with proposed Sec. 39.18(j)(2), which would allow

employees of a DCO to conduct the required testing of a DCO's business

continuity and disaster recovery systems, provided that such employees

are not the persons responsible for developing or operating the systems

being tested.\115\ OCC and MGEX took the position that employees of a

DCO could be independent as long as they are not, or have not been,

involved in designing the models, and OCC further stated that internal

personnel must not otherwise be biased due to their involvement in

implementation of the models.\116\ However, FIA argued that margin

models should be required to be validated by an independent third party

with expertise in risk and the product being cleared.

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\115\ Section 39.18(j)(2), as proposed, and as adopted herein,

states that 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.

\116\ In particular, OCC noted that the Office of the

Comptroller of the Currency, the Department of the Treasury, the

Federal Reserve System and the Federal Deposit Insurance Corporation

recently proposed revisions to their risk-based capital guidelines,

which would require that, with respect to the validation of banks'

internal risk models, ``[t]he review personnel [would] not

necessarily have to be external to the bank in order to achieve the

required independence'' but that ``[a] bank should ensure that

individuals who perform the review are not biased in their

assessment due to their involvement in the development,

implementation, or operation of the models.'' See 76 FR 1890, at

1897 (Jan. 11, 2011) (Risk-Based Capital Guidelines: Market Risk).

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The Commission recognizes that a third party could be more critical

of a DCO's margin model than an employee of a DCO, even if that

employee is ``qualified and independent.'' However, the Commission also

believes that a third party could be less critical if, for example, it

seeks to provide services to the DCO or the industry in the future.

The Commission agrees with CME, OCC, MGEX, and KCC that an employee

of a DCO could be a ``qualified and independent party,'' and thus could

review and validate the DCO's systems for generating initial margin

requirements, under appropriate circumstances. It would probably be

more costly for a DCO to use a third party for this purpose rather than

an employee.

On balance, the Commission believes that it may be appropriate for

a DCO to have an employee review and validate its margin systems.

Therefore, the Commission is adopting Sec. 39.13(g)(3) with the

addition of a sentence stating that ``[s]uch qualified and independent

parties may be independent contractors or employees of the derivatives

clearing organization, but shall not be persons responsible for

development or operation of the systems and models being tested.'' This

is consistent with the language contained in Sec. 39.18(j)(2), as

adopted herein, as well as the

[[Page 69371]]

proposed approach of other financial regulators.\117\ The Commission

also notes that the reference to independent contractors as well as

employees in the added language will also prohibit a DCO from using a

particular third party to conduct the validation if that third party

was or is responsible for development or operation of the relevant

systems and models.

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\117\ Id.

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KCC requested that the Commission clarify that the CRO or other

comparable personnel with responsibility for overall risk management at

the DCO would meet the requirements of a ``qualified and independent

party.'' The Commission does not believe that a DCO's CRO or personnel

responsible for overall risk management would categorically qualify as

an ``independent party.'' This determination would need to be made on a

case-by-case basis depending on whether the CRO or other similar person

was or is responsible for development or operation of the systems and

models being tested.

MGEX requested that the Commission clarify whether the requirement

for independent validation would apply to the primary risk-based

portfolio system such as SPAN,\118\ or each DCO's analysis program for

determining margins, noting its belief that requiring independent tests

on the latter would be excessive. It is not clear what MGEX means by

``each DCO's analysis program for determining margins.'' However, Sec.

39.13(g)(3) requires independent validation with respect to a DCO's

underlying model, e.g., SPAN or OCC's STANS model, as well as the

methodology used to compute the inputs to any such model. On the other

hand, a DCO would not be required to obtain an independent validation

of a change in SPAN parameters as described by CME.\119\

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\118\ For a description of SPAN, see CME's Web site, at http://www.cmegroup.com/clearing/risk-management/span-overview.html#works.

\119\ See id. for a description of SPAN parameters. Therefore,

Sec. 39.13(g)(1), which requires that a DCO review its margin

models and parameters, on a regular basis, requires a broader review

than would be met by compliance with Sec. 39.13(g)(3).

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OCC commented that, as described in the notice of proposed

rulemaking, the ``could materially affect'' standard is deficient in

two respects in that: (1) It fails to include any reference to the

likelihood that a change would actually materially affect the nature or

level of risk, and (2) it omits any reference to the direction of the

change in level of risk. OCC contended that a more appropriate standard

would be to provide that significant changes are those that ``are

reasonably likely to materially change the nature or increase the level

of risks to which the DCO would be exposed.''

In response to this comment, the Commission is modifying the

standard to provide that significant changes are those for which there

is a reasonable possibility that they would materially affect the

nature or level of risks to which a DCO would be exposed. While this

standard identifies the likelihood that a change would materially

affect the nature or level of such risks, the Commission believes that

it is more appropriate than identifying significant changes as only

those that are ``reasonably likely to materially change'' the nature or

level of such risks.

The Commission does not believe that significant changes should be

limited to those that are likely to increase the level of risks. As

described in the notice of proposed rulemaking, the Commission would

expect a DCO to obtain an independent validation prior to any

significant change that would relax risk management standards, but the

Commission would permit a DCO to obtain an independent validation

promptly after a significant change that would enhance risk

protections, in appropriate circumstances. A DCO should obtain such a

validation even if the change were designed to enhance risk

protections, in order to ensure that the change would be effective in

achieving its objective.

OCC also requested that the Commission clarify that the addition of

a new product or new underlying interest would not inherently be deemed

to trigger the independent evaluation requirement. The Commission

believes that whether the addition of a new product or a new underlying

interest would trigger the independent validation requirement would

need to be determined on a case-by-case basis, depending on whether

there is a reasonable possibility that such addition will materially

change the nature or level of risks to which the DCO would be exposed.

One example would be if the addition necessitates a significant change

to the margin model as it applies to the new product or new underlying

interest. Thus, the addition of a futures contract based on a new

broad-based securities index where the DCO already clears futures

contracts based on broad-based securities indexes might not require a

significant change to the applicable margin model. However, the

addition of a new category of swaps, even if the DCO already clears

swaps, might require a significantly different margin model. Another

example might be if a swap cleared by a DCO became subject to a

clearing mandate and the risk profile changed because of changes in

volume and open interest.

e. Spread and Portfolio Margins--Sec. 39.13(g)(4)(i)

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 were a theoretical basis for the

correlation in addition to an exhibited statistical correlation.

Proposed Sec. 39.13(g)(4)(i) would include a non-exclusive list of

possible theoretical bases, including 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.

The Commission requested comment regarding the appropriateness of

requiring a theoretical basis for the correlation between related

positions before reductions in initial margin requirements would be

permitted. In addition, 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.\120\

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\120\ In addition to the other comments discussed herein, Alice

Corporation noted that it supported the cautious approach taken by

the Commission and that offsets across products with different

maturities and risk profiles should be avoided where possible, and

ISDA stated that spread margins should only permitted when a DCO can

demonstrate a strong correlation in stressed market conditions and

agrees to periodic public disclosure of its methodology and results.

With respect to ISDA's comment, the Commission notes that Sec.

39.13(g)(2)(iii), discussed in section IV.D.6.c.(3), above, requires

a DCO to ensure that the actual coverage of its initial margin

requirements, along with projected measures of the performance of

its margin models, must meet an established confidence level of at

least 99 percent, based on data from an appropriate historic time

period, for, among other things, spreads within or between products

for which there is a defined spread margin rate, for each account

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

and for each swap portfolio, by beneficial owner, and Sec.

39.13(g)(7), discussed in section IV.D.6.g, below, imposes related

back testing requirements. In addition, Sec. 39.21(c)(3), discussed

in section IV.L, below, requires a DCO to publicly disclose its

margin methodology.

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KCC and OCC addressed the proposed requirement that the price risks

of related positions would only be considered to be reliably

correlated, and thus be eligible for initial margin reductions, if

there were a theoretical basis for the correlation in addition to

[[Page 69372]]

an exhibited statistical correlation. KCC contended that the proposed

requirement would be difficult for the Commission to implement and

unnecessary because DCOs have no incentive to offer margin reductions

in the absence of high correlation between positions. KCC further noted

that the proposal does not detail what level of observed statistical

correlation is required, and the proposed requirement to articulate a

theoretical basis is vague.

OCC also questioned the appropriateness of the requirement that

there must be a theoretical basis for the correlation, noting that a

theoretical basis for correlation is, by definition, theoretical and

may not be directly observable or verifiable except through the

correlation. OCC stated that it is difficult to imagine a correlation

for which no theoretical basis can be constructed, and in many if not

most cases, the theoretical basis for any significant correlation is

obvious.

The Commission continues to believe that reductions in initial

margin requirements should only be allowed if a DCO is able to

articulate a reasonable theoretical explanation for an observed

statistical correlation to ensure that the positions are reliably

correlated. The Commission notes that it is a matter of basic

statistics that correlation does not equal causation. The world is

replete with examples of events or data that are highly correlated at

various points in time but for which there is no theoretical

relationship. If there is no theoretical relationship, a DCO has no

basis to believe that a statistical relationship--no matter how

strong--is stable, and a margin based on such a relationship may be

insufficient to capture price variation.

Several commenters addressed the appropriateness of applying

proposed Sec. 39.13(g)(4) to portfolio-based margin systems. LCH

commented that the spread margin measure which the Commission proposed

is unsuited and inappropriate for swaps clearing and that the Portfolio

Approach to Interest Rate Scenarios (PAIRS), the historical simulation

method that LCH uses, is more suitable to non-standardized swaps.

Therefore, LCH urged the Commission to amend proposed Sec. 39.13(g)(4)

to afford recognition to this technique. OCC requested that the

Commission acknowledge that its STANS methodology meets the

requirements of proposed Sec. 39.13(g)(4), noting that STANS currently

relies on over 20 million separate correlations. OCC stated that it

would be impractical to attempt to document or even articulate the

``theoretical basis'' for all of these correlations even though it

believes that they would be supportable on a theoretical level, and

further believes that its systems for determining and reviewing the

validity of the correlations it uses are sufficient to ensure that OCC

does not allow unjustified margin offsets. NYPC requested that the

Commission clarify that Sec. 39.13(g)(4) would not be applicable to

margin models that calculate initial margin requirements at the account

level, including NYPC's historical VaR-based margin model.

The Commission intends Sec. 39.13(g)(4) to apply to portfolio-

based margin models as well as product-based margin models. For some

products, DCOs establish defined spread margin rates, pursuant to a

product-based margin methodology. Typically, this occurs where there is

a bilateral correlation, e.g., a March-June calendar spread or a

correlation between two related products.\121\ For other products,

there may be multilateral correlations for which margin is calculated

on a portfolio basis, pursuant to a portfolio-based margin methodology.

In the latter instance, there is not a defined margin amount or margin

reduction for a defined portfolio that remains the same over time.

Instead, margin is recalculated each day for each individual portfolio.

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\121\ A defined spread margin rate may also apply to three

related products, e.g., the Chicago Board of Trade's soybean crush

spread with respect to soybeans, soybean oil and soybean meal.

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

Therefore, the Commission is adopting Sec. 39.13(g)(4), with

several modifications, in order to clarify that margin reductions

calculated on a portfolio basis are also permissible if they meet the

standards of the regulation. First, the Commission is changing the

heading of the provision from ``[s]pread margins'' to ``[s]pread and

portfolio margins.'' The Commission is also removing the parenthetical

``(spread margins)'' after the clause in Sec. 39.13(g)(4)(i) that

states ``[a] derivatives clearing organization may allow reductions in

initial margin requirements for related positions.'' Finally, the

Commission is changing the reference to ``spread margins'' in Sec.

39.13(g)(4)(ii) to ``margin reductions.'' These changes are designed to

make it clear that Sec. 39.13(g)(4) applies to reductions in initial

margin requirements for related positions, whether a DCO uses a

product-based margin model or a portfolio-based margin model.

Better Markets and Mr. Greenberger commented that Sec. 39.13(g)(4)

must require that the relationship between positions be calculated

using the same standards (with respect to volatility and liquidity

requirements) that are applied to the calculation of initial margin for

the individual positions. The Commission agrees with Better Markets and

Mr. Greenberger and, as discussed above, spread and portfolio margins

would also be subject to a 99 percent coverage standard.

f. Price Data--Sec. 39.13(g)(5)

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.

Interactive Data Corporation expressed its belief that the concept

of ``sound valuation models'' should be expanded further with

additional prescriptive guidance in four key dimensions, including: (1)

Leveraging greater trade transparency; (2) using multiple sources; (3)

mitigating conflicts of interest; and (4) sourcing of independent price

data.

The Commission does not believe that it is necessary to be more

specific or prescriptive with respect to this requirement, and is

adopting Sec. 39.13(g)(5) as proposed. As the Commission noted in the

notice of proposed rulemaking, the nature of the applicable valuation

models would necessarily depend on the particular products and the

available sources of any relevant pricing data.

g. Daily Review and Back Tests--Sec. Sec. 39.13(g)(6) and (g)(7)

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 defined ``back test'' in Sec. 39.2,

adopted herein, 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.''

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

introductory paragraph of proposed Sec. 39.13(g)(7) would require

that, in conducting back tests, a DCO 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 percent confidence level or a longer time period. The

applicable time period

[[Page 69373]]

was separately specified for the back tests required by proposed Sec.

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

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 requested

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 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. In the notice of

proposed rulemaking, the Commission noted that, since the composition

of such accounts and swap portfolios may change on a daily basis, it

was anticipated 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 also requested 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.

Several commenters addressed the appropriate frequency of back

tests and/or the appropriate historic time period for the analysis of

price change data. FIA commented that initial margin requirements

should be back tested monthly. MGEX stated that it was not opposed to a

monthly back testing requirement with respect to proposed Sec.

39.13(g)(7)(iii) based on its understanding that the Commission

intended that the DCO must look at its clearing member's net account

and not each underlying customer account with the exception of

swaps.\122\

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\122\ MGEX correctly understands that the Commission's reference

to ``each account held by a clearing member at the DCO, by origin,

house and customer'' in proposed Sec. 39.13(g)(7)(iii) was not

intended to apply to individual accounts by beneficial owner,

although proposed Sec. 39.13(g)(7)(iii) would require monthly back

tests with respect to initial margin requirements for each swap

portfolio, by beneficial owner.

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LCH took the position that back tests should be conducted at least

on a daily basis for all products cleared by a DCO. However, LCH argued

that such back tests should be conducted at the portfolio level because

margining techniques appropriate for swaps, such as LCH's PAIRS

methodology, do not allow for the disaggregation of initial margin and

spread margin requirements at a product level. LCH also commented that,

for back tests to be statistically meaningful, the applicable historic

time period should be a minimum of one calendar year.

KCC stated that it may be appropriate for the Commission to further

define ``significant market volatility,'' for purposes of proposed

Sec. 39.13(g)(7)(i),\123\ but that, more generally, any back-testing

requirements should be based on a discretionary, risk-based

determination by the DCO. In addition, KCC expressed its belief that

the back testing period should be subject to the discretion of the DCO

in light of then-current market conditions, i.e., imposing a specific

back-testing period may inappropriately reflect an exaggerated or

understated level of market volatility.

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\123\ The Commission believes that each DCO should determine

what ``significant volatility'' means based upon the volatility

patterns of each individual product or swap portfolio that it

clears.

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NOCC took the position that products, customers or spread credits

should reach a specified volume or risk exposure level before being

required to be back tested with the proposed frequencies so long as the

DCO can demonstrate that it is meeting the core principle objectives

underlying proposed Sec. 39.13(f).

NYPC requested that the Commission clarify that proposed Sec. Sec.

39.13(g)(6) and (g)(7)(i)-(ii) would not be applicable to margin models

that calculate initial margin requirements at the account level,

including NYPC's historical VaR-based margin model. OCC also stated its

belief that it would not be subject to the requirement for daily review

in proposed Sec. 39.13(g)(7)(i), as it does not margin on a product

basis, but noted that it does conduct daily back testing on all

accounts, i.e., on a portfolio basis.

The Commission is adopting Sec. 39.13(g)(6), eliminating the

language stating ``for each product (that is margined on a product

basis),'' in order to correct a potential inconsistency between the

text of the rule and the notice of proposed rulemaking. In the notice

of proposed rulemaking, the Commission stated that ``[d]aily review and

periodic back testing are essential to enable a DCO to provide adequate

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

proposed, Sec. 39.13(g)(6) would only require a DCO to determine the

adequacy of its initial margin requirements, on a daily basis, for

products that were margined on a product basis. The adequacy of a DCO's

initial margin requirements for futures and options on futures products

margined on a portfolio basis, and for swap portfolios, would not have

been subject to such daily review. The Commission believes that such a

result is untenable, as one of the most rudimentary steps in risk

management is to conduct daily review of margin coverage, i.e., to

determine whether any margin breaches have occurred. Moreover, the

Commission believes that the change will not impose any burden because

it believes that all DCOs currently conduct some form of daily review

of the adequacy of their initial margin requirements, whether they use

a product-based or a portfolio-based margin methodology.

The Commission is adopting Sec. 39.13(g)(7)(i) with modifications

that require a DCO to conduct back tests, on a daily basis, to test the

adequacy of its initial margin requirements with respect to products or

swap portfolios that are experiencing significant market volatility:

(a) For that product if the DCO uses a product-based margin

methodology; (b) for each spread involving that product if there is a

defined spread margin rate; (c) for each account held by a clearing

member at the DCO that contains a significant position \124\ in that

product, by house origin and by each customer origin; and (d) for each

such swap portfolio, including any portfolio containing futures and/or

options and held in a commingled account pursuant to Sec.

39.15(b)(2),\125\ by beneficial owner.

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\124\ The Commission has not defined a ``significant position,''

leaving that determination to the discretion of each DCO, as the

size of a position that would be a ``significant position'' may vary

depending on the nature of the particular product or the composition

of the particular account.

\125\ See discussion of the addition of the same language to

Sec. 39.13(g)(2)(iii)(D), in section IV.D.6.c.(3), above.

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Similarly, the Commission is adopting Sec. 39.13(g)(7)(ii) with

modifications that

[[Page 69374]]

require a DCO to conduct back tests, on at least a monthly basis: (a)

For each product for which the DCO uses a product-based margin

methodology; (b) for each spread for which there is a defined spread

margin rate; (c) for each account held by a clearing member at the DCO,

by house origin and by each customer origin; and (d) for each swap

portfolio, including any portfolio containing futures and/or options

and held in a commingled account pursuant to Sec. 39.15(b)(2),\126\ by

beneficial owner. As adopted, Sec. 39.13(g)(7) no longer contains a

paragraph (iii) as paragraph (ii) now describes all monthly back

testing requirements.

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\126\ Id.

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As originally proposed, Sec. 39.13(g)(7) would only require daily

back testing for products that were experiencing significant market

volatility if the DCO used a product-based margin methodology, and for

spreads involving that product if there was a defined spread margin

rate. It would not require daily back testing for each account, by

customer origin and house origin, that contained a significant position

in that product, whether the DCO used a product-based or a portfolio-

based margin methodology, or for each swap portfolio that was

experiencing significant market volatility. As with respect to Sec.

39.13(g)(6), there was a potential inconsistency in the treatment of

different positions. There is no reasonable basis to require daily back

tests solely with respect to products that are experiencing significant

market volatility for which the DCO uses a product-based margin

methodology and spreads involving such products if there is a defined

spread margin rate, and not to require daily back tests with respect to

accounts, by customer origin and house origin, which contain

significant positions in those products simply because the DCO uses a

portfolio-based margin methodology. Similarly, there is no

justification for requiring daily back tests with respect to products

that are experiencing significant market volatility and not requiring

daily back tests with respect to swap portfolios that are experiencing

significant market volatility. A DCO should be required to conduct

daily back tests when the instruments that it clears are subject to

significant market volatility, whether the DCO bases its initial margin

requirements on a product-based or a portfolio-based margin

methodology, and whether those instruments are futures, options on

futures, or swaps.

Although OCC stated that it currently conducts daily back tests on

all accounts on a portfolio basis, and LCH expressed its view that back

tests should be conducted on a daily basis for all products and swap

portfolios cleared by a DCO, the Commission has determined to permit a

DCO to conduct back tests on at least a monthly basis when significant

market volatility is not present. FIA and MGEX supported monthly back

testing. Apart from KCC's contention that back testing should be

subject to the discretion of the DCO, and NOCC's suggestion that DCOs

should be able to obtain an exemption from the proposed frequencies for

products, customers and spread credits that have not reached a

specified volume or risk exposure level,\127\ none of the commenters

indicated that back tests should be conducted less frequently than

monthly. Moreover, a particular DCO would be able to exercise its

discretion to conduct back tests on a more frequent basis than that

required by the Commission's regulation.

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\127\ The Commission does not believe that it is appropriate to

adopt a regulation establishing an exemption process with respect to

back testing requirements based on volume or risk exposure or

otherwise.

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The Commission has not proposed and is not adopting LCH's

suggestion that the applicable historic time period for the price

change data used for back testing should be a minimum of one calendar

year. However, the Commission is removing the proposed language from

the introductory paragraph of Sec. 39.13(g)(7) regarding the time

periods for historical price changes that must be used in the required

back tests and is revising the introductory paragraph to require a DCO

to use an appropriate time period but not less than the previous 30

days for all of the back tests required by Sec. Sec. 39.13(g)(7)(i)

and (ii).

h. Customer Margin

(1) Gross Margin for Customer Accounts --Sec. 39.13(g)(8)(i)

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 and would prohibit a

DCO from netting positions of different customers against one another.

The proposed regulation would permit a DCO to collect initial margin

for its clearing members' house accounts on a net basis.

Better Markets and LCH (with a suggested exception described below)

supported proposed Sec. 39.13(g)(8)(i).\128\ CME, KCC, OCC, ICE, NYPC,

FIA, and the Commodity Markets Council (CMC) argued against the

adoption of proposed Sec. 39.13(g)(8)(i).

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\128\ LCH also expressed its belief that a DCO should also

collect margin from all affiliated legal entities within a house

account on a gross basis unless there is legal certainty of the

DCO's right to offset risks across the affiliates in the event of

the default of the group or one or more of its affiliated legal

entities. The Commission has not proposed and is not adopting such a

requirement. However, although Sec. 39.13(g)(8)(i) permits a DCO to

collect initial margin for its clearing members' house accounts on a

net basis, it does not require it to do so, and a DCO could

determine to collect house margin in the manner suggested by LCH.

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KCC and ICE pointed out that DCOs that perform net margining have

not had any clearing member defaults or customer losses, including

during the 2008 financial crisis.

Various commenters opposed the proposal based on the potential

extent and costs of operational and technology changes that would need

to be made by clearing members and DCOs: (1) To convert net margining

systems to gross margining systems, and (2) to permit clearing members

to provide individual customer position information to DCOs, and DCOs

to receive individual customer position information and calculate the

margin required for each individual customer account (CME, KCC, ICE,

NYPC, and CMC).

OCC stated that the only means by which it could calculate margin

requirements on a customer-by-customer basis within a clearing member's

omnibus futures customers' account would be to create subaccounts for

each customer. CME, NYPC, KCC, and FIA commented that DCOs do not

currently receive position-level information for each individual

customer of their clearing members. CME and FIA expressed concern about

the costs associated with clearing members having to provide individual

customer position information, and CME indicated that DCOs would incur

costs in processing the information received from clearing members in

order to calculate margin requirements on individual customer accounts

on a daily basis. NYPC also stated that the adoption of proposed Sec.

39.13(g)(8)(i) would require it to make significant changes to its

systems.\129\

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\129\ See further discussion of these costs in section VII,

below. NYPC also commented that given the necessary technology

builds, it would need more than three years to come into compliance

with proposed Sec. Sec. 39.13(g)(8)(i) and 39.13(h)(2). The

Commission believes that the modifications to Sec. 39.13(g)(8)(i),

discussed in this section, would minimize any technology changes

that would be necessary in order to comply with Sec.

39.13(g)(8)(i).

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KCC stated that managing gross customer margin at the DCO level

[[Page 69375]]

would require a DCO to assume the role of a back-office account

management service, requiring continuous updates from each clearing

member regarding customer positions. KCC further noted that DCOs would

be required to adjust the timing deadlines for margin payments, DCOs'

ability to track margin requirements closely with market movements

would be decreased, and DCOs may face difficulty in relaying variation

margin payment information to their settlement banks quickly.

ICE noted that converting to a gross margining system would be a

major operational change for clearing firms and DCOs that use net

margining. However, ICE also stated that most DCOs currently use gross

margining, including ICE Trust (now ICE Clear Credit LLC) and ICE Clear

U.S., although ICE Clear Europe uses net margining. In particular, ICE

stated that gross margining would require reengineering of firms' end-

of-day processing. According to ICE, changes would need to be made to

such DCOs' margining technology, data submission/input mechanism and

margin reporting specifications, and clearing firms or their service

providers would need to implement software updates. ICE noted that

changes to position reporting, reconciliation and margining methodology

are challenging technology changes for clearing members and their

third-party software vendors and typically take at least six to nine

months to complete. However, ICE indicated that an implementation

period of at least 12 months would allow DCOs that currently use net

margining, and their clearing members, to adequately test and implement

the systems necessary for gross margining.

CME, KCC, and CMC all argued that requiring clearing members to

report gross customer positions by beneficial owner to DCOs is not

necessary in order to accomplish reasonable and adequate ``modified''

gross margining. Specifically, CME and KCC urged the Commission to

permit a version of gross margining of customer accounts that would

only require clearing members to report gross customer positions to

DCOs (not by beneficial owner) and that would allow clearing firms to

submit positions as spreadable for those accounts that have recognized

calendar spreads or spreads between correlated products. However, CME

further represented that ``[t]his version of gross margining will

sometimes lead to less than aggregate gross margins as a result of

optimal spreading that occasionally occurs between accounts.

Nevertheless, it approximates aggregate gross margins without imposing

significant costs on the industry.''

In light of the various concerns raised by CME, KCC, ICE, NYPC, and

CMC regarding the operational and technology changes that would be

needed and related costs of requiring a DCO to obtain individual

customer position information from its clearing members and to use such

information to calculate the margin requirements for each individual

customer, the Commission is modifying Sec. 39.13(g)(8)(i). In

particular, the Commission is adding a provision, which states that

``[f]or purposes of calculating the gross initial margin requirement

for each clearing member's customer account(s), to the extent not

inconsistent with other Commission regulations, a derivatives clearing

organization may require its clearing members to report the gross

positions of each individual customer to the derivatives clearing

organization, or it may permit each clearing member to report the sum

of the gross positions of its customers to the derivatives clearing

organization.'' \130\

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\130\ The Commission is including the phrase ``to the extent not

inconsistent with other Commission regulations'' because, in a

separate rulemaking, the Commission has proposed regulations that

would require FCM clearing members to provide daily information

identifying the positions of individual cleared swaps customers to

the relevant DCO and that would require such DCOs to calculate the

amount of collateral required for each cleared swaps customer of

such clearing members on a daily basis. If these regulations are

adopted, they will supersede the provisions of Sec. 39.13(g)(8)(i)

to the extent that they are inconsistent with such provisions, with

respect to cleared swaps. See 76 FR 33818 (June 9, 2011) (Protection

of Cleared Swaps Customer Contracts and Collateral; Conforming

Amendments to the Commodity Broker Bankruptcy Provisions).

The Commission is also making a conforming amendment by

inserting ``and may not permit its clearing members to'' in the

sentence that now reads as follows (added text in italics): ``A

derivatives clearing organization may not, and may not permit its

clearing members to, net positions of different customers against

one another.''.

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Thus, the Commission is providing a DCO with the discretion to

either calculate customer gross margin requirements based on individual

customer position information that it obtains from its clearing members

or based on the sum of the gross positions of all of a clearing

member's customers that the clearing member provides to the DCO,

without forwarding individual customer position information to the DCO.

In either case, the customer gross margin requirement determined by a

DCO must equal ``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.'' The customer gross margin collected by a DCO may not

be subject to ``spreading that occasionally occurs between accounts''

that may lead to ``less than aggregate gross margins,'' as described by

CME.

CME commented that proposed Sec. 39.13(g)(8)(i) was unclear

regarding how DCOs would be expected to treat customer omnibus accounts

of non-clearing FCMs and foreign brokers for which the clearing firm

carrying the account generally does not know the identities of

individual customers within the omnibus accounts. Under current

industry practice, omnibus accounts report gross positions to their

clearing members and clearing members collect margins on a gross basis

for positions held in omnibus accounts.\131\ The Commission does not

intend to alter this current practice by adopting Sec. 39.13(g)(8)(i).

Therefore, the Commission is adding a provision, which states that

``[f]or purposes of this paragraph, a derivatives clearing organization

may rely, and may permit its clearing members to rely, upon the sum of

the gross positions reported to the clearing members by each domestic

or foreign omnibus account that they carry, without obtaining

information identifying the positions of each individual customer

underlying such omnibus accounts.''

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\131\ See, e.g., Margins Handbook, http://www.nfa.futures.org/NFA-compliance/publication-library/margins-handbook.pdf, at 34; CME

Rule 930.J.; ICE Futures U.S. Inc. Rule 5.04; and CBOE Futures

Exchange, LLC Rule 516.

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The Commission believes that giving a DCO the option of permitting

its clearing members to provide the sum of their customers' gross

positions to a DCO, without the need to provide individual customer

position information to the DCO, allows DCOs to provide their clearing

members with a much less costly alternative to requiring clearing

members to provide individual customer position information to the DCO,

and requiring the DCO to calculate the gross margin requirement for

each customer of each clearing member.

The Commission recognizes that Sec. 39.13(g)(8)(i), even as

modified, will require DCOs and their clearing members to incur certain

costs. However, the Commission continues to believe, as stated in the

notice of proposed rulemaking, that gross margining of customer

accounts will: (a) More appropriately address the risks posed to a DCO

by its clearing members' customers than net margining; (b) will

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

[[Page 69376]]

customer default; \132\ and (c) with respect to cleared swaps, will

support the requirement in Sec. 39.13(g)(2)(iii) that a DCO must

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

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\132\ ICE commented that the Commission's rationale for gross

margining, i.e., that it would increase the financial resources

available to a DCO in the event of a customer default, is based upon

the mutualization of customer risk to protect the DCO. ICE stated

its belief that this rationale conflicts with the reasoning behind

the proposal that DCOs individually segregate cleared swaps customer

funds to protect such customers from fellow customer risk. The

Commission notes, however, that gross margining is not only

consistent with, but will be instrumental in achieving, complete

legal segregation for cleared swaps accounts. See 76 FR 33818 (June

9, 2011) (Protection of Cleared Swaps Customer Contracts and

Collateral; Conforming Amendments to the Commodity Broker Bankruptcy

Provisions).

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The Commission believes that the clearing of swaps will increase

the risk that DCOs face. Gross margining will maximize the amount of

money DCOs hold. Because a DCO may not have access to customer initial

margin collected by and held at an FCM if the DCO collects initial

margin on a net basis, if the FCM defaults, the Commission believes

that holding gross initial margin at a DCO is the safest mechanism by

which DCOs can protect themselves from increased risk. If a DCO is

unable to obtain customer margin in the event of default, there is

significant risk of contagion. Consequently, if more margin is held at

the DCO, the potential risk that the failure of one clearing member

will propagate throughout the financial system to other clearing

members and other entities is decreased.\133\

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\133\ As pointed out in the CPSS-IOSCO Consultative Report,

under certain circumstances gross margining may also increase the

portability of customer positions in an FCM insolvency. That is, a

gross margining requirement would increase the likelihood that there

will be sufficient collateral on deposit in support of a customer

position to enable the DCO to transfer it to a solvent FCM. See

CPSS-IOSCO Consultative Report, Principle 14: Segregation and

Portability, Explanatory Notes 3.14.6 and 3.14.8, at 67-68.

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CME and KCC commented that proposed Sec. 39.13(g)(8)(i) would

require clearing members to ``pass-through'' the margin deposits that

they receive from their customers to the DCO, thus requiring clearing

members to apply to their customers the DCO's standards for acceptable

collateral as well as the DCO's concentration limits with respect to

collateral types. CME indicated that this would add pressure with

respect to the available collateral pool, and argued that the

Commission should not impose such additional and costly constraints on

market participants in the absence of significant and demonstrable

benefits. The Commission notes that, although as a business matter

clearing members may determine to ``pass-through'' the margin deposits

that they receive from their customers to the relevant DCO, proposed

Sec. 39.13(g)(8)(i) does not require that a clearing member only

accept from its customers those types of margin assets that are

acceptable for the clearing member to deposit with the DCO.

KCC requested that the Commission clarify whether the requirement

to collect gross customer margin imposes an obligation on the DCO to

determine the defaulting customer accounts in a customer default

situation (which would be costly and burdensome) and stated that having

the total customer gross margin available to the DCO in the event of a

customer default is a prudent risk management technique. The Commission

notes that Commission rules currently permit a DCO to commingle the

initial margin with respect to all of a clearing member's customers in

a single customer origin account at the DCO and to apply the entire

customer origin account to cover losses with respect to a customer

default, whether the DCO collects initial margin on a net basis or on a

gross basis. The Commission does not intend Sec. 39.13(g)(8)(i), by

its terms, to alter this approach.

In a separate rulemaking, however, the Commission has proposed to

require DCOs to legally segregate customer funds and assets margining

swap positions that are held by a clearing member at the DCO in a

commingled cleared swaps customer account.\134\ In addition, European

Union legislation, although not yet finalized, would require central

counterparties to provide individual customer segregation in certain

circumstances.\135\ As previously noted, gross margining will be

instrumental if individual customer segregation is adopted. OCC

requested that the Commission restrict the applicability of proposed

Sec. 39.13(g)(8)(i) to futures customer accounts at both the clearing

level and the FCM level, to make it clear that it does not intend to

impose these margin requirements on accounts that are restricted to

securities products (with respect to an entity that is both a DCO and

an SEC-regulated clearing agency). OCC is correct that Sec.

39.13(g)(8)(i) applies only to customer and house accounts, cleared by

a DCO, which contain futures, options on futures, and/or swap positions

that are subject to the jurisdiction of the Commission. It does not

apply to accounts that only contain securities products that are

subject to the jurisdiction of the SEC.

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\134\ See 76 FR 33818 (June 9, 2011) (Protection of Cleared

Swaps Customer Contracts and Collateral; Conforming Amendments to

the Commodity Broker Bankruptcy Provisions).

\135\ See Financial markets: OTC derivatives, central

counterparties and trade repositories (amend. Directive 98/26/EC),

COD/2010/0250 (June 7, 2011), available at http://www.europarl.europa.eu/oeil/FindByProcnum.do?lang=en&procnum=COD/2010/0250.

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LCH requested that the Commission allow DCOs operating from non-

U.S. jurisdictions to offer ``net omnibus'' account structures for

associated entities operating under the same group or umbrella

structure to customers outside the U.S. The treatment of customers is

outside the scope of this rulemaking. However, to the extent a DCO is

clearing products subject to the Commission's jurisdiction, this rule

would apply at the clearing level regardless of the location of the DCO

or the customer.

The Commission is adopting Sec. 39.13(g)(8)(i) with the

modifications described above. The Commission recognizes that DCOs that

currently use net margining, or that use a ``modified'' version of

gross margining, as well as their clearing members and their service

providers, will need time to make the necessary operational and

technology enhancements that will facilitate gross margining, as

described herein. Therefore, the Commission is adopting an effective

date that is 12 months after the publication of final Sec.

39.13(g)(8)(i) in the Federal Register.

(2) End-of-Day Position Reporting--Sec. 39.19(c)(1)(iv)

Proposed Sec. 39.19(c)(1)(iv) would require each DCO to report to

the Commission, on a daily basis, the end-of-day positions for each

clearing member, by customer origin and house origin; and for customer

origin, separately, the gross positions of each beneficial owner.\136\

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\136\ As originally proposed, Sec. 39.19(c)(1)(iv) would

require each DCO to report to the Commission, on a daily basis, the

end-of-day positions for each clearing member, by customer origin

and house origin. See 75 FR 78185 (Dec. 15, 2010) (Information

Management). The preamble in the notice of proposed rulemaking (76

FR 3698 (Jan. 20, 2011) (Risk Management)), described a proposed

amendment to proposed Sec. 39.19(c)(1)(iv) to add ``and for

customer origin, separately, the gross positions of each beneficial

owner.'' However, this clause was inadvertently omitted from the

language of the regulation in the notice of proposed rulemaking.

Therefore, the Commission subsequently issued a correction at 76 FR

16588 (Mar. 24, 2011) (Risk Management Requirements for Derivatives

Clearing Organizations; Correction).

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As noted by KCC and CMC, the Commission currently receives certain

information about the ownership and control of reportable positions

through its large trader reporting program, under Parts 15 through 21

of the Commission's

[[Page 69377]]

regulations. Commission staff reviews the effectiveness of this program

on a regular basis, and will continue to adopt enhancements where

appropriate.\137\ The large trader reporting system, however, does not

currently apply to many swaps that are, or may be, cleared. The

Commission may need information about large swap positions to assess

the risk profile of a DCO or a clearing FCM.

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\137\ For example, the Commission recently adopted final rules

on Large Trader Reporting for Physical Commodity Swaps at 76 FR

43851 (July 22, 2011).

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CME, KCC, MGEX, FIA, and CMC commented that clearing members do not

generally have information identifying the underlying customers in

customer omnibus accounts carried on behalf of non-clearing member

FCMs, foreign brokers, hedge funds or commodity pools, and therefore

clearing members cannot reasonably be expected to report such

information to DCOs, and DCOs cannot reasonably be expected to report

such information to the Commission. The Commission notes that a DCO may

be able to obtain such information under its own rules. For example,

CME Rule 960 requires a clearing member to immediately disclose the

identities and positions of the beneficial owners of any omnibus

account to CME upon its request.

MGEX expressed its concern that the significant costs resulting

from compliance with a requirement for the routine daily reporting of

all gross customer positions by beneficial owner could lead to further

consolidation in the industry at the FCM, clearing member, and DCO

levels.

The Commission is not adopting the proposed requirement in Sec.

39.19(c)(1)(iv) that a DCO provide daily reports to the Commission of

the gross positions of each beneficial owner within each clearing

member's customer origin account. However, the Commission is adopting

Sec. 39.19(c)(5)(iii),\138\ which requires a DCO to provide this

information to the Commission upon the Commission's request, in the

format and manner, and within the time, specified by the Commission.

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\138\ See further discussion of Sec. 39.19, adopted herein, in

section IV.J, below.

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For example, the Commission could request that a DCO provide

information about customer positions by beneficial owner, on a case-by-

case basis, with respect to a particular clearing member, customer, or

product. Moreover, the Commission could request that such information

be provided for a particular day, month, or until further notice by the

Commission. In recent years, the Commission has worked cooperatively

with several DCOs to obtain information about cleared swap positions.

The Commission notes that any potential costs should be substantially

reduced by the modified requirement that a DCO provide information to

the Commission identifying the positions of beneficial owners of

customer accounts only upon Commission request and not on a daily

basis.

(3) Customer Initial Margin Requirements--Sec. 39.13(g)(8)(ii)

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

clearing members to collect customer initial margin \139\ from their

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

percent of the DCO's initial margin requirements \140\ with respect to

each product and swap portfolio. 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. However, under the proposed regulation, the

Commission could review such percentage levels and require different

percentage levels if the Commission deemed the levels insufficient to

protect the financial integrity of the clearing members or the DCO in

accordance with Core Principle D.\141\

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\139\ The term ``customer initial margin'' is now defined in

Sec. 1.3(kkk), adopted herein.

\140\ A DCO's initial margin requirements are also referred to

herein as ``clearing initial margin'' requirements. ``Clearing

initial margin'' is defined as ``initial margin posted by a clearing

member with a [DCO]'' in Sec. 1.3(jjj), adopted herein.

\141\ Section 5b(c)(2)(D)(iii) of the CEA, 7 U.S.C. 7a-

1(c)(2)(D)(iii).

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OCC stated its view that exchanges, which have historically set

customer level margin requirements, should continue to do so, rather

than DCOs, noting that clearing organizations would ordinarily have no

means to enforce customer level margin requirements.

KCC stated that it generally supports the concept that clearing

members should collect customer initial margin at a level above that of

DCO initial margin, but requested that the Commission clarify the

circumstances in which it may deem the ratio of customer initial margin

to DCO initial margin insufficient to protect the DCO. Although the

FHLBanks opposed the proposal, they recommended that if the Commission

were to adopt it, the Commission should provide additional guidance

and/or establish criteria for DCOs with respect to setting the required

amount of excess margin. MGEX noted that although it currently

maintains a 130 percent requirement, this is a decision that should be

left to each DCO and its clearing members to determine. Because the

circumstances for each DCO or the nature of its clearing members vary,

it would be difficult to provide the general clarification or criteria

that KCC and the FHLBanks are seeking, because such a determination

would need to be made on a case-by-case basis.

MFA argued that a requirement that a DCO must require its clearing

members to collect customer initial margin at a level that is greater

than the DCO's initial margin requirements would be inappropriate

because DCOs do not have information about individual customers'

creditworthiness and such a requirement would impair market liquidity

by limiting the trading activity of certain market participants,

resulting in greater market concentration. Citadel and the FHLBanks

made similar comments.

ICE stated that FCMs are best able to determine how much to charge

above the initial margin requirement because they have complete

visibility into their customers' positions, and the Commission should

not place this requirement on a DCO, but should address this with FCMs

through another set of rules. FIA opposed the proposed rule stating

that the amount of excess margin, if any, that an FCM may require from

its customers is a credit decision that should be made by each FCM

based on its analysis of the creditworthiness of the particular

customer, including the nature of the customer's trading activity and

its record of meeting margin calls.

Currently DCMs require their FCM members to impose customer initial

margin requirements that are a specified percentage higher than the

DCO's initial margin requirements, generally in the neighborhood of 125

percent to 140 percent, as determined by the DCM. DCMs generally permit

FCM members to impose customer initial margin requirements for hedge

positions that are equal to the applicable maintenance margin

requirements (which are generally the same as the applicable clearing

initial margin requirements). This rule simply shifts the

responsibility for establishing customer initial margin requirements

from DCMs to DCOs.

DCOs have greater expertise in risk management and a direct

financial stake in whether their clearing members' customers, and

consequently their clearing members, are able to meet their margin

obligations. Moreover, it is anticipated that some DCOs will clear

fungible swaps that may be listed on multiple SEFs. SEFs may or may not

[[Page 69378]]

impose customer initial margin requirements on their members for

cleared swaps. Requirements set by DCOs may be less susceptible to

pressure to being lowered for competitive reasons. Finally, DCOs will

be the only self-regulatory organizations that will be in a position to

set customer initial margin requirements for swaps that are executed

bilaterally, and voluntarily cleared. Moreover, DCOs will have the

opportunity to review whether their clearing members are collecting

customer initial margin, as required by the DCO, during their reviews

of the risk management policies, procedures, and practices of their

clearing members, pursuant to Sec. 39.13(h)(5).\142\

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\142\ See discussion of Sec. 39.13(h)(5), adopted herein, in

section IV.D.7.e, below.

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Section 39.13(g)(8)(ii) permits a DCO to exercise its discretion in

determining the appropriate percentage by which the customer initial

margin for a particular product or swap portfolio should exceed the

clearing initial margin,\143\ as DCMs do today with respect to futures

and options. This percentage should be based on the nature and

volatility patterns of the particular product or swap portfolio, and

the DCO's related evaluation of the potential risks posed by customers

in general to their clearing members and, in turn, the potential risks

posed by such clearing members in general to the DCO, rather than the

creditworthiness of particular customers. Consequently, a DCO will

retain the flexibility to establish an appropriate percentage for

customer initial margin that applies to each product that it clears,

which will apply to all of its clearing FCMs and all of their

customers. However, as is also the case today, such clearing FCMs would

remain free to exercise their discretion to determine whether they will

collect additional margin over and above that amount either from all of

their customers, or from particular customers based on such customers'

risk profiles.\144\

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\143\ OCC commented that its STANS margin system calculates

margin based on all positions in an account and not on a position-

by-position basis; therefore it would not be able to furnish

clearing members with a number representing the initial margin on a

particular position without conducting subaccounting for each

customer. OCC also noted that since STANS requirements are data-

driven on a month-to-month, and even a day-to-day, basis they can

vary in ways that cannot be readily predicted. The Commission is

adopting Sec. 39.13(g)(8)(i) herein, which requires a DCO to

collect initial margin on a gross basis for its clearing members'

customer accounts. Therefore, a clearing member (or the DCO) will be

required to determine the initial margin that must be posted with

the DCO with respect to each customer's positions. Even if that

amount changes from day to day as a result of the application of a

portfolio-based margin system, a DCO could require that its clearing

members collect customer initial margin in an amount that is a given

percentage in excess of 100 percent of the daily clearing initial

margin requirement with respect to each customer.

\144\ See, e.g., CME Rule 8G930.E (``IRS Clearing members may

call for additional performance bond at their discretion.'')

(available at http://www.cmegroup.com/rulebook/CME/I/8G/) and

International Derivatives Clearinghouse, LLC Rule 614(g) (``A

Clearing Member may call, at any time, for [margin] above and beyond

the minimums required by the Clearinghouse.'') (available at http://www.idch.com/pdfs/idch/20100901rulebook.pdf).

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The Commission continues to believe that requiring a DCO to require

its clearing members to collect customer initial margin in a percentage

higher than 100 percent of the clearing initial margin, for non-hedge

positions, provides a valuable cushion of readily available customer

margin. Citadel stated that the market's extensive experience in a

range of cleared markets demonstrates preparedness for the regular

exchange of margin between clearing members and their customers for

cleared OTC derivatives, even where margin calls occur more frequently

than once daily, and that frequent exchange of margin is also current

market practice for uncleared trades. However, the maintenance of 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

such frequent margin calls to their customers. In addition, many

clearing members choose to deposit excess margin with their DCOs to

provide their own cushion, which may in some instances obviate the need

to transfer funds to the DCO on a daily basis in order to meet

variation margin requirements.

ISDA, FIA, and the FHLBanks commented that if the Commission were

to adopt proposed Sec. 39.13(g)(8)(ii), it should clarify the meaning

of ``non-hedge positions.'' The FHLBanks also stated that the

Commission should provide guidance regarding how the determination as

to whether a position is a hedge or a non-hedge position would be made,

whether by the DCO, the clearing member, or the customer, and expressed

the belief that a clearing member's customers should be responsible for

determining and certifying, to their clearing members or DCOs, whether

their swap positions are ``hedge'' or ``non-hedge'' positions.

Several commenters have argued that there is no basis for

distinguishing between hedge positions and non-hedge positions in

determining whether such positions should be subject to customer

initial margin requirements in excess of clearing initial margin

requirements.\145\ LCH stated that it does not believe that a DCO or a

clearing member should distinguish in any way between a customer's

hedge and non-hedge positions because: (1) if the two parts of the

hedge are carried by the same clearing member within the same DCO, such

hedges would in any event implicitly be recognized by the DCO's risk

calculations and the provision would be unnecessary; and (2) if one or

the other leg of the hedge is uncleared, or is carried by a different

clearing member, or by the same or another clearing member at another

DCO, no recognition of the offsetting hedge should be allowed either by

the DCO(s) or by the clearing member(s), as neither party would have

the economic benefit of the hedged transaction. The Commission notes

that the categorization of a position as a hedge for purposes of this

regulation does not affect the margin collected by the DCO; it only

affects the additional increment that the clearing member collects from

its customer.

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\145\ MFA stated that it would be highly burdensome to

distinguish between hedge and non-hedge positions for purposes of

the application of differentiated margining, especially in a

portfolio margining context. As noted in n. 143, above, a DCO that

uses a portfolio-based margin model could require that its clearing

members collect customer initial margin in an amount that is a given

percentage in excess of 100 percent of the daily clearing initial

margin requirement with respect to each customer. If all of a

particular customer's positions were hedge positions, the DCO could

permit the clearing member to collect customer initial margin in an

amount that equals the amount of clearing initial margin with

respect to that customer's positions. It is only in those

circumstances where a hedger may also engage in speculative trading

that it may be difficult to distinguish between positions for

purposes of the application of differentiated margining in a

portfolio margining context.

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Freddie Mac indicated that the Commission should consider

eliminating the proposed requirement for increased customer initial

margin for ``non-hedge positions,'' noting that customers with non-

hedge positions are not inherently riskier or more likely to miss

margin calls than customers with ``hedge positions.''

As previously noted, DCMs have historically drawn a distinction

between hedge positions and non-hedge positions in setting customer

initial margin requirements, and the Commission believes that it is

reasonable to assume that hedgers may present less risk than

speculators, in that losses on their derivatives positions should be

offset by gains on the positions whose risks they are hedging. The

relevant consideration is the relative risks posed by hedgers versus

non-hedgers, rather than the

[[Page 69379]]

creditworthiness of particular customers.

Freddie Mac recommended that, if the Commission does not eliminate

the distinction between hedge and non-hedge positions, the Commission

should clarify that, for purposes of Sec. 39.13(g)(8)(ii): (1) ``hedge

positions'' would include all swaps that hedge or mitigate any form of

a customer's business risks; (2) such swaps may qualify as ``hedge

positions'' regardless of whether they qualify as ``bona fide hedging

transactions'' under the CEA and Sec. 1.3(z) or qualify as hedges

under applicable accounting standards; and (3) such swaps may qualify

as ``hedge positions'' regardless of the nature of the entity that

holds such positions (e.g., whether it is a financial entity or a non-

financial entity). Freddie Mac indicated that such treatment would be

consistent with Commission proposals for defining hedging for purposes

of other Dodd-Frank Act rules, including the definition of a ``major-

swap participant'' \146\ and rules relating to the availability of the

end-user exception to mandatory clearing.\147\

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\146\ See 75 FR 80174 (Dec. 21, 2010) (Further Definition of

``Swap Dealer,'' ``Security-Based Swap Dealer,'' ``Major Swap

Participant,'' ``Major Security-Based Swap Participant'' and

``Eligible Contract Participant'').

\147\ See 75 FR 80747 (Dec. 23, 2010) (End-User Exception to

Mandatory Clearing).

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The Commission intends to interpret ``hedge positions,'' for

purposes of Sec. 39.13(g)(8)(ii), as referring to those that meet

either the definition set forth in Sec. 1.3(z), or the definition set

forth in Sec. 1.3(ttt), when, and in the form in which, it is

ultimately adopted.\148\ The Commission also believes that, as is

currently the practice, it would be the customer's responsibility to

identify its positions as hedge positions to its clearing FCM.

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\148\ The Commission has proposed a definition of ``hedging or

mitigating commercial risk,'' to be codified at Sec. 1.3(ttt), for

the purposes of the definition of ``Major Swap Participant,'' 75 FR

at 80214-80215 (Further Definition of ``Swap Dealer,'' ``Security-

Based Swap Dealer,'' ``Major Swap Participant,'' ``Major Security-

Based Swap Participant'' and ``Eligible Contract Participant'').

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The Commission is adopting Sec. 39.13(g)(8)(ii) as proposed.

(4) Withdrawal of Customer Initial Margin--Sec. 39.13(g)(8)(iii)

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 swap

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

LCH agreed with the underlying requirement, but stated that it

should be imposed in rules that directly apply to clearing members

rather than in rules applicable to DCOs. KCC also supported the concept

but noted that DCM rules already require customers to maintain minimum

margin levels and that these restrictions are generally tested by a

clearing member's risk department and the clearing member's self-

regulatory organization during examinations. KCC further noted that

DCOs do not have full access to information regarding each customer's

financial condition. MGEX took the position that the Commission \149\

or a clearing member's designated self-regulatory organization (DSRO)

should monitor compliance with such a requirement rather than the DCO,

indicating that it would not be economically feasible for the DCO to do

so.

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\149\ The Commission does not believe that it would be practical

for the Commission to review each clearing member of each DCO to

determine whether the clearing member is prohibiting its customers

from making impermissible withdrawals from their accounts.

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As noted in the notice of proposed rulemaking, the requirement

stated in Sec. 39.13(g)(8)(iii) is consistent with the definition of

``Margin Funds Available for Disbursement'' in the Margins Handbook

prepared by the JAC.\150\ Therefore, DSROs currently review FCMs to

determine whether they are appropriately prohibiting their customers

from withdrawing funds from their futures accounts unless the net

liquidating value plus the margin deposits remaining in such customers'

accounts after the withdrawal would be sufficient to meet the customer

initial margin requirements with respect to such accounts. However, it

is unclear to what extent this requirement would apply to cleared swaps

accounts when such swaps are executed on a DCM which participates in

the JAC. Moreover, clearing members which only clear swaps that are

executed on a SEF will not be subject to the requirements set forth in

the Margins Handbook or subject to review by a DSRO.

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\150\ See http://www.nfa.futures.org/NFA-compliance/publication-library/margins-handbook.pdf, at 45.

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The Commission anticipates that, at a minimum, DCOs will be able to

review whether their clearing members are ensuring that customers do

not make withdrawals from their accounts unless the specified

conditions are met, when they conduct reviews of their clearing

members' risk management policies, procedures, and practices pursuant

to Sec. 39.13(h)(5).\151\

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\151\ See discussion of Sec. 39.13(h)(5), adopted herein, in

section IV.D.7.e, below.

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The Commission is adopting Sec. 39.13(g)(8)(iii) as proposed.

i. Time Deadlines--Sec. 39.13(g)(9)

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

enforce time deadlines for initial and variation margin payments.

LCH submitted a comment letter indicating that it agrees with the

proposal, but stated that it should apply only to a DCO's clearing

members since a DCO has no direct relationship with clients of its

clearing members. Consistent with its original intent, the Commission

is adopting Sec. 39.13(g)(9) with a modification to make it clear that

it only applies to time deadlines for initial and variation margin

payments to a DCO by its clearing members.

7. Other Risk Control Mechanisms

a. Risk Limits--Sec. 39.13(h)(1)(i)

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 Commission believes that an FCM

engages in excess risk-taking if it, or its customers, take on

positions that require financial resources that exceed this threshold.

The DCO would have reasonable discretion in determining: (1) the method

of computing risk exposure; (2) the applicable threshold(s); and (3)

the applicable financial resources, provided however, that the ratio of

exposure to capital would have to remain the same across all capital

levels. For example, if a DCO set limits under which margin could not

exceed 200 percent of capital, the limit for a $100 million clearing

member would be $200 million and the limit for a $200 million clearing

member would be $400 million. 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

[[Page 69380]]

exposure at the clearing member. The Commission could review the amount

of additional initial margin and require a different amount, as

appropriate.

J.P. Morgan and Alice Corporation supported the proposal to require

DCOs to establish risk-based position limits for their clearing

members. J.P. Morgan indicated that in setting such position limits

applicable to any one clearing member, a DCO should consider its

overall exposure to clearing members in the aggregate. The Commission

agrees that this would be prudent and expects that DCOs would take into

consideration the aggregate exposure in establishing individual levels.

J.P. Morgan further took the position that DCOs should monitor

exposures against these limits on a real time basis. As discussed in

section IV.D.4, above, Sec. 39.13(e)(2) requires a DCO to monitor its

credit exposure to each clearing member periodically during each

business day.

FIA stated that it generally agrees with the proposed requirement

that ``the ratio of exposure to capital must remain the same across all

capital levels'' but indicated that the rule should make clear that, in

computing the ratio of exposure to capital, a clearing member's capital

should be calculated net of all risk exposures and potential assessment

obligations at other clearing organizations of which it is a clearing

member. The Commission agrees that it would be appropriate for a DCO to

consider a clearing member's exposures to other clearing organizations,

to the extent that it is able to obtain such information, in

determining a clearing member's applicable financial resources for the

purpose of setting appropriate risk limits.

CME argued that a requirement that DCOs impose risk limits for

every clearing member would be overly prescriptive and unnecessary,

provided that a DCO collects adequate margin, its stress-test results

regarding the clearing member's exposures are acceptable, and it

employs concentration margining (whereby the DCO would set a level of

risk at which it would begin to charge higher margins based on

indicative stress-test levels). In other words, CME suggested that risk

limits may be unnecessary if a DCO sets a level of risk at which it

would begin to charge higher margins based on stress test results with

respect to a clearing member. However, Sec. 39.13(h)(1)(ii) would

allow a DCO to permit a clearing member to exceed an established risk

limit provided that the DCO required the clearing member to post

additional margin. Although CME's proposed approach is worded slightly

differently, the effect would be the same as that of Sec.

39.13(h)(1)(ii), i.e., a clearing member could only exceed a defined

risk level if it posted additional margin.

MGEX indicated that the proposed rule requiring DCOs to impose risk

limits on each clearing member might not be practical, adding

additional cost with little benefit, noting that DCOs currently address

credit and default risk via margins and security deposits on a daily

basis and conduct risk reviews. Rather, according to MGEX, a DCO should

be looking for risk signs and focusing on those that are most relevant.

The Commission believes that the establishment of risk limits for

clearing members would impose little additional cost on DCOs since DCOs

are already required to monitor their clearing members' capital levels

and their own financial resources, as well as the trading activity of

their clearing members. On the other hand, the Commission believes that

the establishment of such risk limits would add significant risk

management benefits to the benefits already conferred by margins,

security deposits, and reviews of clearing members' risk management

policies and procedures.

The Commission is adopting Sec. 39.13(h)(i) as proposed, except

for a technical revision that replaces the phrase ``by customer orgin

and house origin'' with ``by house origin and by each customer

origin,'' which conforms the language with other provisions of part 39.

OCC requested that the Commission clarify that proposed Sec.

39.13(h)(i) would not apply to securities accounts of broker-dealers

that are not FCMs and do no futures business. The Commission does not

intend for Sec. 39.13(h)(i) to apply to such accounts. The Commission

is also adopting Sec. 39.13(h)(ii) as proposed.

b. Large Trader Reports--Sec. 39.13(h)(2)

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

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

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

Commission's regulations, i.e., large trader reports. Large trader

reports are necessary for stress testing to ensure that FCMs and their

customers have not taken on too much risk. 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 would

therefore be required to file such reports on behalf of clearing

members pursuant to Sec. 17.00(i).

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

the large trader reports that it receives 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 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 those actions specified in

proposed Sec. 39.13(h)(6).\152\

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\152\ See discussion of Sec. 39.13(h)(6), adopted herein, in

section IV.D.7.f, below.

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FIA supported the proposal to require DCOs to obtain copies of all

large trader reports that are filed with the Commission. MGEX commented

that the Commission should provide large trader reports to each DCO

rather than imposing a requirement that would require clearing members

to make redundant filings. KCC argued that the proposed requirement

that DCOs obtain large trader reports from clearing members is

duplicative because a DCO receives large trader information from the

exchange.\153\

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\153\ KCC further noted that, in its case, the exchange in turn

receives the relevant large trader reports from the Commission.

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MGEX recommended that the Commission perform the review of large

trader reports itself or permit a clearing member's DSRO to perform

such review instead of DCOs.

NYPC recommended that the Commission not adopt proposed Sec.

39.13(h)(2) because the Commission has expended considerable resources

to modify its own internal programs and processes in order to glean

potentially relevant financial and risk management information from the

large trader data that it receives from clearing members and DCMs, and

even if DCOs had comparable financial and human resources that they

could deploy for such a purpose, the information that they would obtain

would frequently be fragmented and inconclusive, given that--unlike the

Commission--no single DCO will ever have access to information relating

to the futures, option and swap positions that are cleared by other

DCOs or to uncleared swaps. NYPC further argued that given the

necessary technology builds, it would need more than three years to

come into compliance with proposed Sec. Sec. 39.13(g)(8)(i) and

39.13(h)(2).

OCC indicated that it should be the role of a clearing member's

DSRO to require that an FCM submit sufficient information to permit the

DSRO to identify customer accounts that could potentially cause a

clearing member to

[[Page 69381]]

default, and that if DCOs were required to perform all tasks required

by the proposed rules alone, they would be required to build new

surveillance systems and significantly increase their surveillance

staff.

In response to suggestions that the Commission should conduct the

required review of large trader reports, the Commission notes that it

does review large trader reports for financial, market, and risk

surveillance purposes. However, the Commission believes that DCOs

should also have an obligation to review large trader reports for those

large traders whose trades they clear, for their own risk surveillance

purposes, even though as noted by NYPC, they may not have access to

information relating to positions cleared by other DCOs or to uncleared

swaps. Moreover, Sec. 39.13(h)(2) requires a DCO to review such large

trader reports with a view toward taking any necessary additional

actions with respect to such large traders' clearing members in order

to address risks posed by such large traders to the DCO.

In addition, it would not be feasible for a clearing member's DSRO

to review large trader reports. DSRO designations apply to FCMs that

are members of multiple DCMs. Therefore, clearing members that only

trade for their own accounts do not have a DSRO. Clearing members that

solely clear SEF-executed trades also will not have DSROs. Moreover,

risk management ultimately is the responsibility of each DCO. A DSRO

would not be in a position to analyze the daily risk of the overall

portfolio of each large trader at a particular DCO, nor to take any

additional actions to address such risks at a particular DCO.

KCC stated that it is the clearing member's obligation to determine

the financial fitness of large trader customers, in that clearing

members have better, more direct information regarding the credit

quality of the customer and the exposures of the customer under

positions the customer may hold outside the DCO. KCC stated its belief

that imposing a duplicative requirement on DCOs would achieve little

risk management benefit at a high cost. The Commission agrees that

clearing members must determine the financial capacity of their

customers and they may have information which a particular DCO may not

have regarding positions that they may clear for their customers on

other DCOs.\154\ However, this does not obviate the need for each

relevant DCO to ascertain the risks that the large trader poses to that

DCO based on the information which the DCO is able to obtain through

large trader reports.

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\154\ The Commission is modifying the language in proposed Sec.

39.13(h)(2), which would have referred to ``positions at all

clearing members carrying accounts for each such large trader'' by

revising it to read as follows: ``futures, options, and swaps

cleared by the [DCO] which are held by all clearing members carrying

accounts for each such large trader.'' This will make it clear that

the Commission is not attempting to require a DCO to review a large

trader's positions that were cleared by another DCO, as it would not

typically have access to information about such positions. The

technical change from ``positions'' to ``futures, options, and

swaps'' conforms the language with other provisions of part 39.

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ISDA noted that while the expansion of oversight required by

proposed Sec. Sec. 39.13(h)(2) and Sec. 39.13(h)(3) \155\ may provide

benefits, many DCOs do not currently have the systems or infrastructure

to monitor or assess non-clearing member risk.\156\

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\155\ See discussion of Sec. 39.13(h)(3), adopted herein, in

section IV.D.7.c, below.

\156\ ISDA also stated that further clarity regarding how the

Commission intends to apply the large trader definition to swaps is

needed. The Commission notes that it has begun this process by

adopting final rules for Large Trader Reporting for Physical

Commodity Swaps, in a new part 20, at 76 FR 43851 (July 22, 2011).

Since these large trader reporting rules were adopted subsequent to

the Commission's proposal of Sec. 39.13(h)(2), the Commission is

modifying Sec. 39.13(h)(2) to refer to reports required to be filed

with the Commission by, or on behalf of, clearing members pursuant

to parts 17 and 20 of this chapter.

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In response to ISDA's comment, as well as other comments that in

order to comply with Sec. 39.13(h)(2), DCOs would need technology

builds (NYPC), new surveillance systems and additional surveillance

staff (OCC), and that there would be a high cost (KCC), the Commission

notes that some DCOs already receive and review large trader reports

for risk surveillance purposes on a daily basis. In fact, KCC stated in

its comment letter that ``KCC would also remind the Commission that DCO

compliance staff review the reportable position files that they receive

on a daily basis to ascertain large trader risks that [clearing

members] face.'' In addition, at least five years ago, Commission staff

began recommending that DCOs do so, if they had not already been doing

so, in DCO reviews that Commission staff has conducted to determine

whether such DCOs were in compliance with relevant core principles

under the CEA.

The Commission is modifying Sec. 39.13(h)(2) to require a DCO to

obtain large trader reports either from its clearing members or from a

DCM or a SEF for which it clears, which are required to be filed with

the Commission by, or on behalf of, such clearing members. However, the

Commission does not believe that it is practical or appropriate for a

DCO to rely on the Commission to provide large trader reports to the

DCO.

The Commission is adopting Sec. 39.13(h)(2) with the modifications

described above.

c. Stress Tests--Sec. 39.13(h)(3)

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

daily and weekly stress tests. The Commission has defined a ``stress

test'' in Sec. 39.2, adopted herein, as ``a test that compares the

impact of potential extreme price moves, changes in option volatility,

and/or changes 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.'' \157\

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\157\ See further discussion of Sec. 39.2 in section III.B,

above.

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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 the stress tests. However,

the Commission could review the methodology and require any appropriate

changes. The Commission requested 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.

Several commenters addressed daily stress testing. FIA recommended

that all of the proposed stress tests should be conducted on a daily

basis. LCH stated its belief that stress testing requirements should

not be extended to cover large traders that are clients of clearing

[[Page 69382]]

members but that the proposed weekly stress tests should be conducted

daily. OCC stated that it did not see a sufficient benefit to justify

the increased DCO resources that would be required to undertake daily

stress tests on each large trader,\158\ noting that the costs would be

passed on to clearing members and their customers. MGEX indicated that

a requirement for daily stress testing of large traders seems excessive

since the data may be dated even after one day and may not be more

relevant than doing an average stress test over a weekly or monthly

period. MGEX also expressed the view that the value of stress testing

large traders is diminished if they have accounts with different

clearing members.

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\158\ As noted above, proposed Sec. 39.13(h)(3)(i) would not

require daily stress tests on each large trader, but only with

respect to those large traders who pose significant risk to a

clearing member or the DCO in the event of default.

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As stated above, proposed Sec. 39.13(h)(3)(i) would require a DCO

to include positions at all clearing members carrying accounts for the

large trader in the required stress tests. The Commission is making the

same change to Sec. 39.13(h)(3)(i) that it is making to Sec.

39.13(h)(2) by replacing the reference to ``positions at all clearing

members carrying accounts for each such large trader'' with ``futures,

options, and swaps cleared by the derivatives clearing organization,

which are held by all clearing members carrying accounts for each such

large trader.''

KCC stated its belief that the frequency of stress testing should

be left to the discretion of the DCO and should be risk-based in light

of prevailing market conditions. NOCC indicated that products,

customers or spread credits should reach a specified volume or risk

exposure level before being required to be stress tested with the

proposed frequencies so long as the DCO can demonstrate that it is

meeting the core principle objectives underlying proposed Sec.

39.13(f).\159\

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\159\ NOCC made a similar comment with respect to the frequency

of back testing, which is discussed in section IV.D.6.g,, above. The

Commission does not believe that it is appropriate to adopt a

regulation establishing an exemption process with respect to stress

testing requirements based on volume or risk exposure or otherwise.

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The Commission believes that it is appropriate to specify the

minimum frequency of stress tests as set forth in Sec. 39.13(h)(3). As

noted above, several commenters supported certain daily stress testing

requirements. With the exception of KCC's and NOCC's comments, no

commenters suggested that stress tests should be conducted less

frequently than weekly.

LCH recommended that the Commission prescribe that the stress

scenarios used by the DCO in its testing should be adapted for current

market conditions such that price or market shifts should not be

translated literally, but rather proportionally. The Commission

believes that Sec. 39.13(h)(3) should explicitly permit DCOs to

exercise reasonable discretion in determining the methodology to be

used in conducting the required stress tests. The Commission would

recognize the approach suggested by LCH to be an appropriate element of

a DCO's stress testing methodology, but does not believe that it is

necessary to adopt such a prescriptive requirement.

OCC indicated that for regulatory reasons associated with OCC's

status as a dual SEC/Commission registrant, OCC's system does not

consolidate all positions into a single ``customer origin'' and ``house

origin'' for each clearing member, but rather permits multiple account

types, including a firm (proprietary) account that incorporates both

securities and futures positions, a securities customers' account, a

regular futures customer segregated funds account subject to Section 4d

of the CEA, separate segregated funds accounts for cross-margining

arrangements as provided in various Commission orders approving such

arrangements, and others. OCC further stated that because of the

mathematical properties of the risk measures that it uses, its

unconsolidated account level stress testing is more rigorous than if

such stress testing were conducted at the level of each origin as a

whole and argued that it makes sense to aggregate positions for stress

testing in the same manner as they would be aggregated or netted for

liquidation purposes. Therefore, OCC requested that the Commission

clarify that this method of stress testing at the unconsolidated

account level based on appropriate historical data would meet the

requirements of proposed Sec. 39.13(h)(3)(ii). The Commission agrees

with OCC that it would be appropriate for a DCO to conduct the stress

tests required by Sec. 39.13(h)(3)(ii) with respect to separate house

origin and customer origin accounts such as the house account that

incorporates both securities and futures positions identified by

OCC,\160\ separate customer accounts subject to Sections 4d(a) and

4d(f) of the CEA, respectively, or cross-margining accounts.

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\160\ A DCO that is dually-registered as a securities clearing

agency would not be subject to the stress testing requirements of

Sec. 39.13(h)(3)(ii) with respect to an account that only contains

securities positions. However, such a DCO would be subject to the

requirements of Sec. 39.13(h)(3)(ii) with respect to any relevant

account that contains positions in instruments regulated by the

Commission, even if that account also contains securities positions.

In this regard, the Commission is revising Sec. 39.13(h)(3)(ii) to

refer to ``each clearing member account, by house origin and by each

customer origin, and each swap portfolio, including any portfolio

containing futures and/or options and held in a commingled account

pursuant to Sec. 39.15(b)(2) of this part, * * *''

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OCC also argued that while the requirement of conducting stress

tests under ``extreme but plausible'' market conditions may be

appropriate for determining the adequacy of a clearing organization's

resources for withstanding the default of its largest participant, it

would be inappropriate for measuring the adequacy of an individual

clearing member's margin deposits. In particular, OCC expressed its

belief that stress testing the positions, including margin assets, in

clearing member accounts on a daily basis to ensure a positive

liquidating value at more than a 99 percent confidence level is

adequate and appropriate and that DCOs should have the ability to cover

for more extreme market conditions through the use of additional

financial resources, including clearing fund deposits.

A stress test, as defined by the Commission, is not designed to

measure the adequacy of a clearing member's margin deposits or to

ensure that margin assets in clearing members' accounts meet a 99

percent confidence level. Rather, these are the functions of the daily

review and back testing required by Sec. Sec. 39.13(g)(6) and (g)(7),

adopted herein.\161\ Stress tests address the adequacy of the

applicable financial resources to cover losses resulting from potential

extreme price moves, changes in option volatility, and/or changes in

other inputs that affect the value of a position. In other words, if

margin deposits would be sufficient to cover losses 99 percent of the

time, stress tests would determine whether other financial resources

would be available and sufficient to cover losses the remaining 1

percent of the time. Such other financial resources could include the

capital of the clearing member or the DCO, or a DCO's guaranty fund.

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\161\ See discussion of Sec. Sec. 39.13(g)(6) and (g)(7) in

section IV.D.6.g, above.

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The Commission is adopting Sec. 39.13(h)(3) with the modifications

described above.

d. Portfolio Compression--Sec. 39.13(h)(4)

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

[[Page 69383]]

exercises are appropriate for those swaps that it clears. The

Commission requested comment regarding whether such exercises should be

offered monthly, quarterly, or on another frequency. In addition, the

Commission requested comment regarding whether the frequency of such

exercises should vary for different categories of swaps.

Proposed Sec. 39.13(h)(4)(ii) would mandate that a DCO 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 was 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 members 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).

CME commended the Commission for recognizing the importance of

portfolio compression exercises as an important risk management tool.

CME further suggested that the Commission refrain from prescribing the

frequency of such exercises, stating its belief that each DCO is best

positioned to determine the optimal frequency of portfolio compression

exercises for the swaps that it clears, based on the unique

characteristics of the particular products and markets. On the other

hand, the FHLBanks stated that the Commission should specify how often

portfolio compression exercises are to take place. The Commission

agrees with CME and is retaining the language that simply refers to ``a

regular basis.''

ISDA requested that the Commission clarify the meaning of

``multilateral portfolio compression'' in these proposals. ISDA stated

that if the Commission is referring to position netting, then it agrees

that a DCO must offer such exercises. However, ISDA indicated that if

it refers to the provision of multilateral portfolio compression

services such as those currently provided by entities such as

TriOptima, DCOs should not be required to build such duplicative

services, which would be likely to delay their roll-out of

comprehensive clearing services. The Commission agrees that a DCO

should not be required to incur the expense of building its own

multilateral compression services. Therefore, the Commission is

modifying the requirement to make it clear that although a DCO may

develop its own portfolio compression services if it chooses, it is

only required to make such exercises available to its clearing members

if applicable portfolio compression services have been developed by a

third party for those swaps that it clears.\162\

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\162\ This also addresses the FHLBanks' comment that the

Commission should specify what types of swaps are to be included in

portfolio compression exercises.

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The FHLBanks urged the Commission to further define ``reasonably

likely to increase risk exposure to a clearing member'' to include the

risk exposures of a clearing member's customers, and also stated their

view that a clearing member's customers must have the ability to ``opt-

out'' of portfolio compression requirements to the extent that those

customers' swap positions need to be retained for hedge accounting and

other business purposes. In particular, the FHLBanks expressed their

concern that the proposal's ambiguities would cause the internal risk

management strategies of entities that are not swap dealers or major

swap participants to be adversely affected, noting that portfolio

compression could potentially jeopardize hedge accounting treatment for

customers' swap transactions and disrupt anticipated cash flows.

LCH stated that it strongly supports the use of compression

services and believes that they should be encouraged by the Commission

to the greatest extent possible, but it would not necessarily always be

appropriate for a DCO to require its clearing members to participate in

all such exercises. First, LCH noted that a DCO's clearing members may

not always be subject to the Commission's supervision and may not be

required to engage in such compression activities; therefore imposing

such a requirement on the DCO may discourage such firms from becoming

clearing members of that DCO and thereby have the perverse effect of

discouraging such firms from clearing. Second, LCH stated that a

clearing member may have legitimate reasons for not participating in

such compression exercises at all times, or for not submitting all

eligible swaps to such exercises. Therefore, LCH took the position that

the use of compression services should be encouraged but should not be

compulsory, and suggested that the Commission eliminate Sec. 39.13

(h)(4)(ii) in its entirety. For the reasons stated by LCH and the

FHLBanks, the Commission is modifying Sec. 39.13(h)(4) to provide that

participation in compression exercises by clearing members and their

customers would be voluntary.

e. Clearing Members' Risk Management Policies and Procedures--Sec.

39.13(h)(5)

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 would be required to adopt rules that:

(a) require its clearing members to maintain current written risk

management policies and procedures (proposed Sec. 39.13(h)(5)(i)(A));

(b) ensure that the DCO 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 (proposed

Sec. 39.13(h)(5)(i)(B)); 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 (proposed Sec. 39.13(h)(5)(i)(C)).

In addition, proposed Sec. 39.13(h)(5)(ii) would require a DCO to

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

of its clearing members on a periodic basis and document such reviews.

The Commission invited 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 requested

comment regarding whether it 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 invited 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.

ISDA and FIA supported the proposed requirement in Sec.

39.13(h)(5)(i)(A) that clearing members must have written risk

management policies and procedures. FIA also recommended that clearing

members should be required to have adequate staff and systems to

monitor customer risk on a real-time or near-real time basis and to

routinely test their risk management procedures under theoretical

stress scenarios.

NGX stated that the requirement that clearing members have and

follow risk management policies is a sensible requirement in the

context of the

[[Page 69384]]

typical, intermediated clearinghouse.However, NGX argued that such

requirements should not apply to a non-intermediated DCO such as NGX,

where clearing participants are commercial end users, trading and

clearing for their own accounts, and none of the clearing participants

are exposed to the default risk of any other clearing participant or to

that of fellow customers of a clearing participant.

The Commission believes that it is appropriate for a DCO to require

all of its clearing members to maintain written risk management

policies and procedures, regardless of whether such clearing members

have customer business or are exclusively self-clearing. As noted

above, the Commission believes that written policies are a crucial

component of any risk management framework. Moreover, Sec.

39.13(h)(5)(i)(A) does not specify the nature or extent of the required

written risk management policies and procedures, which could vary as

appropriate to a particular type of clearing member, subject to the

requirements of any other applicable Commission regulations.\163\

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\163\ For example, in a separate rulemaking, proposed Sec.

23.600 would set forth detailed requirements for the risk management

programs of swap dealers and major swap participants, and would

require such entities to maintain written procedures and policies

describing their Risk Management Programs. See 75 FR 71397 (Nov. 23,

2010) (Regulations Establishing and Governing the Duties of Swap

Dealers and Major Swap Participants). Such swap dealers and major

swap participants may or may not be clearing members.

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The Commission has not proposed and is not adopting the additional

requirements suggested by FIA, described above, as part of this

rulemaking. However, the Commission has proposed additional

requirements with respect to clearing members' risk management policies

and procedures in a separate rulemaking applicable directly to clearing

members.\164\

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\164\ See 76 FR 45724 (Aug. 1, 2011) (Clearing Member Risk

Management). In that rulemaking, the Commission has proposed to

require FCMs, swap dealers, and major swap participants, each of

which are clearing members, to adopt certain specified risk

management procedures, including written procedures to comply with

the proposed requirements.

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With respect to the proposed requirement in Sec. 39.13(h)(5)(i)(C)

that a DCO must have rules requiring its clearing members to make

information regarding their risk management policies, procedures, and

practices available to the Commission, MGEX stated that the Commission

should seek access to a clearing member's risk management policies and

processes directly and a DCO should not act as an unnecessary conduit

between the Commission and clearing members. The Commission notes that

even if it were to propose a regulation to impose such a requirement

directly on clearing members in the future, it does not preclude the

Commission from requiring DCOs to impose this requirement on their

clearing members at this time.\165\

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\165\ In another context, e.g., a DCM has adopted a rule that

requires the operator of a DCM-approved delivery facility to '' * *

* make such reports, keep such records and permit such facility

visitation as the Exchange, the Commodity Futures Trading Commission

or any other applicable government agency may require * * * .'' See

CBOT Rule 703.A.

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LCH stated that it concurs with the provisions of proposed Sec.

39.13(h)(5) but suggested that the Commission limit the requirements

under proposed paragraph (h)(5)(C) so that they would be applicable

only to those clearing members that are subject to the Commission's

oversight and not to all clearing members of a DCO regardless of the

jurisdiction in which they operate. The Commission notes that risk

management practices of clearing members of registered DCOs, to the

extent that such clearing members are clearing products subject to the

Commission's oversight, are of importance to the Commission in its

capacity as the regulator of the DCO. For purposes of risk management

oversight, there is no basis for differentiating among clearing members

because of their registration status or domicile. Although the

Commission does not directly supervise non-registrants, the Commission

has previously adopted rules that apply to clearing members, whether or

not they are Commission registrants, e.g., Sec. Sec. 1.35(b) and (c)

(recordkeeping requirements), and Part 17 of the Commission's

regulations (reporting requirements). Section 39.13(h)(5)(C) is

consistent with the Commission's approach with respect to such other

rules, and is an appropriate component of the regulatory framework for

DCO risk management.

With regard to the proposed requirement in Sec. 39.13(h)(5)(ii)

that a DCO must review the risk management policies, procedures, and

practices of each of its clearing members on a periodic basis, FIA

stated that all clearing members should be subject to on-site audits at

least annually. NGX suggested that if the Commission requires non-

intermediated DCOs to require their members to have written risk

management policies, the Commission should provide guidance that a non-

intermediated DCO would not be required to conduct on-site audits of

clearing participants and that the DCO would meet its obligations to

review the policies of such clearing participants if it does so only on

a for-cause basis.

The Commission is adopting Sec. 39.13(h)(5)(ii) as proposed,

without prescribing the specific frequency, depth, or methodology of

such reviews, and without specifying when an on-site audit may or may

not be appropriate. The Commission believes that such a review is

important to ensure that each clearing member's risk management

framework is sufficient and properly implemented. The Commission also

believes that a DCO should be permitted to exercise reasonable

discretion with respect to each of these matters, based upon the

nature, risk profiles, or other regulatory supervision of particular

clearing members. The requirement that such reviews must be conducted

on a ``periodic basis'' means that reviews must be conducted routinely

and, therefore, the requirement would not permit a DCO to only conduct

such reviews on a for-cause basis.

A number of commenters noted that many clearing members are

clearing members of multiple DCOs and thus could be subject to multiple

duplicative risk reviews. CME, OCC, MGEX, ICE, and NYPC indicated that

this would be burdensome for such clearing members. For example, MGEX

noted ``the burden a clearing member may be faced with due to

duplication of efforts and associated costs.'' KCC indicated that such

duplicative reviews would achieve little with great expenditure of

resources.

OCC and NYPC also expressed their concerns about the costs to DCOs.

In particular, OCC noted that requiring DCOs to conduct such reviews

would impose a very high cost on a DCO that is not integrated with a

DCM. NYPC noted its concern that the Commission may be underestimating

the immensity of conducting such reviews in that a clearing member's

risk management plan will not address solely the risks associated with

clearing membership, but will be integrated and cover the broad

spectrum of risks, including market, credit, liquidity, capital, and

operational risk, that are associated with the entirety of the clearing

member's securities, banking and futures business, much of which may

have nothing to do with business through the DCO.

In order to address NYPC's specific concern, the Commission is

modifying Sec. 39.13(h)(5)(i)(A) to add the qualifier ``which address

the risks that such clearing members may pose to the derivatives

clearing organization'' after ``risk management policies and

procedures'' and is adding the same qualifier in Sec. 39.13(h)(5)(ii)

after ``risk

[[Page 69385]]

management policies, procedures, and practices of each of its clearing

members.''

To reduce the potential burden of duplicative risk reviews of

clearing members that are clearing members of multiple DCOs, CME and

NYPC urged the Commission to give each DCO reasonable discretion

regarding the frequency, scope, or manner in which it conducts risk

reviews of its clearing members, taking into account various factors

including other regulatory supervision, or review by a governmental

entity or self-regulatory organization, of particular firms. Other

commenters variously suggested that risk reviews should be conducted by

the Commission (OCC and MGEX), by the clearing member's DSRO or a

similar DCO industry group (KCC, OCC, ICE, and MGEX), or by NFA (OCC).

The Commission notes that the current DSRO system is not a viable

option for reviewing clearing members' risk management policies,

procedures and practices. Because DSROs are only responsible for

conducting examinations of DCM-member FCMs' compliance with financial

requirements, clearing members that only engage in house trading do not

have a DSRO, nor will clearing members that solely clear SEF-executed

trades. Moreover, such examinations do not address all of the risk

issues which would concern a particular DCO. Furthermore, even if the

current DSRO system were expanded to include DCOs, or a similar

industry group composed of DCOs were formed, it would be impractical to

allocate the responsibility to one DCO to analyze the risk management

policies, procedures and practices of a common clearing member, on

behalf of all relevant DCOs, when each DCO may impose different risk

management requirements on its clearing members and each DCO may have

differing margin methodologies that call for different risk management

responses from clearing members.

The Commission does not believe that it should assume the sole

oversight of the risk management policies, procedures, and practices of

clearing members of DCOs. The Commission conducts risk surveillance

with respect to both DCOs and clearing members; however, this cannot

replace a DCO's obligation to ensure that its clearing members are

appropriately managing the risks that such clearing members pose to

that particular DCO. Similarly, it does not appear that NFA would be an

efficient alternative. The Commission recognizes that certain DCMs have

entered into regulatory services agreements with NFA, and that NFA has

thereby assumed certain audit responsibilities with respect to FCMs

that are members of those DCMs. However, a DCO remains in the best

position to review the risk management policies, procedures, and

practices of its clearing members in the context of their obligations

to that particular DCO.

The Commission is adopting Sec. 39.13(h)(5) with the modifications

described above.

f. Additional Authority--Sec. 39.13(h)(6)

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 could 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.

KCC stated that it generally supports the concept that DCOs should

impose heightened risk management requirements on clearing members as

their risk profiles change and requested that the Commission clarify

whether each of the potential heightened risk management requirements

enumerated in proposed Sec. 39.13(h)(6)(i)-(vii) must be explicitly

delineated in DCO rules or in the DCO's clearing membership agreement.

The Commission believes that a DCO must have the authority and ability

to take appropriate additional actions with respect to particular

clearing members, as described in Sec. 39.13(h)(6), but how the DCO

asserts such authority, whether by rule or contractual agreement,

should be left to the discretion of the DCO.

J.P. Morgan expressed the view that higher margin multipliers

should be adopted for members who present a higher risk profile as a

result of excessive concentration of risk cleared, reduced

creditworthiness, or other factors affecting a particular member, and

that such margin multipliers should be documented in risk management

policies applicable to all members.

J.P. Morgan's concern that margin multipliers should be applied to

clearing members with a higher risk profile, is addressed in Sec.

39.13(h)(1), adopted herein and discussed in section IV.D.7.a, above,

which requires a DCO to impose risk limits on each clearing member.

The Commission is adopting Sec. 39.13(h)(6) as proposed.

E. Core Principle E--Settlement Procedures--Sec. 39.14

Core Principle E,\166\ as amended by the Dodd-Frank Act, requires a

DCO to: (1) Complete money settlements on a timely basis, but not less

frequently than once each business day; (2) 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); (3) ensure that money settlements are

final when effected; (4) maintain an accurate record of the flow of

funds associated with money settlements; (5) possess the ability to

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

arrangement with another clearing organization; (6) establish rules

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

deliveries; and (7) ensure that it identifies and manages each risk

arising from any of its obligations with respect to physical

deliveries. The Commission proposed Sec. 39.14 to establish

requirements that a DCO would have to meet in order to comply with Core

Principle E.\167\

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\166\ Section 5b(c)(2)(E) of the CEA, 7 U.S.C. 7a-1(c)(2)(E)

(Core Principle E).

\167\ Without addressing any specific aspect of proposed Sec.

39.14, LCH commented that it agrees with the Commission's proposals

for settlement procedures.

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1. Definitions--Sec. 39.14(a)

``Settlement'' was 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''

was 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].''

ISDA and FIA commented that posting of variation margin on swaps

should not be viewed as ``settling'' the present value of the trade and

noted that price alignment interest would still be paid on variation

margin. ISDA stated that, similarly, initial margin is not ``paid'' by

a clearing member to a DCO

[[Page 69386]]

but is often posted with a security interest granted by the clearing

member. FIA also commented that the deposit and withdrawal of initial

margin is not properly defined as a settlement.

NGX stated that, with the exception of a relatively small power

contract, its clearing model does not require daily variation margin

payments and collections from its clearing participants; rather, it

holds collateral (initial margin) in an account at a depository bank

rather than in a settlement account, and additional collateral may be

called for as required. Therefore, NGX stated that it would be clearer

when applied to the NGX model, to use the term ``payment and receipt''

rather than the term ``deposit'' when referring to initial margin.

The Commission proposed a broad definition of ``settlement'' in

Sec. 39.14(a)(1) to encompass all cash flows between clearing members

and a DCO. The Commission recognizes that accounts that are used for

the payment and receipt of variation margin are frequently called

settlement accounts, while accounts that are used for the deposit and

withdrawal of initial margin may be called deposit accounts, or custody

accounts, if the initial margin deposited therein is in the form of

securities. The definition of ``settlement bank'' in Sec. 39.14(a)(2)

was intended to encompass any bank that a DCO uses for settlements, as

defined in Sec. 39.14(a)(1), whether the relevant accounts are called

settlement accounts, deposit accounts, or custody accounts. In order to

avoid confusion, the Commission is modifying Sec. 39.14(a)(2) to

define a settlement bank simply 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 any settlement described in paragraph (a)(1)

above.'' The Commission is adopting Sec. 39.14(a)(1) as proposed,

except for a non-substantive change, which replaces each reference to

``futures, options, and swap positions'' with ``futures, options, and

swaps.''

2. Daily Settlements--Sec. 39.14(b)

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.

CME expressed its support for intra-day settlements. LCH suggested

that a DCO must measure its credit exposures ``several times each

business day,'' and should be obliged to recalculate initial and

variation margin requirements more than once each business day. J.P.

Morgan stated that intraday margin calls should be made with greater

frequency for clearing members who have a higher risk profile.

The Commission does not believe that it is necessary to adopt a

requirement that all DCOs recalculate initial and variation margin

requirements more than once each business day or an explicit

requirement for intraday margin calls for clearing members with a

higher risk profile. The Commission believes that it has struck the

appropriate balance in Sec. 39.14(b), by requiring a DCO to conduct

daily settlements, while permitting a DCO to exercise its discretion

regarding whether it will conduct routine intraday settlements, or

whether it will settle positions on an intraday basis only when certain

thresholds are breached \168\ or in times of extreme market volatility.

This approach is also generally consistent with proposed international

standards.\169\ A particular DCO could determine to conduct routine

intraday settlements, as some have done, or to conduct intraday

settlements for particular clearing members based on their risk

profiles.

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\168\ E.g., a DCO could establish thresholds that relate to the

extent of market volatility, or with respect to a particular

clearing member, the extent of losses that it has suffered on a

particular day or whether it has reached a risk limit established by

the DCO pursuant to Sec. 39.13(h)(1)(i), which is discussed in

section IV.D.7.a, above.

\169\ See CPSS-IOSCO Consultative Report, Principle 6: Margin,

Key Consideration 4, at 40; EMIR, Article 39, paragraph 3, at 46.

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NEM, NGX, and NOCC all requested that the Commission afford

recognition to a clearing model that does not require daily variation

margin payments and collections but permits accrual accounting with

respect to certain energy products.

NEM noted that most Retail Energy Marketers (REMs) \170\ use an

accrual accounting practice that recognizes revenues and costs after

energy delivery to their retail customers and that clearing solutions

that require daily cash settlements would either complicate their

accounting practices or significantly impact REM cash flows.

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\170\ NEM stated that REMs ``sell electricity and natural gas to

consumers as a competitive alternative to the local utility'' and

``often purchase wholesale physical natural gas and electricity on a

spot (delivery) month (day) basis and also purchase swaps to lock in

prices for any consumers who want a long-term fixed price

contract.''

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NGX stated that its clearing model generally does not require daily

variation margin payments and collections, and that settlement on its

energy contracts \171\ occurs only on a monthly basis, after clearing

participant obligations have been netted, consistent with practices in

the cash market and with the end-user nature of the vast majority of

NGX clearing participants. NGX noted that, therefore, the type of daily

settlement risk that proposed Sec. 39.14 addresses is not present in

the NGX model and the degree of risk in the monthly settlement process

is reduced.

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\171\ NGX stated that it ``operates a trading and clearing

system for energy products that provides electronic trading, central

counterparty clearing and data services to the North American

natural gas, electricity and oil markets.''

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Although NOCC supported adoption of proposed Sec. 39.14(b) for

traditional futures and cleared swaps, it indicated that it intends to

develop a clearinghouse that will seek registration as a DCO to clear

energy products, including commercial forward contracts that it

believes will be outside the scope of regulation as futures contracts

or as swaps under the CEA, as well as financial forwards that it

believes will fall within the definition of swaps under the CEA. NOCC

stated that while gains and losses on the commercial forward contracts

and financial forwards that it intends to clear are calculated daily,

they are accrued throughout the delivery period and following the

delivery period, and are not cash settled until final payment occurs

approximately three weeks after the month in which the commodity is

delivered. NOCC proposed that the Commission adopt a rule that would

permit exemptions for alternative risk management frameworks, which

would provide NOCC with the ability to demonstrate to the Commission

that daily accrual settlement of variation margin is a sound practice

appropriately tailored to the unique characteristics of the cash energy

markets and market participants for which NOCC is seeking to provide

the benefits of clearing.

The Commission has not proposed and is not adopting a rule

permitting exemptions for alternative risk management frameworks.

However, a particular DCO may petition the Commission for an exemption

if it believes that it can demonstrate that the daily accrual of gains

and losses provides the same protection to the DCO as would daily

variation margin payments and collections. Therefore, the Commission is

adding a clause to Sec. 39.14(b) that states ``[e]xcept as otherwise

provided by Commission order'' prior to the requirement that a DCO

``shall effect a settlement with each clearing member at least once

each business day.''

[[Page 69387]]

3. Settlement Banks--Sec. 39.14(c)

The introductory paragraph of proposed Sec. 39.14(c) would require

a DCO to 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.

OCC commented that it would not be possible for a DCO to

``eliminate'' all exposure to settlement bank risks and that the

Commission had not provided any guidance as to what it means to

``strictly limit'' such exposure. The Commission notes that the

language in the introductory paragraph of proposed Sec. 39.14(c),

which would require a DCO to ``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 * * *,'' is virtually identical to the

statutory language in Core Principle E.\172\ The Commission is adopting

the introductory paragraph of Sec. 39.14(c) with two modifications.

First, in response to OCC's comment, the Commission is adding the words

``as follows:'' at the end of the sentence, in order to clarify that a

DCO that complies with Sec. 39.14(c)(1), (2), and (3), discussed

below, will be deemed to have ``employ[ed] settlement arrangements that

eliminate or strictly limit its exposure to settlement bank risks''

within the meaning of Sec. 39.14(c). The Commission is also inserting

parentheses around the letter ``s'' in the word ``banks'' in order to

clarify that the Commission is not intending to require that a DCO must

have more than one settlement bank in all circumstances. However, a DCO

will need to have more than one settlement bank to the extent that it

is reasonably necessary in order to eliminate or strictly limit the

DCO's exposures to settlement bank risks, pursuant to Sec.

39.14(c)(3), as further discussed below.

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\172\ See Section 5b(c)(2)(E)(ii) of the CEA, 7 U.S.C. 7a-

1(c)(2)(E)(ii).

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4. Criteria for Acceptable Settlement Banks--Sec. Sec. 39.14(c)(1) and

(c)(2)

Proposed Sec. 39.14(c)(1) would require a DCO to have documented

criteria with respect to those banks that are acceptable settlement

banks for the DCO and its clearing members, including criteria

addressing the capitalization, creditworthiness, access to liquidity,

operational reliability, and regulation or supervision of such banks.

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

settlement bank on an ongoing basis to ensure that such bank continues

to meet the criteria established pursuant to Sec. 39.14(c)(1).

Proposed Sec. Sec. 39.14(c)(1) and (c)(2) are consistent with

international recommendations.\173\

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\173\ See CPSS-IOSCO Consultative Report, Principle 9: Money

Settlements, Key Consideration 3, at 54.

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NYPC agreed with the proposed requirement that DCOs must articulate

the standards that they apply to the selection of settlement banks.

OCC indicated that a DCO may have to deviate from its written

policies on the selection of clearing banks during a major market

disruption, as those settlement banks that are the best options

available at the time may not meet the technical criteria set forth in

a DCO's written policies. The Commission agrees with OCC that a DCO may

have to deviate from its written policies during a major market

disruption. However, whether the Commission would permit a DCO to do so

would need to be addressed in the context of the particular major

market disruption, e.g., based on an analysis of whether all available

settlement banks no longer meet such written criteria.

MGEX commented that the Federal Reserve and other banking

authorities are in the best position to review a bank's financial

condition. NYPC recommended that the Commission modify the proposed

rule to reflect the fact that the only criteria that are likely to be

susceptible to observation by a DCO are a bank's operational

reliability, regulatory capital, and the rating of its parent bank

holding company. The Commission agrees that the Federal Reserve and

other banking authorities may be in the best position to review a

bank's financial condition and that there is certain information about

settlement banks to which a DCO will not have regular access.

Nonetheless, a DCO has a responsibility to undertake reasonable efforts

to ensure that its settlement bank(s) continue to meet the criteria

established by the DCO. A DCO may be able to obtain pertinent

information from public sources, and it should be able to request and

obtain information from an approved settlement bank, which demonstrates

whether the bank continues to meet the criteria established by the DCO.

The Commission is adopting Sec. 39.14(c)(1) with a modification

that replaces the language that states: ``with respect to those banks

that are acceptable settlement banks for the derivatives clearing

organization and its clearing members'' with ``that must be met by any

settlement bank used by the derivatives clearing organization or its

clearing members.'' In addition, the Commission is inserting

parentheses around the letter ``s'' in the word ``banks.'' Consistent

with the modification to the introductory paragraph of Sec. 39.14(c)

described above, these modifications also clarify that there may be

circumstances in which it may be appropriate for a DCO to use a single

settlement bank. The Commission is adopting Sec. 39.14(c)(2) as

proposed.

5. Monitoring and Addressing Exposure to Settlement Banks--Sec.

39.14(c)(3)

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 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.\174\ 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 if any such

actions are reasonably necessary in order to eliminate or strictly

limit such exposures.

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\174\ Some DCOs have their own settlement accounts at each

settlement bank used by their clearing members, in which case a

clearing member's settlement bank is also the DCO's settlement bank,

and transfers between a clearing member's settlement account and a

DCO's settlement account are made internally. Other DCOs permit

their clearing members to use settlement banks at which such DCOs do

not have their own settlement accounts, and settlement transfers are

made between a clearing member's settlement bank and the DCO's

settlement bank. In either event, the settlement bank with the

largest share of settlement activity will always be a bank at which

the DCO maintains a settlement account, as all settlement activity

will involve the DCO.

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OCC commented that the requirement that a DCO monitor its clearing

members' exposure to the settlement banks used by such clearing members

could result in a massive duplication of effort and would be very

burdensome for the DCO. Therefore, OCC suggested that clearing members

or their primary regulators should be responsible for monitoring

clearing members' exposure to their settlement banks.

The Commission does not agree with OCC that proposed Sec.

39.14(c)(3) could result in a massive duplication of effort. The focus

of the monitoring required by Sec. 39.14(c)(3) is on a DCO's exposures

and its clearing members' potential losses insofar as they may create

exposures for the DCO. Therefore, each

[[Page 69388]]

DCO must conduct the required monitoring as each DCO's exposures are

unique to that DCO. In addition, this provision of Sec. 39.14(c)(3) is

consistent with proposed international standards.\175\

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\175\ See CPSS-IOSCO Consultative Report, Principle 9: Money

Settlements, Explanatory Note, 3.9.5, at 56.

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NYPC commented that since initial and variation margin requirements

fluctuate daily, proposed Sec. 39.14(c)(3) would require DCOs to

monitor their exposures to all settlement banks and not merely the

largest. The Commission agrees with NYPC. 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,''

which means that a DCO must conduct such monitoring with respect to all

such settlement banks. The reference to ``the settlement bank with the

largest share of settlement activity'' was made in the context of

requiring a DCO to assess the potential impact of the failure of such

bank.

CME and OCC requested that the Commission clarify that a DCO would

only be required to take any of the actions specified in proposed Sec.

39.14(c)(3)(i)-(iv), if the specific action were reasonably necessary

in order to eliminate or strictly limit exposures to settlement banks,

and that a DCO would not be required to take all of the specified

actions in all cases. CME supported this interpretation and OCC stated

its belief that these requirements would be reasonable if the final

rule were expressly limited in this manner. The Commission is modifying

Sec. 39.14(c)(3)(i)-(iv) to clarify the Commission's intent to

obligate a DCO to employ any one or more of the actions specified in

(i) through (iv), only if any one or more of such actions is reasonably

necessary in order to eliminate or strictly limit such exposures.

CME, ICE, MGEX, and KCC variously commented that prescribing

concentration limits and requiring that a DCO and its clearing members

maintain multiple settlement banks would impose significant expenses on

the DCO, its clearing members, and their customers. CME, MGEX, and NYPC

stated their belief that it would be difficult to comply with this

regulation given the limited number of banks that are qualified and

willing to serve as settlement banks.\176\ CME also commented that the

meaning of ``concentration limits'' is unclear, and stated its belief

that it would be unwise to impose artificial limits on the number of

clearing members or the size of clearing member accounts at a

particular settlement bank.

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\176\ CME also expressed concern that, as drafted, the proposed

regulation appears to require a DCO to approve at least two more

settlement banks, because of the reference to ``settlement banks''

in the plural.

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ICE took the position that hard concentration limits could increase

systemic risk because a DCO would need to distribute funds across

multiple banks. ICE indicated that as settlement funds increased,

highly rated banks would eventually be consumed by the concentration

limits and DCOs may have to open accounts with lower rated banks. ICE

further commented that concentration limits could act as a constraint

on customer choice, in that if one bank had a large number of

settlement customers, there would be natural concentration of

settlement flows, and the DCO could have to direct customers not to use

their chosen bank.

NYPC also questioned whether current settlement banks would be

willing to continue to act in that role if the Commission required a

DCO and some of its clearing members to transfer their business to

other banks. NYPC stated that this would leave the existing settlement

banks with an expensive infrastructure supported by fewer client

accounts.

MGEX stated its belief that requiring a DCO to oversee clearing

members' banks and establishing credit or concentration limits would be

intrusive and suggested that the final rule should provide DCOs with

flexibility.

The Commission notes that proposed Sec. 39.14(c)(3)(iii) would

require a DCO to impose concentration limits with respect to its own or

its clearing members' settlement banks if such action were reasonably

necessary in order to eliminate or strictly limit its exposures to such

settlement banks. Section 39.14(c)(3) would provide a DCO with other

possible options for addressing such exposures. For example, a DCO

could open an account at an additional settlement bank pursuant to

Sec. 39.14(c)(3)(i), or approve an additional settlement bank for use

by its clearing members pursuant to Sec. 39.14(c)(3)(ii), without

imposing concentration limits, if doing so would mean that such limits

would not be reasonably necessary. In addition, proposed Sec.

39.14(c)(3)(iv) would allow a DCO to take other appropriate actions,

which could obviate the potential need for concentration limits.

KCC commented that identifying multiple settlement banks for use by

clearing members could increase a DCO's operational risk by fragmenting

the DCO's margin pool. KCC suggested that there is no need for multiple

settlement banks because there would be little effect on the operations

of a DCO if a non-systemically significant settlement bank failed. KCC

noted that the Federal Deposit Insurance Corporation generally

facilitates the transfer of the accounts and operations of a failed

bank to a successor institution or a bridge bank with little or no

disruption to depositors at the failed bank. KCC further stated that a

DCO's settlement account is essentially a pass-through account and DCOs

generally do not maintain large, long-term balances in the account.

According to KCC, even if a DCO held significant guaranty funds or

security deposits at a settlement bank, such assets would likely be

held in a trust or custody account, which would be unavailable to

creditors of the failed institution and would generally be available to

the DCO within a short period of time following the insolvency of the

settlement bank. KCC also noted that a requirement that DCOs identify

additional settlement banks for use by clearing members would cause a

significant rise in bank service fees for DCOs and clearing members.

NGX noted that proposed Sec. 39.14(c) generally refers to

settlement banks, in the plural, assuming that all DCOs will maintain

accounts with at least two settlement banks. NGX questioned the benefit

of requiring all DCOs, regardless of size, to use multiple settlement

banks. According to NGX, settlement risk varies across DCOs, and the

type of daily settlement risk the proposed rule addresses is not

present at a DCO like NGX, which does not engage in daily variation

margin payments and collections from its clearing participants. NGX

stated that the rule should take account of the level of settlement

activity because requiring a DCO with a relatively small need for

settlement services to divide the flow of funds may cause the DCO to be

less attractive, bear higher costs, and be less competitive with larger

DCOs, while having a negligible impact on systemic risk.\177\ NGX also

commented that the rule could result in increased operational risk at a

DCO like NGX with complex contract settlement and delivery that

requires a settlement bank to have specialized expertise and to

maintain specialized processes and operational capabilities. NGX

requested that the Commission provide the flexibility to permit a DCO

to

[[Page 69389]]

demonstrate that the use of a single settlement bank is appropriate

from both a policy and a financial perspective.

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\177\ However, NGX stated that where a DCO has daily settlements

or monthly settlements in a greater amount, requiring more than one

settlement bank may materially reduce systemic risk without adverse

effects.

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As noted above, the Commission does not intend to require a DCO to

use more than one settlement bank if the particular DCO otherwise

employs settlement arrangements that eliminate or strictly limit its

exposure to settlement bank risks. The Commission understands that the

number of banks that are willing to serve settlement functions might be

limited, particularly for smaller DCOs. The Commission further

understands that it might be costly for some DCOs that currently only

have one settlement bank to use an additional settlement bank. However,

pursuant to Sec. 39.14(c)(3), a DCO would be required to have a second

settlement bank, if it were reasonably necessary in order to eliminate

or strictly limit the DCO's exposures to settlement bank risks.

The Commission is modifying Sec. Sec. 39.14(c)(3)(i) and (ii) to

refer to ``one or more'' additional settlement banks, so that it will

be clear that a DCO would not necessarily be required to maintain

settlement accounts with more than one additional settlement bank or to

approve more than one additional settlement bank that its clearing

members could choose to use, under the specified circumstances. In

addition, the Commission is modifying Sec. 39.14(c)(3)(iii) to

similarly clarify that a DCO may only be required to impose

concentration limits with respect to ``one or more'' of its own or its

clearing members' settlement banks, under the specified circumstances.

The Commission is also modifying Sec. 39.14(c)(3)(ii) by replacing

``for use by its clearing members'' with ``that its clearing members

could choose to use'' to make it clear that the Commission is not

suggesting that a single clearing member might be required to use more

than one settlement bank.\178\

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\178\ For example, it appears that CME may have interpreted

proposed Sec. 39.14(c)(3)(ii) in this unintended manner, since it

stated that ``we do not believe the CFTC should require clearing

members to have accounts at multiple settlement banks, which may

prove to be an impossible (and/or extremely costly) requirement to

satisfy.'' It appears that KCC may also have interpreted proposed

Sec. 39.14(c)(3)(ii) in this manner, in light of its comment that a

requirement that DCOs identify additional settlement banks for use

by clearing members would cause a significant rise in bank service

fees for DCOs and clearing members. There is no reason that

providing greater choice to clearing members regarding which single

settlement bank they could elect to use would cause a rise in bank

service fees for clearing members.

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The Commission is adopting Sec. 39.14(c)(3) with the modifications

described above.

6. Settlement Finality--Sec. 39.14(d)

Proposed Sec. 39.14(d) would require a DCO to 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 must state clearly when settlement fund transfers

would occur and a DCO was required to routinely confirm that its

settlement banks were effecting fund transfers as and when required by

those legal agreements.

ISDA and FIA requested that the rule allow for the correction of

errors.\179\ The Commission agrees with ISDA and FIA that settlement

finality should not preclude the correction of errors, and is adding a

clause to Sec. 39.14(d) that explicitly provides that a DCO's legal

agreements with its settlement banks may provide for the correction of

errors.

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\179\ ISDA also requested that the Commission clarify how the

proposed requirement would be compatible with the fact that title

transfer of initial margin may not occur when it is posted to a DCO.

Title transfer is not a necessary element of settlement finality.

Although in some jurisdictions a clearing member may need to

transfer title to margin collateral to a DCO in order for the DCO to

effectively exert control over such collateral, in other

jurisdictions a clearing member may transfer margin collateral to a

DCO and grant a security interest to the DCO without transfer of

title.

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In addition, the Commission is adding the modifier ``no later

than'' before ``when the derivatives clearing organization's accounts

are debited or credited'' in recognition of the fact that a DCO's legal

agreements with its settlement banks may provide for settlement

finality prior to the time when the DCO's accounts are debited or

credited, e.g., upon the bank's acceptance of a settlement instruction.

KCC commented that a DCO can never effectively ensure that

settlement payments are irrevocable, given the existence of a legal

risk that a settlement payment may be deemed to be an inappropriate

transfer pursuant to applicable bankruptcy law. Therefore, KCC urged

the Commission to eliminate the requirement or to restate the rule as a

requirement to monitor operational risks related to settlement

finality. The Commission does not believe that it is appropriate to do

so. Core Principle E requires a DCO to ``ensure that money settlements

are final when effected.'' \180\ In addition, Section 546(e) of the

U.S. Bankruptcy Code \181\ provides that a bankruptcy trustee may not

avoid a transfer that is a margin payment or a settlement payment made

to a DCO by a clearing member, or made to a clearing member by a DCO

(with the exception of fraudulent transfers). However, the Commission

is modifying Sec. 39.14(d) to state that ``[a DCO] shall ensure that

settlements are final when effected by ensuring that it has entered

into legal agreements that state that settlement fund transfers are

irrevocable and unconditional * * *'' (added text in italics).

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\180\ See Section 5b(c)(2)(E)(iii) of the CEA, 7 U.S.C. 7a-

1(c)(2)(E)(iii).

\181\ 11 U.S.C. 546(e).

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The Commission is adopting Sec. 39.14(d) with the modifications

described above.

7. Recordkeeping--Sec. 39.14(e)

Proposed Sec. 39.14(e) would require a DCO to maintain an accurate

record of the flow of funds associated with each settlement.

KCC expressed its general support of the concept of maintaining

accurate records of settlement fund flows, but stated that it may be

prudent for the Commission to further clarify the extent to which the

additional recordkeeping applies to cross-margining and netting

arrangements that a DCO may have in place with certain clearing members

and their customers. The language in Sec. 39.14(e) is virtually

identical to the Core Principle E language, which the Dodd-Frank Act

added to the CEA.\182\ Moreover, this language is similar to the

language that had been contained in Core Principle E prior to its

amendment by the Dodd-Frank Act.\183\

Therefore, proposed Sec. 39.14(e) would not impose any additional

recordkeeping requirements. The Commission believes that the

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

funds associated with each settlement would necessarily require the

maintenance of an accurate record with respect to any cross-margining

or netting arrangements, without the need to separately address such

arrangements. The Commission is adopting Sec. 39.14(e) as proposed.

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\182\ See Section 5b(c)(2)(E)(iv) of the CEA, 7 U.S.C. 7a-

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

\183\ Prior to amendment by the Dodd Frank Act, Core Principle E

provided, in part, that a [DCO] applicant shall have the ability to

``* * * [m]aintain an adequate record of the flow of funds

associated with each transaction that the applicant clears. * * *''

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8. Netting Arrangements--Sec. 39.14(f)

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.\184\

[[Page 69390]]

The Commission did not receive any comment letters discussing Sec.

39.14(f) and is adopting Sec. 39.14(f) as proposed.

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\184\ See Section 5b(c)(2)(E)(v) of the CEA, 7 U.S.C. 7a-

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

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9. Physical Delivery--Sec. 39.14(g)

Proposed Sec. 39.14(g) 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.

KCC commented that it generally supports the concept of proposed

Sec. 39.14(g), but requested that the Commission clarify that a DCO

may be deemed to have satisfied its obligation to establish rules

relating to physical deliveries if the rules of the exchange that lists

the cleared contracts clearly delineates such physical delivery

obligations. The Commission notes that the rules referenced in Sec.

39.14(g) must be enforceable by and against the DCO. If a DCO were

integrated with a DCM and the DCM's rules were enforceable by and

against the DCO, then it may be that the DCM's rules would satisfy the

requirements of Sec. 39.14(g). However, such compliance would need to

be determined on a case-by-case basis. The Commission is adopting Sec.

39.14(g) as proposed, except for a technical revision that replaces

``contracts, agreements and transactions'' with ``products'' to ensure

consistency with other provisions in part 39.

F. Core Principle F--Treatment of Funds--Sec. 39.15

Core Principle F, \185\ as amended by the Dodd-Frank Act, requires

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

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

assets; (ii) 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 (iii) only invest such funds and assets in instruments

with minimal credit, market, and liquidity risks. The Commission

proposed Sec. 39.15 to establish requirements that a DCO would have to

meet in order to comply with Core Principle F.

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\185\ Section 5b(c)(2)(F) of the CEA, 7 U.S.C. 7a-1(c)(2)(F)

(Core Principle F).

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1. Required Standards and Procedures--Sec. 39.15(a)

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.\186\ The Commission did not receive any comments on proposed

Sec. 39.15(a) and is adopting the provision as proposed.

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\186\ 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.

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2. Segregation--Sec. 39.15(b)(1)

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.

LCH suggested that the Commission clarify the meaning of

``segregated'' and limit the segregation requirement to the funds of

clearing members' clients. LCH also urged the Commission to limit these

requirements to client business cleared by the DCO under the FCM

clearing structure, noting that a DCO based outside the United States

may offer client clearing services through alternative structures and

that it did not believe it would be appropriate for clients clearing

under these non-U.S. structures to be subject to the segregation

requirements of Section 4d of the CEA, but rather to the requirements

set out by the DCO's home or other regulators.

FIA recommended that the proposed rule be revised to make clear

that a DCO should keep margin posted by clearing members to support

proprietary positions separate from the DCO's own assets, noting that

although proprietary funds held at a DCO are not subject to the

segregation provisions of the CEA, it is essential that these funds are

protected in the event of the default of the DCO. The Commission has

not proposed and is not adopting FIA's suggestion that the Commission

expand the applicability of Sec. 39.15(b)(1) in this manner.

BlackRock and FHLBanks expressed their views on specific

segregation models. The Commission has proposed rules in a separate

rulemaking regarding the segregation of cleared swaps customer

contracts and collateral, and the Commission will address BlackRock's

and FHLBanks' comments in connection with the final rulemaking for that

proposal.\187\

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\187\ See 76 FR 33818 (June 9, 2011) (Protection of Cleared

Swaps Customer Contracts and Collateral; Conforming Amendments to

the Commodity Broker Bankruptcy Provisions).

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The comments submitted by LCH, FIA, BlackRock, and FHLBanks all

address the substance or applicability of segregation requirements.

Proposed Sec. 39.15(b)(1) would not have imposed any additional

substantive segregation requirements upon a DCO. It would simply

require a DCO to comply with the substantive segregation requirements

of the CEA and other Commission regulations or orders, which are

currently applicable or which may become applicable in the future. In

particular, Sec. 39.15(b)(1) is not intended to extend the

extraterritorial reach of existing segregation requirements beyond that

which may already exist in such requirements. However, in order to

clarify the Commission's intent in this regard, the Commission has

added ``applicable'' before ``segregation requirements'' in Sec.

39.15(b)(1). In addition, the Commission wishes to clarify that its

current segregation requirements apply to a non-U.S. based DCO with

respect to clearing members that are registered as FCMs, whether they

are clearing business for U.S. based customers or non-U.S. based

customers. Such requirements do not apply with respect to clearing

members that are non-U.S. based and that are not registered as FCMs,

nor required to be registered as FCMs.

The Commission is adopting Sec. 39.15(b)(1) with the modification

described above.

3. Commingling of Futures, Options on Futures, and Swap Positions--

Sec. 39.15(b)(2)

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 swaps account), pursuant to DCO rules that have been approved

by the Commission under Sec. 40.5 of the Commission's regulations. The

DCO's rule filing \188\ 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

[[Page 69391]]

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

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; (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.\189\

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\188\ The DCO's rule filing would also need to comply with the

procedural requirements of Sec. 40.5(a).

\189\ As noted in the Commission's notice of proposed rulemaking

regarding the protection of cleared swaps customer contracts and

collateral, 76 FR at 33818 (June 9, 2011) (Protection of Cleared

Swaps Customer Contracts and Collateral; Conforming Amendments to

the Commodity Broker Bankruptcy Provisions), if the complete legal

segregation model is adopted for cleared swaps, a DCO could more

easily justify the approval of rules or the issuance of a 4d order

allowing the commingling of futures, options, and swaps, since the

impact of any different risk from the product being brought into the

portfolio would be limited to the customer who chooses to trade that

product. In such case, the Commission may still wish to obtain and

review all of the information specified in proposed Sec.

39.15(b)(2)(i), although its specific concerns may be minimized.

However, if the complete legal segregation model is adopted for

cleared swaps, and after the Commission obtains experience with

respect to considering requests to commingle futures, options, and

swaps under Sec. 39.15(b)(2) in an environment where that margin

model applies, the Commission may revisit its ongoing need for all

of the information listed in Sec. 39.15(b)(2)(i).

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Proposed Sec. 39.15(b)(2)(ii) would address 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. Proposed Sec. 39.15(b)(2)(ii) would incorporate the informational

requirements of proposed Sec. 39.15(b)(2)(i), but would require a DCO

to file a petition with the Commission for an order pursuant to Section

4d(a) of the CEA, permitting the DCO and its clearing members to

commingle customer positions in futures, options on futures, and swaps

in a futures account (4d order).

Proposed Sec. 39.15(b)(2)(iii)(A) would provide that the

Commission may request additional information in support of a rule

submission and that it may approve the rules in accordance with Sec.

40.5.\190\ Proposed Sec. 39.15(b)(2)(iii)(B) would provide that the

Commission could request additional information in support of a

petition and that it could issue a 4d order in its discretion.

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\190\ A rule 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 44793-44794 (Provisions Common to Registered Entities;

final rule).

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As noted in the notice of proposed rulemaking, 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 4d(a) or 4d(f) account, as

applicable).

The Commission requested 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 requested 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 requested 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.

In some instances, commenters addressed topics that are more

properly considered by the Commission in connection with a separate

rulemaking,\191\ that relate to substantive requirements that the

Commission might impose as a condition of approving a rule or granting

an order under Sec. 39.15(b)(2),\192\ or that relate to other

provisions adopted herein.\193\ The Commission is not addressing those

comments in its discussion of Sec. 39.15(b)(2) because they are not

within the scope of the proposal.

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\191\ E.g., CME and FIA raised operational concerns in the event

the Commission adopts a different segregation regime for each type

of customer account. Those comments will be considered in connection

with the Commission's proposal regarding the appropriate segregation

regime for cleared swaps accounts. See 76 FR 33818 (June 9, 2011)

(Protection of Cleared Swaps Customer Contracts and Collateral;

Conforming Amendments to the Commodity Broker Bankruptcy

Provisions).

\192\ E.g., LCH suggested additional factors that the Commission

should consider before a DCO or its clearing members should be able

to commingle, and offer offsets between, futures, options on

futures, and swaps, including: (a) clients must hold their futures,

options, and swaps under the same account structure and within the

same legal entity, and (b) the DCO must margin the futures, options,

and swaps using the same margin model; and ELX expressed the view

that in order for a customer to gain the portfolio margining

benefits of commingling futures, options, and swaps executed on a

SEF, it would be necessary for a customer to clear its futures,

options, and swaps through the same DCO.

\193\ LCH stated that all offset assumptions in the DCO's margin

calculations must, at a minimum, be replicated in the DCO's stress

testing and must be recalibrated frequently. The Commission notes

that permitted spread and portfolio margins are addressed in Sec.

39.13(g)(4), discussed in section IV.D.6.e, above, and back testing

of such spread and portfolio margins is addressed in Sec.

39.13(g)(7), discussed in section IV.D.6.g, above.

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CME, FIA, and MFA expressed their general support for the adoption

of rules that would allow commingling of customer positions in futures,

options on futures, and cleared swaps. In particular, CME indicated

that such commingling could achieve important benefits with respect to

greater capital efficiency which would result from margin reductions

for correlated positions, and that adoption of a regulation permitting

such commingling would be consistent with the public interest, in

accordance with Section 4(c) of the CEA. CME further stated that

``[h]aving positions in a single account can also enhance risk

management practices and systemic risk containment by allowing the

customer's portfolio to

[[Page 69392]]

be handled in a coordinated fashion in a transfer or liquidation

scenario.''

CME stated its belief that it would be logical to apply the same

methodology (rule submission or petition for an order) with respect to

the futures account and the cleared swaps account, and that a rule

submission would be the most efficient and optimal approach. The

Commission is retaining the proposed distinction whereby the Commission

may permit futures to be commingled in a Section 4d(f) cleared swaps

account subject to a rule approval process, and may permit cleared

swaps to be commingled in a Section 4d(a) futures account subject to a

4d order. In the latter instance, the 4d petition process would provide

additional procedural protections in that: (1) Review of a 4d petition

by the Commission is not subject to the time limits that apply to a

request for rule approval under Sec. 40.5; and (2) the Commission may

impose conditions in a 4d order, as appropriate. The Commission has

determined that, at this time, it is appropriate to provide these

additional procedural protections before exposing futures customers to

the risks of swaps that may be commingled in a futures account. As also

noted in other contexts in this notice of final rulemaking, DCOs have

greater experience in clearing futures. Swaps will expose DCOs to risks

that can differ in their nature and magnitude. However, as the

Commission and the industry gain more experience with cleared swaps,

the Commission may revisit this issue in the future.

The Commission is adopting CME's suggestion that it revise Sec.

39.15(b)(2)(i)(L) to remove the reference to obtaining daily position

data ``from each beneficial owner.'' Therefore, Sec.

39.15(b)(2)(i)(L), as modified, requires a DCO to submit ``[a]

description of the arrangements for obtaining daily position data with

respect to futures, options on futures, and swaps in the account,''

without specifying the level of detail or the source of the daily

position data that the DCO must obtain. As noted by CME, the Commission

could request additional information from the DCO, in support of its

request for rule approval or petition for a 4d order, pursuant to Sec.

39.15(b)(2)(iii).

The Commission is also making conforming changes to Sec.

39.15(b)(2), to replace a reference to ``cleared swap account'' with

``cleared swaps account'' to achieve consistency with the terminology

in another Commission rulemaking; \194\ is revising the references to

``futures, options on futures, and swap positions'' and ``futures,

options on futures, and swaps'' to read ``futures, options, and

swaps;'' \195\ is replacing a reference to ``contract'' with

``product;'' and is correcting the references to Sec. 39.15(b)(2)(i)

and (ii) in Sec. 39.15(b)(iii)(A) and (B), respectively.

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\194\ See 76 FR 33818 (June 9, 2011) (Protection of Cleared

Swaps Customer Contracts and Collateral; Conforming Amendments to

the Commodity Broker Bankruptcy Provisions).

\195\ This conforming terminology, which appears elsewhere in

part 39, streamlines the rule text without changing the meaning of

the provision. The scope of part 39 covers only those products

subject to the Commission's oversight and would not include, for

example, options on securities. Refinements in the definitions of

products subject to Commission oversight will be addressed in the

future.

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The Commission is adopting Sec. 39.15(b)(2) with the modifications

described above.

4. Holding of Funds and Assets--Sec. 39.15(c)

The introductory paragraph of proposed Sec. 39.15(c) would require

that a DCO 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. The Commission did not

receive any comment letters discussing the introductory paragraph of

proposed Sec. 39.15(c) and is adopting the provision as proposed.

5. Types of Assets--Sec. 39.15(c)(1)

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, and prohibit a DCO from accepting letters of

credit as initial margin.

LCH agreed with the provisions of proposed Sec. 39.15(c), but

added that the rules might more properly require that a DCO must be

able to convert any funds and assets held promptly into cash, and

should prove that it is able to do so on an ongoing basis. J.P. Morgan

stated that it is necessary for DCOs to maintain sufficient liquidity,

and that this could be achieved by requiring that clearing members post

a minimum amount of liquid (cash and qualifying government securities)

margin, among other things.\196\

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\196\ J.P. Morgan also suggested that DCOs could maintain

liquidity by requiring clearing members to make guarantee fund

contributions or by requiring clearing members to participate in a

liquidity facility. The Commission has not proposed and is not

adopting such requirements.

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The Commission believes that the standard of ``minimal credit,

market, and liquidity risks'' is sufficient and that it is not

necessary to modify the language of the regulation to include an

explicit requirement that a DCO must be able to convert funds and

assets promptly into cash or to require that clearing members must post

a minimum amount of cash and qualifying government securities.

Moreover, the requirement that a DCO shall limit the assets that it

accepts as initial margin to those that have ``minimal credit, market,

and liquidity risks'' is consistent with international

recommendations.\197\

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\197\ See CPSS-IOSCO Consultative Report, Principle 5:

Collateral, at 37.

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OCC expressed its belief that the proposal places an excessive

focus on the types of assets that may be used as margin and that the

Commission's central focus should be on whether a DCO's procedures and

risk management systems are sufficient to provide a high degree of

assurance that a portfolio, including margin assets, can be liquidated

with a positive liquidation value. OCC further noted its concern that

some of the collateral that it currently accepts as initial margin,

including less-liquid stocks and long-dated Treasury securities, would

no longer be permitted under the proposed rule. OCC explained that its

``collateral in margins'' or ``CIM'' program looks at each type of

collateral as an asset with specific risk characteristics rather than

as a fixed value, and it recognizes both positive and negative

correlations with other assets and liabilities in a particular account.

As an example, OCC stated that even though XYZ stock may be less

liquid than other stocks, it may have a greater value than a more

liquid stock when it is used as margin for a short position in XYZ call

options. Therefore, OCC urged the Commission not to impose a standard

of ``minimal credit, market, and liquidity risk,'' or not to adopt an

interpretation of such a standard in a manner that would reduce the

opportunities for diversification of collateral and use of assets that

may have specific risk-reducing properties in a particular portfolio.

In particular, OCC stated that ``[w]here a DCO is capable of reflecting

the risk of certain assets in its margin model, we see no reason why

less liquid instruments or instruments with higher than average credit

or market risks should not be acceptable for initial margin.''

The Commission agrees that a DCO should be permitted to accept

assets as initial margin if such assets have specific risk-reducing

properties in a particular portfolio and the DCO's margin model is

capable of appropriately reflecting the risk of those

[[Page 69393]]

assets. Accordingly, although the Commission is retaining the standard

of minimal credit, market, and liquidity risk, it is revising the

provision to add the following: ``A [DCO] may take into account the

specific risk-reducing properties that particular assets have in a

particular portfolio.'' As illustrated by OCC, an asset that would not

generally be acceptable could be acceptable for use in connection with

a particular portfolio.

Freddie Mac requested that the Commission clarify that DCOs may

accept collateral types beyond those specified as permitted investments

under Sec. 1.25. Section 39.15(c) does not prohibit a DCO from

accepting collateral types that are not specified as permitted

investments under Sec. 1.25. The Commission believes that it is

appropriate to permit DCOs to retain the flexibility to accept a

broader range of assets that meet the general requirement of ``minimal

credit, market, and liquidity risks'' than those which are appropriate

investments for funds received from clearing members.

Several comment letters specifically discussed the proposal to

prohibit the use of letters of credit as initial margin. The commenters

disagreed with the Commission's proposed requirement that a DCO may not

accept letters of credit for this purpose. CME stated that letters of

credit provide an absolute assurance of payment and, therefore, the

issuing bank must honor the demand even in circumstances where the DCO

(the beneficiary) breached its duty to the clearing member and even if

the clearing member is unable to reimburse the bank for its payment.

CME also stated that it was not aware of any instances in the cleared

derivatives industry in which a beneficiary of a letter of credit

posted as collateral had sought to draw upon the letter of credit and

had not been promptly paid by the issuer. CME noted that letters of

credit have been especially useful for clearing members to post as

collateral for late-day margin calls. ICE and NOCC similarly commented

that letters of credit should be permitted to serve as non-cash

collateral. NGX indicated that letters of credit are consistent with

Section 4s(e)(3)(D) of the CEA, which provides that the financial

regulators shall establish comparable capital requirements and minimum

initial and variation margin requirements, including the use of non-

cash collateral, for swap dealers.\198\

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\198\ The Commission notes that the minimum initial and

variation margin requirements referenced in Section 4s(e)(3)(D) of

the CEA, 7 U.S.C. 6s(e)(3)(D), apply to uncleared swaps.

NGX also stated its view that in a non-intermediated model, such

as that operated by NGX, the DCO is familiar with its clearing

participants, and can exercise a degree of discretion in accepting

letters of credit without the same risk management challenges that

may be faced by an intermediated DCO.

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Many commenters suggested that letters of credit should be

acceptable if they are subject to appropriate conditions. OCC

recommended that the Commission should allow letters of credit as long

as a DCO sets criteria with respect to issuers, diversifies

concentration of risk among issuers, and limits the proportion of a

clearing member's margin requirement that can be represented by letters

of credit. In addition, OCC stated that it would be appropriate for the

Commission to prohibit a DCO from accepting a letter of credit from a

clearing member if the letter of credit is issued by an institution

affiliated with the clearing member.

Similarly, FIA suggested that a DCO should be permitted to accept

letters of credit on a case-by-case basis subject to the credit quality

of the bank and appropriate limits on the percentage of a clearing

member's margin requirements that can be met by letters of credit. FIA

also indicated that DCOs should limit the aggregate value of letters of

credit that may be issued by any one bank.

FHLBanks wrote that ``a hard and fast prohibition against letters

of credit is inappropriate because it fails to take into account that a

letter of credit issued by a highly creditworthy entity could contain

terms that would make the letter of credit just as liquid as a funded

asset.'' \199\

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\199\ The FHLBanks further noted that the prohibition on letters

of credit may unnecessarily constrain certain end-users from

clearing swaps because they may be precluded from pledging other

assets, e.g., by loan covenants.

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CME stated that it only accepts letters of credit that comply with

its specified terms and conditions, including payment within one hour

of notification of a draw, from issuers that it has reviewed and

approved and that meet its criteria for issuing banks. CME further

noted that it conducts periodic reviews of approved banks and uses caps

and concentration limits in connection with letters of credit.

NGX stated that it has accepted letters of credit that comply with

its requirements regarding timing and acceptable institutions, for many

years, and has successfully drawn on such letters of credit.

Several commenters warned of the potential risks associated with

prohibiting letters of credit, including higher costs for clearing

members and their customers (OCC), the placement of U.S. DCOs at a

disadvantage to foreign clearing houses (ICE),\200\ and increased

systemic risk as a result of decreased voluntary clearing (NOCC).

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\200\ ICE noted that the CPSS-IOSCO Consultative Report did not

prohibit any type of collateral.

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The Commission acknowledges that DCOs have historically been

permitted to exercise their discretion regarding whether and to what

extent they would accept letters of credit for initial margin for

futures and options. Certain DCOs have accepted such letters of credit

without incident and continue to do so. On the other hand, as stated in

the notice of proposed rulemaking, letters of credit are unfunded

financial resources with respect to which funds might be not be

available when they are most needed by the DCO. Moreover, the initial

margin of a defaulting clearing member would typically be the first

asset tapped to cure the clearing member's default. Taking into account

both the strong track record of letters of credit in connection with

cleared futures and options on futures and the potentially greater

risks of cleared swaps, the Commission is modifying the provision to

permit DCOs to accept letters of credit as initial margin for futures

and options on futures. However, the Commission has determined to

maintain an additional safeguard for swaps at this time by prohibiting

a DCO from accepting letters of credit as initial margin for swaps. In

cases where futures and swaps are margined together, the Commission has

determined that letters of credit may not be accepted. The Commission

will monitor developments in this area and may revisit this issue in

the future.

The Commission is adopting Sec. 39.15(c)(1), redesignated as Sec.

39.13(g)(10),\201\ with the modification described above.

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\201\ Redesignation of this provision and several other

provisions proposed as part of Sec. 39.15 is a non-substantive

change that moves the provisions to the risk management rules for

margin requirements. As a risk management rule, the provision

implements Core Principle D, Section 5b(c)(2)(D)(iii) of the CEA,

which provides that ``Each [DCO], through margin requirements and

other risk control mechanisms, shall limit the exposure of the [DCO]

to potential losses from defaults by members and participants of the

[DCO].''

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6. Valuation and Haircuts--Sec. Sec. 39.15(c)(2) and 39.15(c)(3)

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. 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

[[Page 69394]]

initial margin obligations and to evaluate the appropriateness of its

haircuts on at least a quarterly basis.

OCC commented that if a DCO can only accept instruments with

minimal risk, then haircuts should either not be required at all or

should be very small. The Commission notes that, as defined in Sec.

39.15(c)(3), haircuts are ``appropriate reductions in value to reflect

market and credit risk.'' This is a flexible standard that would allow

a DCO to determine the extent of the haircut based on the extent of the

risk posed by the instrument deposited as initial margin.

OCC further stated that proposed Sec. 39.15(c)(3) is ambiguous

regarding what OCC would be required to test on a quarterly basis. OCC

explained that its STANS margin methodology does not apply fixed

haircuts to securities deposited as collateral, but rather treats

collateral as part of a clearing member's overall portfolio, revisiting

each ``haircut'' or valuation on a security-by-security, account-by-

account, and day-by-day basis. Thus, OCC stated that it checks the

adequacy of its haircuts through back testing and not through a

periodic review.

The general language of Sec. 39.15(c)(3), requiring a DCO to

``apply appropriate reductions in value to reflect market and credit

risk * * * to the assets that it accepts in satisfaction of initial

margin obligations'' and to ``evaluate the appropriateness of such

haircuts on at least a quarterly basis,'' is broad enough to encompass

the method of daily valuation and back testing described by OCC.

The Commission is adopting Sec. 39.15(c)(2), redesignated as Sec.

39.13(g)(11), as proposed. The Commission is adopting a technical

revision to Sec. 39.15(c)(3), redesignated as Sec. 39.13(g)(12), by

adding a reference to ``liquidity'' risk to conform the terminology

used to describe haircuts (proposed as ``appropriate reductions in

value to reflect market and credit risk'') with the terminology used in

Sec. 39.13(g)(10), which refers to assets that have ``minimal credit,

market, and liquidity risks.'' \202\ The Commission is also making a

non-substantive revision to replace the phrase ``including in stressed

market conditions'' with ``taking into consideration stressed market

conditions.''

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\202\ Credit, market, and liquidity risks are concepts that are

not mutually exclusive, and this articulation of the types of risks

to be evaluated by a DCO appears in the CEA (Core Principle F,

Treatment of Funds (requiring that ``[f]unds and assets invested by

a [DCO] shall be held in instruments with minimal credit, market,

and liquidity risks''), and ``minimal credit, market, and liquidity

risks'' is set forth as the standard for assets acceptable for a

guaranty fund (Sec. 39.11(e)(3)(i)), and as the standard for assets

acceptable as initial margin (Sec. 39.13(g)(10)).

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7. Concentration Limits--Sec. 39.15(c)(4)

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. The proposed

regulation also would require a DCO to evaluate the appropriateness of

its concentration limits, on at least a monthly basis.

OCC indicated that the proposed rule was not clear regarding

whether it would be sufficient to impose concentration charges rather

than imposing concentration limits, but argued that if the margin

system adequately penalizes concentration of risk, it does not believe

that fixed concentration limits are required. The Commission agrees

that concentration charges, rather than concentration limits, may be

appropriate in certain circumstances, and is modifying the provision to

permit a DCO to apply ``appropriate limitations or charges on the

concentration of assets posted as initial margin'' and to ``evaluate

the appropriateness of any such concentration limits or charges, on at

least a monthly basis.'' The inclusion of concentration charges as an

acceptable alternative to concentration limits is consistent with

international recommendations.\203\

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\203\ See CPSS-IOSCO Consultative Report, Principle 5:

Collateral, Explanatory Note 3.5.4, at 38.

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CME stated its view that the Commission should not prescribe the

frequency of a DCO's reviews of its concentration limits and it urged

the Commission to revise Sec. 39.15(c)(4) to replace ``on at least a

monthly basis'' with ``on a regular basis.'' The Commission believes

that it is appropriate to require a DCO to evaluate the appropriateness

of its concentration limits (or charges) on at least a monthly basis

and notes that Sec. 39.15(c)(4) provides a DCO with the discretion to

determine the nature of such evaluation.

The Commission is adopting Sec. 39.15(c)(4), redesignated as Sec.

39.13(g)(13), with the modifications described above.

8. Pledged Assets--Sec. 39.15(c)(5)

Under proposed Sec. 39.15(c)(5), if a DCO were to permit its

clearing members to pledge assets for initial margin while retaining

such assets in accounts in the names of such clearing members, the DCO

would have to ensure that the assets are unencumbered and that the

pledge has been validly created and validly perfected in the relevant

jurisdiction. The Commission did not receive any comments discussing

proposed Sec. 39.15(c)(5) and is adopting the provision, redesignated

as Sec. 39.13(g)(14), as proposed.

9. Permitted Investments--Sec. 39.15(d)

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 and that any investment of

customer funds or assets by a DCO must comply with Sec. 1.25 of the

Commission's regulations. Moreover, the proposed regulation would apply

the limitations contained in Sec. 1.25 to all customer funds and

assets, whether they are 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 cleared swaps customers subject to

the segregation requirements of Section 4d(f) of the CEA.

The Commission did not receive any comment letters discussing

proposed Sec. 39.15(d). The Commission is adopting the provision,

redesignated as Sec. 39.15(e), as proposed.

10. Transfer of Customer Positions--Sec. 39.15(d)

The Commission proposed regulations addressing the processing,

clearing, and transfer of customer positions by swap dealers (SDs),

major swap participants (MSPs), FCMs, SEFs, DCMs, and DCOs.\204\

Proposed Sec. 39.15(d) would require a DCO to have rules providing

that, upon the request of a customer and subject to the consent of the

receiving clearing member, the DCO would promptly transfer all or a

portion of such customer's portfolio of positions and related funds

from the carrying clearing member of the DCO to another clearing member

of the DCO, without requiring the close-out and rebooking of the

positions prior to the requested transfer.

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\204\ 76 FR 13101 (March 10, 2011) (Straight-Through

Processing).

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MFA, Citadel, and FHLBanks supported the proposal. MFA and Citadel

suggested that the Commission clarify that associated margin should

transfer simultaneously with the transferred positions.

LCH also suggested that the section should be revised to require

that the transfer of positions and related funds be effected

simultaneously. LCH believes that absent such a provision, a

[[Page 69395]]

DCO could be understood to be required to transfer either the positions

or the funds, but not both, and such an obligation would expose the DCO

to risk during the customer transfer.

FIA agreed with the Commission that a customer should not be

required to close-out and re-book positions as a condition of

transferring such positions, and that a clearing member should not

unnecessarily interfere with a customer's request to transfer

positions. However, FIA noted that a DCO will not have the immediate

ability to determine which positions carried in a clearing member's

omnibus account belong to a particular customer. FIA suggested that a

DCO's rules provide that the customer submit its request to transfer

its positions to the clearing member carrying the positions, not to the

DCO. FIA also suggested that the Commission revise the proposed rule to

confirm that a clearing member is required to transfer a customer's

positions only after that customer has met all contractual obligations,

including outstanding margin calls and any additional margin required

to support any remaining positions.

OCC also noted that a customer will not ask a DCO directly to

transfer a customer position. Like FIA, OCC believes that any such

transfer must be subject to all legitimate conditions or restrictions

established by the DCO in connection with its clearing of swaps.

CME stated that it fully supports the concept of applying the same

standards to transfer of customer cleared swaps as have historically

been applied to transfer of customer futures. It noted that a customer

request to transfer its account is made not to a DCO but to the FCM

that carries the customer's account.

ISDA commented that any transfer rule must provide that a party

seeking transfer not be in default to its existing clearing member.

ISDA believes that the transfer rule must take into account any cross-

cleared or cross-margined transactions and in the case where only a

portion of a customer's portfolio is transferred, clearing members must

have the ability to condition the transfer on the posting of additional

margin by the customer.

KCC commented that this rule is not necessary because KCC has never

required a futures position to be closed out and re-booked prior to

transfer from the carrying clearing member to another clearing member,

nor would KCC require a wheat calendar swap to be closed out and re-

booked prior to transfer. The Commission notes that such a requirement

has been imposed by other clearinghouses in connection with swaps.

In response to concerns raised by commenters, the Commission is

revising Sec. 39.15(d) to read as set forth in the regulatory text of

this final rule.

The language making it explicit that positions and margin be

transferred at the same time is responsive to the comments of MFA,

Citadel, and LCH and consistent with prudent risk management

procedures. The language clarifying that a customer transfer

instruction would go to a clearing member and not directly to the DCO

is responsive to the comments of FIA, OCC, and CME. The requirement

that a customer may not be in default is responsive to the comments of

FIA and ISDA and consistent with the statement in the notice of

proposed rulemaking that transfers should be subject to contractual

requirements. The requirement that positions at both clearing members

will have appropriate margin is responsive to the comments of MFA,

Citadel, and ISDA and consistent with the statement in the notice of

proposed rulemaking that transfers should be subject to contractual

requirements.

G. Core Principle G--Default Rules and Procedures--Sec. 39.16

Core Principle G,\205\ as amended by the Dodd-Frank Act, 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. The

Commission proposed Sec. 39.16 to establish requirements that a DCO

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

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\205\ Section 5b(c)(2)(G) of the CEA, 7 U.S.C. 7a-1(c)(2)(G)

(Core Principle G).

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1. General--Sec. 39.16(a)

Proposed Sec. 39.16(a) would require a DCO 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.

The Commission did not receive any comment letters discussing

proposed Sec. 39.16(a), although LCH stated that it concurs with all

the provisions set out under proposed Sec. 39.16. The Commission is

adopting Sec. 39.16(a) as proposed.

2. Default Management Plan--Sec. 39.16(b)

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 also would 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.

OCC agreed with the proposal for annual testing of a DCO's default

management plan, while ISDA stated that such tests should be conducted

at least on a semi-annual basis. FIA indicated that the default

management plan should be subject to frequent, periodic testing. The

Commission believes that it is appropriate and sufficient to require at

least annual testing of a DCO's default management plan. A particular

DCO could determine to test its plan on a semi-annual or other periodic

basis, in its discretion.

ISDA expressed its view that regulators should review and sign off

on the default management plans of DCOs. KCC requested that the

Commission clarify that the default management plan concepts in

proposed Sec. 39.16(b) may be satisfied by annual testing of the DCO's

existing set of default rules and procedures. The Commission does not

believe that it is necessary to adopt an explicit requirement that the

Commission review and approve a DCO's default management plan. However,

Commission staff will review a DCO's default management plan in the

context of the Commission's ongoing DCO review program, including a

determination of whether a DCO's ``existing set of default rules and

procedures'' meet the requirements of Sec. 39.16(b).

The Commission is making a technical revision to Sec. 39.16(b),

removing the parentheticals and substituting the word ``products'' for

the word ``contracts.'' The sentence now reads: ``Such plan shall

address any differences in procedures with respect

[[Page 69396]]

to highly liquid products and less liquid products.''

3. Default Procedures--Sec. 39.16(c)(1)

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.

The Commission did not receive any comment letters discussing

proposed Sec. 39.16(c)(1) and is adopting Sec. 39.16(c)(1) as

proposed.

4. Default Rules--Sec. 39.16(c)(2)

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 would specifically provide that any

allocation would have to be proportional to the size of the

participating or accepting clearing member's positions at the DCO.

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. 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.\206\

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.

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\206\ This is consistent with the segregation requirements of

Section 4d of the CEA and Sec. 1.20 of the Commission's

regulations.

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The Commission did not receive any comment letters discussing

proposed Sec. 39.16(c)(2)(i), (ii) or (iii). The Commission is

adopting Sec. 39.16(c)(2)(i) as proposed. The Commission is making

technical revisions to Sec. Sec. 39.16(c)(2)(ii), (iii), (v) and (vi),

as well as Sec. 39.16(d)(3), by replacing each use of the word

``proprietary'' with ``house.''

As discussed above in connection with participant eligibility

requirements under Sec. 39.12,\207\ the Commission is revising Sec.

39.16(c)(2)(iii) to require a DCO that imposes obligations on its

clearing members to participate in auctions or to accept allocations of

a defaulting clearing member's positions, to permit its clearing

members to outsource these obligations to qualified third parties,

subject to appropriate safeguards imposed by the DCO. The Commission

believes that it is important to permit outsourcing, while recognizing

that it is essential to limit participation only to qualified third

parties. Accordingly, a DCO's rules may impose appropriate terms and

conditions on outsourcing arrangements, addressing, for example, the

necessary qualifications to be eligible to act in the clearing member's

place and conflicts of interest issues. Thus, for example, a clearing

member could hire a qualified third party to act as its agent in an

auction. The Commission cautions, however, that any DCO imposing terms

and conditions that could indirectly deny fair and open access and

therefore are not ``appropriate,'' i.e., not supported by sound risk

management policies, may run afoul of Core Principle C and Sec. 39.12.

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\207\ See discussion in section IV.C.1.i, above.

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The Commission is also making two additional technical revisions to

Sec. 39.16(c)(2)(iii). First, the Commission is replacing ``a

defaulting clearing member's positions'' with ``the customer or house

positions of the defaulting clearing member,'' to correct an oversight

in the proposed language. Second, the Commission is revising Sec.

39.16(c)(2)(iii)(A) to provide that any allocation shall be

``[p]roportional to the size of the participating or accepting clearing

member's positions in the same product class at the derivatives

clearing organization'' (added text in italics) to clarify the

Commission's intent.

With respect to proposed Sec. 39.16(c)(2)(iv), OCC agreed that it

would be appropriate to require DCOs to adopt rules that would define

the sequence in which the funds and assets of a defaulting clearing

member and the financial resources maintained by the DCO would be

applied in the event of a default.

Freddie Mac expressed concern with the broad discretion that would

be given to DCOs to determine the sequence in which financial resources

would be applied in the event of a clearing member default, and

recommended that DCOs should be required to place non-customer

resources (e.g., clearing member guaranty funds and their own capital)

ahead of non-defaulting customer collateral in the risk waterfall. In

particular, Freddie Mac indicated that if the Commission does not

require individual segregation of customer collateral, it should

require DCOs to place non-defaulting customers at the bottom of the

risk waterfall. Freddie Mac stated that the Commission should defer

adoption of proposed Sec. 39.16(c) until after adoption of rules

relating to customer segregation.

The Commission is adopting Sec. 39.16(c)(2)(iv) to require that a

DCO adopt rules that identify the sequence of its default waterfall, as

proposed, without imposing any substantive requirements with respect to

such sequence, as suggested by Freddie Mac. The Commission is

addressing the issue of the application of the collateral of non-

defaulting swaps customers in a separate pending rulemaking,\208\ but

does not believe that it is appropriate to defer the adoption of

proposed Sec. 39.16(c) until that rulemaking is complete.

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\208\ See 76 FR 33818 (June 9, 2011) (Protection of Cleared

Swaps Customer Contracts and Collateral; Conforming Amendments to

the Commodity Broker Bankruptcy Provisions).

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The Commission is making a technical revision to Sec.

39.16(c)(2)(iv) by inserting ``and its customers'' after ``the funds

and assets of the defaulting clearing member'' to correct an oversight

in the proposed language.

ISDA commented that proposed Sec. 39.16(c)(2)(v), which would

require a DCO to adopt ``[a] provision that customer margin posted by a

defaulting clearing member shall not be applied in the event of a

proprietary default'' should be revised to replace the words ``in the

event of'' with ``to cover losses in respect of''; otherwise, ISDA

believed that customer margin would not be able to be applied even to

cover customer losses. The Commission agrees with ISDA and is modifying

Sec. 39.16(c)(2)(v) by replacing ``in the event of'' with ``to cover

losses with respect to'' and has made a similar modification to Sec.

39.16(c)(2)(vi).

CME recommended that the Commission replace ``proprietary

[[Page 69397]]

margins posted by a defaulting clearing member'' in Sec.

39.16(c)(2)(vi) with ``proprietary margins, positions and any other

assets in the account of the defaulting clearing member.'' CME argued

that the Commission's proposed reference to ``proprietary margins

posted by a defaulting clearing member'' is too narrow in scope, since

in the event of a clearing member default (whether originating in the

customer origin or the house origin), a DCO would likely liquidate

positions in the defaulting clearing member's house account and then

apply excess funds and not just proprietary margins to cure the

default. The Commission agrees that ``proprietary margins posted by a

defaulting clearing member'' is too narrow and is replacing the phrase

in Sec. 39.16(c)(2)(vi) with ``house funds and assets of a defaulting

clearing member.'' The Commission believes that ``house funds and

assets'' is broad enough to include ``proprietary margins, positions

and any other assets,'' as suggested by CME, and is consistent with the

language in Sec. 39.16(c)(2)(iv) and Sec. 39.15. The Commission is

similarly replacing ``customer margin posted by a defaulting clearing

member'' in Sec. 39.16(c)(2)(v) with ``the funds and assets of a

defaulting clearing member's customers'' and is replacing ``customer

margin'' in Sec. 39.16(c)(2)(vi) with ``customer funds and assets.''

ISDA commented that proposed Sec. 39.16(c)(2)(vi) should be

revised to insert the word ``excess'' immediately before the words

``proprietary margins'' to make it clear that proprietary margin is to

be applied first to cover proprietary losses, noting that the use of

proprietary margin to cover customer losses ahead of proprietary losses

would hasten the mutualization of losses among clearing members, which

would likely result in higher margin levels being imposed with respect

to customer positions in order to avoid that outcome. The Commission

agrees with ISDA and is modifying Sec. 39.16(c)(2)(vi) by inserting

``excess'' before ``house funds and assets of a defaulting clearing

member,'' as suggested by ISDA.

The Commission is adopting Sec. 39.16(c)(2) with the modifications

described above.

5. Publication of Default Rules--Sec. 39.16(c)(3)

Proposed Sec. 39.16(c)(3) would require that a DCO must make its

default rules publicly available, and would cross-reference Sec.

39.21, adopted herein, which also addresses this requirement.\209\

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\209\ See discussion of Sec. 39.21 in section IV.L, below.

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The Commission did not receive any comment letters discussing

proposed Sec. 39.16(c)(3) and is adopting Sec. 39.16(c)(3) as

proposed.

6. Insolvency of a Clearing Member--Sec. 39.16(d)

Proposed Sec. 39.16(d)(1) would require a DCO to adopt rules that

require a clearing member to provide prompt notice to the DCO if the

clearing member becomes the subject of a bankruptcy petition, a

receivership proceeding, or an equivalent proceeding, e.g., a foreign

liquidation proceeding. Proposed Sec. 39.13(d)(2) would require a DCO

to review the clearing member's continuing eligibility for clearing

membership, upon receipt of 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, upon receipt of such notice.

CME recommended that, in order to preserve a DCO's right to take

appropriate steps before a clearing member files for, or is placed

into, bankruptcy, the Commission should amend proposed Sec. Sec.

39.16(d)(2) and (3) to require DCOs to take appropriate actions ``no

later than upon receipt'' of notice that the clearing member is the

subject of a bankruptcy petition or similar proceeding. The Commission

is adopting Sec. 39.16(d) with the modifications to Sec. Sec.

39.16(d)(2) and (3) suggested by CME. In addition, the Commission is

making a technical revision to Sec. 39.16(d)(3) by replacing the

phrase ``with respect to such clearing member or its positions'' with

the phrase ``with respect to such clearing member or its house or

customer positions.'' This revision eliminates possible ambiguity in

the reference to ``its positions,'' which was intended to reflect

current industry practice and include both house and customer

positions, not just house positions.

H. Core Principle H--Rule Enforcement--Sec. 39.17

Core Principle H,\210\ as amended by the Dodd-Frank Act, requires a

DCO to maintain adequate arrangements and resources for the effective

monitoring and enforcement of compliance with its rules and resolution

of disputes. It also requires a DCO to have the authority and ability

to discipline, limit, suspend, or terminate the activities of a member

or participant due to a violation by the member or participant of any

rule of the DCO. It further requires that a DCO report to the

Commission regarding rule enforcement activities and sanctions imposed

against clearing members.

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\210\ Section 5b(c)(2)(H) of the CEA, 7 U.S.C. 7a-1(c)(2)(H).

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Proposed Sec. 39.17 would codify these requirements, adding a

provision that would require a DCO to report to the Commission in

accordance with proposed Sec. 39.19(c)(4)(xiii). As proposed, Sec.

39.19(c)(4)(xiii) would require a DCO to report the initiation of a

rule enforcement action against a clearing member or the imposition of

sanctions against a clearing member, no later than two business days

after the DCO takes such action. As discussed in connection with rules

implementing Core Principle J (Reporting), the Commission is adopting

that reporting requirement with a modification that only requires a DCO

to report sanctions imposed against a clearing member.\211\

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\211\ See discussion of rule enforcement reporting in section

IV.J.5.j, below.

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The Commission received no comments on proposed Sec. 39.17. The

Commission is adopting Sec. 39.17 as proposed, but with a change to

the cross-reference to Sec. 39.19(c)(4)(xiii) in Sec. 39.17(a)(3) to

reflect the redesignation of that provision as Sec.

39.19(c)(4)(xi).\212\

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\212\ See id. (The Commission is adopting Sec.

39.19(c)(4)(xiii) as a renumbered Sec. 39.19(c)(4)(xi)).

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I. Core Principle I--System Safeguards--Sec. 39.18

Core Principle I,\213\ as amended by the Dodd-Frank Act, requires a

DCO to establish and maintain a program of risk analysis and oversight

that identifies and minimizes 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 that the emergency procedures, back-up

facilities, and disaster recovery plans that a DCO is obligated to

establish and maintain specifically allow for the timely recovery and

resumption of the DCO's operations and the fulfillment of each

obligation and responsibility of the DCO. Finally, Core Principle I

requires that a DCO periodically conduct tests to verify that the DCO's

back-up resources are sufficient to ensure daily processing, clearing,

and settlement.

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\213\ Section 5b(c)(2)(I) of the CEA, 7 U.S.C. 7a-1(c)(2)(I).

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Proposed Sec. 39.18 would codify the obligations contained in Core

Principle I and delineate the minimum requirements that a DCO would be

required to satisfy in order to comply with Core Principle I. Proposed

Sec. 39.18 also would define the terms ``relevant

[[Page 69398]]

area,'' ``recovery time objective,'' and ``wide-scale disruption'' for

purposes of that section.

The Commission received one general comment from LCH. LCH generally

``concurred with all the provisions set out under proposed rule

39.18,'' but urged the Commission to align these provisions with the

CPSS-IOSCO standards, and to phase in such standards.

As discussed below, the Commission received comments on proposed

Sec. Sec. 39.18 (h), (j), and (k), and proposed Sec. 39.30(a).

The Commission did not receive any comments specifically related to

the definitions contained in proposed Sec. 39.18(a); proposed

Sec. Sec. 39.18(b),(c) and (d), which would address the required

program of risk analysis and oversight; proposed Sec. 39.18(e), which

would require a DCO to have a business continuity and disaster recovery

(BC-DR) plan and resources sufficient to enable the DCO to resume daily

processing, clearing and settlement no later than the next business day

following a disruption; proposed Sec. 39.18(f), which would address

outsourcing by a DCO of resources required to meet its responsibilities

with respect to business continuity and disaster recovery plans;

proposed Sec. 39.18(g), which would delineate certain exceptional

events upon the occurrence of which a DCO would be obligated to notify

promptly the Commission's Division of Clearing and Risk; proposed Sec.

39.18(h)(1), which would require a DCO to provide timely advance notice

to the Division of Clearing and Risk of certain planned changes to

automated systems; or proposed Sec. 39.18(i), which would set forth

certain records that a DCO would be required to maintain. The

Commission is adopting each of these provisions as proposed, except

that the Commission is replacing ``contracts'' with ``products'' in

Sec. 39.18(a) and is adding ``of the derivatives clearing

organization's'' before ``own and outsourced resources'' in Sec.

39.18(f)(2)(ii) for clarification.

1. Notice of Changes to Program of Risk Analysis and Oversight--Sec.

39.18(h)(2)

Proposed Sec. 39.18(h)(2) would require a DCO to give Division of

Clearing and Risk staff ``timely advance notice'' of ``planned changes

to the DCO's program of risk analysis and oversight.'' CME commented

that this is an ``extraordinarily broad requirement'' and urged the

Commission to ``appropriately consider[] context and relative risks.''

The Commission is adopting Sec. 39.18(h)(2) as proposed. The

provision merely requires that DCOs submit such notice as part of their

planning process. The Commission expects that staff will evaluate

compliance with this provision, as with all other provisions, giving

appropriate consideration to context and relative risks.

2. Testing--Sec. 39.18(j)

Proposed Sec. 39.18(j) would set forth the requirements for the

testing that a DCO must conduct of its automated systems and BC-DR

plans. Proposed Sec. 39.18(j)(1) would require that DCOs conduct

regular, periodic, and objective testing and review of (i) their

automated systems, to ensure that such systems are reliable, secure,

and have adequate scalable capacity, and (ii) their BC-DR capabilities,

to ensure that the DCO's backup resources meet the standards set forth

in proposed Sec. 39.18(e). Proposed Sec. 39.18(j)(2) would require

that these tests ``be conducted by qualified, independent professionals

* * * [who] may be independent contractors or employees [of the DCO]

but shall not be persons responsible for development or operation of

the capabilities being tested.'' Proposed Sec. 39.18(j)(3) would

require that reports setting forth the protocols for, and the results

of, such tests ``be communicated to, and reviewed by, senior management

of the [DCO]'' and that ``[p]rotocols of tests which result in few or

no exceptions shall be subject to more searching review.''

ICE, OCC, and MGEX objected to the obligation that the testing

required by Sec. 39.18(j) be performed by ``qualified, independent

professionals.'' ICE contended that the proper standard should be to

have qualified, independent professionals review, rather than conduct

testing of, systems or capabilities. Similarly, OCC suggested that the

testing could be overseen, rather than conducted, by an independent

professional. MGEX objected more generally to the requirement that

tests of its BC-DR capabilities be performed by ``independent

professionals'' and expressly objected to the proposal's prohibition on

the use of any employees who participated in the development or the

operation of the systems or capabilities being tested to fulfill this

role. MGEX argued that such persons are the most qualified persons to

run the tests. KCC requested that a DCO's CRO or other similar official

qualify as an `independent professional' for purposes of the testing

rule.

The Commission is adopting Sec. 39.18(j) as proposed. The

Commission notes that the obligation that the required testing of

automated systems and BC-DR capabilities be performed by qualified,

independent professionals is consistent with the Commission's

historical practice of requiring independent testing of systems where

appropriate.\214\

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\214\ For example, paragraph (a)(2) of the application guidance

to Core Principle 9 (prior to amendment by the Dodd-Frank Act) for

contract markets noted that ``Any program of independent testing and

review of [an automated] system should be performed by a qualified,

independent professional.'' 17 CFR part 38, appendix B at Core

Principle 9, paragraph (a)(2).

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The Commission recognizes that persons charged with developing or

operating a system are frequently called upon to test that system. The

Commission believes, however, that the active involvement and direction

of qualified, independent professionals in the testing process is

needed to ensure objective and accurate results.

MGEX's requested approach would result in tests being conducted

only by persons with an inherent conflict of interest (because negative

results of the tests might call into question the work of those who

developed or operate the systems) and, separately, would deny the DCO

the benefit of an independent analysis of the workings of the system.

Accordingly, while some testing of a DCO's automated systems and BC-DR

capabilities may be conducted by persons who design or operate such

system or capabilities, the Commission has decided to retain the

requirement that the objective testing performed to satisfy Sec.

39.18(j) must be conducted by qualified, independent persons, as

defined therein. While a DCO's CRO may appropriately serve this

function if he or she has the appropriate training and experience to be

``qualified'' in this context, and the appropriate role in the

organization to be ``independent,'' the Commission does not believe it

would be advisable to determine that the person serving in such a role

is necessarily qualified and independent.

3. Coordination of BC-DR Plans With Members and Providers of Essential

Services--Sec. 39.18(k)

Proposed Sec. 39.18(k) would require that a DCO to the extent

practicable: (1) Coordinate its BC-DR 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 BC-DR

plans and the plans of its clearing members; and (3) ensure that its

BC-DR plan takes into account the plans of its providers

[[Page 69399]]

of essential services, including telecommunications, power, and water.

MGEX proposed that industry-sponsored events should suffice to

satisfy the requirement that a DCO must coordinate its BC-DR plan with

those of its members. Similarly, KCC requested that the Commission

clarify that coordination would be deemed to be satisfied if the DCO

reviews the BC-DR plans of its clearing members and essential service

providers and subsequently provides to such parties the DCO's own BC-DR

plan. KCC stated that it does not believe that coordination should

involve extensive efforts at achieving specific consistency between the

procedures of each party, as each has a distinct business model that

faces varying operational risks.

NYPC objected to the requirement contained in proposed Sec.

39.18(k)(3). NYPC noted that its business continuity plan (BCP) would

be invoked any time a service provider ceases to provide an essential

service, regardless of whether that service provider has invoked its

own BCP, and thus such information would not necessarily give DCOs any

additional insight into their own BCP. Similarly, CME noted that, while

it obtains representations that its major vendors have disaster

recovery plans, CME does not control, or generally have access to, the

details of the proprietary plans of those service providers.

The Commission is adopting Sec. 39.18(k) as proposed. With respect

to the requirements of Sec. Sec. 39.18(k)(1) and (2), the Commission

recognizes that participation in industry-sponsored events, such as the

annual testing conducted by FIA, serves as an important assessment of

the connectivity between the systems of DCOs and their members

(including backup sites), but such participation would not, in and of

itself, satisfy the requirements of these regulations. The level of

participation of a particular DCO in a particular industry test is left

to the discretion of the DCO, and different DCOs may participate in

such tests to different extents. Moreover, while such industry-

sponsored events may be helpful, it is the responsibility of each DCO--

not that of an industry organization--to ensure that the functionality

of clearing will be maintained between the DCO and its members. The

Commission believes that a DCO will best be able to meet its

responsibilities reliably in a wide-area disaster that affects a DCO

and its clearing members if the DCO has actively worked together with

those clearing members to coordinate their plans and has obtained some

evidence that such plans will appropriately mesh when implemented.

While it is true that a DCO should have backup arrangements that

promptly can be engaged to address a failure of essential services, it

is likely that most DCOs will prepare for a temporary, rather than an

indefinite, loss of such services. Among the benefits provided by

coordination of a DCO's BCP with that of providers of essential

services is an insight into the period of time for which the DCO should

be prepared to provide such services itself.

The Commission recognizes that a service provider may reasonably be

reluctant to provide sensitive details of its own BCP, such as the

precise location of backup facilities, and notes that the proposed

requirement is prefaced with the limitation that a DCO is required to

obtain this information only ``to the extent practicable.''

Nonetheless, merely obtaining a representation that states that a

service provider has a backup plan--with no detail as to the Recovery

Time Objective (RTO) of that service provider, and no insight into how

that service provider's BCP might affect the BCP of the DCO--would

likely be insufficient.

4. Recovery Time Objective--Sec. 39.18(a)

Proposed Sec. 39.18(a) would define an RTO as the 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 a wide-

scale disruption, and defines a wide-scale disruption as 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.

Proposed Sec. 39.18(e)(3) would require that a DCO have an RTO of the

next business day, while proposed Sec. 39.30(a) would require that a

SIDCO have an RTO of two hours.

ICE noted that proposed Sec. 39.18(a) does not specify a minimum

time that a wide-scale disruption must be accommodated, and that costs

would be higher if the unavailability of staff in the relevant area

that must be accommodated is the total loss of personnel. ICE suggested

that one week would allow relocation of personnel outside the affected

area.

The Commission is adopting Sec. Sec. 39.18(a) and 39.18(e)(3) as

proposed. However, as discussed above in connection with the financial

resources requirements, the Commission believes that it would be

premature to take action regarding Sec. 39.30 at this time. The

Commission will consider the proposals relating to SIDCOs together in

the future.

J. Core Principle J--Reporting Requirements--Sec. 39.19

Core Principle J,\215\ as amended by the Dodd-Frank Act, requires a

DCO to provide the Commission with all information that the Commission

determines to be necessary to conduct oversight of the DCO. The

Commission proposed Sec. 39.19 to establish requirements that a DCO

would have to meet in order to comply with Core Principle J. Under

proposed Sec. 39.19, certain reports would have to be made by a DCO to

the Commission: (1) On a periodic basis (daily, quarterly, or

annually), (2) where the reporting requirement is triggered by the

occurrence of a significant event; and (3) upon request by the

Commission. Section 39.19(a) states the general requirement of Core

Principle J. The Commission did not receive any comment letters

discussing Sec. 39.19(a) and is adopting the provision as proposed.

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\215\ Section 5b(c)(2)(J) of the CEA, 7 U.S.C. 7a-1(c)(2)(J).

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1. Submission of Reports--Sec. 39.19(b)

The Commission proposed Sec. 39.19(b) to establish procedural

requirements for electronic submission of reports and determination of

time zones applicable to filing deadlines. The Commission received no

comments and is adopting Sec. Sec. 39.19(b)(1) and (2) as proposed.

For purposes of clarification, the Commission is also adopting Sec.

39.19(b)(3) to provide a definition of ``business day'' as ``the

intraday period of time starting at the business hour of 8:15 a.m. and

ending at the business hour of 4:45 p.m., on all days except Saturdays,

Sundays, and Federal holidays.'' This is consistent with the definition

of ``business day'' set forth in Sec. 40.1(a).\216\

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\216\ See 76 FR at 44790 (July 27, 2011) (Provisions Common to

Registered Entities; final rule).

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2. Daily Reporting--Sec. 39.19(c)(1)

Proposed Sec. 39.19(c)(1) would require a DCO to submit daily

reports with certain initial margin and variation margin data as well

as other cash flows for each clearing member. More specifically, Sec.

39.19(c)(1)(i) would require a DCO to report both the initial margin

requirement for each clearing member, by customer origin and house

origin, and the initial margin on deposit for each clearing member, by

origin.

[[Page 69400]]

Proposed Sec. 39.19(c)(1)(ii) would require a DCO to report the daily

variation margin collected and paid by the DCO, listing the mark-to-

market amount collected from or paid to each clearing member, by

origin.\217\

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\217\ This requirement would apply to options transactions only

to the extent a DCO uses futures-style margining for options.

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Proposed Sec. 39.19(c)(1)(iii) would require a DCO to report all

other cash flows relating to clearing and settlement including, but not

limited to, option premiums and payments related to swaps such as

coupon amounts, collected from or paid to each clearing member, by

origin. Proposed Sec. 39.19(c)(1)(iv) would require a DCO to report

the end-of-day positions for each clearing member, by customer origin

and house origin.

In addition, as discussed in section IV.D.6.h.(2), above, in

connection with the Commission's proposal to require DCOs to collect

initial margin for customer accounts on a gross basis under proposed

Sec. 39.13(g)(8)(i), the Commission further proposed an addition to

proposed Sec. 39.19(c)(1)(iv) that would also require DCOs to report,

for each clearing member's customer account, the end-of-day positions

of each beneficial owner. The Commission is adopting Sec. 39.19(c)(1)

with two modifications. First, the Commission is not requiring

reporting of customer positions by beneficial owner, except upon

Commission request.\218\ Second, as discussed below, the Commission is

renumbering the paragraphs in Sec. 39.19(c)(1) and adding a new

paragraph (ii) to clarify the applicability of the daily reporting

requirements to FCM/BDs. In addition, the Commission is replacing ``by

customer origin and house origin'' with ``by house origin and by each

customer origin''; and is replacing ``options on futures positions''

with ``options positions.''

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\218\ See further discussion of reports of beneficial ownership

in section IV.D.6.h.(2), above.

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MGEX and KCC commented that while such information is available to

them,\219\ they are concerned that if the Commission mandates a

specific form of delivery, the cost to DCOs will be significantly

higher than expected. MGEX referred to its recent experience with the

Trade Capture Reporting initiative conversion to the Commission's new

FIXML standards, which was more costly and time consuming than

expected. KCC commented that all of the data proposed to be reported to

the Commission is already made readily available to the Commission in

varying degrees, and there is little need for the Commission to require

the increasing level of detailed information in specified formats. In

addition, MGEX expressed concern with the Commission's potential data

storage capacity limitations. MGEX concluded that the combination of

these two factors suggest that the burden of the daily reporting

requirements on DCOs and the Commission outweigh the value of these

reports.

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\219\ MGEX noted that it is already ``internally performing

these tasks'' in reference to the several daily reporting

requirements. KCC has also noted that it already submits trading

activity and positions by each clearing member by origin on a daily

basis in file formats prescribed by the Commission.

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MGEX suggested that requiring such data on an as-needed, rather

than a daily, basis would limit the burden on DCOs and the Commission

while ensuring relevancy as to the data being requested. KCC asked that

the Commission reconsider the amount and detail of information

necessary for its oversight role. While CME supported the proposed

reporting requirement, it suggested that the Commission work with DCOs

to determine the form and manner of delivery.

As mentioned in the notice of proposed rulemaking, many DCOs

already provide the Commission with much of the data required under

this provision. The Commission recognizes that the daily reporting

requirements may place an additional burden on a DCO, particularly if

the DCO must employ a specific form of delivery that it does not

already have in place. However, establishment of an automated reporting

system is a one-time cost, and a uniform reporting format for all DCOs

is necessary to facilitate the Commission's ability to receive data

promptly and quickly disseminate it within the agency.\220\

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\220\ The Commission notes that its staff is in the process of

developing a plan for uniform submission of DCO reports.

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The overall purpose of receiving the daily data is to enable

Commission staff to analyze the data on a regular basis so that it can

detect certain trends or unusual activity on a timely basis. Receiving

such data less frequently would significantly reduce its usefulness.

While there may be initial costs for DCOs to set up the reporting

systems, there should be little cost to DCOs on a continuing

basis.\221\ Finally, MGEX's suggestion to require such data on an as-

needed basis does not further the objective of enhanced risk

surveillance, given that the purpose of gathering the data is to

identify and address potential problems at the earliest possible time.

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\221\ See further discussion of the costs and benefits of the

reporting requirements in section VII.J, below.

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OCC expressed concern that the reporting requirements make no

accommodation for clearing members that are FCM/BDs, with respect to

their securities positions. In response to OCC's comment, the

Commission is adding a new paragraph (ii) to Sec. 39.19(c)(1) to

clarify the limited applicability of the daily reporting requirements

to securities positions. The final rule provides that ``The report

shall contain the information required by paragraph (c)(1)(i) of this

section for (A) all futures positions, and options on futures

positions, as applicable; (B) all swaps positions; and (C) all

securities positions that are held in a customer account subject to

Section 4d of the Act or are subject to a cross-margining agreement.''

3. Quarterly Reporting--Sec. 39.19(c)(2)

The Commission is adopting Sec. 39.19(c)(2), requirements for

quarterly reporting of financial resources, as proposed.\222\

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\222\ See further discussion of the quarterly reporting

requirement under Sec. 39.11(f) in section IV.B.10, above.

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4. Annual Reporting--Sec. 39.19(c)(3)

Proposed Sec. 39.19(c)(3) would require a DCO to submit a report

of the CCO and an audited financial statement annually, as required by

Sec. 39.10(c). The Commission received no comments on proposed Sec.

39.19(c)(3), and the Commission is adopting Sec. 39.19(c)(3) as

proposed.

The Commission notes that in a separate proposed rulemaking

implementing Core Principle O (Governance Fitness Standards), it

proposed a new Sec. 39.24(b)(4) which would require annual

verification that directors, members of the disciplinary panel and

disciplinary committee, clearing members, persons with direct access,

and certain affiliates of a DCO, satisfy applicable fitness

standards.\223\ In connection with this, the Commission subsequently

proposed to cross-reference this annual reporting obligation as a

renumbered Sec. 39.19(c)(3)(iii). At such time as the Commission may

adopt the verification requirement as a final rule, Sec. 39.19(c)(3)

will be amended accordingly.

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\223\ See 76 FR at 736 (Jan. 6, 2011) (Governance).

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5. Event-Specific Reporting--Sec. 39.19(c)(4)

a. Decrease in Financial Resources--Sec. 39.19(c)(4)(i)

Under proposed Sec. 39.19(c)(4)(i), a DCO would be required to

report to the

[[Page 69401]]

Commission a 10 percent decrease in the total value of the financial

resources required to be maintained by the DCO under Sec. 39.11(a),

either from the last quarterly report. or from the value as of the

close of the previous business day. Such notification would alert the

Commission of potential strain on the DCO's financial resources, either

gradual or precipitous.

The Commission invited comments regarding possible alternatives as

to what would be considered a significant drop in the value of

financial resources. Although many commenters opposed using the 10

percent threshold as a barometer for a ``significant'' decrease, no

commenter questioned the Commission's objective in obtaining this type

of information in a timely manner.

MGEX commented that 10 percent is an arbitrary threshold and it is

not uncommon for financial resources to fluctuate by 10 percent even in

a stable market. Similarly, OCC and KCC stated that the threshold is

arbitrary and would most likely be crossed on a frequent basis during

the ordinary course of business.\224\ In addition, KCC suggested that

this requirement is duplicative, as a material drop in financial

resources would already be required to be reported by the proposed

requirement to report all material adverse changes (Material Adverse

Change Reporting Requirement).\225\

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\224\ KCC mentioned that changes in the level of excess

permanent margin deposited by clearing members, changes in the

minimum margin requirements on contracts or in the level of the

guarantee pool requirements, and changes in the level of assessments

that can be levied against clearing members in the event of a

default, could cause financial resources to drop more than 10

percent within the ordinary course of business. OCC stated it would

cross the 10 percent threshold on an almost monthly basis, i.e., the

day after monthly expirations occur.

\225\ See discussion of proposed Sec. 39.19(c)(4)(xiv)

(finalized as Sec. 39.19(c)(4)(xii)) in section IV.J.5.k, below.

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OCC, Better Markets, and Mr. Barnard were also concerned about the

types of financial resources to consider when calculating a decrease.

OCC suggested it is counterproductive to report a decrease in financial

resources as a result of a decrease in margin requirements, which is a

sign of risk reduction. Similarly, Better Markets suggested that

coincidental increases in margin-based financial resources, which could

fluctuate substantially, could offset decreases by more important

financial resources. In addition, Mr. Barnard raised concerns

regarding: (1) Grouping all types of financial resources together for

purposes of calculating decreases, and (2) whether only requiring a

report of a decrease in financial resources is sufficient.

Several commenters proposed using a different threshold: (1) OCC

suggested 25 percent; (2) MGEX suggested allowing a DCO to determine

what constitutes a material decrease or, as an alternative, adopting a

threshold of 30 percent over a five-day period and 25 percent when

compared to the previous quarter; and (3) Better Markets suggested

adopting a threshold of 5 percent of non-margin-based financial

resources. NYPC recommended taking an approach similar to the FCM

``early warning'' reporting requirement.\226\

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\226\ Section 1.12(b)(2) requires an FCM to give 24 hours notice

to the Commission if it ``knows or should have known'' that its

adjusted net capital is at any time less than 110 percent of the

amount required by the Commission's net capital rule.

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To compensate for an upwards adjustment of the financial resources

requirement, Better Markets suggested also requiring a report if the

ratio of financial resources to minimum required levels decreases to 1

to 1. Mr. Barnard suggested splitting financial resources into two

groups: (1) The more ``robust'' financial resources (a DCO's own

capital and guaranty fund), and (2) market or risk-related items

(margins); and requiring a report for a decrease in either amount or a

decrease in the total of both amounts. Mr. Barnard also suggested

requiring a DCO to report a calculation of its ``solvency ratio''

(available financial resources/financial resources requirements) and a

5 percent or more drop in such ratio.

In response to commenters' objections to setting the level at 10

percent, the Commission is setting the reporting threshold at a level

of 25 percent for both the daily and quarterly financial resources

decreases. As noted, OCC suggested 25 percent while MGEX suggested 25

percent for the quarterly and 30 percent for a report covering any 5-

day period. MGEX did not explain why there should be a distinction

between the percentage decrease triggering the quarterly and shorter-

term reports. The Commission believes that a 25 percent level addresses

the commenters' concerns about ``noise'' while providing the Commission

with notification of material decreases.

The Commission is not excluding certain financial resources from

the decrease calculation as suggested by several commenters. Although

there are certain financial resources that may fluctuate in the

ordinary course of business, the Commission believes that setting the

reporting threshold level higher should resolve many of these issues

because fewer fluctuations that occur in the ordinary course of

business would trigger the higher 25 percent threshold. Additionally,

the purpose of the financial resources requirement in Core Principle B

and as codified in the Commission's regulations is to ensure that a DCO

has adequate resources to cover the default of the clearing member with

the largest exposure. Financial resources are looked at in the

aggregate. Thus, fluctuations during the ordinary course of business,

even coincidental decreases in financial resources, all reflect the

financial health of the DCO at that time.

The Commission is not replacing the financial resources percentage

decrease reporting requirement with a requirement similar to the FCM

``early warning'' reporting requirement, as suggested by NYPC. While

FCMs do have an ``early warning'' reporting requirement, this is only

in addition to an FCM's requirement to also report decreases of 20

percent pursuant to Sec. 1.12(g)(1).\227\ In fact, even with the new

financial resources reporting requirement for DCOs, DCOs still have a

lesser reporting requirement than FCMs in this regard: DCOs are only

required to report 25 percent decreases, while FCMs are required to

report 20 percent decreases in addition to reporting decreases below

certain thresholds (the ``early warning'' requirement).

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\227\ Section 1.12(g)(1) requires an FCM to provide written

notice within two business days of a substantial reduction in

capital as compared to that last reported in a financial report if

there is a reduction in net capital of 20 percent or more.

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The Commission is adopting the modified Sec. 39.19(c)(4)(i)

reporting requirement described herein. The Commission does not

consider it to be duplicative of the Material Adverse Change Reporting

Requirement, or the quarterly financial resource reporting requirement

under Sec. 39.11(f), as suggested by KCC. Each reporting requirement,

including the financial resources reporting requirement, relates to

specific circumstances that the Commission has determined to be

material and which, based on its experience in conducting financial

risk surveillance, the Commission believes warrants notification. The

Material Adverse Change Reporting Requirement is intended to cover more

unusual changes that are not readily identifiable in advance but would

nonetheless be of interest to Commission staff in conducting its

oversight of a DCO. The Commission is also not requiring the solvency

ratio decrease reporting requirement suggested by Mr. Barnard. The

Commission believes that receiving reports regarding financial

resources decreases will serve the purpose of alerting the Commission

to possible financial distress at a DCO, without

[[Page 69402]]

unnecessarily burdening a DCO with additional reporting requirements.

NYPC pointed out that the proposed rule language referring to a

decrease in the ``total value of financial resources'' could be read to

refer to the total combined default and operating resources. It also

raised a question as to whether the reference to financial resources

``required to be maintained * * * under Sec. 39.11(a)'' referred to

the minimum amount ``required'' or if it was intended to encompass all

financial resources ``available to satisfy'' the requirements.

The Commission intends the reporting requirement in Sec.

39.19(c)(4)(i) to refer only to financial resources available to cover

a default in accordance with Sec. 39.11(a)(1). A significant change in

the amount of financial resources available to meet operating expenses

is addressed by Sec. 39.19(c)(4)(iv).\228\ In response to the

interpretive issues raised by NYPC, the Commission is revising the

language in Sec. 39.19(c)(4)(i) to clarify that the decrease in

financial resources refers to a decrease in resources ``available to

satisfy the requirements under Sec. 39.11(a)(1)'' so it is clear that

the reporting requirement applies only to default resources and refers

to those resources available to the DCO to satisfy the default resource

requirements, even if the amount of those resources exceeds the minimum

amount that is required by Sec. 39.11(a)(1).\229\

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\228\ See discussion of Sec. 39.19(c)(4)(iv) in section

IV.J.5.d, below.

\229\ As a technical matter, ICE Clear sought clarification in

the rule text regarding the reference to Sec. 39.11(a), pointing

out that Sec. 39.11(a) sets the standard for financial resources

and Sec. 39.11(b) lists the financial resources available to

satisfy those standards. ICE Clear recommended that Sec.

39.19(c)(4)(i) be revised to refer to both Sec. Sec. 39.11(a) and

(b). The Commission declines to include a reference to Sec.

39.11(b) as the purpose of the cross-reference is to incorporate by

reference the standard, not the means for satisfying the standard.

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The Commission notes that it should be apprised when a DCO

experiences a 25 percent decrease in the value of its default resources

from the value as of the close of the previous business day, even if

their value has increased substantially since the last quarterly

report. Such a change could signal a significant change in a DCO's risk

profile and early reporting will enable the Commission to take

appropriate measures to facilitate proper risk management at the DCO.

b. Decrease in Ownership Equity--Sec. 39.19(c)(4)(ii)

Proposed Sec. 39.19(c)(4)(ii) would require a DCO to report an

expected 20 percent decrease in ownership equity two business days

prior to the event (or two business days following the event, if the

DCO does not and reasonably should not have known prior to the event).

Such report must include pro forma financial statements (or current

financial statements) reflecting the anticipated condition of the DCO

following the decrease (or current condition). The report is intended

to alert the Commission of major planned events that would

significantly affect ownership equity, most of which are events of

which the DCO would have advance knowledge, such as a reinvestment of

capital, dividend payment, or a major acquisition.

Better Markets commented that a decrease in ownership equity is an

extraordinary event which would warrant notification for even a 5

percent decrease, the threshold the SEC uses for triggering reporting

of acquisition of beneficial ownership of a class of shares. While a

decrease in ownership equity can have a significant effect on the

financial resources of a DCO, the Commission determined that 20 percent

is a level that would represent a significant decrease and yet would

not occur on a frequent basis. The Commission believes that setting the

threshold lower than 20 percent would unnecessarily increase the

potential burden on DCOs as well as on the Commission, which could then

be responsible for reviewing a larger number of reports.

Better Markets also suggested that five business days advance

notice is more appropriate and would not pose a significant burden for

DCOs. While changing the requirement to five business days does not

itself pose an additional burden on a DCO, the Commission is adopting

the two-day notification requirement, as proposed. The Commission has

determined that requiring the report two days prior to such an event is

sufficient for its purposes in reviewing the transaction, particularly

given the confidential nature of such a transaction.

OCC expressed concern that it would be problematic to provide the

necessary financial statements within the time frame required; OCC

stated that it runs financial statements on a monthly basis, thus it

would not have them readily available within two days. Rather, OCC

suggested keeping the notification time frame at two days, but allowing

up to 30 days, or when the financial statements are ready, whichever

occurs first, to provide the financial statements. The Commission is

adopting the two-day requirement, as proposed. A 20 percent decrease in

ownership equity is generally a major, planned event and the Commission

believes it would be highly unusual for a DCO not to have financial

statements prepared in connection with such a transaction.

The Commission is adopting Sec. 39.19(c)(4)(ii) as proposed.

c. Six-Month Liquid Asset Test--Sec. 39.19(c)(4)(iii)

Proposed Sec. 39.19(c)(4)(iii) would require immediate notice of a

deficit in the six months of liquid assets required by Sec.

39.11(e)(2). CME expressed concern with other ``immediate notice''

events,\230\ stating that this would require a DCO to immediately

notify the Commission, in the specific form and manner requested, even

before the DCO attends to the situation and gathers all the relevant

information. CME recommended only requiring ``prompt'' notice, which

would require the DCO to notify the Commission ``quickly and

expeditiously,'' while allowing the DCO to first attend to the

situation at hand and ensure that the information reported to the

Commission is correct and accurate. CME also suggested ``prompt''

notice for the Material Adverse Change Reporting Requirement.

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\230\ CME referred to the immediate notice required under

proposed Sec. Sec. 39.19(c)(4)(v)-(ix).

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The Commission is adopting the rule as proposed and retaining the

``immediate'' reporting requirement for both Sec. 39.19(c)(4)(iii) and

the Material Adverse Change Reporting Requirement.\231\ While the

Commission appreciates that in such situations a DCO would be busy

attending to the matter at hand, the burden to contact the Commission

is minimal. The Commission does not specify a particular form or manner

of delivery, so as to minimize the burden on the DCO. Moreover, the

Commission is concerned that using a time frame of ``prompt'' would

leave too much open to interpretation by the DCO and could lead to

untimely notices.

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\231\ See further discussion of the Material Adverse Change

Reporting Requirement in section IV.J.5.k, below.

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d. Change in Working Capital (Current Assets)--Sec. 39.19(c)(4)(iv)

Proposed Sec. 39.19(c)(4)(iv) would require a DCO to report to the

Commission no later than two business days after working capital is

negative. The report must include a current balance sheet of the DCO.

Better Markets commented that allowing a DCO two days to report

negative working capital is too much time, given the potential gravity

of the situation, and that anything less than a requirement of

immediate notification is ``simply indefensible.''

[[Page 69403]]

As with the ownership equity decrease reporting requirement, OCC

commented that it is problematic to submit a balance sheet in two

business days. OCC suggested keeping the notification requirement at

two days, but allowing up to 30 days (or sooner if ready) to provide a

balance sheet.

The Commission is adopting Sec. 39.19(c)(4)(iv) as proposed,

except that it is revising certain terminology to clarify the intended

meaning of the term ``working capital.'' While the Commission agrees

that negative working capital is a serious matter, immediate reporting

is not necessary to further the Commission's purpose in obtaining this

information. The Commission is allowing up to two days for notification

because immediate notification would require a DCO to put in place a

potentially expensive system to allow for real-time tracking of working

capital. Nonetheless, a DCO is expected to have a general knowledge of

the level of its working capital at all times. By allowing two days for

notification, a DCO will have time to compute whether working capital

is negative if it has reason to believe that this may be the case,

without being required to implement a real-time notification system.

Thus, the purpose of the two business days is actually to give a DCO

time to become aware of its obligation to report, not to allow the DCO

to wait two days after it becomes aware of the situation.

The Commission is also requiring the DCO to submit a balance sheet

within two business days of the DCO experiencing negative working

capital. Given that a DCO would be expected to update its balance sheet

upon realizing that it has negative working capital, the Commission

does not believe this requirement imposes an additional burden on the

DCO.

As ``working capital'' is not a defined term, the Commission is

substituting the term ``current assets'' for ``working capital'' for

purposes of clarification. Thus, ``negative working capital'' now

refers to a situation when current liabilities exceed current assets.

Section 39.19(c)(4)(iv) now reads as follows: ``Change in current

assets. No later than two business days after current liabilities

exceed current assets; the notice shall include a balance sheet that

reflects the derivatives clearing organization's current assets and

current liabilities and an explanation as to the reason for the

negative balance.''

e. Intraday Initial Margin Calls--Sec. 39.19(c)(4)(v)

Proposed Sec. 39.19(c)(4)(v) would require a DCO to report to the

Commission any intraday margin call to a clearing member, no later than

one hour following the margin call. Several commenters stated that the

requirement is unnecessary and a burden on DCOs, while other commenters

requested certain modifications to the proposal.

The Commission is not adopting the intraday margin call reporting

requirement in proposed Sec. 39.19(c)(4)(v). While such information

could provide early notice of potential problems at a DCO, the

Commission has concluded that the requirement would be overly

burdensome to DCOs given the amount of work commenters indicated it

would entail. In addition, the Commission will still receive much of

the same information as part of each DCO's daily reporting under Sec.

39.19(c)(1), and unusual intraday initial margin calls that reflect a

material adverse change will still be reported under the Material

Adverse Change Reporting Requirement.

f. Issues Related to Clearing Members--Sec. Sec. 39.19(c)(4)(vi)-(ix)

Proposed Sec. Sec. 39.19(c)(4)(vi)-(ix) would require a DCO to

report the following issues related to clearing members: (1) A delay in

collection of initial margin; (2) a request to clearing members to

reduce positions; (3) a determination by the DCO to transfer or

liquidate a clearing member position; and (4) a default of a clearing

member. The Commission received comments suggesting that these

reporting requirements are unnecessary or, at the very least, require

some modification. KCC suggested not adopting these requirements

altogether, because notification of these events would still be

required under the Material Adverse Change Reporting Requirement.

The Commission has concluded that delays in the collection of

initial margin are not necessarily signs of a financial problem at

either the DCO or its clearing members. The Commission therefore is not

adopting the requirement to report such delays under proposed Sec.

39.19(c)(4)(vi). Nonetheless, if a delay is evidence of a material

adverse change in the financial condition of a clearing member, it

would still have to be reported under the Material Adverse Change

Reporting Requirement.

The Commission is adopting the remainder of these reporting

requirements as proposed. However, it is redesignating proposed

Sec. Sec. 39.19(c)(4)(vii)-(ix) as Sec. Sec. 39.19(c)(4)(v)-(vii).

These reporting requirements relate to events that occur infrequently

but can be of significance to the Commission's risk surveillance

program even if they do not rise to the level of having ``a material

adverse financial impact'' on the DCO or represent ``a material adverse

change in the financial condition of any clearing member'' under the

Material Adverse Change Reporting Requirement. Thus, with respect to

these reports, the Commission is not relying on the Material Adverse

Change Reporting Requirement as suggested by KCC.

In connection with these proposed requirements, the Commission also

proposed removing Sec. 1.12(f)(1) in light of the fact that its

requirements were substantially similar to those being proposed as

Sec. 39.19(c)(4)(viii). The Commission did not receive any comments on

this proposal and is removing Sec. 1.12(f)(1) as proposed.

g. Change in Ownership or Corporate or Organizational Structure--Sec.

39.19(c)(4)(x)

Proposed Sec. 39.19(c)(4)(x) would require a DCO to report certain

changes in ownership or corporate or organizational structure. In

general, such reports must be submitted to the Commission three months

in advance of the anticipated change. With the exception of the change

discussed below, the Commission is adopting Sec. 39.19(c)(4)(x) as

proposed, redesignated as Sec. 39.19(c)(4)(viii).

Proposed Sec. 39.19(c)(4)(x)(A)(2) (redesignated as Sec.

39.19(c)(4)(viii)(A)(2)) would require a DCO to report the creation of

a new subsidiary, or the elimination of a current subsidiary, of the

DCO or its parent company. CME commented that the creation or

elimination of a separate subsidiary of the DCO's parent company would

not serve the Commission's purpose of conducting effective oversight of

the DCO or enhance the Commission's ability to conduct timely analysis

of a DCO's activities. CME added that the plans of a DCO's parent

company to create (or eliminate) a subsidiary may be highly

confidential.\232\ CME urged the Commission to eliminate such reporting

requirement, asserting that ``the value of this information to the

[Commission] is questionable, and the burdens associated with providing

it may be substantial.'' CME did not provide any explanation as to why

the burden of reporting might be substantial.

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\232\ MGEX also commented on the highly confidential nature of

changes in ownership, corporate or organizational structure. The

Commission believes MGEX's concerns are addressed by the

Commission's procedures for nonpublic records and confidential

treatment requests set forth in Part 145 of the Commission's

regulations.

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While information about corporate changes that potentially impact a

DCO's

[[Page 69404]]

financial standing or operations is helpful to the Commission in its

oversight of a DCO, to avoid creating an unintended burden on DCOs and

Commission staff, particularly where a DCO is part of a complex

corporate structure, the Commission is modifying Sec.

39.19(c)(4)(viii)(A)(2) to eliminate the requirement to report a change

in subsidiaries of the DCO's parent company. Thus, Sec.

39.19(c)(4)(viii)(A) now requires only that a DCO report ``[a]ny

anticipated change in the ownership or corporate or organizational

structure of the [DCO] or its parent(s) that would: * * * (2) Create a

new subsidiary or eliminate a current subsidiary of the [DCO]. * * *

\233\

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\233\ As proposed, the provision referred to the DCO's ``parent

company.'' The Commission is adopting a technical amendment to refer

to the ``parent(s)'' to clarify that there could be more than one

parent, such as in the case of a DCO owned by a joint venture, and

the parent need not have any particular corporate form. For purposes

of these reporting requirements, a ``parent'' is a direct parent,

not an entity further up the chain of ownership.

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h. Change in Key Personnel--Sec. 39.19(c)(4)(xi)

Proposed Sec. 39.19(c)(4)(xi) would require a DCO to report the

departure or addition of any person who qualifies as ``key personnel,''

as defined in Sec. 39.2, no later than two business days following the

change. KCC suggested requiring a report ``within a reasonable period

of time.'' The Commission notes that key personnel are not likely to

change often, and KCC did not provide any explanation as to why the two

business day notification period is inappropriate. The Commission is

adopting Sec. 39.19(c)(4)(xi) as proposed, but redesignated as Sec.

39.19(c)(4)(ix).

i. Change in Credit Facility Funding Arrangement--Sec.

39.19(c)(4)(xii)

Proposed Sec. 39.19(c)(4)(xii) would require a DCO to report no

later than one business day after a DCO changes an existing credit

facility funding arrangement, is notified that such arrangement has

changed, or knows or reasonably should have known that the arrangement

will change. KCC commented that this requirement is duplicative: such

reports would already be required by the Material Adverse Change

Reporting Requirement. CME had no objection to the requirement to

report such changes, but opposed the requirement to notify the

Commission when it knows that the arrangement will change in the

future, stating that it serves little purpose to notify the Commission

without knowing what will change. CME suggested that the requirement

should be to report to the Commission after the terms have changed.

Conversely, Better Markets opposed several components of the proposed

rule, asserting that it is ``too narrow and too loose,'' allowing one

business day is too long, and the standard of reporting when the DCO

``knows or reasonably should have known'' is insufficient. Better

Markets suggested expanding the reporting requirement to cover

alternative sources of liquidity such as access to commercial paper and

repurchase agreement markets. It also suggested requiring such a report

(i) immediately, and (ii) when ``there is a reasonable likelihood that

the arrangement may change.''

The Commission is modifying the rule as suggested by CME by

removing the following: ``or knows or reasonably should have known that

the arrangement will change.'' Thus, a DCO is required to report a

change in a credit facility funding arrangement no later than one

business day after it changes the arrangement or is notified that such

arrangement has changed. The provision is also being redesignated as

Sec. 39.19(c)(4)(x). The Commission is not adopting KCC's suggestion

to rely on the Material Adverse Change Reporting Requirement because a

change in a credit facility funding arrangement would be of specific

interest to the Commission in its conduct of DCO oversight, but such a

change is not likely to rise to the level of being a material adverse

change. The Commission also is declining to adopt Better Markets'

recommendations because they would result in the filing of multiple

reports, many of limited usefulness, which, on balance, would place an

unnecessary burden on DCOs and Commission staff. Nonetheless, the

Commission notes that unusual market conditions such as those that

might limit a DCO's access to commercial paper or ability to enter into

repurchase agreements, thereby adversely affecting the DCO's liquidity,

could constitute a material adverse change that would have to be

reported under the Material Adverse Change Reporting Requirement.

j. Rule Enforcement--Sec. 39.19(c)(4)(xiii)

Proposed Sec. 39.19(c)(4)(xiii) would require a DCO to report the

initiation of a rule enforcement action against a clearing member or

the imposition of sanctions against a clearing member, no later than

two business days after the DCO takes such action. Several commenters

observed that this would result in multiple reports with little useful

information. They further noted that the DCO would otherwise inform the

Commission about serious financial issues, as a matter of current

practice and pursuant to the Material Adverse Change Reporting

Requirement. MGEX recommended that the Commission not adopt the rule

enforcement reporting requirement. OCC and CME recommended that the

Commission not adopt the enforcement reporting requirement as proposed.

MGEX commented that requiring notification of the initiation of

rule enforcement is unnecessary and premature, noting that many

investigations are unrelated to financial risk and many are routine.

OCC made a similar comment. MGEX expressed concern about the harm such

a report could cause to a clearing member's reputation by notifying the

Commission before there has been any determination of any guilt. MGEX

also noted that the Commission is already routinely informed or is

aware of ongoing or potential actions.

OCC stated that the proposed enforcement reports would serve no

purpose because if there were serious financial issues, the DCO would

already have been in regular contact with the Commission long before

the DCO reached the stage of initiating a rule enforcement action.

Thus, OCC believes these reports would not serve as an effective early

warning sign. OCC further opposed this reporting requirement because a

clearing member could appeal a decision after a sanction is imposed.

OCC recommended notification to the Commission within 30 days after a

final decision on a disciplinary matter.

CME believes it is unclear when the notification requirement would

be triggered, and that there are situations when it is unclear when an

enforcement action is considered to be initiated.

The Commission is adopting the rule with modifications. While the

Commission considers information about enforcement actions to be useful

in its oversight of a DCO's rule enforcement program under Core

Principle H, and more broadly in its oversight of a DCO's overall risk

management program, the Commission has concluded that the requirement,

as proposed, could result in the reporting of many events that are not

material to the Commission's oversight of a DCO.\234\ The Commission

recognizes that many enforcement actions may be based on relatively

minor offenses and are

[[Page 69405]]

unlikely to have a significant impact on a DCO's ability to manage risk

related to the provision of clearing and settlement services.

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\234\ Core Principle H provides in relevant part that ``each

derivatives clearing organization shall * * * (iii) report to the

Commission regarding rule enforcement activities and sanctions

imposed against members and participants. * * * '' See also

discussion of Sec. 39.17 in section IV.H, above.

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Therefore, the Commission is adopting the regulation with a

modification such that it would only require the reporting of sanctions

against clearing members, no later than two business days after the DCO

takes such action, and would not require the reporting of the

initiation of rule enforcement actions. The Commission is also

redesignating the provision as Sec. 39.19(c)(4)(xi). The Commission

notes that events or circumstances that rise to the level of having a

material adverse impact on a DCO's ability to comply with the

requirements of Part 39, or relate to a material adverse change in the

financial condition of any clearing member, whether or not they form

the basis of an enforcement action, will have to be formally reported

under Sec. 39.19(c)(4)(xii)(B) or (C), respectively.

Last, OCC requested clarification as to whether the rule

enforcement reporting requirement applies to DCO enforcement activities

involving a clearing member that is only registered as a BD. The

Commission confirms that the requirement to report the imposition of

sanctions against clearing members does not apply to a DCO's clearing

members that are registered as BDs only and engaged solely in

securities-based transactions. However, insofar as such a clearing

member's actions might have a material adverse impact on the DCO's

ability to comply with the requirements of Part 39 or would constitute

a material adverse change in the financial condition of a clearing

member, the DCO would be required to submit a Material Adverse Change

Report, as discussed below.

k. Financial Condition and Events (Material Adverse Change Reporting

Requirement)--Sec. 39.19(c)(4)(xiv)

Proposed Sec. 39.19(c)(4)(xiv) would require a DCO to immediately

notify the Commission after the DCO knows or reasonably should have

known of certain material adverse changes, i.e., the institution of any

legal proceedings which may have a material adverse financial impact on

the DCO; any event, circumstance or situation that materially impedes

the DCO's ability to comply with part 39 of the Commission's

regulations and is not otherwise required to be reported; or a material

adverse change in the financial condition of any clearing member that

is not otherwise required to be reported.\235\ CME and OCC are opposed

to this ``catch-all'' requirement. In particular, CME is concerned that

the requirement is too broad and thus would include a reporting

requirement for anything that is technically in violation of Part 39,

e.g., even if the DCO's email or Web site goes down temporarily. OCC

also commented that the requirement is unnecessary because the

Commission will be receiving adequate reporting as a result of other

reporting requirements in Part 39 and the reporting requirements for

FCMs. Alternatively, CME suggested requiring ``prompt'' notice, rather

than ``immediate'' notice.

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\235\ Because of the potential impact on a DCO of an adverse

change in the financial condition of a clearing member, this

reporting requirement would apply to ``any'' clearing member,

including one that is solely a BD engaging in securities activities.

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The Commission is adopting Sec. 39.19(c)(4)(xiv) as proposed, but

redesignated as Sec. 39.19(c)(4)(xii). CME's concerns are unwarranted

as the reporting requirement would only require reporting incidents

that could have a material adverse effect on the DCO. A Web site

temporarily going down would not necessarily be expected to have a

``material'' adverse effect on the DCO. However, if it did have a

material adverse impact, the Commission would expect it to be reported.

The Commission recognizes that it is requiring a DCO to exercise its

discretion in the first instance to determine what events trigger this

reporting requirement, but the Commission considers this to be an

appropriate responsibility for a DCO.

Moreover, while the Commission will be getting information as a

result of other Part 39 and FCM reporting requirements, there may be

certain conditions or events that could materially impact a DCO that

the Commission could not anticipate, yet about which it would still be

important for the Commission to be notified. This is especially

important in light of the Commission's decision not to adopt certain

proposed reporting requirements, as discussed above.

The Commission is also keeping the timing of the reporting

requirement as ``immediate'' rather than ``prompt,'' as these are

material changes for which immediate notification is essential and for

which the more ambiguous ``prompt'' is not appropriate.\236\

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\236\ See discussion of timing requirements in section IV.J.5.c,

above.

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l. Financial Statements Material Inadequacies--Sec. 39.19(c)(4)(xv)

Proposed Sec. 39.19(c)(4)(xv) would require a DCO to report

material inadequacies in its financial statements. The Commission

received no comments on this requirement, and the Commission is

adopting Sec. 39.19(c)(4)(xv) as proposed (redesignated as Sec.

39.19(c)(4)(xiii)), with the exception of a technical revision to add a

reference to ``in a financial statement'' so that the language now

reads ``If a derivatives clearing organization discovers or is notified

by an independent public accountant of the existence of any material

inadequacy in a financial statement, such derivatives clearing

organization shall give notice. * * *'' \237\

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\237\ The Commission is also making a technical non-substantive

change by substituting the word ``shall'' for the word ``must'' to

conform this provision with other provisions in Sec. 39.19.

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m. Action of Board of Directors or Risk Management Committee--Sec.

39.19(c)(4)(xvi)

In a separate proposed rulemaking that would implement Core

Principle P (Conflicts of Interest), the Commission proposed Sec.

39.25(b), which would require a DCO to report when the board of

directors of a DCO rejects a recommendation or supersedes an action of

the DCO's Risk Management Committee, or when the Risk Management

Committee rejects a recommendation or supersedes an action of its

subcommittee.\238\ In connection with this, the Commission subsequently

proposed to cross reference this reporting obligation in proposed Sec.

39.19(c)(4)(xvi). At such time as the Commission may adopt the

reporting requirement in Sec. 39.25(b) as a final rule, Sec.

39.19(c)(4) will be amended accordingly.

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\238\ See 76 FR at 736 (Jan. 6, 2011) (Governance).

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n. Election of Board of Directors--Sec. 39.19(c)(4)(xvii)

In a separate proposed rulemaking that would implement Core

Principles P (Conflicts of Interest) and Q (Composition of Governing

Boards), the Commission proposed Sec. 40.9(b)(1)(iii), which would

require a DCO to report certain information to the Commission after

each election of its board of directors.\239\ In connection with this,

the Commission subsequently proposed to cross-reference this reporting

obligation in proposed Sec. 39.19(c)(4)(xvii). At such time as the

Commission may adopt the reporting requirement in Sec. 40.9(b)(1)(iii)

as a final rule, Sec. 39.19(c)(4) will be amended accordingly.

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\239\ Id.

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o. System Safeguards--Sec. 39.19(c)(4)(xviii)

Proposed Sec. 39.19(c)(4)(xviii) would require a DCO to report

certain exceptional events and planned changes as required by Sec.

39.18(g) and Sec. 39.18(h),

[[Page 69406]]

respectively. The Commission received no comments on this reporting

requirement, and the Commission is adopting Sec. 39.19(c)(4)(xviii),

redesignated as Sec. 39.19(c)(4)(xvi), as proposed.\240\

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\240\ See discussion of system safeguards reporting in section

IV.I, above.

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K. Core Principle K--Recordkeeping--Sec. 39.20

Core Principle K,\241\ as amended by the Dodd-Frank Act, requires a

DCO to maintain records of all activities related to the business of

the DCO as a DCO, in a form and manner that is acceptable to the

Commission and for a period of not less than 5 years. The Commission

proposed Sec. 39.20 to establish requirements that a DCO would have to

meet in order to comply with Core Principle K.

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\241\ Section 5b(c)(2)(K) of the CEA, 7 U.S.C. 7a-1(c)(2)(K).

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Under proposed Sec. 39.20(b), a DCO would have to maintain records

of all activities related to its business as a DCO ``for a period of

not less than 5 years,'' except for swap data that must be maintained

in accordance with the SDR rules in part 45 of the Commission's

regulations. Mr. Barnard expressed the view that limiting record

retention to five years is insufficient and records should be required

to be kept indefinitely.

The Commission is adopting Sec. 39.20 as proposed. The Commission

believes that codifying the statutory minimum requirement of five years

is appropriate, noting that a five-year minimum is consistent with

other Commission recordkeeping requirements.\242\ In addition, the

exception for swap data recordkeeping addresses situations where the

Commission has previously determined that a five-year minimum may not

be sufficient.\243\

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\242\ See, e.g., Sec. 1.31 of the Commission's regulations.

\243\ See 75 FR 76574 (Dec. 8, 2010) (Swap Data Recordkeeping

and Reporting Requirements).

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L. Core Principle L--Public Information--Sec. 39.21

Core Principle L,\244\ as amended by the Dodd-Frank Act, requires a

DCO to provide market participants sufficient information to enable the

market participants to identify and evaluate accurately the risks and

costs associated with using the DCO's services. More specifically, a

DCO is required to make available to market participants information

concerning the rules and operating and default procedures governing its

clearing and settlement systems and also to disclose publicly and to

the Commission the terms and conditions of each contract, agreement,

and transaction cleared and settled by the DCO, each clearing and other

fee charged to members,\245\ the DCO's margin-setting methodology,

daily settlement prices, and other matters relevant to participation in

the DCO's clearing and settlement activities.

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\244\ Section 5b(c)(2)(L) of the CEA, 7 U.S.C. 7a-1(c)(2)(L).

\245\ The statutory language refers to fees charged to ``members

and participants,'' and the Commission interprets this phrase to

mean fees charged to ``clearing members.''

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Proposed Sec. 39.21 would require a DCO to provide market

participants with sufficient information to enable the market

participants to identify and evaluate accurately the risks and costs

associated with using the services of the DCO. In particular, proposed

Sec. Sec. 39.21(c)(2), (3) and (4) would require a DCO to disclose

publicly and to the Commission information concerning its margin-

setting methodology and the size and composition of the financial

resource package available in the event of a clearing member default.

KCC, MGEX, and NGX variously commented that DCO fees and charges,

margin methodology and financial resource information are confidential

and should not be required to be publicly disclosed for the following

reasons: (1) It is intellectual property, (2) there is no correlation

between the availability of such information and the decision whether

to invest in or trade with a DCO, and (3) privately held companies (or

non-intermediated DCOs in the case of NGX) should not have to disclose

such information. MGEX also suggested that making margin methodology

information available to the public could lead to market manipulation

by those who might attempt to influence the margin level. MGEX

suggested that the rule should only require making the financial

resource package information available upon request by a clearing

member that has signed the DCO's confidentiality agreement. Conversely,

Better Markets believes that Sec. 39.21 does not go far enough and

that many of the DCO reports required by Sec. 39.19 should also be

required to be disclosed to the public, as the Dodd-Frank Act requires

that market participants and the public be informed of the risks and

other potential consequences of transacting with a DCO.\246\ Similarly,

Mr. Barnard suggested requiring public disclosure of all items of

public interest, including event-specific reports under Sec.

39.19(c)(4), except for those that would expose business-specific

confidential issues.

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\246\ In particular, Better Markets stated that, at a minimum, a

DCO should be required to publicly disclose (i) the adequacy of its

financial resources, measured by the required level of financial

resources under Commission rules, and (ii) to the extent they must

be reported to the Commission, a reduction in financial resources,

decrease in ownership equity, or change in ownership or corporate

structure.

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The Commission is adopting Sec. 39.21 as proposed, except for

proposed Sec. 39.21(c)(7), which would require the public disclosure

of information related to governance and conflicts of interest in

accordance with provisions that were proposed in a separate rulemaking.

At such time as the Commission adopts those provisions, Sec. 39.21

will be amended accordingly. The requirement to publicly disclose

clearing and other fees charged by the DCO, margin methodology and

financial resources information comes directly from Core Principle L.

Moreover, the Commission believes that concerns regarding the

confidential nature of this information are unfounded because such

information would seem to be fundamental to a clearing member or

potential clearing member's assessment of the strengths and weaknesses

of a DCO. This does not necessarily require disclosure of proprietary

information; certain DCOs, e.g., CME, already disclose this type of

information on their Web sites.

The Commission is not revising the rule to incorporate Better

Markets' or Mr. Barnard's proposals. From a practical standpoint, some

of the information Better Markets and Mr. Barnard have requested to be

publicly disclosed is otherwise going to be public information,

particularly if the DCO is a public company, and thus subject to SEC

filing requirements. Regardless, the Commission does not interpret Core

Principle L as requiring disclosure of all of the financial workings of

a DCO.

M. Core Principle M--Information Sharing--Sec. 39.22

Core Principle M,\247\ as amended by the Dodd-Frank Act, requires a

DCO to enter into and abide by the terms of each appropriate and

applicable domestic and international information-sharing agreement and

to use relevant information obtained under such agreements in carrying

out its risk management program. The Commission proposed Sec. 39.22 to

codify the statutory requirement.

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\247\ Section 5b(c)(2)(M) of the CEA, 7 U.S.C. 7a-1(c)(2)(M).

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Proposed Sec. 39.22 would require a DCO to enter into certain

information-sharing agreements and use relevant information obtained

from those

[[Page 69407]]

agreements in carrying out the risk management program of the DCO. MGEX

is opposed to sharing confidential information such as proprietary

intellectual property. MGEX also asked for further clarity to be able

to comment further on this requirement.

The Commission is adopting Sec. 39.22 as proposed. The provision

purposely lacks specific details to allow each DCO the discretion to

make its own determination as to which information-sharing agreements

are necessary and appropriate, including taking into account

confidentiality concerns. DCOs may seek further guidance from

Commission staff if they have specific questions about existing or

potential information-sharing arrangements.

N. Core Principle N--Antitrust Considerations--Sec. 39.23

Core Principle N,\248\ as amended by the Dodd-Frank Act, conforms

the standard for DCOs with the standard applied to DCMs under Core

Principle 19.\249\ Proposed Sec. 39.23 would codify Core Principle N.

CME commented that the proposed regulation is adequate, and the

Commission is adopting the rule as proposed.

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\248\ Section 5b(c)(2)(N) of the CEA, 7 U.S.C. 7a-1(c)(2)(N).

\249\ See Section 5(d)(19) of the CEA, 7 U.S.C. 7(d)(19) (DCM

Core Principle 19).

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O. Core Principle R--Legal Risk--Sec. 39.27

Section 725(c) of the Dodd-Frank Act sets forth a new Core

Principle R (Legal Risk).\250\ Core Principle R requires a DCO to have

a well-founded, transparent, and enforceable legal framework for each

aspect of the DCO's activities. Proposed Sec. 39.27 would set forth

the required elements of such a legal framework. The Commission

solicited comment as to the legal risks addressed in proposed Sec.

39.27 and whether the rule should address additional legal risks.

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\250\ Section 5b(c)(2)(R) of the CEA, 7 U.S.C. 7a-1(c)(2)(R).

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CME commented that proposed Sec. 39.27(c)(1), which would require

a DCO that provides clearing services outside the United States to

identify and address all conflict of law issues, should only require a

DCO to identify and address any ``material'' conflict of law issues.

The Commission agrees with CME that a DCO should not be burdened to

identify non-material conflict of law issues and has revised Sec.

39.27(c)(1) to provide that such a DCO must identify and address ``any

material conflict of law issues.'' The Commission is otherwise adopting

the rule as proposed.

P. Special Enforcement Authority for 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 \251\ 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. Proposed Sec.

39.31 would codify this special authority. The Commission did not

receive any comments on this provision. Nevertheless, as discussed

above in connection with the proposals relating to SIDCO financial

resources and system safeguards for SIDCOs, the Commission is not

finalizing the rules relating to SIDCOs at this time. The Commission

expects to consider all the proposals relating to SIDCOs together in

the future.

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\251\ 12 U.S.C. 1818.

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V. Part 140 Amendments--Delegations of Authority

Under Sec. 140.94, the Commission delegates the authority to

perform certain functions that are reserved to the Commission to the

Director of the Division of Clearing and Risk. In connection with the

regulations the Commission is adopting herein, as well as previously

adopted Sec. 39.5, the Commission is amending Sec. 140.94 to delegate

authority to perform certain functions to the Director of the Division

of Clearing and Risk, as discussed below.

With respect to DCO applications, under Sec. 140.94(a)(6), the

Commission is delegating authority to determine whether a DCO

application is materially complete under Sec. 39.3(a)(2), and to

request that an applicant submit supplemental information in order for

the Commission to process a DCO application under Sec. 39.3(a)(3).

In addition to the authority delegated to the Director of the

Division of Clearing and Risk in connection with the Commission's final

rulemaking for Sec. 39.5,\252\ Sec. 140.94(a)(7) delegates authority

to request specific additional information as part of a DCO's swap

submission under Sec. 39.5(b)(3)(ix).

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\252\ The Commission has already delegated authority to the

Director of the Division of Clearing and Risk to: (1) consolidate

multiple swap submissions from one DCO or subdivide a submission as

appropriate for review under Sec. 39.5(b)(2); and request

information from a DCO to assist the Commission's review of a

clearing requirement that has been stayed under Sec. 39.5(d)(3).

See 76 FR at 44474 (July 26, 2011) (Process for Review of Swaps for

Mandatory Clearing; final rule).

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Section 140.94(a)(8) delegates authority to grant an extension of

time for a DCO to file its annual compliance report under Sec.

39.10(c)(4)(iv).

With respect to financial resources requirements for DCOs, Sec.

140.94(a)(9) delegates authority to: (1) determine whether a particular

financial resource may be used to satisfy the requirements of Sec.

39.11(a)(1) under Sec. 39.11(b)(1)(vi); (2) determine whether a

particular financial resource may be used to satisfy the requirements

of Sec. 39.11(a)(2) under Sec. 39.11(b)(2)(ii); (3) review the

methodology used to compute the requirements of Sec. 39.11(a)(1) and

require changes as appropriate under Sec. 39.11(c)(1); (4) review the

methodology used to compute the requirements of Sec. 39.11(a)(2) and

require changes as appropriate under Sec. 39.11(c)(2); (5) request

financial reporting from a DCO (in addition to the quarterly reports)

under Sec. 39.11(f)(1); and (6) grant an extension of time for a DCO

to file its quarterly financial report under Sec. 39.11(f)(4).

Section 140.94(a)(10) delegates authority to request the periodic

financial reports of a DCO's clearing members that are not FCMs under

Sec. 39.12(a)(5)(i)(B).

With respect to risk management requirements, Sec. 140.94(a)(11)

delegates authority to: (1) Review percentage levels for customer

initial margin requirements and require different percentage levels if

levels are deemed insufficient under Sec. 39.13(g)(8)(ii); (2) review

methods, thresholds, and financial resources and require the

application of different methods, thresholds, and financial resources

as appropriate (relating to risk limits on clearing members) under

Sec. 39.13(h)(1)(i)(C); (3) review the amount of additional initial

margin required of a clearing member permitted to exceed its risk

threshold and require a different amount as appropriate under Sec.

39.13(h)(1)(ii); (4) review the selection of accounts and methodology

used in daily stress testing of large trader positions and require

changes as appropriate under Sec. 39.13(h)(3)(i); (5) review

methodology for weekly stress testing of clearing member accounts and

swap portfolios and require changes as appropriate under Sec.

39.13(h)(3)(ii); and (6) request clearing member information and

documents regarding their risk management policies, procedures, and

practices under Sec. 39.13(h)(5)(i)(A).

With respect to rule submissions and 4d petitions relating to the

commingling of futures, options on futures, and cleared swaps in a

cleared swaps

[[Page 69408]]

account or futures account, respectively, Sec. 140.94(a)(12) delegates

authority to request additional information in support of a rule

submission, under Sec. 39.15(b)(2)(iii)(A), and to request additional

information in support of a 4d petition, under Sec.

39.15(b)(2)(iii)(B).

With respect to DCO reporting requirements, Sec. 140.94(a)(13)

delegates authority to: (1) Grant an extension of time for filing of

reports required to be filed annually under Sec. 39.19(c)(3)(iv); (2)

request that a DCO file information related to its business as a

clearing organization, including information relating to trade and

clearing details, under Sec. 39.19(c)(5)(i); (3) request that a DCO

file a written demonstration that the DCO is in compliance with one or

more core principles and relevant rule provisions under Sec.

39.19(c)(5)(ii); and (4) request that a DCO file, for each clearing

member, by customer origin, the end-of day positions for each

beneficial owner under Sec. 39.19(c)(5)(iii).

Finally, Sec. 140.94(a)(14) delegates authority to permit a DCO to

refrain from publishing on its Web site information that is otherwise

required to be published under Sec. 39.21(d).

VI. Effective Dates

For purposes of publication in the Code of Federal Regulations, all

of the rules adopted herein will have an effective date of 60 days

after publication in the Federal Register. The Commission received a

number of comments, however, that discussed a DCO's need for time to

develop appropriate systems and procedures to come into compliance with

some of the rules. The Commission is extending the date by which DCOs

must come into compliance for certain rules as follows:

DCOs must comply with the following rules 180 days after

publication in the Federal Register: Financial resources--Sec. 39.11;

participant and product eligibility--Sec. 39.12; risk management--

Sec. 39.13 (except gross margin--Sec. 39.13(g)(8)(i)); and settlement

procedures--Sec. 39.14.

DCOs must comply with the following rules 1 year after publication

in the Federal Register: chief compliance officer--Sec. 39.10(c);

gross margin--Sec. 39.13(g)(8)(i); system safeguards--Sec. 39.18;

reporting--Sec. 39.19; and recordkeeping--Sec. 39.20.

VII. Section 4(c)

Proposed Sec. Sec. 39.15(b)(2)(i) and 39.15(b)(2)(ii) would

establish procedures for permitting futures and options on futures to

be carried in a cleared swaps account (subject to Section 4d(f) of the

CEA), and for cleared swaps to be carried in a futures account (subject

to Section 4d(a) of the CEA), respectively. In connection with

proposing those rules, the Commission proposed to grant an exemption

under Section 4(c) of the CEA and requested comment on its proposed

exemption.\253\

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\253\ See 76 FR at 3715-3716 (Jan. 20, 2011) (Risk Management).

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Section 4(c) of the CEA provides that, in order to promote

responsible 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.\254\

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\254\ 7 U.S.C. 6(c).

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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 swaps 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.

Under the proposed exemption, a 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 swaps account

subject to Section 4d(f) of the CEA, instead of a futures account; and

similarly, a 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 swaps

account. For the reasons discussed below, the Commission has determined

to grant the exemption under Section 4(c) of the CEA.

In the notice of proposed rulemaking, the Commission expressed its

view 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.

However, the Commission solicited public comment on whether the

proposed regulations would satisfy the requirements for exemption under

Section 4(c) of the CEA.

The Commission received one comment. CME supported the Commission's

conclusion, agreeing that in appropriate circumstances, the commingling

of customer positions in futures, options on futures, and cleared swaps

could achieve important benefits with respect to greater capital

efficiency resulting from margin reductions for correlated positions.

CME believes that adoption of a regulation permitting such commingling

would be consistent with the public interest, adding that ``[h]aving

positions in a single account can also enhance risk management

practices and systemic risk containment by allowing the customer's

portfolio to be handled in a coordinated fashion in a transfer or

liquidation scenario.''

In light of the foregoing, the Commission finds that permitting the

commingling of positions pursuant to Sec. Sec. 39.15(b)(2)(i) and

39.15(b)(2)(ii) will promote responsible economic and financial

innovation and fair competition, and is consistent with the ``public

interest,'' as that term is used in Section 4(c) of the CEA.

VIII. Considerations of Costs and Benefits

Section 15(a) of the CEA requires the Commission to ``consider the

costs and benefits'' of its actions before promulgating a

regulation.\255\ In particular, these costs and benefits must 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. In conducting its evaluation, the Commission

may, in its discretion, give greater weight to any one of the five

enumerated areas and it may determine that, notwithstanding

[[Page 69409]]

costs, a particular rule is necessary to protect the public interest or

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

purposes of the CEA.\256\

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\255\ 7 U.S.C. 19(a).

\256\ See, e.g., Fisherman's Doc Co-op., Inc v. Brown, 75 F.3d

164 (4th Cir. 1996); Center for Auto Safety v. Peck, 751 F.2d 1336

(D.C. Cir. 1985) (noting that an agency has discretion to weigh

factors in undertaking cost-benefit analysis). Section 3 of the CEA

states the purposes of the Act:

It is the purpose of this Act to serve the public interests

described in subsection (a) through a system of effective self-

regulation of trading facilities, clearing systems, market

participants and market professionals under the oversight of the

Commission. To foster these public interests, it is further the

purpose of this Act to deter and prevent price manipulation or any

other disruptions to market integrity; to ensure the financial

integrity of all transactions subject to this Act and the avoidance

of systemic risk; to protect all market participants from fraudulent

or other abusive sales practices and misuses of customer assets; and

to promote responsible innovation and fair competition among boards

of trade, other markets and market participants.

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In the following discussion, the Commission presents its

considerations of the costs and benefits of the final rulemaking in

light of the comments it received, other relevant data and information,

and the five broad areas of market and public concern as required by

section 15(a) of the CEA.

A. Background

A derivatives clearing organization (DCO) is an entity registered

with the Commission through which derivatives transactions are cleared

and settled. A DCO acts as a central counterparty, serving principally

to ensure performance of the contractual obligations of the original

counterparties to derivatives transactions and to manage and mitigate

counterparty risk and systemic risk in the markets they serve. This is

accomplished by interposing the DCO between the counterparties so that

the DCO becomes the buyer to every seller and the seller to every

buyer. Upon novation by the original parties to a transaction, the

contractual obligations of the original parties to one another are

extinguished and replaced by a pair of equal and opposite transactions

between the DCO and the counterparties or their agents.

The DCO's role as central counterparty potentially exposes the DCO

itself to risk from every user whose transactions are cleared through

the DCO. Conversely, if a DCO itself fails or suffers a risk of

failure, the consequences for the market at large are likely to be

serious and widespread. Effective risk management, therefore, is

critical to the functioning of a marketplace in which swaps are cleared

through DCOs.

Clearing members are the entities that deal directly with DCOs.

They may be acting on their own behalf or as agents. DCOs establish

rules and risk management requirements for their clearing members,

which typically include specified levels of financial resources,

operational capacity, and risk management capability; deposit of risk-

based initial margin and payment of daily variation margin sized to

cover current and potential losses of the member; and contribution to a

guaranty fund that can be used in the event of a clearing member

default. These requirements lower systemic risk by reducing the

likelihood of a clearing member default and, in the event a clearing

member default does occur, reducing the likelihood that it will result

in the default of other market participants.

Additionally, unlike bilateral derivatives transactions where

parties do not know the exposures their counterparties have to other

market participants, as a result of the multilateral nature of

centralized clearing, DCOs have a real-time, more complete picture of

each clearing member's risk exposure to multiple parties. Thus the DCO

can more effectively and quickly identify developing risk exposures for

individual clearing members and better manage these risks if clearing

members become distressed.

B. General Comments and Considerations

The Dodd-Frank Act is intended to facilitate stability in the

financial system of the United States by reducing risk, increasing

transparency, and promoting market integrity. To accomplish these

objectives, among other things, the Dodd-Frank Act provides for the

mandatory clearing of certain swaps by DCOs and explicitly authorizes

the Commission to promulgate rules to establish appropriate standards

for DCOs in carrying out their risk mitigation function. Regulatory

standards for DCOs will serve to assure market participants that credit

and other risks associated with cleared swap transactions are being

appropriately managed by DCOs. This, in turn, can promote the use of

cleared swaps. Regulatory standards also can foster market confidence

in the integrity of the derivatives clearing system.

In this final rulemaking, the Commission is adopting regulations to

implement 15 DCO core principles: A (Compliance), B (Financial

Resources), C (Participant and Product Eligibility), D (Risk

Management), E (Settlement Procedures), F (Treatment of Funds), G

(Default Rules and Procedures), H (Rule Enforcement), I (System

Safeguards), J (Reporting), K (Recordkeeping), L (Public Information),

M (Information Sharing), N (Antitrust Considerations), and R (Legal

Risk). In addition, the Commission is adopting regulations to implement

the Chief Compliance Officer provisions of Section 725 of the Dodd-

Frank Act, and to update the regulatory framework for DCOs to reflect

standards and practices that have evolved over the past decade since

the enactment of the CFMA.

This rulemaking process has generated an extensive record, which is

discussed at length throughout this notice as it relates to the

substantive provisions in the final rules. A number of commenters

expressed the view that there would be significant costs associated

with implementing and complying with proposed rules. The Commission

also received comments from KCC, CME, and OCC who stated generally that

the cost-benefit analysis presented in the proposed rulemakings was

insufficient. The Commission has carefully considered alternatives

suggested by commenters, and in a number of instances, for reasons

discussed in detail above, has adopted such alternatives or

modifications to the proposed rules where, in the Commission's

judgment, the alternative or modified standard accomplishes the same

regulatory objective in a more cost-effective manner.

The Commission invited comments on the comprehensive or

``systemic'' costs and benefits of the proposed rules. MFA and Better

Markets addressed this issue stating that the Commission's cost-benefit

analyses presented in the notices of proposed rulemaking may have

understated the benefits of the proposed rules.\257\ MFA commented that

the costs to market participants would be substantial if the Commission

does not adopt the proposed regulations. Better Markets commented that

the only reasonable way to consider costs and benefits of any of the

Commission's rule proposals under Dodd-Frank is to view them as a

whole. According to Better Markets:

\257\ See Letter from Better Markets dated June 3, 2011; Letter

from MFA dated March 21, 2011 (comment file for 76 FR 3698 (Risk

Management)).

It is undeniable that the Proposed Rules are intended and

designed to work as a system. Costing-out individual components of

the Proposed Rules inevitably double counts costs which are

applicable to multiple individual rules. It also prevents the

consideration of the full range of benefits that arise from the

system as a whole that provides for greater stability, reduces

[[Page 69410]]

systemic risk and protects taxpayers and the public treasury from

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future bailouts.

Better Markets believes that the benefits must include the avoided

risk of a new financial crisis and the best measure of this benefit is

the cost of the 2008 financial crisis, which is still accumulating. It

cited Andrew G. Haldane, Executive Director, Financial Stability of the

Bank of England, who estimated that the worldwide cost of the crisis in

terms of lost output was between $60 trillion and $200 trillion,

depending primarily on the long term persistence of the effects.

The Commission agrees with Better Markets that the DCO rules

operate in an integrated, systemic manner to ensure that the risks

associated with cleared swap transactions are being appropriately

managed or addressed by DCOs. When implemented in their entirety, these

rules have the potential to significantly change not only the aggregate

risk profile of the entire derivatives clearing industry, but also the

allocation of risks among DCOs, clearing firms, and market

participants. The final rules require DCOs to admit firms as clearing

members that may differ substantially from existing members with

respect to size, risk profiles, specializations, and risk management

abilities. The rules also help create an environment in which DCOs will

compete for the business of clearing trades of different sizes, and of

many different derivatives products--both futures and swaps. In a

potentially much more diverse range of both participants and products,

these final rules will allow, and in some cases require, DCOs to make

use of a number of risk management tools, including, among others,

periodic valuation of financial resources; a potentially more rigorous

design for margins; stress testing and back testing for financial

resources and margin, respectively; and additional rules and procedures

designed to allow for management of events associated with a clearing

member defaulting on its obligations to the DCO. These rules help

reduce the potential for DCO default, and the potential follow-on

effects on financial markets as a whole. In addition, the daily,

quarterly, annual, and event-specific reporting requirements for DCOs

enhance the tools available to the Commission in conducting its

financial risk surveillance in connection with derivatives clearing by

DCOs.

Certain of the regulations promulgated in this final rulemaking

merely codify the requirements of the CEA, as amended by the Dodd-Frank

Act, e.g., Sec. Sec. 39.10(a) and (b) (compliance with core

principles); 39.17 (rule enforcement); 39.22 (information sharing); and

39.23 (antitrust considerations). For such provisions, the Commission

has not considered alternatives to the statute's prescribed

requirements, even though a DCO may incur costs to comply with these

provisions. As these requirements are imposed by the Dodd-Frank Act,

any associated costs and benefits are the result of statutory

directives, as previously determined by the Congress, that govern DCO

activities independent of the Commission's regulations. By its terms,

CEA Section 15(a) requires the Commission to consider and evaluate the

prospective costs and benefits of regulations and orders of the

Commission prior to their issuance; it does not require the Commission

to evaluate the costs and benefits of the actions or mandates of the

Congress.

In its notice of proposed rulemaking, the Commission requested data

or other information in connection with its cost-benefit

considerations. The Commission received only a few comments providing

quantitative information on the costs of the proposed rules. It

received two comments on the benefits of the proposed rules.

The Commission invited but did not receive public comments specific

to, or related to, its consideration of costs and benefits for proposed

Sec. Sec. 1.3, 39.1, 39.2, 39.4, 39.9, 39.16, 39.18, 39.20, 39.21, and

39.27. However, the Commission received comments on substantive

provisions of those proposed rules and such comments are addressed

above.

The following discussion summarizes the Commission's consideration

of the costs and benefits of the final rules pursuant to CEA Section

15(a).

C. Form DCO--Sec. 39.3(a)(2)

Section 5b(c)(1) of the CEA provides that ``[a] person desiring to

register as a derivatives clearing organization shall submit to the

Commission an application in such form and containing such information

as the Commission may require for the purpose of making the

determinations required for approval under paragraph (2).'' Paragraph

(2), which sets forth the 18 core principles applicable to DCOs,

further provides in paragraph (i) that ``[t]o be registered and to

maintain registration as a derivatives clearing organization, a

derivatives clearing organization shall comply with each core principle

described in this paragraph and any requirement that the Commission may

impose by rule or regulation pursuant to section 8a(5) [of the CEA].''

Accordingly, the standard for approval of DCO registration is the

applicant's ability to satisfy the DCO core principles.

Proposed Sec. 39.3(a)(2) would require that any person seeking to

register as a DCO submit a completed Form DCO, which would be provided

as an appendix to part 39 of the Commission's regulations. The Form

DCO, composed of a cover sheet and list of exhibits, would replace the

general guidance contained in Appendix A to Part 39, ``Application

Guidance and Compliance With Core Principles'' (Guidance), which was

adopted by the Commission in 2001. In accordance with Section 5b(c) of

the Act, the Form DCO is designed to elicit a demonstration that an

applicant can satisfy each of the DCO core principles. Toward this end,

the Form DCO requires submission of extensive information about an

applicant's intended operations. This information has been required of

applicants under the previous Guidance, and the use of the Form DCO

does not represent a departure in substance from the Commission's

practices over the past decade.

Rather, as explained in the proposed rulemaking, the Form DCO was

designed to standardize and clarify the information that the Commission

has required from DCO applicants in the past, in an effort to

facilitate a more streamlined and efficient application process. The

Commission has learned from experience that the general guidance

contained in the previous Appendix A did 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 the Commission requires to conclude

that the applicant has demonstrated its ability to comply with the core

principles.

The Commission did not receive comments specifically with respect

to its cost-benefit analysis of proposed Sec. 39.3(a)(2) or to its

Paperwork Reduction Act estimate that the cost of preparing a completed

application would be $100,000. The Commission notes that applicants for

DCO registration will incur direct costs associated with the

preparation of the completed Form DCO. However, because the Form DCO to

a large extent captures information that has already been required by

the Commission under the Guidance or, with respect to new core

principles, captures information that tracks the statutory

[[Page 69411]]

requirements,\258\ the use of the Form DCO will not impose greater

costs than have been imposed in the past. In fact, by providing greater

clarity as to what is expected from an applicant and by reducing the

need for Commission staff to request, and the applicant to provide,

supplementary information, the Form DCO should reduce costs for

applicants.

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\258\ Exhibits O, P, and Q, relating to the requirements of Core

Principles O (Governance Fitness Standards), P (Conflicts of

Interest), and Q (Composition of Governing Boards), respectively.

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As discussed in more detail in this notice of final rulemaking, the

Commission received two comment letters that addressed the proposed

Form DCO.\259\ The comments did not oppose the concept of the Form DCO.

The comments were directed at the large amount of information required

and the necessity of submitting certain specific information. One of

the comment letters focused on the use of the Form DCO for amending an

existing DCO registration, and the Commission has provided a

clarification to address that commenter's concerns. The Commission has

determined to adopt the final Form DCO largely as proposed, but it has

modified several of the exhibits in response to specific comments.

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\259\ See discussion in Section III.C.1, above.

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The Commission has evaluated the costs and benefits of the required

use of Form DCO, under Sec. 39.3(a)(2), in light of the specific

considerations identified in Section 15(a) of the CEA as follows:

1. Protection of Market Participants and the Public

Costs

Applicants currently incur costs in demonstrating compliance with

the core principles. As described above, based on the staff's

experience in processing DCO applications over the last ten years, the

Commission believes that use of the Form DCO will not increase, and

often may decrease, the time and expense associated with applying for

registration as a DCO for future applicants.

Benefits

The Commission expects that use of the Form DCO will promote the

protection of market participants and the public. Given the critical

role that DCOs play in providing financial integrity to the markets for

which they clear--which now include swaps as well as futures markets--

it is essential that the Commission conduct a comprehensive and

thorough review of all DCO applications. Such review is essential for

the protection of market participants and the public insofar as it

serves to limit the performance of DCO functions to only those entities

that have provided adequate demonstration that they are capable of

satisfying the core principles.

2. Efficiency, Competitiveness, and Financial Integrity

Costs

As noted, the Commission believes that use of the Form DCO will not

increase, and often may decrease, the time and expense associated with

applying for registration as a DCO for future applicants.

Benefits

The Commission expects that use of the Form DCO will promote

efficiency, competitiveness, and financial integrity. As discussed

above, the CEA requires that prospective DCO registrants submit an

application and comply with the core principles. In connection with

these requirements, in 2001, the Commission adopted the Guidance to

assist applicants in preparing application materials. However, the

Commission's experience with protracted reviews of draft applications

and materially incomplete final submissions has indicated a need for

streamlining the application process.

By requiring the use of Form DCO, the Commission is promoting

increased efficiency by providing greater clarity to applicants before

they undertake the application process, thereby facilitating the

submission of a materially complete final application in the first

instance. This will also reduce the need for submission of supplemental

materials and consultation between applicants and the Commission staff.

The result will be more cost effective and expeditious review and

approval of applications. This will benefit applicants as well as free

Commission staff to handle other regulatory matters.

In addition, use of the Form DCO makes available to the public the

Commission's informational requirements so that all prospective

applicants have a heightened understanding of what is involved in the

preparation and processing of an application. It promotes greater

transparency in the process and will enhance competition among DCOs by

making it easier for qualified applicants to undertake and navigate the

application process in a timely manner.

The Form DCO is designed to address an applicant's ability to

comply with the core principles. Compliance with the core principles is

essential to ensure the financial integrity of the derivatives clearing

process and of derivatives markets, generally. In particular, the

required information in Form DCO Exhibits B (financial resources), D

(risk management), E (settlement procedures), F (treatment of funds), G

(default rules and procedures) and I (system safeguards) elicits

important information supporting the applicant's ability to operate a

financially sound clearing organization that can provide reliable

clearing and settlement services and appropriately manage the risks

associated with its role as a central counterparty.

3. Price Discovery

The Commission does not anticipate that use of the Form DCO will

impact the price discovery process.

4. Sound Risk Management Practices

Costs

As noted, the Commission believes that use of the Form DCO will not

increase, and often may decrease, the time and expense associated with

applying for registration as a DCO for future applicants.

Benefits

The Commission expects that use of the Form DCO will promote sound

risk management practices. Use of the Form DCO will reinforce sound

risk management by requiring an applicant to examine its proposed risk

management program through the preparation of a series of detailed

exhibits. The submission of exhibits relating to risk management also

make it easier for Commission staff to analyze and evaluate an

applicant's ability to comply with Core Principle D (risk management,

which includes monitoring and addressing credit exposure through margin

requirements and other risk control mechanisms). Sound risk management

practices are required by the CEA and Commission regulations, and are

essential to the effective functioning of a DCO.

5. Other Public Interest Considerations

Costs

As noted, the Commission believes that use of the Form DCO will not

increase, and often may decrease, the time and expense associated with

applying for registration as a DCO for future applicants.

Benefits

There are considerable benefits to the public in standardizing and

streamlining the DCO application process in terms of more efficient use

of Commission resources and more cost-effective and transparent

requirements for applicants. DCOs play a key role in

[[Page 69412]]

supporting the financial integrity of derivatives markets, and this

role takes on even greater significance with the Dodd-Frank

requirements for swaps clearing. A coherent and comprehensive approach

to DCO registration is needed to ensure that only qualified applicants

will be approved and that they are capable of satisfying the

requirements of the core principles and Commission regulations.

D. Chief Compliance Officer--Sec. 39.10(c)

Section 725(b) of the Dodd-Frank Act added a new paragraph (i) to

Section 5b of the CEA to require each DCO to designate an individual as

its CCO, responsible for the DCO's compliance with the CEA and

Commission regulations and the filing of an annual compliance report.

The provisions regarding the CCO in proposed Sec. 39.10(c) would

largely codify Section 5b(i) of the CEA. There are certain provisions,

however, that effectuate or implement the statutory requirements. For

example, the proposed rules would require that the CCO have the

appropriate background and skills for the position and not be

disqualified from registration under Sections 8a(2) or 8a(3) of the

CEA; meet with the board of directors or the senior officer at least

once a year to discuss the DCO's compliance program; and perform duties

including establishing a code of ethics. In addition, with respect to

the annual report, the proposed rules would set forth certain content

requirements (e.g., discussing areas for compliance program improvement

and listing any material changes to compliance policies and procedures

since the last annual report) and procedural requirements (e.g.,

submitting the annual report to the board of directors or senior

officer prior to submitting the report to the Commission, and

submitting the annual report not more than 90 days after the end of the

DCO's fiscal year unless the Commission grants an extension of time.)

As discussed in detail above, the Commission received a number of

comments that supported the proposed rules for CCOs and the annual

compliance report, and other comments that suggested alternatives or

refinements to the Commission's proposed rules. Commenters did not

provide any quantitative data regarding the costs to either DCOs or

market participants and the public. The Commission addressed those

comments above and, where appropriate, the final rules reflect

commenters' suggestions.

One commenter, MGEX, expressed concerns that relate to the

Commission's implementation of the compliance framework established by

Congress. MGEX stated that the regulations regarding organizational

structure and reporting lines seem ``excessive and beyond what was

contemplated by the passage of the Dodd-Frank Act.'' It also believes

that the regulations do not ``guarantee improved market protection,

which is one of the main goals of the Dodd-Frank Act.''

The Commission does not agree with MGEX that the rules exceed what

was contemplated by Congress. To a great extent the rules codify the

relevant provisions of the CEA, as amended, and it was Congress, not

the Commission, that specified the compliance framework that the

Commission is now implementing. The additional requirements set forth

by the rules are designed to increase the CCO's effectiveness and

ensure that the annual report is a useful compliance and oversight

tool.

MGEX also commented that ``the rules will impose a cost and burden

on the market that will be passed along to the market participants

which decreases the overall efficiency and risk mitigation.'' MGEX did

not provide any details to support its conclusion.

The Commission disagrees with MGEX that the Commission's rules will

impose such a significant burden on the market and market participants.

The principal costs of the CCO requirement result from the statutory

provisions of the CEA which, as amended by the Dodd-Frank Act, requires

each DCO to designate a CCO and submit an annual compliance report.

Although the Commission's rules would impose certain additional costs

in order to implement this statutory requirement, these additional

costs are not expected to significantly increase costs to the DCO or

market participants. For example, a DCO may incur higher costs to the

extent that it needs to pay a higher salary to a person who has the

qualifications set forth in the rule to perform the statutory and

regulatory duties of the CCO.\260\ The Commission believes that such

costs are appropriate because it has determined that a CCO should have

these qualifications to be effective, and notes that the standards are

general enough to provide reasonable discretion to the DCO in its

designation of a CCO.\261\ Similarly, a DCO may have to incur higher

costs in terms of staff time to prepare an annual report that contains

the information required by Sec. 39.10(c)(3), as opposed to a less

comprehensive annual report. However, the Commission believes that the

annual report must contain adequate information if it is to be useful

to the DCO and the Commission. The Commission does not anticipate that

these costs of hiring a qualified CCO, or of preparing a more detailed

annual report, will be significantly higher than the costs to the DCO

imposed by the basic statutory requirements for the CCO.\262\

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\260\ The Commission believes that even in the absence of this

specific rule many DCOs would employ well-qualified persons to

perform the responsibilities of the statutorily-required CCO. In

such circumstances this rule would not result in any additional

costs for a DCO.

\261\ As noted in section IV.A.3, above, the rules do not

require that the person designated as the CCO hold that position,

exclusively. A CCO may have dual responsibilities so long as the CCO

can effectively carry out his or her duties as the CCO. Accordingly,

depending on the skills and background of the personnel within a

particular DCO, a DCO may be able to use an existing staff member to

perform the duties of the CCO.

\262\ In light of the variations that exist today among DCO

compliance programs, including the qualifications of DCO compliance

personnel, the Commission does not believe it is feasible to

quantify the incremental costs associated with Sec. 39.10(c).

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For purposes of the Paperwork Reduction Act, the notice of proposed

rulemaking estimated the cost of preparing the annual report to be

$8000 to $9000 per year. The Commission received no comments on this

estimate. The Commission received comments that the annual report

should be more limited than proposed. The Commission notes that those

comments did not suggest limiting the annual report to achieve a more

favorable cost-benefit ratio, and the Commission addressed those

comments above.

The Commission has evaluated the costs and benefits of Sec.

39.10(c) in light of the specific considerations identified in Section

15(a) of the CEA as follows:

1. Protection of Market Participants and the Public

Costs

As discussed above, there are likely to be direct costs to DCOs in

connection with designating a qualified CCO and annually preparing a

comprehensive compliance report. To the extent that the Commission's

regulations impose more specific or supplemental requirements when

compared to those requirements explicitly imposed by Section 5b(i) of

the CEA, those incremental costs are not likely to be significant.

While it is possible that those incremental costs will be passed along

to clearing members and market participants in the form of increased

clearing fees, the size of those incremental costs, when spread across

recipients of clearing services, are likely to be negligible.

[[Page 69413]]

Benefits

The Commission believes that the CCO rules will protect market

participants and the public by promoting compliance with the core

principles and Commission regulations through the designation and

effective functioning of the CCO, and the establishment of a framework

for preparation of a meaningful annual review of a DCO's compliance

program. While there may be incremental costs associated with

imposition of the Commission's regulatory standards, those costs may be

mitigated by the countervailing benefits of an effective compliance

program that fosters financial integrity of the clearing process and

responsible risk management practices to protect the public from the

adverse consequences that would result from a DCO failure.

The annual compliance report, in particular, will help the DCO and

the Commission to assess whether the DCO has mechanisms in place to

adequately address compliance issues and whether the DCO remains in

compliance with the core principles and the Commission's regulations.

Such compliance will protect market participants and the public.

2. Efficiency, Competitiveness, and Financial Integrity

Costs

The Commission believes that designation of a qualified CCO who

will effectively perform required duties, including the preparation of

an annual compliance report, will not increase costs and is likely to

lead to reduction of costs, in terms of the efficiency,

competitiveness, and financial integrity of the derivatives markets.

Benefits

Clearing is a critical component of the efficient, competitive, and

financially sound functioning of derivatives markets. The financial

integrity of these markets, in particular, is achieved through layers

of protection. Requirements for an effective DCO compliance program

will add a new layer of protection to ensure that the DCO remains

compliant with the CEA and Commission regulations, especially relating

to Core Principles B (financial resources), D (risk management), E

(settlement procedures), F (treatment of funds), G (default rules and

procedures), I (system safeguards), and N (antitrust considerations).

An effective CCO will provide benefits to DCOs and the markets they

serve by implementing measures that enhance the safety and efficiency

of DCOs and reduce systemic risk. Reliable and financially sound DCOs

are essential for the stability of the derivatives markets they serve,

and for the greater public which benefits from a sound financial

system.

3. Price Discovery

The Commission does not anticipate that Sec. 39.10(c) will impact

the price discovery process.

4. Sound Risk Management Practices

Costs

The Commission does not believe that the CCO provisions will impose

costs in terms of sound risk management practices. To the contrary, the

Commission perceives there to be benefits that will result from its CCO

implementing regulations.

Benefits

The regulatory provisions that interpret or implement the statutory

requirements for the CCO and annual report serve to enhance the

standards for a DCO's compliance program which will necessarily

emphasize risk management compliance because of its significance to the

overall purpose and functioning of the DCO. Compliance with Core

Principle D (risk management) and related regulations encompasses,

among other things, measurement and monitoring of credit exposures to

clearing members, implementation of effective risk-based margin

methodologies, and appropriate calculation and back testing of margin

levels. It is the responsibility of the CCO to ensure that the DCO is

compliant with Core Principle D and the regulations thereunder, and is

otherwise engaged in appropriate risk management activities in

accordance with the DCO's own rules, policies and procedures.

5. Other Public Interest Considerations

The Commission does not believe that the rule will have a material

effect on public interest considerations other than those identified

above.

E. Financial Resources--Sec. 39.11

Section 5b(c)(2)(B) of the CEA, Core Principle B, as amended by the

Dodd-Frank Act, requires a DCO to possess financial resources that, at

a minimum, exceed the total amount that would enable the DCO to meet

its financial obligations to its clearing members notwithstanding a

default by the clearing member creating the largest financial exposure

for the DCO in extreme but plausible market conditions, and to cover

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

basis.

Proposed Sec. 39.11 would codify these requirements and set forth

additional standards for the types of financial resources that are

acceptable (Sec. 39.11(b)); computation of the amount of financial

resources required to satisfy the statutory default and operational

resources requirements (Sec. 39.11(c)); valuation of financial

resources (Sec. 39.11(d)); liquidity of financial resources (Sec.

39.11(e)); and quarterly reporting of financial resources (Sec.

39.11(f)).\263\

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\263\ The Commission also proposed Sec. 39.29 which would apply

certain stricter requirements to SIDCOs. As discussed above, the

Commission is not taking action on those proposed rules as part of

this final rulemaking.

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As discussed in more detail above, the Commission received comment

letters requesting further clarity as to the proposed requirements. The

Commission also received comment letters that discussed how the

proposed rules might impose costs or burdens on DCOs.\264\ Two

commenters objected to the requirement that DCOs must monitor ``on a

continual basis'' a clearing member's ability to meet potential

assessments, which one of the commenters characterized as ``overly

burdensome and difficult to administer.'' Regarding the proposed

restrictions on the use of assessment powers, another commenter stated

that the inclusion of assessment powers as a financial resource is

necessary for it to meet its obligations in the event of a default. Two

commenters recommended that the Commission permit letters of credit to

be considered in the financial resources computation. Finally, several

DCOs urged the Commission to allow U.S. Treasuries, in addition to

cash, as a financial resource sufficient to meet the proposed financial

resource liquidity requirement.

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\264\ See discussion in Section IV.B, above.

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As discussed above, in proposing that a DCO ``monitor, on a

continual basis, the financial and operational capacity of its clearing

members to meet potential assessments,'' the Commission did not intend

to require real-time monitoring of clearing members. Rather, the

purpose of the provision was to require a DCO to monitor often enough

to enable it to become aware of any potential problems in a timely

manner. The Commission has modified Sec. 39.11(d)(2)(ii) to remove the

``continual basis'' standard, leaving the DCO to exercise its

discretion in determining the appropriate frequency of periodic reviews

or more frequent reviews as circumstances warrant in connection with

particular clearing members.

The Commission is permitting DCOs to include potential clearing

member

[[Page 69414]]

assessments in calculating default financial resources, as proposed,

subject to the limitations of Sec. 39.11(d)(2)(iii) (30 percent

haircut) and Sec. 39.11(d)(2)(iv) (DCO may count the value of

assessments, after the haircut, to meet up to 20 percent of its default

resources requirement). The comments on this proposal were varied. Some

commenters stated that the Commission had proposed an appropriate,

balanced approach; others stated that the limitations on assessments

were too strict; and still others stated that the Commission should not

permit assessments to count at all.

It is the Commission's view that, in light of recent market events

and as a general matter, it is not prudent to permit a DCO to rely on

letters of credit. However, for the reasons discussed above, the

Commission would consider permitting letters of credit to be included

as a DCO financial resource on a very limited case-by-case basis.

Finally, the Commission is revising Sec. 39.11(e)(1) so that, in

addition to cash, a DCO may use U.S. Treasury obligations and high

quality, liquid, general obligations of a sovereign nation to satisfy

financial resource liquidity requirements. This revised standard

reflects the current practices of U.S. and foreign-based DCOs.

The Commission has evaluated the costs and benefits of Sec. 39.11

in light of the specific considerations identified in Section 15(a) of

the CEA as follows:

1. Protection of Market Participants and the Public

Costs

The regulations require DCOs to take specific actions to ensure

that they are able to meet the statutory requirements for covering

default and operating expenses. These actions include monthly stress

testing to calculate what those financial obligations are, and

quarterly reporting to the Commission to demonstrate the adequacy of

financial resources in terms of dollar amount and liquidity. DCOs will

incur direct costs related to staffing and technology programming to

calculate, monitor, and report financial resources.

Existing DCOs will have already implemented certain practices and

systems for tracking and managing financial resources in order to

comply with Core Principle B, as originally enacted in 2000. Given the

staffing and operational differences among DCOs, the Commission is

unable to accurately estimate or quantify the additional costs DCOs may

incur to comply with the new financial resource rules.\265\ Moreover,

the cost-effects of new cleared products and new market participants

clearing those products are too speculative and uncertain for the

Commission to be able to quantify or estimate at this time. Such costs

or benefits will depend upon a number of variables that are not

estimable or quantifiable at this time, such as the nature and number

of the new products that become subject to clearing, the nature and

number of market participants that enter into transactions involving

such products, and the resulting costs or benefits to such market

participants from the clearing of such products.

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\265\ Commenters did not provide the Commission with

quantitative data regarding such costs.

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

As to costs associated with restrictions the Commission is imposing

on the types and valuation of financial resources that may be counted

as financial resources for purposes of satisfying Core Principle B,

those too will vary among DCOs. For example, for DCOs that do not

include potential clearing member assessments in their calculations of

financial resources, the limitations on assessments will not result in

increased costs. For DCOs that to any extent rely on potential

assessments, the new limitations might require revisions to their

default management plans, an increase in guaranty fund requirements, or

an infusion of additional capital. The same would apply to letters of

credit that cannot be considered to be financial resources for purposes

of complying with Core Principle B, absent relief. Again, because of

the range of circumstances of different DCOs, it is not feasible to

estimate or quantify the costs of the safeguards imposed by the

Commission's financial resource rules.

Benefits

The financial resource rules establish uniform standards that

further the goals of avoiding market disruptions and financial losses

to market participants and the general public, and avoiding systemic

problems that could arise from a DCO's failure to maintain adequate

default or operating resources. While it is not possible to estimate or

quantify the benefits to market participants and the public in

facilitating the financial soundness of a DCO, the Commission believes

that a DCO failure, regardless of the size of the DCO, could adversely

affect the financial markets, market participants, and the public.

2. Efficiency, Competitiveness, and Financial Integrity

Costs

As discussed in connection with factor 1 above, quantification or

estimation of these costs and benefits is not readily feasible. For

some DCOs, the financial resource rules will have little or no direct

or indirect impact. For others, the impact may be more substantial.

Although there may be disparate impact among DCOs, overall the rules

are not expected to impose significant costs in terms of efficiency,

competitiveness, or financial integrity of derivatives markets.

Benefits

The regulations promote financial strength and stability, thereby

fostering efficiency and a greater ability to compete in the broader

financial markets. The regulations promote competition by preventing

DCOs that lack adequate financial safeguards from expanding in ways

that may ultimately harm the broader financial market. The regulations

promote efficiency insofar as DCOs that operate with adequate financial

resources are less likely to fail. The regulations are designed to

ensure that DCOs can meet their financial obligations to market

participants, thus contributing to the financial integrity of the

derivatives markets as a whole.

As highlighted by recent events in the global financial markets,

maintaining sufficient financial resources is a critical aspect of any

financial entity's risk management system, and ultimately contributes

to the goal of stability in the broader financial markets. Therefore,

the Commission believes it is prudent to include financial resources

requirements for entities applying to become or operating as DCOs.

Finally, Congress has determined that a DCO must comply with Core

Principle B to achieve the purposes of the CEA and the Commission has

determined that Sec. 39.11 sets forth the minimum standards for a DCO

to do so.

3. Price Discovery

The Commission does not believe that this rule will have a material

effect on price discovery.

4. Sound Risk Management Practices

Costs

Adequate financial resources are a corollary to strong risk

management. To the extent that the financial resource rules result in

additional costs, these costs are associated with implementing the

practices and procedures that are necessary to ensure a DCO has

adequate financial resources.

[[Page 69415]]

Benefits

The regulations, by setting specific standards with respect to how

DCOs should assess, monitor, and report the adequacy of their financial

resources, contribute to DCOs' maintenance of sound risk management

practices and further the goal of minimizing systemic risk. The

reporting requirements, in particular, will enable the Commission to

conduct more thorough and meaningful oversight of DCOs that will

contribute to improved risk management by DCOs overall.

5. Other Public Interest Considerations

Costs

The Commission has not identified any public interest

considerations that would be negatively affected by the provisions of

the financial resource rules that effectuate or implement the statutory

requirements of Core Principle B (financial resources).

Benefits

The benefits to the public of a DCO maintaining adequate financial

resources are discussed above.

F. Participant and Product Eligibility--Sec. 39.12

Participant Eligibility

Section 5b(c)(2)(C) of the CEA, Core Principle C, as amended by the

Dodd-Frank Act, requires each DCO to establish appropriate admission

and continuing eligibility standards for members of, and participants

in, the DCO, 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.

As discussed above, the Commission crafted the provisions of

proposed Sec. 39.12(a) and related rules to establish a regulatory

framework that accomplishes two goals: (1) to provide for fair and open

access, while (2) limiting risk to the DCO and its clearing members.

The provisions in Sec. 39.12(a)(1) provide for fair and open access in

a number of ways. A DCO is prohibited from adopting restrictive

clearing member standards if less restrictive requirements that would

not materially increase risk to the DCO or clearing members could be

adopted (Sec. 39.12(a)(1)(i)); a DCO must allow all market

participants who satisfy participation requirements to become clearing

members (Sec. 39.12(a)(1)(ii)); the standards must be non-

discriminatory (Sec. 39.12(a)(1)(iii)); and they may not require

clearing members to be swap dealers (Sec. 39.12(a)(1)(iv)), or

clearing members to maintain a swap portfolio of any particular size or

meet a swap transaction volume threshold (Sec. 39.12(a)(1)(v)).

Section 39.12(a)(2) facilitates greater participation by requiring

that capital requirements for clearing members be based on objective,

transparent, and commonly accepted standards that appropriately match

capital to risk (Sec. 39.12(a)(2)(i)); and by setting the minimum

capital requirement at not more than $50 million (Sec.

39.12(a)(2)(ii)).

A number of commenters supported the proposed rules. They asserted

that increased access to clearing would stimulate competition and

diversify risk. A number of other commenters opposed aspects of the

proposed rules, particularly the $50 million capital standard. They

argued that these provisions could increase risk by providing access to

firms with insufficient financial resources or operational capacity.

The Commission did not receive any comments that quantified the

costs associated with the proposed participation rules. Instead,

commenters focused on qualitative considerations, including how the

proposed rules would affect market participants, market risk,

efficiency, competitiveness, the financial integrity of futures

markets, and price discovery.

The Commission is adopting these provisions essentially as

proposed.

The Commission has evaluated the costs and benefits of the proposed

regulations in light of the specific considerations identified in

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

1. Protection of Market Participants and the Public

Costs

The participant eligibility rules may result in costs beyond those

incurred in the normal course of operating a DCO or clearing firm, but

such potential costs are, at this time, speculative in nature and

impossible to estimate or quantify. By providing access to clearing to

additional firms, the rules could impose costs on DCOs, other clearing

members, or customers if a firm admitted to clearing membership in a

DCO pursuant to these rules failed to meet its obligations. Any such

costs depend upon a number of factors that are not presently knowable,

quantifiable, or estimable.

It is not possible to estimate or quantify these costs in a

reliable way for a number of reasons. The historical record prior to

the enactment of the Dodd-Frank Act with respect to the operation of

clearing organizations provides little guidance as to the costs that

may be incurred in the future in the unlikely event of a default at a

DCO. Defaults at DCOs are very rare and the circumstances of each one

are unique. Moreover, the Dodd-Frank Act and implementing regulations

will alter the landscape significantly. Existing DCOs and FCMs will be

clearing new products. New DCOs and FCMs will enter the market.

Mandatory clearing will bring new products and participants to DCOs and

FCMs. The interaction of all these factors creates a wide range of

uncertainty as to the nature of the potential consequences of a default

under the new regulatory regime. In sum, the Commission believes that

the possible future circumstances leading to and potential resulting

consequences of a DCO default are too speculative and uncertain to be

able to quantify or estimate the resulting costs to DCOs, clearing

members, or market participants with any precision or degree of

magnitude.

Whatever these potential costs, the Commission believes that the

participant eligibility rules will reduce the risk that clearing

members will in fact incur such costs. First, increased access to

clearing membership should reduce concentration at any one clearing

member and diversify risk. Second, the rules contain risk management

provisions specifically designed to minimize the likelihood and extent

of defaults. The provisions in Sec. 39.12(a)(2) set forth requirements

that mandate DCOs: Require that all clearing members have sufficient

financial resources to meet obligations arising from participation in

the DCO (Sec. 39.12(a)(2)(i)); establish capital requirements that are

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

members (Sec. 39.12(a)(2)(ii)); require that clearing members have

adequate operational capacity to meet obligations arising from

participation in the DCO (Sec. 39.12(a)(3)); verify the compliance of

each clearing member with the requirements of the DCO (Sec.

39.12(a)(4)); satisfy certain reporting requirements (Sec.

39.12(a)(5)); and have the ability to enforce participation

requirements (Sec. 39.12(a)(6)).

For reasons similar to those described above, it is also not

feasible to quantify or estimate this reduction in costs with any

confidence. Based on its judgment and experience with the regulation

and operation of clearing organizations, the

[[Page 69416]]

Commission believes that these rules will lower the risk that clearing

members will in fact incur such costs. However, the possible future

circumstances leading to and potential resulting consequences of a

future default are too speculative and uncertain to quantify or

estimate, either under the current regulatory regime or under the rules

being adopted by the Commission.

Benefits

Greater access to clearing should benefit market participants by

increasing competition among clearing members. Allowing more firms to

clear should increase competition among clearing firms on both price

and service which should, in turn, reduce costs to market participants.

Further, the safeguards in Sec. 39.12(a)(2) will benefit DCOs,

clearing members, and market participants by reducing risk. Reductions

in risk also benefit the general public by decreasing the probability

of a systemic failure.

For the reasons described above in connection with costs, it is

also impractical to quantify or estimate these benefits associated with

reductions in risk to clearing members, market participants, and the

public.

2. Efficiency, Competitiveness, and Financial Integrity

Costs

The considerations under this factor are very similar to the

considerations under the previous factor with respect to participant

eligibility requirements. Quantification or estimation of these costs

and benefits is not feasible for the reasons set forth under the first

factor. The potential increase in risk of default resulting from open

access is mitigated by the decrease in risk resulting from

diversification of risk, increased competition, and the safeguards set

forth in Sec. 39.12(a)(2).

Benefits

By opening access the rules should increase competition among

clearing members thereby resulting in increased efficiency in the

provision of clearing services. The safeguards in the rules such as the

requirement that DCOs impose risk limits on clearing members will

enhance the financial integrity of the DCO and its clearing members.

3. Price Discovery

Costs

The Commission has not identified any way in which the rules will

impair price discovery.

Benefits

Increased competition among clearing members could bring more

participants into the markets which could result in more competitive

pricing and enhanced price discovery.

4. Sound Risk Management Practices

Costs

According to some commenters, the open access rules could hinder

sound risk management practices by admitting clearing members unable to

participate in the default management process. Other commenters assert

that the rules provide appropriate protections and will facilitate

sound risk management practices. The Commission believes that the open

access rules, when coupled with the default management rules discussed

below, will not impair sound risk management practices. Under the

rules, clearing members will be required to demonstrate that they have

operational capacity to carry out their responsibilities as well as

sufficient financial resources to meet their obligations.

Benefits

As explained above, the provisions in Sec. 39.12(a)(2) require

that DCOs establish a risk management framework with respect to their

members. In addition, open access should lead to diversification of

risk at DCOs and allow additional firms to assist in the resolution of

any defaults.

5. Other Public Interest Considerations

Costs

The Commission has not identified any other public interest

considerations that would be negatively affected by the potential costs

of the eligibility requirements.

Benefits

The CEA, as amended by the Dodd-Frank Act, requires DCOs to allow

for open access and, therefore, broader participation. The Commission

believes that greater participation in clearing could increase

liquidity in the markets. This could help prevent price manipulation or

other anti-competitive practices because it will be harder to organize

concerted efforts to achieve such ends. Finally, Congress has

determined that a DCO must comply with Core Principle C to achieve the

purposes of the CEA and the Commission has determined that Sec.

39.12(a) sets forth the minimum standards for a DCO to comply with the

CEA's participation requirements.

Product Eligibility

Core Principle C also requires a DCO to establish ``appropriate

standards for determining the eligibility of agreements, contracts, or

transactions submitted to the [DCO] for clearing.'' Section 39.12(b)

implements this provision.

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

requirements for determining product eligibility taking into account

the DCO's ability to manage risks associated with the product. Proposed

Sec. Sec. 39.12(b)(2) and (b)(3) would codify section 2(h)(1)(B) of

the CEA. Proposed Sec. 39.12(b)(4) would prohibit a DCO from requiring

an executing party to be a clearing member in order for the product to

be eligible for clearing. Proposed Sec. 39.12(b)(5) would require a

DCO to select contract units for clearing purposes that maximize

liquidity, facilitate transparency, promote open access, and allow for

effective risk management. Proposed Sec. 39.12(b)(6) would require

novation upon acceptance of a swap. Finally, proposed Sec. 39.12(b)(8)

would require a DCO to confirm the terms of a swap at the time the swap

is accepted for clearing.\266\

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\266\ Proposed Sec. 39.12(b)(7) will be addressed in a separate

rulemaking.

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The Commission did not receive any comments directly addressing

cost-benefit considerations. The Commission did receive several

comments on substantive provisions that bear on those considerations.

One commenter suggested that Sec. 39.12(b)(4) may be an impediment to

the development of new DCOs. Several commenters suggested that it would

be impractical or inappropriate for a DCO to establish unit sizes for

clearing that differ from the unit size at execution (Sec.

39.12(b)(5)).

The Commission also received several comments requesting

clarification of certain provisions. As discussed above, the Commission

has made changes to these rules that are responsive to the comments.

The Commission is adopting Sec. 39.12(b) largely as proposed with

several clarifying amendments as discussed above.

The Commission has evaluated the costs and benefits of Sec.

39.12(b) in light of the specific considerations identified in Section

15(a) of the CEA, as follows:

1. Protection of Market Participants and the Public

Costs

The Commission has not identified any new costs arising out of

Sec. Sec. 39.12(b)(1), 39.12(b)(6), or

[[Page 69417]]

39.12(b)(8). DCOs currently perform risk analysis before accepting new

products for clearing, currently novate trades upon acceptance, and

currently issue confirmations to clearing members.

As noted, one commenter suggested that prohibiting a DCO from

requiring one of the original executing parties to be a clearing member

in order for a contract to be eligible for clearing may be an

impediment to the development of new DCOs. The Commission believes

that, to the contrary, such restrictions on product eligibility for

clearing increase overall costs for market participants, and that

prohibiting such restrictions will lead to lower overall costs. Such

restrictions deny the availability and benefits of clearing to non-

clearing members. Open access will enable non-clearing members to

obtain the benefits of clearing and increase competition in clearing

and trading, thereby increasing liquidity, and reducing costs.

The commenters who questioned the unit size provision did not

elaborate on the costs. It is not feasible to quantify these costs for

a number of reasons. The rule provides DCOs with significant

flexibility in selecting unit sizes. Different DCOs may select

different sizes for the same or similar products. Numerous SEFs will

also be making judgments concerning unit size which will influence the

decisions of DCOs and traders. Some products will be subject to

mandatory clearing and others to voluntary clearing. The unpredictable

interaction of these variables creates a wide range of uncertainty as

to the nature of the consequences of the selection of unit sizes by

DCOs. Similar considerations apply to the other provisions of Sec.

39.12(b). In sum, the Commission believes that the possible future

circumstances leading to, and the potential resulting consequences of,

the implementation of Sec. 39.12(b) are too speculative and uncertain

to be able to quantify or estimate resulting costs with any precision

or degree of magnitude.

Benefits

The Commission believes that Sec. 39.12(b) will protect market

participants and the public in many ways. First, these provisions are

likely to facilitate the standardization of swaps, thereby eliminating

differences between the terms of a swap as cleared at the DCO level and

as carried at the customer level. Any such outstanding 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 still has a bilateral position opposite its counterparty. The

customer is still exposed to the credit risk of the counterparty and

the position would not be able to be offset against other positions at

the DCO. Similarly, from a systemic perspective, any differences in

terms between the trades would eliminate the possibility of

multilateral offset and thereby diminish liquidity.

Second, Sec. 39.12(b) can promote liquidity by permitting more

parties to trade the product and by permitting more clearing members to

clear the product. Third, it can enhance risk management by enabling a

DCO, in the event of a default, to have more potential counterparties

for liquidation.

Fourth, these provisions will 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 economically equivalent within the DCO and may

be offset with each other.

Fifth, clearing will eliminate the need for a counterparty to

ascertain the credit-worthiness of each of its counterparties. This

will promote liquidity, competition, and financial integrity to the

benefit of all market participants.

2. Efficiency, Competitiveness, and Financial Integrity

Costs

The Commission has not identified any ways in which the proposals

would reduce efficiency, competitiveness, or financial integrity.

Benefits

The rules should increase participation by clearing members, which

should increase competition among clearing members to provide services

to customers. In addition, the rules will lead to standardization of

products. Finally, the rules will allow for more clearing through

novation, which should result in increased open interest and liquidity.

In turn, this should lead to more competitive and efficient markets. As

noted above, smaller units can promote liquidity and encourage

prospective clearing members to bid on positions and enable them to

accept a forced allocation in the event of a clearing member's default.

This facilitates open access, and at same time promotes risk management

by enabling a DCO, in the event of a default, to be able to rely on

more potential counterparties for liquidation.

3. Price Discovery

Costs

The Commission has not identified any ways in which the rules would

reduce price discovery.

Benefits

As discussed above, the rules will increase competition, which

should enhance price discovery by bringing more participants into the

markets. In addition, standardization means that prices observed on

different trades are more directly comparable, which can improve price

discovery.

4. Sound Risk Management Practices

Costs

The Commission has not identified any ways in which the rules would

impair sound risk management practices.

Benefits

The rules require DCOs to establish appropriate standards for

determining the eligibility of contracts submitted to the DCO for

clearing taking into account the DCO's ability to manage risks

associated with the product. Such standards are a sound risk management

practice.

5. Other Public Interest Considerations

Costs

The Commission has not identified any ways in which the rules would

harm any other public interest considerations.

Benefits

As discussed above, open access, increased competition, greater

liquidity, improved price discovery, and greater financial integrity

are all benefits of the rules. All these factors will benefit the

general public, which may not participate in these markets directly but

may feel their impact on the larger economy.

G. Risk Management--Sec. 39.13

In General

Core Principle D,\267\ as amended by the Dodd-Frank Act, 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

[[Page 69418]]

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 non-defaulting clearing members would not be exposed to losses

that non-defaulting clearing members cannot anticipate or control.

Finally, Core Principle D provides that a DCO must require margin from

each clearing member 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.

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\267\ Section 5b(c)(2)(D) of the CEA; 7 U.S.C. 7a-1(c)(2)(D).

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

The Commission proposed Sec. 39.13 to establish requirements that

a DCO would have to meet in order to comply with Core Principle D. For

a number of provisions of proposed Sec. 39.13, the Commission did not

receive any comments on the associated costs or on cost-benefit

analysis. The Commission discussed in the notice of proposed rulemaking

and above why it believes a DCO must satisfy each of those provisions

to be in compliance with the Core Principle D and why it is appropriate

for market participants to incur any costs associated with implementing

each of those provisions. The Commission also addressed comments that

suggested alternative standards, frameworks, or procedures. Where

appropriate, the Commission revised the proposed rules. To avoid

repetition, the Commission incorporates by reference the above

discussion of Sec. 39.13.

Commenters raised concerns about the costs of Sec. Sec.

39.13(g)(2)(ii) (minimum liquidation time), 39.13(g)(2)(iii) (margin

confidence level), 39.13(g)(8)(i) (gross margin), 39.13(h)(1)(i) (risk

limits), 39.13(h)(2) (large trader reports), and 39.13(h)(5)(ii)

(clearing member risk review) or the Commission's cost-benefit analysis

relating to these rules. The Commission's consideration of the costs

and benefits associated with these rules is discussed in greater detail

below.

Minimum Liquidation Time

As proposed, Sec. 39.13(g)(2)(ii) would require a DCO to use a

liquidation time that is a minimum of five business days for cleared

swaps that are not executed on a DCM, and 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.

Numerous commenters objected to the proposed difference in

requirements that would subject swaps that were either executed

bilaterally or executed on a SEF to a minimum five-day liquidation

time, while permitting equivalent swaps that were executed on a DCM to

be subject to a minimum one-day liquidation time. The Commission did

not receive any comments that quantified the costs of this rule.

As to the actual periods proposed, commenters variously contended

that a liquidation time of five business days may be excessive for some

swaps, a one-day liquidation period is too short, a one-day liquidation

period is appropriate for swaps executed on a DCM or a SEF, and a two-

day liquidation period is appropriate for cleared swaps.

Some commenters encouraged the Commission to permit a DCO to

determine the appropriate liquidation time for all products that it

clears based on the unique characteristics and liquidity of each

relevant product or portfolio. Two commenters recommended that if the

Commission were to mandate minimum liquidation times in the final

rules, it should allow DCOs to apply for exemptions for specific groups

of swaps if market conditions prove that such minimum liquidation times

are excessive.

Upon consideration of the comments, the Commission is adopting

Sec. 39.13(g)(2)(ii) with a number of modifications. First, the final

rule requires a DCO to use the same liquidation time for a product

whether it is executed on a DCM, a SEF, or bilaterally. Second, the

final rule provides that the minimum liquidation time for swaps based

on certain physical commodities, i.e., agricultural commodities,

energy, and metals, as well as futures and options, is one day. For all

other swaps, the minimum liquidation time is five days. Third, to

provide further flexibility, the Commission is adding a provision

specifying that, by order, the Commission may provide for a different

minimum liquidation time for particular products or portfolios.

The Commission has evaluated the costs and benefits of the proposed

regulations in light of the specific considerations identified in

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

1. Protection of Market Participants and the Public

Costs

The Commission anticipates that using only one criterion--i.e., the

characteristic of the commodity underlying a swap--to determine

liquidation time could result in less-than-optimal margin calculations.

For some products, a five-day minimum may prove to be excessive and tie

up more funds than are strictly necessary for risk management purposes.

For other products, a one-day or even a five-day period may be

insufficient and expose a DCO and market participants to additional

risk.

The Commission believes that it is not feasible to estimate or

quantify these costs reliably. In addition to the liquidation time

frame, the margin requirements for a particular instrument depend upon

a variety of characteristics of the instrument and the markets in which

it is traded, including the risk characteristics of the instrument, its

historical price volatility, and liquidity in the relevant market.

Determining such margin requirements does not solely depend upon such

quantitative factors, but also requires expert judgment as to the

extent to which such characteristics and data may be an accurate

predictor of future market behavior with respect to such instruments,

and applying such judgment to the quantitative results. Thousands of

different swap products may be subject to clearing. Determining the

risk characteristics, price volatility, and market liquidity of even a

sample for purposes of determining a liquidation time specifically for

such instrument would be a formidable task for the Commission to

undertake and any results would be subject to a range of uncertainty.

Reliable data is not readily available for many swaps that prior to the

Dodd-Frank Act were executed in unregulated markets.

Given the amount of uncertainty in estimating margin requirements

using either a five-day liquidation time or a one-day liquidation time,

the amount of uncertainty in estimating the cost of using one rather

than the other is compounded. For all the reasons stated in the

previous paragraph, the possible range within which the size of the

difference would fall is very large. In sum, in the absence of a

reasonably feasible and reliable methodology at the present time for

the Commission to use in calculating the appropriate margin

requirements for swaps with either five-day or one-day liquidation

times,\268\ the

[[Page 69419]]

Commission believes that possible future circumstances surrounding

margin levels are too speculative and uncertain to be able to quantify

or estimate the resulting costs to DCOs, clearing members, or the

public from the rule with any precision or degree of magnitude.

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

\268\ The Commission notes that ``[t]he existence of significant

outstanding notional exposures, trading liquidity, and adequate

pricing data'' is one of the factors the Commission must consider in

reviewing whether a swap or group or class of swaps is subject to

the mandatory clearing requirement in CEA Section 2(h)(1). See

Section 2(h)(2)(D) of the CEA. To enable the Commission to make this

determination, the Commission requires DCOs that submit swaps to the

Commission for a mandatory clearing determination to submit data and

other information that would enable the Commission to effectively

consider this factor. See Sec. 39.5(b)(3)(ii)(A), 76 FR at 44473

(July 26, 2011) (Process for Review of Swaps for Mandatory Clearing;

final rule). Not only is this type of information needed for the

Commission to consider the statutory factors and make the

determinations as to which swaps should be subject to mandatory

clearing, but it also would be needed to calculate appropriate

margin amounts for such swaps, were the Commission to attempt such

calculations.

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

Moreover, any potential costs of this rule may be mitigated by the

provision that allows DCOs to request, or the Commission on its own

initiative to make, a determination that the liquidation time for a

particular contract is too long or too short. As markets evolve, it may

become appropriate to ease the requirement for certain swaps subject to

the five-day minimum. Conversely, analysis may reveal that for other

products or portfolios the five-day or one-day minimum is insufficient.

This procedure could serve to reduce costs that may arise from

application of the rule.

Benefits

A minimum liquidation time is a standard input in value-at-risk

models used by DCOs to compute a confidence interval to estimate their

risk. The value-at-risk confidence interval protects DCOs, their

clearing members, market participants, and the public by fixing the

probability that a default will occur and the position cannot be

liquidated in time.

The five-day/one-day distinction for different types of swaps is

based on the ease of liquidation of different product groups and is

consistent with existing requirements that reflect the risk assessments

DCOs have made over the course of their experience clearing these types

of swaps. Several DCOs have determined that these are the appropriate

standards for these instruments and apply it to their margin

requirements. The Commission believes that this is a reasonable and

prudent judgment.

A minimum standard is designed to prevent DCOs from competing by

offering lower margin requirements than other DCOs and, as a result,

taking on more risk than is prudent. In addition, the Commission is

concerned that a DCO may misjudge the appropriate liquidation time

frame because of limited experience with clearing and managing the

risks of financial swaps. A minimum liquidation time frame should

prevent DCOs from taking on too much risk.

While it is not possible to estimate or quantify the benefits to

market participants and the public in facilitating the financial

soundness of DCOs, the Commission believes that a DCO failure,

regardless of the size of the DCO, could adversely affect the financial

markets, market participants, and the public. This rule will diminish

the chances that such a failure will occur.

2. Efficiency, Competitiveness, and Financial Integrity

Costs

The considerations under this factor are similar to the

considerations under the first factor.

Benefits

The rule will promote efficiency, competitiveness and financial

integrity by establishing a minimum standard for all DCOs. While a DCO

will still have considerable latitude in setting risk-based margin

levels, the Commission has determined that establishing a minimum

liquidation time will provide legal certainty for an evolving

marketplace, will offer a practical means for assuring that the

thousands of different swaps that are going to be cleared subject to

the Commission's oversight will have prudent minimum margin

requirements, and will help prevent a potential ``race to the bottom''

by competing DCOs. Competition among DCOs will be channeled to other

areas such as level of service.

The Commission believes that default by a clearing member could

have a significant, adverse effect on market participants or the

public. Market participants may have to incur the costs of making up

any shortfall in margin through guaranty fund deposits and/or

assessments, and any costs associated with participation in an auction

or allocation of the positions of a defaulting clearing member. In a

worst case scenario, a default by a clearing member may undermine the

financial integrity of the DCO, which could have serious and widespread

consequences for the U.S. financial markets. This rule protects market

participants and the public from bearing these costs by requiring a DCO

to follow certain minimum standards in establishing margin

requirements.

3. Price Discovery

The Commission does not believe that this rule will have a material

effect on price discovery.

4. Sound Risk Management Practices

Costs

Because the rule simply establishes minimums, it will not hinder

the exercise of sound risk management practices. The rule specifically

requires DCOs to use longer liquidation times if appropriate for

particular products.

Benefits

As discussed under the first two factors, the rule will foster

sound risk management practices.

5. Other Public Interest Considerations

The Commission has not identified any costs or benefits beyond

those discussed under the first factor.

Margin Confidence Level

As proposed, Sec. 39.13(g)(2)(iii) would require a DCO's initial

margin models to meet an established confidence level of at least 99%

based on data from an appropriate historical period.

A number of commenters stated that each DCO should have discretion

to establish confidence levels based on the particular characteristics

of the products and portfolios it clears and their underlying markets.

However, a number of other commenters stated that a 99% confidence

level was the proper minimum.

The Commission is adopting the rule as proposed.

The Commission has evaluated the costs and benefits of the proposed

regulation in light of the specific considerations identified in

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

1. Protection of Market Participants and the Public

Costs

A 99% confidence level will require that more money be held as

margin as compared to a lower confidence level. There is an opportunity

cost to clearing members holding this money as margin.

The Commission believes that it is not feasible to estimate or

quantify this cost reliably. In addition to the confidence level, the

margin requirements for a particular instrument depend upon a variety

of characteristics of the instrument and the markets in which it is

traded, including the risk characteristics of the instrument, its

historical price volatility, and liquidity in the relevant market.

Determining such margin requirements does not solely depend upon such

quantitative

[[Page 69420]]

factors, but also requires expert judgment as to the extent to which

such characteristics and data may be an accurate predictor of future

market behavior with respect to such instruments, and applying such

judgment to the quantitative results. Thousands of different swap

products may be subject to clearing. Determining the risk

characteristics, price volatility, and market liquidity of even a

sample for purposes of determining a confidence level specifically for

such instrument would be a formidable task for the Commission to

undertake and any results would be subject to a range of uncertainty.

Reliable data is not readily available for many swaps that prior to the

Dodd-Frank Act were executed in unregulated markets. In sum, in the

absence of a reasonably feasible and reliable methodology at the

present time for the Commission to use in calculating the margin

requirements for swaps,\269\ the Commission believes that possible

future circumstances surrounding margin levels are too speculative and

uncertain to be able to quantify or estimate the resulting costs to

DCOs, clearing members, or the public from the rule with any precision

or degree of magnitude.

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\269\ Id.

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Benefits

A minimum confidence level is essential to protect market

participants and the public. A minimum confidence level will prevent

DCOs from competing with respect to how much risk they are willing to

take on or from misjudging the amount of risk they would take on if

they operated under lower standards. In addition, it will provide

assurance to market participants that every DCO has sufficient margin

to effectively manage a default.

Some DCOs currently apply the 99 percent standard. Others use 95-99

percent for some contracts depending on facts and circumstances.

International standards currently recommend 99 percent.\270\ In view of

the increased risk that DCOs will face as a result of clearing swaps,

the Commission believes that protection of market participants and the

public dictates that the minimum standard on this key risk management

element should be set in accordance with current best practices among

DCOs and international standards.

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\270\ See CPSS-IOSCO Consultative Report, Principle 6: Margin,

Key Consideration 3, at 40; EMIR, Article 39, paragraph 1, at 46.

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

2. Efficiency, Competitiveness, and Financial Integrity

Costs

The considerations under this factor are very similar to the

considerations under the first factor.

Benefits

The rule will promote efficiency, competitiveness and financial

integrity by establishing a minimum standard for all DCOs. While a DCO

will still have considerable latitude in setting risk-based margin

levels, the Commission has determined that establishing a minimum

confidence level will provide legal certainty for an evolving

marketplace, will offer a practical means for assuring that the

thousands of different swaps that are going to be cleared subject to

the Commission's oversight will have prudent minimum margin

requirements, and will prevent a potential ``race to the bottom'' by

competing DCOs. As noted above, the Commission is adopting a 99%

standard in order to conform to current best practices among DCOs as

well as international standards. Competition among DCOs will be

channeled to other areas such as level of service.

The Commission believes that default by a clearing member could

have a significant, adverse effect on market participants and the

public. Market participants may have to incur the costs of making up

any shortfall in margin through guaranty fund deposits and/or

assessments, and any costs associated with participation in an auction

or allocation of the positions of a defaulting clearing member. In a

worst case scenario, a default by a clearing member may undermine the

financial integrity of the DCO, which could have significant negative

consequences for the financial stability of U.S. financial markets. As

highlighted by recent events in the global financial markets, the

ability to manage the risks associated with clearing is critical to the

goal of stability in the broader financial markets. This rule protects

market participants and the public from bearing these costs by

requiring a DCO to follow certain minimum standards in establishing

margin requirements.

3. Price Discovery

The Commission does not believe that this rule will have a material

effect on price discovery.

4. Sound Risk Management Practices

Costs

Because the rule simply establishes minimums, it will not hinder

the exercise of sound risk management practices. The rule specifically

requires DCOs to use higher confidence levels if appropriate for

particular products.

Benefits

As discussed under the first two factors, the rule will foster

sound risk management practices.

5. Other Public Interest Considerations

The Commission does not believe that the rule will have a material

effect on public interest considerations other than those identified

above.

Gross Margin

As proposed, Sec. 39.13(g)(8)(i) would require a DCO to collect

initial margin on a gross basis for customer accounts.

Two commenters supported the proposal. Several commenters stated

that the provision of individual customer position information to DCOs

may entail significant, costly, and time-consuming changes to systems

infrastructure at the clearing member level and the DCO level.

In light of the various concerns regarding the operational and

technology changes that would be needed and related costs of requiring

a DCO to obtain individual customer position information from its

clearing members and to use such information to calculate the margin

requirements for each individual customer, the Commission is modifying

Sec. 39.13(g)(8)(i). As amended, the rule provides a DCO with the

discretion to either calculate customer gross margin requirements based

on individual customer position information that it obtains from its

clearing members or based on the sum of the gross positions of all of a

clearing member's customers that the clearing member provides to the

DCO, without forwarding individual customer position information to the

DCO.

The Commission has evaluated the costs and benefits of the proposed

regulation in light of the specific considerations identified in

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

1. Protection of Market Participants and the Public

Costs

Three kinds of costs could result from a change from net to gross

margining, for those DCOs that currently use net margining.\271\ First,

gross margining could change the loss that customers of a clearing

member may face in the event

[[Page 69421]]

of default by a fellow customer of that clearing member. Under net

margining, a greater portion of customer margin is held at the clearing

member and thereby insulated from the DCO, so that non-defaulting

customers face lower risk of losing their margin deposits to the DCO if

a fellow customer defaults. Gross margining gives a DCO access to the

margin deposits of non-defaulting customers of a defaulting FCM.\272\

In this sense, gross margining could shift a portion of the default

risk from the DCO to fellow customers.\273\

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\271\ As discussed in section IV.D.6.h.(1), above, certain DCOs

already use a version of gross margining, in which case the costs of

complying with Sec. 39.13(g)(8)(i) would be considerably less.

\272\ Offsetting this effect is the potential for a failing FCM

to misappropriate customer funds. That potential is greater under

net margining.

\273\ The Commission has proposed rules that would not permit

this in the case of swaps. See 76 FR 33818 (June 9, 2011)

(Protection of Cleared Swaps Customer Contracts and Collateral;

Conforming Amendments to the Commodity Broker Bankruptcy

Provisions).

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It is not possible to estimate or quantify these costs--which would

only arise in the event of a default of a customer--in a reliable way

for a number of reasons. The historical record prior to the enactment

of the Dodd-Frank Act with respect to the operation of clearing

organizations provides little guidance as to the costs that may be

incurred in the future in the unlikely event of a default at a DCO.

Defaults at DCOs are very rare and the circumstances of each one are

unique. Moreover, the Dodd-Frank Act and implementing regulations will

alter the landscape significantly. Existing DCOs and FCMs will be

clearing new products. New DCOs and FCMs will enter the market.

Mandatory clearing will bring new products and participants to DCOs and

FCMs. The interaction of all these factors creates a wide range of

uncertainty as to the nature of the potential consequences of a default

under the new regulatory regime. In sum, the Commission believes that

the possible future circumstances leading to and potential resulting

consequences of a future default are too speculative and uncertain to

be able to quantify or estimate the resulting costs to clearing members

with any precision or degree of magnitude.

Second, because gross margining means that more customer margin is

held at the DCO, rather than the FCM, gross margining also means that

any return on this margin (e.g., interest earned) is earned by the DCO,

rather than the FCM. This is largely a transfer between those parties.

If there is no offsetting change in other terms of the relationship

between customers, FCMs and DCOs, gross margining leads to a cost for

FCMs and a benefit to DCOs from this change.

Third, gross margining could result in changes in operating costs

for DCOs and clearing members. Gross margining could require the DCO to

possess more detailed information about customer positions. The

provision of individual customer position information to DCOs may

entail significant, costly, and time-consuming changes to systems

infrastructure at the clearing firm level and the DCO level. For

example, NYPC stated that its preliminary cost estimate for compliance

with the customer gross margin and large trader report requirements

contained in proposed Sec. Sec. 39.13(g)(8)(i) and 39.13(h)(2) was

approximately 128,650 hours and $14.5 million.

In order to reduce the potential costs, the Commission has revised

Sec. 39.13(g)(8)(i) to allow a DCO to permit an FCM to provide the DCO

with the sum of the gross positions of all of its customers so that the

DCO may calculate the applicable gross margin requirement based on that

sum. Under this scenario, a DCO will not have to establish a framework

to receive each customer's position information and calculate the

initial margin requirement applicable to each customer's positions. The

Commission believes this alternative framework will be significantly

less expensive for market participants. Whether a DCO chooses to make

the calculation based on individual customer position information or

the sum of customers' gross positions submitted by the clearing member,

the clearing member's customer gross margin requirement will be the

same.

NYPC also commented that such implementation costs could

significantly deter new clearinghouses like NYPC from launching.

However, NYPC did not provide an estimate for the costs of a new

clearinghouse system capable of gross margining in relation to the cost

of retrofitting an existing net margin system. The Commission believes

that retrofitting an existing system may be more expensive than

implementing a new system from scratch, and that it is unclear whether

additional implementation costs would deter any new clearinghouses.

Benefits

The Commission believes that the clearing of swaps will increase

the risk that DCOs face. Gross margining will increase the amount of

money that DCOs hold. Under gross margining, the amount of margin at

the DCO more accurately approximates the risks posed to a DCO by its

clearing members' customers than net margining and increases the

financial resources available to a DCO in the event of a customer

default.

A DCO may not be able to collect initial customer margin from an

FCM if the FCM defaults. This could have a serious adverse impact on

the financial stability of a DCO, non-defaulting customers, and

potentially wider markets. In this regard, a significant customer

default leading to an FCM default could strain a DCO's financial

resources, causing it to exhaust the initial margin available to cover

the default and forcing other clearing members and/or the DCO to incur

related costs. In the worst case, an FCM default resulting from a large

customer default could cause a DCO to fail if its financial resources

are inadequate to cover the losses it incurs as a result of the

default. Gross margining provides the DCO with a larger financial

cushion that can be tapped in the event of a default. Initial margin is

the DCO's first ``line of defense'' in managing a default, and a larger

initial margin held at the DCO will help compensate for the DCO's

inability to collect additional margin from a defaulting clearing

member. This rule protects market participants and the public from

bearing these costs by requiring a DCO to hold additional margin.

2. Efficiency, Competitiveness, and Financial Integrity

Costs

The considerations under this factor are very similar to the

considerations under the first factor.

Benefits

The rule promotes efficiency, competitiveness, and financial

integrity by providing that the amount of margin at the DCO more

accurately approximates the risks posed to a DCO by its clearing

members' customers and by increasing the financial resources available

to a DCO in the event of a customer default.

3. Price Discovery

The Commission does not believe that this rule will have a material

effect on price discovery.

4. Sound Risk Management Practices

The considerations relating to sound risk management practices are

very similar to the considerations under the first factor.

5. Other Public Interest Considerations

The Commission does not believe that the rule will have a material

effect on

[[Page 69422]]

public interest considerations other than those identified above.

Risk Limits

As 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.

Several commenters supported the rule as an appropriate risk

management procedure. Two commenters suggested that the rule is overly

prescriptive. The Commission did not receive any comments that

quantified the costs of this rule.

The Commission is adopting Sec. 39.13(h)(i) as proposed.

The Commission has evaluated the costs and benefits of the proposed

regulation in light of the specific considerations identified in

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

1. Protection of Market Participants and the Public

Costs

Some DCOs already set limits and will not incur any costs. Others

will incur the costs of calculating limits for each clearing member.

Such costs will be incremental because all DCOs currently have

procedures for monitoring clearing member risk and may already have

informal triggers or alerts in place. For clearing members, the rule

would impose opportunity costs to the extent the limits constrain their

activities.

Under the rule each DCO would have discretion to set limits for

each clearing member. It would be pure conjecture for the Commission to

estimate what levels DCOs would set for their clearing members and how

much that would constrain such clearing members. Each DCO would rely on

the informed judgment of its risk management committee and/or risk

management staff to assess the risks and resources of each clearing

member and arrive at the applicable limits for each one. Estimating the

extent to which this would constrain clearing members is even more

speculative. That would entail a guess as to the risk appetite of each

clearing member. In sum, the Commission believes that possible future

circumstances surrounding risk limits are too speculative and uncertain

to be able to quantify or estimate the resulting costs to DCOs,

clearing members, or the public with any precision or degree of

magnitude.

Benefits

The rule will benefit market participants by reducing the ability

of clearing members and their customers to assume excessive risks. This

will diminish the chances of default with all the attendant

consequences previously discussed.

2. Efficiency, Competitiveness, and Financial Integrity

Costs

The considerations under this factor are very similar to the

considerations under the first factor.

Benefits

Because the rule provides DCOs the discretion to tailor the limits

for each clearing member in accordance with the DCO's assessment of the

risk that the clearing member poses, it will foster efficiency and

competitiveness in the markets. Because it will decrease the chance of

default it will foster financial integrity.

The Commission believes that default by a clearing member could

have a significant, adverse effect on market participants or the

public. Market participants may have to incur the costs of making up

any shortfall in margin through guaranty fund deposits and/or

assessments, and any costs associated with participation in an auction

or allocation of the positions of a defaulting clearing member. In a

worst case scenario, a default by a clearing member may undermine the

financial integrity of the DCO, which could have serious and widespread

consequences for the stability of U.S. financial markets. This rule

protects market participants and the public from bearing these costs by

requiring a DCO to analyze the risk posed by each clearing member and

impose appropriate limits.

3. Price Discovery

The Commission does not believe that this rule will have a material

effect on price discovery.

4. Sound Risk Management Practices

Costs

The considerations under this factor are very similar to the

considerations under the first factor.

Benefits

Risk limits are a sound risk management practice currently employed

by several DCOs. The rule will extend the practice across all DCOs.

5. Other Public Interest Considerations

The Commission does not believe that the rule will have a material

effect on public interest considerations other than those identified

above.

Large Trader Reports

As proposed, Sec. 39.13(h)(2) would require a DCO to obtain from

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

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

Commission's regulations, i.e., large trader reports. Proposed Sec.

39.13(h)(2) would further require a DCO to review the large trader

reports that it receives from its clearing members on a daily basis to

ascertain the risk of the overall portfolio of each large trader.

One commenter supported the proposal. One commenter argued that the

proposed requirement that DCOs obtain large trader reports from

clearing members is duplicative because a DCO receives large trader

information from the exchange. One commenter stated that a DCO would

need new technology to implement the rule. One commenter stated that a

DCO would need additional surveillance staff.

The Commission is modifying Sec. 39.13(h)(2) to require a DCO to

obtain large trader reports either from its clearing members or from a

DCM or a SEF for which it clears.

The Commission has evaluated the costs and benefits of the proposed

regulations in light of the specific considerations identified in

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

1. Protection of Market Participants and the Public

Costs

The Commission notes that some DCOs already receive large trader

reports from DCMs and review large trader reports for risk surveillance

purposes on a daily basis. For them, this rule imposes no additional

cost. For other DCOs, the receipt and analysis of large trader

information may entail significant, costly, and time-consuming changes

to systems infrastructure. Clearing members could also incur costs to

provide large trader reports to DCOs. For example, NYPC stated that its

preliminary cost estimate for compliance with the customer gross margin

and large trader report requirements contained in proposed Sec. Sec.

39.13(g)(8)(i) and 39.13(h)(2) was approximately 128,650 hours and

$14.5 million.

In order to reduce costs, the Commission modified Sec. 39.13(h)(2)

to permit a DCO to obtain large trader reports either from its clearing

members or from a DCM or a SEF for which it clears. The latter approach

would

[[Page 69423]]

eliminate duplicative reporting for clearing members and would

significantly reduce costs for DCOs by enabling them to obtain the data

from a single source.

Benefits

Currently, at some DCOs, the receipt and analysis of large trader

reports is an integral part of their risk management programs.

Extension of this practice to all DCOs would benefit market

participants and the public. Proactive analysis of this information

allows DCOs to identify and to address incipient problems in customer

accounts before they get out of hand. In particular, large trader

reports are an essential part of a rigorous risk management system

because they provide information that is required for stress testing.

A default by a clearing member could have a significant, adverse

effect on market participants or the public. Market participants may

have to incur the costs of making up any shortfall in margin through

guaranty fund deposits and/or assessments, and any costs associated

with participation in an auction or allocation of the positions of a

defaulting clearing member. In a worst case scenario, a default by a

clearing member may undermine the financial integrity of the DCO, which

could have serious and widespread consequences for the stability of

U.S. financial markets. This rule protects market participants and the

public by requiring a DCO to analyze the potential risks at an earlier

stage.

2. Efficiency, Competitiveness, and Financial Integrity

The considerations under this factor are very similar to the

considerations under the first factor.

3. Price Discovery

The Commission does not believe that this rule will have a material

effect on price discovery.

4. Sound Risk Management Practices

The considerations under this factor are very similar to the

considerations under the first factor.

5. Other Public Interest Considerations

The Commission does not believe that the rule will have a material

effect on public interest considerations other than those identified

above.

Clearing Member Risk Review

As proposed, Sec. 39.13(h)(5)(ii) would require each DCO to review

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

clearing members on a periodic basis.

Several commenters asserted that the review would be burdensome for

such clearing members. The Commission did not receive any comments that

quantified the costs of this rule.

The Commission is adopting the rule with two modifications. These

changes clarify that a DCO's review need only cover those procedures of

a clearing member which address the risks that such clearing member may

pose to the DCO.

The Commission has evaluated the costs and benefits of Sec.

39.13(h)(5)(ii) in light of the specific considerations identified in

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

1. Protection of Market Participants and the Public

Costs

Those DCOs that currently conduct risk reviews of their clearing

members are not likely to incur any additional costs as a result of the

rule.\274\ Those DCOs that do not currently have such a program will

incur costs to build on existing procedures for reviewing applicants

for clearing membership in order to develop programs for ongoing review

of clearing members. Clearing members will incur costs in working with

the DCOs that review them. Commission staff intends to work with the

DCOs to develop arrangements designed to avoid duplicative efforts

without compromising the requirement that each DCO maintain an

understanding of the risks of each of its clearing members.

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

\274\ To the extent that some DCOs would conduct risk reviews in

the absence of a rule, the incremental benefits of the rule are

reduced. Even for these DCOs, however, a rule provides the market

with the benefit of greater certainty that risk reviews of members

will be continued in the future.

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

In recognition that each DCO has a unique product mix and set of

rules, the rule does not prescribe the specific frequency, depth, or

methodology of such reviews, nor does it specify when an on-site audit

may or may not be appropriate. Nevertheless, based on the Commission's

experience overseeing DCOs that currently conduct risk reviews of

clearing members, the Commission estimates the approximate costs of

this rule as follows.\275\

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

\275\ Figures used in the estimate are based on the judgment of

Commission staff with experience overseeing DCO reviews of clearing

member risk.

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

The Commission estimates that a risk review by a large DCO

typically would require on the order of 100 person-hours of work by a

supervisor and several risk analysts. This includes preparation, an on-

site visit, and drafting the report. The Commission also estimates that

a large DCO would perform, on average, 40 risk reviews a year, although

the number would vary depending on the number of clearing members a

particular DCO has, and other circumstances. The Commission estimates

compensation costs on the order of $150 an hour for risk analysts, and

$250 an hour for a supervisor. Based on these estimates, the Commission

estimates that the annual cost to a large DCO would be roughly on the

order of $700,000.\276\ Costs for particular DCOs are likely to vary

from this amount based on the size of the DCO, the DCO's management and

compensation practices, and the DCO's exercise of the flexibility

allowed by the rule provision. In light of the potential consequences

of risk management failures by clearing members discussed below, and of

the Commission's judgment that DCOs are the market participants in the

best position to review clearing member risk management programs, the

Commission believes that the benefits of this provision would justify

the costs even if costs proved to be substantially larger than the

Commission's estimate.

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

\276\ For example, 20 hours supervisor time per review x $250/hr

plus 80 hours analyst time per review x $150/hr = $17,000 x 40

reviews = $680,000.

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

Benefits

Rigorous risk management programs at clearing members benefit

market participants by providing safeguards to prevent default.

Clearing members are at the front line of risk management. The

Commission believes that risk reviews are important to ensure that each

clearing member's risk management framework is sufficient and properly

implemented. The Commission believes that a clearing member's DCO

should undertake the review because that DCO is in the best position to

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

clearing members in the context of the clearing members' obligations

under the DCO's rules.

2. Efficiency, Competitiveness, and Financial Integrity

Costs

The considerations under this factor are very similar to the

considerations under the first factor.

Benefits

Ensuring that each clearing member has proper risk management

procedures for each DCO at which it clears will promote efficiency and

competitiveness in the clearing process by ensuring that the clearing

member is in compliance

[[Page 69424]]

with each such DCO's rules and encouraging the exercise of best

practices. The rule will foster financial integrity for the reasons set

forth under the first factor.

The Commission believes that default by a clearing member could

have a significant, adverse effect on market participants and the

public. Market participants may have to incur the costs of making up

any shortfall in margin through guaranty fund deposits and/or

assessments, and any costs associated with participation in an auction

or allocation of the positions of a defaulting clearing member. In a

worst case scenario, a default by an FCM may undermine the financial

integrity of the DCO, which could have serious and widespread

consequences for the stability of U.S. financial markets. This rule

protects market participants and the public from bearing these costs by

requiring a DCO to periodically review the risk management procedures

of each of its clearing members.

3. Price Discovery

The Commission does not believe that this rule will have a material

effect on price discovery.

4. Sound Risk Management Practices

The considerations under this factor are similar to the

considerations under the first factor.

5. Other Public Interest Considerations

The Commission does not believe that the rule will have a material

effect on public interest considerations other than those identified

above.

H. Settlement Procedures--Sec. 39.14(c)(3)

Section 5b(c)(2)(E) of the CEA, Core Principle E, as amended by the

Dodd-Frank Act, requires a DCO to: (1) complete money settlements on a

timely basis, but not less frequently than once each business day; (2)

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); (3) ensure that

money settlements are final when effected; (4) maintain an accurate

record of the flow of funds associated with money settlements; (5)

possess the ability to comply with the terms and conditions of any

permitted netting or offset arrangement with another clearing

organization; (6) establish rules that clearly state each obligation of

the DCO with respect to physical deliveries; and (7) ensure that it

identifies and manages each risk arising from any of its obligations

with respect to physical deliveries.

The Commission proposed Sec. 39.14 to implement Core Principle E.

With the exception of proposed Sec. 39.14(c), the commenters did not

address the costs of the proposed rule or the Commission's

consideration of costs and benefits.

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 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.'' It would further require that a DCO (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

reasonably necessary in order to eliminate or strictly limit such

exposures.

As discussed above, several commenters expressed concern that these

provisions would impose costly requirements that are unnecessary or

could have unintended adverse consequences. In this regard, one

commenter claimed that the requirement to monitor clearing members'

exposure to their settlement banks could result in a duplication of

effort that would be burdensome for a DCO. Commenters also stated that

there are a limited number of banks that are qualified and willing to

serve as settlement banks; as such, it may be difficult for smaller

DCOs to maintain more than one settlement bank given the associated

costs. Further, commenters stated that imposing concentration limits

could increase systemic risk because a DCO would need to distribute

funds across multiple banks and as settlement funds increased, highly

rated banks would eventually reach the applicable concentration limit,

potentially forcing DCOs to open accounts with lower rated banks.

None of the commenters provided quantitative data or information to

support their assertions as to the potential costs and burdens of

compliance with Sec. 39.14(c)(3), and none addressed the benefits of

the rule.

As discussed above, the Commission believes that there are risks

associated with a DCO concentrating all its funds in a single

settlement bank. Bank failure in such a circumstance could have adverse

consequences for the DCO, its clearing members, and their customers.

However, the Commission also acknowledges the concerns expressed by

commenters, particularly given the settlement practices and procedures

that DCOs currently maintain in the absence of such a regulation.

Accordingly, the Commission is modifying Sec. 39.14(c)(3) to

eliminate any implied requirement that all DCOs must maintain

settlement accounts at more than one bank, and is retaining the

requirement that a DCO monitor exposure to its settlement bank(s) and

those of its clearing members, including an ongoing assessment of the

effect to the DCO of a failure of the settlement bank that has the

largest share of settlement activity. It is also clarifying its intent

to qualify the need to take actions set forth in Sec. 39.14(c)(3)(i)-

(iv) (such as imposing concentration limits) ``to the extent that any

such action or actions are reasonably necessary in order to eliminate

or strictly limit such exposures.'' Thus, the Commission is providing

DCOs with more flexibility than would have been provided under the

proposed rule which, in turn, should reduce the costs associated with

compliance.

The Commission has evaluated the costs and benefits of Sec.

39.14(c)(3) in light of the specific considerations identified in

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

1. Protection of Market Participants and the Public

Costs

A DCO's monitoring of its exposure to its settlement bank(s) and

those of its clearing members is a sound business practice in which a

DCO should be engaged notwithstanding the rule. Nevertheless, the

Commission believes the rule will require commitment of DCO staff

resources, the costs of which could be passed along to clearing members

and market participants as part of the DCO's clearing fees. Such costs

could vary significantly across DCOs given differences in operational

and risk management procedures, settlement arrangements, and fee

pricing practices. Given these circumstances, the Commission is unable

to quantify the costs attributable to the Commission's rule, and no

commenter provided an estimate. As a general matter, however, the

Commission is mindful that the measures set forth in Sec.

39.14(c)(3)(i)-(iv), specifically the requirement that DCOs take

actions that are ``reasonably necessary in order to eliminate or

strictly limit'' exposure to settlement banks, could cause DCOs to

incur costs. Such costs could include, for example, the costs of

establishing an account at an additional settlement bank, which would

entail evaluating the bank to ensure that it meets the DCO's

[[Page 69425]]

criteria for a settlement bank, reviewing account agreements, and

establishing connectivity to the bank. There may also be fees charged

by a bank for standby services if the bank is not used as the primary

settlement bank, or there may be other account-related fees. The

Commission is unable to ascertain the specific amount of any such costs

for DCOs because of the varying nature of settlement bank arrangements

across DCOs.

Benefits

Use of multiple settlement banks by DCOs, as well as imposition of

concentration limits and other safeguards provided for in Sec.

39.14(c)(3)(i)-(iv), when reasonably necessary, could help insulate the

DCO and its members from the risk of default by a settlement bank. This

in turn could provide market participants and the public with greater

protection from disruption of markets, as well as the clearing and

settlement system.

Affording a DCO flexibility in managing its settlement bank

arrangements and, to a lesser degree, those of its clearing members,

benefits market participants and the public by reducing the costs and

potential inefficiencies associated with maintaining settlement

arrangements with multiple settlement banks when that might not yield a

concomitant benefit in the form of risk reduction. The rule sets forth

general standards while permitting each DCO to tailor its settlement

bank arrangements to its unique circumstances and risk tolerances.

2. Efficiency, Competitiveness, and Financial Integrity

Costs

Quantification or estimation of costs to efficiency,

competitiveness, and financial integrity of markets are not readily

ascertainable, and no commenter provided an estimate.

Benefits

The rule permits DCOs to obtain settlement services from a single

bank if the size and needs of the DCO, as well as the availability of

suitable settlement bank services, makes the use of more than one

settlement bank cost-prohibitive and it is not reasonably necessary to

have more than one settlement bank in order to eliminate or strictly

limit the DCO's exposures. More efficient use of DCO resources can

result in enhanced efficiency and financial integrity of the markets

for which the DCO clears. Particularly for smaller DCOs, it may not be

practical to obtain settlement services from more than one settlement

bank because of the costs of evaluating a bank's suitability to perform

settlement functions, reviewing account agreements, and establishing

connectivity to the bank. There also may be account-related fees

charged by a bank, including fees for standby services, if the bank is

used as a back-up settlement bank and not the primary settlement bank.

3. Price Discovery

The Commission has not identified any ways in which Sec.

39.14(c)(3) could affect price discovery.

4. Sound Risk Management Practices

Costs

The Commission has not identified any ways in which Sec.

39.14(c)(3) could impair sound risk management practices.

Benefits

The Commission regards an effective settlement framework as a sound

risk management practice because it reduces the risks associated with a

bank's potential failure to make timely settlement. The requirements

that a DCO monitor risk exposures to settlement banks and address

diversification concerns, as reasonably necessary, are important

adjuncts to a DCO's overall risk management practices.

5. Other Public Interest Considerations.

The Commission has not identified any other costs or benefits that

should be taken into account.

I. Treatment of Funds--Sec. 39.15

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

to: (i) Establish standards and procedures that are designed to protect

and ensure the safety of its clearing members' funds and assets; (ii)

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 (iii)

only invest such funds and assets in instruments with minimal credit,

market, and liquidity risks.\277\

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

\277\ Section 5b(c)(2)(F) of the CEA; 7 U.S.C. 7a-1(c)(2)(F)

(Core Principle F).

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

Proposed Sec. 39.15 would establish minimum standards for DCO

compliance with Core Principle F. Among other things, it would set

forth standards for the types of assets that could be accepted as

initial margin. In this regard, 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 risk. It would further

specify that a DCO may not accept letters of credit as initial margin.

The Commission received comments on substantive aspects of the

proposed rules, and it has addressed those comments above. The

Commission also received several comments on potential costs associated

with the proposed Sec. 39.15(c)(1) prohibition on the acceptance of

letters of credit as initial margin.\278\ CME asserted that the

prohibition is unnecessary because letters of credit provide an

absolute assurance of payment and, therefore, the issuing bank must

honor the demand even in circumstances where the beneficiary is unable

to reimburse the bank for its payment. Other commenters suggested that

letters of credit should be acceptable if they are subject to

appropriate conditions. Finally, several commenters warned of the

potential risks associated with prohibiting letters of credit,

including higher costs for clearing members and their customers, the

potential placement of U.S. DCOs at a disadvantage as compared to

foreign clearing houses, and increased systemic risk as a result of

decreased voluntary clearing.

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\278\ The Commission notes that proposed 39.15(c)(1) regarding

types of assets that can be accepted as initial margin has been

redesignated as Sec. 39.13(g)(10) under the risk management rules.

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

Taking into account both the strong track record of letters of

credit in connection with cleared futures and options on futures and

the potentially greater risks of cleared swaps, the Commission has

determined to modify the rule to permit letters of credit in connection

with cleared futures and options on futures but to retain the

prohibition on letters of credit as initial margin for swaps. Certain

DCOs have accepted letters of credit as initial margin for futures and

options on futures for a number of years without incident and continue

to do so. On the other hand, letters of credit are only a promise by a

bank to pay, not an asset that can be sold. The Commission is concerned

that the potential losses that swap market participants could incur may

be of a greater magnitude than potential losses with respect to futures

and options. Initial margin is the first financial resource that a DCO

will apply in the event of a clearing member default. If a DCO were to

need to draw on a letter of credit posted by a clearing member whose

customers had suffered such losses, the larger the amount that it would

need to draw, the greater the risk that the issuing bank may be unable

to pay under the terms of the letter of credit. Accordingly, the

Commission is modifying the proposal as described.

[[Page 69426]]

The Commission has evaluated the costs and benefits of Sec.

39.13(g)(10) in light of the specific considerations identified in

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

1. Protection of Market Participants and the Public

Costs

The prohibition on accepting letters of credit as initial margin

for swaps may impose higher costs for clearing members because they

will have to deposit cash or other assets that have minimal credit,

market, and liquidity risk for those products. This could increase

costs for market participants and decrease capital efficiency. It may

also place U.S. DCOs at a disadvantage to those foreign clearing houses

that permit letters of credit to be used as initial margin for swaps.

The Commission notes, however, that in response to the comments it has

modified the rule to permit letters of credit for futures. Therefore,

futures market participants will not incur any costs as a result of

this provision.

It is not possible to estimate or quantify these costs for a number

of reasons. The Dodd-Frank Act and implementing regulations will

significantly affect the manner in which swaps are developed, traded,

executed, and cleared. Existing DCOs and FCMs will be clearing new

products. New DCOs and FCMs will enter the market. Mandatory clearing

will bring new products and participants to DCOs and FCMs. The

interaction of all these factors creates a wide range of uncertainty as

to which products will be cleared, what their margin requirements will

be, and the extent to which clearing members would post letters of

credit as margin if permitted. Under these circumstances, the potential

opportunity costs that may arise from the deposit of cash or other

assets rather than letters of credit depends on a variety of future

circumstances and actions of market participants that cannot be known

or predicted at the present time. In sum, the Commission believes that

the possible future circumstances involving the posting of letters of

credit as margin is too speculative and uncertain to be able to

quantify or estimate the resulting costs to clearing members with any

precision or degree of magnitude.

Benefits

One of the primary functions of a DCO is to guarantee financial

performance, which includes performing daily variation settlement.

Daily pays are made in cash, and to the extent a DCO relies on margin

deposits to meet its end-of-day obligations, it must have access to

sufficient cash or highly liquid assets. Similarly, initial margin may

be tapped by a DCO in the event of a clearing member default. By

limiting the use of letters of credit, the DCO will avoid the

possibility that a letter of credit would be dishonored when presented

to the issuing bank.

Thus, requiring initial margin in the form of assets that can be

immediately sold provides greater financial protection to the DCO,

clearing members, and market participants.

2. Efficiency, Competitiveness, and Financial Integrity

Costs

As noted above, there could be competitive disadvantages to DCOs if

foreign competitors do not impose similar restrictions on initial

margin deposits. In addition, the prospect of increased costs may

reduce voluntary clearing of swaps, which would be inconsistent with

the goals of the Dodd-Frank Act and could potentially lead to systemic

risk.

Benefits

A DCO can be more efficient in facilitating payments if it has

readily available liquid assets as opposed to a conditional obligation

that must be presented for payment. Holding actual assets provides

greater assurance of financial integrity to the clearing process, as

the DCO will not have to bear the costs of possible default on the part

of the issuing bank. Even an irrevocable letter of credit can be

dishonored, with the DCO's only recourse being a lawsuit.

3. Price Discovery

The Commission does not believe this rule will have a material

effect on price discovery.

4. Sound Risk Management Practices

Costs

The Commission does not believe this rule will have a material

adverse impact on sound risk management practices.

Benefits

The Commission expects that prohibiting the use of letters of

credit as initial margin for swaps could serve to strengthen a DCO's

risk management program. It eliminates the risk of funds not being

available if a letter of credit were to be dishonored, which could have

a significant impact because initial margin is the first financial

resource to be tapped in the event of a clearing member default.

5. Other Public Considerations

The Commission does not believe this rule will have a material

impact on public interest considerations other than those discussed

above.

J. Reporting--Sec. 39.19

Core Principle J,\279\ as amended by the Dodd-Frank Act, requires a

DCO to provide the Commission with all information that the Commission

determines to be necessary to conduct oversight of the DCO.

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\279\ Section 5b(c)(2)(J) of the CEA, 7 U.S.C. 7a-1(c)(2)(J).

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The Commission proposed Sec. 39.19 to establish minimum

requirements that a DCO would have to meet in order to comply with Core

Principle J. Under proposed Sec. 39.19, certain reports would have to

be made by a DCO to the Commission (1) On a periodic basis (daily,

quarterly, or annually); (2) where the reporting requirement is

triggered by the occurrence of a significant event; and (3) upon

request by the Commission.

The rules would require DCOs to provide information that the

Commission has determined is necessary to conduct oversight of DCOs.

The proposed reporting regime would assist the Commission in monitoring

the financial strength and operational capabilities of a DCO and in

evaluating whether a DCO's risk management practices are effective. The

required reports also would assist the Commission in taking prompt

action as necessary to identify incipient problems and address them at

an early stage. A self-reporting program of this type enhances the

Commission's ability to conduct oversight given its limited resources

which do not permit routine on-site surveillance of DCOs.

The proposed rules would require submission of information

electronically and in a form and manner prescribed by the Commission.

These general procedural standards would provide flexibility to the

Commission in establishing and updating uniform format and delivery

protocols that would assist the Commission in conducting timely review

of submissions. In this regard, the transmission of information using a

uniform format would enable Commission staff to sort and interpret data

without the need to convert the data into a format that provides the

necessary functionality, e.g., it would be designed to provide the

Commission with the ability to compare data across DCOs when necessary.

A number of commenters discussed costs associated with proposed

Sec. 39.19

[[Page 69427]]

in the form of comments on the substantive provisions of the proposed

rule. For example, a number of commenters discussed whether alternative

reporting requirements might better inform the Commission of potential

risks. Some commenters questioned the need for certain information and

some commenters questioned the feasibility of the reporting

requirements. The Commission has addressed those comments above.

The Commission also received comments that directly addressed two

areas of the Commission's cost-benefit analysis of proposed Sec.

39.19: (1) The cost of preparing and submitting daily and annual

audited financial reports; and (2) the cost of reporting a 10 percent

decrease in financial resources. Those comments are discussed in detail

below.

a. Cost of Preparing and Submitting Daily and Annual Reports

Proposed Sec. 39.19(c) would require a DCO to submit various

periodic reports for the purposes of risk surveillance and oversight of

the DCO's compliance with the core principles and Commission

regulations. In the notice of proposed rulemaking, the Commission

observed that the information that would be reported was information

readily available to a DCO and which, in certain instances, was already

being reported to the Commission. The Commission requested data or

other information that could quantify or qualify costs.

Only NYPC provided an estimate of the fixed cost of implementing an

automated system for daily reporting. In a comment letter submitted by

NYPC, the cost was estimated at $582,000.

In a follow-up phone conversation with representatives of NYPC,

Commission staff discussed the basis for NYPC's estimate that

implementing an automated system for daily reporting would cost

$582,000. Staff was told that NYPC already provides certain daily

reports to the Commission, but that the additional data that it would

have to report under the proposal (not including the proposed gross

margin data or large trader data) would necessitate implementing an

automated system. NYPC representatives confirmed that the estimate was

for a one-time cost, not the cost of generating and transmitting the

actual daily reports. NYPC also confirmed that the cost of generating

and transmitting the actual daily reports would be minimal.

The Commission was able to estimate the costs of providing reports

and presented this information in the Paperwork Reduction Act

discussion. It estimated that daily reporting could require a DCO to

expend up to $8,280 per year, and an annual report could require a DCO

to expend up to $482,110 per year.

KCC and MGEX commented that the variable cost for daily reporting

could be significantly more than the Commission's estimates if the

Commission were to require a costly format and method of delivery. MGEX

also commented that the Commission may have underestimated the cost of

providing the annual report (audited financial report under Sec.

39.19(c)(3)(ii)), and that the Commission's estimate is ``extremely

excessive, particularly when most of [the annual reporting requirements

do] not appear to be required by the Dodd-Frank Act.'' Finally, MGEX

believes that the proposed rules will not guarantee increased market

participation or improve legitimate risk management and hedging

activity, and the additional costs will create barriers to entry and

decrease DCO competition.

Although KCC and MGEX commented that the costs of preparing the

reports may be greater than the Commission's estimates, neither DCO

provided an alternative estimate. Nor did they suggest alternative

reporting requirements that would achieve the purposes of the CEA with

a more favorable cost-benefit ratio. As to the estimated costs of the

required format and method of delivery, the Commission notes that it

based its estimate on the cost of using the SHAMIS system. The

Commission has no basis for concluding that the cost of using an

alternative system would be less substantial and it received no

comments on this.

The Commission believes that the costs that DCOs will incur to

implement a system to provide such information to the Commission are

necessary and justified. As explained above, the Commission has

determined that the information required in the reports is necessary

for the Commission to conduct adequate oversight of DCOs, particularly

given its limited ability to conduct on-site reviews.

b. Reporting a 10 Percent Decrease in Financial Resources

Under proposed Sec. 39.19(c)(4)(i), a DCO would be required to

report a decrease of 10 percent in the total value of its financial

resources either from (1) the value reported in the DCO's last

quarterly report or (2) from the value as of the close of the previous

business day. This would allow the Commission to more quickly identify

and address financial problems at the DCO. As discussed above, the

Commission raised the reporting threshold from 10 percent to 25 percent

in response to comments that a higher percentage might yield more

meaningful results. In addition, the higher threshold is likely to

reduce the number of reports that might be submitted under this

requirement.

NYPC commented that compliance with the proposed reporting

requirement would necessitate an expenditure of approximately 15,000

hours and $1.7 million. NYPC explained that this estimate reflects

implementing a system that would track default resources and working

capital, combined. After talking with Commission staff, NYPC submitted

a comment letter that provided a preliminary estimate of approximately

4,600 hours and $566,000 for designing, building, and testing a

reporting system for a decline in default resources only.

Based on NYPC's initial comment letter, the Commission believes

that the material costs associated with Sec. 39.19(c)(4)(i) are the

initial investments made by a DCO to develop and implement a system

(automated or not) to alert the DCO that the valuation threshold has

been met. As discussed above, it is important for the Commission to be

apprised of a 25% reduction in default resources because it could

indicate that the DCO's financial resources are strained and corrective

action may be needed.

The Commission has evaluated the costs and benefits of Sec. 39.19

in light of the specific considerations identified in Section 15(a) of

the CEA as follows:

1. Protection of Market Participants and the Public

Costs

Section 39.19 requires DCOs to provide information that the

Commission has determined is necessary for oversight of DCOs and to

provide that information in a time frame, format, and delivery method

that will enable effective use of the information. To the extent that

DCOs do not already have an infrastructure for preparing and

transmitting reports, they will incur one-time costs to put such a

framework in place.

Benefits

The comprehensive regulatory reporting program will enhance

protection of market participants and the public by promoting more in-

depth and effective oversight by the Commission. The reports will

assist the Commission's Risk Surveillance staff in monitoring clearing

house risk and evaluating DCOs' management and mitigation of that risk.

In addition, the

[[Page 69428]]

information will assist the Commission to identify incipient problems

and address them at an early stage.

2. Efficiency, Competitiveness, and Financial Integrity

Costs

The Commission does not believe that the reporting requirements

will adversely impact efficiency, competitiveness, or the financial

integrity of derivatives markets.

Benefits

The reporting requirements will protect the financial integrity of

derivatives markets because they will support effective and timely

oversight of DCOs. This will help to minimize the risk of default and

the impact default would have on the markets.

3. Price Discovery

The Commission does not believe that Sec. 39.19 will have a

material impact on price discovery.

4. Sound Risk Management Practices

Costs

The Commission does not believe that the reporting requirements

will adversely impact sound risk management practices.

Benefits

The reporting requirements are expected to enhance sound risk

management practices because the Commission will be able to more

effectively evaluate a DCO's risk management practices on an on-going

basis. The Commission staff can build a knowledge base that will

support prompt action if there are adverse changes in trends or

financial profiles.

5. Other Public Interest Considerations

The Commission does not believe this rule will have a material

impact on public interest considerations other than those discussed

above. Effective oversight of DCOs will enhance the safety and

efficiency of DCOs and reduce systemic risk. Safe and reliable DCOs are

essential not only for the stability of the derivatives markets they

serve but also the public which relies on the prices formed in these

markets for all manner of commerce.

IX. 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.\280\

The rules adopted herein will affect only DCOs). 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.\281\ The Commission has

previously determined that DCOs are not small entities for the purpose

of the RFA.\282\ Accordingly, the Chairman, on behalf of the

Commission, hereby certifies pursuant to 5 U.S.C. 605(b) that these

rules will not have a significant economic impact on a substantial

number of small entities. The Chairman made the same certification in

the proposed rulemakings, and the Commission did not receive any

comments on the RFA in relation to any of those rulemakings.

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\280\ 5 U.S.C. 601 et seq.

\281\ 47 FR 18618 (Apr. 30, 1982).

\282\ See 66 FR 45604, at 45609 (Aug. 29, 2001) (New Regulatory

Framework for Clearing Organizations).

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B. Paperwork Reduction Act

The Commission may not conduct or sponsor, and a registered entity

is not required to respond to, a collection of information unless it

displays a currently valid Office of Management and Budget (OMB)

control number. The Commission's adoption of Sec. Sec. 39.3 (DCO

registration application requirements), 39.10 (annual compliance report

and recordkeeping), 39.11 (financial resources quarterly report), 39.14

(settlement recordkeeping), 39.18 (system safeguards reporting and

recordkeeping), 39.19 (periodic and event-specific reporting), and

39.20 (general recordkeeping), imposes new information collection

requirements on registered entities within the meaning of the Paperwork

Reduction Act.\283\

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\283\ 44 U.S.C. 3501 et seq.

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

Accordingly, the Commission requested and OMB assigned control

numbers for the required collections of information. The Commission has

submitted this notice of final rulemaking along with supporting

documentation for OMB's review in accordance with 44 U.S.C. 3507(d) and

5 CFR 1320.11. The titles for these collections of information are

``Financial Resources Requirements for Derivatives Clearing

Organizations, OMB control number 3038-0066,'' ``Information Management

Requirements for Derivatives Clearing Organizations, OMB control number

3038-0069,'' ``General Regulations and Derivatives Clearing

Organizations, OMB control number 3038-0081,'' and ``Risk Management

Requirements for Derivatives Clearing Organizations, OMB control number

3038-0076.'' Many of the responses to this new collection of

information are mandatory.

The Commission protects proprietary information according to the

Freedom of Information Act and 17 CFR part 145, ``Commission Records

and Information.'' In addition, Section 8(a)(1) of the CEA strictly

prohibits the Commission, unless specifically authorized by the Act,

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.

The regulations require each respondent to file certain information

with the Commission and to maintain certain records.\284\ The

Commission received comments from NYPC and MGEX regarding the estimated

costs of preparing and submitting daily reports. It also received

comments from MGEX regarding costs associated with annual reports and

the proposed rules in general.

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

\284\ See 75 FR at 63119 (Oct. 14, 2010) (Financial Resources)

(requirement to file quarterly reports); see also discussion of the

financial resources reporting requirements in section IV.B.10,

above.

See 75 FR at 77583-77584 (Dec. 13, 2010) (General Regulations)

(proposed requirements: (i) For the CCO to submit an annual report

to the Commission; (ii) to retain a copy of the policies and

procedures adopted in furtherance of compliance with the CEA; (iii)

to retain copies of materials, including written reports provided to

the board of directors in connection with the board's review of the

annual report; and (iv) to retain any records relevant to the annual

report, including, but not limited to, work papers and other

documents that form the basis of the report, and memoranda,

correspondence, other documents, and records that are (a) created,

sent or received in connection with the annual report and (b)

contain conclusions, opinions, analyses, or financial data related

to the annual report); see also discussion of Sec. 39.10 in section

IV.A, above.

See 75 FR at 78193 (Dec. 15, 2010) (Information Management)

(proposed requirements to file specified information with the

Commission (i) periodically, on a daily, quarterly, and annual

basis; (ii) as specified events occur; and (iii) upon Commission

request); see also discussion of reporting requirements in section

IV.J, above.

See 75 FR at 78196 (Dec. 15, 2010) (Information Management)

(proposed requirement 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); see also discussion of recordkeeping

requirements in section IV.K, above.

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NYPC and MGEX commented that the costs associated with the rules in

the Information Management proposed rulemaking would be higher than the

[[Page 69429]]

Commission estimated.\285\ With respect to daily reporting, NYPC

commented that designing, building, and testing the application

necessary to automate the process of producing daily reports would

require approximately 5,200 hours and cost $582,000.\286\ MGEX

commented that the cost to a DCO could be significantly more than the

estimated cost if the Commission were to require a costly format and

method of delivery.

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

\285\ See 75 FR at 78193 (Dec. 15, 2010) (Information

Management). In the Paperwork Reduction Act discussion, the

Commission estimated that daily reporting would result in an

aggregated cost of $8,280 initially (12 respondents x $690) and

$16,800 per annum (12 respondents x $1,400). Annual reporting would

result in an aggregated cost of $5,785,320 per annum (12 respondents

x $482,110).

\286\ In a follow-up phone conversation with representatives of

NYPC, Commission staff discussed the basis for NYPC's estimate that

implementing an automated system for daily reporting would cost

$582,000. Commission staff was told that NYPC already provides

certain daily reports to the Commission's Risk Surveillance Group,

but that the additional data that it would have to report under the

Information Management NPRM (not including the gross margin data or

large trader data) would necessitate implementing an automated

system. NYPC representatives confirmed that the estimate was for a

one-time cost, not the cost of generating and transmitting the

actual daily reports. NYPC also confirmed that the cost of

generating and transmitting the actual daily reports would be

minimal.

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

With respect to annual reporting, MGEX commented that the

Commission may have underestimated the associated costs because the

Commission did not address the costs of building reporting methods,

forms, programs, or the allocation of labor resources. In addition,

MGEX believes that the estimated costs associated with the annual

report are ``extremely excessive, particularly when most of [the annual

report requirements do] not appear to be required by the Dodd-Frank

Act.'' MGEX further commented that the proposed rules will not

guarantee increased market participation or improve legitimate risk

management and hedging activity, and the additional costs would create

barriers to entry and decreased DCO competition.

Finally, with respect to the estimated costs identified in the Risk

Management notice of proposed rulemaking,\287\ MGEX noted that the

Commission had estimated the total hours for the proposed collection of

information to be 50 hours per year per respondent for the additional

reporting requirements at an annual cost of $500 per respondent (50

hours x $10). MGEX stated its belief that these estimates, both in

hours and cost, are extremely low, and that it did not appear that the

Commission had accounted for the costs to implement a system; collect,

forward and format data; monitor and enforce compliance; and document

compliance with the proposed rulemaking. MGEX noted that the costs are

not limited to reporting to the Commission for many of the proposed

rules, and that reporting may be the least expensive facet. MGEX

specifically identified reporting the gross position of each beneficial

owner as a requirement for which the Commission did not provide any

cost estimates.

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

\287\ See 76 FR at 3716-3717 (Jan. 20, 2011) (Risk Management).

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

Although MGEX commented that the costs of the proposed requirements

may be greater than the costs the Commission set forth in the

Information Management and Risk Management proposed rulemakings, and

that the Commission did not estimate the costs of building reporting

methods, forms, programs, or the allocation of labor resources, MGEX

did not provide an estimate of these costs. Nor did MGEX suggest

alternative reporting requirements that would achieve the purposes of

the CEA with a more favorable cost-benefit ratio.

As to the estimated costs of the required format and method of

delivery, the Commission notes that the estimates of these costs were

based on the cost of using the SHAMIS system. There was no basis for

concluding that the cost of using an alternative system would be more

substantial and the Commission received no comment to that effect.

Moreover, Core Principle J requires a DCO to provide reports to the

Commission, and all DCOs will have to bear these costs in order to

comply with Core Principle J. Core Principle J requires each DCO ``to

provide to the Commission all information that the Commission

determines to be necessary to conduct oversight of the [DCO].'' As

discussed above and in the Information Management proposed rulemaking,

the Commission believes that the daily and annual reporting

requirements provide the Commission with information that is important

to its oversight of a DCO to ensure the DCO is in compliance with the

core principles. This can lead to increased market participation and

improve legitimate risk management and hedging activity. Accordingly,

the Commission believes the collection of information related to the

reporting rules is necessary to achieve the purposes of the CEA,

particularly in light of the Dodd-Frank Act clearing mandate for

swaps.\288\

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

\288\ See further discussion of the costs and benefits

associated with the reporting requirements in section VII.J, above.

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

The Commission has considered the comments of NYPC and MGEX but is

declining to revise the estimated costs. The Commission believes that

its original estimates remain appropriate for PRA purposes.

List of Subjects

17 CFR Part 1

Brokers, Commodity futures, Consumer protection, Definitions,

Swaps.

17 CFR Part 21

Brokers, Commodity futures, Reporting and recordkeeping

requirements.

17 CFR Part 39

Definitions, Commodity futures, Reporting and recordkeeping

requirements, Swaps, Business and industry, Participant and product

eligibility, Risk management, Settlement procedures, Treatment of

funds, Default rules and procedures, System safeguards, Enforcement

authority, Application form.

17 CFR Part 140

Authority delegations (Government agencies), Conflict of interests,

Organization and functions (Government agencies).

For the reasons stated in the preamble, amend 17 CFR parts 1, 21,

39, and 140 as follows:

PART 1--GENERAL REGULATIONS UNDER THE COMMODITY EXCHANGE ACT

0

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

Authority: 7 U.S.C. 1a, 2, 5, 6, 6a, 6b, 6c, 6d, 6e, 6f, 6g, 6h,

6i, 6j, 6k, 6l, 6m, 6n, 6o, 6p, 7, 7a, 7b, 8, 9, 12, 12a, 12c, 13a,

13a-1, 16, 16a, 19, 21, 23, and 24, as amended by Pub. L. 111-203,

124 Stat. 1376.

0

2. Amend Sec. 1.3 to revise paragraphs (c) and (d), remove and reserve

paragraph (k), and add paragraphs (aaa), (bbb), (ccc), (ddd), (eee),

and (fff) to read as follows:

Sec. 1.3 Definitions.

* * * * *

(c) Clearing member. This term means 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.

(d) Clearing organization or derivatives clearing organization.

This term means a clearinghouse, clearing association, clearing

corporation, or similar entity, facility, system, or

[[Page 69430]]

organization that, with respect to an agreement, contract, or

transaction--

(1) Enables each party to the agreement, contract, or transaction

to substitute, through novation or otherwise, the credit of the

derivatives clearing organization for the credit of the parties;

(2) Arranges or provides, on a multilateral basis, for the

settlement or netting of obligations resulting from such agreements,

contracts, or transactions executed by participants in the derivatives

clearing organization; or

(3) Otherwise provides clearing services or arrangements that

mutualize or transfer among participants in the derivatives clearing

organization the credit risk arising from such agreements, contracts,

or transactions executed by the participants.

(4) Exclusions. The terms clearing organization and derivatives

clearing organization do not include an entity, facility, system, or

organization solely because it arranges or provides for--

(i) Settlement, netting, or novation of obligations resulting from

agreements, contracts or transactions, on a bilateral basis and without

a central counterparty;

(ii) Settlement or netting of cash payments through an interbank

payment system; or

(iii) Settlement, netting, or novation of obligations resulting

from a sale of a commodity in a transaction in the spot market for the

commodity.

* * * * *

(k) [Reserved]

* * * * *

(aaa) Clearing initial margin. This term means initial margin

posted by a clearing member with a derivatives clearing organization.

(bbb) Customer initial margin. This term means initial margin

posted by a customer with a futures commission merchant, or by a non-

clearing member futures commission merchant with a clearing member.

(ccc) Initial margin. This term means 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.

(ddd) Margin call. This term means a request from a futures

commission merchant to a customer to post customer initial margin; or a

request by a derivatives clearing organization to a clearing member to

post clearing initial margin or variation margin.

(eee) Spread margin. This term means reduced initial margin that

takes into account correlations between certain related positions held

in a single account.

(fff) Variation margin. This term means 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.

0

3. Amend Sec. 1.12 to remove and reserve paragraph (f)(1).

PART 21--SPECIAL CALLS

0

4. The authority citation for part 21 is revised to read as follows:

Authority: 7 U.S.C. 1a, 2, 2a, 4, 6a, 6c, 6f, 6g, 6i, 6k, 6m,

6n, 7, 7a, 12a, 19 and 21, as amended by Pub. L. 111-203, 124 Stat.

1376; 5 U.S.C. 552 and 552(b), unless otherwise noted.

0

5. Redesignate Sec. 21.04 as Sec. 21.05.

0

6. Add a new Sec. 21.04 to read as follows:

Sec. 21.04 Special calls for information on customer accounts or

related cleared positions.

Upon special call by the Commission, each futures commission

merchant, clearing member or foreign broker shall provide information

to the Commission concerning customer accounts or related positions

cleared on a derivatives clearing organization in the format and manner

and within the time provided by the Commission in the special call.

0

7. Add Sec. 21.06 to read as follows:

Sec. 21.06 Delegation of authority to the Director of the Division of

Clearing and Risk.

The Commission hereby delegates, until the Commission orders

otherwise, the special call authority set forth in Sec. 21.04 to the

Director of the Division of Clearing and Risk to be exercised by such

Director or by such other employee or employees of such Director as

designated from time to time by the Director. The Director of the

Division of Clearing and Risk may submit to the Commission for its

consideration any matter which has been delegated in this section.

Nothing in this section shall be deemed to prohibit the Commission, at

its election, from exercising the authority delegated in this section

to the Director.

PART 39--DERIVATIVES CLEARING ORGANIZATIONS

0

8. Revise part 39 to read as follows:

Subpart A--General Provisions Applicable to Derivatives Clearing

Organizations

Sec.

39.1 Scope.

39.2 Definitions.

39.3 Procedures for registration.

39.4 Procedures for implementing derivatives clearing organization

rules and clearing new products.

39.5 Submission of swaps for Commission determination regarding

clearing requirements.

39.6 [Reserved]

39.7 Enforceability.

39.8 Fraud in connection with the clearing of transactions on a

derivatives clearing organization.

Subpart B--Compliance With Core Principles

39.9 Scope.

39.10 Compliance with core principles.

39.11 Financial resources.

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 Rule enforcement.

39.18 System safeguards.

39.19 Reporting.

39.20 Recordkeeping.

39.21 Public information.

39.22 Information sharing.

39.23 Antitrust considerations.

39.24 [Reserved]

39.25 [Reserved]

39.26 [Reserved]

39.27 Legal risk considerations.

Appendix A to Part 39--Form DCO Derivatives Clearing Organization

Application for Registrations

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

Stat. 1376.

Subpart A--General Provisions Applicable to Derivatives Clearing

Organizations

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 applies to register as such with the

Commission pursuant to section 5b(b) or otherwise.

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.

Customer means a person trading in any commodity named in the

definition of commodity in section 1a(9) of the Act or in Sec. 1.3 of

this chapter, or in any swap as defined in section 1a(47) of the Act or

in Sec. 1.3 of this chapter; Provided, however, an owner or holder of

a house

[[Page 69431]]

account as defined in this section shall not be deemed to be a customer

within the meaning of section 4d of the Act, the regulations that

implement sections 4d and 4f of the Act and Sec. 1.35, and such an

owner or holder of such a house account shall otherwise be deemed to be

a customer within the meaning of the Act and Sec. Sec. 1.37 and 1.46

of this chapter and all other sections of these rules, regulations, and

orders which do not implement sections 4d and 4f of the Act.

Customer account or customer origin means a clearing member account

held on behalf of customers, as that term is defined in this section,

and which is subject to section 4d(a) or section 4d(f) of the Act.

House account or house origin means a clearing member account which

is not subject to section 4d(a) or 4d(f) of the Act.

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 potential

extreme price moves, changes in option volatility, and/or changes 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, which has been designated by

the Financial Stability Oversight Council to be systemically important

and for which the Commission acts as the Supervisory Agency pursuant to

section 803(8) of the Dodd-Frank Wall Street Reform and Consumer

Protection Act.

Sec. 39.3 Procedures for registration.

(a) Application procedures. (1) An organization desiring to be

registered as a derivatives clearing organization shall file

electronically an application for registration with the Secretary of

the Commission in the format and manner specified by the Commission.

The Commission will review the application for registration as a

derivatives clearing organization pursuant to the 180-day timeframe and

procedures specified in section 6(a) of the Act. The Commission may

approve or deny the application or, if deemed appropriate, register the

applicant as a derivatives clearing organization subject to conditions.

(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 the appendix to this part 39 (application). An

applicant, when filing a Form DCO for purposes of amending its pending

application or requesting an amendment to an existing registration, is

only required to submit exhibits and updated information that are

relevant to the requested amendment and are necessary to demonstrate

compliance with the core principles affected by the requested

amendment. 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 format and manner specified 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 Risk 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 designation 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 Risk 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 format and manner specified

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.

(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

[[Page 69432]]

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 format and manner specified 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.

(f) Request for transfer of registration and open interest. (1) In

anticipation of a corporate change that will result in the transfer of

all or substantially all of a derivatives clearing organization's

assets to another legal entity, the derivatives clearing organization

shall submit a request for approval to transfer the derivatives

clearing organization's registration and positions comprising open

interest for clearing and settlement.

(2) Timing of submission and other procedural requirements. (i) The

request shall be submitted no later than three months prior to the

anticipated corporate change, or as otherwise permitted under Sec.

39.19(c)(4)(viii)(C) of this part.

(ii) The derivatives clearing organization shall submit a request

for transfer by filing electronically such a request with the Secretary

of the Commission in the format and manner specified by the Commission.

(iii) The derivatives clearing organization shall submit a

confirmation of change report pursuant to Sec. 39.19(c)(4)(viii)(D) of

this part.

(3) Required information. The request shall include the following:

(i) The underlying agreement that governs the corporate change;

(ii) A narrative description of the corporate change, including the

reason for the change and its impact on the derivatives clearing

organization's financial resources, governance, and operations, and its

impact on the rights and obligations of clearing members and market

participants holding the positions that comprise the derivatives

clearing organization's open interest;

(iii) A discussion of the transferee's ability to comply with the

Act, including the core principles applicable to derivatives clearing

organizations, and the Commission's regulations thereunder;

(iv) The governing documents of the transferee, including but not

limited to articles of incorporation and bylaws;

(v) The transferee's rules marked to show changes from the current

rules of the derivatives clearing organization;

(vi) A list of products for which the derivatives clearing

organization requests transfer of open interest;

(vii) A representation by the derivatives clearing organization

that it is in compliance with the Act, including the core principles

applicable to derivatives clearing organizations, and the Commission's

regulations thereunder; and

(viii) A representation by the transferee that it understands that

the derivatives clearing organization is a regulated entity that must

comply with the Act, including the core principles applicable to

derivatives clearing organizations, and the Commission's regulations

thereunder, in order to maintain its registration as a derivatives

clearing organization; and further, that the transferee will continue

to comply with all self-regulatory requirements applicable to a

derivatives clearing organization under the Act and the Commission's

regulations thereunder.

(4) Commission determination. The Commission will review a request

as soon as practicable, and based on the Commission's determination as

to the transferee's ability to continue to operate the derivatives

clearing organization in compliance with the Act and the Commission's

regulations thereunder, such request will be approved or denied

pursuant to a Commission order.

Sec. 39.4 Procedures for implementing derivatives clearing

organization rules and clearing new products.

(a) Request for approval of rules. An applicant for registration,

or a registered derivatives clearing organization, may request,

pursuant to the procedures of Sec. 40.5 of this chapter, that the

Commission approve any or all of its rules and subsequent amendments

thereto, including operational rules, prior to their implementation or,

notwithstanding the provisions of section 5c(c)(2) of the Act, at any

time thereafter, under the procedures of Sec. 40.5 of this chapter. A

derivatives clearing organization may label as, ``Approved by the

Commission,'' only those rules that have been so approved.

(b) Self-certification of rules. Proposed new or amended rules of a

derivatives clearing organization not voluntarily submitted for prior

Commission approval pursuant to paragraph (a) of this section must be

submitted to the Commission with a certification that the proposed new

rule or rule amendment complies with the Act and rules thereunder

pursuant to the procedures of Sec. 40.6 of this chapter.

(c) Acceptance of new products for clearing. (1) A dormant

derivatives clearing organization within the meaning of Sec. 40.1 of

this chapter may not accept for clearing a new product until its

registration as a derivatives clearing organization is reinstated under

the procedures of Sec. 39.3 of this part; provided however, that an

application for reinstatement may rely upon previously submitted

materials that still pertain to, and accurately describe, current

conditions.

(2) A derivatives clearing organization that accepts for clearing a

new product that is a swap shall comply with the requirements of Sec.

39.5 of this part.

(d) Orders regarding competition. An applicant for registration or

a registered derivatives clearing organization may request that the

Commission issue an order concerning whether a rule or practice of the

organization is the least anticompetitive means of achieving the

objectives, purposes, and policies of the Act.

(e) Holding securities in a futures portfolio margining account. A

derivatives clearing organization seeking to provide a portfolio

margining program under which securities would be held in a futures

account as defined in Sec. 1.3(vv) of this chapter, shall submit rules

to implement such portfolio margining program for Commission approval

in accordance with Sec. 40.5 of this chapter. Concurrent with the

submission of such rules for Commission approval, the derivatives

clearing organization shall petition the Commission for an order under

section 4d of the Act.

Sec. 39.5 Review of swaps for Commission determination on clearing

requirement.

(a) Eligibility to clear swaps. (1) A derivatives clearing

organization shall be presumed eligible to accept for clearing any swap

that is within a group, category, type, or class of swaps that the

derivatives clearing organization already clears. Such presumption of

eligibility, however, is subject to review by the Commission.

(2) A derivatives clearing organization that wishes to accept for

clearing any swap that is not within a group, category, type, or class

of swaps that the derivatives clearing organization already clears

shall request a determination by the Commission of the derivatives

clearing organization's eligibility to clear such a swap before

accepting the swap for clearing. The request, which shall be filed

electronically with the Secretary of the Commission, shall address the

derivatives clearing

[[Page 69433]]

organization's ability, if it accepts the swap for clearing, to

maintain compliance with section 5b(c)(2) of the Act, specifically:

(i) The sufficiency of the derivatives clearing organization's

financial resources; and

(ii) The derivative clearing organization's ability to manage the

risks associated with clearing the swap, especially if the Commission

determines that the swap is required to be cleared.

(b) Swap submissions. (1) A derivatives clearing organization shall

submit to the Commission each swap, or any group, category, type, or

class of swaps that it plans to accept for clearing. The derivatives

clearing organization making the submission must be eligible under

paragraph (a) of this section to accept for clearing the submitted

swap, or group, category, type, or class of swaps.

(2) A derivatives clearing organization shall submit swaps to the

Commission, to the extent reasonable and practicable to do so, by

group, category, type, or class of swaps. The Commission may in its

reasonable discretion consolidate multiple submissions from one

derivatives clearing organization or subdivide a derivatives clearing

organization's submission as appropriate for review.

(3) The submission shall be filed electronically with the Secretary

of the Commission and shall include:

(i) A statement that the derivatives clearing organization is

eligible to accept the swap, or group, category, type, or class of

swaps for clearing and describes the extent to which, if the Commission

were to determine that the swap, or group, category, type, or class of

swaps is required to be cleared, the derivatives clearing organization

will be able to maintain compliance with section 5b(c)(2) of the Act;

(ii) A statement that includes, but is not limited to, information

that will assist the Commission in making a quantitative and

qualitative assessment of the following factors:

(A) The existence of significant outstanding notional exposures,

trading liquidity, and adequate pricing data;

(B) The availability of rule framework, capacity, operational

expertise and resources, and credit support infrastructure to clear the

contract on terms that are consistent with the material terms and

trading conventions on which the contract is then traded;

(C) The effect on the mitigation of systemic risk, taking into

account the size of the market for such contract and the resources of

the derivatives clearing organization available to clear the contract;

(D) The effect on competition, including appropriate fees and

charges applied to clearing; and

(E) The existence of reasonable legal certainty in the event of the

insolvency of the relevant derivatives clearing organization or one or

more of its clearing members with regard to the treatment of customer

and swap counterparty positions, funds, and property;

(iii) Product specifications, including copies of any standardized

legal documentation, generally accepted contract terms, standard

practices for managing any life cycle events associated with the swap,

and the extent to which the swap is electronically confirmable;

(iv) Participant eligibility standards, if different from the

derivatives clearing organization's general participant eligibility

standards;

(v) Pricing sources, models, and procedures, demonstrating an

ability to obtain sufficient price data to measure credit exposures in

a timely and accurate manner, including any agreements with clearing

members to provide price data and copies of executed agreements with

third-party price vendors, and information about any price reference

index used, such as the name of the index, the source that calculates

it, the methodology used to calculate the price reference index and how

often it is calculated, and when and where it is published publicly;

(vi) Risk management procedures, including measurement and

monitoring of credit exposures, initial and variation margin

methodology, methodologies for stress testing and back testing,

settlement procedures, and default management procedures;

(vii) Applicable rules, manuals, policies, or procedures;

(viii) A description of the manner in which the derivatives

clearing organization has provided notice of the submission to its

members and a summary of any views on the submission expressed by the

members (a copy of the notice to members shall be included with the

submission); and

(ix) Any additional information specifically requested by the

Commission.

(4) The Commission must have received the submission by the open of

business on the business day preceding the acceptance of the swap, or

group, category, type, or class of swaps for clearing.

(5) The submission will be made available to the public and posted

on the Commission Web site for a 30-day public comment period. A

derivatives clearing organization that wishes to request confidential

treatment for portions of its submission may do so in accordance with

the procedures set out in Sec. 145.9(d) of this chapter.

(6) The Commission will review the submission and determine whether

the swap, or group, category, type, or class of swaps described in the

submission is required to be cleared. The Commission will make its

determination not later than 90 days after a complete submission has

been received, unless the submitting derivatives clearing organization

agrees to an extension. The determination of when such submission is

complete shall be at the sole discretion of the Commission. In making a

determination that a clearing requirement shall apply, the Commission

may impose such terms and conditions to the clearing requirement as the

Commission determines to be appropriate.

(c) Commission-initiated reviews. (1) The Commission, on an ongoing

basis, will review swaps that have not been accepted for clearing by a

derivatives clearing organization to make a determination as to whether

the swaps should be required to be cleared. In undertaking such

reviews, the Commission will use information obtained pursuant to

Commission regulations from swap data repositories, swap dealers, and

major swap participants, and any other available information.

(2) Notice regarding any determination made under paragraph (c)(1)

of this section will be made available to the public and posted on the

Commission Web site for a 30-day public comment period.

(3) If no derivatives clearing organization has accepted for

clearing a particular swap, group, category, type, or class of swaps

that the Commission finds would otherwise be subject to a clearing

requirement, the Commission will:

(i) Investigate the relevant facts and circumstances;

(ii) Within 30 days of the completion of its investigation, issue a

public report containing the results of the investigation; and

(iii) Take such actions as the Commission determines to be

necessary and in the public interest, which may include requiring the

retaining of adequate margin or capital by parties to the swap, group,

category, type, or class of swaps.

(d) Stay of clearing requirement. (1) After making a determination

that a swap, or group, category, type, or class of swaps is required to

be cleared, the Commission, on application of a counterparty to a swap

or on its own

[[Page 69434]]

initiative, may stay the clearing requirement until the Commission

completes a review of the terms of the swap, or group, category, type,

or class of swaps and the clearing arrangement.

(2) A counterparty to a swap that wishes to apply for a stay of the

clearing requirement for that swap shall submit a written request to

the Secretary of the Commission that includes:

(i) The identity and contact information of the counterparty to the

swap;

(ii) The terms of the swap subject to the clearing requirement;

(iii) The name of the derivatives clearing organization clearing

the swap;

(iv) A description of the clearing arrangement; and

(v) A statement explaining why the swap should not be subject to a

clearing requirement.

(3) A derivatives clearing organization that has accepted for

clearing a swap, or group, category, type, or class of swaps that is

subject to a stay of the clearing requirement shall provide any

information requested by the Commission in the course of its review.

(4) The Commission will complete its review not later than 90 days

after issuance of the stay, unless the derivatives clearing

organization that clears the swap, or group, category, type, or class

of swaps agrees to an extension.

(5) Upon completion of its review, the Commission may:

(i) Determine, subject to any terms and conditions as the

Commission determines to be appropriate, that the swap, or group,

category, type, or class of swaps must be cleared; or

(ii) Determine that the clearing requirement will not apply to the

swap, or group, category, type, or class of swaps, but clearing may

continue on a non-mandatory basis.

Sec. 39.6 [Reserved]

Sec. 39.7 Enforceability.

An agreement, contract or transaction submitted to a derivatives

clearing organization for clearing shall not be void, voidable, subject

to rescission, or otherwise invalidated or rendered unenforceable as a

result of:

(a) A violation by the derivatives clearing organization of the

provisions of the Act or of Commission regulations; or

(b) Any Commission proceeding to alter or supplement a rule under

section 8a(7) of the Act, to declare an emergency under section 8a(9)

of the Act, or any other proceeding the effect of which is to alter,

supplement, or require a derivatives clearing organization to adopt a

specific rule or procedure, or to take or refrain from taking a

specific action.

Sec. 39.8 Fraud in connection with the clearing of transactions on a

derivatives clearing organization.

It shall be unlawful for any person, directly or indirectly, in or

in connection with the clearing of transactions by a derivatives

clearing organization:

(a) To cheat or defraud or attempt to cheat or defraud any person;

(b) Willfully to make or cause to be made to any person any false

report or statement or cause to be entered for any person any false

record; or

(c) Willfully to deceive or attempt to deceive any person by any

means whatsoever.

Subpart B--Compliance with Core Principles

Sec. 39.9 Scope.

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 Compliance with core principles.

(a) To be registered and to maintain registration as a derivatives

clearing organization, a derivatives clearing organization shall comply

with each core principle set forth in section 5b(c)(2) of the Act and

any requirement that the Commission may impose by rule or regulation

pursuant to section 8a(5) of the Act; and

(b) Subject to any rule or regulation prescribed by the Commission,

a registered derivatives clearing organization shall have reasonable

discretion in establishing the manner by which it complies with each

core principle.

(c) Chief compliance officer--(1) Designation. Each derivatives

clearing organization shall establish the position of chief compliance

officer, designate an individual to serve as the chief compliance

officer, and provide the chief compliance officer with the full

responsibility and authority to develop and enforce, in consultation

with the board of directors or the senior officer, appropriate

compliance policies and procedures, to fulfill the duties set forth in

the Act and Commission regulations.

(i) The individual designated to serve as chief compliance officer

shall have the background and skills appropriate for fulfilling the

responsibilities of the position. No individual who would be

disqualified from registration under sections 8a(2) or 8a(3) of the Act

may serve as a chief compliance officer.

(ii) The chief compliance officer shall report to the board of

directors or the senior officer of the derivatives clearing

organization. The board of directors or the senior officer shall

approve the compensation of the chief compliance officer.

(iii) The chief compliance officer shall meet with the board of

directors or the senior officer at least once a year.

(iv) A change in the designation of the individual serving as the

chief compliance officer of the derivatives clearing organization shall

be reported to the Commission in accordance with the requirements of

Sec. 39.19(c)(4)(ix) of this part.

(2) Chief compliance officer duties. The chief compliance officer's

duties shall include, but are not limited to:

(i) Reviewing the derivatives clearing organization's compliance

with the core principles set forth in section 5b of the Act, and the

Commission's regulations thereunder;

(ii) In consultation with the board of directors or the senior

officer, resolving any conflicts of interest that may arise;

(iii) Establishing and administering written policies and

procedures reasonably designed to prevent violation of the Act;

(iv) Taking reasonable steps to ensure compliance with the Act and

Commission regulations relating to agreements, contracts, or

transactions, and with Commission regulations prescribed under section

5b of the Act;

(v) Establishing procedures for the remediation of noncompliance

issues identified by the chief compliance officer through any

compliance office review, look-back, internal or external audit

finding, self-reported error, or validated complaint; and

(vi) Establishing and following appropriate procedures for the

handling, management response, remediation, retesting, and closing of

noncompliance issues.

(3) Annual report. The chief compliance officer shall, not less

than annually, prepare and sign a written report that covers the most

recently completed fiscal year of the derivatives clearing

organization, and provide the annual report to the board of directors

or the senior officer. The annual report shall, at a minimum:

(i) Contain a description of the derivatives clearing

organization's

[[Page 69435]]

written policies and procedures, including the code of ethics and

conflict of interest policies;

(ii) Review each core principle and applicable Commission

regulation, and with respect to each:

(A) Identify the compliance policies and procedures that are

designed to ensure compliance with the core principle;

(B) Provide an assessment as to the effectiveness of these policies

and procedures;

(C) Discuss areas for improvement, and recommend potential or

prospective changes or improvements to the derivatives clearing

organization's compliance program and resources allocated to

compliance;

(iii) List any material changes to compliance policies and

procedures since the last annual report;

(iv) Describe the financial, managerial, and operational resources

set aside for compliance with the Act and Commission regulations; and

(v) Describe any material compliance matters, including incidents

of noncompliance, since the date of the last annual report and describe

the corresponding action taken.

(4) Submission of annual report to the Commission. (i) Prior to

submitting the annual report to the Commission, the chief compliance

officer shall provide the annual report to the board of directors or

the senior officer of the derivatives clearing organization for review.

Submission of the report to the board of directors or the senior

officer shall be recorded in the board minutes or otherwise, as

evidence of compliance with this requirement.

(ii) The annual report shall be submitted electronically to the

Secretary of the Commission in the format and manner specified by the

Commission not more than 90 days after the end of the derivatives

clearing organization's fiscal year, concurrently with submission of

the fiscal year-end audited financial statement that is required to be

furnished to the Commission pursuant to Sec. 39.19(c)(3)(ii) of this

part. The report shall include a certification by the chief compliance

officer that, to the best of his or her knowledge and reasonable

belief, and under penalty of law, the annual report is accurate and

complete.

(iii) The derivatives clearing organization shall promptly submit

an amended annual report if material errors or omissions in the report

are identified after submission. An amendment must contain the

certification required under paragraph (c)(4)(ii) of this section.

(iv) A derivatives clearing organization may request from the

Commission an extension of time to submit its annual report in

accordance with Sec. 39.19(c)(3) of this part.

(5) Recordkeeping. (i) The derivatives clearing organization shall

maintain:

(A) A copy of all compliance policies and procedures and all other

policies and procedures adopted in furtherance of compliance with the

Act and Commission regulations;

(B) Copies of materials, including written reports provided to the

board of directors or the senior officer in connection with the review

of the annual report under paragraph (c)(4)(i) of this section; and

(C) Any records relevant to the annual report, including, but not

limited to, work papers and other documents that form the basis of the

report, and memoranda, correspondence, other documents, and records

that are created, sent, or received in connection with the annual

report and contain conclusions, opinions, analyses, or financial data

related to the annual report.

(ii) The derivatives clearing organization shall maintain records

in accordance with Sec. 1.31 of this chapter and Sec. 39.20 of this

part.

Sec. 39.11 Financial resources.

(a) General. A derivatives clearing organization shall maintain

financial resources sufficient to cover its exposures with a high

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

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

derivatives clearing organization shall identify and adequately manage

its general business risks and hold sufficient liquid resources to

cover potential business losses that are not related to clearing

members' defaults, so that the derivatives clearing organization can

continue to provide services as an ongoing concern. Financial resources

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

the total amount that would:

(1) Enable the derivatives clearing organization to meet its

financial obligations to its clearing members notwithstanding a default

by the clearing member creating the largest financial exposure for the

derivatives clearing organization in extreme but plausible market

conditions; Provided that if a clearing member controls another

clearing member or is under common control with another clearing

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

clearing member for purposes of this provision; and

(2) Enable the derivatives clearing organization to cover its

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

rolling basis.

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

to satisfy the requirements of paragraph (a)(1) of this section may

include:

(i) Margin to the extent permitted under parts 1, 22, and 190 of

this chapter and under the rules of the derivatives clearing

organization;

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

(iii) Guaranty fund deposits;

(iv) Default insurance;

(v) Potential assessments for additional guaranty fund

contributions, if permitted by the derivatives clearing organization's

rules; and

(vi) Any other financial resource deemed acceptable by the

Commission.

(2) Financial resources available to satisfy the requirements of

paragraph (a)(2) of this section may include:

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

(ii) Any other financial resource deemed acceptable by the

Commission.

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

satisfy the requirements of either paragraph (a)(1) or paragraph (a)(2)

of this section, but not both paragraphs, and only to the extent the

use of such financial resource is not otherwise limited by the Act,

Commission regulations, the derivatives clearing organization's rules,

or any contractual arrangements to which the derivatives clearing

organization is a party.

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

derivatives clearing organization shall, on a monthly basis, perform

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

the financial resources needed to meet the requirements of paragraph

(a)(1) of this section. The derivatives clearing organization shall

have reasonable discretion in determining the methodology used to

compute such requirements, provided that the methodology must take into

account both historical data and hypothetical scenarios. The Commission

may review the methodology and require changes as appropriate.

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

make a reasonable calculation of its projected operating costs over a

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

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

clearing organization shall have reasonable discretion in determining

the methodology used to compute such projected operating costs. The

Commission may review the

[[Page 69436]]

methodology and require changes as appropriate.

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

but not less than monthly, a derivatives clearing organization shall

compute the current market value of each financial resource used to

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

value to reflect credit, market, and liquidity risks (haircuts) shall

be applied as appropriate and evaluated on a monthly basis.

(2) If assessments for additional guaranty fund contributions are

permitted by the derivatives clearing organization's rules, in

calculating the financial resources available to meet its obligations

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

(i) The derivatives clearing organization shall have rules

requiring that its clearing members have the ability to meet an

assessment within the time frame of a normal end-of-day variation

settlement cycle;

(ii) The derivatives clearing organization shall monitor the

financial and operational capacity of its clearing members to meet

potential assessments;

(iii) The derivatives clearing organization shall apply a 30

percent haircut to the value of potential assessments, and

(iv) The derivatives clearing organization shall only count the

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

those obligations.

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

clearing organization shall effectively measure, monitor, and manage

its liquidity risks, maintaining sufficient liquid resources such that

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

derivatives clearing organization shall hold assets in a manner where

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

(ii) The financial resources allocated by the derivatives clearing

organization to meet the requirements of paragraph (a)(1) of this

section shall be sufficiently liquid to enable the derivatives clearing

organization to fulfill its obligations as a central counterparty

during a one-day settlement cycle. The derivatives clearing

organization shall maintain cash, U.S. Treasury obligations, or high

quality, liquid, general obligations of a sovereign nation, in an

amount greater than or equal to an amount calculated as follows:

(A) Calculate the average daily settlement pay for each clearing

member over the last fiscal quarter;

(B) Calculate the sum of those average daily settlement pays; and

(C) Using that sum, calculate the average of its clearing members'

average pays.

(iii) The derivatives clearing organization may take into account a

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

the remainder of the requirement under paragraph (e)(1)(ii) of this

section.

(2) The financial resources allocated by the derivatives clearing

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

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

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

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

sufficiently liquid, the derivatives clearing organization may take

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

purpose of meeting this requirement.

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

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

basis;

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

manner that bears little or no principal risk; and

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

guaranty fund.

(f) Reporting requirements.

(1) Each fiscal quarter, or at any time upon Commission request, a

derivatives clearing organization shall:

(i) Report to the Commission;

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

requirements of paragraph (a);

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

accordance with the requirements of paragraph (d) of this section; and

(C) The manner in which the derivatives clearing organization meets

the liquidity requirements of paragraph (e) of this section;

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

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

the derivatives clearing organization or of its parent company; and

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

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

organization reports having guaranty funds deposits as a financial

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

this section.

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

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

quarter.

(3) The derivatives clearing organization shall provide the

Commission with:

(i) Sufficient documentation explaining the methodology used to

compute its financial resources requirements under paragraph (a) of

this section,

(ii) Sufficient documentation explaining the basis for its

determinations regarding the valuation and liquidity requirements set

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

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

facility, insurance coverage, or other arrangement evidencing or

otherwise supporting the derivatives clearing organization's

conclusions.

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

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

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

upon request by the derivatives clearing organization.

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 achieve

the same objective and 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 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.

[[Page 69437]]

(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. A derivatives clearing organization may permit such

financial resources to include, without limitation, 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. 240.15c3-1of this title, for broker-dealers, or any similar

risk adjusted capital calculation for all other 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 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 non-futures commission

merchants, to provide to the derivatives clearing organization periodic

financial reports that contain any financial information that the

derivatives clearing organization determines is necessary to assess

whether participation requirements are being met on an ongoing basis.

(A) A derivatives clearing organization shall require clearing

members that are futures commission merchants to provide the financial

reports that are specified in Sec. 1.10 of this chapter to the

derivatives clearing organization.

(B) A derivatives clearing organization shall require clearing

members that are not futures commission merchants to make the periodic

financial reports provided pursuant to paragraph (a)(5)(i) of this

section available to the Commission upon the Commission's request or,

in lieu of imposing this requirement, a derivatives clearing

organization may provide such financial reports directly to 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,

liquidating, transferring, auctioning, and/or allocating 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 unusual risk characteristics of a

product.

(2) A derivatives clearing organization shall adopt rules providing

that all swaps with the same terms and conditions, as defined by

product specifications established under derivatives clearing

organization rules, 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.

(3) A derivatives clearing organization shall provide for non-

discriminatory clearing of a swap executed bilaterally or on or subject

to the rules of an unaffiliated swap execution facility or designated

contract market.

(4) A derivatives clearing organization shall not require that one

of the original executing parties be a clearing member in order for a

product to be eligible for clearing.

(5) A derivatives clearing organization shall select product unit

sizes and other terms and conditions that maximize liquidity,

facilitate transparency in pricing, promote open access, and allow for

effective risk management. To the extent appropriate to further these

objectives, a derivatives clearing organization shall select product

units for clearing purposes that are smaller than the product units in

which trades submitted for clearing were executed.

(6) 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 an equal and opposite swap

between the derivatives clearing organization and each clearing member

acting as principal for a house trade or acting as agent for a customer

trade;

(iii) All terms of a cleared swap must conform to product

specifications 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.

(7) [Reserved]

(8) Confirmation. A derivatives clearing organization shall provide

each

[[Page 69438]]

clearing member carrying a cleared swap with a definitive written

record of the terms of the transaction which shall legally supersede

any previous agreement and serve as a confirmation of the swap. The

confirmation of all terms of the transaction shall take place at the

same time as the swap is accepted for clearing.

Sec. 39.13 Risk management.

(a) 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 house and customer 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 non-defaulting clearing members cannot anticipate or control.

(g) Margin requirements. (1) General. 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 unusual characteristics of, or risks associated with, particular

products or portfolios, including but not limited to jump-to-default

risk or similar jump risk.

(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) A minimum liquidation time that is one day for futures and

options;

(B) A minimum liquidation time that is one day for swaps on

agricultural commodities, energy commodities, and metals;

(C) A minimum liquidation time that is five days for all other

swaps; or

(D) Such longer liquidation time as is appropriate based on the

specific characteristics of a particular product or portfolio; provided

further that the Commission, by order, may establish shorter or longer

liquidation times for 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

percent, based on data from an appropriate historic time period, for:

(A) Each product for which the derivatives clearing organization

uses a product-based margin methodology;

(B) Each spread within or between products for which there is a

defined spread margin rate;

(C) Each account held by a clearing member at the derivatives

clearing organization, by house origin and by each customer origin; and

(D) Each swap portfolio, including any portfolio containing futures

and/or options and held in a commingled account pursuant to Sec.

39.15(b)(2) of this part, 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. Such qualified and independent

parties may be independent contractors or employees of the derivatives

clearing organization, but shall not be persons responsible for

development or operation of the systems and models being tested.

(4) Spread and portfolio margins. (i) A derivatives clearing

organization may allow reductions in initial margin requirements for

related positions 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

margin reductions 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.

(7) Back tests. A derivatives clearing organization shall conduct

back tests, as defined in Sec. 39.2 of this part, using an appropriate

time period but not less than the previous 30 days, as follows:

(i) On a daily basis, a derivatives clearing organization shall

conduct back

[[Page 69439]]

tests with respect to products or swap portfolios that are experiencing

significant market volatility, to test the adequacy of its initial

margin requirements, as follows:

(A) For that product if the derivatives clearing organization uses

a product-based margin methodology;

(B) For each spread involving that product if there is a defined

spread margin rate;

(C) For each account held by a clearing member at the derivatives

clearing organization that contains a significant position in that

product, by house origin and by each customer origin; and

(D) For each such swap portfolio, including any portfolio

containing futures and/or options and held in a commingled account

pursuant to Sec. 39.15(b)(2) of this part, by beneficial owner.

(ii) On at least a monthly basis, a derivatives clearing

organization shall conduct back tests to test the adequacy of its

initial margin requirements, as follows:

(A) For each product for which the derivatives clearing

organization uses a product-based margin methodology;

(B) For each spread for which there is a defined spread margin

rate;

(C) For each account held by a clearing member at the derivatives

clearing organization, by house origin and by each customer origin; and

(D) For each swap portfolio, including any portfolio containing

futures and/or options and held in a commingled account pursuant to

Sec. 39.15(b)(2) of this part, by beneficial owner.

(8) Customer margin. (i) Gross margin. (A) A derivatives clearing

organization shall collect initial margin on a gross basis for each

clearing member's customer account(s) 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.

(B) For purposes of calculating the gross initial margin

requirement for each clearing member's customer account(s), to the

extent not inconsistent with other Commission regulations, a

derivatives clearing organization may require its clearing members to

report the gross positions of each individual customer to the

derivatives clearing organization, or it may permit each clearing

member to report the sum of the gross positions of its customers to the

derivatives clearing organization.

(C) For purposes of this paragraph (g)(8), a derivatives clearing

organization may rely, and may permit its clearing members to rely,

upon the sum of the gross positions reported to the clearing members by

each domestic or foreign omnibus account that they carry, without

obtaining information identifying the positions of each individual

customer underlying such omnibus accounts.

(D) A derivatives clearing organization may not, and may not permit

its clearing members to, net positions of different customers against

one another.

(E) 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

percent 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 by its clearing

members.

(10) Types of assets. A derivatives clearing organization shall

limit the assets it accepts as initial margin to those that have

minimal credit, market, and liquidity risks. A derivatives clearing

organization may take into account the specific risk-reducing

properties that particular assets have in a particular portfolio. A

derivatives clearing organization may accept letters of credit as

initial margin for futures and options on futures but shall not accept

letters of credit as initial margin for swaps.

(11) Valuation. A derivatives clearing organization shall use

prudent valuation practices to value assets posted as initial margin on

a daily basis.

(12) Haircuts. A derivatives clearing organization shall apply

appropriate reductions in value to reflect credit, market, and

liquidity risks (haircuts), to the assets that it accepts in

satisfaction of initial margin obligations, taking into consideration

stressed market conditions, and shall evaluate the appropriateness of

such haircuts on at least a quarterly basis.

(13) Concentration limits or charges. A derivatives clearing

organization shall apply appropriate limitations or charges 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 or charges, on at least a monthly

basis.

(14) 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.

(h) Other risk control mechanisms-- (1) Risk limits. (i) A

derivatives clearing organization shall impose risk limits on each

clearing member, by house origin and by each customer 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.

[[Page 69440]]

(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

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 or from a relevant designated contract

market or swap execution facility, copies of all reports that are

required to be filed with the Commission by, or on behalf of, such

clearing members pursuant to parts 17 and 20 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 futures, options, and swaps cleared by the

derivatives clearing organization, which are held by 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 futures, options, and swaps cleared by the

derivatives clearing organization, which are held by 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 house origin and by each customer origin, and each

swap portfolio, including any portfolio containing futures and/or

options and held in a commingled account pursuant to Sec. 39.15(b)(2)

of this part, 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. A derivatives clearing organization

shall make portfolio compression exercises available, on a regular and

voluntary basis, for its clearing members that clear swaps, to the

extent that such exercises are appropriate for those swaps that it

clears; provided, however, a derivatives clearing organization is not

required to develop its own portfolio compression services, and is only

required to make such portfolio compression exercises available, if

applicable portfolio compression services have been developed by a

third party.

(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, which address the risks that such

clearing members may pose to the derivatives clearing organization;

(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, which address the risks that such clearing members may pose to

the derivatives clearing organization, 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 swaps;

(ii) Payment and receipt of option premiums;

(iii) Deposit and withdrawal of initial margin for futures,

options, and swaps;

(iv) All payments due in final settlement of futures, options, and

swaps 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 any settlement described in paragraph

(a)(1) above.

(b) Daily settlements. Except as otherwise provided by Commission

order, 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 bank(s) to effect settlements with

its clearing members, as follows:

(1) A derivatives clearing organization shall have documented

criteria that must be met by any settlement bank used by the

derivatives clearing organization or its clearing members, including

criteria addressing the capitalization, creditworthiness, access to

liquidity, operational reliability, and regulation or supervision of

such bank(s).

(2) A derivatives clearing organization shall monitor each approved

settlement

[[Page 69441]]

bank on an ongoing basis to ensure that such bank continues to meet the

criteria established pursuant to paragraph (c)(1) of this section.

(3) A derivatives clearing organization shall monitor the full

range and concentration of its exposures to its own and its clearing

members' settlement bank(s) 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 take any one or more of

the following actions, to the extent that any such action or actions

are reasonably necessary in order to eliminate or strictly limit such

exposures:

(i) Maintain settlement accounts at one or more additional

settlement banks; and/or

(ii) Approve one or more additional settlement banks that its

clearing members could choose to use; and/or

(iii) Impose concentration limits with respect to one or more of

its own or its clearing members' settlement banks; and/or

(iv) Take any other appropriate actions.

(d) Settlement finality. A derivatives clearing organization shall

ensure that settlements are final when effected by ensuring that it has

entered into legal agreements that state that settlement fund transfers

are irrevocable and unconditional no later than when the derivatives

clearing organization's accounts are debited or credited; provided,

however, a derivatives clearing organization's legal agreements with

its settlement banks may provide for the correction of errors. 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 products 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 applicable 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, and swaps. (i) Cleared swaps

account. In order for a derivatives clearing organization and its

clearing members to commingle customer positions in futures, options,

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) Identification of the futures, options, and swaps that would be

commingled, including product specifications or the criteria that would

be used to define eligible futures, options, and swaps;

(B) Analysis of the risk characteristics of the eligible products;

(C) Identification of whether the swaps would be executed

bilaterally and/or executed on a designated contract market and/or a

swap execution facility;

(D) Analysis of the liquidity of the respective markets for the

futures, options, 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, and swaps in a timely

manner, without compromising the financial integrity of the account,

and, as appropriate, proposed means for addressing insufficient

liquidity;

(E) 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, 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, and swaps that

would be commingled;

(I) A description and analysis of the margin methodology that would

be applied to the commingled futures, options, 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, 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, or swaps in the

account; and

(L) A description of the arrangements for obtaining daily position

data with respect to futures, options, 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, 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)(2)(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

[[Page 69442]]

petition filed under paragraph (b)(2)(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 of loss or of

delay in the access by the derivatives clearing organization to such

funds and assets.

(d) Transfer of customer positions. A derivatives clearing

organization shall have rules providing that the derivatives clearing

organization will promptly transfer all or a portion of a customer's

portfolio of positions and related funds at the same time from the

carrying clearing member of the derivatives clearing organization to

another clearing member of the derivatives clearing organization,

without requiring the close-out and re-booking of the positions prior

to the requested transfer, subject to the following conditions:

(1) The customer has instructed the carrying clearing member to

make the transfer;

(2) The customer is not currently in default to the carrying

clearing member;

(3) The transferred positions will have appropriate margin at the

receiving clearing member;

(4) Any remaining positions will have appropriate margin at the

carrying clearing member; and

(5) The receiving clearing member has consented to the transfer.

(e) 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

chapter, 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) 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 a derivatives

clearing organization may have 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 products

and less liquid products. A derivatives clearing organization shall

conduct and document a test of its default management plan at least on

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 house 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 the customer or house positions of the

defaulting clearing member, provided that:

(A) The derivatives clearing organization shall permit a clearing

member to outsource to a qualified third party, authority to act in the

clearing member's place in any auction, subject to appropriate

safeguards imposed by the derivatives clearing organization;

(B) The derivatives clearing organization shall permit a clearing

member to outsource to a qualified third party, authority to act in the

clearing member's place in any allocations, subject to appropriate

safeguards imposed by the derivatives clearing organization; and

(C) Any allocation shall be proportional to the size of the

participating or accepting clearing member's positions in the same

product class at the derivatives clearing organization;

(iv) The sequence in which the funds and assets of the defaulting

clearing member and its customers and the financial resources

maintained by the derivatives clearing organization would be applied in

the event of a default;

(v) A provision that the funds and assets of a defaulting clearing

member's customers shall not be applied to cover losses with respect to

a house default;

(vi) A provision that the excess house funds and assets of a

defaulting clearing member shall be applied to cover losses with

respect to a customer default, if the relevant customer funds and

assets are 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) No later than upon receipt of such notice, a derivatives

clearing organization shall review the continuing eligibility of the

clearing member for clearing membership; and

(3) No later than 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 house or

customer positions, including but not limited to liquidation or

transfer of positions, suspension, or revocation of clearing

membership.

Sec. 39.17 Rule enforcement.

(a) General. Each derivatives clearing organization shall:

(1) Maintain adequate arrangements and resources for the effective

monitoring and enforcement of compliance with the rules of the

derivatives clearing organization and the resolution of disputes;

(2) Have the authority and ability to discipline, limit, suspend,

or terminate the activities of a clearing member due to a violation by

the clearing member of any rule of the derivatives clearing

organization; and

(3) Report to the Commission regarding rule enforcement activities

and sanctions imposed against clearing members as provided in paragraph

(a) (2) of this section, in accordance with Sec. 39.19(c)(4)(xi) of

this part.

(b) Authority to enforce rules. The board of directors of the

derivatives clearing organization may delegate responsibility for

compliance with the requirements of paragraph (a) of this

[[Page 69443]]

section to the risk management committee, unless the responsibilities

are otherwise required to be carried out by the chief compliance

officer pursuant to the Act or this part.

Sec. 39.18 System safeguards.

(a) Definitions. For purposes of this section:

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 products, after those capabilities

become temporarily inoperable for any reason up to or including a wide-

scale disruption.

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 clearing and settlement of existing and new products.

The term ``relevant area'' also includes communities economically

integrated with, adjacent to, or within normal commuting distance of

that metropolitan or other geographic area.

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) General--(1) Program of risk analysis. Each derivatives

clearing organization shall establish and 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) of this section 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) of this section 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

section shall include all of the derivatives clearing organization's

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 Risk

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 Risk 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

[[Page 69444]]

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.

Sec. 39.19 Reporting.

(a) General. Each derivatives clearing organization shall provide

to the Commission the information specified in this section and any

other information that the Commission deems necessary to conduct its

oversight of a derivatives clearing organization.

(b) Submission of reports. (1) Unless otherwise specified by the

Commission or its designee, each derivatives clearing organization

shall submit the information required by this section to the Commission

electronically and in a format and manner specified by the Commission.

(2) Time zones. Unless otherwise specified by the Commission or its

designee, any stated time in this section is Central time for

information concerning derivatives clearing organizations located in

that time zone, and Eastern time for information concerning all other

derivatives clearing organizations.

(3) Unless otherwise specified by the Commission or its designee,

business day means the intraday period of time starting at the business

hour of 8:15 a.m. and ending at the business hour of 4:45 p.m., on all

days except Saturdays, Sundays, and Federal holidays.

(c) Reporting requirements. Each registered derivatives clearing

organization shall provide to the Commission or other person as may be

required or permitted by this paragraph the information specified

below:

(1) Daily reporting. (i) A report containing the information

specified by this paragraph (c)(1), which shall be compiled as of the

end of each trading day and shall be submitted to the Commission by 10

a.m. on the following business day:

(A) Initial margin requirements and initial margin on deposit for

each clearing member, by house origin and by each customer origin;

(B) Daily variation margin, separately listing the mark-to-market

amount collected from or paid to each clearing member, by house origin

and by each customer origin;

(C) All other daily cash flows relating to clearing and settlement

including, but not limited to, option premiums and payments related to

swaps such as coupon amounts, collected from or paid to each clearing

member, by house origin and by each customer origin; and

(D) End-of-day positions for each clearing member, by house origin

and by each customer origin.

(ii) The report shall contain the information required by paragraph

(c)(1)(i) of this section for:

(A) All futures positions, and options positions, as applicable;

(B) All swaps positions; and

(C) All securities positions that are held in a customer account

subject to section 4d of the Act or are subject to a cross-margining

agreement.

(2) Quarterly reporting. A report of the derivatives clearing

organization's financial resources as required by Sec. 39.11(f) of

this part; provided that, additional reports may be required by

paragraph (c)(4)(i) of this section or Sec. 39.11(f) of this part.

(3) Annual reporting--(i) Annual report of chief compliance

officer. The annual report of the chief compliance officer required by

Sec. 39.10 of this part.

(ii) Audited financial statements. Audited year-end financial

statements of the derivatives clearing organization or, if there are no

financial statements available for the derivatives clearing

organization itself, the consolidated audited year-end financial

statements of the derivatives clearing organization's parent company.

(iii) [Reserved]

(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 a 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) Event-specific reporting--(i) Decrease in financial resources.

If there is a decrease of 25 percent in the total value of the

financial resources available to satisfy the requirements under Sec.

39.11(a)(1) of this part, either from the last quarterly report

submitted under Sec. 39.11(f) of this part or from the value as of the

close of the previous business day, the derivatives clearing

organization shall report such decrease to the Commission no later than

one business day following the day the 25 percent threshold was

reached. The report shall include:

(A) The total value of the financial resources:

(1) As of the close of business the day the 25 percent threshold

was reached, and

(2) If reporting a decrease in value from the previous business

day, the total value of the financial resources immediately prior to

the 25 percent decline;

(B) A breakdown of the value of each financial resource reported in

each of paragraphs (c)(4)(i)(A)(1) and (2) of this section, calculated

in accordance with the requirements of Sec. 39.11(d) of this part,

including the value of each individual clearing member's guaranty fund

deposit if the derivatives clearing organization reports guaranty fund

deposits as a financial resource; and

(C) A detailed explanation for the decrease.

(ii) Decrease in ownership equity. No later than two business days

prior to an event which the derivatives clearing organization knows or

reasonably should know will cause a decrease of 20 percent or more in

ownership equity from the last reported ownership equity balance as

reported on a quarterly or audited financial statement required to be

submitted by paragraph (c)(2) or (c)(3)(ii), respectively, of this

section; but in any event no later than two business days after such

decrease in ownership equity for events that caused the decrease about

which the derivatives clearing organization did not know and reasonably

could not have

[[Page 69445]]

known prior to the event. The report shall include:

(A) Pro forma financial statements reflecting the derivatives

clearing organization's estimated future financial condition following

the anticipated decrease for reports submitted prior to the anticipated

decrease and current financial statements for reports submitted after

such a decrease; and

(B) Details describing the reason for the anticipated decrease or

decrease in the balance.

(iii) Six-month liquid asset requirement. Immediate notice when a

derivatives clearing organization knows or reasonably should know of a

deficit in the six-month liquid asset requirement of Sec. 39.11(e)(2).

(iv) Change in current assets. No later than two business days

after current liabilities exceed current assets; the notice shall

include a balance sheet that reflects the derivatives clearing

organization's current assets and current liabilities and an

explanation as to the reason for the negative balance.

(v) Request to clearing member to reduce its positions. Immediate

notice, of a derivatives clearing organization's request to a clearing

member to reduce its positions because the derivatives clearing

organization has determined that the clearing member has exceeded its

exposure limit, has failed to meet an initial or variation margin call,

or has failed to fulfill any other financial obligation to the

derivatives clearing organization. The notice shall include:

(A) The name of the clearing member;

(B) The time the clearing member was contacted;

(C) The number of positions by which the derivatives clearing

organization requested the reduction;

(D) All products that are the subject of the request; and

(E) The reason for the request.

(vi) Determination to transfer or liquidate positions. Immediate

notice, of a determination that any position a derivatives clearing

organization carries for one of its clearing members must be liquidated

immediately or transferred immediately, or that the trading of any

account of a clearing member shall be only for the purpose of

liquidation because that clearing member has failed to meet an initial

or variation margin call or has failed to fulfill any other financial

obligation to the derivatives clearing organization. The notice shall

include:

(A) The name of the clearing member;

(B) The time the clearing member was contacted;

(C) The products that are subject to the determination;

(D) The number of positions that are subject to the determination;

and

(E) The reason for the determination.

(vii) Default of a clearing member. Immediate notice, upon the

default of a clearing member. An event of default shall be determined

in accordance with the rules of the derivatives clearing organization.

The notice of default shall include:

(A) The name of the clearing member;

(B) The products the clearing member defaulted upon;

(C) The number of positions the clearing member defaulted upon; and

(D) The amount of the financial obligation.

(viii) Change in ownership or corporate or organizational

structure. (A) Reporting requirement. Any anticipated change in the

ownership or corporate or organizational structure of the derivatives

clearing organization or its parent(s) that would:

(1) Result in at least a 10 percent change of ownership of the

derivatives clearing organization,

(2) Create a new subsidiary or eliminate a current subsidiary of

the derivatives clearing organization, or

(3) Result in the transfer of all or substantially all of the

assets of the derivatives clearing organization, including its

registration as a derivatives clearing organization to another legal

entity.

(B) Required information. The report shall include: a chart

outlining the new ownership or corporate or organizational structure; a

brief description of the purpose and impact of the change; and any

relevant agreements effecting the change and corporate documents such

as articles of incorporation and bylaws. With respect to a corporate

change for which a derivatives clearing organization submits a request

for approval to transfer its derivatives clearing organization

registration and open interest under Sec. 39.3(f) of this part, the

informational requirements of this paragraph (c)(4)(viii)(B) shall be

satisfied by the derivatives clearing organization's compliance with

Sec. 39.3(f)(3).

(C) Time of report. The report shall be submitted to the Commission

no later than three months prior to the anticipated change; provided

that the derivatives clearing organization may report the anticipated

change to the Commission later than three months prior to the

anticipated change if the derivatives clearing organization does not

know and reasonably could not have known of the anticipated change

three months prior to the anticipated change. In such event, the

derivatives clearing organization shall immediately report such change

to the Commission as soon as it knows of such change.

(D) Confirmation of change report. The derivatives clearing

organization shall report to the Commission the consummation of the

change no later than two business days following the effective date of

the change.

(ix) Change in key personnel. No later than two business days

following the departure, or addition of persons who are key personnel

as defined in Sec. 39.1(b), a report that includes, as applicable, the

name of the person who will assume the duties of the position on a

temporary basis until a permanent replacement fills the position.

(x) Change in credit facility funding arrangement. No later than

one business day after a derivatives clearing organization changes an

existing credit facility funding arrangement it may have in place, or

is notified that such arrangement has changed, including but not

limited to a change in lender, change in the size of the facility,

change in expiration date, or any other material changes or conditions.

(xi) Sanctions. Notice of action taken, no later than two business

days after the derivatives clearing organization imposes sanctions

against a clearing member.

(xii) Financial condition and events. Immediate notice after the

derivatives clearing organization knows or reasonably should have known

of:

(A) The institution of any legal proceedings which may have a

material adverse financial impact on the derivatives clearing

organization;

(B) Any event, circumstance or situation that materially impedes

the derivatives clearing organization's ability to comply with this

part and is not otherwise required to be reported under this section;

or

(C) A material adverse change in the financial condition of any

clearing member that is not otherwise required to be reported under

this section.

(xiii) Financial statements material inadequacies. If a derivatives

clearing organization discovers or is notified by an independent public

accountant of the existence of any material inadequacy in a financial

statement, such derivatives clearing organization shall give notice of

such material inadequacy within 24 hours, and within 48 hours after

giving such notice file a written report stating what steps have been

and are being taken to correct the material inadequacy.

(xiv) [Reserved]

(xv) [Reserved]

(xvi) System safeguards. A report of:

[[Page 69446]]

(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.

(5) Requested reporting. (i) Upon request by the Commission, a

derivatives clearing organization shall file with the Commission such

information related to its business as a clearing organization,

including information relating to trade and clearing details, in the

format and manner specified, and within the time provided, by the

Commission in the request.

(ii) Upon request by the Commission, a derivatives clearing

organization shall file with the Commission a written demonstration,

containing such supporting data, information and documents, that the

derivatives clearing organization is in compliance with one or more

core principles and relevant provisions of this part, in the format and

manner specified, and within the time provided, by the Commission in

the request.

(iii) Upon request by the Commission, a derivatives clearing

organization shall file with the Commission, for each customer origin

of each clearing member, the end-of-day gross positions of each

beneficial owner, in the format and manner specified, and within the

time provided, by the Commission in the request. Nothing in this

paragraph shall affect the obligation of a derivatives clearing

organization to comply with the daily reporting requirements of

paragraph (c)(1) of this section.

Sec. 39.20 Recordkeeping.

(a) Requirement to maintain information. Each derivatives clearing

organization shall maintain records of all activities related to its

business as a derivatives clearing organization. Such records shall

include, but are not limited to, records of:

(1) All cleared transactions, including swaps;

(2) All information necessary to record allocation of bunched

orders for cleared swaps;

(3) All information required to be created, generated, or reported

under this part 39, including but not limited to the results of and

methodology used for all tests, reviews, and calculations in connection

with setting and evaluating margin levels, determining the value and

adequacy of financial resources, and establishing settlement prices;

(4) All rules and procedures required to be submitted pursuant to

this part 39 and part 40 of this chapter, including all proposed

changes in rules, procedures or operations subject to Sec. 40.10 of

this chapter; and

(5) Any data or documentation required by the Commission or by the

derivatives clearing organization to be submitted to the derivatives

clearing organization by its clearing members, or by any other person

in connection with the derivatives clearing organization's clearing and

settlement activities.

(b) Form and manner of maintaining information. (1) General. The

records required to be maintained by this chapter shall be maintained

in accordance with the provisions of Sec. 1.31 of this chapter, for a

period of not less than 5 years, except as provided in paragraph (b)(2)

of this section.

(2) Exception for swap data. Each derivatives clearing organization

that clears swaps must maintain swap data in accordance with the

requirements of part 45 of this chapter.

Sec. 39.21 Public information.

(a) General. Each derivatives clearing organization shall provide

to market participants sufficient information to enable the market

participants to identify and evaluate accurately the risks and costs

associated with using the services of the derivatives clearing

organization. In furtherance of this objective, each derivatives

clearing organization shall have clear and comprehensive rules and

procedures.

(b) Availability of information. Each derivatives clearing

organization shall make information concerning the rules and the

operating and default procedures governing the clearing and settlement

systems of the derivatives clearing organization available to market

participants.

(c) Public disclosure. Each derivatives clearing organization shall

disclose publicly and to the Commission information concerning:

(1) The terms and conditions of each contract, agreement, and

transaction cleared and settled by the derivatives clearing

organization;

(2) Each clearing and other fee that the derivatives clearing

organization charges its clearing members;

(3) The margin-setting methodology;

(4) The size and composition of the financial resource package

available in the event of a clearing member default;

(5) Daily settlement prices, volume, and open interest for each

contract, agreement, or transaction cleared or settled by the

derivatives clearing organization;

(6) The derivatives clearing organization's rules and procedures

for defaults in accordance with Sec. 39.16 of this part; and

(7) Any other matter that is relevant to participation in the

clearing and settlement activities of the derivatives clearing

organization.

(d) Publication of information. The derivatives clearing

organization shall make its rulebook, a list of all current clearing

members, and the information listed in paragraph (c) of this section

readily available to the general public, in a timely manner, by posting

such information on the derivatives clearing organization's Web site,

unless otherwise permitted by the Commission. The information required

in paragraph (c)(5) of this section shall be made available to the

public no later than the business day following the day to which the

information pertains.

Sec. 39.22 Information sharing.

Each derivatives clearing organization shall enter into, and abide

by the terms of, each appropriate and applicable domestic and

international information-sharing agreement, and shall use relevant

information obtained from each such agreement in carrying out the risk

management program of the derivatives clearing organization.

Sec. 39.23 Antitrust considerations.

Unless necessary or appropriate to achieve the purposes of the Act,

a derivatives clearing organization shall not adopt any rule or take

any action that results in any unreasonable restraint of trade, or

impose any material anticompetitive burden.

Sec. 39.24 [Reserved]

Sec. 39.25 [Reserved]

Sec. 39.26 [Reserved]

Sec. 39.27 Legal risk considerations.

(a) Legal authorization. A derivatives clearing organization shall

be duly organized, legally authorized to conduct business, and remain

in good standing at all times in the relevant jurisdictions. If the

derivatives clearing organization provides clearing services outside

the United States, it shall be duly organized to conduct business and

remain in good standing at all times in the relevant jurisdictions, and

be authorized by the appropriate foreign licensing authority.

(b) Legal framework. A derivatives clearing organization shall

operate pursuant to a well-founded, transparent, and enforceable legal

framework that addresses each aspect of the activities of the

derivatives clearing organization. As applicable, the framework shall

provide for:

(1) The derivatives clearing organization to act as a counterparty,

including novation;

(2) Netting arrangements;

(3) The derivatives clearing organization's interest in collateral;

[[Page 69447]]

(4) The steps that a derivatives clearing organization would 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 (no later than when a derivatives

clearing organization's accounts are debited and credited); and

(6) Other significant aspects of the derivatives clearing

organization's operations, risk management procedures, and related

requirements.

(c) Conflict of laws. If a derivatives clearing organization

provides clearing services outside the United States:

(1) The derivatives clearing organization shall identify and

address any material conflict of law issues. The derivatives clearing

organization's contractual agreements shall specify a choice of law.

(2) The derivatives clearing organization shall be able to

demonstrate the enforceability of its choice of law in relevant

jurisdictions and that its rules, procedures, and contracts are

enforceable in all relevant jurisdictions.

Appendix to Part 39--Form DCO Derivatives Clearing Organization

Application for Registrations

BILLING CODE 6351-01-P

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BILLING CODE 6351-01-C

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

0

9. The authority citation for part 140 continues to read as follows:

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

0

10. Amend Sec. 140.94 by revising the section heading and paragraph

(a)(5), redesignating paragraph (a)(6) as paragraph (a)(7), revise

newly redesignated paragraph (a)(7), and add new paragraphs (a)(6) and

(a)(8) through (a)(14) to read as follows:

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

of Clearing and Risk.

(a) * * *

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

chapter;

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

39.3(a)(2) and (a)(3) of this chapter;

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

39.5(b)(2), (b)(3)(ix), and (d)(3) of this chapter;

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

39.10(c)(4)(iv) of this chapter;

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

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

chapter;

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

39.12(a)(5)(i)(B) of this chapter;

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

39.13(g)(8)(ii), (h)(1)(i)(C), (h)(1)(ii), (h)(3)(i), (h)(3)(ii), and

(h)(5)(i)(A) of this chapter;

(12) The authority to request additional information in support of

a rule submission under Sec. 39.15(b)(2)(iii)(A) of this chapter and

in support of a petition pursuant to section 4d of the Act under Sec.

39.15(b)(2)(iii)(B) of this chapter;

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

39.19(c)(3)(iv), (c)(5)(i), (c)(5)(ii), and (c)(5)(iii) of this

chapter; and

(14) All functions reserved to the Commission in Sec. 39.21(d) of

this chapter.

Issued in Washington, DC, on October 18, 2011, by the

Commission.

David A. Stawick,

Secretary of the Commission.

Appendices to Derivatives Clearing Organization General Provisions and

Core Principles--Commission Voting Summary and Statements of

Commissioners

Note: The following appendices will not appear in the Code of

Federal Regulations

[[Page 69473]]

Appendix 1--Commission Voting Summary

On this matter, Chairman Gensler and Commissioners Dunn and Chilton

voted in the affirmative; Commissioners Sommers and O'Malia voted in

the negative.

Appendix 2--Statement of Chairman Gary Gensler

I support the final rulemaking on core principles for derivatives

clearing organizations (DCOs)