2012-12746

Federal Register, Volume 77 Issue 118 (Tuesday, June 19, 2012)[Federal Register Volume 77, Number 118 (Tuesday, June 19, 2012)]

[Rules and Regulations]

[Pages 36611-36726]

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

[FR Doc No: 2012-12746]

[[Page 36611]]

Vol. 77

Tuesday,

No. 118

June 19, 2012

Part II

Commodity Futures Trading Commission

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17 CFR Parts 1, 16, and 38

Core Principles and Other Requirements for Designated Contract Markets;

Final Rule

Federal Register / Vol. 77, No. 118 / Tuesday, June 19, 2012 / Rules

and Regulations

[[Page 36612]]

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COMMODITY FUTURES TRADING COMMISSION

17 CFR Parts 1, 16, and 38

RIN 3038-AD09

Core Principles and Other Requirements for Designated Contract

Markets

AGENCY: Commodity Futures Trading Commission.

ACTION: Final rule.

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SUMMARY: The Commodity Futures Trading Commission (``Commission'' or

``CFTC'') is adopting new and amended rules, guidance, and acceptable

practices to implement certain statutory provisions enacted by Title

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

(``Dodd-Frank Act''). The final rules, guidance and acceptable

practices, which apply to the designation and operation of contract

markets, implement the Dodd-Frank Act's new statutory framework that,

among other things, amends section 5 of the Commodity Exchange Act

(``the Act'' or ``CEA'') concerning designation and operation of

contract markets, and adds a new CEA section 2(h)(8) to mandate the

listing, trading and execution of certain swaps on designated contract

markets (``DCMs'').

DATES: Effective date: The rules will become effective August 20, 2012.

Compliance date: The compliance date for contract markets that have

obtained designation on, or prior to, the date of publication of this

release: Designated contract markets must comply with the rules adopted

in this release (except Sec. 38.151(a)) by October 17, 2012; and must

comply with Sec. 38.151(a) in accordance with the timeline described

in SUPPLEMENTARY INFORMATION.

FOR FURTHER INFORMATION CONTACT: Nancy Markowitz, Deputy Director, 202-

418-5453, [email protected], Nadia Zakir, Special Counsel, 202-418-

5720, [email protected], or Aaron Brodsky, Attorney-Advisor, 202-418-

5349, [email protected], Division of Market Oversight, Commodity

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

NW., Washington, DC 20581.

SUPPLEMENTARY INFORMATION:

Table of Contents

I. Background

A. Title VII of the Dodd-Frank Act

B. The Dodd-Frank Act Amendments Applicable to Designated

Contract Markets

II. Final Rules

A. Repeal of Designation Criteria

B. Adoption of Rules and Revised Guidance and Acceptable

Practices

C. General Regulations (Subpart A)

1. Sec. 38.1-Scope

2. Sec. 38.2-Exempt Provisions

3. Sec. 38.3--Procedures for Designation

4. Sec. 38.4--Procedures for Listing Products and Implementing

Designated Contract Market Rules

5. Sec. 38.5--Information Relating to Contract Market

Compliance

6. Sec. 38.7--Prohibited Use of Data Collected for Regulatory

Purposes

7. Sec. 38.8--Listing of Swaps on a Designated Contract Market

8. Sec. 38.9--Boards of Trade Operating Both a Designated

Contract Market and a Swap Execution Facility

9. Sec. 38.10--Reporting of Swaps Traded on a Designated

Contract Market

D. Core Principles

1. Subpart B--Designation as Contract Market

2. Subpart C--Compliance With Rules

i. Sec. 38.150--Core Principle 2

ii. Sec. 38.151--Access Requirements

iii. Sec. 38.152--Abusive Trading Practices Prohibited

iv. Sec. 38.153--Capacity to Detect and Investigate Rule

Violations

v. Sec. 38.154--Regulatory Services Provided by a Third Party

vi. Sec. 38.155--Compliance Staff and Resources

vii. Sec. 38.156--Automated Trade Surveillance System

viii. Sec. 38.157--Real-Time Market Monitoring

ix. Sec. 38.158--Investigations and Investigation Reports

x. Sec. 38.159--Ability to Obtain Information

xi. Sec. 38.160--Additional Sources for Compliance

3. Subpart D--Contracts Not Readily Subject to Manipulation

4. Subpart E--Prevention of Market Disruption

i. Sec. 38.251--General Requirements

ii. Sec. 38.252--Additional Requirements for Physical-Delivery

Contracts

iii. Sec. 38.253--Additional Requirements for Cash-Settled

Contracts

iv. Sec. 38.254--Ability to Obtain Information

v. Sec. 38.255--Risk Controls for Trading

vi. Sec. 38.256--Trade Reconstruction

vii. Sec. 38.257--Regulatory Service Provider

viii. Sec. 38.258--Additional Sources for Compliance

5. Subpart F--Position Limitations or Accountability

6. Subpart G--Emergency Authority

7. Subpart H--Availability of General Information

i. Sec. 38.401(a)--General

ii. Sec. 38.401(b)--Accuracy Requirement

iii. Sec. 38.401(c)--Notice of Regulatory Submissions

iv. Sec. 38.401(d)--Rulebook

8. Subpart I--Daily Publication of Trading Information

9. Subpart J--Execution of Transactions

10. Subpart K--Trade Information

i. Sec. 38.551--Audit Trail Required

ii. Sec. 38.552--Elements of an Acceptable Audit Trail Program

iii. Sec. 38.553--Enforcement of Audit Trail Requirements

11. Subpart L--Financial Integrity of Transactions

i. Sec. 38.601--Mandatory Clearing

ii. Sec. 38.602--General Financial Integrity

iii. Sec. 38.603--Protection of Customer Funds

iv. Sec. 38.604--Financial Surveillance

v. Sec. 38.605--Requirements for Financial Surveillance Program

vi. Sec. 38.606--Financial Regulatory Services Provided by a

Third Party

vii. Sec. 38.607--Direct Access

12. Subpart M--Protection of Markets and Market Participants

i. Sec. 38.651--Additional Sources for Compliance

13. Subpart N--Disciplinary Procedures

i. Sec. 38.701--Enforcement Staff

ii. Sec. 38.702--Disciplinary Panels

iii. Sec. 38.703--Review of Investigation Report

iv. Sec. 38.704--Notice of Charges

v. Sec. 38.705--Right to Representation

vi. Sec. 38.706--Answer to Charges

vii. Sec. 38.707--Admission or Failure To Deny Charges

viii. Sec. 38.708--Denial of Charges and Right to Hearing

ix. Sec. 38.709--Settlement Offers

x. Sec. 38.710--Hearings

xi. Sec. 38.711--Decisions

xii. Sec. 38.712--Right To Appeal

xiii. Sec. 38.713--Final Decisions

xiv. Sec. 38.714--Disciplinary Sanctions

xv. Sec. 38.715--Summary Fines

xvi. Sec. 38.716--Emergency Disciplinary Actions

14. Subpart O--Dispute Resolution

15. Subpart P--Governance Fitness Standards

16. Subpart Q--Conflicts of Interest

17. Subpart R--Composition of Governing Boards of Contract

Markets

18. Subpart S--Recordkeeping

i. Sec. 38.951--Additional Sources for Compliance

19. Subpart T--Antitrust Considerations

20. Subpart U--System Safeguards

i. Sec. 38.1051--General Requirements

21. Subpart V--Financial Resources

i. Sec. 38.1100(a)--Core Principle 21, and Sec. 38.1101(a) and

(c)--General Rule and Computation of Financial Resources Requirement

ii. Sec. 38.1101(b)--Types of Financial Resources

iii. Sec. 38.1101(d)--Valuation of Financial Resources

iv. Sec. 38.1101(e)--Liquidity of Financial Resources

v. Sec. 38.1101(f)--Reporting Requirements

22. Subpart W--Diversity of Boards of Directors

23. Subpart X--Securities and Exchange Commission

i. Sec. 38.1200 (Core Principle 23), Sec. 38.1201 (Additional

Sources for Compliance), and Guidance in Appendix B.

III. Related Matters

A. Regulatory Flexibility Act

B. Paperwork Reduction Act

C. Cost Benefit Considerations

IV. Text of Final Rules

I. Background

A. Title VII of the Dodd-Frank Act

On July 21, 2010, President Obama signed the Dodd-Frank Wall Street

[[Page 36613]]

Reform and Consumer Protection Act.\1\ Title VII of the Dodd-Frank Act

\2\ amended the CEA\3\ to establish a comprehensive, new regulatory

framework for swaps and security-based swaps. The legislation was

enacted 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 robust recordkeeping and real-time reporting regimes; and (4)

enhancing the Commission's rulemaking and enforcement authorities with

respect to, among others, 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) (``Dodd-Frank Act'').

\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. (amended 2010).

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B. The Dodd-Frank Act Amendments Applicable to Designated Contract

Markets

In this final rulemaking, the Commission is establishing the

regulatory obligations that each DCM must meet in order to comply with

section 5 of the CEA, as amended by the Dodd-Frank Act, initially upon

designation and thereafter on an ongoing basis.

Section 735 of the Dodd-Frank Act amended section 5 of the CEA

pertaining to the designation and operation of contract markets, by:

(i) Eliminating the eight criteria that must be met for designation as

a contract market, contained in former section 5(b) of the CEA; (ii)

amending most of the core principles, including incorporating most of

the substantive elements of the former designation criteria, and

requiring that all DCMs demonstrate compliance with each of the core

principles as a condition of obtaining and maintaining designation as a

contract market; and (iii) adding five new core principles, including

Core Principle 13 (Disciplinary Procedures), Core Principle 20 (System

Safeguards), Core Principle 21 (Financial Resources), Core Principle 22

(Diversity of Boards of Directors), and Core Principle 23 (Securities

and Exchange Commission).\4\

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\4\ New Core Principle 13 is verbatim of former Designation

Criterion 6.

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In addition, section 723(a)(3) of the Dodd-Frank Act added section

2(h)(8) of the CEA to require, among other things, that swaps that are

required to be cleared must be executed either on a DCM or on a Swap

Execution Facility (``SEF''),\5\ unless no DCM or SEF makes the swap

``available to trade.'' \6\ Section 5h(a)(1) of the CEA, as amended by

the Dodd-Frank Act, also prohibits any person from operating a facility

for the trading and processing of swaps unless the facility is

registered as a SEF or a DCM. Accordingly, unless otherwise specified

in this release, each of the 23 core principles and the final

implementing regulations, guidance and acceptable practices, apply to

all ``contracts'' listed on a DCM, which will include swaps, futures

and options contracts. The rules adopted in this release also implement

relevant provisions related to the trading and execution of swaps on

DCMs.

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\5\ The Commission proposed rules governing the registration and

operation of SEFs in a separate, rulemaking titled ``Core Principles

and Other Requirements for Swap Execution Facilities.'' 76 FR 1214,

Jan. 7, 2011. The core principles applicable to DCMs pursuant to

section 5 of the Act and the core principles applicable to swap

execution facilities pursuant to section 5h of the Act include, in a

number of instances, similar or identical language. Although the

Commission's interpretation of specific language in section 5 of the

Act may inform its interpretation of similar or identical language

in section 5h of the Act, and vice versa, the Commission may

interpret the core principles applicable to each category of

registered entity in light of that category's unique market

characteristics and regulatory functions and responsibilities.

\6\ See section 723(a) of the Dodd-Frank Act. The Commission

separately proposed rules implementing the ``made available to

trade'' mandate. See 76 FR 77728, Dec. 14, 2011.

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On December 22, 2010, the Commission published proposed regulations

to implement the statutory provisions of the Dodd-Frank Act relevant to

the designation and operation of DCMs (``DCM NPRM''), under part 38 of

the Commission's regulations.\7\

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\7\ 75 FR 80572, Dec. 22, 2010 (``DCM NPRM''). The DCM NPRM also

proposed revisions to related regulations under parts 1 and 16.

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The proposed rulemaking was subject to an initial 60-day comment

period, which closed on February 22, 2011. The comment period was

subsequently reopened on two separate occasions, each time for an

additional 30 days.\8\ The Commission received numerous written

comments from members of the public, and Commission staff participated

in several meetings with market participants, including representatives

of both currently-designated and prospective contract markets.\9\

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\8\ See 76 FR 14825, Mar. 18, 2011; see also 76 FR 25274, May 4,

2011.

\9\ The Commission received comment letters from numerous

parties, including the following: ACM Capital Management; Alice

Corporation; Alternative Investment Management Association; American

Bankers Association and ABA Securities Association; American Gas

Association; Argus Media, Inc. (``Argus''); Better Markets, Inc.

(``Better Markets''); BJ D'Milli; BlackRock, Inc. (``BlackRock'');

Bloomberg; CBOE Futures Exchanges (``CFE''); CME Group Inc.

(``CME'') (CME's comments were submitted on behalf of its four DCMs:

the Chicago Mercantile Exchange, Inc., the Board of Trade of the

City of Chicago, Inc., the New York Mercantile Exchange, Inc., and

the Commodity Exchange, Inc.); Citadel; Committee on Capital Markets

Regulation; Committee on Futures and Derivatives Regulation of the

New York City Bar Association; DC Energy; The Depository Trust &

Clearing Corporation; East Coast Petroleum; ELX Futures, L.P.

(``ELX''); Eris Exchange, LLC (``Eris''); Electric Trade

Association; FIA/FSR/IIB/IRI/ISDA/SIFMA/US Chamber of Commercial

(jointly); Green Exchange LLC (``GreenX''); ICAP;

IntercontinentalExchange, Inc. (``ICE'') (ICE's comments were

submitted on behalf of its four regulated futures exchanges: ICE

Future US, Chicago Climate Futures Exchange, ICE Futures Europe, and

ICE Futures Canada); International Swaps and Derivatives Association

(``ISDA''); Kansas City Board of Trade (``KCBT''); Markit;

MarkitSERV; Minneapolis Grain Exchange, Inc. (``MGEX''); Noble

Energy; NYSE Liffe US LLC (``NYSE Liffe''); Nodal Exchange, LLC

(``Nodal''); Todd Petzel; OneChicago LLC Futures Exchange (``OCX'');

Swaps and Derivatives Market Association; Tradeweb; Trading

Technologies International, Inc. (``Trading Technologies'');

Wholesale Markets Brokers' Association; Working Group of Commercial

Energy Firms (Hunton and Williams); and joint letter from CME, NYSE

Liffe, GreenX, Eris Exchange, CBOE Futures Exchange, KCBT and MGEX

(``CME Joint Comment Letter''). A number of comment letters solely

addressed the implementation phasing for Dodd-Frank rulemakings.

Those comments are outside the scope of this rulemaking and are more

appropriate to the recent rulemaking pertaining to ``Swap

Transaction Compliance and Implementation Schedule: Clearing and

Trade Execution Requirements under section 2(h) of the CEA.'' See 76

FR 58186, Sep. 20, 2011.

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In this notice of final rulemaking, the Commission is adopting many

of the proposed rules, guidance, and acceptable practices. However, as

a result of the written comments received and dialogue with market

participants, the Commission has revised and/or eliminated a number of

regulations that were proposed in the DCM NPRM, and in a number of

instances, has codified guidance and/or acceptable practices in lieu of

the proposed rules.

The Commission also received a number of comments pertaining to the

costs and/or benefits of certain proposed regulations. The Commission

has undertaken an extensive review of the costs and benefits of the

regulations being adopted in this release pursuant to section 15(a) of

the CEA,\10\ as is further discussed in the cost benefit consideration

section of this final rulemaking. As discussed in that section, the

Commission has determined that the final rules appropriately balance

the costs and benefits associated with oversight of DCMs pursuant to

the

[[Page 36614]]

CEA, as amended by the Dodd-Frank Act.

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\10\ 7 U.S.C. 19.

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The Commission is hereby adopting final regulations to implement

section 5 of the CEA, as well as the requirements of sections 2(h)(8)

and 5h(a)(1) of the CEA, as amended by the Dodd-Frank Act, as

applicable to DCMs. The final regulations will eliminate the guidance

on compliance with the designation criteria for DCMs, implement new and

revised regulations for the core principles, and codify certain

requirements and practices that have evolved over the years and are

commonly accepted in the industry.

The final regulations adopted herein will become effective 60 days

after publication in the Federal Register. Contract markets that have

obtained designation prior to or at the time of the publication of this

release must comply with the new and revised rules adopted in this

release, except Sec. 38.151(a), within 60 days of the effective date

of this release; and must comply with Sec. 38.151(a) in accordance

with the timeline described in the discussion of that rule below.

II. Final Rules

A. Repeal of Designation Criteria

Section 735 of the Dodd-Frank Act eliminated the eight DCM

designation criteria in former CEA section 5(b), and largely

incorporated the substance of those criteria into the core principles.

Accordingly, the Commission is eliminating the guidance on compliance

with the designation criteria for DCMs contained in appendix A to part

38.\11\

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\11\ As proposed in the DCM NPRM, appendix A to part 38 will

contain the application form for contract market designation.

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B. Adoption of Rules and Revised Guidance and Acceptable Practices

To implement section 735 of the Dodd-Frank Act, the Commission

proposed a number of new and revised rules, guidance, and acceptable

practices to implement the new and revised core principles. As

described in the DCM NPRM, the Commission evaluated the preexisting

regulatory framework for overseeing DCMs, which consisted largely of

guidance and acceptable practices, in order to update those provisions

and to determine which core principles would benefit from having new or

revised derivative regulations. Based on that review, and in view of

the Dodd-Frank Act's amendments to section 5(d)(1) of the CEA,\12\

which specifically provides the Commission with discretion to

determine, by rule or regulation, the manner in which boards of trade

comply with the core principles, the Commission proposed revised

guidance and acceptable practices for some core principles and, for

several core principles, proposed to codify rules in lieu of guidance

and acceptable practices.\13\

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\12\ Former Core Principle 1 stated, among other things, that

boards of trade ``shall have reasonable discretion in establishing

the manner in which they comply with the core principles.'' This

``reasonable discretion'' provision underpinned the Commission's use

of core principle guidance and acceptable practices. Section 735 of

the Dodd-Frank Act amended this provision to include the proviso

that ``[u]nless otherwise determined by the Commission by rule or

regulation * * *,'' boards of trade shall have reasonable discretion

in establishing the manner in which they comply with the core

principles. See 7 U.S.C. 7(d)(1)(amended 2010).

\13\ Guidance provides DCMs and DCM applicants with contextual

information regarding the core principles, including important

concerns which the Commission believes should be taken into account

in complying with specific core principles. In contrast, the

acceptable practices are more specific than guidance and provide

examples of how DCMs may satisfy particular requirements of the core

principles; they do not, however, establish mandatory means of

compliance. Acceptable practices are intended to assist DCMs by

establishing non-exclusive safe harbors. The safe harbors apply only

to compliance with specific aspects of the core principle, and do

not protect the contract market with respect to charges of

violations of other sections of the CEA or other aspects of the core

principle.

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Summary of Comments

The Commission received a number of comments generally pertaining

to the proposed codification of rules in lieu of guidance and/or

acceptable practices. Several commenters contended that the principles-

based regime has permitted the U.S. futures markets to prosper and keep

pace with rapidly changing technology and market needs, and that a

rules-based regime will stifle growth, innovation, and competition.\14\

Others noted that the futures markets' resilience throughout the

financial crisis is evidence in support of the effectiveness of a

principles-based regime.\15\ Commenters also argued that the

prescriptive nature of the rules will result in increased costs for

DCMs and for the Commission \16\ and that current industry best

practices are subject to change and are only able to evolve through

continuous improvement and innovation, which is only possible under a

flexible regime.\17\ Several commenters provided comments on the

codification of specific rules in lieu of guidance and/or acceptable

practices, which are addressed below, in the discussion of the

respective rules.

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\14\ CME Comment Letter at 3-4 (Feb. 22, 2011); Eris Comment

Letter at 1-2 (Feb. 22, 2011); GreenX Comment Letter at 1 (Feb. 22,

2011); ICE Comment Letter at 3 (Feb. 22, 2011); KCBT Comment Letter

at 1, 9 (Feb. 22, 2011).

\15\ CME Comment Letter at 3 (Feb. 22, 2011); ICE Comment Letter

at 2 (Feb. 22, 2011); KCBT Comment Letter at 9 (Feb. 22, 2011); Eris

Comment Letter at 3 (June 3, 2011).

\16\ CME Comment Letter at 3 (Feb. 22, 2011); GreenX Comment

Letter at 2 (Feb. 2, 2011); MGEX Comment Letter at 2 (Feb. 22,

2011).

\17\ CME Comment Letter at 3 (Feb. 22, 2011); GreenX Comment

Letter at 2, 11 (Feb. 22, 2011).

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Discussion

This final rulemaking largely adopts the framework of rules,

guidance and acceptable practices that was proposed in the DCM NPRM,

with certain substantive revisions to the regulations, as described in

this release. For several core principles, the Commission is

maintaining the rules, guidance and acceptable practices, as proposed,

with appropriate revisions arising from the Commission's consideration

of comments. In several instances, this final rulemaking converts

proposed rules to guidance and/or acceptable practices for various DCM

compliance practices.

In determining whether to codify a compliance practice in the form

of a rule or guidance/acceptable practice, the Commission was guided by

whether the practice consisted of a commonly-accepted industry

practice. Where there is a standard industry practice that the

Commission has determined to be an acceptable compliance practice, the

Commission believes that the promulgation of clear-cut regulations will

provide greater legal certainty and transparency to DCMs in determining

their compliance obligations, and to market participants in determining

their obligations as DCM members, and will facilitate the enforcement

of such provisions. Several of the rules adopted in this notice of

final rulemaking largely codify practices that are commonly accepted in

the industry and are currently being undertaken by most, if not all,

DCMs.

In the context of each individual rule, the Commission also was

guided by comments that provided a basis for greater flexibility or, in

some instances, for greater specificity, in respect to the stated

compliance obligation.

In addition, the Commission's determination to codify certain

compliance practices as rules, rather than as guidance/acceptable

practices, is based on its long experience in regulating DCMs. In

numerous instances, the rules codify practices that have evolved from

the Division of Market Oversight's (``DMO'') recommendations in the

context of Rule Enforcement Reviews (``RERs'').\18\

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\18\ As noted in the DCM NPRM, the RERs are the cornerstone of

the Commission's oversight program, serving as a key tool for

monitoring a DCM's compliance with the core principles, and also as

a primary means for identifying industry trends and DCM best

practices for self-regulation. See DCM NPRM at 80574-75 for a more

detailed discussion of RERs.

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[[Page 36615]]

Some commenters claimed that the Commission's approach was overly

prescriptive and inconsistent with the core principle framework.\19\

While maintaining the core principle framework as part of the Dodd-

Frank Act, Congress revised DCM Core Principle 1 to specifically

provide the Commission with discretion to determine, by rule or

regulation, the manner in which boards of trade are to comply with the

core principles.\20\ Accordingly, in circumstances where a standard

industry practice has developed, the Commission is adopting rules in

order to provide greater legal certainty and transparency to DCMs and

market participants. In other circumstances, the Commission is

maintaining the guidance and acceptable practices framework,

particularly where the Commission experienced that a standard

compliance approach has not evolved within the industry over the years.

In those instances, the final regulations maintain the flexibility for

DCMs to determine the specific manner in which they choose to satisfy

their compliance obligations.

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\19\ See e.g., CME Comment Letters (Feb. 22, 2011, Apr. 18,

2011, Jun. 3, 2011 and Aug. 3, 2011); MGEX Comment Letter (Jun. 3,

2011); GreenX Comment Letter (Feb. 22, 2011).

\20\ 7 U.S.C. 7(d)(1)(amended 2010).

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Several commenters claimed that the codification of additional

rules will increase the Commission's costs of regulating DCMs. The

Commission believes that a regulatory framework consisting of a higher

proportion of rules, in addition to guidance and acceptable practices,

may in fact be less costly to administer, as DCMs will have a clear

understanding of what is required in order to demonstrate compliance

with the core principles. The costs and benefits of this final

rulemaking are described further in the Cost Benefit Consideration

discussion of this release.

C. General Regulations (Subpart A)

The regulations in this final rulemaking are codified in a series

of subparts under part 38. The general regulations consisting of

Sec. Sec. 38.1 through 38.10 \21\ are codified in subpart A, and the

regulations applicable to each of the 23 core principles are codified

in subparts B through X, respectively.\22\

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\21\ The DCM NPRM did not propose any revisions to Sec. 38.6 of

the Commission's regulations.

\22\ Each of these subparts begins with a regulation containing

the language of the core principle.

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1. Sec. 38.1--Scope

The Commission proposed non-substantive revisions to Sec. 38.1

that corrected cross-references to other sections of the Commission's

regulations. Section 38.1 is adopted as proposed.

2. Sec. 38.2--Applicable Provisions

Proposed Sec. 38.2 specified the Commission regulations that are

applicable to DCMs. In addition to revising the heading, the proposed

revisions to Sec. 38.2 updated the list of Commission regulations that

are applicable to DCMs, including the relevant regulations that have

been codified, or are proposed to be codified, upon the Commission's

finalization of the relevant rulemakings that culminated upon enactment

of the Dodd-Frank Act. These included regulations relating to real-time

reporting of swaps and the determination of appropriate block size for

swaps under part 43, requirements for swap data recordkeeping and

reporting under part 45, designation requirements for swap data

repositories under part 49, and position limits under part 150 and/or

part 151, as applicable.

Discussion

The Commission is revising Sec. 38.2 to specify the Commission

regulations from which DCMs will be exempt. The original intent of

Sec. 38.2 was to exempt DCMs from various Commission regulations under

Title 17 that were codified prior to the CFMA. Proposed Sec. 38.2

listed the specific regulations with which DCMs were required to

comply, with the understanding that the DCM was exempt from those not

listed. In this final rulemaking, to add clarity, the Commission is

revising the title of the rule to ``Exempt Provisions'' and is

modifying Sec. 38.2 to reflect the list of regulations from which DCMs

are exempt. Those regulations include: Sec. 1.35(e)-(j), Sec.

1.39(b), Sec. 1.44, Sec. 1.53, Sec. 1.54, Sec. 1.59(b) and (c),

Sec. 1.62, Sec. 1.63(a) and (b) and (d) and(f), Sec. 1.64, Sec.

1.69, part 8, Sec. 100.1, Sec. 155.2, and part 156. While Sec. 38.2

likely will be amended if and when the referenced rules are eliminated

from the regulations or modified, this revised approach will eliminate

the need for the Commission to continually update Sec. 38.2 when new

regulations with which DCMs must comply are codified.

3. Sec. 38.3--Procedures for Designation

Sec. 38.3(a)--Application Procedures

Among the proposed revisions to Sec. 38.3, which contains the

application and designation procedures for DCM applicants, the

Commission proposed to eliminate the 90-day expedited review procedures

for DCM applications, which currently are codified in Sec. 38.3(a)(2).

The proposed modification would result in all DCM applications being

subject to the statutory 180-day review procedures provided under

section 6(a) of the CEA and Sec. 38.3(a)(1) of the Commission's

regulations.\23\

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\23\ 7 U.S.C. 8(a).

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As noted above, the Dodd-Frank Act eliminated the standalone DCM

designation criteria. Accordingly, the Commission proposed re-

designating appendix A to include a new DCM application form (``Form

DCM'') that contains comprehensive instructions and a list of necessary

information and documentation required to initiate a DCM designation

proceeding. All new applicants seeking designation would submit to the

Commission a completed form, including the information required in each

exhibit.\24\

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\24\ Form DCM would also be used by applicants amending a

pending application and existing DCMs applying for an amendment to

their order of designation.

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The DCM NPRM also proposed certain revisions to Sec. 38.3 that

would require DCM applications and certain related DCM filings to be

filed with the Secretary of the Commission in an electronic format, via

the Internet, email, or other means of direct electronic submission as

approved by the Commission.\25\

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\25\ The proposed electronic filing requirements would

specifically apply to DCM applications, reinstatements, requests for

transfer of designations, requests for withdrawal of application for

designation, and vacation of designations. As explained in the DCM

NPRM, the proposed revisions would make the DCM application filing

process consistent with the electronic process used for filing rule

and product submissions under parts 39 and 40 of the Commission's

regulations. See 17 CFR parts 39 and 40. In addition to these

substantive revisions, many of the proposed revisions to Sec. 38.3

were non-substantive and were intended to clarify the rule.

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Summary of Comments

Two commenters discussed the proposed elimination of the 90-day

expedited review process for DCM applications in Sec. 38.3(a)(1).

Nodal expressed support for the proposed elimination of the 90-day

review procedures.\26\ Eris opposed the proposed elimination and

commented, among other things, that Form DCM should result in a

streamlined and standardized review process and that eliminating the

90-day accelerated review process would place new entities at a

competitive disadvantage because it

[[Page 36616]]

would delay their time to market, which is critical for new

entrants.\27\

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\26\ Nodal Comment Letter at 5 (Feb. 22, 2011).

\27\ Eris Comment Letter at 4 (Feb. 22, 2011).

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Discussion

The Commission is adopting proposed Sec. 38.3(a) with one

modification.

As described in the DCM NPRM, the Commission proposed eliminating

the 90-day accelerated review process based on its experience in

processing DCM applications. Specifically, the Commission has found

that in the interest of meeting the expedited approval timeline,

applicants seeking expedited review often filed incomplete or draft

applications without adequate supporting materials. Accordingly, the

90-day review process required the expenditure of significant

Commission resources as well as the applicant's resources, and often

resulted in placing the DCM designation requests on the 180-day review

track. It is the Commission's view that the 180-day review period is a

more reasonable timeframe for the review of designation requests and

will result in more efficient use of the applicant's and the

Commission's resources.

In regards to Eris' specific claim that elimination of the 90-day

accelerated review process would place new entities at a competitive

disadvantage by delaying their time to market, the Commission notes

that eliminating the 90-day review process will not prevent Commission

staff from reviewing and/or rendering a determination on a DCM

application before the 180-day period ends, particularly in instances

where a DCM application is substantially complete, does not raise novel

issues, and/or where a DCM applicant timely provides supplemental or

follow-up responses or documentation necessary for a designation

determination.\28\ Similarly, while the Commission recognizes that Form

DCM will provide the added benefit of a more streamlined and

standardized procedure for submitting and reviewing DCM applications,

such benefits will not necessarily result in an expedited Commission

determination. Rather, the completeness of the application and timely

response to Commission staff's requests will determine the timeframe

within which the Commission reviews a DCM application.

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\28\ Section 6(a) of the Act provides that ``the Commission

shall approve or deny an application for designation or registration

as a contract market * * * within 180 days of the filing of the

application.'' 7 U.S.C. 8(a).

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To account for potential changes in the Commission's prospective

technological capabilities, the Commission is slightly modifying the

proposed text of Sec. 38.3(a) to clarify that a board of trade must

file Form DCM electronically ``in a format and manner specified by the

Secretary of the Commission.''

The Commission is also making several minor non-substantive and

organizational revisions to Form DCM. Additionally, the Commission is

clarifying that the exhibits submitted in connection with Form DCM

should include a description of how the applicant meets the definition

of ``board of trade'' (as defined in section 1a(2) of the CEA).

Applicants must submit all applicable exhibits simultaneous with the

submission of completed Form DCM. Form DCM and all exhibits must be

substantially complete prior to submission.

Sec. 38.3(b)--Reinstatement of Dormant Designation

Proposed Sec. 38.3(b) required that a dormant DCM, prior to

listing or relisting products for trading, must reinstate its

designation under the procedures of paragraphs (a)(1) and (2) of Sec.

38.3. The proposed rule provided that applications for reinstatement of

designation may rely upon previously-submitted materials that pertain

to, and accurately describe, current conditions. The Commission did not

receive any comments on Sec. 38.3(b) and is adopting this provision as

proposed.

Sec. 38.3(c)--Delegation of Authority

Proposed Sec. 38.3(c) delegated authority to the Director of the

Division of Market Oversight (or such other employees as the Director

may designate) to notify an applicant seeking designation in the event

that the application is materially incomplete and that the 180-day

review period is stayed. The Commission did not receive any comments on

Sec. 38.3(c) and is adopting this provision as proposed.

Sec. 38.3(d)--Request for Transfer of Designation

The Commission proposed new Sec. 38.3(d) to formalize the

procedures that a DCM must follow when requesting the transfer of its

DCM designation and positions comprising open interest, in anticipation

of a corporate event (e.g., a merger, corporate reorganization, or

change in corporate domicile) which results in the transfer of all or

substantially all of the DCM's assets to another legal entity. Proposed

Sec. 38.3(d)(2) required a DCM to submit to the Commission a request

for transfer of designation no later than three months prior to the

anticipated corporate change. If a DCM did not know or could not

reasonably have known of the anticipated change three months prior to

the change, it was required to immediately file the request as soon as

it did know of such change. The proposed rule required, that in either

case, the request must include a series of submissions, including,

among other things, the underlying agreement that governs the corporate

change, a narrative description of the corporate change that includes

the reason for the change and its impact on the DCM, a discussion of

the transferee's ability to comply with the CEA and the Commission's

regulations, the governing documents of the transferee, and a list of

contracts, agreements, transactions or swaps for which the DCM requests

transfer of open interest.

Proposed Sec. 38.3(d) also required, as a condition of approval,

that the DCM submit a representation that it is in compliance with the

CEA, including the DCM core principles, and the Commission's

regulations. In addition, the proposed rule required a DCM to submit

various representations by the transferee, including, but not limited

to, a representation that the transferee will assume responsibility for

complying with all applicable provisions of the CEA and the

Commission's regulations and that none of the proposed rule changes

will affect the rights and obligations of any participant to which open

positions are transferred.

Summary of Comments

CME contended that the proposed rule is overly prescriptive because

it applies a ``one-size-fits-all approach'' even though the

circumstances of each transfer are likely to be unique.\29\ While CME

did not oppose the three-month advance notification requirement, it did

oppose what it believed to be the broad scope of the additional

documentation required to be submitted simultaneously with such

notification.\30\ CME stated that the required information is

unnecessary and is likely to result in later notification to the

Commission.\31\ As an alternative, CME recommended that the Commission

tailor the information it requires based on the nature of the requested

transfer.\32\

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\29\ CME Comment Letter at 11 (Feb. 22, 2011).

\30\ Id.

\31\ Id.

\32\ Id.

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CME also contended that if a DCM could not have reasonably known of

an anticipated change three months in advance, then it cannot

``immediately'' file both the request and all of the required

submissions once it does know, because preparing the

[[Page 36617]]

submissions takes time. CME suggested that the rule be amended to

require that the documentation be filed ``promptly'' as soon as the DCM

knows of the change, rather than ``immediately.'' \33\

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

\33\ Id.

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Discussion

In response to CME's contention that each transfer is likely to be

unique, and its opposition to some of the documentation required by the

rule, the Commission notes that the specific information requirements

contained in the proposed rule are necessary to enable the Commission

to determine that the transfer is in compliance with the CEA. The

required documents, such as the transfer agreement, governing

documents, list of contracts to be transferred, and compliance

representations, are relevant to the Commission's determination of the

DCM's ongoing compliance with the CEA. Such documentation is also

relatively standard in transfer transactions. The Commission

recognizes, however, that there may be some variations in the form of

governance documents or underlying agreements for each transfer.

Accordingly, DCMs may provide the substance of the required information

in the form available to them.

In response to CME's suggestion that the rule be amended to require

that the documentation be filed ``promptly'' as soon as the DCM knows

of the change, rather than ``immediately,'' the Commission notes that

the proposed rule specifically stated that in situations where a DCM

could not have reasonably known of an anticipated change three months

in advance, the DCM must immediately file the request as soon as it

knows of such change, with an explanation as to the timing of the

request. The Commission believes that in the context of this rule, use

of the term ``promptly'' rather than ``immediately'' would not provide

a meaningful distinction, as the rule simply requires DCMs to provide

the documentation as soon as they know of the change.

As described in connection with Sec. 38.3(a), the Commission is

slightly modifying the proposed text to clarify that a DCM must file a

request for transfer of designation electronically ``in a format and

manner specified by the Secretary of the Commission.'' The Commission

is adopting the remainder of the rule as proposed.

Sec. 38.3(e)--Request for Withdrawal of Application for Designation

Proposed Sec. 38.3(e) specified the procedures that a DCM must

follow for withdrawing an application for designation. The Commission

did not receive any comments on this provision. The Commission is

slightly modifying the proposed text to clarify that an applicant must

file a request for withdrawal of application for designation

electronically ``in a format and manner specified by the Secretary of

the Commission.'' The Commission is adopting the remainder of the rule

as proposed.

Sec. 38.3(f)--Request for Vacation of Designation

Proposed Sec. 38.3(f) specified the procedures that a DCM must

follow for vacating its designation. The Commission did not receive any

comments on this provision. The Commission is adopting it as proposed,

with a slight modification to the proposed text to clarify that a DCM

must file a request for vacation of designation electronically ``in a

format and manner specified by the Secretary of the Commission.''

Sec. 38.3(g)--Requirements for Existing Designated Contract Markets

Proposed Sec. 38.3(g) required that each existing DCM provide the

Commission with a signed certification of its compliance with each of

the 23 core principles and the Commission's regulations under part 38,

within 60 days of the effective date of the publication of the final

rules proposed in the DCM NPRM. The failure of any existing DCM to

provide such certification would be grounds for revocation of the DCM's

designation status. The Commission requested comments on whether the 60

day period is sufficient, and if not, what period of time may be more

appropriate, and why.

Summary of Comments

Multiple commenters opposed the proposed 60-day timeframe for

existing DCMs to certify compliance with the core principles and

associated regulations. Commenters suggested several alternative

timeframes, including 90 days,\34\ 120 days,\35\ 180 days,\36\ 12

months,\37\ and 18 months.\38\ KCBT argued that the proposed effective

date is unreasonable and would be burdensome for DCMs, and suggested

that the Commission work with each DCM to create a reasonable

compliance timeframe.\39\

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\34\ Nodal Comment Letter at 4 (Feb. 22, 2011).

\35\ CFE Comment Letter at 6-7 (Feb. 22, 2011).

\36\ GreenX Comment Letter at 21 (Feb. 22, 2011).

\37\ MGEX Comment Letter at 2 (Feb. 22, 2011), and at 1 (June 3,

2011).

\38\ NYSE Liffe Comment Letter at 14 (Feb. 22, 2011).

\39\ KCBT Comment Letter at 2 (Feb. 22, 2011).

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

Commenters stated that a 60-day timeframe would be unreasonable

given the expenditure of resources and detailed analysis required as a

result of significant changes to existing core principles and the

addition of new core principles. GreenX stated that Core Principle 21

(Financial Resources) may require DCMs to obtain new investment or

financing arrangements.\40\ KCBT stated that it will take DCMs time to

convert programs and processes from current acceptable practices to

adherence to what it sees as prescriptive objectives and deadlines.\41\

Nodal, which is currently operating as an exempt commercial market

(``ECM''), stated that 60 days is an unnecessarily harsh timeframe for

an existing business to transform its operations and demand changes

from its support providers.\42\ Finally, NYSE Liffe claimed that even

90 or 120 days would be insufficient because certain proposals, such as

Core Principles 2 (Compliance with Rules), 4 (Prevention of Market

Disruption), and 20 (System Safeguards), will require the

implementation of automated systems that require significant time to

implement coding and conduct testing.\43\ NYSE Liffe further claimed

that the DCM's management and boards will have to review and approve

rule changes before they can be implemented, and that the DCM will also

have to negotiate and execute changes to contracts with third-party

service providers.\44\ CME disagreed with the assertion that the

proposed new regulations simply codify practices that are commonly

accepted in the industry, and argued that the rules will necessitate

strategic, operational, system, and rule changes.\45\ CME claimed that

it would need a minimum of 180 days just to assess the impact of the

new regulations and to identify, design, and plan the projects

necessary to implement them.\46\

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\40\ GreenX Comment Letter at 21 (Feb. 22, 2011).

\41\ KCBT Comment Letter at 2 (Feb. 22, 2011).

\42\ Nodal Comment Letter at 4 (Feb. 22, 2011).

\43\ NYSE Liffe Comment Letter at 14 (Feb. 22, 2011).

\44\ Id.

\45\ CME Comment Letter at 12 (Feb. 22, 2011).

\46\ Id.

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MGEX stated that a ``catch all'' certification is of limited value

given that DCMs spend ``countless hours and dollars'' demonstrating

that they are in compliance with core principles through RERs and

responding to other

[[Page 36618]]

Commission inquiries.\47\ MGEX also questioned whether it can conclude

with any certainty that it is in compliance with the new and revised

core principles and regulations.\48\ MGEX requested that the

certification requirement be stricken, or if the requirement is deemed

necessary, that the process be limited to providing a signed letter

attesting to compliance (and that all application forms and

documentation that are required with a formal application should be

waived for existing DCMs).\49\ MGEX also requested that current DCMs

that are already compliant with the existing core principles should be

grandfathered.\50\

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

\47\ MGEX Comment Letter at 2 (Feb. 22, 2011).

\48\ Id.

\49\ Id.

\50\ MGEX Comment Letter at 1 (June 3, 2011).

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Nodal stated that the proposed rules do not address how a DCM

applicant that is operating as an ECM pursuant to a grandfathering

order can comply with the DCM requirements, and suggested that the

Commission stagger certain compliance timeframes to accommodate

entities that are operating pursuant to grandfather relief and that may

potentially seek to operate as a DCM.\51\

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

\51\ Nodal Comment Letter at 4 (Feb. 22, 2011).

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

Discussion

The Commission acknowledges commenters' concerns regarding the 60-

day time frame for existing DCMs to certify compliance with the core

principles and is eliminating this requirement from the final rules. In

addition, the Commission has determined that existing DCMs may need

additional time to comply with the rules being adopted in this release,

and is therefore allowing DCMs an additional 60 days after the

effective date of this release to comply with all of the new and

revised final rules, except for Sec. 38.151(a), as described in this

release. All DCMs are expected to be in compliance with the final rules

by that date. Albeit, the new and revised core principles, as amended

by the Dodd-Frank Act, took effect on July 16, 2011, and all DCMs were

required to be in compliance with each of the new and revised core

principles as of that date. The Commission further notes that all DCMs

will continue to be subject to compliance reviews by the Commission,

including RERs.

With respect to Nodal's comments regarding the impact of the

effective date of the DCM and SEF rules on ECMs, the Commission issued

orders whereby entities operating as exempt commercial markets pursuant

to section 2(h)(3)-(7) of the CEA, or as exempt boards of trade

pursuant to section 5d of the CEA, could receive grandfather relief to

continue to operate in accordance with those provisions notwithstanding

their deletion from the CEA effective July 15, 2011, by the Dodd-Frank

Act.\52\ The continued operation and compliance timeframes for exempt

boards of trade and exempt commercial markets are addressed by those

orders, and accordingly, are outside the scope of this rulemaking.

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\52\ See 75 FR 56513, Sept. 16, 2010; see also 76 FR 42508, Jul.

14, 2011.

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4. Sec. 38.4--Procedures for Listing Products and Implementing

Designated Contract Market Rules

The proposed amendments to Sec. 38.4 were largely intended to

conform the rule to Sec. Sec. 40.3 (Voluntary submission of new

products for Commission review and approval) and 40.5(b) (Voluntary

submission of rules for Commission review and approval).\53\ Those

rules were recently revised in the separate release pertaining to

``Provisions Common to Registered Entities.'' \54\

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

\53\ Section 40.3 was amended to require additional information

to be provided by registered entities submitting new products for

the Commission's review and approval. Section 40.5(b) codified a new

standard for the review of new rules or rule amendments as

established under the Dodd-Frank Act. 75 FR 44776, Jul. 27, 2011.

\54\ Id.

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Summary of Comments

In comments submitted both in connection with this rulemaking and

with the proposed rulemaking for ``Provisions Common to Registered

Entities,'' \55\ CME stated that the proposed procedures for listing

products would increase the burdens associated with new product

submissions and rule changes and would create new and costly

bureaucratic inefficiencies, competitive disadvantages in the global

marketplace, and impediments to innovation.\56\ CME stated that there

has been no showing that the current streamlined process undermines

market integrity, and that the process in fact has facilitated growth

and innovation.\57\

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

\55\ Id.

\56\ CME Comment Letter at 10, 13 (Feb. 22, 2011).

\57\ Id.

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

CFE stated that a number of the regulations proposed in the DCM

NPRM require DCMs to provide notification and reports to the

Commission, but that the proposed regulations do not specify the manner

in which the required notifications and reports should be submitted to

the Commission.\58\ CFE requested that the Commission designate a

single email address for the submission of all DCM notifications and

reports.\59\

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

\58\ CFE Comment Letter at 7 (Feb. 22, 2011).

\59\ Id.

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

Discussion

The Commission is adopting the rule as proposed. The rule conforms

to revisions to part 40 that were made in a separate rulemaking for

``Provisions Common to Registered Entities.'' \60\ In that rulemaking,

the Commission, among other things, revised and eliminated several

proposed documentation provisions in order to respond to comments that

the submission of documentation in connection with new rules and rule

amendments would be burdensome. The Commission also noted that the

final rules will conserve both Commission and registered entity

resources and will be less burdensome than existing practice. CME's

comments on these provisions were addressed in the part 40 rulemaking,

and are outside the scope of this rulemaking.'' \61\

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

\60\ 75 FR 44776, July 27, 2011.

\61\ Id.

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

In response to CFE's comment, the Commission notes that all filings

submitted pursuant to part 38 should be filed electronically with the

Secretary of the Commission, in a format and manner determined by the

Secretary, at [email protected] and the Division of Market Oversight

at [email protected]

5. Sec. 38.5--Information Relating to Contract Market Compliance

Sec. 38.5(a)--Requests for Information; Sec. 38.5(b)--Demonstration of

Compliance; and, Sec. 38.5(d)--Delegation of Authority

The provisions in Sec. 38.5 address requirements for DCMs to

provide information relating to contract market compliance. Proposed

Sec. 38.5(a) required that a DCM must file with the Commission

information related to its business as a DCM, including information

relating to data entry and trade details, upon Commission request.

Proposed Sec. 38.5(b) required that a DCM must file with the

Commission a written demonstration that the DCM is in compliance the

core principles, upon Commission request. Proposed Sec. 38.5(d)

delegates the Commission's authority to seek information as set forth

in paragraph Sec. 38.5(b) to the Director of the Division of Market

Oversight, or such other employees as the Director may designate. As

noted in the DCM NPRM, except for technical revisions, the

aforementioned proposed rules were not substantively modified from

their current versions. The Commission did

[[Page 36619]]

not receive any comments on these rules and adopts them as proposed.

Sec. 38.5(c)--Equity Interest Transfers

Proposed Sec. 38.5(c) required DCMs to file with the Commission a

notice of the transfer of ten percent or more of its equity, no later

than the business day following the date on which the DCM enters into a

firm obligation to transfer the equity interest.\62\ The proposed rule

required that the notification include several submissions, including

any relevant agreements (including preliminary agreements), changes to

relevant corporate documents, a chart outlining any new ownership or

corporate or organizational structure, a brief description of the

purpose and any impact of the equity interest transfer, and a

representation from the DCM that it meets all of the requirements of

section 5(d) of the Act and Commission regulations thereunder. The

proposed rule also required that DCMs notify the Commission of the

consummation of the transaction on the day in which it occurs. Proposed

Sec. 38.5(c)(3) \63\ required that when there is a change in

ownership, the DCM must certify, no later than two business days

following the date on which the change in ownership occurs, that the

DCM meets all of the requirements of section 5(d) of the CEA, as

amended by the Dodd-Frank Act, and the provisions of part 38 of the

Commission's regulations. The proposed rule also required that the DCM

include, as part of its certification, an explanation of whether any

aspects of the DCM's operations will change as a result of the change

in ownership and, if so, that the DCM must provide a description of the

changes.

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\62\ See generally, DCM NPRM for an explanation of the proposed

10 percent threshold.

\63\ The Commission proposed redesignating Sec. 38.5(d) as

Sec. 38.5(c).

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Summary of Comments

Two commenters stated that they do not object to the general

notification requirement, but contended that the submissions required

to be simultaneously filed with the initial notification do not lend

themselves to preparation within the 24-hour time frame proposed in the

rules.\64\ NYSE Liffe proposed that a period of ten business days to

provide the additional information would allow more time for the DCM to

provide accurate and meaningful information.\65\ NYSE Liffe also

requested clarification that the requirement to provide ``preliminary

agreements'' only pertains to agreements that have been executed, and

not to drafts that may have been exchanged for purposes of

discussion.\66\

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\64\ CME Comment Letter at 13 (Feb. 22, 2011) (noting that

associated changes to relevant corporate documents are unlikely to

be finalized until closer to the transfer date); NYSE Liffe Comment

Letter at 13 (Feb. 22, 2011) (noting that the information will have

to be collected and formatted).

\65\ NYSE Liffe Comment Letter at 14 (Feb. 22, 2011).

\66\ Id.

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CME stated that a representation from a DCM that it meets all of

the requirements of section 5(d) of the CEA is more appropriate as a

requirement upon consummation of the equity interest transfer, rather

than with the initial notification.\67\

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

\67\ CME Comment Letter at 13 (Feb. 22, 2011).

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

MGEX stated that as a mutual association with a membership-based

ownership structure, it frequently experiences changes in membership

and ownership.\68\ MGEX stated that notice to the Commission seems

reasonable for single event situations where a new party obtains a ten

percent or more interest at one time, but disagreed with the rationale

for the requirement to recertify again as part of such event.\69\

Instead, MGEX suggested that the Commission should inquire only if

there is a concern over such an event.\70\

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

\68\ MGEX Comment Letter at 2 (Feb. 22, 2011).

\69\ Id. at 3.

\70\ Id.

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Discussion

The Commission is adopting the proposed rule with certain

revisions.

The Commission is revising the rule to provide that the DCM must

submit to the Commission a notification of each transaction involving

the transfer of ten percent or more of the equity interest in the

designated contract market, and that such notification must be provided

at the earliest possible time but in no event later than ten business

days following the date upon which the designated contract market

enters into a legally binding obligation to transfer the equity

interest.

The Commission acknowledges NYSE Liffe and CME's concerns regarding

the timing of the submission filing requirement and therefore has

extended the time period to up to ten business days for a DCM to file

notification with the Commission upon entering into an agreement to

transfer an equity interest of ten percent or more. While DCMs may take

up to ten business days to submit a notification, the DCM must provide

Commission staff with sufficient time, prior to consummating the equity

interest transfer, to review and consider the implications of the

change in ownership, including whether the change in ownership will

adversely impact the operations of the DCM or the DCM's ability to

comply with the core principles and the Commission's regulations

thereunder. The rule further reminds DCMs that any aspect of an equity

interest transfer described that necessitates the filing of a rule as

defined in part 40 of the Commission regulations must comply with the

rule submission requirements, including timing of filing, of section

5c(c) of the CEA and part 40, and all other applicable Commission

regulations.

In response to CME's comment that the representation from a DCM

that it meets all of the requirements of section 5(d) of the CEA is

more appropriate as a requirement upon consummation of the equity

interest transfer, and NYSE Liffe's comment that the Commission clarify

that ``preliminary agreements'' do not include draft documents, the

Commission is revising the rule to eliminate references to the specific

documents that must be provided with the notification. Rather, the

Commission may upon receiving a notification of the equity interest

transfer, where necessary, request appropriate documentation pursuant

to its authority under Sec. 38.5 of the Commission's regulations. Such

documentation may include: (i) Relevant agreement(s), including any

preliminary agreements (not including draft documents); (ii) associated

changes to relevant corporate documents; (iii) chart outlining any new

ownership or corporate or organizational structure, if available; (iv)

a brief description of the purpose and any impact of the equity

interest transfer; and, (v) a certification, upon consummation of the

equity interest transfer that the designated contract market continues

to meet all of the requirements of section 5(d) of the Act and

Commission regulations adopted thereunder.

The Commission acknowledges MGEX's comment but believes that the

rule is necessary. The Commission must oversee and ensure the continued

compliance of all DCMs with the core principles and the Commission's

regulations. In order to fulfill its oversight obligations, and to

ensure that DCMs maintain compliance with their self-regulatory

obligations, the Commission must undertake an effective due diligence

review of the impact of ownership transfers. Accordingly, the

Commission adopts the proposed rule, with the aforementioned

modifications.

[[Page 36620]]

6. Sec. 38.7--Prohibited Use of Data Collected for Regulatory Purposes

Proposed Sec. 38.7 \71\ prohibited DCMs from using proprietary

data or personal information submitted by any person to the DCM for

regulatory purposes, for business or marketing purposes. In the DCM

NPRM, the Commission noted that nothing in the proposed provision

should be viewed as prohibiting a DCM from sharing such information

with another DCM or SEF for regulatory purposes, where necessary.

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

\71\ The DCM NPRM did not propose any revisions to current Sec.

38.6 (Enforceability), and this provision remains unchanged.

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

Summary of Comments

Several commenters argued that the restriction on the use of

proprietary or personal information is too broad. CME stated that the

proposed rules should distinguish between proprietary and personal

information that is provided to a DCM exclusively for regulatory

purposes and information that is provided to a DCM for both regulatory

and non-regulatory purposes.\72\ CME claimed that a DCM should be

permitted to use the latter type of information for business or

marketing purposes, provided that the DCM has transparent rules and

policies which disclose what information collected by the DCM will be

used exclusively for the furtherance of its self-regulatory obligations

and how such confidential information will be protected.\73\ CME also

contended that a DCM should not be precluded from using proprietary or

personal information that is provided for regulatory purposes for

business or marketing purposes where the market participant has

specifically agreed to such use.\74\ MGEX agreed with the underlying

purpose of the proposed rule but suggested allowing market participants

to opt-out of having their information used for business or marketing

purposes.\75\

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

\72\ CME Comment Letter at 13-14 (Feb. 22, 2011).

\73\ Id.

\74\ Id.

\75\ MGEX Comment Letter at 3 (Feb. 22, 2011).

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

ELX stated that the standard should rest on whether the use and

manner of use of the information violates the reasonable expectation of

confidentiality on the part of the disclosing firm.\76\ For example,

ELX stated that senior officers of the exchange should have access to

such data to understand the markets they are responsible for overseeing

even if they don't have a ``compliance'' moniker in their title.\77\

ELX also stated that an exchange should be able to consolidate

proprietary data in an anonymous fashion to explain its markets without

running afoul of the proposed rule.\78\ ELX also claimed that a DCM

should be able to use its discretion to convey proprietary information

for business or marketing purposes back to employees of the firm that

supplied the data.\79\ For example, ELX stated that a DCM should be

permitted to explain to a trading desk how the activities of its firm

have changed or could be conducted more cost-effectively.\80\

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

\76\ ELX Comment Letter at 3 (Feb. 22, 2011).

\77\ Id.

\78\ Id.

\79\ Id.

\80\ Id.

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Discussion

The Commission has considered the comments and is amending proposed

Sec. 38.7 to allow DCMs to use proprietary or personal information for

business or marketing purposes if the person from whom they collect or

receive such information clearly consents to the use of its information

in such a manner. In response to CME and ELX's comments, the Commission

notes that a DCM could use information that it receives for both

regulatory and non-regulatory purposes for business or marketing

purposes (or could convey proprietary information back to employees of

the firm that supplied the data) if the source of the information

clearly consents to the use in such a manner. The Commission is also

amending the proposed rule to prohibit a DCM from conditioning access

to its trading facility based upon such consent.

Finally, as stated in the preamble to the proposed rule and

amplified above, the Commission notes that Sec. 38.7 is intended to

protect regulatory information provided by market participants to DCMs

from unauthorized commercial use.\81\ The Commission notes consistent

with the requirements of the final rule, DCMs should have rules to

safeguard regulatory information from misuse. The Commission would

expect such rules, among other things, to restrict access to such

information within the DCM to avoid improper use of such information

for commercial purposes.

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\81\ See 75 FR 80572, 80577, note 37, Dec. 22, 2010.

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7. Sec. 38.8--Listing of Swaps on a Designated Contract Market

Proposed Sec. 38.8(a) required a DCM to notify the Commission,

prior to or upon listing its first swap contract, of the manner in

which it will fulfill each of the requirements under the amended CEA

and part 38 with respect to the listing, trading, execution and

reporting of swap transactions.

Proposed Sec. 38.8(b) required a DCM, before it lists swaps, to

request from the Commission a unique, alphanumeric code for the purpose

of identifying the DCM. The rule required a DCM to do so pursuant to

the swap recordkeeping and reporting requirements under then-proposed

part 45 of the Commission's regulations. Proposed Sec. 38.8(b) also

codified the obligations of DCMs to comply with the provisions of part

45, which set forth the recordkeeping and reporting requirements for

DCMs with respect to swaps.\82\

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\82\ See ``Swap Data Recordkeeping and Reporting Requirements,''

Proposed Rule, 75 FR 76573, Dec. 8, 2010.

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Summary of Comments

CFE argued that a DCM should be allowed to offer trading in swaps

in the same manner that a SEF is permitted to do so, and that it would

be costly and unnecessary to require a DCM to create a separate SEF in

order to offer trading in swaps instead of just permitting the DCM to

adopt separate rules that permit the trading of swaps on the DCM

consistent with the SEF requirements.\83\ CFE argued that a DCM should

not have to create a separate entity, board, board committees,

membership application and approval process, and rule set in order to

offer trading in swaps in the same manner that a SEF can do when it

already has all of those components in place and can simply add any

required components for SEFs.\84\

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

\83\ CFE Comment Letter at 1 (Feb. 22, 2011).

\84\ Id. at 2.

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ELX stated that the DCM NPRM did not make clear what criteria will

be used to distinguish between a swap contract and a futures contract,

and claimed that this ambiguity will cause uncertainty and redundant

costs for boards of trade that would prefer to follow a DCM model

without having to adopt a parallel set of rules and procedures.\85\ ELX

cited compliance with section 727 of the Dodd-Frank Act and Sec. 38.10

as one area where clarity is needed.\86\

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\85\ ELX Comment Letter at 4 (Feb. 22, 2011).

\86\ Id. at 5.

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Discussion

The Commission is adopting the rule as proposed, with one

clarification. CFE's comments take issue with provisions in the Dodd-

Frank Act that are not within the Commission's discretion to revise.

Swaps are permitted to be traded on a SEF or a DCM, pursuant to rules

promulgated for each entity.\87\ Accordingly, swaps

[[Page 36621]]

traded on a DCM must be traded pursuant to DCM rules. As noted in the

Final Exemptive Order issued July 14, 2011,\88\ DCMs may list and trade

swaps after July 16, 2011 without further exemptive relief. In that

Order, the Commission noted that if a DCM intends to trade swaps

pursuant to the rules, processes, and procedures currently regulating

trading on its DCM, the DCM may need to amend or otherwise update its

rules, processes, and procedures in order to address the trading of

swaps.\89\ In response to ELX, the determining factors in

distinguishing between swaps and futures are outside of the scope of

this proceeding. The CEA provided a definition for swaps under section

1a(47), and the Commission published proposed rules and interpretive

guidance to further define the term on May 23, 2011.\90\

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\87\ See CEA section 2(h)(8), 7 U.S.C. 2(h)(8). See also 17 CFR

38.9 (``A board of trade that operates a designated contract market

and that intends to also operate a swap execution facility must

separately register[hellip]and on an ongoing basis, comply with the

core principles under Section 5h of the Act, and the swap execution

facility rules under part 37 of this chapter'').

\88\ 76 FR 42508, Jul. 14, 2011.

\89\ Id. at 42,518, n. 131. On July 27, 2011, DMO staff sent a

notification letter to all existing DCMs stating that if the DCM

intends to list swaps prior to the effective date of the final rules

implementing part 38, it must include with its initial submission of

the terms and conditions of a swap contract (pursuant to section

5c(c) of the CEA, as amended by the Dodd-Frank Act) any amendments

to its rules that are necessary to provide for the trading of swaps,

including a concise explanation and analysis of any systems and

oversight procedures that the DCM proposes to revise in order to

accommodate the trading of swaps. The information requested in the

July 27 letter is separate from the request in proposed section

38.8(a); however, information provided in response to the July 27

letter may support, in part, the requirement under section 38.8(a)

to provide a written demonstration detailing how the DCM is

addressing its self-regulatory obligations with respect to swap

transactions.

\90\ 76 FR 29818, May 23, 2011.

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

The Commission is modifying Sec. 38.8(b), consistent with the

Commission's final Swap Data Recordkeeping and Reporting Requirements

Rule,\91\ to require DCMs to generate and assign a unique swap

identifier at, or as soon as technologically practicable following, the

time of execution of the swap. The unique swap identifier (``USI'')

must have two alphanumeric components. The first component is the

unique alphanumeric code assigned to the DCM by the Commission for the

purpose of identifying the DCM with respect to USI creation. DCMs must

obtain this first alphanumeric component from the Commission prior to

executing any swap on its facility.\92\ The second component is an

alphanumeric code generated and assigned to that swap by the automated

systems of the DCM, which shall be unique to that swap and different

with respect to all such codes generated and assigned by that DCM to

all other swaps. Each DCM must generate and assign a USI at, or as soon

as technologically practicable, following the time of execution of the

swap. The DCM is required to transmit the USI to the SDR, each swap

counterparty, and the registered derivative clearing organization

(``DCO'') (if the swap is cleared). The DCM, similar to all registered

entities and counterparties, is required to use the USI to identify the

swap in ``all recordkeeping and all swap data reporting pursuant to

[part 45].'' This clarification is based upon the final rulemaking that

implements swap data recordkeeping and reporting requirements under

part 45 of the Commission's regulations.\93\

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\91\ 77 FR 2136, Jan. 13, 2012.

\92\ The Commission will establish a formal process by which

DCMs can obtain a USI identifier.

\93\ 77 FR 2136, Jan. 13, 2012.

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8. Sec. 38.9--Boards of Trade Operating Both a Designated Contract

Market and a Swap Execution Facility

Proposed Sec. 38.9(a) codified the requirement that a board of

trade that operates a DCM and that intends to operate a SEF must

separately register pursuant to the SEF registration requirements and,

on an ongoing basis, must separately comply with the SEF core

principles under section 5h of the CEA, as amended by the Dodd-Frank

Act, and the applicable Commission regulations to be codified under

part 37 of the Commission regulations.\94\

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\94\ See notice of proposed rulemaking pertaining to ``Core

Principles and Other Requirements for Swap Execution Facilities.''

76 FR 1214, Jan. 7, 2011.

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

Proposed Sec. 38.9(b) codified the statutory requirement that any

board of trade that is a DCM and intends to operate as an independent

SEF may use the same electronic trade execution system for listing and

executing swaps, provided that the board of trade makes it clear to

market participants whether the electronic trading of such swaps is

taking place on or through the DCM or the SEF.\95\

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

\95\ Section 5h(c) of the CEA, as amended by the Dodd-Frank Act,

provides:

IDENTIFICATION OF FACILITY USED TO TRADE SWAPS BY CONTRACT

MARKETS.--A board of trade that operates a contract market shall, to

the extent that the board of trade also operates a swap execution

facility and uses the same electronic trade execution system for

listing and executing trades of swaps on or through the contract

market and the swap execution facility, identify whether the

electronic trading of such swaps is taking place on or through the

contract market or the swap execution facility.

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

Summary of Comments

CME requested clarification as to whether the regulation is

intended to create a more substantive obligation on the part of DCMs

and SEFs given that market participants typically interface with

electronic platforms through proprietary or third-party front end

systems that are not controlled by the DCM.\96\

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

\96\ CME Comment Letter at 14 (Feb. 22, 2011).

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

ICE noted that while the proposed rule prescribed how a DCM can

list swaps, it did not describe how the core principles, written for

futures contracts, apply to a DCM listing swaps. ICE requested

clarification that a swap can be executed on a DCM using the same

execution methods as on a SEF, such as a request for quote (``RFQ'')

mechanism.\97\ Finally, ICE stated that, like a SEF, a DCM should be

able to allow the bilateral execution of swaps where there is no

clearing mandate.\98\ ICE claimed that without these clarifications,

there will be a bias away from the trading of swaps on DCMs in favor of

SEFs, and that the rulemaking would frustrate Congress' intention of

also having swaps trade on DCMs.\99\

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

\97\ ICE Comment Letter at 10 (Feb. 22, 2011).

\98\ Id.

\99\ Id.

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

Alice Corporation states that organizations that choose to operate

both a SEF and DCM should be able to meet the requirements of both

entities with a single organization.\100\ Alice Corporation also stated

that it offers the ability to fill a large size order with multiple

contracts on an all-or-nothing basis, as customers with large orders

sometimes wish to execute with a single contracts.\101\ Alice stated

that this design would enable automatic execution of block size trades,

and questioned whether an impartially offered price discount for volume

would be acceptable to the Commission.\102\

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

\100\ Alice Corporation Comment Letter at 3 (May 31, 2011).

\101\ Id.

\102\ Id.

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

Discussion

The Commission is adopting the rule as proposed. In response to

CME's comment, the Commission notes that it would not be sufficient for

a board of trade that operates both a DCM and a SEF to simply have DCM

rules that might identify whether a transaction is being executed on a

DCM or a SEF. Instead, a consolidated DCM/SEF trading screen must

identify whether the execution is occurring on the DCM or the SEF,

irrespective of how proprietary or third-party front end

[[Page 36622]]

systems eventually present that data to market participants. Section

5h(c) of the CEA, as amended by the Dodd-Frank Act, clearly requires

that a board of trade that operates both a DCM and SEF identify to

market participants whether each swap is being executed on the DCM or

the SEF.

With respect to comments requesting clarification that a swap can

be executed on a DCM using execution methods other than a central limit

order book \103\ the Commission notes that swaps executed on a DCM are

subject to all rules and requirements applicable to futures and options

traded on DCMs.\104\ In particular, all swaps traded on a DCM must be

executed through the DCM's trading facility, except as otherwise

expressly permitted by Core Principle 9,\105\ and are subject to the

Commission's rules pertaining to DCMs. Only certain Commission rules,

for example, those relating to the real-time and regulatory reporting

of swaps, will be different for swaps in relation to futures. In

response to ICE's comment that a DCM, like a SEF, should be able to

allow the bilateral execution of swaps where there is no clearing

mandate, the Commission notes that ICE's position is based on the

proposed SEF rules, which are not yet finalized.\106\ Moreover, the

Commission further notes that under the CEA, a DCM must be a board of

trade, which is defined under section 1a(2) of the CEA, 7 U.S.C. 1a(2),

as an organized exchange or other trading facility.\107\ As defined

under the CEA, both an organized exchange,\108\ and other trading

facility \109\ require, among other things, multiple participants to

execute or trade contracts or transactions, by accepting bids or offers

made by other participants that are open to multiple participants in

the facility or system, or through the interaction of multiple bids or

offers within a system with a pre-determined nondiscretionary automated

trade matching and execution algorithm.

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

\103\ ICE Comment Letter at 2-3 (Feb. 22, 2011); Alice

Corporation Comment Letter at 3 (May 31, 2011).

\104\ Section 723 of the Dodd-Frank Act provides that the

execution of swaps subject to the clearing requirement of section

2(h)(1) of the CEA must occur either on a DCM or on a SEF, unless no

DCM or SEF makes the swap available to trade.

\105\ Core Principle 9 provides, in relevant part, that ``[t]he

rules of the board of trade may authorize, for bona fide business

purposes:

(i) Transfer trades or office trades;

(ii) An exchange of--

(I) Futures in connection with a cash commodity transaction;

(II) Futures for cash commodities; or

(III) Futures for swaps; or

(iii) A futures commission merchant, acting as principal or

agent, to enter into or confirm the execution of a contract for the

purchase or sale of a commodity for future delivery if the contract

is reported, recorded, or cleared in accordance with the rules of

the contract market or a derivatives clearing organization. 7 U.S.C.

5(d)(9).

\106\ The Commission further notes that pursuant to Core

Principle 21, all contracts traded on a DCM must be cleared through

a registered DCO, irrespective of the clearing mandate.

\107\ The CEA requires that DCMs must be boards of trade, as

defined under the CEA. See, e.g., 7 U.S.C. 7(a) (stating the a board

of trade may apply for designation as a contract market); see also 7

U.S.C. 7(d) (core principles apply to board of trade).

\108\ As defined in section 1a(37) of the CEA, the term

``organized exchange'' means a trading facility that: (A) Permits

trading: (i) By or on behalf of a person that is not an eligible

contract participant; or (ii) by persons other than on a principal-

to-principal basis; or (B) has adopted (directly or through another

nongovernmental entity) rules that: (i) Govern the conduct of

participants, other than rules that govern the submission of orders

or execution of transactions on the trading facility; and (ii)

include disciplinary sanctions other than the exclusion of

participants from trading.

\109\ As defined in section 1a(51) (A) of the CEA, the term

``trading facility'' means a person or group of persons that

constitutes, maintains, or provides a physical or electronic

facility or system in which multiple participants have the ability

to execute or trade agreements, contracts, or transactions--(i) by

accepting bids or offers made by other participants that are open to

multiple participants in the facility or system; or (ii) through the

interaction of multiple bids or multiple offers within a system with

a pre-determined nondiscretionary automated trade matching and

execution algorithm. See section 1a(51)(B) and (C) for exclusions

and special rules application to trading facility.

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

The Commission has considered Alice Corporation's comments, and

notes that while a board of trade that is a single corporate entity may

operate both a DCM and a SEF, DCMs and SEFs have separate core

principles and requirements, and any entity that operates both must

separately meet the statutory and regulatory requirements of each

facility. In response to Alice Corporation's further comment that

counterparties on a DCM should be able to offer volume-based quotes, it

is unclear whether Alice Corporation's comment is being offered in the

context of acceptable methods of trading on a DCM's central marketplace

or in the context of off-exchange transactions. If the former, the

Commission reiterates that the acceptable methods of trading on a DCM's

central marketplace are specifically determined under the CEA, which

requires at a minimum that DCMs must be ``trading facilities,'' though

even in that context the Commission has accepted trading systems beyond

pure price-and-time algorithms. If Alice Corporation's reference to

volume-based quotes is some sort of off-exchange trading methodology,

the Commission reiterates that its analysis of such a proposal would be

conducted under Core Principle 9. The comment does not offer sufficient

information to analyze the suggestion at this time.

9. Sec. 38.10--Reporting of Swaps Traded on a Designated Contract

Market

Proposed Sec. 38.10 codified the compliance obligations of DCMs

with respect to real-time reporting of swap transactions and swap data

recordkeeping and reporting obligations, as was required under then-

proposed parts 43 \110\ and 45 \111\ of the Commission's regulations,

respectively.

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

\110\ See ``Real Time Public Reporting of Swap Transaction

Data,'' Proposed Rule, 75 FR 76139, Dec. 7, 2010.

\111\ See ``Swap Data Recordkeeping and Reporting

Requirements,'' Proposed Rule, 75 FR 76573, Dec. 8, 2010.

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

Summary of Comments and Discussion

CME referred the Commission to comments it submitted on February 7,

2011 with respect to proposed rulemakings under part 43 (real-time

public reporting of swap transaction data) and part 45 (swap data

recordkeeping and reporting requirements).\112\

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

\112\ CME Comment Letter at 14 (Feb. 22, 2011).

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

Rule 38.10 references the reporting requirements contained under

parts 43 and 45, but does not contain the substantive obligations

associated with the requirements. Accordingly, CME's comments were

considered in connection with the final rulemakings under parts 43 and

45.

The Commission is adopting this provision as proposed, with certain

clarifications to conform the rule to the regulations under parts 43

and 45. Specifically, proposed Sec. 38.10 required that each DCM, with

respect to swaps traded on or through the DCM, report specified swap

data to an SDR. The Commission is modifying Sec. 38.10 to clarify that

DCMs must maintain and report specified swap data for swaps traded ``on

or pursuant'' to the rules of the DCM. The clarification is consistent

with the rulemakings that implement real-time reporting of swap

transaction data and swap data recordkeeping and reporting requirements

under parts 43 and 45 of the Commission's regulations.\113\

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

\113\ 75 FR 76140, Dec. 7, 2010; 75 FR 76574, Dec. 8, 2010.

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

D. Core Principles

As noted above, this release reorganizes part 38 to include

subparts A through X. Each of subparts B through X includes relevant

regulations applicable to the 23 core principles. This final rulemaking

codifies within each subpart the statutory language of the respective

core principle.\114\

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

\114\ As noted in the DCM NPRM, in two instances the language of

the core principle, as codified, was slightly revised to add

references to the CEA where the statutory language simply cited to

the CEA section without citing to the statute. These non-substantive

edits were made to sections 38.100 and 38.1200.

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[[Page 36623]]

1. Subpart B--Designation as Contract Market

In the DCM NPRM, the Commission proposed to codify the statutory

text of Core Principle 1 in Sec. 38.100.\115\ The Commission is

adopting Sec. 38.100 as proposed.

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

\115\ Section 735 of the Dodd-Frank Act amended Core Principle 1

by adding that compliance with the core principles, and any other

rule or regulation that the Commission may impose under section

8a(5) of the CEA, is a necessary condition to obtain and maintain

designation as a contract market, and by adding the condition that

``unless otherwise determined by the Commission by rule or

regulation,'' DCMs have reasonable discretion in establishing the

manner in which they comply with the core principles. 7 U.S.C.

7(d)(1).

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

2. Subpart C--Compliance With Rules

Section 5(d)(2) of the CEA, as amended by the Dodd-Frank Act,

requires that a DCM establish, monitor, and enforce compliance with its

rules, including rules regarding access requirements and the terms and

conditions of any contract to be traded on the contract market, and

rules prohibiting abusive trade practices.\116\ A DCM must also have

the capacity to detect and investigate potential rule violations and to

sanction any person that violates its rules. In addition, a DCM's rules

must provide it with the ability and authority to perform the

obligations and responsibilities required under Core Principle 2,

including the capacity to carry out such international information

sharing agreements that the Commission may require.

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

\116\ Section 735 of the Dodd-Frank Act amended section 5 of the

CEA to eliminate DCM designation criteria and amends several core

principles, including Core Principle 2. Core Principle 2 was amended

to include language formerly found in Designation Criterion 8--

Ability to Obtain Information, and to specifically require that a

DCM have the ability to detect, investigate, and sanction rule

violations.

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

The Commission proposed several rules implementing amended Core

Principle 2, as further described below.

i. Sec. 38.150--Core Principle 2

Proposed Sec. 38.150 codified the text of section 5(d)(2) of the

CEA.

CME commented that a DCM cannot be expected to carry out

international or other informational sharing agreements to which it is

not a party, and should not be compelled by regulation to enter into

such agreements.\117\ KCBT opposed the requirement that a DCM establish

rules and enter into informational-sharing agreements, particularly

when such agreements contain specific requirements that are unsuitable

to a DCM or conditions with which the DCM is unable to comply.\118\

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

\117\ CME Comment Letter at 15 (Feb. 22, 2011).

\118\ KCBT Comment Letter at 3 (Feb. 22, 2011).

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

Discussion

The Commission is adopting Sec. 38.150 as proposed. Section 38.150

simply codifies the statutory language of the core principle. The

Commission, therefore, does not have discretion to amend the

requirements or obligations imposed by the statute.\119\

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

\119\ Section 5(d)(2)(C) of the CEA, as amended by the Dodd-

Frank Act, states that ``[t]he rules of the contract market shall

provide the board of trade with the ability and authority to obtain

any necessary information to perform any function described in this

subsection, including the capacity to carry out such international

information sharing agreements as the Commission may require.'' 7

U.S.C. 7(d)(2).

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

ii. Sec. 38.151--Access Requirements

Sec. 38.151(a)--Jurisdiction

Proposed Sec. 38.151(a) required that prior to granting a member

or market participant access to its markets, the DCM must require the

member or market participant to consent to its jurisdiction.

Summary of Comments

CFE stated that the term ``market participant'' used in the

proposed rule should be limited to non-members of a DCM that have the

ability to enter orders directly into a DCM's trade matching system for

execution, and that the term should not include non-members that do not

have this ability.\120\ CFE further commented that the proposed rule

should not apply to customers whose orders pass through a member's

system before receipt by a DCM because, according to CFE, in that

instance the customer order is being received by the DCM from the

member.\121\ CFE also asserted that customers that submit orders

through a member do not have the privilege of trading on a DCM and thus

the proposed rule should not apply to them.\122\

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

\120\ CFE Comment Letter at 2 (Feb. 22, 2011).

\121\ Id.

\122\ Id.

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

CME recommended that the Commission withdraw the proposed

rule.\123\ It contended that requiring clearing firms to obtain every

customer's consent to the regulatory jurisdiction of each DCM would be

costly.\124\ Moreover, CME commented that even if such consent were

obtained, the proposed rule would be entirely ineffective in achieving

the Commission's desired outcome.\125\ CME explained that if a non-

member who had consented to the exchange's jurisdiction under the

proposed rule committed a rule violation and subsequently elected not

to cooperate in the investigation or disciplinary process, the

exchange's only recourse would be to deny the non-member access and, if

appropriate, refer the matter to the Commission.\126\ CME further

explained that a DCM's enforcement options, and the regulatory

outcomes, do not change based on whether or not there is a record of

the non-member consenting to jurisdiction, but rather depend on whether

the non-member chooses to participate in the DCM's investigative and

disciplinary processes.\127\

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

\123\ CME Comment Letter at 17 (Feb. 22, 2011).

\124\ Id. at 16.

\125\ Id.

\126\ Id.

\127\ Id.

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

ICE contended that the proposed rule should distinguish between

direct-access and intermediated market participants.\128\ Furthermore,

ICE stated that a trader should be specifically subject to the

jurisdiction and the disciplinary process of the DCM only when the

privilege of trading on a DCM is specifically granted by the DCM.\129\

Likewise, KCBT explained that even if a non-member consents to KCBT

jurisdiction, but later fails to abide by such consent, KCBT's only

recourse would be to revoke such participant's market access.\130\

Therefore, KCBT questioned the benefit of implementing the proposed

rule.\131\

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

\128\ ICE Comment Letter at 12-13 (Feb. 22, 2011).

\129\ Id. at 15.

\130\ KCBT Comment Letter at 2 (Feb. 22, 2011).

\131\ Id.

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

NYSE Liffe sought clarification regarding the type of market

participant covered by the proposed rule.\132\ NYSE Liffe requested

that the Commission confirm that, unless NYSE Liffe permits market

participants direct access to its trading platform, it would not

consider a DCM to be ``granting'' market participants access to its

markets, thus necessitating that it require market participants to

consent to the DCM's jurisdiction.\133\

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

\132\ NYSE Liffe Comment Letter at 11 (Feb. 22, 2011).

\133\ Id.

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

Discussion

The Commission is adopting Sec. 38.151(a) as proposed. While

acknowledging the comments described above, the Commission believes

that Sec. 38.151(a) codifies jurisdictional requirements necessary to

effectuate the statutory mandate of Core Principle 2 that a board of

trade ``shall have the capacity to detect, investigate, and apply

appropriate sanctions to any person that violates any rule of the

[[Page 36624]]

contract market.'' In the Commission's view, settled jurisdiction--

established by a DCM prior to granting members and market participants

access to its markets--is necessary to effectively investigate and

sanction persons that violate DCM rules. In particular, a DCM should

not be in the position of asking market participants to voluntarily

submit to jurisdiction and cooperate in investigatory proceedings after

a potential rule violation has been found. Similarly, market

participants should be clear that their trading practices are subject

to the rules of a DCM, including rules that require cooperation in

investigatory and disciplinary processes. For the avoidance of doubt,

the Commission notes that the scope of Sec. 38.151(a) is not limited

to market participants with direct market access, or limited as

otherwise suggested by CFE, ICE and NYSE Liffe. To the contrary,

persons whose trades are intermediated, persons who are customers of

member firms, and persons whose access to the exchange is granted by or

through member firms are within the scope of Sec. 38.151(a).

The Commission notes commenters' suggestion that a DCM's ultimate

recourse against non-members who fail to cooperate in investigations or

disciplinary proceedings is to deny such non-members access to the

exchange and, if appropriate, refer them to the Commission. The

Commission confirms that denial of access and referral to the

Commission are the appropriate steps for a DCM to take when a market

participant fails to cooperate in an investigation or disciplinary

proceedings. The Commission expects that DCMs will in fact follow these

steps. However, the Commission does not agree that this absolves DCMs

from their responsibility to establish jurisdiction over members and

market participants as an initial condition of trading. Finally, the

Commission recognizes that DCMs may need additional time to secure

existing market participants' agreements to jurisdiction. Accordingly,

the Commission is granting DCMs up to 180 days following the applicable

effective date of the rules being adopted in this release to comply

with the requirements of Sec. 38.151(a) with respect to existing

members and market participants. Each DCM may determine for itself how

it will secure such agreements. For example, a DCM could utilize its

clearing firms to secure the agreement. With respect to new members and

market participants, DCMs will be subject to Sec. 38.151(a) on the

effective date of the rules being adopted in this release.

Sec. 38.151(b)--Impartial Access by Members, Market Participants and

Independent Software Vendors

Proposed Sec. 38.151(b) required that a DCM provide its members,

market participants and independent software vendors (``ISVs'') with

impartial access to its markets and services, including: (1) access

criteria that are impartial, transparent, and applied in a non-

discriminatory manner, and (2) comparable fee structures for members,

market participants and ISVs, receiving equal access to, or services

from, the DCM. In regards to the proposed rule's comparable fee

structure requirement, the DCM NPRM preamble discussion of proposed

Sec. 38.151(b) stated that ``[f]ee structures may differ among

categories if such fee structures are reasonably related to the cost of

providing access or services to a particular category.''\134\

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

\134\ See DCM NPRM at 80579. As an example, the preamble further

stated that ``if a certain category required greater information

technology or administrative expenses on the part of the DCM, then a

DCM may recoup those costs in establishing fees for that category or

member or market participant.'' Id.

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

Summary of Comments

Chris Barnard supported this requirement, stating that the only

reason for charging different fee structure would relate to differing

costs of providing access or service to a particular category.\135\ CFE

commented that the Commission's application of the requirement to have

comparable fee structures is too narrow.\136\ CFE stated that it is in

a DCM's best interest to set fees at levels that encourage

participation on the DCM (rather than to exclude participants) because

having greater participation leads to greater contract volume and thus

more transaction revenue for the DCM.\137\ CFE agreed that a DCM should

be able to have fee structures that differ among categories and did not

believe that the only permitted differentiation should be based on

cost.\138\

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

\135\ Barnard Comment Letter at 2 (Feb. 22, 2011).

\136\ CFE Comment Letter at 3 (Feb. 22, 2011).

\137\ Id.

\138\ Id.

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

CME stated that the fee restrictions imposed by the proposed rule

exceed the Commission's authority under the Dodd-Frank Act, and

questioned the basis for the proposed rule.\139\ In particular, CME

argued that the agency lacks authority to set or limit fees charged by

DCMs.\140\

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

\139\ CME Comment Letter at 8-9 (Feb. 22, 2011).

\140\ Id.

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

ELX stated that exchanges must have some flexibility in

implementing fees in order to allow new markets to effectively build a

customer base.\141\ According to ELX, not all customers ``receive the

same commission'' from their FCM, IB or executing broker, and it is

artificial to require exchanges to forego their flexibility in pricing

to build a marketplace.\142\ ELX further stated that competition should

not be rigidly regulated at the exchange level while other regulated

entities doing business with customers are permitted to use competitive

pricing.\143\

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

\141\ ELX Comment Letter at 3 (Feb. 22, 2011).

\142\ Id. at 4.

\143\ Id.

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

ICE noted that the discriminatory conduct prohibited by the

proposed rule would be subject to review by the Commission as an

``access denial'' issue under part 9 of the Commission's

regulations.\144\ Moreover, ICE asserted that in its view, there has

been no pattern of DCMs denying access to their markets that warrants

the proposed rule.\145\ ICE added that the proposed rule should not

require access requirements for traders who do not apply for, and are

not granted access to, the trading platform by the DCM.\146\

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

\144\ ICE Comment Letter at 15 (Feb. 22, 2011).

\145\ Id. at 15.

\146\ Id.

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

KCBT objected to the Commission's mandate of access and fee

equality, stating that the mandate may not take into consideration all

aspects of an exchange's varying fee or access structures, including

beneficial rate structures for high-volume traders or market maker

programs.\147\ Consequently, KCBT urged the Commission to withdraw from

its attempt to impose fee restrictions on DCMs.\148\

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

\147\ KCBT Comment Letter at 3 (Feb. 22, 2011).

\148\ Id.

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

MGEX stated that in general, it is in the best interest of the DCM

to have open and available markets and services.\149\ Therefore, MGEX

argued that the proposed rule is unnecessary and infringes on the

business judgment of the DCM.\150\

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

\149\ MGEX Comment Letter at 3 (Feb. 22, 2011).

\150\ Id.

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

Trading Technologies stated that the Commission should modify its

proposed impartial access rules to require that DCM co-location service

fees be reasonably related to the cost of providing such services.\151\

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

\151\ Trading Technologies Comment Letter at 4 (Jun. 3, 2011).

The Commission recently addressed co-location fees in a separate

proposed rulemaking for ``Co-location/Proximity Hosting Services.''

See notice of proposed rulemaking, 75 FR 33198, Jun. 11, 2010.

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[[Page 36625]]

Discussion

The Commission is adopting the rule as proposed, with the

modifications and clarifications described below.

The Commission believes that the proposed rule falls within the

Commission's authority under the Dodd-Frank Act. As an initial matter,

Congress, under the Dodd-Frank Act, expressly authorized the Commission

to promulgate rules implementing requirements for DCMs, including

access requirements.\152\ Moreover, the statutory language of Core

Principle 2 expressly requires that DCMs ``establish, monitor and

enforce compliance with the rules of the contract market, including:

(1) Access requirements[.]'' \153\ Though the CEA does not specify that

DCMs provide ``impartial'' access, the Commission believes that a

reasonable reading of the CEA is that it permits rules that would

promote impartial access.

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

\152\ See CEA section 5(d)(1)(A)(ii) (Core Principle 1), 7

U.S.C. 7(d)(1).

\153\ CEA section 5(d)(2)(A)(i) (Core Principle 2), 7 U.S.C.

7(d)(2).

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

The Commission has considered comments that claimed that the rule

is unnecessary, and believes that impartial access rules are necessary

in order to prevent the use of discriminatory access requirements as a

competitive tool against certain participants. In particular, access to

a DCM should be based on the financial and operational soundness of a

participant, not on factors that could bar access and result in

discriminatory access or act as a barrier to entry. Any participant

should be able to demonstrate financial soundness by showing either

that it is a clearing member of a DCO that clears products traded on

that DCM, or that it has clearing arrangements in place with such a

clearing member. Furthermore, granting impartial access to participants

that satisfy a DCM's access requirements will likely enhance the DCM's

liquidity and the overall transparency of the swaps and futures

markets.

In regards to comments pertaining to the proposed rule's treatment

of fees, the Commission believes that commenters have misinterpreted

the proposed requirement for comparable fee structures for categories

of market participants receiving equal access to the DCM. The

requirement in proposed Sec. 38.151(b) neither sets nor limits fees

charged by DCMs. Rather, it states only that the DCM set non-

discriminatory fee classes for those receiving access to the DCM as a

way to implement the requirement of impartial access to DCMs. DCMs may

establish different categories of market participants, but may not

discriminate within a particular category. Accordingly, contrary to

CME's comment claiming that the fee restrictions imposed by the

proposed rule exceed the Commission's authority under the Dodd-Frank

Act, the rule does not set or impose fees on DCMs.

To clarify the DCM NPRM preamble discussion of the proposed rule's

fee requirement, and in response to CFE and KCBT's comment that a DCM

should be able to differentiate among categories by using factors other

than cost, the Commission notes that when a DCM determines its fee

structure, it may consider other factors in addition to the cost of

providing a member, market participant or ISV with access. The proposed

requirement that DCMs have a comparable fee structure for categories of

market participants was not designed to be a rigid requirement that

fails to take into account legitimate business justifications for

offering different fees to different categories of entities seeking

access. The Commission recognizes that DCMs may also consider services

they receive from members, market participants or ISVs (in addition to

costs) when determining their fee structure. Market making is an

example of one type of service that could merit a fee discount.

To address comments submitted in connection with proposed Sec.

38.151(a) pertaining to the uncertainty of the term ``market

participant,'' the Commission is replacing the term ``market

participant'' in proposed Sec. 38.151(b) with the phrase ``persons

with trading privileges.''

The Commission is adopting the remainder of the rule as proposed.

Sec. 38.151(c)--Limitations on Access

Proposed Sec. 38.151(c) required a DCM to establish and

impartially enforce rules governing any decision by the DCM to deny,

suspend, or permanently bar a member's or market participant's access

to the contract market. Any decision by a DCM to deny, suspend, or

permanently bar a member's or market participant's access to the DCM

must be impartial and applied in a non-discriminatory manner.

Summary of Comments

CFE, ICE, and NYSE Liffe commented on the uncertainty of the term

``market participant'' as used in paragraphs (a), (b), and (c) of

proposed Sec. 38.151.\154\

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

\154\ CFE Comment Letter at 2 (Feb. 22, 2011); ICE Comment

Letter at 14 (Feb. 22, 2011); NYSE Liffe Comment Letter at 11 (Feb.

22, 2011).

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

Discussion

To address comments pertaining to the uncertainty of the term

``market participant,'' the Commission is replacing the term ``market

participant'' in proposed Sec. 38.151(c) with the phrase ``persons

with trading privileges.''

iii. Sec. 38.152--Abusive Trading Practices Prohibited

As proposed, Sec. 38.152 required a DCM to prohibit the following

abusive trading practices: front-running, wash trading, pre-arranged

trading, fraudulent trading, money passes, and any other trading

practices that the DCM deems to be abusive. Additionally, a DCM

permitting intermediation would be required to prohibit additional

trading practices, including trading ahead of customer orders, trading

against customer orders, accommodation trading, and improper cross-

trading. The proposal also required a DCM to prohibit any other

manipulative or disruptive trading practices prohibited by the Act or

by the Commission pursuant to regulation.\155\

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

\155\ Section 747 of the Dodd-Frank Act amended section 4c(a) of

the CEA, 7 U.S.C. 6c(a), by adding three disruptive practices which

make it: unlawful for any person to engage in any trading, practice,

or conduct on or subject to the rules of a registered entity that--

(A) Violate bids or offers;

(B) Demonstrates intentional or reckless disregard for the

orderly execution of transactions during the closing period; or

(C) Is, is of the character of, or is commonly known as the

trade as `spoofing' (bidding or offering with the intent to cancel

the bid or offer before execution).

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

Summary of Comments

CME and MGEX stated that the proposed rule is too vague because it

does not specifically define the enumerated prohibited trade

practices.\156\ CME also stated that DCMs should have reasonable

discretion to establish rules appropriate to their markets that are

consistent with the CEA and that satisfy the core principles.\157\ CME

additionally commented that prearranged trading, which is identified in

the proposed rule as a prohibited trade practice, may be permissible at

DCMs that allow for block trading, exchange for related position

transactions, and pre-execution communications, subject to specified

conditions.\158\

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

\156\ CME Comment Letter at 17 (Feb. 22, 2011) (CME also argued

that the proposed regulation was superfluous given that Core

Principle 12 already requires a DCM to establish and enforce rules

to protect markets and market participants from abusive practices);

MGEX Comment Letter at 3 (Feb. 22, 2011).

\157\ CME Comment Letter at 17 (Feb. 22, 2011).

\158\ Id. at 17-18.

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

Chris Barnard commented that the proposed rule refers to the

prohibition of ``any other manipulative or disruptive trading practices

prohibited by the Act

[[Page 36626]]

or by the Commission,'' which is important in order to cover new

disruptive practices as they emerge, including spoofing.\159\ Better

Markets commented that it is unclear whether any of the practices

associated with high frequency trading will be prohibited by the

Commission.\160\ Better Markets recommended that the Commission expand

its list of prohibited trade practices to include exploiting a large

quantity or block trade, price spraying, rebate harvesting, and

layering the market, as all four of those practices involve fraudulent

trading.\161\

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

\159\ Barnard Comment Letter at 3 (May 20, 2011).

\160\ Better Markets Comment Letter at 5 (Feb. 22, 2011).

\161\ Id. at 5-8.

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

Discussion

The Commission is adopting Sec. 38.152 as proposed, subject to the

modification described below.

In response to CME and MGEX's concerns regarding the perceived

vagueness of the enumerated trading practices, the Commission notes

that the definitions of the respective abusive trading practices are

commonly known within the industry. Moreover, the enumerated practices

in the proposed rule are commonly prohibited within the industry and

are typically already prohibited in DCM rulebooks.\162\ Although the

Commission believes, as noted by CME, that a DCM should have reasonable

discretion to establish rules for their markets, the Commission

believes that, at a minimum, a DCM must prohibit the abusive trading

practices identified in the rule. Indeed, in the RERs conducted by

Commission staff to examine DCMs' core principle compliance, Commission

staff has found that it is essential for a DCM to be able to

demonstrate the capacity to detect, investigate, and enforce the

trading violations prohibited under the rule. Consistent with CME's

comments on this issue, the Commission clarifies that in certain

limited circumstances, as provided under the CEA and the Commission

regulations, pre-arranged trading, including block trading and exchange

for related position transactions, are permissible at DCMs.

Accordingly, the Commission is amending proposed Sec. 38.152 to

clarify that a DCM must prohibit pre-arranged trading except as

otherwise permitted in part 38 of this chapter. The Commission confirms

that pre-execution communications are permissible if allowed by a DCM's

rules that have been certified to or approved by the Commission.

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

\162\ See e.g., CME Rule 534 (Wash Trades Prohibited), and MGEX

Rule 743.00 (Accommodation or Wash Trades Forbidden).

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

In response to Chris Barnard's comment about the inclusion of

``spoofing'' as a prohibited trade practice, the Commission notes that

section 747 of the Dodd-Frank Act amended section 4c(a) of the CEA and

includes spoofing as a disruptive trading practice. In the final rule,

DCMs are required to prohibit any other manipulative or disruptive

trading practices prohibited by the Act. Additionally, the Commission

notes that Better Markets' comments regarding Core Principle 2 and high

frequency trading are addressed in the context of Core Principle 4.

iv. Sec. 38.153--Capacity To Detect and Investigate Rule Violations

Proposed Sec. 38.153 required that a DCM have arrangements and

resources for effective rule enforcement.\163\ This included the

authority to collect information and examine books and records of

members and market participants. Additionally, the proposed rule

required a DCM to have, in addition to appropriate resources for trade

practice surveillance programs, appropriate resources to enforce all of

its rules.

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

\163\ As noted in the DCM NPRM, proposed regulation 38.153 was

based on the former application guidance for Core Principle 2.

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

Summary of Comments

CFE requested that the Commission clarify the term ``market

participant.'' \164\ CFE claimed that if the term ``market

participant'' were to be interpreted to apply to all customers and not

just those customers with direct electronic access to the DCM, then the

rule would greatly expand a DCM's regulatory responsibilities over

participants with whom it has no direct relationship or

connection.\165\ CFE further asserted that the rule would greatly

increase costs for the DCM and that it would be very difficult for a

DCM to undertake the same examination responsibilities for customers

that do not have a direct relationship with the DCM that are applicable

to a DCM member.

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

\164\ CFE Comment Letter at 2 (Feb. 2, 2011).

\165\ Id.

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

CME stated that the proposed rule appears to imply that the entire

class of non-member, non-registered market participants will be subject

to the panoply of recordkeeping requirements currently applicable only

to members, registrants, and direct access clients of CME.\166\

Additionally, CME commented that the proposed rule does not detail

which books, records and information the DCM must be able to obtain

from non-member market participants.\167\

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

\166\ CME Comment Letter at 18 (Feb. 22, 2011).

\167\ Id.

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

Discussion

The Commission is adopting this provision as proposed, subject to

the modification described below.

The Commission is cognizant that a broad interpretation of the term

``market participant'' could significantly increase the regulatory

responsibilities for DCMs. As noted above, the use of ``market

participant'' may be interpreted to capture a wider range of persons

than the Commission intended. Therefore, in response to the commenters'

concerns, the Commission is replacing the term ``market participant''

with ``persons under investigation'' in the final rule. Thus, a DCM

must have the authority to collect books and records from its members,

and from any persons under investigation, for effective enforcement of

its rules. The books and records collected by the DCM should encompass

all information and documents that are necessary to detect and

prosecute rule violations.

v. Sec. 38.154--Regulatory Services Provided by a Third Party

As the Commission stated in the DCM NPRM, the CEA ``provides that a

DCM may comply with applicable core principles by delegating relevant

functions to a registered futures association or another registered

entity'' (collectively, a ``regulatory service provider'').\168\

Proposed Sec. 38.154(a) required that a DCM that contracts with a

regulatory service provider ensure that its regulatory service provider

has sufficient capacity and resources to provide timely and effective

regulatory services. The proposed rule also made clear that a DCM

``will at all times remain responsible for the performance of any

regulatory services received, for compliance with the [DCM's]

obligations under the CEA and Commission regulations, and for the

regulatory service provider's performance on its behalf.'' \169\

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

\168\ Id. at 80580.

\169\ 75 FR 80572, 80612, Dec. 22, 2010.

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

Proposed Sec. 38.154(b) required that a DCM maintain adequate

compliance staff to supervise any services performed by a regulatory

service provider. The proposed rule also required that the DCM hold

regular meetings with its regulatory service provider to discuss

current work and other matters of regulatory concern. The DCM must also

conduct periodic reviews of the adequacy and

[[Page 36627]]

effectiveness of services provided on its behalf.

Proposed Sec. 38.154(c) required a DCM that utilizes a regulatory

service provider to retain exclusive authority over certain areas,

including the cancellation of trades, issuance of disciplinary charges

against members or market participants, and denials of access to the

trading platform for disciplinary reasons. While the proposed rule

permitted a DCM to retain exclusive authority in other areas of its

choosing, it required that the decision to open an investigation into a

possible rule violation reside with the regulatory service provider.

Summary of Comments

MGEX, KCBT and CME asserted that the proposed rule was overly

burdensome or unnecessary.\170\ MGEX expressed general opposition to

proposed Sec. 38.154, stating that if a service has been delegated to

another registered entity pursuant to a Commission-approved agreement,

then this ``should be sufficient and no other formal agreement is

necessary.'' \171\ KCBT contended that proposed Sec. 38.154 is overly

burdensome and duplicative, particularly when a DCM contracts with a

regulatory service provider that is also a DCM required to comply with

the same core principles.\172\ KCBT noted that it currently is a party

to a services agreement with another DCM and that it will be costly and

unnecessary to perform periodic reviews and hold regular meetings with

this regulatory service provider.\173\

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

\170\ MGEX Comment Letter at 3 (Feb. 22, 2011); KCBT Comment

Letter at 3 (Feb. 22, 2011); CME Comment Letter at 19 (Feb. 22,

2011).

\171\ MGEX Comment Letter at 3 (Feb. 22, 2011).

\172\ KCBT Comment Letter at 3 (Feb. 22, 2011).

\173\ Id.

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

Similarly, CME contended that the proposed rule was overly

prescriptive and suggested that the rules would better serve as

guidance and acceptable practices.\174\ In particular, CME pointed to

the requirements that a DCM conduct periodic reviews of the services

provided and hold regular meetings with the regulatory service provider

to discuss ongoing investigations, trading patterns, market

participants, and any other matters of regulatory concern.\175\ CME

stated that ``[w]hile it may well be that it is constructive for the

DCM to hold regular meetings with its service provider and `discuss

market participants,' the core principle should stand on its own and

the DCM should have the flexibility to determine how best to

demonstrate compliance with the core principle.'' \176\

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

\174\ CME Comment Letter at 18-19 (Feb. 22, 2011).

\175\ Id.

\176\ CME Comment Letter at 19 (Feb. 22, 2011).

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

CME further objected to the requirement that exclusive authority to

open investigations remain with the regulatory service provider.\177\

While it argued that the regulatory service provider ``should have the

independence to open an investigation at its discretion, [CME] sees no

reason why the DCM cannot also direct the regulatory service provider

to open an investigation.'' \178\ Additionally, CME and KCBT both

objected to the requirement in proposed Sec. 38.154(c) that all

decisions concerning the cancellation of trades remain within the

exclusive authority of the DCM.\179\ CME and KCBT argued that a DCM may

be better served by granting such authority to a regulatory service

provider.\180\

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

\177\ Id.

\178\ Id.

\179\ CME Comment Letter at 19 (Feb. 22, 2011); KCBT Comment

Letter at 3 (Feb. 22, 2011).

\180\ Id.

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

NYSE Liffe expressed support for the idea that a DCM will remain

ultimately responsible for meeting its regulatory obligations even when

it contracts with a regulatory service provider.\181\ However, NYSE

Liffe requested clarification regarding what authority must be

maintained by a DCM when it uses a third-party regulatory service

provider.\182\ NYSE Liffe pointed to the requirement in proposed Sec.

38.154(c) that a DCM must retain ``exclusive authority'' in certain

areas and requested further clarification as to the definition of

``exclusive authority.'' \183\ In particular, NYSE Liffe requested

guidance as to whether a DCM retains ``exclusive authority'' if its

regulatory service provider prepares and presents an investigation

report to a DCM's review panel, or assists DCM staff in presenting the

matter, as long as the ultimate decision to bring a disciplinary action

remains with the DCM's review panel.\184\ Additionally, NYSE Liffe

sought guidance as to whether a regulatory service provider would be

permitted to ``prosecute a disciplinary proceeding * * * so long as the

ultimate decision to impose a penalty on a respondent, including a

possible denial of access to the trading platform, resides with a

hearing panel formed pursuant to the DCM's rules?'' \185\

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

\181\ NYSE Liffe Comment Letter at 9 (Feb. 22, 2011).

\182\ Id.

\183\ Id.

\184\ Id.

\185\ Id. at 10.

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

Discussion

The Commission is adopting Sec. 38.154(a) and (b), as proposed,

and is adopting Sec. 38.154(c) with certain modifications.

In the past, the Commission has described acceptable

``contracting'' and ``delegating'' arrangements for the performance of

core principle functions by third-parties.\186\ The Commission proposed

Sec. 38.154 to clarify its previous guidance on such arrangements. In

particular, the Commission does not draw substantive distinctions

between ``contracting'' and ``delegating'' arrangements as they pertain

to core principle compliance functions. Regardless of the term by which

a DCM may refer to its utilization of a third-party, the Commission

believes that the same regulatory requirements are applicable for

purposes of part 38. For purposes of part 38, the Commission refers to

such arrangements as ``delegation.'' The Commission also notes that

DCMs must remain responsible for carrying out any function delegated to

a third party, and that DCMs must ensure that the services received

will enable the DCM to remain in compliance with the CEA's

requirements. The Commission believes that proposed Sec. 38.154

effectively establishes a system for administering regulatory services

provided to DCMs by third party regulatory service providers. The

Commission is of the view that the rule generally provides an

appropriate balance between flexibility and ensuring that a DCM

properly oversees the actions of its regulatory service provider to

ensure accountability and effective performance.

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

\186\ See 66 FR 42256, 42266, Aug. 10, 2001.

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

The Commission acknowledges comments asserting that the rule is

overly burdensome or unnecessary but believes that a DCM that elects to

use a regulatory service provider must properly supervise the quality

and effectiveness of the regulatory services provided on its behalf.

The Commission believes that proper supervision will require that a DCM

have complete and timely knowledge of relevant work performed by the

DCM's regulatory service provider on its behalf. The Commission also

believes that such knowledge can only be acquired through the periodic

reviews and regular meetings required under proposed Sec. 38.154.

Additionally, the Commission acknowledges CME and KCBT's comments

regarding the cancellation of trades but believes that the potential

economic consequences of trade

[[Page 36628]]

cancellations on a DCM's members and market participants are such that

a DCM should retain exclusive authority over the cancellation of

trades.

The Commission has considered CME's comment regarding the

importance of allowing a DCM to open investigations into possible rule

violations. The Commission believes that a DCM should have the ability

to request that its regulatory service provider conduct an

investigation on a market participant or to conduct such an

investigation on its own. Consequently, the Commission is modifying

Sec. 38.154(c) by removing the requirement that the decision to open

an investigation into possible rule violations reside exclusively with

the regulatory service provider.

Lastly, in response to the request by NYSE Liffe for additional

guidance regarding whether certain regulatory decisions must be

retained by a DCM, the Commission believes that a DCM would retain

``exclusive authority'' under Sec. 38.154(c) if it permits a

regulatory service provider to present, or assist DCM staff to present,

an investigation report or evidence to a disciplinary panel as long as

the decisions to bring a disciplinary action and impose a disciplinary

penalty on a respondent, including the decision to deny access, remains

with the DCM or the DCM's disciplinary bodies.

vi. Sec. 38.155--Compliance Staff and Resources

In proposed Sec. 38.155(a), the Commission required that a DCM

establish and maintain sufficient compliance staff and resources to

conduct a number of enumerated tasks, such as audit trail reviews,

trade practice surveillance, market surveillance, and real time market

monitoring. The proposed rule also required that the DCM have

sufficient compliance staff to address unusual market or trading events

and to conduct and complete any investigations in a timely manner.

In proposed Sec. 38.155(b), the Commission required a DCM to

monitor the size and workload of its compliance staff annually to

ensure that staff and resources are adequate. In the preamble to the

proposed rule, the Commission clarified that it was not proposing that

compliance staff size be determined based on a specific formula.

Rather, the Commission intended ``to leave to the discretion of each

individual DCM to determine the size of the staff it needs to

effectively perform its self-regulatory responsibilities.'' \187\ In

making this determination, the proposed rule also set forth certain

factors that should be considered in determining the appropriate level

of compliance resources and staff.

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

\187\ DCM NPRM at 80580.

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

Summary of Comments

NYSE Liffe noted that in proposed Sec. 38.154(b), ``a DCM that

contracts with a regulatory service provider must still maintain

sufficient compliance staff.'' \188\ NYSE Liffe suggested that Sec.

38.155 take into consideration whether a DCM has contracted with a

regulatory service provider in determining the appropriate level of

compliance staff and resources.\189\ NYSE Liffe also requested that the

Commission ``make clear that a DCM meets its requirement to have

sufficient compliance staff to address unusual market or trading events

where its regulatory services provider has sufficient resources for

addressing these unusual events.'' \190\

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

\188\ NYSE Liffe Comment Letter at 10 (Feb. 22, 2011). See also

DCM NPRM at 80612.

\189\ NYSE Comment Letter at 10 (Feb. 22, 2011).

\190\ Id.

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

Chris Barnard requested that the Commission amend Sec. 38.155 to

require DCMs to have a chief compliance officer ``working within a job

description, structures, rules and procedures that act to maintain its

independence.'' \191\

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

\191\ Barnard Comment Letter at 3 (May 20, 2011).

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

Discussion

The Commission believes that proposed Sec. 38.155 effectively sets

forth the requirement that DCMs must establish and maintain sufficient

compliance staff to enforce compliance with its rules as required under

Core Principle 2, and accordingly, the Commission is adopting Sec.

38.155 as proposed.

The Commission is of the view that having adequate staff to perform

a DCM's compliance and enforcement responsibilities is essential to the

effectiveness of its self-regulatory programs, including market

surveillance, audit trail, trade practice surveillance, and

disciplinary programs. The Commission believes (as noted by NYSE Liffe)

that the staff of a regulatory service provider may be taken into

consideration when determining whether a DCM has sufficient compliance

staff. However, the Commission notes that pursuant to Sec. 38.154(b),

each DCM must still retain sufficient compliance staff to supervise the

quality and effectiveness of any services provided by a regulatory

service provider on its behalf.

The Commission acknowledges Chris Barnard's comment that a DCM

should be required to designate a chief compliance officer but notes

that the Dodd-Frank Act mandates that certain regulated entities, such

as SEFs, swap data repositories, and derivatives clearing

organizations, designate chief compliance officers. There is no

explicit statutory requirement for DCMs. Therefore, the Commission does

not believe it is appropriate to require DCMs to appoint a chief

compliance officer. However, it is current industry practice for DCMs

to designate an individual as chief regulatory officer, and it will be

difficult for a DCM to meet the requirements of Sec. 38.155 without a

chief regulatory officer or similar individual to supervise its

regulatory program, including any services rendered to the DCM by a

regulatory service provider.

vii. Sec. 38.156--Automated Trade Surveillance System

Proposed Sec. 38.156 required a DCM to maintain an automated trade

surveillance system capable of detecting and investigating potential

trade practice violations. The automated trade surveillance would be

required to maintain all data reflecting the details of each order

entered into the trading system, including order modifications and

cancellations, and data reflecting transactions executed on the DCM.

The proposed rule required the automated surveillance system to process

this data on a trade date plus one day basis (``T+1 basis'').

Additionally, according to the rule, the automated trade surveillance

system would be required to provide users with the ability to compute,

retain and compare trading statistics; compute profit and loss; and

reconstruct the sequence of trading activity.

Summary of Comments

CME commented that an exchange does not capture order details,

modifications or cancellations for open-outcry orders in an automated

manner unless such orders are transmitted to the floor via the

exchange's order routing system, or with respect to privately

negotiated transactions.\192\ CME asserted that it has been unable to

design a system that automates the actual investigation of potential

trade practice violations, and that it would not be able to do so

within 60 days of the final rules taking effect.\193\ CME further

argued that it is unclear whether the regulation applies to electronic

trading or open outcry trading.\194\ CME challenged the use of what it

deems as ``broad and ambiguous'' terms to describe

[[Page 36629]]

capabilities that a DCM's automated trade surveillance system is

required to have, including the capability to detect and flag specific

trade execution patterns and anomalies; compute, retain and compare

trading statistics; and compute trade gains, losses, and futures-

equivalent positions.\195\ CME recommended that the Commission

reconsider the requirements of this regulation and consider a more

flexible, core principles-based approach.\196\

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

\192\ CME Comment Letter at 20 (Feb. 22, 2011).

\193\ Id.

\194\ Id.

\195\ Id.

\196\ Id.

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

MGEX agreed with the proposed requirement that a DCM's automated

surveillance system must maintain all trade data and order data on a

T+1 basis, but opposed the proposed requirement that a DCM compute,

retain and compare trading statistics.\197\ MGEX contended that this

information is not a trade data item and requested that this

requirement be removed from the final rule.\198\

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

\197\ MGEX Comment Letter at 4 (Feb. 22, 2011).

\198\ Id.

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

NYSE Liffe commented that it would take significant time to

determine the types of changes to existing automated systems required

to implement the proposed rules, including Sec. 38.156, and

recommended that the Commission provide existing DCMs with at least 18

months from the effective date of the rule to certify compliance with

the final regulations.\199\

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

\199\ NYSE Liffe Comment Letter at 14 (Feb. 22, 2011).

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

Better Markets commented that an automated trade surveillance

system, which records orders, modifications of orders, and

cancellations, must allow for such data to be time-stamped at intervals

consistent with the capabilities of high frequency traders that use the

DCM's systems to transact.\200\

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

\200\ Better Markets Comment Letter at 9 (Feb. 22, 2011).

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

Discussion

The Commission is adopting proposed Sec. 38.156, with one

modification.

The requirement that an automated trade surveillance system

maintain all data reflecting the details of each order entered into the

trading system is being moved to Sec. 38.552 (Elements of an

acceptable audit trail program). Specifically, the Commission believes

that Sec. 38.552(b) is the more logical place in the Commission's

rules to address this aspect of a DCM's automated surveillance system

because paragraph (b) specifies the requirements for a DCM's audit

trail program, including a history of all orders and trades.

In response to CME's comment regarding a system that automates the

actual investigation, the Commission notes that CME has misinterpreted

the proposed rule, as Sec. 38.156 applies to a DCM's automated

surveillance system and not to the actual investigation which the

Commission expects would be carried out by a DCM's compliance staff

with the assistance of automated surveillance tools. The Commission

confirms that the speed and timing of capturing information through an

automated trade surveillance system is different for open-outcry than

for electronic trading, as CME stated in its comments; this is

addressed in the discussion concerning Sec. 38.552.

In regards to CME's comment pertaining to the breadth of the rule,

while the Commission acknowledges that computing, retaining, and

comparing trading statistics may not specifically be a trade data item,

the Commission believes that these analytical tools are a necessary

component of an effective trade surveillance system. The Commission

notes that timing concerns raised by NYSE Liffe regarding compliance

with the final rules are addressed above in the Sec. 38.3 discussion.

Additionally, the Commission notes that Better Markets' comments

regarding Core Principle 2 and high frequency trading are addressed in

the context of Core Principle 4.

viii. Sec. 38.157--Real-Time Market Monitoring

Proposed Sec. 38.157 codified existing practices at DCMs for real-

time monitoring of electronic trading, and reflected the growth of

electronic trading in the U.S. futures markets, as well as the

Commission's experience in designating new contract markets since

passage of the CFMA.\201\ Proposed Sec. 38.157 required a DCM to

conduct real-time market monitoring of all trading activity on its

electronic trading platform to ensure orderly trading and identify

market or system anomalies. The proposed rule further required a DCM to

have the authority to cancel trades and adjust trade prices when

necessary, and that any price adjustments or trade cancellations must

be transparent to the market and subject to clear, fair and publicly-

available standards.

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

\201\ See DCM NPRM at 80581.

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

Summary of Comments

In its comments, CME reiterated its belief that the proposed rules

are overly prescriptive.\202\ CME argued that the standards set in the

proposed rule are unreasonably high.\203\ CME pointed to the

requirement that a DCM ``conduct real-time market monitoring of all

trading activity on its electronic trading platform(s) to ensure

orderly trading and identify any market or system anomalies'' and

argued that it is not clear whether any DCM could comply with these

standards.\204\

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

\202\ CME Comment Letter at 20-21 (Feb. 22, 2011).

\203\ Id.

\204\ CME Comment Letter at 20-21 (Feb. 22, 2011) (citing DCM

NPRM at 80613, with emphasis added by CME).

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

Better Markets stated that when conducting real-time market

monitoring, DCMs should have the capability to monitor high frequency

trading.\205\ Better Markets argued that this process should include

``monitoring of orders and cancellations, each time-stamped at

intervals consistent with the capabilities of [high frequency

traders].'' \206\

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

\205\ Better Markets Comment Letter at 9 (Feb. 22, 2011).

\206\ Id.

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

Discussion

The Commission is adopting Sec. 38.157, as proposed, subject to

the modification described below.

In regard to the CME's comment, the Commission believes that Sec.

38.157, as proposed, enables a DCM to effectively monitor its

electronic markets and grants a DCM the flexibility to determine the

best way to conduct real-time market monitoring. The Commission also

believes that the proposed rule correctly mandates that a DCM conduct

real-time market monitoring of all trading activity that occurs on its

electronic trading platform(s) in order to detect disorderly trading

and market or system anomalies, and take appropriate regulatory action.

The Commission recognizes that real-time market monitoring cannot

ensure orderly trading at all times, but it should be able to identify

disorderly trading when it occurs. Therefore, the Commission is

modifying the first sentence of proposed Sec. 38.157 to remove the

requirement to ``ensure orderly trading'' and instead state that ``a

designated contract market must conduct real-time market monitoring of

all trading activity on its electronic trading platform(s) to identify

disorderly trading and any market or system anomalies.'' In response to

Better Markets' comments, the Commission believes that Sec. 38.157 is

sufficient to establish a DCM's obligations with respect to real-time

market monitoring of all trading on a DCM's electronic trading

platform, including high frequency trading. The Commission will

continue to assess the impact of high

[[Page 36630]]

frequency trading on the markets regulated by the Commission.

The Commission believes that Sec. 38.157 effectively establishes a

DCM's obligations with respect to real-time market monitoring of

trading activity on its electronic trading platforms. Accordingly, the

Commission is adopting Sec. 38.157 as modified above.

ix. Sec. 38.158--Investigations and Investigation Reports

Sec. 38.158(a)--Procedures

Proposed paragraph (a) of Sec. 38.158 required that a DCM have

procedures to conduct investigations of possible rule violations. The

proposed rule required that an investigation must be commenced upon

Commission staff's request or upon discovery of information by the DCM

indicating a possible basis for finding that a violation has occurred

or will occur.

Summary of Comments

CME argued that the proposed rule diminishes any discretion on

behalf of DCMs to determine the matters that warrant a formal

investigation, because at the time of discovery or upon receipt of

information, and before a review occurs, there always may be a possible

basis that a violation has occurred or will occur.\207\ CME agreed that

written referrals from the Commission, law enforcement authorities,

other regulatory agencies, or other SROs should result in a formal

investigation in every instance.\208\ However, CME contended that the

DCM should have reasonable discretion to determine how it responds to

complaints and other referrals, including the discretion to follow-up

with a less formal inquiry in certain situations.\209\

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

\207\ CME Comment Letter at 21 (Feb. 22, 2011).

\208\ Id.

\209\ Id.

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

Discussion

The Commission is adopting Sec. 38.158(a) as proposed, subject to

a minor modification. The Commission confirms that in certain

circumstances a DCM should have reasonable discretion regarding whether

or not to open an investigation, as noted by CME. Consequently, the

Commission is revising paragraph (a) of Sec. 38.158 to reflect that an

investigation must be commenced upon receipt of a request from

Commission staff or upon the discovery or receipt of information by the

DCM that indicates a ``reasonable basis'' for finding that a violation

``may have'' occurred or will occur.

Sec. 38.158(b)--Timeliness

Proposed Sec. 38.158(b) required that an investigation be

completed in a timely manner, which is defined in the proposed rule as

12 months after an investigation is opened, absent mitigating factors.

The mitigating factors identified in the proposed rule included the

complexity of the investigation, the number of firms or individuals

involved as potential wrongdoers, the number of potential violations to

be investigated, and the volume of documents and data to be examined by

compliance staff.

Summary of Comments

CME expressed general support for the proposed rule, but

recommended that the list of possible mitigating circumstances also

include the domicile of the subjects and cooperative enforcement

matters with the Commission, since the DCM may not have independent

control over the pace of the investigation.\210\ CME also requested

that the Commission make clear that the time period necessary to

prosecute an investigation once it is referred for enforcement action

is independent of the 12-month period referenced in the

regulation.\211\

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

\210\ Id.

\211\ Id. at 22.

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

Discussion

The Commission is adopting the rule as proposed.

The Commission believes that a 12-month period to complete an

investigation is appropriate and timely. Although the Commission

believes, as noted by CME, that additional mitigating factors could

justifiably contribute to a delay in completing an investigation within

a 12-month period the Commission notes that the factors included in the

proposed rule were not intended to be an exhaustive list of mitigating

circumstances. In the Commission's view, the factors listed in the

proposed rule represent some of the more common examples that could

delay completing an investigation within the 12-month period. The

Commission also confirms that Sec. 38.158 only applies to the

investigation phase of a matter.

Sec. 38.158(c)--Investigation Reports When a Reasonable Basis Exists

for Finding a Violation

Proposed Sec. 38.158(c) sets forth the elements and information

that must be included in an investigation report when there is a

reasonable basis for finding a rule violation, including: (i) The

reason for the investigation; (ii) a summary of the complaint, if any;

(iii) the relevant facts; (iv) compliance staff's analysis and

conclusions; (v) a recommendation as to whether disciplinary action

should be pursued; and (vi) the member or market participant's

disciplinary history.

Summary of Comments

CME commented that rule violations can range from very minor to

egregious and not every rule violation merits formal disciplinary

action.\212\ CME argued that minor transgressions can effectively be

addressed by the issuance of a warning letter by CME compliance staff,

and that the Commission should amend the rule accordingly to account

for this possibility.\213\

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

\212\ Id.

\213\ Id.

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

CME and ICE opposed the requirement that a DCM include a

respondent's disciplinary history in the investigative report that is

submitted to a review panel.\214\ CME commented that a respondent's

disciplinary history is not relevant to the consideration of whether

that respondent has committed a further violation of the DCM's

rules.\215\ However, CME noted that an exception would be where the

prior disciplinary offense is an element of proof for the rule

violations for which compliance staff is asking the review panel to

issue charges, such as a violation of a previously issued ``cease and

desist'' order.\216\ ICE stated that unless the rule violations that

are the subject of the investigative report involve pervasive

recordkeeping violations, only substantive violations in the

respondent's history would be relevant to the review panel's

deliberations.\217\

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

\214\ CME Comment Letter at 21-22 (Feb. 22, 2011); ICE Comment

Letter at 15 (Feb. 22, 2011).

\215\ CME Comment Letter at 35 (Feb. 22, 2011).

\216\ Id.

\217\ ICE Comment Letter at 15 (Feb. 22, 2011).

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

Discussion

The Commission is adopting the rule as proposed, subject to one

modification to address the comments from CME and ICE.

The Commission confirms, as CME noted, that ``minor

transgressions'' can be addressed by a DCM's compliance staff with the

issuance of warning letters and this is discussed below in Sec.

38.158(e). However, as further discussed below in Sec. Sec. 38.158(d)

and (e), no more than one warning letter may be issued to the same

person or entity found to have committed the same rule violation within

a rolling 12-month period.

The Commission also agrees with CME and ICE that a respondent's

disciplinary history is not always

[[Page 36631]]

relevant to the consideration of whether a respondent has committed a

further violation of a DCM's rules. As a result, this requirement is

being eliminated from the final rule. The Commission notes, however,

that all disciplinary sanctions, including sanctions imposed pursuant

to an accepted settlement offer, must take into account the

respondent's disciplinary history.

Sec. 38.158(d)--Investigation Reports When No Reasonable Basis Exists

for Finding a Violation

Proposed Sec. 38.158(d) sets forth the elements and information

that must be included in an investigation report when it has been

determined that no reasonable basis exists for finding a rule

violation, including: (i) The reason the investigation was initiated;

(ii) a summary of the complaint, if any; (iii) the relevant facts; and

(iv) compliance staff's analysis and conclusions. The proposed rule

also required that if a DCM's compliance staff recommends that a

warning letter be issued, the investigation report must also include

the potential wrongdoer's disciplinary history.

Summary of Comments

CME recommended that the Commission amend the proposed rule to

account for a DCM's ability to close a case administratively and still

issue a warning letter without disciplinary committee approval, as the

CME Market Regulation Department currently has such authority.\218\

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

\218\ CME Comment Letter at 22 (Feb. 22, 2011).

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

Discussion

The Commission is adopting Sec. 38.158(d) as proposed, subject to

one modification.

The Commission is eliminating the provision in paragraph (d) that

discussed the concept of warning letters because the Commission does

not believe that a DCM would need to limit the number of warning

letters that can be issued when a rule violation has not been found.

For example, Commission staff has found in its RERs that some DCMs

issue warning letters as reminders or for educational purposes. The

Commission notes, however, that this modification does not impact the

limitation on the number of warning letters that may be issued--by a

disciplinary panel or by compliance staff--to the same person for the

same violation in a rolling 12-month period when a rule violation is

found to have been committed.

Sec. 38.158(e)--Warning Letters

Proposed Sec. 38.158(e) provided that a DCM may authorize its

compliance staff to issue a warning letter or to recommend that a

disciplinary committee issue a warning letter. The proposed rule also

provided that no more than one warning letter for the same potential

violation may be issued to the same person or entity during a rolling

12-month period.

Summary of Comments

CME and MGEX opposed the requirement that a DCM may only issue one

warning letter to the same person for the same rule violation in a

rolling 12-month period.\219\ CME stated that the rule is unduly

prescriptive and fails to take into consideration important factors

that are relevant to a DCM when evaluating potential sanctions in a

disciplinary matter.\220\ CME stated that the DCM should have

discretion to determine the appropriate sanctions in all cases.\221\

MGEX contended that the requirement will effectively prohibit a DCM

from using warning letters as an educational tool or reminder.\222\

According to MGEX, the proposed rule forces DCMs to adopt summary fines

and prevents them from pursuing minor infractions, which may lead to

additional unintended consequences outside of the purpose of the Dodd-

Frank Act.\223\ MGEX recommended that the Commission remove this

requirement and provide the DCM more flexibility in determining the

proper methodology for enforcing rules, regulations, and

procedures.\224\

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

\219\ CME Comment Letter at 22-23 (Feb. 22, 2011); MGEX Comment

Letter at 4 (Feb. 22, 2011).

\220\ CME Comment Letter at 22 (Feb. 22, 2011).

\221\ Id.

\222\ MGEX Comment Letter at 4 (Feb. 22, 2011).

\223\ Id.

\224\ Id.

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

Discussion

The Commission is adopting Sec. 38.158(e) with certain

modifications, including to convert a portion of the rule to guidance.

The Commission acknowledges the comments from CME and MGEX

concerning the issuance of warning letters but believes that in order

to ensure that warning letters serve as effective deterrents, and to

preserve the value of disciplinary sanctions, the Commission believes

that no more than one warning letter may be issued to the same person

or entity found to have committed the same rule violation within a

rolling 12-month period.\225\ As discussed in the DCM NPRM, while a

warning letter may be appropriate for a first-time violation, the

Commission does not believe that more than one warning letter in a

rolling 12-month period for the same violation is ever

appropriate.\226\ This provision will remain as a rule. A policy of

issuing repeated warning letters, rather than issuing meaningful

sanctions, to members and market participants who repeatedly violate

the same or similar rules denigrates the effectiveness of a DCM's rule

enforcement program.\227\ Furthermore, the section of the proposed rule

governing warning letters is consistent with what Commission staff has

advised DCM applicants in the past and with recommendations made in

prior RERs.\228\

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

\225\ For purposes of this rule, the Commission does not

consider a ``reminder letter'' or such other similar letter to be

any different than a warning letter.

\226\ See DCM NPRM at 80581.

\227\ See id. at 80581.

\228\ See 1998 Rule Enforcement Review of Kansas City Board of

Trade; and Rule Enforcement Review of the Minneapolis Grain Exchange

(Aug. 27, 2009).

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

The Commission notes that the final rule does not include the

reference that a warning letter issued in accordance with this section

is not a penalty or an indication that a finding of a violation has

been made because paragraph (e) only addresses warning letters that are

issued for a finding of a violation. Also, the provision requiring a

copy of a warning letter issued by compliance staff to be included in

the investigation report is being eliminated from the final rule

because the Commission has determined that such a requirement is

unnecessary.

As noted above, the Commission believes that minor transgressions

can be addressed by the issuance of a warning letter by a DCM's

compliance staff. Accordingly, in order to provide a DCM with

flexibility in this regard, the Commission is moving this provision of

the rule to the guidance section of Core Principle 2. The text of the

guidance provides that the rules of a DCM may authorize compliance

staff to issue a warning letter to a person or entity under

investigation or to recommend that a disciplinary panel take such

action.

x. Sec. 38.159--Ability To Obtain Information

Proposed Sec. 38.159 required a DCM to have the ability and

authority to obtain any necessary information to perform any function

required under proposed subpart C (Compliance with rules) of the

Commission's regulations. This would include the capacity to carry out

any international information sharing agreements required by the

[[Page 36632]]

Commission. Proposed Sec. 38.159 also provided ``that information

sharing agreements can be established with other designated contract

markets and swap execution facilities, or the Commission can act in

conjunction with a DCM to carry out such information sharing.'' \229\

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

\229\ DCM NPRM at 80614.

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

Summary of Comments

CME and KCBT stated that a DCM should not be mandated to carry out

international or other informational sharing agreements to which it is

not a party and should not be compelled by Commission regulation to

enter into agreements, particularly when such agreements contain terms

determined by other parties, which conceivably could include terms or

conditions unsuitable to a DCM or conditions that a DCM is unable to

comply with.\230\

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

\230\ CME Comment Letter at 15 (Feb. 22, 2011); KCBT Comment

Letter at 3 (Feb. 22, 2012).

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

Discussion

The Commission is adopting Sec. 38.159 as proposed. In response to

CME and KCBT's comments, Sec. 38.159 clarifies and codifies the Core

Principle 2 requirement that a DCM have the ability and authority to

obtain necessary information to perform its rule enforcement

obligations. The core principle specifically requires that the rules of

the DCM provide it with the ability and authority to perform any

function described in the core principle, including capacity to carry

out such international information sharing agreements, as the

Commission may require. The rule provides that information sharing

agreements can be established with other DCMs or SEFs, or that the

Commission can act in conjunction with a DCM to carry out such

information sharing.\231\ The Commission notes that the language of

Sec. 38.159, including the language to which CME objects, is

substantially similar to the language of Core Principle 2. The

Commission also notes that while the rule requires DCMs to have the

capacity to carry out such information sharing agreements, as is

required by the statute, the rule does not mandate or prescribe the

specific terms of such agreements, and thus, DCMs would have the

ability to collaborate on the terms of such agreements. The Commission

believes that Sec. 38.159 appropriately implements the requirements of

section 5(d)(2)(C) of the CEA and is adopting Sec. 38.159 as proposed.

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

\231\ As noted in the DCM NPRM, this proposed language is

virtually identical to the language found in the guidance for former

Designation Criterion 8.

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

xi. Sec. 38.160--Additional Rules Required

Proposed Sec. 38.160 required a DCM to adopt and enforce any

additional rules that it believes are necessary to comply with the

requirements of this subpart C.

The Commission has determined to codify proposed Sec. 38.160 as

guidance for Core Principle 2 in appendix B, rather than a rule, in

order to provide DCMs with added flexibility in adopting rules that

they believe are necessary to comply with this core principle.

Consistent with this determination, the Commission is replacing

proposed Sec. 38.160 with new Sec. 38.160 (titled ``Additional

sources for compliance'') that simply permits DCMs to rely upon the

guidance in appendix B of this part to demonstrate to the Commission

compliance with Sec. 38.150 of this part.

3. Subpart D--Contracts Not Readily Subject To Manipulation

The Dodd-Frank Act did not revise the statutory text of Core

Principle 3 (Contracts Not Readily Subject to Manipulation). DCMs

historically have complied with the requirements of Core Principle 3

through the guidance provided in Guideline No. 1, which was codified in

former appendix A to part 40, which is now superseded by appendix C

under part 38 of this final rulemaking. In the DCM NPRM, the Commission

proposed to maintain the guidance under former Guideline No. 1 in new

appendix C, but with certain proposed revisions, as the central mode of

compliance for DCMs under Core Principle 3. In addition to the

guidance, the DCM NPRM proposed two rules under Core Principle 3.

Proposed Sec. 38.200 codified the statutory language of Core Principle

3, and proposed Sec. 38.201 referred applicants and DCMs to the

guidance in appendix C to part 38 for purposes of demonstrating to the

Commission their compliance with the requirements of Sec. 38.200.

In the DCM NPRM, the Commission proposed certain revisions to

former Guideline No. 1, including: (1) Codifying the provision in

appendix C of part 38, and eliminating it from part 40; (2) re-titling

the guidance as ``Demonstration of Compliance That a Contract is not

Readily Susceptible to Manipulation;'' and (3) amending and updating

the guidance to expand the provision to include swap transactions.

Proposed appendix C to part 38 was intended to act as a source for

new and existing DCMs to reference for best practices when developing

products to list for trading. The amended guidance provided greater

detail to DCMs regarding the relevant considerations in demonstrating

compliance with Core Principle 3 when designing a contract and

submitting supporting documentation and data to the Commission at the

time the DCM submits: (1) The terms and conditions of a new contract

under Sec. Sec. 40.2 or 40.3, or (2) amendments to terms and

conditions under Sec. Sec. 40.5 or 40.6. Specifically, proposed

appendix C to part 38 provided guidance regarding: (1) The forms of

supporting information a new contract submission should include; (2)

how to estimate deliverable supplies; (3) the contract terms and

conditions that should be specified for physically delivered contracts;

(4) how to demonstrate that a cash-settled contract is reflective of

the underlying cash market, is not readily subject to manipulation or

distortion, and is based on a cash price series that is reliable,

acceptable, publicly available and timely; (5) the contract terms and

conditions that should be specified for cash-settled contracts; (6) the

requirements for options on futures contracts; (7) the terms and

conditions for non-price based futures contracts; and (8) the terms and

conditions for swap contracts.

Estimating Deliverable Supply

Summary of Comments

CME commented on the proposed guidance pertaining to estimating

deliverable supply in paragraph (b)(1)(i)(A) of proposed appendix

C.\232\ CME contended that the proposed definition of deliverable

supply is restrictive and inconsistent with long-standing industry

practice.\233\ Specifically, CME objected to the proposed provision

that states that ``an appropriate estimate of deliverable supply

excludes supplies that are committed to some commercial use.'' \234\

CME stated that DCMs have historically estimated deliverable supplies

by including in their calculations all supplies that are stored in the

delivery territory or that move through the

[[Page 36633]]

delivery territory, including a determination of amounts committed to

commercial use.\235\ CME asserted that the proposed rulemaking does not

identify any problems with continuing to use the current methodology in

these markets, and claimed that if the proposed standard is adopted, it

will impose additional costs on exchanges and market participants,

including requiring exchanges to survey market participants annually

with no defined benefit.\236\

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

\232\ CME Comment Letter at 38 (Feb. 22, 2011). Proposed

paragraph (b)(1)(i)(A) of appendix C provided guidance on how to

estimate the deliverable supply of a commodity that underlies a

futures contract. The estimated deliverable supply should reflect

the amount of that commodity that can reasonably be expected to be

readily available to long traders to take delivery and short traders

to make delivery at the expiration of a futures contract. This

information is used by Commission staff when considering a

contract's terms and conditions in determining whether a contract is

readily susceptible to manipulation. DCM NPRM at 80631.

\233\ CME Comment Letter at 38 (Feb. 22, 2011).

\234\ See proposed paragraph (b)(1)(i)(A), appendix C. DCM NPRM

at 80631.

\235\ CME Comment Letter at 38 (Feb. 22, 2011).

\236\ Id.

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

Moreover, CME argued that the requirement that DCMs submit monthly

deliverable supply estimates ``for at least the most recent five years

for which data sources permit'' to be used by the Commission to review

a DCM's certification or approval request for a new contract or related

rule amendment is onerous for DCMs.\237\ Instead, CME suggested that

the Commission require monthly estimates of deliverable supply for the

most recent three years.\238\

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

\237\ Id.

\238\ Id.

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

Discussion

The Commission acknowledges CME's comments regarding the proposed

guidance for estimating deliverable supply but notes that a DCM has

historically been required to estimate deliverable supplies, which has

required that a DCM consult with market participants on a regular

basis. In that regard, contrary to CME's claim, the proposed guidance

stating that exchanges should survey market participants should not

impose additional costs on exchanges. As noted above, Commission staff

will continue to work with exchange staff to determine how the

deliverable supply for a certain commodity should be estimated.

Moreover, the Commission confirms, as noted by CME, that the term

``commercial use'' may not be appropriate and could cause confusion.

Accordingly, the Commission is eliminating the sentence in proposed

paragraph (b)(1)(i)(A) that references the term ``commercial use,'' and

is replacing it with the term ``long-term agreement.'' Specifically,

the Commission will clarify in paragraph (b)(1)(i)(A) that an estimate

of deliverable supply would not include supply that is committed for

long-term agreements (i.e., the amount of supply that would not be

available to fulfill the delivery obligations arising from current

trading).

The Commission is further clarifying in paragraph (b)(1)(i)(A) of

the guidance that an exchange may include all or a portion of the

supply that is committed for long-term agreements if it can demonstrate

that those supplies are consistently and regularly made available to

the spot market for traders to acquire at prevailing economic values.

Specifically, the Commission is adding language to paragraph

(b)(1)(i)(A) to provide that if the estimated deliverable supply that

is committed for long-term agreements, or a significant portion

thereof, can be demonstrated by the exchange to be consistently and

regularly made available to the spot market for short traders to

acquire at prevailing economic values, then those ``available''

supplies committed for long-term contracts may be included in the

exchange's estimate of deliverable supply for that commodity.\239\

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

\239\ In adding this language, the Commission is responding to

CME's March 28, 2011 comment letter which stated that the Commission

should define what it understands as ``long-term agreement,''

stating that requiring DCMs to consult with market participants to

estimate deliverable supply on a monthly basis would be a

substantial burden.

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

Similarly, in paragraph (b)(1)(i)(C) of the guidance, the

Commission is eliminating the term ``commercial use'' and replacing it

with the term ``committed for long-term agreements.''

The Commission further agrees with CME that three years of monthly

estimates of deliverable supply is sufficient for the Commission to use

to determine whether or not a contract is readily susceptible to

manipulation or distortion. In this regard, the Commission is amending

paragraphs (a)(2), (b)(1)(i)(A), (b)(1)(i)(B), and (b)(1)(i)(C) to

reflect a three year obligation.

Calculation of Price Indices

Summary of Comments

CME commented on the proposed guidance for calculating price

indices in paragraphs (c)(3)(ii) and (g)(ii) of appendix C.\240\ CME

stated that the guidance may not be applicable for some markets where

there may not be eight independent entities in the entire industry, and

that in those situations, the cash settlement survey should include

transactions representing at least 51 percent of the total production

of the commodity in question.\241\

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

\240\ CME Comment Letter at 38-39 (Feb. 22, 2011). Proposed

paragraphs (c)(3)(ii) and (g)(ii) of appendix C addressed

calculation procedures for safeguarding against potential attempts

to artificially influence a cash settlement price for futures

contracts settled by cash settlement. The guidance provided that if

the cash price is determined by a survey of cash market sources, the

survey should include either: (1) at least four independent entities

(if such sources do not take a position); or (2) eight entities (if

such sources trade for their own accounts).

\241\ CME Comment Letter at 38 (Feb. 22, 2011). Proposed

c(3)(ii) and (g)(ii) of appendix C provided that: ``Where a

designated contract market itself generates the cash settlement

price series, the designated contract market should establish

calculation procedures that safeguard against potential attempts to

artificially influence the price. For example, if the cash

settlement price is derived by the designated contract market based

on a survey of cash market sources, the designated contract market

should maintain a list of such entities which all should be

reputable sources with knowledge of the cash market. In addition,

the sample of sources polled should be representative of the cash

market, and the poll should be conducted at a time when trading in

the cash market is active. The cash-settlement survey should include

a minimum of four independent entities if such sources do not take

positions in the commodity (e.g., if the survey list is comprised

exclusively of brokers) or at least eight independent entities if

such sources trade for their own accounts (e.g., if the survey list

is comprised of dealers or merchants).''

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

Argus stated that it is important that the examination of a

referenced index price should recognize the differences in markets and

instrument types, and that the methodologies used to determine an index

price may vary depending on the characteristics of the market in

question.\242\ Accordingly, Argus recommended that any review of the

integrity of a price index should be flexible enough to account for

differences in markets and instrument types.\243\ Argus also requested

that the Commission clarify that the proposed guidance for calculation

of prices is applicable only to DCMs or SEFs, and does not apply to

independent price data providers of price indices.\244\ Argus stated

that as a market data price provider it obtains price data that is

voluntarily provided to it by market participants, and that it has no

means of requiring participants to provide that data.\245\ In that

regard, Argus contended that for less liquid markets, there may only be

a few market participants willing to provide data to Argus to use to

determine a price series for a commodity.\246\ Argus noted that, in

contrast, a DCM or SEF has the ability to use market transactions

traded on its platform, or to survey market participants that trade on

its platform, to determine a cash settlement price.\247\ Thus, Argus

stated that the guidance in paragraph (c)(3)(ii) should not apply to

market data price providers.\248\

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

\242\ Argus Comment Letter at 4 (Feb. 22, 2011).

\243\ Id.

\244\ Id. at 4-6.

\245\ Id.

\246\ Id.

\247\ Id.

\248\ Id.

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

Discussion

In light of the concerns raised in the comments above, the

Commission is

[[Page 36634]]

eliminating the last sentence of paragraphs (c)(3)(ii) and (g)(ii),

which provides that ``[t]he cash-settlement survey should include a

minimum of four independent entities if such sources do not take

positions in the commodity (e.g., if the survey list is comprised

exclusively of brokers) or at least eight independent entities if such

sources trade for their own accounts (e.g., if the survey list is

comprised of dealers or merchants).'' The Commission notes that the

guidance in appendix C to part 38 is not a restrictive list of

acceptable methodologies. The Commission will continue to review a

contract's susceptibility to manipulation on a contract-by-contract

basis, including taking into account the characteristics of the

underlying market with respect to the price methodology used by

independent price data providers.

The Commission is also making several clarifying amendments to

appendix C to part 38. The Commission is amending the guidance in

paragraph (c)(2) pertaining to a DCM's evaluation of the susceptibility

of a cash-settled contract to manipulation. Specifically, the

Commission is adding the phrase ``[i]n a manner that follows the

determination of deliverable supply as noted above in b(1)'' to the

first sentence in paragraph (c)(2). This will clarify that for cash-

settled contracts based on physical commodities, an exchange should

analyze the size and liquidity of the cash market that underlies the

listed contract as it would if the contract were settled through

physical delivery.

The Commission also is amending paragraph (c)(4)(i)(E) regarding

Maximum Price Fluctuations Limits for cash-settled contracts, to

clarify that for broad-based stock index futures contracts, rules

should be adopted to coordinate with New York Stock Exchange (``NYSE'')

declared Circuit Breaker Trading Halts.\249\ However, because there are

proposals for alternative market coordination currently being

considered (other than the Circuit Breaker Trading Halt), the guidance

will be amended to add the proviso ``or other market coordinated

Circuit Breaker mechanism.'' \250\

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

\249\ See discussion of NYSE circuit breakers, available at:

http://usequities.nyx.com/markets/nyse-equities/circuit-breakers.

\250\ See supra discussion of section 38.255.

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

Finally, the Commission is amending paragraph (e)(1), regarding

Security Futures Contracts, to eliminate the sentence that states ``[a]

designated contract market should follow the appropriate guidance

regarding physically delivered security futures products that are

settled through physical delivery or cash settlement.'' The sentence

was included in the guidance and is being eliminated because part 41

Security Futures Products governs trading in those contracts including

the minimum requirements that an underlying security or security index

must have and maintain to be listed for trading on a DCM.

4. Subpart E--Prevention of Market Disruption

The Dodd-Frank Act amended current Core Principle 4 by: (i)

Changing the title of the core principle from ``Monitoring of Trading''

to ``Prevention of Market Disruption;'' and (ii) specifying the methods

and procedures DCMs must employ in discharging their obligations under

Core Principle 4. The amendments to Core Principle 4 emphasize that

DCMs must take an active role not only in monitoring trading activities

within their markets, but in preventing market disruptions. The rules

proposed for this core principle largely codified the relevant

provisions of the existing Application Guidance and Acceptable

Practices for Core Principle 4, as contained in appendix B to part 38,

and included new requirements that clarified and strengthened certain

DCM obligations arising under the amended core principle.

i. Sec. 38.251--General Requirements

Core Principle 4 requires DCMs to conduct real-time monitoring of

trading and have the ability to comprehensively and accurately

reconstruct trading.\251\ Accordingly, these requirements are set forth

in proposed Sec. 38.251. Further, the proposed rule required that

intraday trade monitoring must include the capacity to detect abnormal

price movements, unusual trading volumes, impairments to market

liquidity, and position-limit violations. Proposed Sec. 38.251 also

required that, where the DCM cannot reasonably demonstrate that its

manual processes are effective in detecting and preventing abuses, the

DCM must implement automated trading alerts to detect potential

problems.

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

\251\ 7 U.S.C. 7(d)(4).

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

The Commission invited comment on whether DCMs should be required

to monitor the extent of high frequency trading, and whether automated

trading systems should include the ability to detect and flag high

frequency trading anomalies.

Summary of Comments

Several commenters asserted that their current regulatory systems

do not allow for effective real-time monitoring of position limits. CME

opined that requiring real-time monitoring capabilities across every

instrument for vague terms such as ``abnormal price movements,''

``unusual trading volumes,'' and ``impairments to market liquidity''

does not provide DCMs with sufficient clarity with respect to what

specific capabilities satisfy the standard.\252\ CME specifically

stated that the Commission should clarify and appreciate the unique

aspects of different types of trading venues and distinguish where

requirements are different.\253\ CME also stated that the regulations

should distinguish between trading conducted on an electronic venue and

trading conducted in an open-outcry venue.\254\ MGEX stated that the

automated trading alert requirement of proposed Sec. 38.251 ``seems to

add more burden and cost than potentially providing any real value.''

\255\ KCBT requested that the Commission remove this requirement and

stated that customer reportable positions are received once daily on a

T+1 basis and that it is impractical to require DCMs to monitor for

intraday compliance with position limits.\256\

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

\252\ CME Comment Letter at 24 (Feb. 22, 2011).

\253\ Id.

\254\ Id.

\255\ MGEX Comment Letter at 4 (Feb. 22, 2011). MGEX also stated

that the Commission should adopt a more flexible core principle

approach. See MGEX Comment Letter at 2 (June 3, 2011).

\256\ KCBT Comment Letter at 4 (Feb. 22, 2011).

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

ICE stated that it has previously made the Commission aware of the

difficulties inherent in trying to monitor positions on a real-time

basis, and that the only way to accurately determine whether an

intraday position limit violation has occurred is on the basis of

information available on a T+1 basis.\257\ ICE also requested that the

Commission delete the phrase ``impairments to market liquidity'' from

the rule, arguing that the wording is vague and has ``no foundation''

in the core principle.\258\

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

\257\ ICE Comment Letter at 11 (Feb. 22, 2011).

\258\ Id.

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

With respect to the monitoring of high frequency trading, several

commenters stated that such monitoring would be problematic.\259\ MGEX

and CME raised concerns over the absence of a definition for high

frequency trading, which CME claimed can include many

[[Page 36635]]

different trading strategies.\260\ CME questioned whether the

Commission had unique concerns about high frequency traders, and

further remarked that the Commission has not articulated what purpose

would be served by singling out high frequency trading for special

monitoring.\261\ CME further stated that empirical studies have

consistently demonstrated that high frequency trading fosters tighter

markets, greater liquidity and enhanced market efficiency.\262\

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

\259\ KCBT Comment Letter at 4 (Feb. 22, 2011); MGEX Comment

Letter at 4 (Feb. 22, 2011); CME Comment Letter at 24-25 (Feb. 22,

2011).

\260\ MGEX Comment Letter at 4 (Feb. 22, 2011); CME Comment

Letter at 24-25 (Feb. 22, 2011).

\261\ CME Comment Letter at 25 (Feb. 22, 2011).

\262\ Id.

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

CME stated that ``[a]s a practical matter, however, CME Group, and

we imagine other DCMs, certainly have the capability to monitor the

messaging frequency of participants in their markets and can quickly

and easily identify which participants generate high messaging

traffic.'' \263\ CME also stated that it requires registered users who

predominantly enter orders via an automated trading system to be

identified as automated traders and that their orders are identified in

the audit trail as originating from automated systems.\264\ Finally,

CME noted that its systems were designed to identify anomalies or

transaction patterns that violate their rules or might otherwise be

indicative of some other risk to the orderly functioning of the

markets.\265\

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

\263\ Id.

\264\ Id.

\265\ Id.

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

Better Markets opined that the Dodd-Frank Act provides the

Commission with an opportunity to get ahead of high frequency and

algorithmic trading and that, while hedgers undoubtedly need market

liquidity, high frequency traders generate volume that does not

reliably generate liquidity for market participants.\266\ In addition,

Better Markets commented that many widely used tactics of high

frequency traders are specifically designed to influence pricing

decisions by providing false signals of market price levels and depth,

and, as a result, the Commission must take an expressly restrictive

approach to high frequency trading.\267\

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

\266\ Better Markets Comment Letter at 7 (Jun. 3, 2011).

\267\ Id.

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

Discussion

The Commission is adopting proposed Sec. 38.251, with certain

modifications, including converting portions of the rule to guidance.

The Commission is modifying Sec. 38.251 to eliminate the

obligation to monitor, on an intraday basis, for ``impairments to

market liquidity.'' The Commission is also revising the rule to clarify

what must be included in real-time monitoring as compared to monitoring

of intraday trading that may not need to be done in real time.

Monitoring of market conditions, price movements and trading volumes in

order to detect and attempt to resolve abnormalities must be

accomplished in real time in order to achieve, as much as is possible,

the statute's new emphasis on preventive actions. It is acceptable,

however, to have a program that detects, on a T+1 basis, trading abuses

and position-limit violations that occur intraday.

In addition, the rule is now being supplemented with guidance and

acceptable practices in appendix B to part 38. The Commission believes

that monitoring for market anomalies is a key part of a DCM's ability

to demonstrate its ``capacity and responsibility to prevent

manipulation, price distortion, and disruptions of the delivery or

cash-settlement process,'' as required by the statute. Moreover, given

the number of listed contracts and the volumes of trading on any

particular DCM, the Commission believes that automated trading alerts,

preferably in real time, are the most effective means of detecting

market anomalies. While having an effective automated alerts regime

will be set forth as a method of monitoring in guidance, a DCM will

maintain flexibility in meeting the requirement of the rule by, for

example, demonstrating the effectiveness of an alternate method of

monitoring.

With respect to position-limit monitoring, the DCM NPRM did not

require that such limits necessarily be monitored in real time.

However, DCMs must have the ability to monitor such limits, including

for intraday violations, at a minimum on a T+1 basis. Therefore, the

requirement to monitor for position-limit violations is clarified in

the rule and further described in the guidance and acceptable practices

in appendix B, giving the DCM some flexibility in meeting the

requirement.

As for the Commission's inquiry about requiring additional

monitoring of high-frequency trading, the Commission recognizes that

DCMs should be capable of monitoring for the types of trading that may

be characterized as ``high frequency,'' but has decided not to

implement, in this rulemaking, further rules pertaining to the

monitoring of high frequency trading. The Commission is encouraged that

there are efforts underway, both within and outside the Commission, to

define and develop approaches for better monitoring of high-frequency

and algorithmic trading. This is particularly evident from recent work

done at the behest of the Commission's Technology Advisory Committee

(TAC).\268\ Further, the United Kingdom government's Foresight Project

also commissioned a recently released report on the future of computer

trading in financial markets, which aims to assess the risks and

benefits of automated buying and selling. This project may assist the

Commission's further development of a regulatory framework for high

frequency trading activities.\269\

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

\268\ See, e.g., reports associated with the TAC available at

http://www.cftc.gov/idc/groups/public/@swaps/documents/dfsubmission/tacpresentation030111_ptfs2.pdf.

\269\ See ``The Future of Computer Trading in Financial

Markets'' available at http://www.bis.gov.uk/foresight/our-work/projects/current-projects/computer-trading.

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

ii. Sec. 38.252--Additional Requirements for Physical-Delivery

Contracts

Proposed Sec. 38.252 required, among other things, that for

physical-delivery contracts, DCMs must monitor each contract's terms

and conditions as to whether there is convergence of the futures price

to the cash price of the underlying commodity and must take meaningful

corrective action, including addressing conditions that interfere with

convergence, or if appropriate, change contract terms and conditions,

when lack of convergence impacts the ability to use the markets for

making hedging decisions and for price discovery.

The Commission requested comments on what other factors, in

addition to the delivery mechanism, a DCM should be required to

consider in determining whether convergence is occurring.

Summary of Comments

CME, MGEX and KCBT all opposed what they deemed to be a

prescriptive rule, and noted that most of the requirements in proposed

Sec. 38.252 are currently acceptable practices under appendix B for

the monitoring of trading.\270\ These commenters contended that the

requirements in proposed Sec. 38.252 should remain as acceptable

practices.\271\

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

\270\ CME Comment Letter at 25 (Feb. 22, 2011); MGEX Comment

Letter at 5 (Feb. 22, 2011); KCBT Comment Letter at 4-5 (Feb. 22,

2011).

\271\ Id.

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

ICE also noted that for certain products it is inherently more

difficult to statistically determine convergence of futures to cash

market prices.\272\

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

\272\ ICE Comment Letter at 12 (Feb. 22, 2011).

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

Discussion

The Commission is adopting Sec. 38.252, with certain

modifications, including

[[Page 36636]]

converting a portion of the rule to acceptable practices.

The Commission is retaining as a rule the general obligation that

DCMs monitor physical-delivery contracts with respect to their terms

and conditions as they relate to the underlying market and monitor the

adequacy of deliverable supplies to meet futures delivery requirements.

The DCM must also make a good-faith effort to resolve conditions that

threaten reasonable convergence or the adequacy of deliverable

supplies. While the Commission acknowledges ICE's comment that for

certain products it may be more difficult to ascertain convergence

because of the absence of reliable cash prices, the Commission is of

the view that a DCM must monitor the performance of its contracts to

ensure they continue to perform their economic functions.

In order to provide DCMs with additional flexibility in meeting

their monitoring obligations associated with physical-delivery

contracts, the specific elements of such monitoring that were initially

included in the proposed rule are now included in acceptable practices

under appendix B of part 38, rather than in the rule.

iii. Sec. 38.253--Additional Requirements for Cash-Settled Contracts

In addition to requirements that DCMs monitor the pricing and

methodologies for settling cash-settled contracts, proposed Sec.

38.253 required that, where a DCM contract is settled by reference to

the price of a contract or instrument traded in another venue,

including a price or index derived from prices on another exchange, the

DCM must have rules that require the traders on the DCM's market to

provide the DCM with their positions in the reference market as the

traders' contracts approach settlement. In the alternative, Sec.

38.253 provided that the DCM may have an information sharing agreement

with the other venue or designated contract market.

Summary of Comments

Argus commented that it is inappropriate to require DCMs to monitor

the ``availability and pricing of the commodity making up the index to

which the contract will be settled'' where the index price is generated

based upon transactions that are executed off the DCM's market.\273\

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

\273\ Argus Comment Letter at 6 (Feb. 22, 2011).

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

CME disagreed with what it contended was the prescriptive nature of

the proposed rule, and noted that many of the requirements in proposed

Sec. 38.253 are currently acceptable practices for trade

monitoring.\274\ CME suggested that the requirements in Sec. 38.253

remain as acceptable practices.\275\ CME further stated that the

Commission is uniquely situated to add regulatory value to the industry

by reviewing for potential cross-venue rule violations, and noted that

the Commission is the central repository for position information

delivered to it on a daily basis and in a common format, across all

venues.\276\ CME also asserted that the Commission would be imposing an

onerous burden on DCMs and their customers by requiring the reporting

of information that the Commission already receives or will be

receiving.\277\ CME also stated that the alternative proposal, that the

DCM enter into an information-sharing agreement with the other venue,

also will result in additional costs to both entities, and that it may

not be practical or prudent for a DCM to enter into such an agreement

with the other venue.\278\ CME noted that its rules already allow it to

request such information from market participants on an as-needed

basis.\279\

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

\274\ CME Comment Letter at 26 (Feb. 22, 2011).

\275\ Id.

\276\ Id.

\277\ Id.

\278\ Id.

\279\ Id.

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

Nodal stated that DCMs that are a party to an industry agreement

(such as the International Information Sharing Memorandum of

Understanding & Agreement) should satisfy the information sharing

requirement in this rule by virtue of such agreement.\280\

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

\280\ Nodal Comment Letter at 5 (Feb. 22, 2011).

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

Discussion

The Commission is codifying proposed Sec. 38.253, with certain

modifications, including to convert a portion of the rule to acceptable

practices. The Commission removed from the rule the requirement that

DCMs monitor the availability and pricing of the commodity making up

the index to which the contract will be settled. Section 38.253(a)

requires that DCMs monitor the pricing of the index to which the

contract is settled, and that DCMs monitor the continued

appropriateness of the index to which the contract is settled and take

steps to resolve conditions, including amending contract terms where

necessary, where there is a threat of manipulation, disruptions, or

distortions. For cash-settled contracts, the Commission believes that a

DCM must have the ability to determine whether a trader in its market

is manipulating the instrument or index to which the DCM contract

settles.

In regards to Sec. 38.253(b), as the CME noted, the Commission

does obtain certain position information in the large-trader reporting

systems for futures and swaps. However, the Commission may not

routinely obtain such position information, including where a DCM

contract settles to the price of a non-U.S. futures contract or a cash

index. Notwithstanding the continued importance of a DCM's obligation

to monitor across other venues in such circumstances, the Commission

believes that the rule need not set forth the specific methods to

accomplish such monitoring. Accordingly, the Commission sets forth the

specific methods of accomplishing the cross-venue monitoring under

acceptable practices. Specifically, the rule requires that the

monitoring of cash-settled contracts must include access to information

on the activities of its traders' in the reference market. The

acceptable practices for this rule provides that a DCM, at a minimum,

gather such information, either directly or through information sharing

agreements, to traders' position and transactions in the reference

market for traders of a significant size in the DCM contract, near the

settlement of the contract.

iv. Sec. 38.254--Ability To Obtain Information

To ensure that DCMs have the ability to properly assess the

potential for price manipulation, price distortions, and the disruption

of the delivery or cash-settlement process, proposed Sec. 38.254

provided that each DCM require that traders in their market keep

records, including records of their activity in the underlying

commodity and related derivative markets and contracts, and make such

records available, upon request, to the designated contract

market.\281\ The proposed rule further required that DCMs with

participants trading through intermediaries must either use a

comprehensive large-trader reporting system or be able to demonstrate

that it can obtain position data from other sources in order to conduct

an effective surveillance program.

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

\281\ The pre-existing acceptable practice for Core Principle 4

provides that DCMs, at a minimum, should have routine access to the

positions and trading of their market participants.

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

Summary of Comments

CME opposed the proposed rule and recommended that the types of

records that the DCM should require traders to keep should be covered

in acceptable

[[Page 36637]]

practices.\282\ KCBT contended that it is unnecessary and burdensome

for a DCM to require traders to keep such records.\283\ Similarly, MGEX

raised concerns about the burden that will be placed on its traders as

a result of the proposed record-keeping obligation, and noted that, for

contracts not traded on the DCM, it is unclear what records a DCM must

tell its trader to keep.\284\

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

\282\ CME Comment Letter at 26 (Feb. 22, 2011).

\283\ KCBT Comment Letter at 5 (Feb. 22, 2011).

\284\ MGEX Comment Letter at 5 (Feb. 22, 2011).

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

Discussion

The Commission is adopting Sec. 38.254 as proposed, but is

allowing, as an acceptable practice in appendix B, that DCMs limit the

requirement of Sec. 38.254(b) to those transactions or positions that

are reportable under the DCM's large-trader reporting system or where

the market participant otherwise holds substantial positions.

The Commission has considered the comments, but does not believe

that this rule is unnecessary or that the requirements should instead

be codified as acceptable practices. The Commission notes that a

trader's burden to keep such records is sound commercial practice, and

that a trader of a reportable size is already required, under

Commission's regulations Sec. 18.05 for futures and options and Sec.

20.6 for swaps, to keep records of such activity and to make them

available to the Commission upon request. In addition, the Commission

has found trader records to be an invaluable tool in its surveillance

efforts, and believes that the DCM, as a self-regulatory organization,

should have direct access to such information in order to discharge its

obligations under the DCM core principles, and in particular Core

Principle 4.

v. Sec. 38.255--Risk Controls for Trading

Proposed Sec. 38.255 required DCMs to have in place effective risk

controls including, but not limited to, pauses and/or halts to trading

in the event of extraordinary price movements that may result in

distorted prices or trigger market disruptions. Additionally, the rule

provided that where a DCM's contract is linked to, or a substitute for,

other contracts on the DCM or on other trading venues, including where

a contract is based on the price of an equity security or the level of

an equity index, risk controls should, to the extent possible, be

coordinated with those other contracts or trading venues. In the

preamble of the DCM NPRM, the Commission requested comments on what

types of pauses and halts are necessary and appropriate for particular

market conditions. The preamble of the DCM NPRM also recognized that

pauses and halts comprise only one category of risk controls, and that

additional controls may be necessary to reduce the potential for market

disruptions. The preamble specifically listed several risk controls

that the Commission had in mind, including price collars or bands,

maximum order size limits, stop-loss order protections, kill buttons,

and any others that may be suggested by commenters. The Commission

invited comments on the appropriateness of the listed risk controls,

and posed the following questions: What other DCM risk controls are

appropriate or necessary to reduce the risk of market disruptions?

Which risk controls should be mandated, and how?

Summary of Comments

Several commenters asserted that DCMs should have discretion to

determine the specific risk controls that should be implemented within

their markets.\285\ CME commented that the marketplace would benefit

from some standardization of the types of pre-trade risk controls

employed by DCMs and other trading venues, and expressed support for an

acceptable practice framework that includes pre-trade quantity limits,

price banding, and messaging throttles, but argued that the specific

parameters of such controls should be determined by the DCMs.\286\

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

\285\ CME Comment Letter at 26 (Feb. 22, 2011); KCBT Comment

Letter at 5 (Feb. 22, 2011); ICE Comment Letter at 11-12 (Feb. 22,

2011); CFE Comment Letter at 4 (Feb. 22, 2011); NYSE Liffe Comment

Letter at 11 (Feb. 22, 2011); ELX Comment Letter at 4 (Feb. 22,

2011); MGEX Comment Letter at 5 (Feb. 22, 2011); ICE Comment Letter

at 12 (Feb. 22, 2011); Barnard Comment Letter at 3 (Feb. 22, 2011).

\286\ CME Comment Letter at 27 (Feb. 22, 2011).

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

Various commenters also stated that there are effective ways to

prevent market disruptions other than pauses and halts, and that the

appropriate controls may depend on a number of factors, such as the

product, number of market participants, and the market's liquidity. CME

contended that the Commission should not impose rules that mandate

coordination of such risk controls.\287\ NYSE Liffe argued that a DCM

should be able to take into account other controls, but should not be

required to adopt identical controls.\288\ MGEX stated that forcing

market coordination of trading pauses and halts is unnecessary, and

that if market instability moves from one contract market to another,

the next market should be able to pause or halt trading as it

determines necessary.\289\ ICE stated that a temporary price floor or

ceiling can work better than a pause or halt since trading can continue

uninterrupted, thereby offering the earliest opportunity for price

reversal should the market deem a sudden large move to be an

overreaction or error.\290\ ICE also stated that pauses and halts are

not the only effective way to prevent market disruption, and that by

being prescriptive, the Commission is freezing innovation in preventing

market disruptions.\291\

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

\287\ Id.

\288\ NYSE Liffe Comment Letter at 11 (Feb. 22, 2011).

\289\ MGEX Comment Letter at 5 (Feb. 22, 2011).

\290\ ICE Comment Letter at 12 (Feb. 22, 2011).

\291\ Id.

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

Finally, Better Markets asserted that the proposed rules are

extremely useful, but incomplete.\292\ Better Markets stated that there

should be a ``speed limit'' to serve as a buffer against the potential

for an uncontrolled spiral of disruption fueled by HFTs, and that the

rule should require that bids be kept open for minimum durations and

that positions be held for minimum durations.\293\

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

\292\ Better Markets Comment Letter at 9 (Feb. 22, 2011).

\293\ Id.

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

Discussion

The Commission is adopting proposed Sec. 38.255, with certain

modifications, including converting a portion of the rule to acceptable

practices. As stated in the DCM NPRM, the Commission believes that

pauses and halts are effective risk management tools that must be

implemented by DCMs to facilitate orderly markets. As the Commission

noted in the DCM NPRM, risk controls such as trading pauses and halts,

among other things, can allow time for participants to analyze the

market impact of new information that may have caused a sudden market

move, allow new orders to come into a market that has moved

dramatically, and allow traders to assess and secure their capital

needs in the face of potential margin calls. Automated risk control

mechanisms, including pauses and halts, have proven to be effective and

necessary in preventing market disruptions and, therefore, will remain

as part of the rule.

The Commission notes that the pauses and halts are intended to

apply in the event of extraordinary price movements that may trigger or

propagate systemic disruptions. Accordingly, in response to ICE and

other commenters that question the necessity of pauses and halts over

other forms of risk controls, the Commission notes that a DCM's ability

to pause or halt trading in extraordinary

[[Page 36638]]

circumstances and, importantly, to re-start trading through the

appropriate re-opening procedures, will allow DCMs to mitigate the

propagation of shocks that are of a systemic nature and to facilitate

orderly markets. Furthermore, DCMs must ensure that such pauses and

halts are effective for their specific order-routing and trading

environment and are adapted to the specific types of products traded.

Following the DCM NPRM's publication, the Pre-Trade Functionality

Subcommittee of the CFTC Technology Advisory Committee (``TAC'') issued

a report that recommended the implementation of several trade risk

controls at the exchange level.\294\ The controls recommended in the

Subcommittee report were consistent, in large part, with the trade

controls referenced in the preamble to the DCM NPRM, and which are

being adopted in this final rulemaking.\295\ The TAC accepted the

Subcommittee report, which specifically recommended that exchanges

implement pre-trade limits on order size, price collars around the

current price, intraday position limits (of a type that represent

financial risk to the clearing member), message throttles, and clear

error-trade and order-cancellation policies.\296\ The Subcommittee

report noted that ``[s]ome measure of standardization of pre-trade risk

controls at the exchange level is the cheapest, most effective and most

robust path to addressing the Commission's concern [for preserving

market integrity].'' \297\

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

\294\ ``Recommendations on Pre-Trade practices for Trading

Firms, Clearing Firms and Exchanges involved in Direct Market

Access,'' March 1, 2011, available at http://www.cftc.gov/idc/groups/public/@swaps/documents/dfsubmission/tacpresentation030111_ptfs2.pdf.

\295\ The DCM NPRM specifically mentioned position limits that

must be monitored for intraday violations, daily price limits,

trading pauses, reasonability tests for order price and size, stop

logic functionality, and trade-cancellation policies in the form of

``no-bust'' ranges.

\296\ See ``Pre-Trade Functionality Subcommittee of the CFTC

Technology Advisory Committee report, ``Recommendations on Pre-Trade

Practices for Trading Firms, Clearing Firms, and Exchanges Involved

in Direct Market Access,'' at 4-5 (March 1, 2011), accepted by the

TAC and available at: http://www.cftc.gov/idc/groups/public/@swaps/documents/dfsubmission/tacpresentation030111_ptfs2.pdf.

\297\ Id. at 4.

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

The Commission believes that the implementation of the specific

automated trade risk controls listed in the DCM NPRM is generally

desirable, but also recognizes that such controls should be adapted to

the unique characteristics of the markets to which they apply. Indeed,

any controls should consider the delicate balance between avoiding a

market disruption while not impeding a market's price discovery

function. Controls that unduly restrict a market's ability to respond

to legitimate market events will interfere with price discovery.

Accordingly, consistent with many of the comments on this subject,

the Commission is enumerating specific types of automated risk

controls, in addition to pauses and halts, that may be implemented by

DCMs in the acceptable practices rather than in the rule, in order to

give DCMs greater discretion to select among the enumerated risk

controls, or to create new risk controls that may be more appropriate

or necessary for their markets. DCMs also will have discretion in

determining the parameters for the selected controls. Specifically, the

acceptable practices for Core Principle 4 provide that DCMs should have

appropriate trade risk controls adapted to the unique characteristics

of the markets to which they apply that are designed to prevent market

disruptions without unduly interfering with that market's price

discovery function. The acceptable practices also enumerate several of

the pre-trade controls cited by the Joint CFTC/Securities and Exchange

Commission (``SEC'') Advisory Committee, specifically: Pre-trade limits

on order size, price collars or bands around the current price, message

throttles, and daily price limits.\298\

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

\298\ The DCM NPRM did not specifically address whether DCMs

should require market participants to certify that their electronic

systems were adequately tested before trading on a DCM, nor did it

specifically address pre-trade, post trade or emergency controls and

supervision of electronic systems. The Commission may address

electronic system testing, controls, and supervision-related issues

in a subsequent proceeding.

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

Additionally, in response to commenters' concerns, the Commission

is moving the language in the proposed rule concerning the coordination

of risk controls among other markets or exchanges to the acceptable

practices. Specifically, a DCM with a contract that is linked to, or is

a substitute for, other contracts, either on its market or on other

trading venues, must, to the extent practicable, coordinate its risk

controls with any similar controls placed on those other contracts. If

a contract is based on the price of an equity security or the level of

an equity index, such risk controls must, to the extent practicable, be

coordinated with any similar controls placed on national security

exchanges.

Independent of this rulemaking, the Joint CFTC/SEC Advisory

Committee recommended that the SEC and CFTC require that the pause

rules of the exchanges and FINRA be expanded to cover all but the most

inactively traded and listed equity securities, ETFs, and options and

single stock futures on those securities.\299\

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\299\ The Joint CFTC-SEC Advisory Committee on Emerging

Regulatory Issues was established a few days after the dramatic

securities market events of May 6, 2010, called by some the ``Flash

Crash.'' The Committee is charged with addressing regulatory issues

of mutual concern to the CFTC and SEC. See ``Recommendations

Regarding Regulatory Responses to the Market Events of May 6,

2010,'' (Feb. 18, 2011) available at http://www.cftc.gov/MarketReports/StaffReportonMay6MarketEvents/index.htm.

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

vi. Sec. 38.256--Trade Reconstruction

The Dodd-Frank Act added language to Core Principle 4 providing

that a DCM must have the ability to comprehensively and accurately

reconstruct all trading on its trading facility. These audit-trail data

and reconstructions must also be made available to the Commission in a

form, manner, and time as determined by the Commission. Proposed Sec.

38.256 codified these requirements.

Summary of Comments

CME argued that audit trial data is extremely detailed and

voluminous and that the DCMs should be given adequate time to prepare

the trading data before it is supplied to the Commission.\300\ CME

suggested that the wording ``in a form, manner, and time as determined

by the Commission'' be replaced with ``such reasonable time as

determined by the Commission.\301\

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

\300\ CME Comment Letter at 27 (Feb. 22, 2011).

\301\ Id.

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

Chris Barnard expressed support for the trade reconstruction

requirement but requested that the rule be clarified to ensure that the

trade reconstruction requirement includes all trading events, including

the entry of bids and offers in the order of their occurrence, as well

as executed trades in order.\302\

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

\302\ Barnard Comment Letter at 2 (May 20, 2011).

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

Discussion

The Commission is clarifying the rule slightly so that the audit

trail data must be available to the Commission ``in a form, manner, and

time that is acceptable to the Commission.'' The revised wording is

consistent with Sec. 38.950(a), which requires that DCMs maintain

records in a form and manner that is acceptable to the Commission.

The Commission believes that the DCM audit-trail requirements

contained in Sec. 38.551 and Sec. 38.552 clarify the DCM's obligation

for reconstruction of trading and are sufficient to meet Mr. Barnard's

concerns.

[[Page 36639]]

vii. Sec. 38.257--Regulatory Service Provider

Proposed Sec. 38.257 provided that a DCM must comply with the

regulations in subpart E through a dedicated regulatory department, or

by delegation of that function to a regulatory service provider over

which the DCM has supervisory authority.

Discussion

The Commission did not receive any comments on the proposed rule,

and is adopting the rule as proposed.

viii. Sec. 38.258--Additional Rules Required

Proposed Sec. 38.258 required a DCM to adopt and enforce any

additional rules that it believed were necessary to comply with the

requirements of subpart E.

Discussion

Though the Commission did not receive any comments on the proposed

rule, the Commission is of the view that the obligations in the

proposed rule are more appropriate in the guidance. Accordingly, the

proposed rule is moved to guidance. Consistent with this determination,

the Commission is replacing proposed Sec. 38.258 with new Sec. 38.258

(titled ``Additional sources for compliance'') that simply permits DCMs

to rely upon the guidance and acceptable practices in appendix B of

this part to demonstrate to the Commission compliance with Core

Principle 4.

5. Subpart F--Position Limitations or Accountability

Core Principle 5 under section 5(d)(5) of the CEA requires that

DCMs adopt for each contract, as is necessary and appropriate, position

limitations or position accountability. The Dodd-Frank Act amended Core

Principle 5 by adding that for any contract that is subject to a

position limitation established by the Commission pursuant to section

4a(a) of the CEA, the DCM shall set the position limitation of the

board of trade at a level not higher than the position limitation

established by the Commission. At the time of the publication of the

DCM NPRM, the federal position limits established by the Commission

were codified in part 150 of the Commission's regulations, and the

Commission had proposed rules to replace part 150 with new requirements

in part 151, consistent with the requirements of the Dodd-Frank Act.

The Commission published the final rules for ``Position Limits for

Futures and Swaps'' on November 18, 2011.\303\ That final rulemaking

requires DCMs to comply with part 150 (Limits on Positions) until such

time that the Commission replaces part 150 with the new part 151

(Limits on Positions).\304\ In that final release, the Commission

requires that exchanges adopt their own position limits for 28 physical

commodity contracts subject to federal limits, and provides acceptable

practices for establishing position limits in other commodity

contracts. The Commission also established alternative acceptable

practices of adopting position accountability rules in lieu of position

limits for non-spot months in those other commodity contracts. Proposed

Sec. 38.301 required that each DCM must comply with the requirements

of part 151 as a condition of its compliance with Core Principle 5.

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

\303\ See ``Position Limits for Futures and Swaps,'' 76 FR

71626, Nov. 18, 2011.

\304\ Id. at 71632.

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

Summary of Comments

CME stated that the proposed position limits in the part 151

rulemaking may affect the price discovery mechanism of the U.S. futures

markets and asked that the Commission give careful consideration to the

comments it submitted in the part 151 rulemaking.\305\

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

\305\ CME Comment Letter at 27 (Feb. 22, 2011).

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

Discussion

The Commission is adopting the rule, with one modification. The

rule is being revised to add an additional clause that requires DCMs to

continue to meet the requirements of part 150 of the Commission's

regulations--the current position limit regulations--until such time

that compliance is required under part 151. This clarification will

ensure that DCMs are in compliance with the Commission's regulations

under part 150 in the interim period--until the compliance date for the

new position limits regulations takes effect. CME's comments were more

appropriate to the Position Limit rulemaking proceeding, and they were

addressed in that rulemaking.\306\

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

\306\ 76 FR 71626, Nov. 18, 2011.

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

6. Subpart G--Emergency Authority

The Dodd-Frank Act made minor, non-substantive changes to Core

Principle 6 under section 5(d)(6) of the CEA. In implementing the core

principles, the Commission proposed to retain most of the former

Application Guidance associated with Core Principle 6 (found in

appendix B to part 38 of the Commission's regulations) with some

revisions and additions.

Proposed Sec. 38.350 codified the statutory text of the core

principle. Proposed Sec. 38.351 referred applicants and DCMs to the

guidance and acceptable practices in appendix B to part 38 for purposes

of demonstrating to the Commission their compliance with the

requirements of subpart G. The proposed guidance provided that a DCM

should have the authority to intervene as necessary to maintain fair

and orderly trading and to prevent or address manipulation or

disruptive trading practices, whether the need for intervention arises

exclusively from the DCM's own market or as part of a coordinated,

cross-market intervention. The proposed guidance also provided that the

DCM rules should include procedures and guidelines to avoid conflicts

of interest in accordance with new provisions proposed in Sec. 40.9

and to include alternate lines of communication and approval procedures

in order to be able to address, in real time, emergencies that may

arise. The proposed guidance also clarified that the DCM must have

rules that allow it to take such market actions as may be directed by

the Commission.

The proposed rulemaking also proposed certain acceptable practices,

including that the DCM have: (i) Procedures and guidelines for

decision-making and implementation of emergency intervention in the

market, and (ii) the authority to: Liquidate or transfer open positions

in the market,\307\ suspend or curtail trading in any contract, require

market participants in any contract to meet special margin

requirements, and allow it to take such market actions as the

Commission may direct.

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\307\ In situations where a swap is traded on more than one

platform, emergency action to liquidate or transfer open interest

must be directed, or agreed to, by the Commission or Commission

staff.

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

Summary of Comments

KCBT contended that liquidation of positions and special margin

requirements are more appropriately addressed in the rules and

procedures relevant to Derivatives Clearing Organizations.\308\ CME

commented that the Commission should revise the proposed guidance to

make clear that DCMs have the flexibility and independence necessary to

address market emergencies.\309\

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

\308\ KCBT Comment Letter at 6 (Feb. 22, 2011); see also 76 FR

69334, Nov. 8, 2011.

\309\ CME Comment Letter at 28 (Feb. 22, 2011).

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

Discussion

The Commission adopts proposed Sec. Sec. 38.350 and 38.351,

without modification.

In response to the comments pertaining to the proposed guidance,

the

[[Page 36640]]

Commission is making slight revisions to the guidance to clarify that

DCMs retain the authority to independently respond to emergencies in an

effective and timely manner consistent with the nature of the

emergency, as long as all such actions taken by the DCM are made in

good faith to protect the integrity of the markets.

In response to KCBT's comments, the Commission notes that the

statute requires DCMs, in consultation and cooperation with the

Commission, to adopt rules permitting them to liquidate open positions

and impose special margin requirements under their emergency authority.

7. Subpart H--Availability of General Information

Core Principle 7 requires that DCMs make available to the public

accurate information concerning the contract market's rules and

regulations, contracts and operations. The Dodd-Frank Act amended Core

Principle 7 by adding a provision requiring the board of trade to make

public the rules and specifications describing the operation of the

DCM's electronic matching platform or trade execution facility.\310\

Since passage of the CFMA, the types of information and the various

practices for providing information have become standardized across the

industry as DCMs have adopted practices that comply with the current

guidance and acceptable practices for Core Principle 7. Accordingly,

proposed Sec. 38.401 in subpart H codified these practices. In

addition, the Commission proposed several additional provisions to

ensure that pertinent information is available to the Commission,

market participants and the public, as described below.

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

\310\ This requirement, while new to the text of Core Principle

7, was previously required as part of former Designation Criteria 4.

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

The Commission also proposed to codify the statutory text of the

core principle in Sec. 38.400, and is adopting the rule, as proposed.

i. Sec. 38.401(a)--General

Proposed Sec. 38.401(a) required DCMs to have in place procedures,

arrangements and resources for disclosing to market authorities, market

participants, and the public accurate and relevant information

pertaining to: (i) Contract terms and conditions, (ii) rules and

regulations applicable to the trading mechanism; and (iii) rules and

specifications pertaining to the operation of the electronic matching

platform or trade execution facility. Under the proposed rule, DCMs are

required to ensure that market authorities, market participants, and

the public have available all material information pertaining to new

product listings, new or amended governance, trading and product rules,

or other changes to information previously disclosed by the DCM, within

the time period prescribed in proposed Sec. 38.401(c). Section

38.401(a) of the proposed regulation required that DCMs provide the

required information to market participants and the public by posting

such information on their Web site, as set forth in proposed Sec.

38.401(c).

Discussion

The Commission did not receive comments on the proposed rule, and

is adopting the proposed rule with minor, non-substantive

modifications.\311\

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

\311\ The Commission is revising Sec. 38.401(a) to clarify

several internal references.

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

ii. Sec. 38.401(b)--Accuracy Requirement

Proposed Sec. 38.401(b) required that each DCM have procedures in

place to ensure that any information or communication with the

Commission is accurate and complete, and further that no false or

misleading information is submitted and that no material information is

omitted. Similarly, the proposed rule required that each DCM have

procedures in place to ensure the accuracy and completeness of any

information made available to market participants and the public,

including information that is made available on its Web site.

Summary of Comments

NYSE Liffe expressed concern that the requirement to provide

``accurate and complete'' information in ``any communication'' with the

Commission would chill dialogue between DCMs and Commission staff.\312\

NYSE Liffe argued that in addition to submitting formal filings with

the Commission, DCM staff frequently interact with Commission staff on

a more informal basis, and in some cases DCM staff may speak without

complete information.\313\ NYSE Liffe asserted that a DCM may feel

constrained from directly responding to Commission inquiries or from

reaching out to Commission staff if it is concerned that the

information it provides to the Commission may later prove to be

inaccurate or incomplete.\314\ Accordingly, NYSE Liffe requested

clarification that the proposed rule will only apply to formal filings

made with the Commission.\315\ NYSE Liffe also noted that while it

makes every effort to accurately post information required to be made

public, for several data elements, it must rely on data sent to it by

clearing service providers and member firms.\316\ NYSE Liffe argued

that it would be inappropriate to set a strict liability standard over

aggregated data that part 16 of the Commission's rules requires the DCM

to make public when it does not entirely control the generation of

component parts of that data.\317\

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

\312\ NYSE Liffe Comment Letter at 12 (Feb. 22, 2011).

\313\ Id.

\314\ Id.

\315\ Id.

\316\ Id. at 13.

\317\ Id.

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

Discussion

The Commission is adopting proposed Sec. 38.401(b), with certain

revisions. While DCMs must provide the Commission with accurate and

complete information, the Commission recognizes that the proposed rule

text may raise concerns with DCMs in freely communicating with

Commission staff in certain instances. Accordingly, the Commission is

revising the rule to clarify that a DCM must ``provide information that

it believes, to the best of its knowledge, is accurate and complete,

and must not omit material information'' with respect to any

communication with the Commission, and any information required to be

transmitted or made available to market participants and the public,

including on its Web site or otherwise. The requirements of Sec.

38.401(b) are intended to be, and should be interpreted as being,

consistent with the false reporting provision under section 9(a)(3) of

the CEA, 7 U.S.C. 13. The amended rule accommodates the possibility

that DCMs may not exercise complete control over all of the information

that they receive from third-parties and later make public.

iii. Sec. 38.401(c)--Notice of Regulatory Submissions

The Commission historically has required DCMs to update their

rulebooks upon the effectiveness of a rule amendment, product listing

or rule certification that has been filed with the Commission. While

proposed Sec. 38.401(c) maintained the general requirement for posting

rules in the DCM rulebook upon their effectiveness, the Commission

believed that market participants and the public would benefit from

notifications of proposed rule amendments, product listing (or de-

listings) and rule certifications in advance of their taking

effect.\318\

[[Page 36641]]

Accordingly, proposed Sec. 38.401(c) required each DCM to post on its

Web site all rule filings and submissions that it makes to the

Secretary of the Commission. The proposed rule required that this

information be posted on the DCM's Web site simultaneous with the

filing of such information with the Commission. The DCM NPRM stated

that, where applicable, the DCM Web site should make clear that the

posted submissions are pending before the Commission.\319\ This

requirement was designed to provide market participants with advance

notice of rule amendments and certifications, consistent with the goal

of Core Principle 7 to make pertinent information available to market

participants and the public. This proposed posting requirement was in

addition to the obligation of DCMs to update their rulebooks upon the

effectiveness of a rule submission or certification.

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

\318\ This is especially relevant when the Commission determines

to stay the certification of a DCM submission, as provided by the

Dodd-Frank Act, for a 90-day review period, thereby triggering a

public comment period.

\319\ The DCM NPRM noted, for example, that a DCM's Web site may

contain a separate web page for ``regulatory filings'' or ``rule

certifications'' for posting submissions or certifications

pertaining to new product listings, new rules, rule amendments or

changes to previously-disclosed information. DCM NPRM at 80586.

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

To the extent that a DCM requests confidential treatment of certain

information filed or submitted to the Commission, the proposed rule

required the DCM to post the public portions of the filing or

submission on its Web site.

Summary of Comments

CME and KCBT both contended that the requirement that DCMs post

regulatory submissions on their Web site simultaneously with their

filing with the Commission is duplicative, as the Commission already

posts these submissions on the CFTC Web site.\320\ CME and KCBT further

argued that they use other methods to communicate regulatory changes to

the public, including bulletins, email notifications, and press

releases.\321\ CME requested that if the Commission does choose to

retain this requirement, that a DCM be given a minimum of one business

day to post such filings, rather than having to post ``simultaneously''

with the Commission filing.\322\ CME noted that even a one-day standard

would be a significantly higher standard than the Commission holds

itself to with respect to posting the filings it receives from DCMs

today.\323\

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

\320\ CME Comment Letter 28-29 (Feb. 22, 2011); KCBT Comment

Letter at 6 (Feb. 22, 2011).

\321\ CME Comment Letter at 29 (Feb. 22, 2011); KCBT Comment

Letter at 6 (Feb. 22, 2011).

\322\ CME Comment Letter at 29 (Feb. 22, 2011).

\323\ Id.

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

Discussion

The Commission is adopting the proposed rule, with certain

modifications. The Commission believes it is important for market

participants and the public to have advance notice of rule amendments

and certifications prior to their taking effect, consistent with the

goal of Core Principle 7 to make pertinent information available to

market participants and the public. Where applicable, the DCM Web site

should make clear that the posted submissions have been submitted to

the Commission, but are not yet in effect. For example, a DCM could

post its submissions or information filed with the Commission on a

separate web page that is designated as ``regulatory filings'' or

``proposed rulebook amendments.'' The Commission notes that the

requirement to make information available to the public necessitates

that such information can be accessed by visitors to the Web site

without the need to register, log in, provide a user name or obtain a

password, as is the current practice under Commission regulations.\324\

In response to CME, the Commission notes that it adopted a similar

requirement in the final rulemaking pertaining to Provisions Common to

Registered Entities.\325\ In that final rulemaking, the Commission

codified in Sec. 40.5(a)(6) the requirement that a registered entity

submitting a voluntary rule submission post such submission on its Web

site concurrent with the filing of such submission with the

Commission.\326\ Consistent with Sec. 40.5, the Commission is revising

the posting requirement in the proposed rule from ``simultaneous'' to

``concurrently'' with the filing of the information with the

Commission. The proposed rule is also being revised to clarify that the

posting requirement applies to any information or ``submission''

provided to the Commission.

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

\324\ See former acceptable practices to Core Principle 7. 17

CFR part 38, appendix B (2010).

\325\ See 76 FR 44776, 44794, July 27, 2011.

\326\ Id.

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iv. Sec. 38.401(d)--Rulebook

Proposed Sec. 38.401(d) codified the pre-existing DCM practices

pertaining to updating DCM rulebooks.\327\ The proposed rule required

that DCMs post and routinely update, their rulebooks, which appear on

their Web sites. The proposed rule required that each DCM update its

rulebook the day that a new product is listed or a new or amended rule

takes effect. The proposed rule further required that DCM Web sites be

readily accessible to the public, and that the information posted

therein be available to visitors to the Web site without requiring

registration, log-in, or user name or password.

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

\327\ As noted above, the requirement to maintain an accurate

and updated rulebook does not relieve DCMs of their obligations

under proposed paragraph (c) to post on their Web sites all rule

filings and submissions submitted to the Commission.

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

Discussion

The Commission did not receive comments regarding this proposed

rule and is adopting the rule as proposed. As noted in the DCM NPRM,

the vast majority of DCMs maintain Web sites that comply with the

requirements in the rule.

8. Subpart I--Daily Publication of Trading Information

Core Principle 8 requires that DCMs make available to the public

accurate information on settlement prices, volume, open interest, and

opening and closing ranges for actively traded contracts on the

contract market. The Dodd-Frank Act did not amend Core Principle 8.

Accordingly, proposed Sec. 38.451 codified the pre-existing acceptable

practices, which largely required that DCMs comply with Sec. 16.01

(Trading volume, open contracts, prices and critical dates) of the

Commission's regulations.

In addition, the Commission proposed certain revisions to Sec.

16.01, consistent with the Dodd-Frank Act amendments to the CEA,

including revisions regarding the information a reporting market must

record and publish on futures, swap, and options contracts on a

commodity.\328\ Specifically, the proposed amendments to part 16

specified the type of information that DCMs or SEFs must publish daily

regarding the swaps contracts traded. The proposed rule required that

DCMs and SEFs publish specified information for each trading day, for

each swap, class of swaps, option on a swap, or class of options on a

swap, as appropriate. For swap contracts that are standard-sized

contracts (i.e., contracts that have a set contract size for all

contracts), the proposed rule required the reporting of volume and open

interest for swaps and options on swaps in terms of number of contracts

traded, similar to how futures contracts currently are reported. For

swap contracts that are non-standard-sized (i.e., contracts whose

contract size can

[[Page 36642]]

vary for each transaction), the proposed rule required that the volume

and open interest be reported in terms of total notional value traded

for that trading day.

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

\328\ The term commodity also includes ``excluded commodities.''

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

The Commission also proposed to amend Sec. 16.01(b) to require

each DCM or SEF to publish for each trading day, by commodity and

contract month or by tenor of the swap, the opening price, high price,

low price and settlement price of the swap or option on swap contract.

The Commission requested comments on end-of-day price reporting for

swaps. Specifically, the Commission requested comments on the following

issues:

For interest rate swaps, because the tenor on an interest

rate swap can be one of thousands of possible periods, what would be an

appropriate manner to display end-of-day prices for each interest rate

swap?

Would certain end-of-day swap price reporting be more

meaningful than others? If so, which methods of price reporting would

be more meaningful and why?

Would certain end-of-day swap price reporting be

misleading? If so, which methods of price reporting would be misleading

and why?

The Commission also proposed to revise Sec. 16.01 to require

reporting markets to report directly to the Commission pursuant to the

requirements of 16.01(d), information pertaining to the total volume of

block trades that are included in the total volume of trading.

Finally, the Commission also proposed to codify the statutory text

of the core principle in Sec. 38.450, and is adopting the rule, as

proposed.

Summary of Comments

Several commenters discussed the revised reporting requirements

that were proposed in Sec. 16.01. Eris stated that DCMs and SEFs

should be held to the same reporting standards for interest rate

swaps.\329\ In particular, Eris commented that a DCM or SEF should

report real-time, intraday prices for par swaps at standard maturities,

publish open interest grouped in maturity buckets based on the

remaining tenor of each instrument, and publish at the end of day the

settlement curve from the clearinghouse as well as the specific

settlement values applied to each cleared swap.\330\ Specifically, Eris

recommended: (1) That daily open interest should be published publicly

in a summary fashion with open interest grouped in maturity buckets

based on the remaining tenor of each instrument, (2) that end of day

pricing should be based upon a market-driven curve where the

clearinghouse's methodology to generate the daily settlement curve, as

well as all of the inputs and components of the settlement curve, are

made transparent to the full trading community, and (3) the

clearinghouse should publish the specific daily settlement values

applied to each cleared swap, without revealing open interest at a

granular level.\331\

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

\329\ Eris Comment Letter at 4 (Feb. 22, 2011).

\330\ Id. at 4-5.

\331\ Id.

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

Better Markets recommended that proposed Sec. 16.01 also require

the daily publication of the number of orders and order cancellations

separately for futures, options and swaps.\332\ According to Better

Markets, that data would indicate the levels of high frequency trading

activity within market segments.\333\

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

\332\ Better Markets Comment Letter at 9 (Feb. 22, 2011).

\333\ Id.

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

CME stated that while it does not object to reporting block trades

that are included in the daily volume of trading, this new requirement

will require it to ascertain what systems changes will be necessary and

how long such changes will take to implement.\334\ CME also stated that

the end of day price reporting of interest rate swaps should be

addressed as a separate initiative outside of the DCM and SEF

rulemakings given the state of change in the swaps markets and how the

market is expected to evolve as a result of regulatory reforms

underway.\335\

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

\334\ CME Comment Letter at 29 (Feb. 22, 2011).

\335\ Id.

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

Discussion

The Commission is codifying Sec. 16.01 as proposed, with a

technical revision to renumber paragraph (a).

The Commission recognizes that the end-of-day reporting for

interest rate swaps by each DCM and SEF may require a more flexible

reporting scheme to take into account the venue in which the interest-

rate swap is cleared. In this respect, the daily settlement curve (the

yield curve for particular interest rate (e.g., LIBOR, TIBOR, Euribor,

etc.)) at each clearinghouse may differ based on the assumptions of the

curve. The Commission has considered the proposed reporting standard

put forth by Eris, however, in light of the novelty of swaps trading on

DCMs, the Commission believes that the more detailed reporting

obligations under Sec. 16.01 are warranted at this time. The

Commission did not receive any objections to the additional reporting

of block trades or to the swaps reporting standards. The Commission

further clarifies that in making information available to the general

public, as required in 16.01(e), DCMs should ensure that such

information can be accessed by visitors to the Web site without the

need to register, log in, provide a user name or obtain a

password.\336\

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

\336\ See e.g., former acceptable practices to Core Principle 7

(imposing similar requirement with respect to rulebooks). 17 CFR

part 38, appendix B (2010).

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

Better Markets' comments pertaining to high frequency trading are

addressed under the general discussion in Core Principle 4 pertaining

to HFTs.

9. Subpart J--Execution of Transactions

The Dodd-Frank Act revised Core Principle 9 to read as follows:

The board of trade shall provide a competitive, open and

efficient market and mechanism for executing transactions that

protects the price discovery process of trading in the centralized

market of the board of trade. * * * The rules of the board of trade

may authorize, for bona fide business purposes:

(a) Transfer trades or office trades;

(b) An exchange of:

(1) Futures in connection with a cash commodity transaction;

(2) Futures for cash commodities; or

(3) Future for swaps; or

(c) A futures commission merchant, acting as principal or agent,

to enter into or confirm the execution of a contract for the

purchase or sale of a commodity for future delivery if the contract

is reported, recorded, or cleared in accordance with the rules of

the contract market or a derivatives clearing organization.\337\

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

\337\ 7 U.S.C. 7(d)(9). The language that provides that off-

exchange transactions are permitted for bona fide business purposes

if authorized by the board of trade's rules was formerly contained

in Designation Criteria 3.

In view of Congress' revisions to Core Principle 9, and the

Commission's own experience over the past decade in overseeing

compliance with former Core Principle 9 \338\ and related regulation

1.38,\339\ the Commission proposed a number of new and revised rules,

guidance and acceptable practices in order to implement the revised

core principle, which requires DCMs to

[[Page 36643]]

provide a competitive, open and efficient market and mechanism for

executing transactions that protects the price discovery process of

trading in the centralized market of the board of trade.

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

\338\ Former Core Principle 9 provided as follows: ``[T]he board

of trade shall provide a competitive, open and efficient market and

mechanism for executing transactions.''

\339\ As described in the DCM NPRM, regulation 1.38 (Execution

of Transactions) of the Commission's regulations requires, among

other things, that all purchases and sales of a commodity for future

delivery or a commodity option on or subject to the rules of a DCM

be executed by open and competitive methods, with certain exceptions

for transactions that are executed noncompetitively pursuant to a

DCM's rules. See DCM NPRM, 75 FR at 80588 (discussing regulation

1.38).

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

Proposed Sec. 38.500 codified the statutory text of Core Principle

9.\340\ Proposed Sec. 38.501 specified the manner in which

transactions on the DCM's centralized market must be executed, and set

forth the requirements applicable to transactions that are executed off

of the DCM's centralized market, and incorporated certain

clarifications pertaining to the allowable types of off-exchange

transactions. Proposed Sec. 38.502 implemented the core principle's

requirement that DCMs provide a market and mechanism for executing

transactions that protects the price discovery process of trading in

its centralized market. The rule proposed a centralized market trading

requirement for all contracts listed on a DCM.

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

\340\ The Commission is finalizing regulation 38.500 in this

release.

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

Proposed Sec. 38.503 set forth revised rules and related guidance

pertaining to block transactions in futures contracts, including the

appropriate size, price and reporting of block trades; proposed Sec.

38.504 set forth rules pertaining to block transactions in swap

contracts. Finally, the DCM NPRM proposed new and revised rules under

Core Principle 9 that clarified other off-exchange transactions,

referred to collectively as ``exchanges of derivatives for related

positions'' and office trades and transfer trades.

Summary of Comments and Discussion

The Commission received a significant number of comments on all

aspects of the proposed rules under Core Principle 9, comprising both

general and specific comments pertaining to the Commission's

interpretation of Core Principle 9 and various other aspects of the

proposed rules.

In particular, commenters raised numerous questions pertaining to

the centralized market trading requirement rule's delisting requirement

for non-compliant contracts and the available alternatives for trading

such contracts.\341\ Commenters also raised questions pertaining to

certain aspects of the proposed rules for block transactions and

exchanges of derivatives for related position transactions.\342\ The

Commission has considered these comments, along with comments

pertaining to other aspects of the proposed rules under Core Principle

9, and believes that additional time is appropriate before finalizing

the proposed rules for Core Principle 9. In particular, the Commission

plans and expects to take up the proposed rules under Core Principle 9

when it considers the final SEF rulemaking. The additional time will

allow the Commission to consider the available alternatives for

contracts that may not comply with the proposed centralized market

trading requirement (including listing contracts on a SEF), as well as

the related implications of the rules for off-exchange transactions,

including block transactions and exchange of derivatives for relates

position transactions (``EDRPs''). At that time, the Commission will

address the comments received in connection with proposed Sec. Sec.

38.501-38.506.

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

\341\ See, e.g., CME Comment Letter at 4-8, 29-30 (Feb. 22,

2011); CME Comment Letter at 2-6 (April 18, 2011); CME Joint Comment

Letter at 2-6 (June 3, 2011); CME Comment Letter (Aug. 3, 2011);

BlackRock Comment Letter at 2-3 (Feb. 22, 2011); ICE Comment Letter

at 3-6 (Feb. 22, 2011); CFE Comment Letter at 4-7 (Feb. 22, 2011);

CFE Comment Letter (June 3, 2011); OCX Comment Letter at 2-5 (Feb.

22, 2011); Eris Comment Letter at 1-3 (Feb. 22, 2011); Eris Comment

Letter at 3 (June 3, 2011); GreenX Comment Letter at 8-11 (Feb. 22,

2011); GreenX Comment Letter at 4 (April 18, 2011); and, GreenX

Comment Letter (June 3, 2011).

\342\ See, e.g., ICE Comment Letter at 7 (Feb. 22, 2011); CME

Comment Letter at 31 (Feb. 22, 2011); ELX Comment Letter at 3 (Feb.

22, 2011); and, KCBT Comment Letter at 6 (Feb. 22, 2011).

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

10. Subpart K--Trade Information

Section 5(d)(10) of the CEA (Core Principle 10), as amended by the

Dodd-Frank Act, requires DCMs to capture, verify, and retain detailed

trade information (i.e., audit trail data) for all transactions in

their markets. The core principle requires DCMs to maintain rules and

procedures that provide for the recording and safe storage of all

identifying trade information in a manner that enables the DCM to

assist in the prevention of customer and market abuses and to provide

evidence of any rule violations. The Dodd-Frank Act did not

substantively revise Core Principle 10, and therefore, the application

guidance and acceptable practices for former Core Principle 10 provided

the basis for the Commission's proposed audit trail regulations in

subpart K.\343\ In addition, the Commission also looked to the issues

that arose in the context of RERs pertaining to Core Principle 10.

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

\343\ The Commission previously expressed the regulatory

requirements of former Core Principle 10 through its application

guidance for that core principle. See 17 CFR part 38, app. B,

Application Guidance and Acceptable Practices for Core Principle 10.

It also provided additional insight regarding the core principle

through detailed acceptable practices that all DCMs could use to

demonstrate compliance with former Core Principle 10. The acceptable

practices explained that ``the goal of an audit trail is to detect

and deter customer and market abuse.'' Id. at (b)(1). It also

outlined the elements of an effective audit trail. Those elements

included original source documents, which help to establish the

accuracy and authenticity of an audit trail. Also included is a

transaction history database and electronic analysis capability,

which allow a DCM to more easily access and review audit trail data

to identify possible trading abuses and rule violations. Finally,

the acceptable practices pointed to a DCM's safe storage capability,

emphasizing that audit trail data must be stored in a manner that

protects it from unauthorized alteration, accidental erasure, or

other loss.

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

The Commission proposed to codify the statutory text of Core

Principle 10 in proposed Sec. 38.550, and is adopting that rule as

proposed.

i. Sec. 38.551--Audit Trail Required

Proposed Sec. 38.551 is based on the application guidance and

acceptable practices for former Core Principle 10.\344\ Proposed Sec.

38.551 established the overarching requirement that a DCM's audit trail

program must help to ensure that the DCM can appropriately monitor and

investigate any potential customer and market abuse. The proposed rule

also provided that the audit trail data captured by a DCM must be

sufficient to reconstruct all transactions within a reasonable period

of time, and to provide evidence of any rule violations that may have

occurred. The proposed rule further provided that audit trails must be

sufficient to track customer orders from the time of receipt through

fill, allocation, or other disposition. Proposed Sec. 38.551 applied

equally to open-outcry and electronic trading.\345\

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

\344\ 17 CFR part 38, app. B, Core Principle 10, Application

Guidance and Acceptable Practices.

\345\ 75 FR 80572, 80617-80618, Dec. 22, 2010.

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

Summary of Comments

Two commenters stated that the proposed rule is too

prescriptive.\346\ CME argued that the proposals were a departure from

a principles-based regulatory regime and would stifle growth and

innovation.\347\ Similarly, MGEX argued that prescriptive rules would

impose additional burdens and costs upon DCMs.\348\

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

\346\ CME Comment Letter at 33-34 (Feb. 22, 2011); and MGEX

Comment Letter at 7 (Feb. 22, 2011).

\347\ CME Comment Letter at 34 (Feb. 22, 2011).

\348\ MGEX Comment Letter at 7 (Feb. 22, 2011).

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

Chris Barnard agreed with the proposed requirement that all DCMs

have the ability to reconstruct all trading.\349\ Mr. Barnard suggested

that the requirement that an exchange be able to reconstruct trading

should include ``all trading events, including the entry of bids and

offers in the order of their occurrence, as well as executed trades * *

*'' in order to permit

[[Page 36644]]

exchanges to fully reconstruct and verify all trading activities.\350\

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

\349\ Barnard Comment Letter at 2 (May 20, 2011).

\350\ Id.

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

Discussion

The Commission is adopting Sec. 38.551 as proposed. While the

Commission acknowledges CME and MGEX's comments, the Commission does

not believe that requiring an exchange to capture and retain all audit

trail data--to ensure that the exchange can reconstruct all

transactions on its markets--places an undue burden on exchanges or

stifles innovation. As noted above, the requirement that DCMs capture

and retain all audit trail data is central to ensuring that the DCM can

appropriately monitor and investigate any potential customer and market

abuse, as required by the core principle. The Commission is not

persuaded that this requirement would unduly burden DCMs, as these

requirements are the same as the responsibilities currently outlined in

the Acceptable Practices and Application Guidance for Core Principle

10. In addition, exchanges are free to decide the manner and the

technology they use to capture and retain audit trail data. The

Commission is not prescribing how this should be done and therefore

does not believe that this requirement will stifle innovation.

The Commission also notes that the text of Sec. 38.551 defines

certain regulatory outcomes that exchanges must achieve, but does not

prescribe a specific means by which exchanges must achieve those

outcomes. Accordingly, the rule is not prescriptive as it permits an

exchange to achieve the required outcome in a number of ways.

Proposed Sec. 38.551 required that a DCM ``must capture and retain

all audit trail data necessary to detect, investigate, and prevent

customer and market abuses.'' \351\ The creation and retention of a

comprehensive audit trail enables exchanges to properly reconstruct any

and all trading events and to conduct a thorough forensic review of all

trade information. The Commission believes that the ability to

reconstruct trading is a fundamental element of a DCM's surveillance

and rule enforcement programs.

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

\351\ DCM NPRM at 80617-18.

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

ii. Sec. 38.552--Elements of an Acceptable Audit Trail Program

Proposed Sec. 38.552 established the four elements of an

acceptable audit trail program. First, proposed Sec. 38.552(a)

required a DCM's audit trail to include original source documents,

defined to include unalterable, sequentially-identified records on

which trade execution information is originally recorded, whether

manually or electronically. Additionally, the proposal required that

customer order records indicate the terms of the order, the account

identifier that relates to the account owner, and the time of the order

entry. Finally, proposed Sec. 38.552(a) required that, for open-outcry

trades, the time of report of order execution also be captured in the

audit trail.

Second, proposed Sec. 38.552(b) required that a DCM's audit trail

program must include a transaction history database. Proposed Sec.

38.552(b) specified the trade information required to be included in a

transaction history database, including a history of all orders and

trades; all data input in the trade matching system for clearing; the

categories of participants for which trades were executed (i.e.,

customer type indicator or ``CTI'' codes); timing and sequencing data

sufficient to reconstruct trading; and identification of each account

to which fills were allocated.

Third, proposed Sec. 38.552(c) required that a DCM's audit trail

program have electronic analysis capability for all data in its

transaction history database, and that such electronic analysis

capability allow the exchange to reconstruct trades in order to

identify possible rule violations.

Finally, proposed Sec. 38.552(d) required that a DCM's audit trail

program include the ability to safely store all audit trail data, and

to retain data in accordance with the recordkeeping requirements of DCM

Core Principle 18 and associated regulations. Safe storage capability

required a DCM to protect its audit trail data from unauthorized

alteration, accidental erasure, or other loss.

Summary of Comments

In addition to submitting general comments asserting that the

proposed rules are overly prescriptive, CME stated that while it

currently maintains a database that includes a history of all orders

and trades for electronic trading, the open outcry trading venue ``does

not support an electronic transaction history database that captures

the history of all orders, including orders that may be cancelled prior

to execution.'' \352\ CME requested that, in the event that open-outcry

orders are not entered into an electronic order routing system, the

Commission clarify the requirements to take into account the

distinctions between electronic and open-outcry trading.\353\

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

\352\ CME Comment Letter at 33 (Feb. 22, 2011).

\353\ Id.

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

Better Markets requested that the Commission consider the impact

that high-frequency traders may have on creation and maintenance of an

exchange's audit trail data.\354\ Specifically, Better Markets

commented that each of the elements of an exchange's audit trail,

including all customer orders, should be ``time-stamped at intervals

consistent with the capabilities of [high-frequency traders] * * *''

\355\

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

\354\ Better Markets Comment Letter at 9 (Feb. 22, 2011).

\355\ Id. at 10.

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

Discussion

The Commission is adopting Sec. 38.552 as proposed, with certain

revisions in response to comments received, and additional

clarifications as explained below.

First, in response to CME's comment that the Commission's audit

trail rules should recognize the distinctions between electronic

trading and open outcry trading, the Commission is revising Sec.

38.552(b) to specify that a transaction history database must include a

history of all trades, whether executed electronically or via open-

outcry. However, order information must be included in the database

only to the extent that such orders are entered into an electronic

trading system. In addition, Sec. 38.552(b) also clarifies that order

data includes modifications and cancellations of such orders. This

reflects a regulatory requirement previously proposed as part of Sec.

38.156, but moved to Sec. 38.552(b) in the final rules. The final

rules further revise Sec. 38.552(b)(2) by replacing the customer type

indicators listed in the proposed rule with the term ``customer type

indicator code.''

The final rules also revise Sec. 38.552(c) to include the

requirement that an exchange's electronic analysis capability must

provide it with the ability to reconstruct trading and identify

possible trading violations.\356\

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

\356\ The text added to regulation 38.552(c) is language

originally proposed in regulation 38.156 and has now been deleted

from regulation 38.156.

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

The Commission acknowledges Better Markets' comments regarding

audit trail data with respect to high-frequency trading. However, the

Commission believes that the audit trail rules adopted herein,

particularly the requirements that an exchange retain and maintain all

data necessary to permit it to reconstruct trading, will help ensure

that information and trades entered into an electronic trading system

by high-frequency traders will be collected and retained as any other

[[Page 36645]]

audit trail data would be collected and retained.

The Commission believes that the four elements set forth in Sec.

38.552 are necessary to ensure that a DCM can capture and retain

sufficient trade-related information, can reconstruct trading promptly,

and has the necessary tools to detect and deter potential customer and

market abuses through its audit trail. Specifically, original source

documents must include all necessary trade information to reconstruct

trading on the DCM. The transaction history database facilitates rapid

access and analysis of all original source documents, thereby aiding

DCMs in monitoring for customer and market abuses, while electronic

analysis capability helps ensure effective use of audit trail data by

requiring appropriate tools to use in conjunction with a DCM's

transaction history database. Safe storage capability enables a DCM to

properly preserve and protect the audit trail data so that it is

readily available for the DCM to use in any future investigation or

inquiry into possible violations of DCM rules.

With the clarifications and revisions discussed above, the

Commission adopts Sec. 38.552 as the elements required of an

acceptable audit trail program.

iii. Sec. 38.553--Enforcement of Audit Trail Requirements

Proposed Sec. 38.553 established the elements of an effective

audit trail enforcement program. The proposed rule was organized in two

parts. First, proposed Sec. 38.553(a) required a DCM to develop an

effective audit trail enforcement program. The proposed rule provided

that an effective enforcement program must, at a minimum, review all

members and market participants annually to verify their compliance

with all applicable audit trail requirements.

Proposed Sec. 38.553(a) was further divided into two paragraphs.

Paragraph (a)(1) set forth minimum review criteria for an electronic

trading audit trail, including annual examinations by DCMs of randomly

selected samples of front-end audit trail data from order routing

systems to ensure the presence and accuracy of required audit trail

data. In addition, paragraph (a)(1) required that exchanges: Review the

processes used by members and market participants to assign and

maintain exchange user identifications; review usage patterns

associated with user identifications; and review account numbers and

CTI codes in trade records to test for accuracy and improper usage.

Paragraph (a)(2) of proposed Sec. 38.553 established minimum review

criteria for open-outcry trading, requiring DCMs to conduct annual

reviews of all members and market participants to verify their

compliance with their trade timing, order ticket, and trading card

requirements.

Second, proposed Sec. 38.553(b) required DCMs to develop programs

to ensure effective enforcement of their audit trail and recordkeeping

requirements. This requirement applied equally to both open-outcry and

electronic trading. Proposed Sec. 38.553(b) required exchanges'

enforcement programs to identify members and market participants that

routinely failed to comply with the requirements of Core Principle 10

and to levy meaningful sanctions when deficiencies were found. Such

sanctions could not include more than one warning letter or other non-

financial penalty for the same violation within a rolling 12 month

period.

Summary of Comments

As noted above with respect to other rules, several commenters

requested clarification of the term ``market participant'' in Sec.

38.553(a) and Sec. 38.553(b), including questioning who qualifies as a

``market participant.'' \357\ Specifically, MGEX and NYSE Liffe

suggested that the term ``market participant'' should be limited to

only those participants who have direct access to the trading

platform.\358\ CME commented that the Commission should limit the

requirement for annual audit trail reviews to the ``clearing firm level

rather than the market participant level'' because conducting an annual

audit trail and recordkeeping review of ``every participant who enters

an order into [a trading system would be] exceptionally onerous, costly

and unproductive.'' \359\ Additionally, MGEX argued that exchanges

should be permitted to conduct annual reviews by testing a sample of

market participants in order to make the annual reviews of audit trail

and recordkeeping requirements ``more efficient, adequate and less

burdensome.'' \360\

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

\357\ CME Comment Letter (Feb. 22, 2011); NYSE Liffe Comment

Letter (Feb. 22, 2011); MGEX Comment Letter (Feb. 22, 2011).

\358\ MGEX Comment Letter at 7 (Feb. 22, 2011); NYSE Liffe

Comment Letter at 12 (Feb. 22, 2011).

\359\ CME Comment Letter at 33(Feb. 22, 2011).

\360\ MGEX Comment Letter at 7 (Feb. 22, 2011).

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

In response to the proposed Sec. 38.553(b)'s requirement for

sufficient sanctions for violations of audit trail and recordkeeping

requirements, MGEX argued that such a requirement is ``arbitrary and

counterproductive.'' \361\ MGEX proposed that the Commission should

simply require exchanges to have an adequate audit trail program,

including adequate enforcement of the audit trail requirements.\362\

MGEX argued that such an approach would allow an exchange to develop

``what works best for their business while meeting intended audit trail

requirements.'' \363\

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

\361\ Id.

\362\ Id.

\363\ Id.

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

Discussion

The Commission adopts proposed Sec. 38.553, with certain

amendments.

The Commission has considered the comments pertaining to this rule

and believes that the term ``market participants,'' as used in

Sec. Sec. 38.553(a) and 38.553(b), requires clarification.

Accordingly, ``market participants'' is amended to instead state

``persons and firms subject to designated contract market recordkeeping

rules'' throughout Sec. 38.553. The Commission recognizes that the

term ``market participants'' may be viewed to capture a wider range of

persons than the Commission intended to subject to the proposed

regulation. Therefore, this amendment to Sec. 38.553 clarifies that

its requirements apply to those individuals and firms that are subject

to DCM recordkeeping rules.

The Commission does not believe that sampling-based reviews of

audit trail and recordkeeping requirements are adequate to reasonably

ensure compliance with audit trail rules. Sections 38.553(a) and

38.553(b) require audit trail enforcement programs that will yield some

certainty with respect to exchanges' accurate and consistent access to

all data necessary to reconstruct all transactions in their markets and

provide evidence of customer and market abuses. Absent reliable audit

trail data, an exchange's ability to detect or investigate customer or

market abuses may be severely diminished.

The Commission does not believe that requiring exchanges to issue

no more than one warning letter for the same violation within a rolling

12-month time period is arbitrary and counterproductive. The proposed

requirement to limit DCMs to no more than one warning letter for the

same violation within a rolling 12-month time period helps ensure that

exchanges levy meaningful fines and sanctions to deter recidivist

behavior. However, the Commission is amending Sec. 38.553(b) to

clarify that its requirements with respect to warning letters only

apply where exchange compliance staff finds an actual rule violation,

rather than just the suspicion of a violation.

[[Page 36646]]

The Commission notes that Sec. 38.553 reflects staff's findings

and recommendations in recent RERs regarding DCMs' audit trail

enforcement programs, including recommendations regarding more frequent

audit trail reviews and larger sanctions for audit trail violations.

The proposed rule also reflects the Commission's directive to DCMs in

recent RERs to develop audit trail programs for electronic trading that

are comparable in rigor and scope to their audit trail programs for

open-outcry trading.\364\ Accordingly, the Commission is adopting Sec.

38.553 with the aforementioned modifications.

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

\364\ See Rule Enforcement Review of the Minneapolis Grain

Exchange (August 27, 2009), and Rule Enforcement Review of ICE

Futures U.S. (Feb. 2, 2010).

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

11. Subpart L--Financial Integrity of Transactions

The Dodd-Frank Act amended the text of Core Principle 11 largely to

incorporate the language from former Designation Criteria 5.\365\

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

\365\ Former Designation Criterion 5 stated that ``the board of

trade shall establish and enforce rules and procedures for ensuring

the financial integrity of transactions entered into by or through

the facilities of the contract market, including the clearance and

settlement of the transactions with a derivatives clearing

organization.'' 17 CFR Part 38, app. A (2010).

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

This core principle requires that a DCM establish and enforce rules

and procedures for ensuring the financial integrity of transactions

entered into, on, or through the facilities of the contract market,

including the clearing and settlement of the transactions with a DCO.

Core Principle 11 also requires that a DCM establish and enforce rules

to ensure: (i) The financial integrity of any futures commission

merchant (``FCM'') and introducing broker (``IB''); and (ii) the

protection of customer funds. Because the substance of this core

principle is unchanged, the Commission interpreted the statutory

provisions in the same manner as they are currently interpreted. The

Commission proposed to codify current practices carried out by the

industry, as well as practices listed in the application guidance for

Core Principle 11 and former Designation Criterion 5. In addition,

based upon its experience, the Commission proposed some new practices

and requirements for DCMs in implementing Core Principle 11.\366\ Among

other rules, the Commission proposed to codify the statutory text of

Core Principle 11 in Sec. 38.600, and is adopting the rule as

proposed.

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

\366\ The Commission received five comment letters that

discussed proposed regulations 38.600 through 38.607. The comments

were received from ICE Comment Letter (Feb. 22, 2011), ELX Comment

Letter (Feb. 22, 2011), MGEX Comment Letter (Feb. 22, 2011), KCBT

Comment Letter (Feb. 22, 2011), and CME Comment Letter (Feb. 22,

2011).

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

i. Sec. 38.601--Mandatory Clearing

Proposed Sec. 38.601 provided that all transactions executed on or

through a DCM, other than transactions in security futures products, be

cleared through a Commission-registered DCO.

Summary of Comments

CME commented that the mandatory clearing requirement should not

apply to swaps traded on a DCM because not all swap contracts will be

required to be cleared, such as foreign exchange swaps and swaps for

end users.\367\ CME further stated that this requirement would put a

DCM at a competitive disadvantage to a SEF without justification, and

recommended that the Commission revise proposed Sec. 38.601 to exclude

swaps from the clearing rule.\368\

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

\367\ CME Comment Letter at 34 (Feb. 22, 2011).

\368\ Id.

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

Discussion

The Commission is adopting the proposed rule, with certain

amendments. The Commission believes that the language of the core

principle specifically imposes a clearing obligation for all

transactions executed on a DCM (as is the current practice) and has

therefore not revised the rule to exclude swaps.\369\

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

\369\ Although the DCM and SEF Financial Integrity Core

Principles are similar, the SEF core principle contains the language

``including the clearance and settlement of the swaps pursuant to

section 2(h)(1).'' Section 5h(f)(7) of the CEA, 7 U.S.C. 7b-2(f)(7),

as added by section 733(f) of the Dodd-Frank Act. The DCM core

principle states ``including the clearance and settlement of the

transactions with a derivatives clearing organization.'' The

Commission reads section 2(h)(1) as a limitation on the clearing

obligation for SEFs, and as a result, proposed regulation 37.701

requires all transactions executed on a SEF to be cleared unless the

transaction is exempted from clearing under section 2(h)(7) of the

CEA or the Commission determines that the clearing requirement under

section 2(h)(1) of the CEA is inapplicable. Since Congress did not

provide for a limitation on the clearing obligation in the DCM core

principle, all transactions executed on or through a DCM must be

cleared through a Commission-registered DCO.

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

However, the Commission has revised the rule to make clear that

transactions in security futures products that are executed on or

through a DCM are also subject to the mandatory clearing requirement.

Such products may be cleared either through a DCO or through a clearing

agency registered pursuant to section 17A of the Securities Exchange

Act of 1934.\370\

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

\370\ 15 U.S.C. 78a et seq. (2010)

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

ii. Sec. 38.602--General Financial Integrity

Proposed Sec. 38.602 provided that DCMs must adopt rules

establishing minimum financial standards for both member FCMs and IBs

and non-intermediated market participants.

Summary of Comments

ICE contended that the Commission has expanded the standard in Core

Principle 11 by requiring DCMs to establish minimum financial standards

for all of their members and non-intermediated market

participants.\371\ ICE further stated that many DCMs eliminated

specific financial standards for their non-FCM members and instead

require that non-FCM member transactions be guaranteed by a clearing

member.\372\ As a result, ICE requested confirmation that a DCM rule

requiring such clearing arrangements to be in place would satisfy

proposed Sec. 38.602.\373\ ICE also requested confirmation that a DCM

rule requiring an FCM to maintain capital in accordance with applicable

Commission regulations would satisfy the DCM's duty to set financial

requirements for its FCM members.\374\

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

\371\ ICE Comment Letter at 12 (Feb. 22, 2011).

\372\ Id. at 13.

\373\ Id.

\374\ Id.

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

Discussion

The Commission is adopting the rule as proposed. In response to

ICE's comments, the Commission confirms that a DCM rule requiring that

transactions by a non-FCM member be guaranteed by a clearing member

will satisfy Sec. 38.602.\375\

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

\375\ The Commission notes that this requirement does not speak

to DCO requirements under, for example, Core Principle D (Risk

Management) for its clearing members.

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

However, a DCM rule requiring an FCM to maintain capital in

accordance with applicable Commission regulations will not, in itself,

satisfy the DCM's duty to set minimum financial standards for its FCM

members. The term ``minimum financial standards'' used in Sec. 38.602

is not intended to cover only capital requirements. Rather, Sec.

38.602 should be read in conjunction with Sec. 38.604, which requires

surveillance by a DCM of financial and related information from each of

its members. The Commission notes that a DCM's duty to set financial

standards for its FCM members involves setting capital requirements,

conducting surveillance of the potential future exposure of each FCM as

compared to its capital, and taking appropriate action in light of the

results of such surveillance.

[[Page 36647]]

iii. Sec. 38.603--Protection of Customer Funds

Proposed Sec. 38.603 provided that DCMs must adopt rules for the

protection of customer funds, including the segregation of customer and

proprietary funds, the custody of customer funds, the investment

standards for customer funds, intermediary default procedures and

related recordkeeping.

Summary of Comments

KCBT stated that because its rules incorporate by reference the

requirements of the CEA, the requirement to implement exchange rules

that mirror Commission regulations is duplicative, unnecessary and

burdensome.\376\ In addition, KCBT noted that its clearing corporation

already has rules in place to address intermediary default

procedures.\377\

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

\376\ KCBT Comment Letter at 7 (Feb. 22, 2011).

\377\ Id.

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Discussion

The Commission is adopting the rule as proposed. In response to the

comments, the Commission confirms that DCMs must adopt rules as

required under Sec. 38.603. Establishing such rules is important

because it will provide evidence: (i) that each DCM has focused

attention on the specific regulations promulgated under the CEA; and

(ii) that such regulations are appropriately implemented. Section

38.603 does not specify the exact rules to be implemented by each DCM,

but sets forth the substance of what the rules of each DCM must

address.

In response to KCBT's comment that its clearing corporation already

has rules in place to address intermediary default procedures, the

Commission notes that DCO rules protect the DCO, not fellow customers.

Nonetheless, the performance of the functions required by Sec. 38.603

may be allocated between a DCO and DCM pursuant to appropriate written

agreements. Such agreements would have to include an arrangement

between the DCO and DCM that the DCO would undertake the responsibility

to protect the individual customers of the DCM.

iv. Sec. 38.604--Financial Surveillance

Proposed Sec. 38.604 required that a DCM must routinely receive

and promptly review financial and related information from its members,

and conduct ongoing financial surveillance of the risk created by the

positions taken by an FCM's customers. To meet this requirement, the

DCM must have rules pertaining to minimum financial standards of

intermediaries that include, among other things, rules prescribing

minimum capital requirements for member FCMs and IBs.\378\ The DCM must

also have rules pertaining to the protection of customer funds that

must include, among other things, that each DCM must continually survey

the obligations of each FCM created by its customers' positions and, as

appropriate, compare those obligations to the financial resources of

the FCM. If the obligations of a member FCM appear excessive as

compared to the FCM's capital, a DCM should take appropriate action,

including contacting the FCM or the FCM's designated self-regulatory

organization (``DSRO'').

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

\378\ An FCM that is a clearing member will also have additional

obligations to the DCO as a result of its clearing membership.

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

Summary of Comments

KCBT commented that it already reviews on a daily basis the open

positions and percentage of open interest held by each clearing member,

and ``pay/collect information'' based upon open positions and

reportable positions.\379\ KCBT is concerned that the use of the terms

``continually'' and ``excessive'' in the proposed regulation is

vague.\380\ In addition, KCBT noted that the DSRO should continue to

review the obligations of each firm for which it is the DSRO because

the DSRO has access to all customer positions being carried by the FCM

in all markets and thus is in a better position to ensure that the FCM

has sufficient capital for the overall positions being carried by the

FCM.\381\

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

\379\ See KCBT Comment Letter at 7 (Feb. 22, 2011).

\380\ Id.

\381\ Id.

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

Discussion

The Commission is adopting the rule as proposed and notes that the

rule codifies existing industry practice. In response to comments

raised by KCBT, the Commission notes that the term ``continually'' in

the proposed rule requires that a DCM survey the obligations of each

FCM created by the positions of its customers throughout the trading

day, not just based upon end-of-day positions. Financial risk can shift

dramatically throughout the day as a result of the combination of price

move and new trades, making it difficult for a DCM to fulfill its

obligations to establish and enforce rules to ensure: (i) the financial

integrity of FCMs and IBs and (ii) the protection of customer funds

pursuant to Core Principle 11, if such DCM limited its monitoring to

daily. FCMs and IBs could be exposed to excessive risk if they are

taking on risky positions during the day with the expectation that

those risks will be offset prior to the daily review period set by the

DCM. The Commission also notes that an arrangement between a DCO and a

DCM, whereby the DCO is responsible to a DCM for the performance of

certain functions, including the monitoring required pursuant to Sec.

38.604, will continue to be permitted by the Commission.

In response to KCBT's comment regarding the vagueness of the word

``excessive,'' the Commission expects a DCM to exercise professional

judgment in monitoring the risks of its FCMs as compared to their

available capital, and to take follow-up action to inquire into and

address any exceptional situations. This monitoring should occur in

addition to any DSRO review.

v. Sec. 38.605--Requirements for Financial Surveillance Program

Proposed Sec. 38.605 required DCMs, as self-regulatory

organizations (``SROs''), to comply with the standards of amended Sec.

1.52 to ensure the financial integrity of intermediaries by

establishing and carrying out an SRO program for the examination and

financial supervision of intermediaries. Section 1.52, as proposed to

be amended, sets forth the required elements of SRO supervisory

programs and permits one or more SROs to establish, subject to

Commission approval, a joint audit plan to provide for the SRO

supervision of members of more than one SRO. As noted in the DCM NPRM,

proposed amendments to Sec. 1.52 included references to existing

guidance to SROs contained in the Financial and Segregation

Interpretation No. 4-1 (Advisory Interpretation for Self-Regulatory

Organization Surveillance Over Members' Compliance with Minimum

Financial, Segregation, Reporting, and Related Recordkeeping

Requirements), and Addendums A and B to Financial and Segregation

Interpretation No. 4-1, and Financial and Segregation Interpretation

No. 4-2 (Risk-Based Auditing), which guided the practices of members of

the Joint Audit Committee (``JAC'') operating a joint audit plan that

had been approved by the Commission.\382\

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\382\ See 73 FR 52832, Sept. 11, 2008 (requesting comments prior

to the Commission's approval of the most recent Joint Audit

Committee agreement, which approval was granted March 18, 2009). See

also, DCM NPRM, 75 FR at 80596.

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

Discussion

No comments were received pertaining to the proposed rules, and the

Commission is adopting proposed

[[Page 36648]]

Sec. 38.605 and Sec. 1.52 without modification.

The Commission notes that the staff guidance contained in Division

of Trading and Markets Financial and Segregation Interpretations 4-1

and 4-2, and related Addendums A and B to Financial and Segregation

Interpretations 4-1, remains effective. Accordingly, while the revised

Sec. 1.52(b)(4) provides that an SRO's financial surveillance program

must include the onsite examination of each member FCM no less

frequently than once every 18 months, Financial and Segregation

Interpretation No. 4-2 provides that FCMs should generally be subject

to an onsite examination at least once every 9 to 18 months, with

examination cycles exceeding 15 months only for registrants with a

demonstrated history of strong compliance and risk management in order

to provide flexibility for unexpected events or to vary examination

dates.

While Sec. 1.52 now codifies long established staff positions, and

SRO practice, with respect to the manner in which SROs execute their

financial surveillance and supervisory programs with respect to member

intermediaries, the Commission will continue to evaluate options to

further enhance the manner in which intermediaries are supervised and

to strengthen the protection of customer funds.

vi. Sec. 38.606--Financial Regulatory Services Provided by a Third

Party

Proposed Sec. 38.606 provided that DCMs may satisfy their

financial surveillance responsibilities under proposed Sec. Sec.

38.604 and 38.605 by outsourcing such responsibilities to a registered

futures association or other regulated entity, including, for example,

a DCO. Proposed Sec. 38.606 provided that a DCM must ensure that the

regulatory service provider has the capacity and resources to conduct

the necessary financial surveillance and, notwithstanding the use of a

regulatory service provider, the DCM remains responsible for compliance

with its financial surveillance obligations.

Summary of Comments

MGEX commented that the proposed requirements seem reasonable, and

stated that the requirements could be satisfied under the current

delegation and information sharing agreements such as the Commission-

approved JAC Agreement for Services.\383\ MGEX also commented that DCMs

should not be required to audit third party regulatory providers

because that would frustrate the purpose, efficiency, and economic

value of outsourcing to a third party.\384\

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

\383\ MGEX Comment Letter at 8 (Feb. 22, 2011).

\384\ Id.

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Discussion

The Commission is adopting the proposed rule without modification.

In response to MGEX's comments, the Commission notes that Sec. 38.606

would not be satisfied solely by relying on a DCM's JAC Agreement. The

current JAC Agreement does not cover the type of financial surveillance

specified in Sec. 38.604, nor does it, by its terms, serve as an

outsourcing regulatory services agreement for the type of outsourcing

contemplated under Sec. 38.606. Accordingly, in order to satisfy the

requirements of both Sec. Sec. 38.604 and 38.605, a regulatory

services agreement must specifically include the following: (i) the

regulatory services to be performed, which to satisfy Sec. 38.604 must

include intraday monitoring of FCM obligations and positions; (ii) to

whom and for whom such services are to be provided; and (iii) a

statement or representation that the provider of the services has the

capacity and resources to perform the identified services.

vii. Sec. 38.607--Direct Access

Proposed Sec. 38.607 required a DCM that allows customers direct

access to its contract market to implement certain direct access

controls and procedures in order to provide member FCMs with tools to

manage their financial risk. The proposed rule contemplated that an FCM

would continue to have primary responsibility for overall risk

management, but that the DCM would be required to establish an

automated risk management system permitting an FCM to set appropriate

risk limits for each customer with direct access to the contract

market.

Summary of Comments

CME supports risk controls at both the DCM and DCO levels, and also

at clearing firm and direct access client levels.\385\ CME supports the

discretion that the proposed rules provide a DCM in terms of the

control model for access, and recommended a level of standardization

with respect to the types of DCM pre-trade controls in the form of

acceptable practices.\386\ ELX recommended that the Commission consider

allowing an FCM to bypass use of DCM-provided controls if an FCM has

its own controls that a DCM tests and deems to be sufficient.\387\ MGEX

commented that the Commission should not mandate that a DCM provide the

technology as a prescriptive rule, and further claimed that such tools

are the FCM's responsibility and DCMs should not be required to assume

these responsibilities.\388\

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

\385\ CME Comment Letter at 34 (Feb. 22, 2011).

\386\ Id.

\387\ ELX Comment Letter at 5 (Feb. 22, 2011).

\388\ MGEX Comment Letter at 8 (Feb. 22, 2011).

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Discussion

After reviewing the comments discussed above, the Commission is

adopting the proposed rule without modification and believes that risk

controls are appropriate at the FCM, DCO and DCM levels. The Commission

notes that it is impossible for an FCM to protect itself without the

aid of the DCM when a customer has direct access to a DCM and thus

completes trades that are the financial responsibility of such

customer's FCM before the FCM's systems have an opportunity to prevent

the execution of such trades. As a result, DCMs allowing customers

direct access to their markets must implement certain controls and

procedures to allow FCMs to manage their risk. As stated in the

proposed rule, these controls would not be required for a DCM that

permits only intermediated transactions and does not permit direct

access.

The responsibility to utilize these controls and procedures remains

with the FCM. Each FCM permitting direct access must use DCM-provided

controls, regardless of the purported efficacy of an FCM's

controls.\389\ This principle is supported by CME's comment letter, the

Commission's Technology Advisory Committee report (the ``DMA

Report''),\390\ and the FIA Report on Market Access Risk Management

[[Page 36649]]

Recommendations (the ``FIA Report'').\391\

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\389\ The efficacy of these controls also hinge, in part, on the

proper functioning of the electronic systems of DCMs, FCMs and

direct access market participants, and thus, necessitates that such

electronic systems are routinely tested and monitored. Accordingly,

the Commission may address additional electronic system testing and

supervision-related issues in the future.

\390\ See Pre-Trade Functionality Subcommittee of the CFTC

Technology Advisory Committee report, ``Recommendations on Pre-Trade

Practices for Trading Firms, Clearing Firms, and Exchanges Involved

in Direct Market Access'' (March 1, 2011), accepted by the TAC and

available at: http://www.cftc.gov/idc/groups/public/@swaps/documents/dfsubmission/tacpresentation030111_ptfs2.pdf. The DMA

Report recommends specific controls that should be adopted by each

FCM and DCM and notes that ``the exchanges are the point furthest

downstream, so coordination at this level has the greatest leverage

to impact the industry as a whole.'' DMA Report at p. 4. The

controls provided by the DCM serve as the backstop, in the event

that an FCM's controls are insufficient. The DMA Report notes that,

although the recommendations may seem redundant, it ``strongly

believes that an approach of multiple, redundant checks across the

supply chain offers the most robust protection to markets.'' Id. at

p. 5.

\391\ See FIA report on ``Market Access Risk Management

Recommendations'' (April 2010), available at: http://www.futuresindustry.org/downloads/Market_Access-6.pdf. (``FIA

Report'').

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

As discussed in the DCM NPRM, the Technical Committee of the

International Organization of Security Commissions (``IOSCO'')

published a final report on principles for direct electronic access in

August of 2010 (the ``IOSCO DEA Report'') stating that, in an automated

trading environment, the only controls that can effectively enforce

limitations on risk are automated controls.\392\ Further, the IOSCO DEA

Report noted that a market should not permit direct electronic access

unless effective systems and controls are in place to enable risk

management, including automated pre-trade controls enabling

intermediaries to implement appropriate trading limits.\393\ The IOSCO

DEA Report stated that ``[t]here is no convincing rationale for not

using automated credit limit system filters * * * it will be critical

for intermediaries, third party vendors and markets to cooperate in

putting into place appropriate systems and controls.'' \394\ One

example provided in the report was that a market could provide and

operate an automated system (i.e., software and hardware) that would be

used by the intermediary and clearing firm.\395\

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

\392\ IOSCO, Final Report of the IOSCO Technical Committee,

``Principles for Direct Electronic Access to Markets,'' at 20, IOSCO

Doc. FR08/10 (August 12, 2010), available at http://www.iosco.org/library/pubdocs/pdf/IOSCOPD332.pdf.

\393\ Id.

\394\ Id. at p. 22.

\395\ Id.

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Further, the FIA's working group, consisting of DCMs, clearing

firms, and trading firms, recommended that pre-trade controls be set at

the exchange level, and that the controls be mandatory to ensure that

there are no latency disadvantages.\396\ In a publication in January

2011, the FIA reported that the majority of exchanges have policies and

tools in place that comply with those recommendations.\397\ The DMA

Report also discussed the latency for an FCM that elects to use a DCM's

controls as compared to an FCM that does not.\398\ This disadvantage is

eliminated if each DCM requires all FCMs to use the DCM-provided

protections.

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

\396\ See e.g., FIA Report.

\397\ See Leslie Sutphen, ``Exchange Survey Finds Wide Range of

Risk Controls in Place'' (January 2011), at 28, available at: http://www.futuresindustry.org/downloads/RC-survey.pdf.

\398\ See DMA Report at p. 4.

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12. Subpart M--Protection of Markets and Market Participants

Core Principle 12, as amended by the Dodd-Frank Act, requires that

DCMs establish and enforce rules to protect markets and market

participants from abusive practices committed by any party, including

abusive practices committed by a party acting as an agent for a

participant, and promote fair and equitable trading on the contract

market.

The Commission proposed to codify the statutory text of the core

principle in Sec. 38.650, and is adopting the rule as proposed.

i. Sec. 38.651--Additional Sources for Compliance

Proposed Sec. 38.651 required that a DCM have and enforce rules

that are designed to promote fair and equitable trading and to protect

the market and market participants from abusive practices including

fraudulent, noncompetitive or unfair actions, committed by any party.

The rule also required that DCMs must have methods and resources

appropriate to the nature of the trading system and the structure of

the market to detect trade practice and market abuses and to discipline

such behavior, in accordance with Core Principles 2 and 4, and the

associated regulations in subparts C and E of this part, respectively.

The proposed rule required that DCMs also must provide a competitive,

open and efficient market and mechanism for executing transactions in

accordance with Core Principle 9 and the associated regulations under

subpart J of this part.

Summary of Comments

Chris Barnard and Better Markets referenced a discussion from the

DCM NPRM preamble that provided that a DCM must establish rules that

require the fair, equitable, and timely provision of information

regarding prices, bids, and offers to market participants.\399\ Mr.

Barnard requested that the Commission amend the wording of proposed

Sec. Sec. 38.650 and 38.651 to include this language and Better

Markets requested that the proposed rules prohibit privileged access to

data feeds, arguing that the practice is disruptive of fair and

equitable trading.\400\

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

\399\ Better Markets Comment Letter at 10 (Feb. 22, 2011) and

Barnard Comment Letter at 4 (May 20, 2011) (citing DCM NPRM at

80597).

\400\ Id.

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

Discussion

The Commission is adopting the rule with a technical modification

to revise the heading of the rule from ``Additional sources for

compliance'' to the more appropriate ``Protection of markets and market

participants.'' All other aspects of the proposed rule will remain

unchanged.

The Commission believes that Mr. Barnard's concerns are adequately

addressed by the rules adopted in this release. As an initial matter,

Sec. 38.650 simply codifies the language of Core Principle 12 and thus

cannot be amended by the Commission. Additionally, the broad

requirement to promote ``fair and equitable trading'' contained in

Sec. Sec. 38.650 and 38.651, as well as the Core Principle 9

requirement to provide a ``competitive, open, and efficient market and

mechanism for executing transactions,'' are sufficient to capture the

obligation to provide fair, equitable, and timely information regarding

prices, bids, and offers. With respect to Better Markets' comment, the

Commission notes that the language from the DCM NPRM cited by Better

Markets was not intended to preclude co-location. Instead, the DCM NPRM

provides that a market should be fair and equitable in its information

distribution, meaning all participants in co-location agreements should

pay the same price for a given level of service and access. This does

not mean that everyone in the market is required to get information at

the same time, but rather that every member of a connection or access

type class must be treated equally in terms of service and cost. The

faster access to price, bid, and offer information afforded by co-

location is no different than the faster access to information afforded

to traders in the pits prior to the markets becoming electronic. The

Commission believes that prohibiting co-location, or requiring that co-

location services be throttled to a point that all participants are

able to consume information or access the matching engine at the same

speed, would not be practical or reasonable. The Commission also notes

that it recently addressed co-location fees in a separate proposed

rulemaking for ``Co-location/Proximity Hosting Services.'' \401\

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

\401\ See, Notice of proposed rulemaking, 75 FR 33198, Jun. 11,

2010.

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13. Subpart N--Disciplinary Procedures

Core Principle 13 is a new core principle, created by section 735

of the Dodd-Frank Act. The core principle incorporates the concepts

from former Designation Criterion 6 (Disciplinary Procedures) and

former DCM Core Principle 2.\402\ The core principle

[[Page 36650]]

specifically requires that DCMs establish and enforce disciplinary

procedures that authorize the DCM to discipline, suspend or expel

market participants and members that violate the DCM's rules, or

delegate the function to third parties.

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

\402\ Compare former CEA section 5(b)(6) and section 5(d)(2)

with CEA section 5(d)(13) as amended by the Dodd-Frank Act. Prior to

the passage of the Dodd-Frank Act, the standards for DCMs'

disciplinary practices were found in Designation Criterion 6 and the

statutory language, guidance, and acceptable practices for former

Core Principle 2. Designation Criterion 6 required that a DCM

establish and enforce disciplinary procedures that authorized it to

discipline, suspend, or expel members or market participants that

violated the rules of the DCM, or similar methods for performing the

same functions, including delegation of the functions to third

parties. Paragraph (a)(2) of the application guidance for former

Core Principle 2 required DCMs to have the ``arrangements,

resources, and authority [necessary] for effective rule

enforcement,'' and the ``authority and ability to discipline and

limit, or suspend the activities of a member or market participant

pursuant to clear and fair standards.'' 17 CFR part 38, app. B,

Application Guidance for Core Principle 2 at (a)(2) (2010). In

addition, paragraph (b)(4) of the former core principle's acceptable

practices required any DCM that wished to take advantage of the

acceptable practice's safe harbor to have ``prompt and effective

disciplinary action for any violation * * * found to have been

committed.'' 17 CFR part 38, app. B, Acceptable Practices for Core

Principle 2 at (b)(4) (2010). Paragraph (b)(4) also referenced part

8 of the Commission's regulations as an example that DCMs could

follow to comply with Core Principle 2. 17 CFR 8.01 et seq. In its

experience, the Commission has found that many DCMs' disciplinary

programs do in fact model the disciplinary structures and processes

in part 8. While the acceptable practices for former Core Principle

2 offered the disciplinary procedures in part 8 as an example of

appropriate disciplinary procedures, DCMs were exempt from part 8

pursuant to regulation 38.2. The disciplinary procedures proposed

herein do not re-subject DCMs to part 8 of the Commission's

regulations, but rather propose new disciplinary procedures for

inclusion in part 38.

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

Summary of Comments

Several commenters submitted letters discussing the disciplinary

procedures contained in subpart N. While the comments were generally

supportive of the Commission's objectives, commenters expressed a

general desire for the Commission to rely on a more principles-based

approach, and argued that the proposed rules were overly prescriptive.

Some commenters also articulated specific concerns regarding several

rules that they believed would adversely impact DCMs.

Discussion

The Commission thoroughly reviewed and considered all comments

received and, where appropriate, made modifications to the proposed

rules, including converting some proposed rules into guidance. These

modifications, explained further below, have resulted in changes to the

numbering of the proposed regulations and in a reduction in the number

of separately-enumerated rules, from 16 proposed rules to 12 final

rules.

The Commission proposed to codify the statutory text of the core

principle in proposed Sec. 38.700, and adopts the rule as proposed.

The Commission is also adding Sec. 38.712 to refer applicants and DCMs

to the guidance in appendix B to part 38.

i. Sec. 38.701--Enforcement Staff

Proposed Sec. 38.701 required that a DCM establish and maintain

sufficient enforcement staff and resources to effectively and promptly

prosecute possible rule violations within the jurisdiction of the

contract market. The proposed rule also required a DCM to monitor the

size and workload of its enforcement staff annually and increase its

resources and staff as appropriate. The Commission recognized that at

some DCMs, compliance staff also serves as enforcement staff. That is,

they both investigate cases and present them before disciplinary

panels. These proposed rules were not intended to prohibit that

practice.

The Commission believes that adequate staff and resources are

essential to the effective performance of a DCM's disciplinary program.

This has repeatedly been reflected in Commission staff's findings and

recommendations in recent RERs, in which DMO staff recommended that

DCMs increase their compliance and/or enforcement staff levels and

monitor the size of their staff and increase the number of staff

appropriately as trading volume increases, new responsibilities are

assigned to staff, or internal reviews demonstrate that work is not

completed in an effective or timely manner.

Proposed Sec. 38.701 also provided that a DCM's enforcement staff

may not include members of the exchange or persons whose interests

conflict with their enforcement duties. Moreover, the proposed rule

prohibited a member of the enforcement staff from operating under the

direction or control of any person or persons with trading privileges

at the contract market. These provisions sought to ensure the

independence of enforcement staff, and help promote disciplinary

procedures that are free of potential conflicts of interest.

Summary of Comments

MGEX noted that, as a combined DCM/DCO, it interprets the rule to

allow staff to serve as enforcement and review staff for both the DCM

and DCO divisions of MGEX, and any other entities that become a

combined DCM/DCO.\403\

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

\403\ MGEX Comment Letter at 8 (Feb. 22, 2011).

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

Discussion

The Commission is adopting the rule as proposed. The Commission

believes that adequate staff and resources are essential to the

effective performance of a DCM's disciplinary program. This has

repeatedly been reflected in Commission staff's findings and

recommendations in recent RERs, in which Commission staff recommended

that DCMs increase their compliance and/or enforcement staff levels and

monitor the size of their staff and increase the number of staff

appropriately as trading volume increases, new responsibilities are

assigned to staff, or internal reviews demonstrate that work is not

completed in an effective or timely manner.\404\

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

\404\ See Rule Enforcement Review of the Minneapolis Grain

Exchange (Aug. 27, 2009), Rule Enforcement Review of ICE Futures

U.S. (Feb. 2, 2010), Rule Enforcement Review of the Chicago Board of

Trade and the Chicago Mercantile Exchange (Sep. 13, 2010), and Rule

Enforcement Review of New York Mercantile Exchange and Commodity

Exchange (August 30, 2011) for findings and recommendations

pertaining to the adequate size of DCM compliance and enforcement

staffs.

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

The Commission notes that MGEX's interpretation regarding the

sharing of compliance staff across a combined DCM/DCO is acceptable,

provided that the combined DCM/DCO has sufficient staff to meet the

DCM's regulatory compliance needs in an effective and timely manner. In

addition, with respect to DCM matters, staff must be accountable to the

DCM and its Regulatory Oversight Committee. The Commission also notes,

however, that its a priori acceptance of integrated compliance staff is

limited to the unique circumstances of a fully integrated exchange and

clearing house.

ii. Sec. 38.702--Disciplinary Panels

Proposed Sec. 38.702 required a DCM to establish one or more

Review Panels and one or more hearing panels (together, ``disciplinary

panels'') to fulfill its obligations under this section. The

composition of both panels was required to meet the composition

requirements of proposed Sec. 40.9(c)(3)(ii) \405\ and could not

include

[[Page 36651]]

any members of the DCM's compliance staff, or any person involved in

adjudicating any other stage of the same proceeding. Paragraph (b) of

the proposed rule provided that a Review Panel must be responsible for

determining whether a reasonable basis exists for finding a violation

of contract market rules, and for authorizing the issuance of a notice

of charges against persons alleged to have violated exchange rules. If

a notice of charges is issued, then paragraph (c) of the proposed rule

helped to ensure an impartial hearing by requiring a separate hearing

panel to adjudicate the matter and issue sanctions. While proposed

Sec. 38.702 required DCMs to empanel distinct bodies to issue charges

and to adjudicate charges in a particular matter, the rule permitted

DCMs to determine for themselves whether their review and hearing

panels are separate standing panels or ad hoc bodies whose members are

chosen from a larger ``disciplinary committee'' to serve in one

capacity or the other for a particular disciplinary matter.

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\405\ Section 40.9(c)(3)(ii), as proposed in the separate

release titled ``Requirements for Derivatives Clearing

Organizations, Designated Contract Markets, and Swap Execution

Facilities Regarding the Mitigation of Conflicts of Interest'',

provided that ``Each Disciplinary Panel shall include at least one

person who would not be disqualified from serving as a Public

Director by regulation 1.3(ccc)(1)(i)-(vi) and (2) of this chapter

(a ``Public Participant''). Such Public Participant shall chair each

Disciplinary Panel. In addition, any registered entity specified in

paragraph (c)(3)(i) of this section shall adopt rules that would, at

a minimum: (A) Further preclude any group or class of participants

from dominating or exercising disproportionate influence on a

Disciplinary Panel and (B) Prohibit any member of a Disciplinary

Panel from participating in deliberations or voting on any matter in

which the member has a financial interest.'' See 75 FR 63732, Oct.

18, 2010.

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Summary of Comments

A number of commenters opposed the two-panel approach described in

proposed Sec. 38.702. CME stated that the Commission should rely on

core principles, rather than what it sees as a prescriptive approach,

as DCMs may have an established structure or may develop new structures

that clearly satisfy the objective of the core principle, but that may

not precisely comply with the language.\406\ CME illustrated two

practices it believed may be precluded by the text of proposed Sec.

38.702: (1) CME's Market Regulation staff determines whether certain

non-egregious rule violations merit referral to a Review Panel and they

issue warning letters on an administrative basis; and (2) CME's hearing

panel adjudicates a disciplinary case prior to the issuance of charges

pursuant to a supported settlement agreement.\407\

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

\406\ CME Comment Letter at 35 (Feb. 22, 2011).

\407\ Id.

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

ELX contended that the proposed rule would impose the need to

create processes and procedures for certain functions already carried

out by its Compliance Director, who is supervised by the Regulatory

Oversight Committee.\408\ ELX suggested that a DCM should be able to

obtain a waiver from the two-panel requirement if it already has been

designated as a contract market and currently operates under an

alternative structure with respect to disciplinary procedures that have

sufficient controls.\409\

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

\408\ ELX Comment letter at 5 (Feb. 22, 2011).

\409\ Id.

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

MGEX argued that the rule is overly prescriptive, that there is no

reasonable basis for the distinction between the two panels, and that

one panel would maximize resources and streamline the process for all

involved.\410\ MGEX argued that staff is able to differentiate between

the roles, and that the Commission should simply have the right to

inquire if it has a question surrounding disciplinary panels or

processes.\411\

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\410\ MGEX Comment Letter at 9 (Feb. 22, 2011).

\411\ Id.

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Discussion

The Commission is adopting the proposed rule with certain

modifications to address comments. The Commission considered

commenters' views and believes that the proposed rule can be modified

to address concerns without diminishing the purpose of the proposed

rule. Accordingly, the final rule will require DCMs to have one or more

disciplinary panels, without imposing a specific requirement for DCMs

to maintain a ``review panel'' and a ``hearing panel.'' The final rules

replace specific panel names (i.e. ``review panel'' and ``hearing

panel'') with a generic reference to the ``disciplinary panel''

throughout part 38. However, even under a single-panel approach,

individuals who determine to issue charges in a particular disciplinary

matter may not also adjudicate the matter. The final text of Sec.

38.702 permits flexibility in the structure of DCMs' disciplinary

bodies, but not in the basic prohibition against vesting the same

individuals with the authority to both issue and adjudicate charges in

the same matter. The modifications reflected in the final text of Sec.

38.702, together with the revisions made to the final text of Sec.

38.703, permit DCMs to rely on their senior-most compliance officer

(i.e., a DCM's Chief Regulatory Officer), rather than on a disciplinary

panel, to issue disciplinary charges, as suggested by ELX. However, the

Commission notes that the adjudication of charges must still be

performed by a disciplinary panel. Finally, the composition and

conflicts requirements for disciplinary panels will be adopted with one

modification, by replacing the reference to Sec. 40.9(c)(3)(ii) with a

reference to the more general ``part 40.''

iii. Sec. 38.703--Review of Investigation Report

The introductory paragraph of proposed Sec. 38.703 required a

Review Panel to promptly review an investigation report received

pursuant to proposed Sec. 38.158(c), and to take action on any

investigation report received within 30 days of such receipt. Under

paragraph (a) of the proposed rule, after receipt of the investigation

report, if a Review Panel determined that additional investigation or

evidence was needed, it would be required to promptly direct the

compliance staff to conduct further investigation. In the alternative,

under paragraph (b) of the proposed rule, if a Review Panel determined

that no reasonable basis existed for finding a violation, or that

prosecution was unwarranted, it would be permitted to direct that no

further action be taken, and that a written statement be provided

setting forth the facts and analysis supporting the decision.

Finally, under paragraph (c) of the proposed rule, if a Review

Panel determined that a reasonable basis existed for finding a

violation and adjudication was warranted, it was required to direct

that the person or entity alleged to have committed the violation be

served with a notice of charges.

Summary of Comments

While CME agreed that an investigation report should include the

subject's disciplinary history, CME disagreed with the requirement in

proposed Sec. 38.158 that the disciplinary history be included in the

version of the investigation report sent to the Review Panel.\412\ CME

believed that the disciplinary history should not be considered by the

Review Panel at all when determining whether to issue formal charges,

arguing that a market participant's disciplinary history is not

relevant to the consideration of whether it committed a further

violation of DCM rules.\413\

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\412\ CME Comment Letter at 35 (Feb. 22, 2011).

\413\ Id. While the Commission largely agrees with CME's

comment, the Commission directs interested parties to regulation

38.158 for a further discussion of the required components of

investigation reports.

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Discussion

Consistent with revisions to proposed Sec. 38.702, the Commission

is modifying proposed Sec. 38.703 to provide greater flexibility to

market participants in determining an approach to disciplinary panels.

The Commission is eliminating

[[Page 36652]]

all but paragraph (c) of the proposed rule, and is moving paragraph (c)

to Sec. 38.704 (Notice of charges), which the Commission is

renumbering as Sec. 38.703. The revisions to proposed rules Sec.

38.702 and Sec. 38.703 will provide DCMs with the flexibility to

follow a single-panel approach, provided that a single panel does not

perform the function of issuing and adjudicating the same charges. In

addition, a DCM will have the flexibility to allow its senior-most

regulatory officer, such as its Chief Regulatory Officer, to review an

investigation report and determine whether a notice of charges should

be issued in a particular matter.

iv. Sec. 38.704--Notice of Charges

Proposed Sec. 38.704 described the minimally acceptable contents

of a notice of charges (``notice'') issued by a Review Panel. The rule

required that the notice adequately state the acts, conduct, or

practices in which the respondent is alleged to have engaged; state the

rule, or rules, alleged to have been violated; and prescribe the period

within which a hearing on the charges may be requested. Further, the

proposed rule also required that the notice advise the respondent

charged that he is entitled, upon request, to a hearing on the charges.

Paragraphs (a) and (b) of the proposed rule provided that a DCM may

adopt rules providing that: (1) The failure to request a hearing within

the time prescribed in the notice, except for good cause, may be deemed

a waiver of the right to a hearing; and (2) the failure to answer or

expressly deny a charge may be deemed to be an admission of such

charge.

Discussion

No comments were received regarding proposed Sec. 38.704, and the

Commission is adopting the proposed rule with certain modifications.

Given that paragraphs (a) and (b) of proposed Sec. 38.704 allowed,

but did not require, a DCM to issue rules regarding failures to request

a hearing and expressly answer or deny a charge, the Commission

believes that the language in these paragraphs is better suited as

guidance rather than a rule. The Commission will adopt this language as

guidance in appendix B to part 38.

In addition to the aforementioned revisions, and as described

above, the Commission is moving paragraph (c) of proposed Sec. 38.703

to proposed Sec. 38.704, and is renumbering proposed Sec. 38.704 as

Sec. 38.703.

v. Sec. 38.705--Right to Representation

Proposed Sec. 38.705 required that, upon being served with a

notice of charges, a respondent must have the right to be represented

by counsel or any other representative of his or her choosing in all

succeeding stages of the disciplinary process. Together with proposed

Sec. Sec. 38.704 (requiring an adequate notice of charges to the

respondent), 38.708 (conferring the right to hearing), and 38.710

(hearing procedures), Sec. 38.705 helped ensure basic fairness for

respondents in disciplinary proceedings.

Summary of Comments

CME commented that the language of this rule should be limited to

avoid conflicts in representation and, accordingly, requested that the

rule be revised to clarify that a respondent may not be represented by:

(1) A member of the DCM's disciplinary committees; (2) a member of the

DCM's Board of Directors; (3) an employee of the DCM; and (4) a person

substantially related to the underlying investigation, such as a

material witness or other respondent.\414\

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\414\ CME Comment Letter at 35 (Feb. 22, 2011).

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Discussion

The Commission is adopting the proposed rule with certain

modifications. The Commission acknowledges CME's concern and is

amending the proposed rule to incorporate CME's suggestion to clarify

that a respondent must have the right to be represented by legal

counsel or any other representative of its choosing in all succeeding

stages of the disciplinary process, except any member of the designated

contract market's board of directors or disciplinary panel, any

employee of the designated contract market, or any person substantially

related to the underlying investigations, such as material witness or

respondent. Additionally, as a result of the rule deletions and

modifications discussed above, proposed Sec. 38.705 as modified is

being adopted as Sec. 38.704.

vi. Sec. 38.706--Answer to Charges

Proposed Sec. 38.706 provided that a respondent must be given a

reasonable period of time to file an answer to a charge. In general,

paragraphs (a) through (c) of the proposed rule provided that the rules

of the DCM may require that: (1) The answer must be in writing and

include a statement that the respondent admits, denies or does not have

and is unable to obtain sufficient information to admit or deny each

allegation; (2) failure to file an answer on a timely basis shall be

deemed an admission of all allegations in the notice of charges; and

(3) failure in an answer to deny expressly a charge shall be deemed to

be an admission of such charge.

Discussion

Although no specific comments were received on proposed Sec.

38.706, commenters generally requested greater flexibility to establish

their own disciplinary procedures.\415\ The Commission believes that

proposed Sec. 38.706 is a rule where greater flexibility can

reasonably be accorded. Accordingly, the Commission is maintaining as a

rule the requirement that a respondent must be given a reasonable

period of time to file an answer to a notice of charges, and is

condensing the remainder of the proposed rule by replacing

subparagraphs (a), (b), and (c) with a requirement that any rules

adopted by a DCM governing the requirements and timeliness of a

respondent's answer to charges must be ``fair, equitable, and publicly

available.'' Finally, as a result of the rule deletions and

modifications discussed above, proposed Sec. 38.706 as modified is

being adopted as Sec. 38.705.

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\415\ See generally, CME Comment Letter (Feb. 22, 2011); and

MGEX Comment Letter (Feb. 22, 2011).

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vii. Sec. 38.707--Admission or Failure To Deny Charges

Proposed Sec. 38.707 provided that, if a respondent admits or

fails to deny any of the violations alleged in a notice of charges,

then a hearing panel may find that the violations admitted or not

denied have in fact been committed. If a DCM adopted a rule concerning

the admission or failure to deny charges, then paragraphs (a) through

(c) of the proposed rule provided that: (1) The hearing panel must

impose a sanction for each violation found to have been committed; (2)

the DCM must promptly notify the respondent in writing of any sanction

to be imposed and advise the respondent that they may request a hearing

on such sanction within the period of time stated in the notice; and

(3) the rules of the DCM may provide that if the respondent fails to

request a hearing within the period of time stated in the notice, then

the respondent will be deemed to have accepted the sanction.

Discussion

Although the Commission did not receive specific comments

pertaining to the proposed rule, the Commission is moving the entire

rule, with certain modifications, to the guidance in appendix B. Given

that proposed Sec. 38.707 allowed, but did not require, a DCM to issue

rules regarding a respondent's admission or failure to

[[Page 36653]]

deny charges, the Commission believes that the proposed rule is better

suited as guidance in appendix B to part 38 rather than a rule. The

Commission believes adopting the proposed rule as guidance, rather than

a rule, will grant DCMs greater flexibility in administering their

obligations, consistent with the general comments seeking the same.

Furthermore, the text that will now be included as guidance is being

modified to reflect the single-panel approach adopted in Sec. 38.702,

replacing specific panel names with a generic reference to the

``disciplinary panel.''

viii. Sec. 38.708--Denial of Charges and Right to Hearing

Proposed Sec. 38.708 provided that in every instance where a

respondent has requested a hearing on a charge that he or she denies,

or on a sanction set by the hearing panel pursuant to proposed Sec.

38.707, the respondent must be given the opportunity for a hearing in

accordance with the requirements of proposed Sec. 38.710. The DCM's

rules were permitted to provide that, except for good cause, the

hearing must be concerned only with those charges denied or sanctions

set by the hearing panel under proposed Sec. 38.707 for which a

hearing has been requested.

Discussion

The Commission did not receive comments pertaining to this rule,

but is adopting the proposed rule with modifications.

The Commission is revising the proposed rule to reflect the single-

panel approach adopted in Sec. 38.702, replacing specific panel names

with a generic reference to the ``disciplinary panel.'' In order to

provide DCMs with greater flexibility in establishing disciplinary

procedures, the Commission also is removing the section of the proposed

rule which was optional--allowing a DCM's rules to provide that, except

for good cause, a hearing must be concerned only with those charges

denied or sanctions set by the panel for which a hearing has been

requested. Finally, as a result of the withdrawal of certain preceding

rules discussed above, proposed Sec. 38.708 as modified is being

adopted as Sec. 38.706.

ix. Sec. 38.709--Settlement Offers

Proposed Sec. 38.709 provided the procedures a DCM must follow if

it permits the use of settlements to resolve disciplinary cases.

Paragraph (a) of the proposed rule stated that the rules of a DCM may

permit a respondent to submit a written offer of settlement any time

after an investigation report is completed. The proposed rule permitted

the disciplinary panel presiding over the matter to accept the offer of

settlement, but prohibited the panel from altering the terms of the

offer unless the respondent agreed. In addition, paragraph (b) of the

proposed rule provided that the rules of the DCM may allow a

disciplinary panel to permit the respondent to accept a sanction

without admitting or denying the rule violations upon which the

sanction is based.

Paragraph (c) of proposed Sec. 38.709 stated that a disciplinary

panel accepting a settlement offer must issue a written decision

specifying the rule violations it has reason to believe were committed,

and any sanction imposed, including any order of restitution where

customer harm has been demonstrated. Importantly, paragraph (c) also

provided that if an offer of settlement is accepted without the

agreement of a DCM's enforcement staff, the decision must carefully

explain the disciplinary panel's acceptance of the settlement. Finally,

paragraph (d) of proposed Sec. 38.709 allowed a respondent to withdraw

his or her offer of settlement at any time before final acceptance by a

disciplinary panel. If an offer is withdrawn after submission, or is

rejected by a disciplinary panel, the respondent must not be deemed to

have made any admissions by reason of the offer of settlement and must

not be otherwise prejudiced by having submitted the offer of

settlement.

Discussion

Although no specific comments were received in regards to this

proposed rule, the Commission is adopting the provisions of the

proposed rule as guidance in appendix B. The Commission believes that

adopting the proposed rule as guidance rather than a rule will grant

DCMs greater flexibility in administering their obligations, consistent

with the general comments seeking the same. Furthermore, the Commission

is revising the guidance text to make it consistent with its

modifications regarding the single-panel approach adopted in Sec.

38.702 and the customer restitution revisions adopted below with

respect to proposed Sec. 38.714.

x. Sec. 38.710--Hearings

Proposed Sec. 38.710 required a DCM to adopt rules that provide

certain minimum requirements for any hearing conducted pursuant to a

notice of charges. In general, sections (a)(1) through (a)(7) of the

proposed rule required the following: (1) A fair hearing; (2) authority

for a respondent to examine evidence relied on by enforcement staff in

presenting the charges contained in the notice of charges; (3) the

DCM's enforcement and compliance staffs must be parties to the hearing

and the enforcement staff must present its case on those charges and

sanctions that are the subject of the hearing; (4) the respondent must

be entitled to appear personally at the hearing, have the authority to

cross-examine persons appearing as witnesses at the hearing, and call

witnesses and present evidence as may be relevant to the charges; (5)

the DCM must require persons within its jurisdiction who are called as

witnesses to participate in the hearing and produce evidence; (6) a

copy of the hearing must be made and become a record of the proceeding

if the respondent has requested a hearing; and (7) the rules of the DCM

may provide that the cost of transcribing the record must be borne by a

respondent who requests a transcript. Additionally, proposed paragraph

(b) specified that the rules of the DCM may provide that a sanction be

summarily imposed upon any person within its jurisdiction whose actions

impede the progress of a hearing.

Summary of Comments

Two commenters requested that the Commission revise proposed Sec.

38.710(a)(2). CFE commented that proposed Sec. 38.710(a)(2) should

limit a respondent's access only to evidence a DCM plans to introduce

at a hearing.\416\ CFE further requested the exclusion of evidence

covered under attorney-client privilege, attorney work product

privilege, or other confidential reports and methodologies, including

the disclosure of the name of a confidential complainant.\417\ CFE also

argued that investigation and examination materials prepared by a DCM

should be protected from disclosure as internal work product unless the

DCM intends to introduce them at the hearing.\418\

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\416\ CFE Comment Letter at 5 (Feb. 22, 2011).

\417\ Id.

\418\ Id.

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CME similarly argued that proposed Sec. 38.710(a)(2) should be

revised so that a respondent may not access protected attorney work

product, attorney-client communications, and investigative work product

(such as investigation and exception reports).\419\

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\419\ CME Comment Letter at 36 (Feb. 22, 2011).

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Discussion

The Commission is adopting paragraph (a) of the proposed rule with

certain modifications, and is converting paragraph (b) of the proposed

rule to guidance in appendix B.

[[Page 36654]]

The Commission has considered CFE and CME's comments, and believes

that a DCM should be permitted to withhold certain documents from a

respondent in certain circumstances, and thus, is revising proposed

Sec. 38.710(a)(2) (now Sec. 38.707(a)(2)) accordingly. Because

proposed Sec. 38.710(b) (which provided that the DCMs' rules may

provide that a sanction may be summarily imposed upon any person whose

actions impede the progress of a hearing) was an optional requirement

for DCMs, the Commission is adopting this language as guidance in

appendix B to part 38. Furthermore, the Commission is eliminating

proposed Sec. 38.710(a)(7), an optional rule that in certain cases

allowed for the cost of transcribing the record of the hearing to be

borne by the respondent. The Commission also is revising the rule text

to make it consistent with its modifications regarding the single-panel

approach adopted in Sec. 38.702 and its modifications to proposed

Sec. 38.712 discussed below. Finally, as a result of the withdrawal

and renumbering of the rules discussed above, proposed Sec. 38.710 as

modified is being adopted as Sec. 38.707.

xi. Sec. 38.711--Decisions

Proposed Sec. 38.711 detailed the procedures that a hearing panel

must follow in rendering disciplinary decisions. The proposed rule

required that all decisions include: (1) A notice of charges or a

summary of the charges; (2) the answer, if any, or a summary of the

answer; (3) a summary of the evidence produced at the hearing or, where

appropriate, incorporation by reference in the investigation report;

(4) a statement of findings and conclusions with respect to each

charge, and a careful explanation of the evidentiary and other basis

for such findings and conclusions with respect to each charge; (5) an

indication of each specific rule with which the respondent was found to

have violated; and (6) a declaration of any penalty imposed against the

respondent, including the basis for such sanctions and the effective

date of such sanctions.

Discussion

No comments were received on proposed Sec. 38.711. The Commission

is adopting Sec. 38.711 as proposed with minor modifications to

reflect the single-panel approach adopted in Sec. 38.702, and

replacing specific panel names with a generic reference to the

``disciplinary panel.'' In addition, as a result of the withdrawal and

renumbering of preceding rules discussed above, proposed Sec. 38.711

as modified is being adopted as Sec. 38.708.

xii. Sec. 38.712--Right To Appeal

Proposed Sec. 38.712 provided the procedures that a DCM must

follow in the event that the DCM's rules authorize an appeal of adverse

decisions in all or in certain classes of cases. Notably, the proposed

rule required a DCM that permits appeals by disciplinary respondents to

also permit appeals by its enforcement staff. For DCMs that permit

appeals, the language in paragraphs (a) through (d) of proposed Sec.

38.712 generally required the DCM to: (1) Establish an appellate panel

that is authorized to hear appeals; (2) ensure that the appellate panel

composition is consistent with Sec. 40.9(c)(iv) of the Commission's

regulations and does not include any members of the DCM's compliance

staff, or any person involved in adjudicating any other stage of the

same proceeding; (3) except for good cause shown, conduct the appeal or

review solely on the record before the hearing panel, the written

exceptions filed by the parties, and the oral or written arguments of

the parties; and (4) issue a written decision of the appellate panel

and provide a copy to the respondent promptly following the appeal or

review proceeding.

Discussion

Although no specific comments were received on proposed Sec.

38.712, the Commission is converting the proposed rule to guidance in

appendix B. Given that proposed Sec. 38.712 allowed, but did not

require, a DCM to issue rules regarding a respondent's right to appeal,

the Commission is moving this provision to guidance in appendix B to

part 38. The Commission believes that adopting the proposed rule as

guidance rather than a rule, will grant DCMs greater flexibility in

administering their obligations, consistent with the general comments

seeking the same.

The Commission notes that the reference to Sec. 40.9(c)(iv) in the

proposed rule was a technical error. Instead, proposed Sec. 38.712

should have referenced the composition requirements of an appellate

panel outlined in Sec. 40.9(c)(3)(iii). Accordingly, the Commission is

replacing the reference to Sec. 40.9(c)(iv) with a reference to the

more general ``part 40'' in the guidance text. Furthermore, the

Commission is revising the guidance text to reflect the single-panel

approach now adopted in Sec. 38.702, replacing specific panel names

with a generic reference to the ``disciplinary panel.''

xiii. Sec. 38.713--Final Decisions

Proposed Sec. 38.713 required that each DCM establish rules

setting forth when a decision rendered under this subpart N will become

the final decision of the DCM.

Discussion

No comments were received in regards to the proposed rule, and the

Commission is adopting the proposal without modification. However, as a

result of the renumbering of certain preceding rules discussed above,

proposed Sec. 38.713 is being adopted as Sec. 38.709.

xiv. Sec. 38.714--Disciplinary Sanctions

Proposed Sec. 38.714 required that every disciplinary sanction

imposed by a DCM must be commensurate with the violations committed and

must be clearly sufficient to deter recidivism or similar violations by

other market participants. Additionally, the proposed rule required

that, in the event of demonstrated customer harm, any disciplinary

sanction must include full customer restitution. In evaluating

appropriate sanctions, the proposed rule required the DCM to take into

account a respondent's disciplinary history.\420\

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\420\ Proposed regulation 38.158(c), which was proposed with

respect to Core Principle 2, required that a copy of a member or

market participant's disciplinary history be included in the

compliance staff's investigation report.

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

Summary of Comments

CFE supported the goal articulated in proposed Sec. 38.714, but

argued that in certain situations, the requirement for customer

restitution should not apply where it may not be possible for a DCM to

determine the amount of customer harm, which parties may have been

harmed, and/or how the harm was allocated among potentially aggrieved

parties.\421\ CFE requested that the Commission clarify that the

requirement to include customer restitution in a disciplinary sanction

does not apply to the extent that a DCM is unable to determine with

reasonable certainty what the restitution should be, to whom to provide

restitution, and/or how to allocate restitution.\422\

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\421\ CFE Comment Letter at 6 (Feb. 22, 2011).

\422\ Id.

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Chris Barnard argued that sanctions should include a public

reprimand and/or be published.\423\

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\423\ Barnard Comment Letter at 2, 4 (May 20, 2011) (Barnard

stated that under a properly functioning sanctions regime, sanctions

must be: (1) Significantly greater than potential benefits derived

from a breach of rules; (2) targeted at those parties who stand to

gain from a breach of rules, whether natural or legal persons; and

(3) include a public reprimand and/or be published).

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[[Page 36655]]

Discussion

The Commission is adopting the proposed rule with certain

modifications. The Commission has considered CFE's comment, and is

revising the proposed rule so that it does not require customer

restitution if the amount of restitution, or the recipient, cannot be

reasonably determined. Furthermore, the Commission is revising the

proposed rule to clarify that a respondent's disciplinary history

should be taken into account in all sanction determinations, including

sanctions imposed pursuant to an accepted settlement offer. The

Commission also notes that final disciplinary actions taken against

registered persons and entities are recorded in the National Futures

Association's Background Affiliation Status Information Center

(``BASIC'') database, which is available to the public online. Finally,

as a result of the renumbering of preceding rules discussed above, the

Commission is renumbering the proposed rule as Sec. 38.710.

xv. Sec. 38.715--Summary Fines for Violations of Rules Regarding

Timely Submission of Records, Decorum, or Other Similar Activities

Proposed Sec. 38.715 permitted a DCM to adopt a summary fine

schedule for violations of rules relating to timely submission of

accurate records required for clearing or verifying each day's

transactions, decorum, attire, or other similar activities. Under the

proposed rule, a DCM may authorize its compliance staff to summarily

impose minor sanctions against persons within the DCM's jurisdiction

for violating such rules. The proposed rule made clear that a DCM

should issue no more than one warning letter in a rolling 12-month

period for the same violation before sanctions are imposed.

Additionally, the proposed rule specified that a summary fine schedule

must provide for progressively larger fines for recurring violations.

Summary of Comments

CME objected to the restriction of one letter of warning per

rolling 12-month period.\424\

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\424\ CME Comment Letter at 36 (Feb. 22, 2011).

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Discussion

The Commission is partially adopting the proposed rule, and is

converting the remaining portion of the rule to guidance in appendix B.

The Commission is maintaining as a rule the provision in the

proposed rule that prohibits a DCM from issuing more than one warning

letter per rolling 12-month period for the same violation. Commission

staff has consistently recommended in RERs that DCMs must engage in

progressive discipline in order to deter recidivism.

The Commission is converting the remainder of proposed Sec. 38.715

to guidance in appendix B because the proposed rule allowed, but did

not require, a DCM to adopt a summary fine schedule.

Finally, the proposed rule is being renumbered in its adopted form

from Sec. 38.715 to Sec. 38.711, and is retitled as ``Warning

letters.''

xvi. Sec. 38.716--Emergency Disciplinary Actions

Proposed Sec. 38.716 provided that a DCM may impose a sanction,

including a suspension, or take other summary action against a person

or entity subject to its jurisdiction upon a reasonable belief that

such immediate action is necessary to protect the best interest of the

marketplace. The proposed rule also provided that any emergency action

taken by the DCM must be in accordance with certain procedural

safeguards that protect the respondent, including the right to be

served with notice before the action is taken or otherwise at the

earliest possible opportunity after action has been taken; the right to

be represented by legal counsel in any proceeding subsequent to the

emergency disciplinary action; the right to a hearing as soon as

reasonably practical; and the right to receive a written decision on

the summary action taken by the DCM.

Discussion

No comments were received on proposed Sec. 38.716. Given that

proposed Sec. 38.716 allowed, but did not require, a DCM to adopt

rules regarding emergency disciplinary actions, the Commission is

moving the text of proposed Sec. 38.716 to guidance in appendix B to

part 38.

Due to the renumbering described above, the Commission is also

replacing proposed Sec. 38.712 with new Sec. 38.712 (titled

``Additional sources for compliance'') that simply permits DCMs to rely

upon the guidance in appendix B of this part to demonstrate to the

Commission compliance with the requirements of Sec. 38.700 of this

part.

14. Subpart O--Dispute Resolution

The Dodd-Frank Act re-designated former Core Principle 13 as Core

Principle 14. Aside from renumbering the core principle, the language

of the core principle remained substantively unchanged. The core

principle governs the obligations of DCMs to implement and enforce a

dispute resolution program for their market participants and market

intermediaries.\425\

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\425\ 17 CFR part 38, app. B.

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In addition to proposing to codify the statutory text of the core

principle in proposed Sec. 38.750, the Commission proposed to maintain

the guidance and acceptable practices.

Discussion

No comments were received on proposed Sec. 38.750, Sec. 38.751,

or the proposed guidance under Core Principle 14. The Commission is

adopting the rules and guidance as proposed.

15. Subpart P--Governance Fitness Standards

Other than to re-designate former Core Principle 14 as Core

Principle 15, the Dodd-Frank Act did not revise the text of this core

principle. Core Principle 15 requires DCMs to establish and enforce

appropriate fitness standards for directors, members of any

disciplinary committee, members of the contract market, and any other

persons with direct access to the facility (including any parties

affiliated with any of the persons described in this core principle).

In the DCM NPRM, the Commission proposed to codify the statutory text

of the core principle in Sec. 38.800. The Commission did not receive

comments pertaining to proposed Sec. 38.800, and is adopting the rule

as proposed.

As noted in the DCM NPRM, the substantive regulations implementing

Core Principle 15 were proposed in a separate rulemaking that also

would implement Core Principles 16 (Conflicts of Interest), 17

(Composition of Governing Boards of Contract Markets) and 22 (Diversity

of Boards of Directors).\426\ Until such time as the Commission may

adopt the substantive rules implementing Core Principle 15, the

Commission is maintaining the current Guidance under part 38 applicable

to Governance Fitness Standards (formerly Core Principle 14).

Accordingly, the existing Guidance from appendix B of Part 38

applicable to Core Principle 15 is being codified under the revised

appendix B adopted in this final rulemaking.\427\ At such time as the

[[Page 36656]]

Commission may adopt the final rules implementing Core Principle 15,

appendix B will be amended accordingly.

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\426\ See ``Governance Requirements for Derivatives Clearing

Organizations, Designated Contract Markets, and Swap Execution

Facilities; Additional Requirements Regarding the Mitigation of

Conflicts of Interest,'' Notice of Proposed Rulemaking, 76 FR 722,

January 6, 2011. CME submitted a comment letter discussing proposed

regulation 38.801 in connection with 76 FR 722.

\427\ The Commission is also adding regulation 38.801 to simply

permit DCMs to continue to rely upon the guidance in appendix B to

demonstrate to the Commission compliance with regulation 38.800.

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CME submitted a comment letter discussing proposed Sec. 38.801 in

connection with the separate proposed rulemaking implementing Core

Principle 15. CME's comments will be considered in connection with that

rulemaking.

16. Subpart Q--Conflicts of Interest

The Dodd-Frank Act re-designated current Core Principle 15

(Conflicts of Interest) as Core Principle 16, and in all other

respects, did not substantively amend the core principle. The

Commission proposed to codify the statutory text of the core principle

in proposed Sec. 38.850, and is codifying the statutory text of Core

Principle 16 in Sec. 38.850 as proposed.

As noted in the DCM NPRM, the substantive regulations implementing

Core Principle 16 were proposed in two separate rulemakings that also

would implement Core Principles 15 (Governance Fitness Standards), 17

(Composition of Governing Boards of Contract Markets) and 22 (Diversity

of Boards of Directors).\428\ Until such time as the Commission may

adopt the substantive rules implementing Core Principle 16, the

Commission is maintaining the current guidance and acceptable practices

under Part 38 applicable to Conflicts of Interest (formerly Core

Principle 15). Accordingly, the existing Guidance and Acceptable

Practices from appendix B of part 38 applicable to Core Principle 16

are being codified in the revised appendix B adopted in this final

rulemaking.\429\ At such time as the Commission may adopt the final

rules implementing Core Principle 16, appendix B will be amended

accordingly.

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\428\ See ``Governance Requirements for Derivatives Clearing

Organizations, Designated Contract Markets, and Swap Execution

Facilities; Additional Requirements Regarding the Mitigation of

Conflicts of Interest,'' Notice of Proposed Rulemaking, 76 FR 722,

January 6, 2011; and ``Requirements for Derivatives Clearing

Organizations, Designated Contract Markets, and Swap Execution

Facilities Regarding the Mitigation of Conflicts of Interest,'' 75

FR 63732, Oct. 18, 2010.

\429\ The Commission is also adding regulation 38.851 to simply

permit DCMs to continue to rely upon the guidance in appendix B to

demonstrate to the Commission compliance with section 38.850.

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CME submitted a comment letter that referenced comments it

submitted in connection with the separate rulemakings implementing Core

Principle 16. CME's comments will be considered in connection with

those rulemakings.

17. Subpart R--Composition of Governing Boards of Contract Markets

The Dodd-Frank Act re-designated former Core Principle 16

(Composition of Governing Boards of Mutually Owned Contract Markets) as

Core Principle 17, and revised the title of the core principle to

``Composition of Governing Boards of Contract Markets.'' In addition,

while the core principle formerly applied only to mutually owned DCMs,

and required such DCMs to ensure that the composition of their

governing boards included market participants, the amended core

principle was amended to require the governance arrangements of all DCM

to be designed to permit the consideration of the views of market

participants.\430\ The Commission proposed to codify the statutory text

of the core principle in proposed Sec. 38.900, and is adopting the

rule as proposed.

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\430\ 7 U.S.C. 7(d)(17).

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As noted in the DCM NPRM, the substantive regulations implementing

Core Principle 17 were proposed in a separate rulemaking that also

would implement Core Principles 15 (Governance Fitness Standards), 16

(Conflicts of Interest), and 22 (Diversity of Boards of

Directors).\431\ The rules implementing Core Principle 17 will be

adopted in that separate rulemaking.

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\431\ See ``Governance Requirements for Derivatives Clearing

Organizations, Designated Contract Markets, and Swap Execution

Facilities; Additional Requirements Regarding the Mitigation of

Conflicts of Interest,'' Notice of Proposed Rulemaking, 76 FR 722,

January 6, 2011. CME submitted a comment letter discussing proposed

regulation 38.801 in connection with 76 FR 722.

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18. Subpart S--Recordkeeping

Core Principle 18, as amended by section 735 of the Dodd-Frank Act,

requires all DCMs to maintain records of all activities related to

their business as contract markets, in a form and manner acceptable to

the Commission, for at least five years.\432\

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\432\ See section 5(d)(18) of the CEA, 7 U.S.C. 7(d)(18).

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The Commission proposed to codify the statutory text of the core

principle in Sec. 38.950, and is adopting the rule as proposed.

i. Sec. 38.951--Additional Sources for Compliance

Proposed Sec. 38.951 required all DCMs to maintain records,

including trade records and investigatory and disciplinary files, in

accordance with Commission regulation Sec. 1.31, and in accordance

with proposed Commission regulation Sec. 45.1 with respect to swap

transactions.\433\ The proposed rule reiterated DCMs' obligation to

comply with Sec. 1.31(a), which requires that DCM books and records be

readily accessible for the first two years of the minimum five-year

statutory period, and be open to inspection by any representatives of

the Commission or the United States Department of Justice.\434\ Section

1.31(a) also requires DCMs to promptly provide either copies or

original books and records upon request of a Commission

representative.\435\ As noted in the preamble, the proposed rule also

incorporated by reference Sec. 1.31(b)'s description of the acceptable

methods of storing books and records.\436\ Finally, proposed Sec.

38.951 also incorporated by reference the requirements set forth in

Sec. 1.31(c) regarding electronic storage systems, and the

requirements in Sec. 1.31(d) regarding retention of trading cards and

of other trade, order, and financial reports.\437\ Separately, proposed

Sec. 38.951 also required DCMs to comply with the recordkeeping

requirements in Sec. 45.1 with respect to swaps transactions.\438\

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\433\ See DCM NPRM at 80622.

\434\ Id.

\435\ Id.

\436\ Id. at 80601.

\437\ Id. at 80622.

\438\ See proposed regulation 38.951. At the time of the DCM

NPRM, the part 45 rules were proposed. See 75 FR 80622, Dec. 22,

2010. The part 45 rules were recently codified. See 77 FR 2136, Jan.

13, 2012.

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Summary of Comments

MGEX argued that the proposed rule is too prescriptive in requiring

that all records and data must be indexed and duplicated.\439\ MGEX

also commented that the requirement to retain records for ``at least 5

years'' created uncertainty and requested clarification on how long

records must be kept.\440\ MGEX questioned the rationale for obligating

DCMs to keep Commission-required data separate from other data.\441\

Further, MGEX stated that ``DCMs should not be substitute storage

facilities for Commission data, nor should they be required to relocate

and resubmit data that has already been submitted to the Commission.''

\442\ Chris Barnard recommended that records should be required to be

kept indefinitely rather than for at least five years.\443\

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\439\ MGEX Comment Letters at 9 (Feb. 22, 2011) and at 3 (June

3, 2011).

\440\ Id. (requesting a limit on the length of time a DCM should

be required to hold data).

\441\ Id.

\442\ Id.

\443\ Barnard Comment Letter at 4 (Feb. 22, 2011).

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[[Page 36657]]

Discussion

The Commission is adopting the proposed rules under Core Principle

18 with the modification described below.

The Commission acknowledges MGEX's comment but notes that Sec.

38.951 incorporates recordkeeping requirements to which DCMs are

already subject by direct operation of Sec. 1.31. Even if the

Commission were to amend Sec. 38.951 as requested, many of the

concerns expressed by MGEX would remain, including the obligation to

keep certain data separately. In this regard, the Commission notes that

the Acceptable Practices for former Core Principle 17 stated that Sec.

1.31 ``governs recordkeeping requirements under the Act.'' \444\ Upon

adopting Sec. Sec. 38.950 and 38.951, Sec. 1.31 will still govern

significant elements of recordkeeping under the Act. Accordingly, the

Commission is largely adopting Sec. 38.951 as proposed. The Commission

is making one modification to the proposed rule, however, by replacing

the reference to Sec. 45.1 with a reference to the more general ``part

45.''

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\444\ See 17 CFR part 38, app. B, Application Guidance and

Acceptable Practices for Core Principle 17.

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In response to MGEX's request for clarification regarding the

requirement to retain records for ``at least 5 years,'' the Commission

notes that the recordkeeping requirement for swaps is governed by rules

that were recently codified in part 45, which requires DCMs to maintain

all requisite records from the date of the creation of the swap through

the life of the swap and for a period of at least five years from the

final termination of the swap.\445\ With respect to all other records,

DCMs can satisfy their recordkeeping requirement pursuant to Sec.

38.950 by retaining such records for five years, unless the Commission

determines prior to the expiration of the five-year term that the

records must be retained for a longer period of time. The Commission

also notes that the ``at least 5 years'' obligation is required under

statute. Specifically, as noted in the preamble of the proposed rule,

one notable difference between the former Core Principle 18, and the

current amended version, is that while records were previously required

to be maintained ``for a period of 5 years,'' Core Principle 18 now

requires that records must be retained for ``at least 5 years.'' \446\

Accordingly, the proposed rule required a DCM maintain records of all

activities related to its business as a DCM in a form and manner

acceptable to the Commission for at least five years.\447\ Similarly,

in response to Chris Barnard's recommendation that the records be held

indefinitely, the Commission believes that the current statutory

requirement to maintain records for at least 5 years is sufficient at

this time, but notes that it may extend the time period if it

determines that an extended recordkeeping time is necessary.

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\445\ 77 FR 2136, Jan. 13, 2012.

\446\ See preamble to proposed regulation 38.950. 75 FR 80601,

Dec. 22, 2010.

\447\ See proposed regulation 38.950(a). 75 FR 80622, Dec. 22,

2010.

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19. Subpart T--Antitrust Considerations

The Dodd-Frank Act renumbered former Core Principle 18 as Core

Principle 19, and in all other respects, maintained the statutory text

of the core principle. As noted in the DCM NPRM, the Commission

believed that the existing guidance to this Core Principle remained

appropriate. Accordingly, other than to codify the statutory text of

Core Principle 19 into proposed Sec. 38.1000, the Commission did not

propose any amendments to the pre-existing guidance under part 38.

Proposed Sec. 38.1001 referred applicants and DCMs to the guidance

in appendix B to part 38 for purposes of demonstrating to the

Commission their compliance with the requirements of proposed Sec.

38.1000.

Discussion

No comments were received in regards to the proposed rule and

guidance, and the Commission is adopting the rule and guidance as

proposed.

20. Subpart U--System Safeguards

Core Principle 20 is a new core principle created by the Dodd-Frank

Act, and pertains to the establishment of system safeguards by all

DCMs. Core Principle 20 specifically requires DCMs to: (1) Establish

and maintain a program of risk oversight to identify and minimize

sources of operational risk through the development of appropriate

controls and procedures and the development of automated systems that

are reliable, secure, and have adequate scalable capacity; (2)

establish and maintain emergency procedures, backup facilities, and a

plan for disaster recovery that allow for the timely recovery and

resumption of operations and the fulfillment of the responsibilities

and obligations of the DCM; and (3) periodically conduct tests to

verify that backup resources are sufficient to ensure continued order

processing and trade matching, price reporting, market surveillance,

and maintenance of a comprehensive and accurate audit trail. The rules

proposed under subpart U implement these requirements. The Commission

proposed to codify the statutory text of the core principle in proposed

Sec. 38.1050, and adopts the rule as proposed.

i. Sec. 38.1051--General Requirements

The rules proposed under Sec. 38.1051 (a) and (b) would require a

DCM's program of risk analysis and oversight to address six categories

of risk analysis and oversight, including information security;

business continuity-disaster recovery (``BC-DR'') planning and

resources; capacity and performance planning; systems operations;

systems development and quality assurance; and physical security and

environmental controls.

The proposed rule in Sec. 38.1051(c) specifically would require

each DCM to maintain a BC-DR plan and BC-DR resources sufficient to

enable resumption of trading and of all of the responsibilities and

obligations of the DCM during the next business day following any

disruption of its operations, either through sufficient infrastructure

and personnel resources of its own or through sufficient contractual

arrangements with other DCMs or disaster recovery service providers.

The proposed rule also would require each DCM to notify Commission

staff of various system security-related events, including prompt

notice of all electronic trading halts and systems malfunctions in

Sec. 38.1051(e)(1), timely advance notice of all planned changes to

automated systems that may impact the reliability, security, or

adequate scalable capacity of such systems in Sec. 38.1051(f)(1), and

timely advance notice of all planned changes to programs of risk

analysis and oversight in Sec. 38.1051(f)(2). The proposed rule also

required DCMs to provide relevant documents to the Commission in Sec.

38.1051(g) and to conduct regular, periodic, objective testing and

review of its automated systems in Sec. 38.1051(h). Moreover, proposed

Sec. 38.1051(i) would require each DCM, to the extent practicable, to

coordinate its BC-DR plan with those of the members and market

participants upon whom it depends to provide liquidity, to initiate

coordinated testing of such plans, and to take into account in its own

BC-DR plan, the BC-DR plans of relevant telecommunications, power,

water, and other essential service providers.

Summary of Comments

CME commented that recovery time objectives (``RTOs'') in each

catastrophic

[[Page 36658]]

situation should consider the impact on all market participants and

independent technology services providers in the context of determining

a proper RTO.\448\ CME also objected to what it considers to be an

overly broad requirement in Sec. 38.1051(e)(1) to notify Commission

staff promptly of all electronic trading halts and systems

malfunctions.\449\ CME argued that required reporting should be limited

to any material system failures. Further, CME criticized Sec.

38.1051(f)(1), arguing that the mandate that DCMs provide the

Commission with timely advance notice of all planned changes to

automated systems that may impact the reliability, security, or

adequate scalable capacity of such systems is overly burdensome, and

not cost effective.\450\ Additionally, CME argued that the Sec.

38.1051(f)(2) requirement that DCMs provide timely advance notice of

all planned changes to their program of risk analysis and oversight is

too broad and generally unnecessary.\451\ Finally, CME noted that it

does not control, or generally have access to, the details of the

disaster recovery plans of its major vendors.\452\

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

\448\ CME Comment Letter at 36 (Feb. 22, 2011).

\449\ Id. at 37.

\450\ Id.

\451\ Id.

\452\ Id.

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

Discussion

The Commission is adopting the proposed rule, with the

modifications described below. As noted in the DCM NPRM, automated

systems play a central and critical role in today's electronic

financial market environment, and the oversight of core principle

compliance by DCMs with respect to automated systems is an essential

part of effective oversight of both futures and swaps markets. Advanced

computer systems are fundamental to a DCM's ability to meet its

obligations and responsibilities.\453\

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\453\ See 75 CFR 80572, 80601-80602, Dec., 22, 2010.

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

The Commission has considered CME's comment, and believes that

timely advance notice of all planned changes to address system

malfunctions is not necessary and is revising the rule to provide that

DCMs only need to promptly advise the Commission of all significant

system malfunctions. With respect to planned changes to automated

systems or risk analysis and oversight programs, the revised rule will

require timely advance notification of material changes to automated

systems or risk analysis and oversight programs. Finally, the rule does

not require DCMs to control or have access to the details of the

disaster recovery plans of its major vendors. Rather, the rule suggests

coordination to the extent possible.

21. Subpart V--Financial Resources

New Core Principle 21 requires DCMs to have adequate financial

resources to discharge their responsibilities, and specifically

requires that DCMs maintain financial resources sufficient to cover

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

rolling basis.

i. Sec. 38.1100--Core Principle 21, and Sec. 38.1101(a) and (c)

General Rule and Computation of Financial Resources Requirement

Proposed Sec. 38.1100 codifies the statutory text of the core

principle and is being adopted as proposed.

Proposed Sec. 38.1101(a)(1) and (3) required DCMs to maintain

sufficient financial resources to cover operating costs for at least

one year, calculated on a rolling basis, at all times. Proposed Sec.

38.1101(a)(2) would require any entity operating as both a DCM and a

DCO to comply with both the DCM financial resources requirements, and

also the DCO financial resources requirements in Sec. 39.11.\454\

Proposed Sec. 38.1101(c) required a DCM to make a reasonable

calculation of the financial resources it needs to meet the

requirements of proposed Sec. 38.1101(a) at the end of each fiscal

quarter.

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\454\ See 76 FR 69334, Nov. 8, 2011. Commission regulation 39.11

establishes requirements that a DCO will have to meet in order to

comply with DCO Core Principle B (Financial Resources), as amended

by the Dodd-Frank Act. Amended Core Principle B 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 conditions; and enable the DCO to cover its

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

basis.

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Summary of Comments

OCX requested that the Commission define whether ``operating

costs'' are gross or net.\455\ GreenX recommended that the Commission

expressly state that ``operating costs'' should be determined from a

cash flow statement perspective.\456\

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\455\ OCX Comment Letter at 5 (Feb. 22, 2011).

\456\ GreenX Comment Letter at 19 (Feb. 22, 2011).

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Chris Barnard recommended that each DCM calculate and regularly

publish its solvency ratio, defined as the DCM's available financial

resources divided by the DCM's financial resources requirement.\457\

Chris Barnard stated that the Commission should be notified when this

ratio falls below 105 percent.\458\

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

\457\ Barnard Comment Letter at 5 (May 20, 2011).

\458\ Id.

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

KCBT stated that the proposed requirements would result in

duplication for entities that operate both a DCM and a DCO, because

proposed Sec. 39.11 imposed similar requirements on DCOs.\459\ KCBT

stated that its DCO was established as its wholly-owned subsidiary

corporation for purposes of limiting liability and that as a

``privately-owned, for-profit corporation, it should be able to

determine its own levels of capital resources and deployment.'' \460\

KCBT referenced this rationale in response to proposed Sec.

38.1101(a)(3), (b), (e), and (f).\461\

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

\459\ KCBT Comment Letter at 8 (Feb. 22, 2011).

\460\ Id.

\461\ Id.

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Discussion

The Commission is adopting proposed Sec. 38.1101 (a) and (c) with

the modification described below. The Commission notes that

specifically defining ``operating costs'' could result in unintended

restrictions on DCMs. The Commission will maintain the flexibility of

the proposed rule by not further defining ``operating costs'' and

instead permitting each DCM to have reasonable discretion in

determining the methodology it will use to make the calculation. For

these reasons, the Commission also declines to incorporate a solvency

ratio requirement to the final rules.

Finally, the Commission has revised the text of Sec. 38.1101(a)(2)

(redesignated as paragraph (a)(3)) to clarify that a DCM that is also

registered with the Commission as a DCO must demonstrate that it has

sufficient resources to operate the combined entity as both a DCM and

DCO,\462\ and further, that such combined entity need only file single

quarterly financial resources reports in accordance with Sec.

39.11(f). The Commission is not requiring a dually-registered entity to

file two separate reports because the operating resource requirements

for a DCM and DCO are the same, and the combined DCM/DCO is required to

have sufficient financial resources to cover its operating costs as a

combined entity. The DCO financial resource requirements in Sec. 39.11

differ from those in Sec. 38.1101 only insofar as they add a

requirement for default resources, which is applicable only to a

[[Page 36659]]

DCM/DCO acting in its capacity as a DCO.

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\462\ The Commission anticipates that a corporate entity that

operates more than one registered entity may share certain costs,

and may allocate those costs among the registered entities as

determined by the Commission on a case by case basis.

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ii. Sec. 38.1101(b)--Types of Financial Resources

Under proposed Sec. 38.1101(b), financial resources available to

DCMs to satisfy the applicable financial requirements would include the

DCM's own capital (assets in excess of liabilities) and any other

financial resource deemed acceptable by the Commission. A DCM would be

able to request an informal interpretation from Commission staff on

whether a particular financial resource would be acceptable.

Summary of Comments

OCX stated that the proposed rule may encourage DCMs to cut

services in order to reduce their operational need for cash.\463\

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

\463\ OCX Comment Letter at 5 (Feb. 22, 2011).

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

Several commenters recommended that the Commission include specific

examples of financial resources that might satisfy the requirement. OCX

inquired whether firm commitments from owners to honor capital calls

would be acceptable under the proposed rule.\464\ CME contended that

the intent of Congress was to construe the terms ``financial

resources'' broadly and include anything of value at the DCM's

disposal, including operating revenues.\465\ CME stated that if

Congress wanted to exclude operating revenues from what would be

considered financial resources, Congress could have incorporated an

``equity concept.'' \466\

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

\464\ Id.

\465\ CME Comment Letter at 37 (Feb. 22, 2011).

\466\ Id.

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GreenX contended that the Commission should continue to permit

flexibility for DCMs, but also requested that the Commission provide

specific examples of which assets can be included in the calculation of

``financial resources.'' \467\ GreenX requested confirmation that

accounts receivable and other assets that are reasonably expected to

result in payments to the DCM, as well as subordinated loans, are

acceptable financial resources.\468\ GreenX also stated that committed

lines of credit and similar facilities should be considered ``good''

financial resources, and that such interpretation is standard in the

ordinary business world.\469\ GreenX stated that the proposed increase

in the amount of financial resources needed by DCMs, and the

restrictions on the use of debt financing, would impede the ability of

start-ups to become and remain DCMs.\470\

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

\467\ GreenX Comment Letter at 19 (Feb. 22, 2011).

\468\ Id.

\469\ Id. at 18.

\470\ GreenX Comment Letter at 14 (Feb. 22, 2011).

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GreenX proposed language to replace proposed Sec. 38.1101(a)(3),

(b), and (e) that would provide that a DCM ``be required to maintain

sufficient financial resources to cover its projected operating costs

for a period of at least one year, including unencumbered, liquid

assets equal to at least six months of such projected operating costs,

and that committed lines of credit or various debt instruments may be

included in calculating those financial resources, as long as the DCM

is not incurring indebtedness secured by its assets and counting both

those assets and the indebtedness as part of its financial resources.''

\471\ GreenX further contended that if the Commission is unwilling to

accept this language, the Commission should: (i) clearly specify that

the ``financial resources'' requirement in proposed Sec. 38.1101(a)(3)

is a separate requirement from the liquidity requirement in proposed

Sec. 38.1101(e), and (ii) delete the language in the proposed

liquidity requirement suggesting that proposed Sec. 38.1101(e) is part

of the proposed one year's required operating costs coverage.\472\

Absent revision, GreenX stated that the current proposal could result

in a requirement of up to 18 months of financial resources if a DCM

used a line of credit to satisfy the liquidity requirement.\473\

Moreover, if this provision is not changed, GreenX recommended that the

Commission undertake a cost-benefit analysis of requiring DCMs to

maintain financial resources in excess of one year's operating

costs.\474\ GreenX also stated that the Commission should not adopt a

``one-size-fits-all approach'' to the financial resources requirements

as between DCOs and DCMs, since different circumstances and different

purposes support differential treatment.\475\

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

\471\ Id. at 17.

\472\ Id. GreenX recommended striking the words in proposed

regulation 38.1101(e) ``to meet the requirements of paragraph (a) of

this section'' and ``If any portion of such financial resources is

not sufficiently liquid.''

\473\ Id. at 14-15.

\474\ Id. at 17-18.

\475\ GreenX discussed the significantly different roles played

by DCMs and DCOs (i.e., DCMs do not guarantee or novate trades and

their capital is not at risk in the event of a default) and further

states that the ``Commission should not adopt a one-size-fits-all

approach and should not treat DCOs and DCMs in the same manner where

different circumstances and different purposes support differential

treatment.'' GreenX notes that ``the role of financial resources

(and letters of credit) in the DCM context is to ensure that DCMs

can continue to operate in the ordinary course of business and make

payments as they become due, which does not have the same time

sensitivity that it does in the DCO context.'' See GreenX Comment

Letter at 17 (Feb. 22, 2001).

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Discussion

The Commission is adopting the proposed rule with one modification.

The provision in Sec. 38.1101(b) stating that acceptable financial

resources include a DCM's own capital and ``any other financial

resource deemed acceptable by the Commission'' was meant to capture

other types of resources on a case-by-case basis and provide

flexibility to both DCMs and the Commission. Accordingly, the

Commission notes that a DCM's own capital means its assets minus its

liabilities calculated in accordance with the Generally Accepted

Accounting Principles (``GAAP''). The Commission believes that if a

certain financial resource is deemed to be an asset under GAAP, it is

appropriate for inclusion in the calculation for this rule, and the

rule has been revised accordingly. To the extent a certain financial

resource is not considered an asset under GAAP, but based upon the

facts and circumstances a DCM believes that the particular asset should

be so considered, Commission staff will work with the DCM to determine

whether such resource is acceptable. In response to comments pertaining

to the acceptable forms of financial resources, the Commission may

consider projected revenues as an acceptable financial resource for

established DCMs that can demonstrate a historical record of revenue;

but not for DCM applicants, relatively new DCMs or DCMs with no such

record.

The Commission believes that GreenX misinterprets the relationship

of Sec. 38.1101(a)(3) and Sec. 38.1101(e). The Commission clarifies

that the one-year financial resources requirements in Sec.

38.1101(a)(3) and the six month liquidity requirement in Sec.

38.1101(e) could be met by using the same financial resources. GreenX

is correct that if a sufficient portion of the financial resources used

for the one-year financial resources requirement in Sec. 38.1101(a)(3)

are illiquid, it is possible that an entity could be required to have

18 months of financial resources to meet the requirements of these two

sections. However, the Commission is requiring only one-year of

financial resources, six months of which must be liquid financial

resources. Each DCM may exercise discretion in determining how to meet

this requirement (e.g., six months of liquid financial resources

combined with six months of illiquid ones, 12 months of liquid

financial resources, or 12 months of illiquid financial resources with

a line of credit

[[Page 36660]]

covering six months of financial resources). Indeed, the Commission

notes that most, if not all, DCMs have considerably more financial

resources than the minimum one-year required by this rule. In addition,

if a DCM does not have this liquidity, it is not achieving the goal of

the core principle, as it will be unable to pay its creditors. Further,

the language of the core principle does not limit the resource

requirement to one year, as it specifically states that a DCM's

financial resources are adequate if the value of such resources exceeds

one year of operating costs. Also in response to GreenX, the costs and

benefits associated with all of the rules being adopted in this

release, including Sec. 38.1101, are discussed in the cost benefit

section of the release.

In response to GreenX's comment regarding the financial resources

requirements of DCOs and DCMs, the Commission notes that the financial

resources requirements in Sec. 38.1101, for DCMs, and in Sec. 39.11,

for DCOs, are different. In addition to the requirement to maintain

financial resources sufficient to cover operating costs for one year,

Sec. 39.11 also requires DCOs to possess a certain level of default

resources.\476\ As GreenX correctly notes, DCMs do not guarantee or

novate trades and a ``one-size-fits-all'' approach is not being applied

here.

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\476\ See 76 FR 69334, Nov. 8, 2011.

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iii. Sec. 38.1101(d)--Valuation of Financial Resources

Proposed Sec. 38.1101(d) required DCMs to calculate the current

market value of each financial resource used to meet their obligations

under these proposed rules, no less frequently than at the end of each

fiscal quarter. The proposed rule required DCMs to perform the

valuation at other times as appropriate. As the Commission noted in the

DCM NPRM, the proposed rule is designed to address the need to update

valuations in circumstances where there may have been material

fluctuations in market value that could impact a DCM's ability to meet

its obligations on a rolling basis as required by proposed Sec.

38.1101(a). The proposed rule requires that when valuing a financial

resource, the DCM reduce the value, as appropriate, to reflect any

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

a haircut.\477\ Under the proposed rule, DCMs would be permitted to

exercise discretion in determining the applicable haircuts, although

such haircuts would be subject to Commission review and acceptance.

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

\477\ A ``haircut'' is a deduction taken from the value of an

asset to reserve for potential future adverse price movements in

such asset.

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

Summary of Comments

GreenX recommended an explicit statement that the use of GAAP

principles in calculating the market value of each financial resource

in meeting obligations under the rules would satisfy the requirements

of this subsection, without limiting other potential methods of

complying.\478\

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

\478\ GreenX Comment Letter at 19 (Feb. 22, 2011).

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

Discussion

The Commission is adopting the proposed rule without modification.

In response to GreenX's comment, the Commission notes that GAAP does

not include haircuts, but valuation under GAAP does take into account

current market values. The Commission expects each DCM to monitor the

value of its resources to be certain that the calculation of the value

of its assets reflects current market conditions in accordance with

GAAP. A haircut is not intended to be applied in the ordinary course,

but to be used in those unusual market circumstances that require an

accounting intervention. As stated in the DCM NPRM, the Commission will

permit DCMs discretion to, in the first instance, choose an appropriate

haircut methodology. The Commission will evaluate the appropriateness

of such methodology on a case-by-case basis.

iv. Sec. 38.1101(e)--Liquidity of Financial Resources

Proposed Sec. 38.1101(e) required that DCMs maintain unencumbered

liquid financial assets, such as cash or highly liquid securities,

equal to at least six months' operating costs. As noted in the DCM

NPRM, the Commission believes the requirement to have six months' worth

of unencumbered liquid financial assets would give a DCM time to

liquidate the remaining financial assets it needs to continue operating

for the last six months of the required one-year period. A DCM would be

permitted to use a committed line of credit or similar facility to

satisfy the requirement, in the event that the DCM does not have six

months' worth of unencumbered liquid financial assets.

The Commission notes that a DCM may only use a committed line of

credit or similar facility to meet the liquidity requirements set forth

in proposed Sec. 38.1101(e). Accordingly, a committed line of credit

or similar facility is not listed in proposed Sec. 38.1101(b) as a

financial resource available to a DCM to satisfy the requirements of

proposed Sec. 38.1101(a).

Summary of Comments

CME stated that the liquidity measurement is only relevant in the

context of winding-down, and claims that a three month period, rather

than six months, is a more accurate assessment of how long it would

take for a DCM to wind down.\479\

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\479\ CME Comment Letter at 37 (Feb. 22, 2011).

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

GreenX requested clarification of the terms ``unencumbered'' and

``committed.'' \480\ GreenX suggested that assets should be considered

unencumbered even if they are ``subject to security interests or

adverse claims, as long as the DCM can use and expend those assets in

the ordinary course without requiring consent of lenders or

claimants.'' \481\ GreenX also requested that the Commission clarify

whether ``committed'' is intended to mean anything other than a line of

credit or similar facility that has been extended pursuant to a legally

binding agreement.\482\ Finally, GreenX recommended that the Commission

expressly state that lines of credit and similar facilities incurred

from banks and other commercial financial institutions on market

standard terms will presumptively qualify as good ``committed lines of

credits and similar facilities'' for purposes of proposed Sec.

38.1101.\483\ GreenX requested that any requirements applicable for

lines of credit be specified in the final regulations.\484\

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

\480\ GreenX Comment Letter at 18 (Feb. 22, 2011).

\481\ Id.

\482\ Id.

\483\ Id.

\484\ Id.

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Discussion

The Commission is adopting the proposed rule without modification.

The Commission believes that a six month period is appropriate for

a wind down period and notes that commenters did not provide any

support for the claim that a wind down would take only three months.

In response to GreenX's request for clarification, the Commission

notes that it is using ``unencumbered'' in the ``normal commercial

sense'' to ``refer to assets that are not subject to a security

interest or other adverse claims.'' \485\ By ``committed line of credit

or similar facility,'' the Commission means a committed, irrevocable

contractual obligation to provide funds on demand with preconditions

limited to the execution of appropriate agreements. In other words, a

facility with a material adverse financial condition restriction would

not be acceptable. The purpose of

[[Page 36661]]

this requirement is for a DCM to have no impediments to accessing its

line of credit at the time it needs liquidity. Further, DCMs are

encouraged to periodically check their line of credit arrangements to

confirm that no operational difficulties are present.

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\485\ Id.

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v. Sec. 38.1101(f)--Reporting Requirements

Proposed Sec. 38.1101(f) required DCMs, at the end of each fiscal

quarter, or at any time upon Commission request, to report to the

Commission: (i) the amount of financial resources necessary to meet the

requirements set forth in the regulation; and (ii) the value of each

financial resource available to meet those requirements. The proposed

rule also required a DCM to provide the Commission with a financial

statement, including the balance sheet, income statement, and statement

of cash flows, of the DCM or of its parent company (if the DCM does not

have an independent financial statement and the parent company's

financial statement is prepared on a consolidated basis).

Under the proposed rule, a DCM was required to provide the

Commission with sufficient documentation explaining the methodology it

used to calculate its financial requirements, and the basis for its

valuation and liquidity determinations. The proposed rule also required

the DCM to provide copies of any agreements establishing or amending a

credit facility, insurance coverage, or any similar arrangement that

evidences or otherwise supports its conclusions. The Commission, in its

sole discretion, would determine the sufficiency of the documentation

provided. According to the proposed rule, the DCM would have 17

business days \486\ from the end of the fiscal quarter to file the

report, unless it requests an extension of time from the Commission.

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\486\ This filing deadline is consistent with the deadline

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

CFR regulation 1.10(b).

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

Summary of Comments

Three commenters requested an extended deadline for filing the

financial reports required as a result of the proposed rule. CFE stated

that for DCMs that are public, or have financial statements

consolidated with those of a public company, the filing deadlines

should be the same as those required by the SEC for Forms 10-Q and 10-

K.\487\ CME provided a similar comment stating that the proposed 17 day

filing deadline is not feasible and that instead, the requirement

should be consistent with the SEC's reporting requirements.\488\

Similarly, GreenX stated that it has procedures in place to comply with

the SEC's requirements and that the proposed requirements in this rule

would require new programming and resources.\489\ GreenX recommended

extending the reporting deadline to 30 calendar days, noting that this

is still more burdensome than the requirements imposed by the SEC on

national securities exchanges.\490\ Rather than recommending an

extended deadline, KCBT objected to the proposed quarterly filings and

stated that the annual submissions that it provides to the Commission

should suffice.\491\

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\487\ CFE Comment Letter at 6 (Feb. 22, 2011).

\488\ CME Comment Letter at 38 (Feb. 22, 2011).

\489\ GreenX Comment Letter at 20 (Feb. 22, 2011) (GreenX also

stated that normal year-end adjustments typically require much more

than 17 business days to complete).

\490\ Id.

\491\ KCBT Comment Letter at 8 (Feb. 22. 2011).

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In addition to the comments received regarding the reporting

deadline, two commenters requested clarification as to the

confidentiality of any filings made pursuant to proposed Sec.

38.1101(f).\492\ Further, CME requested clarification that consolidated

financial statements covering multiple DCMs, and DCOs where relevant,

comply with the proposed rule.\493\

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\492\ CFE Comment Letter at 6 (Feb. 22, 2011); CME Comment

Letter at 37-38 (Feb. 22, 2011).

\493\ CME Comment Letter at 37-38 (Feb. 22, 2011).

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

Discussion

The Commission is adopting the proposed rule with certain

amendments.

The Commission is persuaded that the proposed 17 business day

filing deadline may be overly burdensome. The SEC requires its

quarterly reports on Form 10-Q to be filed with the SEC 40 calendar

days after the end of the fiscal quarter for accelerated filers and 45

calendar days after the end of the fiscal quarter for all other SEC-

registered entities.\494\ The SEC requires annual reports on Form 10-K

to be filed with the SEC 60 calendar days after the end of the fiscal

year for large accelerated filers, 75 calendar days for other

accelerated filers and 90 calendar days for non-accelerated

filers.\495\ The Commission has extended the 17 business day proposed

filing deadline to 40 calendar days for the required reports for the

first three quarters. This revision to the rule will harmonize the

Commission's financial resource filing requirement with the SEC's

requirements for its Form 10-Q. Similarly, the Commission has extended

the filing deadline for the fourth quarter report to 60 days in order

to harmonize the requirement with the SEC's filing deadline for the

Form 10-K. However, to the extent that a DCM is also registered as a

DCO, the DCM must file its quarterly financial reports in accordance

with the requirement of Sec. 39.11 (which requires that reports be

filed within 17 business days after the end of each fiscal quarter).

The shorter time frame for submission of a dual registrant's quarterly

financial reports is based on the heightened significance of financial

oversight for the clearinghouse, which serves as the central

counterparty for all cleared transactions.

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

\494\ See 17 CFR 249.308a.

\495\ See 17 CFR 249.310.

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

The Commission has considered KCBT's comments, but does not believe

that annual submissions are sufficient. The Commission believes that

prudent financial management requires DCMs to prepare and review

financial reports more frequently than annually, and expects that DCMs

currently are reviewing their finances on at least a quarterly basis.

In response to the comments requesting clarification on the

confidentiality of the filings made pursuant to the financial resources

regulations, the Commission does not plan to make such reports public.

However, where such information is, in fact, confidential, the

Commission encourages DCMs to submit a written request for confidential

treatment of such filings under the Freedom of Information Act

(``FOIA''),\496\ pursuant to the procedures established in Sec. 145.9

of the Commission's regulations.\497\ The determination of whether to

disclose or exempt such information in the context of a FOIA proceeding

would be governed by the provisions of part 145, and any other relevant

provision.

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\496\ 5 U.S.C. 552 et seq. (2010).

\497\ 17 CFR 145.9 (2010).

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

In response to the request for clarification in regard to

consolidated financial statements, the Commission clarifies that

consolidated financial statements would comply with the rule.

Section 38.1101(g) delegates authority to perform certain functions

that are reserved to the Commission under Sec. 38.1101 to the Director

of the Division of Market Oversight.

22. Subpart W--Diversity of Boards of Directors

Core Principle 22 is a new core principle that was added by the

Dodd-Frank Act. The core principle requires that publicly traded DCMs

must endeavor to recruit individuals to serve on their board of

directors from among

[[Page 36662]]

a broad and culturally diverse pool of qualified candidates.

In the DCM NPRM, the Commission proposed to codify the statutory

text of the core principle in proposed Sec. 38.1150, and is adopting

Sec. 38.1150 as proposed.

As noted in the DCM NPRM, the substantive regulations implementing

Core Principle 22 were proposed in a separate rulemaking that also

would implement Core Principles 15 (Governance Fitness Standards), 16

(Conflicts of Interest), and 17 (Composition of Governing Boards of

Contract Markets).\498\ The rules implementing Core Principle 22 will

be adopted in that separate rulemaking.

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\498\ See ``Governance Requirements for Derivatives Clearing

Organizations, Designated Contract Markets, and Swap Execution

Facilities; Additional Requirements Regarding the Mitigation of

Conflicts of Interest,'' Notice of Proposed Rulemaking, 76 FR 722,

January 6, 2011. CME submitted a comment letter discussing proposed

regulation 38.801 in connection with 76 FR 722.

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

CME submitted a comment letter responding to the DCM NPRM that

referenced comments it submitted in connection with that rulemaking.

CME's comments will be considered in connection with that rulemaking.

23. Subpart X--Securities and Exchange Commission

The Dodd-Frank Act added new Core Principle 23, requiring that DCMs

keep any records relating to swaps defined in CEA section 1a(47)(A)(v),

as amended by the Dodd-Frank Act, open to inspection and examination by

the SEC.\499\ Consistent with the text of this core principle, the

Commission proposed guidance under part 38 that provided that each DCM

should have arrangements and resources for collecting and maintaining

accurate records pertaining to any swap agreements defined in section

1a(47)(A)(v) of the amended CEA.

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

\499\ 7 U.S.C. 7; see also section 5(d)(23) of the CEA, as

amended by the Dodd-Frank Act.

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

i. Sec. 38.1200--Core Principle 23, Sec. 38.1201 (Additional Sources

for Compliance), and Guidance in Appendix B

The Commission proposed a combination of rules and guidance to

implement the core principle. Proposed Sec. 38.1200 codified the

statutory text of the core principle. Proposed Sec. 38.1201 referred

applicants and DCMs to the guidance in appendix B to part 38 for

purposes of demonstrating to the Commission their compliance with the

requirements of the core principle. The proposed guidance stated that

DCMs should have arrangements and resources for collecting and

maintaining accurate records pertaining to any swaps agreements defined

in section 1a(47)(A)(v) of the Act.

Summary of Comments

CME requested guidance on what records need to be retained and for

how long they must be retained.\500\

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

\500\ CME Comment Letter at 38 (Feb. 22, 2011).

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

Discussion

The Commission is adopting the proposed rules and guidance, with

the modifications described below.

In response to CME's comment, the Commission notes that the

guidance provides that DCMs should retain ``any'' records relevant to

swaps defined under CEA section 1a(47)(a)(v), and that the DCM should

leave such records open to inspection and examination, for a period of

five years. Commission staff consulted with representatives from the

SEC, who confirmed that SEC's relevant recordkeeping requirements

typically extend for a period of five years.\501\ The five year

requirement is also consistent with the recordkeeping requirement under

Core Principle 18 and Sec. 1.31 of the Commission's regulations.

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

\501\ See 76 FR 10982, Feb. 28, 2011, (Proposed regulation

818(b) requires security-based swap execution facilities to keep

books and records ``for a period of not less than five years,'' the

first two years in an easily accessible place). Rule 17a-1(b)

(240.17a-1(b) requires national securities exchanges, among others,

to keep books and records for a period of not less than five years,

the first two years in an easily accessible place, subject to a

destruction and disposition provisions, which allows exchanges to

destroy physical documents pursuant to an effective and approved

plan regarding such destruction and transferring/indexing of such

documents onto some recording medium.).

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III. Related Matters

A. Regulatory Flexibility Act

The Regulatory Flexibility Act (``RFA'') \502\ requires federal

agencies, in promulgating rules, to consider the impact of those rules

on small entities. The rules adopted herein will affect designated

contract markets (``DCMs''). The Commission has previously established

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

in evaluating the impact of its rules on small entities in accordance

with the RFA.\503\ The Commission previously determined that DCMs are

not small entities for the purpose of the RFA.\504\ The Commission

received no comments on the impact of the rules contained herein on

small entities. Therefore, the Chairman, on behalf of the Commission

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

a significant economic impact on a substantial number of small

entities.

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\502\ 5 U.S.C. 601 et seq. (2010).

\503\ 47 FR 18618-21, Apr. 30 1982.

\504\ Id.

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B. Paperwork Reduction Act

This final rulemaking contains information collection requirements.

The Paperwork Reduction Act (``PRA'') \505\ imposes certain

requirements on federal agencies in connection with their conducting or

sponsoring any collection of information as defined by the PRA. An

agency may not conduct or sponsor, and a person is not required to

respond to, a collection of information unless it displays a currently

valid control number. The Commission proposed to amend collection 3038-

0052 to allow for an increase in response hours for the proposed

rulemaking amending part 38, which included the increase in burden

hours that will result from the amendments to rules 1.52 and 16.01 that

are also part of this rulemaking.\506\ Notably, most of the collection

burdens associated with part 38 are covered by a currently approved

collection of information for part 38, or by other existing or pending

collections of information. Thus, only those burdens that are not

covered elsewhere are included in the Commission's proposed amendment.

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\505\ 44 U.S.C. 3501 et seq.

\506\ See 75 FR 80572, 80603, Dec. 22, 2010 .

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The title of the collection will continue to be ``Part 38--

Designated Contract Markets.'' The Commission submitted the amended

collection to the Office of Management and Budget (``OMB'') for its

review and approval in accordance with 44 U.S.C. 3507(d) and 5 CFR

1320.11. Pursuant to a notice of action from OMB in March 2011,

approval of the amended collection is pending a resubmission of the

proposed information collection that includes a description of the

comments received on the collection and the Commission's responses

thereto, which will be made available by OMB at www.reginfo.gov.

Responses to this collection of information will be mandatory. The

Commission will protect proprietary information gathered according to

the FOIA and 17 CFR part 145, ``Commission Records and Information.''

In addition, section 8(a)(1) of the CEA strictly prohibits the

Commission, unless specifically authorized by the CEA, from making

public ``data and information that would separately disclose the

business transactions or market positions of any person and trade

secrets or names of customers.'' \507\ The Commission is also required

to protect certain information

[[Page 36663]]

contained in a government system of records according to the Privacy

Act of 1974.\508\

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\507\ 7 U.S.C. 12.

\508\ 5 U.S.C. 552a.

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Proposed Collection

In its existing collection of information for part 38, the

Commission estimated 300 hours average response time from each

respondent for the collection of designation and compliance

information.\509\ Based on its experience with administering registered

entities' submission requirements since implementation of the Commodity

Futures Modernization Act of 2000,\510\ the Commission estimated in the

DCM NPRM that the response time for the designation and compliance

collections in the proposed rule would generally increase the

information collection burden by 10 percent. This increase is due to

the introduction of swaps trading on DCMs permitted under section

723(a)(3) of the Dodd-Frank Act and the addition of new core principles

with which DCMs must comply, excepting Core Principle 21 (Financial

Resources), for which a separate burden estimate is discussed below,

and the burdens associated with any information collection requirements

that are being accounted for in other existing or pending collections.

With respect to all but financial resources compliance, the Commission

estimated in the DCM NPRM that it would collect information from 17

respondents.\511\ Accordingly, a 10 percent estimated increase would

result in 30 additional hours per respondent and 510 additional hours

annually for all respondents for designation and compliance.

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\509\ 66 FR 42256, 42268, Aug. 10, 2001.

\510\ Public Law 106-554, 114 Stat. 2763 (2000).

\511\ The number of designated contract markets increased from

13 to 17 since the last amendment to Collection 3038-0052 and from

17 to 18 since the DCM NPRM was published in the Federal Register.

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

With respect to Core Principle 21, the Commission estimated in the

DCM NPRM that each of the 17 anticipated respondents may expend up to

10 hours quarterly for filings required under the proposed regulations,

totaling 40 hours annually for each respondent and 680 hours across all

respondents with respect to compliance with Core Principle 21.

Commission staff estimated that respondents could expend up to an

additional $3,640 annually based on an hourly wage rate of $52 (30

hours + 40 hours x $52) to comply with the proposed rules. This would

result in an aggregated additional cost of $61,880 per annum (17

respondents x $3,640).

Summary of Comments and Discussion

Estimated Burden Hours for Compliance for Part 38 Amendments

The Commission received several comments regarding the estimated

hours of burden for compliance with the proposal to amend part 38.\512\

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\512\ As noted above, the Commission is not finalizing proposed

regulations 38.501--38.506 at this time, and expects and plans to do

so when it considers the final SEF rulemaking, The Commission will

consider all comments related to these provisions at such time.

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

In particular, the Commission confirms that that the new DCM

application form, Form DCM, provides a roadmap of required

documentation, balances the needs of the Commission with the needs of

the marketplace, and should result in a streamlined and standardized

review process, as was noted by Eris.\513\

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

\513\ Eris Comment Letter at 4 (Feb. 22, 2011).

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Other commenters suggested that the 60 days proposed in Sec.

38.3(g) for existing DCMs to certify compliance with the core

principles and the rules implementing them would be unduly

burdensome.\514\ As discussed in the preamble, the Commission is

eliminating this provision from the final rules.

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

\514\ See, e.g., GreenX Comment Letter at 21 (Feb. 22, 2011);

KCBT Comment Letter at 2 (Feb. 22, 2011); Nodal Comment Letter at 4

(Feb. 22, 2011); NYSE Liffe Comment Letter at 14 (Feb. 22, 2011);

CME Comment Letter at 12 (Feb. 22, 2011); and CFE Comment Letter at

7 (Feb. 22, 2011).

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

CME stated that it would be costly to comply with the proposed

Sec. 38.151(a) requirement that clearing firms obtain every customer's

consent to the regulatory jurisdiction of each DCM.\515\ The Commission

believes that Sec. 38.151(a) codifies requirements necessary to

effectuate Core Principle 2's statutory mandate; a DCM must have an

agreement in place prior to granting members and market participants

access to its markets in order to ensure that the DCM has the capacity

to detect, investigate, and apply appropriate sanctions to persons that

violate DCM rules. Any incremental costs associated with this rule are

covered by the 10 percent increase contained in the Commission's

amended information collection.

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

\515\ CME Comment Letter at 16 (Feb. 22, 2011).

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

CME stated that an increased documentation burden associated with

the submission process would greatly increase the cost and timing for

DCMs to list products, without providing any corresponding benefit to

the marketplace.\516\ CME stated that the Commission indicated that the

proposed rules for Provisions Common to Registered Entities will

increase the overall collection burden on registered entities by

approximately 8,300 hours per year.\517\ The referenced burden was

accounted for in the Commission's information collection for the part

40 rules that were adopted in July, 2011, however, and therefore the

burden associated with that collection is not duplicated here.\518\

Notwithstanding this, the Commission believes that any DCM must have an

agreement with its customers such that the customer agrees to cooperate

with the DCM, where necessary, in order for the DCM to perform its

statutory functions.

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\516\ CME Comment Letter at 10 (Feb. 22, 2011).

\517\ See 75 FR 67282, 67290, Nov. 2, 2010.

\518\ See Collection 3038-0093.

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Similarly, CME commented on the burdens associated with rules

implementing Core Principles 8 and 18, in particular, the requirement

to separately identify block trading in daily volume reports.\519\ The

burden associated with block trading is accounted for in the

information collection associated with the Commission's Real-Time

Public Reporting of Swap Transaction Data rulemaking.\520\ To avoid

double-counting, no adjustment is being made to the amendment to this

part 38 collection.

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

\519\ CME Comment Letter at 30-31 (Feb. 22, 2011).

\520\ See ``Real Time Public Reporting of Swap Transaction

Data,'' 77 FR 2909, Jan. 20, 2012.

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

In addition, MGEX commented on the rules implementing the general

recordkeeping requirements of Core Principle 18.\521\ Core Principle 18

incorporates by reference Sec. 1.31 of the Commission regulations and

the recordkeeping requirements in the Commission's Swap Data,

Recordkeeping, and Reporting Requirements rulemaking.\522\ The Sec.

1.31 requirements are already covered by the existing information

collection for part 38, with the incremental costs associated with the

introduction of swap trading, if a DCM elects to do so, covered by the

10 percent increase contained in the Commission's amended information

collection. The recordkeeping requirements in the proposed Swap Data,

Recordkeeping, and Reporting Requirements rulemaking are accounted for

in the information collection request that was developed for that

rulemaking. To avoid double-counting, no adjustment is being made to

the amendment to the part 38 information collection in response to the

comment.

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

\521\ MGEX Comment Letter at 9 (Feb. 22, 2011).

\522\ See ``Swap Data Recordkeeping and Reporting

Requirements,'' 77 FR 2136, Jan. 13, 2012.

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With respect to the information collection in rules implementing

Core

[[Page 36664]]

Principle 10, CME and MGEX commented that establishing specific audit

trail requirements would be burdensome, costly, and unnecessary.\523\

DCM compliance with Core Principle 10 should predate the enactment of

the Dodd-Frank Act, however, and the information collections associated

with Core Principle 10 are covered by the Commission's existing part 38

information collection. Any burden increase associated with the

maintenance of additional records resulting from the introduction of

swap trading, if a DCM elects to do so, has been accounted for in the

10 percent increase in designation and compliance costs discussed

above.

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

\523\ CME Comment Letter at 33 (Feb. 22, 2011) and MGEX Comment

Letter at 7 (Feb. 22, 2011).

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

CME submitted a comment regarding the information collection

burdens associated with rules that were proposed to implement new Core

Principle 20, which requires each DCM to maintain a business

continuity-disaster recovery plan and to report system security-related

events and all planned changes to automated systems that may impact the

reliability, security, or scalability of the systems.\524\ In response

to CME's concerns that the rule would require reporting of

insignificant system events, the Commission is adopting final rules

that require reporting only of significant system malfunctions and

advance notification only of material system changes. The resulting

burden reduction eliminates the need to increase the proposed part 38

information collection amendment.

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

\524\ CME Comment Letter at 36-37 (Feb. 22, 2011).

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

Finally, MGEX commented that the hours estimated for designation

and compliance and the additional new annual cost of compliance with

the proposed rules were extremely low, and claimed that due to the vast

number of additional requirements, the total burden is becoming

``unwieldy and excessive.'' \525\ MGEX did not provide any estimate of

what costs would be more accurate for purposes of the part 38

information collection, and thus the Commission could not evaluate

alternative estimates to determine whether they would be more

appropriate than what was proposed, which was based on past Commission

experience with existing collections of information and which accounts

only for those collections of information that are not now or will not

be covered by other collections of information.

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

\525\ MGEX Comment Letter at 9-10 (Feb. 22, 2011).

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

Estimated Burden Hours for Core Principle 21

In addition to the general increase proposed for the existing part

38 collection discussed above, the Dodd-Frank Act established new Core

Principle 21 (Financial Resources) that requires respondents to have

adequate financial, operational and managerial resources.\526\ In order

to demonstrate compliance with Core Principle 21, each respondent will

need to file specific reports with the Commission on a quarterly basis,

which would result in four quarterly responses per respondent per year.

In the proposed rulemaking, the Commission estimated that each

respondent would expend 10 hours to prepare each filing required under

the proposed regulations, and the Commission estimated that it would

receive filings from 17 respondents.

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\526\ See section 735(b) of the Dodd-Frank Act.

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The Commission received several comments on the proposed financial

resources collection. KCBT stated that the financial resources rules,

as proposed, would result in duplicative reporting for entities that

operate as both a DCM and DCO.\527\ In response to this comment, the

Commission is now finalizing the rules with revisions that clarify that

a DCM that also is registered with the Commission as a DCO is obligated

only to file its financial resources reports under the DCO rules,

though it nonetheless must maintain the financial resources necessary

to satisfy the operating cost requirements of the DCM and the DCO

separately.

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

\527\ KCBT Comment Letter at 7-9 (Feb. 22, 2011).

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

CFE, GreenX, and KCBT requested that the Commission extend the

proposed deadline for filing of financial resources reports from 17

days after the end of each quarter, in particular to accommodate DCMs

that are public companies, or that have financial statements that are

consolidated with those of a public company, so that the filing

requirements would be aligned with the requirements for SEC forms 10-Q

and 10-K, which are longer.\528\ GreenX stated that failing to extend

the time for filing to align with the SEC filing requirements, for

which it and other public companies already have procedures and

controls in place, would result in unnecessary new programming and

staff resources.\529\ KCBT objected to the quarterly filing requirement

and suggested that annual reporting would be sufficient.\530\

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\528\ CFE Comment Letter (Feb. 22, 2011), GreenX Comment Letter

(Feb. 22, 2011), KCBT Comment Letter (Feb. 22, 2011).

\529\ GreenX Comment Letter at 19-20 (Feb. 22, 2011).

\530\ KCBT Comment Letter at 8-9 (Feb. 22, 2011).

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The Commission is not persuaded that an annual reporting

requirement would be sufficient in terms of financial management on the

part of the DCM or regulatory oversight on the part of the Commission.

With respect to regulatory oversight, the adoption of an annual

reporting requirement alone would result in a need for periodic checks

by the Commission on financial resources compliance by DCMs between

annual reports. The multiple unscheduled checks that would be necessary

each year, in the form of calls for a demonstration of compliance by a

DCM, as well as more formal rule enforcement reviews, would burden the

Commission's examination resources. If DCMs are required to report on a

quarterly basis, DCMs may be able to demonstrate risks toward which the

Commission's resources should be directed. Moreover, unscheduled checks

would most likely be more burdensome for DCMs than quarterly reporting.

Thus, the Commission is adopting both quarterly and annual reporting

requirements in these final rules.

However, in response to the comments, the Commission is adopting

final rules that would mitigate the burden that would result from the

adoption of filing deadlines that do not align with SEC filing

requirements. Accordingly, the final rules establish a deadline for the

filing of financial resources reports of 40 calendar days after the end

of the quarter for the first three quarters of a DCM's fiscal year, and

60 calendar days after the end of the DCM's fourth quarter.

Final Burden Estimate

The final rules require each respondent to file information with

the Commission. Information collections are included in several of the

general provisions being adopted in Subpart A, as well as in certain

regulations implementing Core Principles 5, 7, 8, 10, 11, 13, 18, 20,

and 21. The Commission has carefully evaluated the comments discussed

above and determined that the 10 percent general increase by which the

Commission seeks to amend its part 38 collection of information is

appropriate. The 10 percent increase is intended to cover only the

burdens associated with collections of information that are not already

covered in the existing part 38 information collection, or in other

existing collections or collections that are being established with

other rulemakings.

[[Page 36665]]

The 10 percent increase tracks the already approved part 38

information collection, which accounted for the many one-time or

infrequent information collections contained in part 38 over the

assumed life of a DCM. As a general rule, the information collections

in this rulemaking that are not already covered have the same

characteristics: The required filing of one-time certifications and

demonstrations of compliance by existing DCMs; the filing of occasional

exemptive requests; reporting of material events that are expected to

occur infrequently; the expansion of a DCM's existing audit trail

program to cover swap transactions, if the DCM determines to list

swaps; and the one-time or infrequent system changes needed to report

transactions, such as EDRPs, that are not covered in the information

collection requests of other rulemakings.

The changes sought by the commenters that are being adopted would

only marginally reduce the overall information collection burden. Thus

the Commission has determined not to reduce its burden estimates.

Accordingly, the Commission expects that with respect to all but

financial resources compliance, a 10 percent estimated increase would

result in 30 additional hours per respondent and 540 additional hours

annually for all respondents for designation and compliance.

With respect to Core Principle 21, the Commission expects that each

of the 18 anticipated respondents may expend up to 10 hours quarterly

for filings required under the regulations, totaling 40 hours annually

for each respondent and 720 hours across all respondents with respect

to compliance with Core Principle 21.

Aggregate Information Burden

In conclusion, amended collection 3038-0052 will result in

respondents expending up to an additional $3,640 annually based on an

hourly wage rate of $52 (30 hours + 40 hours x $52) to comply with the

proposed rules. This would result in an aggregated additional cost of

$65,520 per annum (18 respondents x $3,640). This final burden estimate

accounts for the 18 respondents that the Commission believes will be

affected by the final rule, rather than the 17 initially proposed.\531\

Otherwise, there is no change from the rule as proposed.

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\531\ The DCM NPRM referenced 17 respondents. The number of

respondents was revised to 18 to include Eris, which was designated

on October 28, 2011.

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C. Cost Benefit Considerations

Background on Designated Contract Markets

Designated contract markets (``DCMs'') were established by the

Commodity Futures Modernization Act of 2000 (``CFMA'') as one of two

forms of Commission-regulated markets for the trading of futures and

options contracts based on an underlying commodity, index, or

instrument. Specifically, the CFMA established, under section 5 of the

CEA, eight designation criteria and 18 core principles governing the

designation and operation of DCMs. To implement the CFMA, the

Commission codified regulations under part 38 consisting largely of

guidance and acceptable practices which were illustrative of the types

of matters an applicant or DCM may address and at times provided a safe

harbor for demonstrating compliance, but did not necessarily mandate

the principle means of compliance.

Section 735 of the Dodd-Frank Act amended section 5 of the CEA by:

(1) Eliminating the eight designation criteria contained in former

section 5(b) of the CEA; (2) revising the existing core principles,

including the incorporation of many of the substantive elements of the

former designation criteria; and (3) adding five new core principles,

thereby requiring applicants and DCMs to comply with a total of 23 core

principles as a condition of obtaining and maintaining designation as a

contract market.

The Dodd-Frank Act also amended Core Principle 1 to provide that in

its discretion, the Commission may determine by rule or regulation the

manner in which DCMs comply with the Core Principles.\532\ Accordingly,

in proposing this rulemaking, the Commission undertook a comprehensive

evaluation of its existing DCM rules, guidance, and acceptable

practices associated with each core principle in order to update those

provisions and determine which core principles would benefit from new

or revised regulations. As described in this notice of final

rulemaking, in addition to codifying new rules for several core

principles, the Commission also is maintaining the guidance and

acceptable practices, with necessary modifications, in many instances.

The Commission believes that the promulgation of bright-line

requirements in those instances where an industry best practice has

developed will better serve the goals of the Dodd-Frank Act, and will

provide the industry and market participants with greater specificity

and regulatory transparency, and will improve the Commission's ability

to effectively enforce its regulations.

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\532\ The Dodd-Frank Act amended Core Principle 1 to clarify

that boards of trade have reasonable discretion in establishing the

manner in which they comply with the core principles, ``[u]nless

otherwise determined by the Commission by rule or regulation.'' 7

U.S.C. 7(d)(1).

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The Commission's Cost Benefit Consideration

Section 15(a) of the CEA requires the Commission to ``consider the

costs and benefits'' of its actions 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.\533\

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\533\ 7 U.S.C. 19(a).

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To further the Commission's consideration of the costs and benefits

imposed by its regulations, the Commission requested in the DCM NPRM

that commenters provide data and any other information or statistics on

which they relied to reach any conclusions regarding the costs and

benefits of the proposed rules.\534\ The Commission received one

comment that provided quantitative information pertaining to the costs

relevant to the Commission's proposed rules for Core Principle 9.\535\

A number of commenters did, however, express the general view that

there would be significant costs associated with implementing and

complying with the proposed rules, with some commenters generally

stating their belief that the costs would outweigh any potential

benefits.\536\ Given the lack of quantitative data provided in the

comments or publicly available, the Commission has provided a

qualitative description of the costs that would be incurred by

DCMs.\537\ In a

[[Page 36666]]

number of instances, the Commission is adopting rules that codify

existing norms and best practices of DCMs (often reflected in existing

guidance and acceptable practices and recommendations made in recent

Rule Enforcement Reviews (``RERs''). In those cases, the existing norms

or best practices serve as the baseline--that is, the point from which

the Commission considers the incremental costs and benefits of the

regulations adopted in this release. In other cases, however, there is

no existing baseline either because the requirements arise under the

new or revised core principles, or because the Commission determined to

revise existing requirements or practices.

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\534\ 75 FR at 80605, Dec. 22, 2010.

\535\ CME Comment Letter (Aug. 3, 2011). As discussed above, the

Commission will consider all comments related to the proposed rules

implementing Core Principle 9 when it finalizes those rules. The

Commission expects and plans to finalize the rules implementing Core

Principle 9 when it finalizes the SEF rulemaking.

\536\ See, e.g., comment letters from CME (Feb. 22, 2011, Apr.

18, 2011, Jun. 3, 2011 and Aug. 3, 2011), MGEX (Feb. 22, 2011 and

Jun. 3, 2011), and GreenX (Feb. 22, 2011).

\537\ Moreover, for each core principle, the first section of

the regulation is a codification of the statutory language of the

core principle as a rule--and accordingly, the Commission did not

consider the costs and benefits of these rules because they do not

reflect the exercise of discretion by the Commission. Where the

Commission includes additional regulations for a core principle, the

Commission considered the costs and benefits.

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To assist the Commission and the public in assessing and

understanding the economic costs and benefits of the final rule, the

Commission has analyzed the costs of those regulations adopted in this

rulemaking that impose additional requirements on DCMs above and beyond

the baseline described above. In most instances, quantification of

costs is not reasonably feasible because costs depend on the size and

structure of DCMs, which vary markedly, or because quantification

required information or data in the possession of the DCMs to which the

Commission does not have access, and which was not provided in response

to the NPRM. The Commission notes that to the extent that the

regulations adopted in this rulemaking result in additional costs,

those costs will be realized by DCMs in order to protect market

participants and the public. In adopting these final regulations, the

Commission attempted to take the least-prescriptive means necessary to

promote the interests of the Dodd-Frank Act without impacting

innovation and flexibility.

The following costs and benefits are organized, for the most part,

by core principle. For each DCM core principle,\538\ the Commission

summarizes the final regulations, describes and responds to comments

discussing the costs and benefits of the proposed regulations, and

considers the costs and benefits of the associated regulations,

followed by a consideration of those costs and benefits in light of the

five factors set out in Sec. 15(a) of the CEA. In addition, the

Commission considers the costs and benefits associated with the

codification of rules in place of guidance and acceptable practices.

The Commission notes that many of its regulations refer to requirements

that are contained in other rulemakings, some of which have been

finalized and others which are still before the Commission. The costs

and benefits of these regulations are discussed in connection with

those other rulemakings.

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\538\ The costs and benefits of Core Principles 15, 16, 17, and

22 are discussed in connection with separate rulemakings for

``Governance Requirements for Derivatives Clearing Organizations,

Designated Contract Markets, and Swap Execution Facilities;

Additional Requirements Regarding the Mitigation of Conflicts of

Interest,'' 76 FR 722, Jan. 6, 2011, and ``Requirements for

Derivatives Clearing Organizations, Designated Contract Markets, and

Swap Execution Facilities Regarding the Mitigation of Conflicts of

Interest,'' 75 FR 63732, Oct. 18, 2010. The substantive regulations

implementing Core Principles 15, 16, 17, and 22 were proposed in

those separate rulemakings. Until such time as the Commission may

adopt the final substantive rules implementing these core

principles, the Commission is maintaining the current guidance and

acceptable practices under part 38 relevant to Core Principles 15

and 16. Accordingly, the existing guidance and acceptable practices

from appendix B to part 38 relevant to these core principles is

being codified in the revised appendix B adopted in this final

rulemaking. This will not result in additional costs because the

Commission is simply codifying existing Guidance and Acceptable

Practices. At such time as the Commission may adopt the final rules

implementing these core principles, appendix B will be amended

accordingly.

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The Commission further notes that certain final rules, including

Sec. Sec. 38.3(b), (c), (e), and (f), 38.5(a) and (b) and 38.256,

38.257, and 38.258 are essentially unchanged from existing rules

applicable to DCMs and are not discussed further in this section, since

they do not impose new costs and benefits as a result of the

Commission's rulemaking.

Finally, the Commission is obligated to estimate the burden of, and

provide supporting statements for, any collections of information it

seeks to establish under considerations contained in the Paperwork

Reduction Act,\539\ and to seek approval of those requirements from the

Office of Management and Budget. Therefore, the estimated burden and

support for the collections of information in this rulemaking, as well

as the consideration of comments thereto, are discussed in the

Paperwork Reduction Act section of this rulemaking as required by that

statute.

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\539\ 44 U.S.C. 3501 et seq.

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(1) Rules in Lieu of Guidance and Acceptable Practices

Appendices A and B to part 38 of the Commission's regulations

provide guidance and acceptable practices for DCMs to comply with the

CFMA DCM core principles and designation criteria. In this release, the

Commission is codifying as rules certain of these obligations of DCMs.

The rules codify certain DCM practices that Commission staff has

historically recommended in RERs as appropriate under the guidance and

acceptable practices, which are already followed by DCMs. In certain

cases, the rules are less prescriptive than the existing guidance and

acceptable practices they replace, and the rules therefore maintain the

flexibility for DCMs to determine many aspects of their compliance

programs.

Summary of Comments

As described in this release, the Commission received a number of

comments opposing the codification of rules in lieu of guidance and

acceptable practices. In response to commenters' concerns, the

Commission is converting some of the proposed rules, in whole or in

part, to guidance or acceptable practices.

CME, GreenX, MGEX, and KCBT expressed concern with the costs

imposed by the conversion of guidance and acceptable practices to

rules, stating that rules are more costly and burdensome to DCMs and

will increase costs to the Commission \540\ and end-users of

derivatives.\541\ CME claimed that there is no public policy benefit to

what it described as ``one-size fits all rules.'' \542\ OCX and CME

questioned the benefit of what they viewed as the prescriptive tone of

the proposed rules.\543\ Commenters also asserted that converting

guidance and acceptable practices to rules may hinder or deter

innovation for DCMs.\544\

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\540\ See CME Comment Letters (Feb. 22, 2011, Apr. 18, 2011,

Jun. 3, 2011 and Aug. 3, 2011); MGEX Comment Letter (Jun. 3, 2011);

GreenX Comment Letter (Feb. 22, 2011); KCBT Comment Letter at 9

(Feb. 22, 2011).

\541\ CME Comment Letter at 3 (Feb. 22, 2011).

\542\ CME Comment Letter at 8 (Feb. 22, 2011).

\543\ OCX Comment Letter at 1-2 (Feb. 22, 2011); CME Comment

Letter at 2-3 (Feb. 22, 2011).

\544\ See e.g., ICE Comment Letter at 1-2 (Feb. 22, 2011), Eris

Comment Letter at 2 (Feb. 22, 2011), CME Comment Letter at 3-4 (Feb.

22, 2011), GreenX Comment Letter at 1 (Feb. 22, 2011).

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Discussion

As explained throughout this release, in several instances the

Commission has converted compliance obligations that were previously

proposed as rules to guidance and acceptable practices (in whole or in

part) in order to accommodate certain comments raised by market

participants. In determining whether to codify a compliance practice in

the form of a rule or guidance and acceptable practices, the Commission

was guided by: (i) The comment letters that provided a basis for

greater flexibility or, in some instances, for greater specificity,

with respect to the stated compliance obligation; (ii) whether the

practice consisted of a widely-accepted industry practice; and

[[Page 36667]]

(iii) whether the proposed rules were of a discretionary nature, and

thus, were more appropriate as guidance and/or acceptable practices. In

other circumstances, the Commission believes that maintaining certain

regulations as rules will better serve market participants and the

public by providing greater transparency and specificity and by

improving the ability of the Commission to effectively enforce its

regulations.

While CME claimed that the codification of rules is more costly to

the Commission,\545\ the Commission does not believe that rules are

necessarily more costly to administer than guidance and acceptable

practices. To the contrary, guidance and acceptable practices may be

more costly to the Commission than rules because of the potential need

to review individual exchange actions that do not meet the provisions

of guidance and acceptable practices to determine if they comply with

the underlying core principle. The Commission also notes that many of

the rules are general in nature, allow for innovation and flexibility,

and are not intended to be ``one size fits all.'' In response to the

comment that rules will be more costly for end-users, the Commission

notes that these regulations apply to DCMs, not to end-users, and are

intended to protect market participants.

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\545\ CME Comment Letter at 2-4 (Feb. 22, 2011).

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Commenters have suggested that as markets evolve or DCMs innovate,

rules may become outdated and may no longer be consistent with evolving

industry practice.\546\ The Commission notes that in such instances,

DCMs could petition the Commission for exemptive orders in order to

implement new methods of compliance or request that the Commission

propose revisions to its rules. The Commission notes that in accordance

with Executive Order 13579, it will periodically review its existing

significant regulations to determine whether any such regulations

should be modified, streamlined, expanded, or repealed so as to make

the agency's regulatory program more effective or less burdensome in

achieving the regulatory objectives.\547\

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\546\ See e.g., CME Comment Letter at 3 (Feb. 22, 2011), Eris

Comment Letter at 3 (Jun. 3, 2011), ICE Comment Letter at 10-11

(Feb. 22, 2011).

\547\ 76 FR 41587, July 14, 2011.

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Commenters also stated that converting guidance and acceptable

practices to rules may hinder or deter innovation for DCMs.\548\ The

Commission notes, in response to comments received, that many of the

rules that commenters interpret as possibly having an effect on

innovation, such as those that relate to technology (including certain

rules under Core Principle 4, Prevention of Market Disruption), have

been moved to guidance and acceptable practices in the final rule in

order to provide DCMs with greater flexibility.

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\548\ See e.g., ICE Comment Letter at 1-2 (Feb. 22, 2011), Eris

Comment Letter at 2 (Feb. 22, 2011), CME Comment Letter at 3 (Feb.

22, 2011), GreenX Comment Letter at 1 (Feb. 22, 2011).

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Costs

Costs to DCMs

As noted above, the rules finalized in this release generally are

designed to codify existing industry practice, and implement new or

revised core principles. However, the Commission is cognizant of the

possibility that less established DCMs may require more significant

modifications to their existing programs to comply with these rules if

they do not currently follow industry practices. Nevertheless, it is

likely less costly for DCMs to demonstrate compliance with rules than

to demonstrate compliance with guidance and acceptable practices, which

may require significantly more communications and exchange of documents

with Commission staff. Accordingly, the primary cost imposed on DCMs as

a result of converting guidance and acceptable practices to rules is

the potential inability of DCMs to choose a different method of

complying with the core principles as DCMs innovate or industry

standards evolve. This cost may be present in each instance throughout

this document where the Commission is replacing guidance or acceptable

practices with rules. However, the Commission has made every attempt to

provide sufficient flexibility to allow DCMs to continue to pursue the

most efficient methods of compliance, within the rules, guidance and

acceptable practice structure adopted in this release.

It also is possible that certain DCMs are currently engaged in

practices that they consider to be in compliance with core principles,

but which do not precisely follow existing guidance or acceptable

practices (perhaps because the DCM considers a somewhat different

method of complying with the core principle to be more efficient given

the nature of the DCM). In such an instance, a DCM would now need to

change those practices to be in full compliance with the rule. The

Commission is not aware of any specific examples of DCMs that consider

themselves to be in compliance with core principles, while not

following the Commission's guidance or acceptable practices. Therefore,

the Commission is unable to quantify the cost associated with this

potential scenario. However, all DCMs should be in compliance with

existing guidance and acceptable practices, and the Commission does not

believe that DCMs employing variant practices can object to the cost of

complying with existing guidance and acceptable practices.

As discussed above, the Commission notes that many of the rules

that could affect innovation, such as those that relate to technology,

have been moved to guidance and acceptable practices in the final rule

in order to provide DCMs with added flexibility. However, even with

guidance and acceptable practices in place of rules, innovation costs

may still exist to a degree since the Commission may need to modify

guidance and acceptable practices as industry practices evolve.

Furthermore, as is the case under current guidance and acceptable

practices, a DCM that devises a new method of complying with a core

principle may incur certain costs to demonstrate such compliance to the

Commission. It is not feasible to quantify these costs since the

Commission has no way to predict how industry practices will evolve or

what rule adjustments will be needed.

Costs to Market Participants and the Public

If converting guidance and acceptable practices to rules hinders or

deters innovation for DCMs, commenters have asserted that DCMs may

decline to innovate to the same extent that they innovate at present,

potentially depriving market participants and the public of important

advancements. However, costs to market participants as a result of

converting some of the guidance and acceptable practices to rules

should be minimal since existing requirements, including guidance and

acceptable practices, would also need to be adjusted as important

advancements occur, and commenters provided no specific examples of how

converting the guidance and acceptable practices to rules would deter

innovation. It is not feasible to quantify these costs since the

Commission has no way to predict how DCMs will innovate or industry

practices will evolve.

Benefits

Benefits to DCMs, Market Participants, and the Public

The codification of rules in lieu of guidance and acceptable

practices provides specificity and transparency to DCMs, market

participants, and the public. It also increases the likelihood of

prompt compliance with the core

[[Page 36668]]

principles because DCMs will have a clear understanding of what is

required in order to demonstrate compliance with the applicable core

principle. In turn, a DCM's ability to achieve prompt compliance with

the rules instills confidence in market participants and the public who

utilize the markets to offset risk and who utilize prices derived from

the price discovery process of trading in centralized DCM markets.

Specific enforceable standards also promote more efficient and

effective enforcement by the Commission.

The costs and benefits of each of the rules, including rules that

replace guidance or acceptable practices, are set out below in the

cost-benefit discussion for the general compliance regulations under

part 38 and for each core principle.

(2) General Compliance Regulations Under Part 38 \549\

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\549\ Proposed regulations 38.1 and 38.2 are not discussed

because they impose no requirements on market participants.

Regulation 38.1 updates internal references within part 38 and

regulation 38.2 specifies the regulations from which DCMs will be

exempt. Proposed regulations 38.3(b), (c), (e), and (f) are

essentially unchanged from existing rules and impose no new costs or

benefits. Additionally, regulation 38.6 is not being revised by this

release.

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Sec. 38.3(a) (Application procedures)

Rule Sec. 38.3 sets forth the application and approval procedures

for new DCM applicants. Rule Sec. 38.3(a) specifies the application

process, including the new requirement that the board of trade file the

DCM Application Form (``Form DCM'') electronically. Rule Sec. 38.3(a)

also eliminates the 90-day expedited approval procedures for DCM

applications. Accordingly, all DCM applications will be reviewed within

the 180-day period governed by procedures specified in CEA section

6(a).\550\

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\550\ 7 U.S.C. 8(a).

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Summary of Comments and Discussion

The Commission did not receive comments on the costs associated

with filling out Form DCM.

Eris contended that eliminating the 90-day accelerated review

process would place new entities at a competitive disadvantage because

it would delay their time to market, which they believe is critical for

new entrants.\551\

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\551\ Eris Comment Letter at 4 (Feb. 22, 2011). Eris was

designated as a contract market on October 28, 2011.

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The Commission has found that, in the interest of meeting the

expedited approval timeline, applicants seeking expedited review often

file incomplete or draft applications without adequate supporting

materials. This has resulted in the expenditure of significant amounts

of staff time reviewing incomplete or draft applications, necessitating

numerous follow-up conversations with applicants, and usually resulting

in the removal of applications from the expedited review timeline.

Additionally, some applications raise new or unique issues that require

additional time for the Commission to review. Notably, since the

passage of the CFMA, eleven DCM applicants have requested expedited

treatment, but, for some of the reasons noted above, only three were

designated within the shortened timeframe.\552\ Moreover, eliminating

the accelerated 90-day review process will not prevent DCMs from coming

to market in an expeditious manner because the rule does not prevent

the Commission from continuing to review applications within a shorter

timeframe if DCM applicants submit substantially complete applications.

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\552\ The three applicants that were designated within the

shortened timeframe included NYSE Liffe, Chicago Climate Futures

Exchange (``CCFE''), and GreenX. The remaining applications that

were not approved during the expedited timeframe included: Inet

Futures Exchange, OneChicago, CBOE Futures Exchange, U.S. Futures

Exchange, ELX Futures, The Trend Exchange, NQLX Futures Exchange,

and Cantor Futures. The Commission notes that while NYSE Liffe,

CCFE, and GreenX became designated within 90 days, they each

submitted multiple draft DCM applications that were processed and

reviewed by Commission staff for significantly longer than 90 days.

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Costs

Form DCM is designed to elicit a demonstration that an applicant

can satisfy each of the DCM core principles. Toward this end, Form DCM

requires submission of information about an applicant's intended

operations. Much of this information has been required of applicants

under previous regulations. Accordingly, the use of Form DCM does not

represent a substantive departure from the Commission's practices over

the past decade. With respect to new core principles, Form DCM captures

information that tracks statutory requirements and applicable

Commission implementing regulations. In fact, by providing greater

specificity and transparency 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, Form DCM should reduce

costs for applicants by minimizing the flow of documentation and

discussions between DCM applicants and Commission staff needed for

applicants to submit a complete application.

As noted above, eliminating the 90-day expedited review period is

unlikely to impose additional costs on DCMs or to result in competitive

disadvantage because it does not prevent the Commission from continuing

to review applications within a shorter timeframe if DCM applicants

submit substantially complete applications.

Benefits

The new application form has several benefits for DCM applicants.

The new form is designed to ensure that applicants are in compliance

with the DCM Core Principles--as required by the statute. The form

improves upon existing practice by standardizing the information that a

DCM must provide. The form includes comprehensive instructions that

will guide DCM applicants and specify lists of documents and

information that must be provided as exhibits. The Commission

anticipates that the new application form will streamline the DCM

designation process, both for DCM applicants and the Commission. The

form will provide applicants with greater specificity and transparency

regarding the type of information that is required. The use of the

standardized form is expected to reduce the amount of time Commission

staff will need to review applications, which should enable qualified

DCMs to begin operating sooner. Other than the specific requirements

necessitated by the new and revised core principles, and applicable

regulations, the majority of information required under the new form

consists of information that the Commission historically has required.

With respect to the elimination of the expedited review period, the

Commission determined in the proposal that the 90-day accelerated

review process was inefficient and impracticable. Applicants seeking

expedited review often filed incomplete or draft applications, without

adequate supporting materials, in the interest of meeting the expedited

approval timeline.\553\ This required Commission staff to expend

significant amounts of time reviewing incomplete or draft applications

and usually resulted in removal of the application from the expedited

review timeline. Eliminating the expedited process is consistent with

[[Page 36669]]

the statutory 180-day review period, and should result in a better use

of Commission resources. During the 180-day review period, applicants

will have adequate time to respond to Commission staff requests for

additional information, resulting in a more efficient process for

applicants and for the Commission.\554\

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\553\ For example, while NYSE Liffe, GreenX, and CCFE became

designated 79, 88, and 60 days, respectively, after they submitted

their applications, they each submitted several versions of draft

applications that required numerous follow-up conversations with

Commission staff. While GreenX technically became designated within

88 days, the Commission actually processed GreenX's application in

draft form for nearly a year.

\554\ This rule is consistent with the Commission's elimination

of the 90-day expedited review procedures for derivatives clearing

organization applications under part 39. See ``Derivatives Clearing

Organization General Provisions and Core Principles,'' 76 FR 69334,

69337, Nov. 8, 2011.

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Section 15(a) Factors

1. Protection of market participants and the public. Given the

critical role that DCMs play in the financial markets, a role that now

includes providing a marketplace for the trading of swaps as well as

futures and options, it is essential that the Commission conduct a

comprehensive and thorough review of all DCM applications. Such review

is essential for the protection of market participants and the public

insofar as it serves to limit the performance of DCM functions to only

those entities that have provided adequate demonstration that they are

capable of satisfying the core principles. The new Form DCM and the

elimination of the 90-day application review period will enable the

Commission to more efficiently and accurately determine whether it is

appropriate to designate a DCM applicant as a contract market.

2. Efficiency, competitiveness, and financial integrity. The

Commission expects that the use of Form DCM will promote efficiency,

competitiveness, and financial integrity by requiring at the outset all

information the Commission deems necessary to consider an application

for designation as a contract market. As discussed above, the

Commission's experience with lengthy reviews of draft applications and

other materially incomplete submissions highlights the need for a

streamlined and formalized process. By replacing a series of provisions

under current Sec. 38.3(a) with a streamlined Form DCM, and by

eliminating the 90-day expedited application review period, the

Commission is promoting increased efficiency by providing specific

guidance to applicants and DCMs before they undertake the application

process, and by facilitating the submission of a materially complete

final application. This also will reduce the need for the submission of

supplemental materials and repeated consultation between applicants and

Commission staff. The result will be a more cost effective and

expeditious review and approval of applications. This will benefit

potential and existing DCMs as well as free Commission staff to handle

other regulatory matters.

In addition, the use of Form DCM will make 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. Form DCM will promote

greater transparency in the process and will enhance competition among

DCMs by making it easier for qualified applicants to undertake and

navigate the application process in a timely manner.

Form DCM is designed to address an applicant or a DCM's ability to

comply with the core principles, which form the bedrock of the

Commission's oversight, and which Congress determined are essential to

ensure the financial integrity of transactions and derivatives markets,

generally. In particular, the required information in the Form DCM

(Exhibits I-J--Financial Information and M and T--Compliance) elicit

important information supporting the applicant or DCM's ability to

operate a financially sound DCM and appropriately manage the risks

associated with its role in the financial markets.

3. Price discovery. The Commission does not anticipate that use of

Form DCM or the elimination of the 90-day review period will impact the

price discovery process.

4. Sound risk management policies. The Commission expects that the

use of Form DCM will promote sound risk management practices by

requiring applicants and DCMs to examine their proposed risk management

program through a series of detailed exhibits and submissions. The

submission of exhibits relating to risk management, including exhibits

I-J (Financial Information) and M, O, and T (Compliance) aid Commission

staff's analysis and evaluation of an applicant's ability to comply

with the core principles.

5. Other public interest considerations. The standardization and

streamlining of the DCM application process benefits the public in

terms of more efficient use of Commission resources and more cost-

effective and transparent requirements for applicants and DCMs. DCMs

play a key role in the financial markets, and this role takes on even

greater significance now that swaps may be traded on DCMs. A coherent

and comprehensive approach to DCM designation 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.

Sec. 38.3(d) (Request for transfer of designation) and Sec. 38.5

(Information relating to contract market compliance)

Rule Sec. 38.3(d) is a new rule that formalizes the procedures

under which a DCM may request the transfer of its designation to a new

legal entity as a result of a corporate event such as a merger or

corporate reorganization. Rule Sec. 38.5(c) \555\ is a new rule that

requires that the DCM must submit to the Commission a notification of

each transaction involving the transfer of ten percent or more of the

equity interest in the designated contract market, and that such

notification must be provided at the earliest possible time but in no

event later than ten business days following the date upon which the

designated contract market enters into a legally binding obligation to

transfer the equity interest. As described in the preamble, upon

receiving a notification of an equity interest transfer, the Commission

may request, where necessary, additional information and specific

documentation from the DCM pursuant to its authority under Sec. 38.5,

although such documentation is no longer required with the initial

notification. The Commission did not receive any comments discussing

the costs or benefits of proposed Sec. Sec. 38.3(d) or 38.5(c).

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\555\ The provisions in regulation 38.5 regarding requests for

information and demonstrations of compliance (paragraphs (a) and (b)

in the final rules) were largely unchanged after Dodd-Frank and will

not be discussed in this rulemaking because they do not result in

any incremental costs or benefits.

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Costs

Under Sec. 38.3(d), only DCMs that wish to request the transfer of

their designation will incur the one-time cost associated with filing

the request with the Commission and preparing the underlying documents

and representations that must be included with the request. The

Commission notes that it has historically requested that DCMs file

similar information in the event of a transfer of designation. The

Commission is reducing the burden associated with the proposed

regulations by clarifying that DCMs have the flexibility to determine

the appropriate form of the documents they are required to submit. The

Commission estimates that the submissions and notifications required

under Sec. 38.3(d) will take around two hours to compile at a cost of

approximately $104.

The Commission is also reducing the burden associated with proposed

[[Page 36670]]

Sec. 38.5(c) by eliminating the requirement that DCMs must provide a

series of documents and a representation along with the notification of

an equity interest transfer. DCMs that enter into agreements that could

result in equity interest transfers of 10 percent or more will incur

one-time costs associated with preparing and submitting the required

notification for each event. The Commission estimates that the initial

notification required under Sec. 38.5(c) will take around one hour to

compile at a cost of approximately $52.

Benefits

Section 38.3(d) formalizes the procedures that a DCM must follow

when requesting the transfer of its DCM designation and positions

comprising open interest in anticipation of a corporate event. The

provision requiring three months advance notice of an anticipated

corporate change will provide the Commission with sufficient time to

evaluate the anticipated change and determine the likely impact of the

change on the DCM's governance and obligations, as well as the impact

of the change on the rights and obligations of market participants

holding open positions. The rule will permit the Commission to evaluate

the transferee's ability to comply with the applicable laws and

regulations. The rule also requires DCMs to submit a representation

that they are in compliance with the applicable laws and regulations.

This requirement provides regulatory specificity to DCMs regarding

their obligations.

Section 38.5 provides Commission staff with an opportunity to

determine whether a change in ownership at a DCM resulting from an

equity interest transfer will adversely impact the operations of the

DCM, or the DCM's ability to comply with the Core Principles and the

Commission's regulations. Section 38.5 ensures that DCMs remain mindful

of their self-regulatory responsibilities when negotiating the terms of

significant equity interest transfers.

Section 15(a) Factors (Sec. Sec. 38.3(d) and 38.5(c))

1. Protection of market participants and the public. Given the

critical role that DCMs play in the financial markets, a role that now

includes providing a marketplace for the trading of swaps as well as

futures and options, it is essential that the Commission conduct a

comprehensive and thorough review of all requests for transfer of

designation and notifications of equity interest transfers. Such review

is essential for the protection of market participants and the public

insofar as it serves to limit the performance of DCM functions to only

those entities that have provided adequate demonstration that they are

capable of satisfying the core principles. The new formalized

procedures for transfers of designation and equity interest transfers

will provide the Commission with the opportunity to determine the

impact those transfers are likely to have on a DCM's ability to comply

with the core principles and on the market.

2. Efficiency, competitiveness, and financial integrity. The

Commission expects that the formalized procedures for requesting a

transfer of designation and for notifying the Commission of an equity

interest transfer will promote efficiency, competitiveness, and

financial integrity by providing the Commission with the opportunity to

obtain the information the Commission deems necessary to consider such

requests. The result will be more cost effective review and approval of

requests for transfer of designation and equity interest. This will

benefit DCMs. Financial integrity is also promoted as the transferee's

ability to meet core principles will be examined.

3. Price discovery. The Commission does not anticipate that the

formalized process for requesting a transfer of designation or

notifying the Commission of an equity interest transfer will impact the

price discovery process.

4. Sound risk management policies. The Commission expects that the

formalized processes for transfers of designation and equity interests

will promote sound risk management practices by requiring DCMs to

examine their proposed risk management program through a series of

submissions that aid Commission staff's analysis and evaluation of a

DCM's ability to comply with the core principles.

5. Other public interest considerations. The standardization and

streamlining of the transfer of designation and equity interest

transfer process benefits the public by permitting more efficient use

of Commission resources and more cost-effective requirements for DCMs.

A coherent and comprehensive approach to transfers of designations and

equity interests is needed to ensure that all DCMs continue to satisfy

the requirements of the core principles and Commission regulations.

Sec. 38.3(g) (Requirements for existing designated contract markets)

Proposed rule Sec. 38.3(g) required existing DCMs to certify

compliance with each of the core principles within 60 days of the

effective date of the final rules. In response to comments, the

Commission has eliminated this requirement from the final rules. The

Commission believes that the removal of this provision will decrease

costs for DCMs.

Sec. 38.4 (Procedures for Listing Products)

Section 38.4 conforms the prior regulation to that of new rules in

part 40 of the Commission's regulations.\556\ There are no costs

imposed by the conforming changes beyond those discussed in connection

with that rulemaking.

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\556\ ``Provisions Common to Registered Entities,'' 76 FR 44776,

Jul. 27, 2011.

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Sec. 38.7 (Prohibited use of data collected for regulatory purposes)

Rule Sec. 38.7 is a new rule that prohibits a DCM from using for

business or marketing purposes proprietary or personal information that

it collects from market participants unless the market participant

clearly consents to the use of its information in such a manner.\557\

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\557\ The Commission notes that the requirements of regulation

38.7 are in line with similar rules intended to provide privacy

protections to certain consumer information finalized in a separate

rulemaking implementing regulations under the Fair Credit Reporting

Act. See 76 FR 43879, Jul. 22, 2011.

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Costs

The Commission notes that in response to general comments that did

not discuss costs or benefits, it has amended this provision to allow

DCMs to use this information for business or marketing purposes if the

market participant clearly consents to the use of its information in

such a manner. The costs imposed by this provision are limited to the

cost a DCM might incur in obtaining a market participant's consent to

use its information for the purposes described above. The Commission

does not prescribe the method by which a DCM must obtain such consent

and believes that the burden of doing so would be minimal and would

likely involve sending an email or a letter.

Benefits

This rule protects market participants' information provided to a

DCM for regulatory purposes from being used to advance the commercial

interests of the DCM. The rule eliminates incentives on the part of

DCMs to use market participants' proprietary or personal information

for their own commercial gain. The rule does, however, afford market

participants the flexibility to

[[Page 36671]]

consent to a DCM's use of their personal information for commercial

purposes if they so desire.

Section 15(a) Factors

1. Protection of market participants and the public. This rule

protects market participants and the public by ensuring that

information they provide to DCMs for regulatory purposes it not used

inappropriately to advance the commercial interests of the DCM without

their consent.

2. Efficiency, competitiveness, and financial integrity. This rule

encourages greater participation in the markets by ensuring market

participants that their proprietary and personal information will not

be used by DCMs without their consent. Increased participation by

market participants will foster greater liquidity, tighter spreads, and

more competitive markets. The rule also promotes efficient and

competitive markets by ensuring that DCMs do not use access to their

market participants' data (without their consent) as a source of

competitive advantage.

3. Price discovery. Fostering a competitive environment, as

mentioned above, aids in the compilation of information traded in

markets to further price discovery.

4. Sound risk management practices. The Commission has not

identified any effects that this rule will have on sound risk

management practices.

5. Other public interest considerations. The Commission has not

identified any effects that this rule will have on other public

interest considerations.

Sec. 38.8 (Listing of Swaps on a Designated Contract Market)

Section 38.8(a) provides that a DCM that lists a swap contract for

trading on its contract market for the first time must file with the

Commission a written demonstration detailing how the DCM is addressing

its self-regulatory obligations with respect to swap transactions.

Section 38.8(b) provides that prior to listing swaps for trading on

or through the DCM, each DCM must request an alphanumeric code from the

Commission for purposes of identifying the DCM pursuant to part 45.

Summary of Comments and Discussion

ELX argued that the DCM NPRM did not make clear what criteria will

be used to distinguish between a swap contract and a futures contract

and argued that this ambiguity will cause uncertainty and redundant

costs for boards of trade that would prefer to follow a DCM model

without having to adopt a parallel set of rules and procedures.\558\

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\558\ ELX Comment Letter at 4 (Feb. 22, 2011).

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

As noted in the Final Exemptive Order issued July 14, 2011,\559\ a

DCM may list and trade swaps after July 16, 2011 under the DCM's rules

related to futures contracts, without further exemptive relief. In the

Order, the Commission noted that if a DCM intends to trade swaps

pursuant to the rules, processes, and procedures currently regulating

trading on its DCM, the DCM may need to amend or otherwise update its

rules, processes, and procedures in order to address the trading of

swaps.\560\

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\559\ 76 FR 42508, Jul. 14, 2011.

\560\ Id. at 42518, n. 131.

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Costs and Benefits

In order to comply with new Sec. 38.8(a), DCMs listing swaps for

the first time will incur costs associated with filing the required

demonstration detailing how the DCM is addressing its self-regulatory

obligations and fulfilling its statutory and regulatory obligations

with respect to swap transactions. The Commission estimates that this

filing will take two hours to complete at a cost of about $104.

With respect to Sec. 38.8(b), the comments, costs, and benefits of

this provision will be discussed in the rulemaking that implement swap

data recordkeeping and reporting requirements under part 45 of the

Commission's regulations.\561\

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\561\ See 77 FR 2136, Jan. 13, 2012.

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Sec. 38.9 (Boards of Trade Operating Both a Designated Contract Market

and Swap Execution Facility)

Section 38.9 provides that a board of trade that operates a DCM

also may operate a SEF, provided that the board of trade separately

register as a SEF pursuant to the requirements set forth in part 37.

The rule also requires such boards of trade to comply with the core

principles under section 5h of the Act and the SEF rules under part 37,

on an ongoing basis.

Additionally, the rule codifies the requirement contained in

section 5h(c) of the CEA, which provides that a board of trade that

operates both a DCM and a SEF, and that uses the same electronic trade

execution system for executing and trading swaps that it uses in its

capacity as a DCM, must clearly identify to market participants for

each swap whether the execution or trading is taking place on the DCM

or the SEF. The Commission did not receive any comments on the costs or

benefits of this provision and is adopting the rule as proposed.

Costs and Benefits

The obligations imposed by Sec. 38.9 are codifications of the new

statutory requirement placed on DCMs. The obligations imposed by the

CEA are not within the Commission's discretion to change. However, the

Commission believes there are several benefits to restating the

statutory requirements in the regulations. Codification of statutory

requirements in the regulations will improve the Commission's ability

to enforce the statutory language and will provide market participants

with a more unified regulatory picture and with greater context and

specificity regarding the congressional intent underlying the

regulations.

Sec. 38.10 (Reporting of Swaps Traded on a Designated Contract Market)

Section 38.10 provides that each DCM that trades swaps must report

specified swap data as provided under parts 43 and 45.\562\ This

provision is consistent with the statute's reporting requirements as

reflected in sections 2(a)(13)-(14) and 21(b) of the CEA. The costs and

benefits of these rules are discussed in connection with those

rulemakings.

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\562\ ``Real-Time Public Reporting of Swap Transaction Data,''

77 FR 1182, Jan. 9, 2012; ``Swap Data Recordkeeping and Reporting

Requirements,'' 77 FR 2136, Jan. 13, 2012.

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(3) Core Principle 2: Compliance With Rules

For the most part, the regulations adopted under Core Principle 2

codify: (1) Language found in the guidance and acceptable practices

issued under former Core Principle 2 and former Designation Criterion

8; (2) existing DCM compliance practices that the Commission believes

constitute best practices; and (3) recommendations made over the past

several years by the Commission in RERs, and which are currently

largely followed. The Commission also incorporated into the rules for

Core Principle 2 certain concepts contained in part 8 of its

regulations--Exchange Procedures for Disciplinary, Summary, and

Membership Denial Actions. Most DCMs' compliance and enforcement

practices relating to Core Principle 2 obligations historically have

been consistent with the rules contained in part 8. The Commission is

also adopting some requirements that are new for DCMs. The costs and

benefits of each of these requirements are discussed below.

[[Page 36672]]

Sec. 38.151(a) (Jurisdiction), Sec. 38.151(b) (Impartial access by

members, persons with trading privileges, and independent software

vendors) and Sec. 38.151(c) (Limitations on access)

Section 38.151(a) requires that prior to granting a member or

market participant access to its markets, the DCM must require the

member or market participant to consent to its jurisdiction. Section

38.151(b)(1) requires a DCM to provide its members, persons with

trading privileges, and independent software vendors (``ISVs'') with

impartial access to its markets and services, including access criteria

that are impartial, transparent, and applied in a non-discriminatory

manner. Section 38.151(b)(2) requires that the DCM provide comparable

fee structures for members, persons with trading privileges, and ISVs

receiving equal access to, or services from, the DCM.

Section 38.151(c) (Limitations on Access) requires a DCM to

establish and impartially enforce rules governing any decision by the

DCM to deny, suspend, or permanently bar a member's or a person with

trading privileges access to the contract market. Accordingly, any

decision by a DCM to deny, suspend, or permanently bar a member's or

person with trading privileges access to the DCM must be impartial and

applied in a non-discriminatory manner. Section 38.151(a) derives from

the statutory language of Core Principle 2. While Sec. Sec. 38.151(b)

and (c) are new rules, they codify existing industry practice and

current Commission requirements.

Summary of Comments

CME stated that it would be costly to comply with the proposed

Sec. 38.151(a) requirement that clearing firms obtain every customer's

consent to the regulatory jurisdiction of each DCM.\563\ KCBT

questioned the benefit of implementing the proposed rule.\564\

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\563\ CME Comment Letter at 16 (Feb. 22, 2011).

\564\ KCBT Comment Letter at 2 (Feb. 22, 2011).

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With respect to 38.151(b)(1), MGEX stated that it is generally in

the best interest of the DCM to have open and available markets and

services. Therefore, MGEX argued that the proposed rule was unnecessary

and infringed on the business judgment of the DCM.\565\

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\565\ MGEX Comment Letter at 3 (Feb. 22, 2011).

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With respect to 38.151(b)(2), CME argued that the Commission does

not have the authority to set or limit fees charged by DCMs, likening

the requirement for comparable fee structures to an industry-wide fee

cap that has the effect of a tax.\566\

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\566\ CME Comment Letter at 8-9 (Feb. 22, 2011).

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Discussion

The Commission believes that Sec. 38.151(a) codifies

jurisdictional requirements necessary to effectuate Core Principle 2's

statutory mandate that a board of trade ``shall have the capacity to

detect, investigate, and apply appropriate sanctions to any person that

violates any rules of the contract market.'' In the Commission's view,

a DCM must establish jurisdiction prior to granting members and market

participants access to its markets in order to effectively investigate

and sanction persons that violate DCM rules. A DCM should not be in the

position of asking market participants to voluntarily submit to

jurisdiction after a potential rule violation has been found. In

response to CME's comment, the Commission clarifies that each DCM may

determine for itself how it will secure such agreements. For example, a

DCM could utilize its clearing firms to secure the agreement. The

Commission recognizes that DCMs may need additional time to secure

market participants' agreements to jurisdiction. Accordingly, in order

to reduce the burden associated with this rule, the Commission is

granting DCMs up to 180 additional days following the applicable

effective date for existing members and market participants to comply

with the requirements of Sec. 38.151(a).

With respect to Sec. 38.151(b), and as discussed in further detail

in the preamble, the Commission has considered the arguments asserted

by commenters and determined that the rule is necessary in order to

prevent the use of discriminatory access requirements as a competitive

tool against certain participants. The Commission has, however,

listened to commenters' concerns about the costs associated with the

regulation and believes the rules strike an appropriate balance.

Any comment implying that the Commission is attempting to set or

limit fees charged by DCMs is misplaced. The requirement in Sec.

38.151(b)(2) neither sets nor limits fees charged by DCMs. Rather, the

rule states only that the DCM set non-discriminatory fee classes for

those receiving access to the DCM as a way to implement the requirement

of impartial access to DCMs. Accordingly, DCMs may establish different

categories of market participants, but may not discriminate within a

particular category. As the Commission noted in the preamble, when a

DCM determines its fee structure, it may consider other factors in

addition to the cost of providing access. The fee structure was not

designed to be a rigid requirement that fails to take account of

legitimate business justifications for offering different fees to

different categories of entities seeking access. The Commission

recognizes that DCMs may also consider services they receive (in

addition to costs) when determining their fee structure. Accordingly,

the comment suggesting that the Commission does not have authority to

set fees is misplaced as the rule neither sets nor limits fees charged

by DCMs.

Costs

The costs associated with Sec. 38.151(a) derive from the statute

and are likely to be limited to the cost of obtaining customers'

consent to the DCM's jurisdiction. In response to comments received,

the Commission is not mandating the method for obtaining consent; this

may afford cost savings to DCMs. The Commission believes that most DCMs

are generally already in compliance with the requirements of Sec.

38.151(b), which require that DCMs provide comparable fee structures

for members, persons with trading privileges, and ISVs receiving equal

access to, or services from, the DCM. In addition, the Commission

believes that most DCMs currently have rules that comply with the

requirements of Sec. 38.151(c), which states that DCMs must establish

and enforce rules governing any decisions to deny, suspend, or

permanently bar a member's or market participant's access to the

contract market. Accordingly, the Commission believes that the final

rule is unlikely to impose additional costs on DCMs.

Benefits

The requirements of Sec. 38.151(a) ensure that DCMs can

effectively investigate and sanction persons that violate DCM rules, as

required by Core Principle 2. A DCM should not be in the position of

asking market participants to voluntarily submit to jurisdiction after

a potential rule violation has been found. This requirement also

ensures that market participants are clear that their trading practices

are subject to the rules of a DCM.

As noted above, the impartial access requirements of Sec.

38.151(b) prevent DCMs from using discriminatory access fee

requirements as a competitive tool against certain participants. Access

(and decisions to limit access) to a DCM should be based on the

financial and operational soundness of a participant, rather than

discriminatory or other improper motives. Impartial access benefits the

market by ensuring that all participants that meet the requirements are

able to trade on the DCM, thus

[[Page 36673]]

potentially increasing liquidity in the marketplace. The preamble's

discussion that any participant should be able to demonstrate financial

soundness either by showing that it is a clearing member of a DCO that

clears products traded on that DCM or by showing that it has clearing

arrangements in place with such a clearing member specifies that access

will be neutral and non-discriminatory. Granting such impartial access

to participants will likely improve competition within the market by

ensuring access criteria do not inappropriately deter market

participants from participating in the market.

The benefits described above also apply to the requirement that DCM

decisions to deny, suspend, or permanently bar a member or person with

trading privileges' access to the DCM should be impartial and applied

in a non-discriminatory manner.

Section 15(a) Factors

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

rules protect market participants by ensuring that DCMs can effectively

investigate and sanction persons that violate DCM rules, and by

ensuring that similarly situated market participants receive similar

access criteria and comparable fee structures, consistent with the

statute. Accordingly, the rules protect market participants from the

potential that DCMs may employ unfair or discriminatory practices in

rendering access determinations. In addition, the rules will provide

market participants with greater specificity regarding DCMs procedures

for denials and suspensions. This will benefit the market by ensuring

that market participants know what behavior will lead to denials and

suspensions and that denials and suspensions are being imposed in a

fair and non-discriminatory manner.

2. Efficiency, competitiveness, and financial integrity. The rules

prevent DCMs from employing discriminatory or preferential criteria in

granting members, persons with trading privileges, and ISVs access to

their market. Accordingly, the rules will likely promote participation

and competition within the marketplace by ensuring access criteria do

not inappropriately deter market participants from participating in the

market. Efficiency is promoted by defining clear rules governing the

denial or suspension of a member's or person with trading privileges

access to the contract market. The final rules may also promote

financial integrity in the derivatives markets because sound, non-

discriminatory access criteria and fee structures are less likely to

deter the financial integrity of members and market participants.

3. Price discovery. As noted above, the rules are likely to

increase competition within the market by optimizing market

participation. Increased participation is likely to enhance the DCM's

liquidity, leading to enhanced price discovery.

4. Sound risk management practices. The Commission has not

identified any effects that this rule will have on sound risk

management practices other than the effects related to the factors

above, especially with respect to financial integrity.

5. Other public interest considerations. The Commission has not

identified any effects that this rule will have on other public

interest considerations.

Sec. 38.152 (Abusive Trading Practices Prohibited)

Section 38.152 requires a DCM to prohibit abusive trading

practices, including front-running, wash trading, fraudulent trading,

and money passes, as well as any other trading practices that the DCM

deems to be abusive. The Commission did not receive any comments

discussing the costs or benefits of this provision.\567\

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\567\ CME commented that the rule is overly prescriptive. CME

Comment Letter at 17-18 (Feb. 22, 2011). The Commission considered

this comment in preparing this release and discusses the costs and

benefits of the codification of rules in lieu of guidance and

acceptable practices in further detail in section C(1) above.

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Costs

DCMs generally already have rules in place that prohibit the

conduct enumerated in the CEA and the final rule. They also have the

systems and staff necessary to detect, investigate, and prosecute

possible rule violations. Accordingly, the Commission believes that the

final rule is unlikely to impose additional costs on most DCMs.

Benefits

The rule ensures that DCMs prohibit the specific trading practices

identified in the rule, as well as any manipulative or disruptive

trading practices prohibited by the CEA or by Commission regulation.

Market participants and the public are likely to have greater

confidence in markets that are protected from abusive trade practices,

and therefore will be more willing to participate in the market, which

may enhance liquidity, competition, and price discovery.

Section 15(a) Factors

1. Protection of market participants and the public. Congress

determined in Core Principle 2 that market participants must be

protected from abusive trade practices. Market participants rely on

properly functioning futures markets in order to hedge risk and must

have confidence in the integrity of the markets in order to actively

participate. Rule 38.152 requires DCMs to prohibit conduct that could

result in harm to market participants, as well as members of the public

who rely on the prices derived from the market. The rule protects

market participants and the public from possible wrongdoing on the part

of firms and commodity professionals with whom they deal.

2. Efficiency, competitiveness and financial integrity of futures

markets. The rule promotes efficiency, competitiveness, and financial

integrity in the DCM market because markets that are protected from

abusive trade practices will likely attract greater market

participation, and increase public confidence in the market, and

thereby will likely increase competition and liquidity.

3. Price discovery. The rule similarly promotes price discovery

because markets protected from the trading abuses prohibited by the

rule are likely to operate more efficiently and more accurately and to

attract greater market participation and competition; such markets

better reflect the forces of supply and demand, leading to greater

price discovery.

4. Sound risk management practices. The Commission has not

identified any effects that this rule will have on sound risk

management practices, other than the effects related to the factors

above.

5. Other public interest considerations. The Commission has not

identified any effects that this rule will have on other public

interest considerations.

Sec. 38.153 (Capacity To Detect and Investigate Rule Violations), Sec.

38.155 (Compliance Staff and Resources), Sec. 38.156 (Automated Trade

Surveillance System), and Sec. 38.157 (Real Time Market Monitoring)

Sec. 38.153 (Capacity To Detect and Investigate Rule Violations)

Section 38.153 requires that a DCM have arrangements and

appropriate resources for the effective enforcement of all of its

rules, including the authority to collect information and examine books

and records of members and persons under investigation, and adequate

resources for trade and surveillance programs. While the proposed rule

required DCMs to have the authority to collect information and

[[Page 36674]]

examine books and records for ``members'' and ``market participants,''

the final rule imposes a lesser burden on DCMs by replacing the term

``market participants'' with ``persons under investigation.''

Summary of Comments and Discussion

CFE requested that the Commission clarify the term ``market

participant,'' arguing that if the term ``market participant'' were to

be interpreted to apply to all customers--and not just those customers

with direct electronic access to the DCM--a DCM's regulatory

responsibilities would greatly expand over participants with whom it

has no direct relationship or connection, greatly increasing costs for

the DCM.\568\

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\568\ CFE Comment Letter at 2 (Feb. 22, 2011).

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Similarly, CME stated that the proposed rule implied that the

entire class of non-member, non-registered market participants would be

subject to the panoply of recordkeeping requirements currently

applicable only to members, registrants, and direct access clients of

CME.\569\ CME stated that there has been no showing that such a

requirement will further the DCM's ability to effectively carry out its

self-regulatory responsibilities and that it would be imprudent to

impose these costs and burdens on market participants.\570\

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\569\ CME Comment Letter at 18 (Feb. 22, 2011).

\570\ Id.

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The Commission notes that Core Principle 2 requires a DCM to have,

in addition to appropriate resources for trade practice surveillance

programs, appropriate resources to enforce all of its rules. Further,

the Commission is cognizant that a broad interpretation of the term

``market participant'' could significantly increase the regulatory

responsibilities for DCMs. In response to the commenters' concerns, the

Commission is replacing the term ``market participant'' in the proposed

rule with ``persons under investigation'' in the final rule, which will

reduce the costs of compliance.

Costs

The requirements of this rule are not new for DCMs. Prior to the

Dodd-Frank Act, the Commission expected a DCM to have adequate capacity

and resources for effective rule enforcement.\571\ The existing costs

associated with Sec. 38.153 include the initial and recurring costs

associated with a DCM investing in the resources and staff necessary to

provide effective rule enforcement. A DCM must have sufficient staff

and resources, including the resources to collect information and

examine books and records of members and persons under investigation

and to analyze data to determine whether a rule violation occurred.

Other costs include automated systems to assist the compliance staff in

carrying out self-regulatory responsibilities for the DCM. The

Commission believes that existing DCMs generally already have the

systems necessary for effective rule enforcement. Further, replacing

the term ``market participant'' with ``persons under investigation'' in

the final rule will reduce the costs by narrowing the scope of the

requirement.

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

\571\ Commission staff has recommended these practices through

RERs.

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

Benefits

The rule ensures that a DCM has arrangements and resources for

effective rule enforcement. A DCM can best administer its compliance

and rule enforcement obligations when it has the ability to access and

examine the books and records of its members and persons under

investigation.

Sec. 38.155 (Compliance staff and resources)

Section 38.155 requires that a DCM establish and maintain

sufficient compliance staff and resources to conduct a number of

enumerated tasks, such as audit trail reviews, trade practice

surveillance, market surveillance, real-time market monitoring, and the

ability to address unusual market or trading events and to complete any

investigations in a timely manner. The Commission did not receive any

comments discussing the costs or benefits of this provision.

Costs

The Commission notes that it currently requires DCMs to have

sufficient compliance staff and resources to perform the noted

regulatory functions and that most DCMs have already expended the costs

necessary to comply with the requirements under Sec. 38.155. Any DCM

not currently in compliance with the rule will incur the cost of hiring

and maintaining sufficient staff and resources (e.g. electronic

systems) to conduct effective audit trail reviews, trade practice

surveillance, market surveillance, and real-time market monitoring, to

address unusual market or trading events, and to complete any

investigations in a timely manner. However, this requirement is

consistent with existing practice at many DCMs and reflects staff

recommendations made in RERs from time to time. DCMs will also incur

the cost of the annual monitoring of the size and workload of

compliance staff and resources, which will require oversight time for

compliance staff, management and the regulatory oversight committee.

Any costs associated with Sec. 38.155 will vary depending upon a DCM's

trading volumes, the number of products offered for trading, and the

complexity of conducting surveillance on the particular products

offered by the DCM. In addition, changes in market characteristics such

as volatility, the presence or absence of intermediaries, and the

nature and sophistication of market participants may also impact the

costs associated with Sec. 38.155.

Benefits

This rule ensures that DCMs have adequate compliance staff and

resources to conduct effective audit trail reviews, trade practice

surveillance, market surveillance, and real-time market monitoring in

order to help detect rule violations and abusive trading practices.

DCMs must also have adequate resources necessary to address unusual

market or trading events in order to help stabilize market conditions

if necessary and to complete any investigations in a timely manner. To

this end, the rule promotes market integrity, customer protection, and

the effectiveness of DCMs as self-regulatory organizations.

Sec. 38.156 (Automated trade surveillance system)

Section 38.156 requires a DCM to maintain an automated trade

surveillance system capable of detecting and investigating potential

trade practice violations and able to process this data on a trade date

plus one (``T+1 basis''). The Commission did not receive any comments

discussing the costs or benefits of this provision.\572\

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

\572\ In its comment letter, CME stated this rule is overly

prescriptive. See CME Comment Letter at 20 (Feb. 22, 2011). The

Commission considered this comment in preparing this release and

discusses the costs and benefits of the codification of rules in

lieu of guidance and acceptable practices in further detail in

section C(1) above.

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

Costs

Costs associated with Sec. 38.156 include the costs of developing

and maintaining an automated system capable of conducting trade

practice surveillance, as well as requiring a DCM to have adequate

compliance staff to administer the trade surveillance system. Adequate

staff resources are necessary to administer, maintain, and periodically

upgrade the system. For existing DCMs, the costs associated with Sec.

38.156 should not be new, as the regulation generally reflects current

industry practices and Commission

[[Page 36675]]

requirements. Further, any costs will vary according to the complexity

and analytical power of the trade surveillance system it builds, as

well as the amount of compliance staff necessary to administer,

maintain, and upgrade the system given the DCM's product and

participant profiles. Moreover, the Commission has found, through RERs,

that a DCM's automated surveillance system typically satisfies the

requirements set forth in the final rule (e.g., the ability to compute,

retain, and compare trading statistics). Therefore, the Commission

believes that it will be unnecessary for most DCMs to incur costs to

significantly upgrade their automated surveillance systems to comply

with the final rule.

Benefits

The rule ensures that a DCM has an adequate automated trade

practice surveillance system. These systems play a critical role in

ensuring that a DCM can effectively conduct investigations and detect

and prosecute possible trading abuses, including the abusive trading

practices enumerated in Sec. 38.152. Such systems improve DCM

compliance staff's ability to sort and query voluminous amounts of data

in order to better detect potential rule violations and abusive trading

practices that could harm market participants.

Sec. 38.157 (Real-Time Market Monitoring)

Section 38.157 requires a DCM to conduct real-time market

monitoring of all trading activity on its electronic trading

platform(s) to identify disorderly trading and any market or system

anomalies and to have the authority to cancel trades and adjust trade

prices when necessary.\573\

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

\573\ In its comment letter, CME stated that this rule is overly

prescriptive. CME Comment Letter at 20-21 (Feb. 22, 2011). The

Commission considered this comment in preparing this release and

discusses the costs and benefits of the codification of rules in

lieu of guidance and acceptable practices in further detail in

section C(1) above. The Commission did not receive any other

comments discussing the costs or benefits of this provision.

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

Costs

Costs associated with Sec. 38.157 include the costs of developing

and maintaining electronic systems to facilitate real-time monitoring

of all trading activity on a DCM's electronic trading platform(s). DCMs

will also bear the cost of maintaining sufficient staff to conduct

real-time market monitoring and to administer any interventions in the

market that may be required, including the cancellation of trades,

suspension and resumption of trading, and responses to any disorderly

market conditions requiring human intervention.

The Commission notes, however, that existing DCMs already have

market monitoring capabilities, either directly or through a regulatory

service provider. In addition, existing DCMs also have rules and

procedures in place regarding items such as the cancellation of trades.

As such, many of the costs associated with Sec. 38.157 are likely to

have been previously expended by existing DCMs. The Commission also

notes that the change in the final rule that replaces the requirement

to ``ensure orderly trading'' with a requirement to ``identify

disorderly trading'' will likely reduce the overall burden of the rule.

Moreover, any costs associated with Sec. 38.157 will vary widely

according to a DCM's trading volumes, the number of products offered

for trading, and the complexity of conducting real-time market

monitoring on the particular products offered by the DCM. In addition,

changes in market characteristics such as volatility, the presence or

absence of intermediaries, and the nature and sophistication of market

participants may also impact the costs associated with Sec. 38.157 due

to their correlation to system and staff requirements.

Benefits

The real-time monitoring requirements imposed by the rule will

promote orderly trading and will ensure that DCMs have the capability

to promptly identify and correct market or system anomalies. Prompt

responses to these anomalies will likely mitigate the effects of these

anomalies and may help prevent them from generating systemic risk or

other severe problems. The requirement that any price adjustments or

trade cancellations be transparent to the market and subject to clear,

fair, and publicly-available standards ensures that market participants

are not subject to arbitrary or opaque processes in the event that

their trades are involuntarily cancelled.

Section 15(a) Factors (Sec. 38.153 and Sec. Sec. 38.155-38.157)

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

protect market participants and the public by requiring that a DCM has

the capacity to detect and investigate rule violations, including

adequate compliance staff and resources, automated trade surveillance

and real time monitoring capability. These rules will help ensure fair

and equitable markets that are protected from abusive trading practices

or manipulative market conditions. Under the rules, market users are

protected from possible wrongdoing on the parts of firms and commodity

professionals with whom they deal to access the marketplace. In

addition, the rules are likely to protect the public from the potential

of price distortion.

Additionally, the requirement in Sec. 38.157 that any price

adjustments or trade cancellations are transparent to the market and

subject to clear, fair and publicly-available standards protects market

participants from opaque rules related to price adjustments and trade

cancellations.

2. Efficiency, competitiveness and financial integrity of futures

markets. The requirement that DCMs have the capability to monitor and

detect rule and trade practice violations and market anomalies improves

market efficiency, promotes financial integrity, and helps to ensure

fair and equitable markets by ensuring that violations and market

anomalies are promptly addressed and do not generate systemic risk or

other severe problems. It also helps to ensure that market prices are

not distorted by prohibited activities. The rules also enhance the

competitiveness of the market by increasing participant confidence in

the integrity of the market and by requiring DCMs to maintain and

establish resources for effective rule enforcement through the

collection of relevant information and examination of relevant books

and records.

3. Price discovery. Requiring DCMs to conduct effective monitoring

and surveillance of their markets and to have the capacity to detect

rule violations will help ensure that legitimate trades with

fundamental supply and demand information are accurately portrayed in

market prices. Mitigating rule violations, which deter from the price

discovery process in DCM markets, helps provide confidence in the

prices market participants use to hedge risk and to provide confidence

in the price discovery process.

4. Sound risk management practices. The rules promote sound risk

management practices as they would allow DCMs to better evaluate and be

aware of risks posed by trading practices or member activities.

5. Other public interest considerations. The Commission has not

identified any effects that this rule will have on other public

interest considerations.

Sec. 38.154 (Regulatory Services Provided by a Third Party)

Section 38.154(a) requires that a DCM that contracts with a

registered futures association or another registered entity

(collectively, a ``regulatory service provider'') ensures that its

regulatory

[[Page 36676]]

service provider has sufficient capacity and resources to provide

timely and effective regulatory services.

Section 38.154(b) requires that a DCM maintain adequate compliance

staff to supervise and periodically review any services performed by a

regulatory service provider.

Section 38.154(c) requires a DCM that utilizes a regulatory service

provider to retain exclusive authority over certain decisions. While

the proposed rule permitted a DCM to retain exclusive authority in

other areas of its choosing, it required the decision to open an

investigation into a possible rule violation to reside exclusively with

the regulatory service provider. As discussed in the preamble, this

requirement has been removed from the final rule. These regulations

update and clarify the last general public guidance issued

approximately 10 years ago by the Commission in this area.\574\

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

\574\ See 66 FR 42256, 42266, Aug. 10, 2001.

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

Summary of Comments

MGEX, KCBT, and CME stated that the proposed rule is either overly

burdensome or unnecessary.\575\ MGEX expressed its general opposition

to proposed Sec. 38.154 by stating that if a service has been

delegated to another registered entity pursuant to a Commission-

approved agreement, then this ``should be sufficient and no other

formal agreement is necessary.'' \576\ KCBT contended that proposed

Sec. 38.154 is overly burdensome and duplicative, particularly when a

DCM contracts with a regulatory service provider that is also a DCM

required to comply with the same core principles.\577\ KCBT noted that

it is currently party to a services agreement with another DCM and

argued that it will be costly and unnecessary to perform periodic

reviews and hold regular meetings with this regulatory service

provider.\578\ CME contended that the proposed rule is overly

prescriptive and suggested that the rule would be better served as

guidance and acceptable practices.\579\

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

\575\ MGEX Comment Letter at 3 (Feb. 22, 2011); KCBT Comment

Letter at 3 (Feb. 22, 2011); CME Comment Letter at 18-19 (Feb. 22,

2011).

\576\ MGEX Comment Letter at 3 (Feb. 22, 2011).

\577\ KCBT Comment Letter at 3 (Feb. 22, 2011).

\578\ Id.

\579\ CME Comment Letter at 18-19 (Feb. 22, 2011).

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Discussion

The Commission has determined that, on the whole, Sec. 38.154

strikes the appropriate balance between flexibility and ensuring that a

DCM properly oversees the actions of its regulatory service provider to

ensure accountability and effective performance. The Commission

believes that it is necessary to require a DCM to conduct periodic

reviews and to hold regular meetings with its regulatory service

provider. A DCM that elects to use a regulatory service provider must

properly supervise the quality and effectiveness of the services

provided on its behalf, and can only do so by acquiring detailed

knowledge during periodic reviews and regular meetings required under

Sec. 38.154.

Costs

The costs associated with Sec. 38.154 will include the cost of

initially determining whether a regulatory service provider has the

capacity and resources necessary to provide timely and effective

regulatory services. An existing DCM replacing a current regulatory

service provider with a new one will have a similar cost. For existing

DCMs with a regulatory service provider, this should not be a new cost

as DCMs are currently required to conduct such due diligence when

entering into an agreement for regulatory services from a third-party

provider, in line with existing industry practices.

The costs associated with Sec. 38.154 will also include the cost

of hiring and maintaining sufficient compliance staff at the exchange

to effectively supervise the quality and effectiveness of the services

provided by a regulatory service provider, including the cost of

holding regular meetings with their regulatory service provider and the

cost of periodic reviews of the adequacy and effectiveness of services

provided. These costs will vary widely depending upon a DCM's trading

volumes, the number of products offered for trading, and the complexity

of conducting surveillance on the particular products offered by the

DCM. Changes in market characteristics such as volatility, the presence

or absence of intermediaries, and the nature and sophistication of

market participants may also impact the costs associated with Sec.

38.154. DCMs will also bear the cost of documenting any instances where

their actions differed from those recommended by their regulatory

service provider. Commenters did not, however, provide any specific

costs to the Commission.

The Commission notes that prior to the Dodd-Frank Act, many of the

requirements under Sec. 38.154 (and many of the associated costs

summarized above), were already required under Commission policy with

respect to compliance with Core Principle 2. Section 38.154

communicates the Commission's expectations with respect to supervision

of third-party regulatory service providers in a more consistent and

explicit manner.

Benefits

The rule ensures that all regulatory service providers have the

capacity to provide the services they contract to perform, and that

DCMs are aware of the quality and outputs of the services provided on

their behalf. Additionally, the rule ensures that all DCMs have the

staff to adequately supervise their regulatory service providers and

that these regulatory service providers effectively perform the

services they are engaged to perform. By requiring that DCMs oversee

the services provided by the regulatory service provider, and thereby

ensuring that the service provider is meeting the expected standards

for compliance, the rule will likely result in cost savings to the DCM,

as the failure of a service provider to adequately fulfill its duties

may result in costs to DCMs for not meeting compliance obligations.

Section 15(a) Factors

1. Protection of market participants and the public. The final rule

promotes the protection of market participants and the public because

it ensures that regulatory service providers that are utilized by DCMs

are properly supervised and have the capacity to perform the services

they are engaged to provide, including conducting market surveillance

for rule violations and performing other market regulatory activities

that protect market participants and the public.

2. Efficiency, competitiveness and financial integrity of futures

markets. Markets that have effective oversight, surveillance, and

monitoring are likely to function more efficiently as rule violations

and market abuses would be detected more quickly. Proper supervision of

a regulatory service provider that provides these functions will ensure

the provider has the ability to perform these activities and will in

turn promote confidence in the market and likely increase competition.

3. Price discovery. The Commission has not identified any effects

that this rule will have on price discovery.

4. Sound risk management practices. The Commission has not

identified any effects that this rule will have on sound risk

management practices, other than those enumerated with regard to the

factors above.

5. Other public interest considerations. Section 38.154 is

particularly important in promoting the public interest as regulatory

service providers that help DCMs comply with their obligations are

effectively standing

[[Page 36677]]

in place of their DCM clients in providing elements of front-line self-

regulation.

Sec. 38.158 (Investigations and Investigation Reports)

Section 38.158(a) requires that a DCM have procedures in place to

conduct investigations of possible rule violations, and requires an

investigation to be commenced upon the request of Commission staff, or

upon the discovery by a DCM of information indicating a reasonable

basis for a finding that a violation may have occurred or will occur.

The final rule reduces the burden imposed by the proposed rule by now

requiring that an investigation must be commenced upon receipt of a

request from Commission staff or upon the discovery or receipt of

information by the DCM that indicates a ``reasonable basis'' for

finding that a violation ``may have'' occurred or will occur. Section

38.158(b) requires that an investigation be completed within 12 months

after an investigation is opened, absent mitigating factors as

specified in the rule. Sections 38.158(c) and (d) set forth the

elements and information that must be included in an investigation

report when there is or is not a reasonable basis for finding a rule

violation. Section 38.158(e) provides that no more than one warning

letter for the same violation may be issued to the same person or

entity during a rolling 12-month period.\580\

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

\580\ In its comment letter, CME stated that this rule is overly

prescriptive. CME Comment Letter at 21-22 (Feb. 22, 2011). The

Commission considered this comment in preparing this release and

discusses the costs and benefits of the codification of rules in

lieu of guidance and acceptable practices in further detail in

section C(1) above. The Commission did not receive any other

comments discussing the costs or benefits of these provisions.

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

Costs

Section 38.158(a) codifies the current practice at DCMs because

every DCM already has investigation procedures, guidelines, and

compliance staff. Therefore, the Commission does not believe the final

rule creates any new resource requirements. Unlike the proposed rule,

which may have imposed certain costs not currently incurred by DCMs,

the final rule limits the situations under which a DCM must conduct an

investigation and keeps the final rule in line with current practices.

Under section 38.158(b), a DCM may have to periodically adjust its

compliance staff resources to ensure that investigations are completed

within the time period specified in the final rule. However, the

Commission notes that this is not a new cost for DCMs. The Commission,

through RERs, has already communicated to DCMs that it expects a DCM to

complete investigations in a timely manner.

Sections 38.158 (c) and (d) require a DCM to have sufficient

compliance staff to conduct investigations and to prepare investigation

reports. The Commission notes that this is not a new cost for DCMs. The

Commission, through RERs, has already communicated to DCMs that it

expects a DCM to have adequate staff to perform these responsibilities.

The Commission has also reduced the cost associated with proposed Sec.

38.158(c) by eliminating the requirement that an investigation report

include the member or market participant's disciplinary history at the

DCM.

Under Sec. 38.158(e), a DCM will be required to maintain

sufficient compliance staff to conduct investigations and to determine

whether a warning letter should be issued for exchange rule violations.

The Commission notes that this is not a new cost for DCMs. The

Commission, through RERs, has already communicated to DCMs that it

expects a DCM to have adequate staff to perform its self-regulatory

responsibilities and to issue warning letters when appropriate.

Benefits

Section 38.158(a) provides that a DCM must establish and maintain

procedures that require its compliance staff to conduct investigations

of possible rule violations. Investigations that examine potential rule

violations help to ensure that rule violations are appropriately

examined and prosecuted.

The Commission has determined that the completion of investigations

in a timely manner, as required by Sec. 38.158(b), increases the

effectiveness of a DCM's rule enforcement program because prompt

resolution of investigations is essential to discouraging further

violations of a DCM's rules and addressing violations before they

escalate. Timely investigations also assist the Commission in

appropriately and quickly removing bad actors from markets. By ensuring

that DCMs are effectively overseeing potential rule violations on a

regular and timely basis, the rule helps DCMs to determine and address

violations before they escalate, and serves as a beneficial deterrent

against misconduct.

The required elements and information that must be included in an

investigation report under Sec. Sec. 38.158 (c) and (d) will assist

disciplinary panels in determining whether there is a reasonable basis

for finding that a violation of exchange rules warrants the issuance of

charges. The investigation reports that must be provided to the

Commission will also assist in reviewing the adequacy of a DCM's trade

practice and disciplinary programs.

Section 38.158(e) will ensure that warning letters serve as

effective deterrents and will protect the public and market

participants against individuals engaging in recidivist activity. A

policy of issuing repeated warning letters rather than issuing

meaningful sanctions to members and market participants who repeatedly

violate the same or similar rules denigrates the effectiveness of a

DCM's rule enforcement program.

Section 15(a) Factors

1. Protection of market participants and the public. The final rule

protects market participants and the public by requiring DCMs to flag

potential rule violations, providing a framework for which an

investigation is conducted, and protecting against individuals who

attempt to engage in violative recidivist activity. By ensuring that

investigations are adequately performed, the rule protects market

participants and the public by ensuring that remedial action is taken

as appropriate. Moreover, timely investigation of rule violations will

help to promote fair and equitable markets free of abusive trading

practices or manipulative market conditions, and will provide market

users assurance that the overseers of the markets in which they trade

have the capacity to effectively investigate wrongdoing.

2. Efficiency, competitiveness and financial integrity of futures

markets. For the reasons noted above, the final rule also promotes

efficiency, competitiveness, and financial integrity in the derivatives

markets by requiring that a DCM have adequate resources to commence an

investigation upon the discovery or receipt of information indicating

that there is a reasonable basis for finding that a violation may have

occurred or will occur, and to conduct this investigation in a timely

manner.

3. Price discovery. The requirement that DCMs conduct

investigations in a timely manner helps to ensure that the market is

protected from disruptive and manipulative practices. This rule will

help protect the price discovery process of markets from these

violations, and thus help provide confidence in the prices market

participants use to hedge risk.

4. Sound risk management practices. The Commission has not

identified any effects that this rule will have on sound risk

management practices other than

[[Page 36678]]

those enumerated with regard to the factors above.

5. Other public interest considerations. The Commission has not

identified any effects that this rule will have on other public

interest considerations.

Sec. 38.159 (Ability To Obtain Information)

Section 38.159 implements the Core Principle 2 requirement that a

DCM have the ability and authority to obtain necessary information to

perform its rule enforcement obligations, including information sharing

agreements. The Commission did not receive any comments discussing the

costs or benefits of this provision.

Costs and Benefits

This rule codifies and implements the requirements of Core

Principle 2 that DCM must have the ability and authority to obtain any

necessary information to perform any required function, including the

capacity to carry out such international information-sharing

agreements, as the Commission may require. To the extent that a DCM

determines it is necessary for it to enter into an information sharing

agreement with other DCMs or SEFs, the rule makes it clear that this is

permitted. In so doing, DCMs may face additional costs. However, these

costs are unlikely to be significant and will only be incurred should a

DCM determine that it is necessary to enter into an information sharing

agreement with another DCM or with a SEF. Additionally, some DCMs are

already parties to such agreements. The Commission is unable to

quantify the cost of entering into such agreements as the costs will

vary depending on several factors, including the nature of the

agreement, the size of the DCM, and whether the DCM is negotiating a

new agreement or signing-on to an existing agreement.

Section 15(a) Factors

1. Protection of market participants and the public. The final rule

protects market participants and the public by providing a mechanism

for which DCMs can obtain necessary information to carry out their

duties. A DCM's ability and authority to obtain information in order to

perform its rule enforcement obligations is imperative in order to

identify rule violations and ensure that remedial action is taken as

appropriate. Moreover, this requirement will help to promote fair and

equitable markets free of abusive trading practices or manipulative

market conditions, and will provide market users assurance that the

overseers of the markets in which they trade have the capacity to

effectively investigate wrongdoing.

2. Efficiency, competitiveness and financial integrity of futures

markets. For the reasons noted above, the final rule also promotes

efficiency, competitiveness, and financial integrity in the derivatives

markets by requiring that a DCM have an adequate means to obtain

information to enforce its rules.

3. Price discovery. The requirement that DCMs have a mechanism to

obtain appropriate information about traders in its markets helps to

ensure that the market is protected from disruptive and manipulative

practices. This rule will help protect the price discovery process of

markets from these violations, and thus help provide confidence in the

prices market participants use to hedge risk.

4. Sound risk management practices. The Commission has not

identified any effects that this rule will have on sound risk

management practices other than those enumerated with regard to the

factors above.

5. Other public interest considerations. The Commission has not

identified any effects that this rule will have on other public

interest considerations.

(4) Core Principle 3: Contracts Not Readily Susceptible to

Manipulation

Sec. 38.201 (Additional Sources for Compliance and Appendix C)

Section 38.201 refers applicants and DCMs to the guidance in

appendix C to part 38 (Demonstration of Compliance That a Contract is

Not Readily Susceptible to Manipulation), for purposes of demonstrating

their compliance with the requirements of Sec. 38.200, which codifies

Core Principle 3. The guidance under appendix C to part 38 amends and

replaces Guideline No. 1 under appendix A to part 40.

Summary of Comments and Discussion

CME commented that the proposed rulemaking did not identify any

problems with continuing to use the current methodology to estimate

deliverable supply, and claimed that if the proposed standard is

adopted, it will impose additional costs on exchanges and market

participants with no defined benefit, including requiring exchanges to

survey market participants annually.\581\ CME also commented on the

provision that DCMs submit monthly deliverable supply estimates,

stating that this requirement is onerous for DCMs and suggesting that

the Commission should only require monthly estimates of deliverable

supply for the most recent three years.\582\

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\581\ CME Comment Letter at 38 (Feb. 22, 2011).

\582\ CME Comment Letter at 9 (Mar. 28, 2011).

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

The Commission notes that the proposed guidance regarding

estimating deliverable supply is not a departure from existing and

longstanding practice. Estimating deliverable supply has historically

required that a DCM consult with market participants on a regular, if

not monthly, basis. In that regard, the burden of maintaining contacts

with market participants should not be any more or less than it has

been. In response to CME's second comment, the Commission has made

amendments to its proposed appendix C by requiring DCMs to submit

monthly estimates of deliverable supply for the most recent three years

rather than for five years.

Costs

In order to comply with this regulation, DCMs would have to incur

the cost of supplying supporting information and documentation to

justify the contract specifications of a new product or substantial

rule amendment. However, the Commission believes there will likely be

no additional costs attributed to the rule because under existing

practices, DCMs conduct market analysis for new products before

deciding whether or not it makes business sense to list a new product

for trading, including interviewing market participants. Additionally,

DCMs also conduct market analysis before adopting amendments to

existing contract terms and conditions.

Benefits

The guidance outlined in appendix C to part 38 provides a reference

for existing and new regulated markets for information that should be

provided to the Commission for new products and rule amendments based

on best practices developed over the past three decades by the

Commission and other regulators. This guidance will likely reduce the

time and costs that regulated markets will incur in providing the

appropriate information. The guidance also reduces the amount of time

it takes Commission staff to analyze whether a new product or rule

amendment is in compliance with the CEA. Some DCMs regularly provide

the information outlined in appendix C, but others do not include

enough information for Commission staff to determine whether the

contract is in compliance with the CEA. Having all of the supporting

information included in a new product submission or rule amendment

reduces the resources Commission staff must

[[Page 36679]]

expend to request such information from the exchange or to find

independently.

Section 15(a) Factors

1. Protection of market participants and the public. The

information recommended in appendix C for inclusion in the new product

or rule amendment submission provides insight and evidence of the DCM's

research into the underlying cash market of the DCM's product. This

should allow for a timely review by Commission staff of the DCM's

supporting analysis and data to determine whether the contract is not

readily susceptible to manipulation.

2. Efficiency, competitiveness and financial integrity of futures

markets. By providing guidance based on best practices regarding what a

DCM should consider when developing a futures contract or amending the

rules of an existing contract, the contracts listed by DCMs, as a

whole, should be more reflective of the underlying cash market by

promoting efficient pricing through convergence.

3. Price discovery. The guidance provides the information a DCM

should analyze to determine if its contract is designed in such a way

to promote convergence at expiration, and thus promote the price

discovery mechanism of the centralized market.

4. Sound risk management practices. By following the best practices

outlined in the guidance in appendix C, a DCM can minimize the

susceptibility of a contract to manipulation or price distortion while

it is developing the contract terms and conditions for its futures

contract. As a result, the risks to the DCM's clearing house and market

participants would also be minimized.

5. Other public interest considerations. The Commission has not

identified any effects that this rule will have on other public

interest considerations.

(5) Core Principle 4: Prevention of Market Disruption

Sec. 38.251 (General Requirements)

Section 38.251 requires that DCMs collect and evaluate data on

individual traders' market activity on an ongoing basis, monitor and

evaluate general market data, have the ability to conduct real-time

monitoring of trading and comprehensive and accurate trade

reconstructions, and monitor for violations of exchange-set position

limits. Based upon comments, the Commission removed what were perceived

as prescriptive elements from the proposed rule (including a

requirement that DCMs have manual processes or automated alerts

effective in detecting and preventing trading abuses) and included them

in the guidance and acceptable practices in appendix B.

Summary of Comments and Discussion

Several commenters asserted that their current regulatory systems

do not allow for effective real-time monitoring of position limits and

that this regulation would impose additional costs.\583\ Additionally,

MGEX stated that the automated trading alert requirement of proposed

Sec. 38.251 did not provide any real value and only imposed more

burden and cost.\584\

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\583\ CME Comment Letter at 24-25 (Feb. 22, 2011), MGEX Comment

Letter at 4 (Feb. 22, 2011), KCBT Comment Letter at 4 (Feb. 22,

2011), and ICE Comment Letter at 4 (Feb. 22, 2011).

\584\ MGEX Comment Letter at 4 (Feb. 22, 2011).

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

The Commission notes that while Sec. 38.251 requires that DCMs

monitor for intraday position-limit violations it does not require that

position limits necessarily be monitored in real-time. Instead, the

rule requires that DCMs demonstrate the ability to comprehensively and

accurately reconstruct daily trading activity for the purposes of

detecting trading abuses and violations of exchange-set position

limits, including those that may have occurred intraday. The acceptable

practices under appendix B explains that while real-time monitoring is

the most effective method, an acceptable program may monitor for

intraday violations on a T + 1 basis. The flexibility afforded by the

guidance should limit the cost of compliance given that T+1 monitoring

is likely less costly than real-time monitoring.

In order to provide greater specificity to market participants,

reduce costs, and maximize flexibility, the Commission is also

converting the requirement that a DCM have an effective automated

alerts regime to detect trading abuses from a rule to an acceptable

practice so that a DCM will have added flexibility in meeting this

requirement, as the Commission believes that automated trading alerts,

though not necessarily in real time, are the most effective means of

detecting market anomalies. The Commission is also removing provisions

from the proposal dealing with the real-time monitoring of impairments

to market liquidity and clarifying in the guidance and acceptable

practices what must be included in real-time monitoring as compared to

what may not need to be monitored in real-time.

Costs

While some DCMs already have the ability to monitor for intraday

trading abuses and market activity, including position-limit violations

as required in Sec. 38.251, other DCMs may need to hire additional

staff (even if the monitoring is done on a T+1 basis) and may need to

install and maintain new or advanced systems with improved

capabilities. Additional costs will vary based on the number of

products a DCM offers and its trading volumes. However, the Commission

notes that a DCM may be able to reduce the costs associated with this

rule by using a unified monitoring system to jointly satisfy the

requirements of Sec. 38.251 and Sec. 38.157 (Real-time market

monitoring). Notwithstanding any related costs, Sec. 38.251 brings

DCMs into compliance with the statutory language of the Dodd-Frank Act,

which requires that DCMs conduct real-time monitoring of trading

activities and be able to reconstruct trading. The regulation does so

by minimizing costs while abiding by the Dodd-Frank Act.

Benefits

The Dodd-Frank Act amended Core Principle 4 to emphasize that DCMs

must take an active role not only in monitoring trading activities

within their markets, but in preventing market disruptions. Rule 38.251

requires that DCMs have the proper tools to prevent manipulation or

other disruptions. By requiring DCMs to prevent manipulation or other

disruptions, the Commission is able to help ensure that market

participants are able to execute trades at prices that are not subject

to preventable market disruptions. Moreover, to help reduce the cost of

compliance, the Commission is providing DCMs with flexibility in

meeting the rule's requirements as set forth in guidance and acceptable

practices.

Sec. 38.252 (Additional Requirements for Physical-Delivery Contracts)

Section 38.252 requires that DCMs monitor physical-delivery

contracts' terms and conditions as they relate to the underlying

commodity market and to the convergence between the contract price and

the price of the underlying commodity, address conditions that

interfere with convergence, and monitor the supply of the commodity

used to satisfy the delivery requirements.\585\

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\585\ The Commission received comments from CME, MGEX, and KCBT

stating that this rule is overly prescriptive. CME Comment Letter at

25 (Feb. 22, 2011), MGEX Comment Letter at 4-5 (Feb. 22, 2011), KCBT

Comment Letter at 4 (Feb. 22, 2011). The Commission considered these

comments in preparing this release and discusses the costs and

benefits of the codification of rules in lieu of guidance and

acceptable practices in further detail in section C(1) above.

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[[Page 36680]]

Costs and Benefits

The Commission has a long history of monitoring for convergence and

addressing issues of non-convergence.\586\ The Commission notes that

this surveillance requirement is currently in place and that DCMs are

unlikely to incur any additional costs as a result of this codification

of an existing practice. The rules adopted in this release ensure that

market participants are better able to hedge their risk and that price

discovery is enhanced by helping to detect disconnects between futures

and underlying physical market prices. Close monitoring of physical-

delivery contracts helps prevent the manipulation of prices, and the

public benefits from futures prices that reflect actual market

conditions because those prices often form the basis for transactions

taking place in the physical market.

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\586\ See, e.g., ``Statement of the Agricultural Advisory

Committee,'' October 29, 2009, available at: http://www.cftc.gov/idc/groups/public/@aboutcftc/documents/file/aac102909_bruns.pdf.

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Sec. 38.253 (Additional Requirements for Cash-Settled Contracts)

Section 38.253 requires that for cash-settled contracts, a DCM must

monitor the pricing of the index to which the contract will be settled

and also monitor the continued appropriateness of the methodology for

deriving the index. If a DCM's contract is settled by reference to the

price of a contract or commodity traded in another venue, the DCM must

have access to information on the activities of its traders in the

reference market.

Summary of Comments and Discussion

CME commented that the Commission is uniquely situated to add

regulatory value to the industry by reviewing for potential cross-venue

rule violations, noting that the Commission is the central repository

for position information delivered to it on a daily basis in a common

format across all venues.\587\ CME asserted that the Commission would

be imposing an onerous burden on DCMs and their customers by requiring

the reporting of information that the Commission already receives or

will be receiving.\588\ CME also stated that the alternative proposal,

that the DCM enter into an information-sharing agreement with the other

venue, also will result in additional costs to both entities, and that

it may not be practical or prudent for a DCM to enter into such an

agreement with the other venue.\589\ CME noted that its rules already

allow it to request such information from market participants on an as-

needed basis.\590\ Argus stated that the cost of monitoring the

``availability and pricing'' of the commodity making up a third-party

index to which a contract is settled would be prohibitive.\591\

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

\587\ CME Comment Letter at 25-26 (Feb. 22, 2011).

\588\ Id. at 26.

\589\ Id.

\590\ Id.

\591\ Argus Comment Letter at 6-7 (Feb. 22, 2011).

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The Commission believes that a DCM must have the ability to

determine whether a trader in its market is manipulating the instrument

or index to which the DCM contract cash-settles. A DCM must be able to

obtain information on its traders' activities in the underlying

instrument or index. Nonetheless, the Commission believes the rule need

not prescribe the specific methods to accomplish this, for example, by

information-sharing agreements or by placing a reporting burden on

traders who carry a position near contract settlement. Accordingly, the

description of the methods for obtaining these data on traders'

activity in an underlying index or instrument are set forth in the

acceptable practices, rather than included in the rule. Also, the

specific requirement that DCMs monitor the availability and pricing of

the commodity making up the index has been removed from the rule.

Costs

DCMs have, as a part of the contract market designation process,

long been required to perform this type of surveillance on cash-settled

contracts, and thus are unlikely to incur substantial additional costs

on these contracts. DCMs may, however, incur significant additional

costs for collecting information on traders' activities in the

underlying instrument or index. These costs cannot be quantified

because they will vary according to the particular instrument or index.

Moreover, no DCM provided the Commission with any quantification of the

costs of compliance. In consideration of the comment received from CME,

the Commission has attempted to minimize the costs that will be

incurred by giving DCMs some flexibility in determining the size of

positions and the dates for which position data is collected. This will

sharply reduce the costs for DCMs that routinely have few traders that

hold substantial positions near contract expirations.

Benefits

In certain markets, the settlement price is linked to prices

established in another market. Linked markets are becoming more and

more prevalent, and the interconnected nature of these markets may

create incentives for traders to disrupt or manipulate prices in the

reference market in order to influence the prices in the linked market.

Detecting and preventing this sort of manipulation requires information

on traders' activities in the cash-settled contract and in, or related

to, the index to which it is settled. This rule ensures that DCMs have

the information and tools they need to accomplish their statutory duty

to prevent manipulation and disruptions to the cash-settlement process

and enhances the confidence of market participants and the public that

these contracts are free of manipulation.

Sec. 38.254 (Ability To Obtain Information)

Section 38.254 requires DCMs to require that traders in their

markets keep records, including records of their activity in the

underlying commodity and related derivative markets and contracts. If

its market has intermediaries, the DCM must either use a comprehensive

large-trader reporting system or obtain position data from other

sources in order to conduct an effective surveillance program.

Summary of Comments and Discussion

KCBT contended that it is unnecessary and burdensome for a DCM to

require traders to keep such records.\592\ Similarly, MGEX discussed

the burden that the proposed rule would place on its traders as a

result of the proposed record-keeping obligation, and noted that, for

contracts not traded on the DCM, it is unclear what records a DCM must

tell its traders to keep.\593\

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\592\ KCBT Comment Letter at 5 (Feb. 22, 2011).

\593\ MGEX Comment Letter at 5 (Feb. 22, 2011).

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The Commission notes that a trader's burden to keep such records is

sound commercial practice, and that a trader of a reportable size is

already required, under Sec. 18.05 of the Commission's regulations, to

keep records of such trades and to make them available to the

Commission upon request. In addition, the Commission has found trader

records to be an invaluable tool in its market surveillance effort, and

believes that the DCM, as an SRO, should have direct access to such

information in order to fulfill its obligations under the DCM core

principles, and in particular, Core Principle 4. The Commission is,

however, providing in appendix B an

[[Page 36681]]

acceptable practice for meeting the requirements of Sec. 38.254(b)

that allows the DCM to limit the duration and scope of the trader's

obligations. For instance, in the acceptable practices, the Commission

permits a DCM to restrict the record-keeping requirement to traders who

are reportable to the DCM in its large-trader reporting system or who

otherwise hold a substantial position. As an acceptable practice, the

reportable level of a trader is at the discretion of the DCM, as long

as the reportable level is consistent with an effective oversight

program.

Costs

A trader's cost to keep such records should be minimal if, as

expected, it is part of their normal business practice. Moreover, the

Commission already imposes a similar requirement on large traders under

its rule 18.05 (Maintenance of books and records). As a result, a

trader's additional cost to provide records to the DCM, and the DCM's

cost to request and process the records, will be low if, based upon the

Commission's experience, such requests are infrequent and targeted to

specific and significant market situations.\594\

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

\594\ CME opposed the rule as proposed and recommended that the

types of records the DCM should require traders to keep should be

covered in acceptable practices. CME Comment Letter at 26 (Feb. 22,

2011).

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

Benefits

This rule ensures that DCMs have sufficient information in order to

assess the potential for price manipulation, price distortions, and the

disruption of the delivery or cash-settlement process as required by

Core Principle 4. Detecting and preventing manipulation requires

information on large traders' positions in the relevant contracts and

their activities in the underlying markets. Access to this information

is vital to an effective surveillance program. Absent this information,

the DCM may fail in its statutory duty to prevent manipulation and

disruptions to the cash-settlement process.

Sec. 38.255 (Risk controls for trading)

Section 38.255 requires that DCMs establish and maintain risk

control mechanisms to prevent or reduce the potential risk of price

distortions and market disruptions, including, but not limited to,

market restrictions that automatically pause or halt trading in market

conditions prescribed by the DCM.\595\ While the rule requires pauses

and halts, the acceptable practices enumerate other additional types of

risk controls that would also be permitted, giving wide discretion to

the DCM to select among the listed controls, to create new ones that

are most appropriate for their markets, and to choose the parameters

for those selected. If equity products are traded on the DCM, then the

acceptable practices for this rule include, to the extent practicable,

coordination of such controls with those placed by national security

exchanges.\596\

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\595\ The Commission received several comments stating that rule

Sec. 38.255 should not be prescriptive. See, e.g., CME Comment

Letter at 26-27 (Feb. 22, 2011), KCBT Comment Letter at 5 (Feb. 22,

2011), ICE Comment Letter at 12 (Feb. 22, 2011), CFE Comment Letter

at 3-4 (Feb. 22, 2011), NYSE Liffe Comment Letter at 11 (Feb. 22,

2011), ELX Comment Letter at 4 (Feb. 22, 2011), and MGEX Comment

Letter at 5-6 (Feb. 22, 2011). The Commission considered these

comments in preparing this release and discusses the costs and

benefits of the codification of rules in lieu of guidance and

acceptable practices in further detail in section C(1) above.

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

Summary of Comments and Discussion

ICE stated that a temporary price floor or ceiling can work better

than a pause or halt since trading can continue uninterrupted, thereby

offering the earliest opportunity for price reversal should the market

deem a sudden large move to be an overreaction or error.\597\ ICE also

stated that pauses and halts are not the only effective way to prevent

market disruption, and that by being prescriptive, the Commission is

freezing innovation in preventing market disruptions.\598\

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

\597\ ICE Comment Letter at 12 (Feb. 22, 2011).

\598\ Id.

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

In response to ICE and other commenters that question the necessity

of pauses and halts over other forms of risk controls, the Commission

notes that pauses and halts to trading have been effective in the past.

The ability of DCMs to pause or halt trading in extraordinary

circumstances and, importantly, to re-start trading through the

appropriate re-opening procedures, will allow DCMs to mitigate the

propagation of shocks that are of a systemic nature and to facilitate

orderly markets. Furthermore, DCMs must ensure that such pauses and

halts are effective for their specific order-routing and trading

environment and are adapted to the specific types of products traded.

With respect to ICE's comment regarding innovation, the Commission

notes that DCMs are not prohibited from implementing additional risk

controls, such as temporary price floors or ceilings as ICE suggests,

or any other appropriate risk control, including those not enumerated

in the acceptable practices.

Costs

Although pauses and halts are not currently required by Commission

regulation, many DCMs already have the types of risk controls that are

required by Sec. 38.255, as well as others that have been moved to

acceptable practices.\599\ There may be certain one-time costs of

programming such controls where they are not already present as well as

on-going costs to maintain and adjust such controls across time. Some

DCMs have pauses and halts only for stock index futures, while

utilizing other risk controls for other contracts. For those DCMs, the

costs of adding pause and halt functionality to the other contracts

should be minimal since much of that technology would already exist.

DCMs that do not currently utilize pauses and halts should be able to

implement them with existing software, so that the cost should be

relatively modest. As noted in the Pre-Trade Functionality Subcommittee

of the CFTC Technology Advisory Committee report, the costs would

largely be borne by the exchanges and would center around intellectual

property, as many exchanges develop, own, and manage their own

technology.\600\ However, the exact costs associated with implementing

risk controls were not described in verifiable detail in the Pre-Trade

Functionality Subcommittee report and can vary greatly from one DCM to

another. Additionally, the costs will depend on which specific risk

controls will be implemented and the trading platform being used by the

DCM. The Commission received no comments indicating that risk controls

cannot be implemented in a cost-effective manner using commercially

available technology.

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

\599\ An FIA working group survey revealed that 66 percent of

exchanges surveyed currently offer pre-trade risk controls at the

exchange levels and that an additional 27 percent of respondents are

planning to add such controls in the future. See http://www.futuresindustry.org/downloads/RC-survey.pdf at 27.

\600\ See ``Recommendations on Pre-Trade Practices for Trading

Firms, Clearing Firms and Exchanges involved in Direct Market

Access,'' Pre-Trade Functionality Subcommittee of the CFTC

Technology Advisory Committee (``TAC Subcommittee

Recommendations''), (March 1, 2011) at 4, available at http://www.cftc.gov/idc/groups/public/@swaps/documents/dfsubmission/tacpresentation030111_ptfs2.pdf. The Commission notes that the

subcommittee report was submitted to the Technology Advisory

Committee and made available for public comment, but no final action

has been taken by the full committee.

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

As further noted in the Pre-Trade Functionality Subcommittee of the

CFTC Technology Advisory Committee report, ``[s]ome measure of

standardization of pre-trade risk controls at the exchange level is the

[[Page 36682]]

cheapest, most effective and most robust path to addressing the

Commission's concern [for preserving market integrity].'' \601\

Congress specifically modified DCM Core Principle 4 to substitute the

title ``prevention of market disruptions'' for the previous title of

``monitoring of trading.'' The new rules on risk controls, which are

designed to prevent market disruptions before they occur, bring the

rules in line with the amended statute.

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

\601\ See TAC Recommendations at 4, available at http://www.cftc.gov/idc/groups/public/@swaps/documents/dfsubmission/tacpresentation030111_ptfs2.pd.

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

Benefits

The Commission anticipates that the benefits of this rule will be

substantial. As noted in the DCM NPRM, risk controls such as automated

trading pauses and halts can, among other things, allow time for

participants to analyze the market impact of new information that may

have caused a sudden market move, allow new orders to come into a

market that has moved dramatically, and allow traders to assess and

secure their capital needs in the face of potential margin calls.\602\

Moreover, the Commission notes that pauses and halts are particularly

intended to apply in the event of extraordinary price movements that

may trigger or propagate systemic disruptions. Accordingly, the

Commission notes that a DCM's ability to pause or halt trading in

certain circumstances and, importantly, to re-start trading through the

appropriate re-opening procedures will allow DCMs to mitigate the

propagation of shocks that are of a systemic nature and to facilitate

orderly markets. For these reasons, the Commission believes that pauses

and halts are the most effective risk management tools to carry out

this purpose and will facilitate orderly markets and prevent systemic

disruptions. While the Commission is requiring pauses and halts in the

rule, the Commission is enumerating other types of automated risk

controls that may be implemented by DCMs in the acceptable practices in

order to give DCMs greater discretion to select among the enumerated

risk controls or to create new risk controls. The Commission believes

that this combination of rules and acceptable practices will facilitate

orderly markets and mitigate systemic disruptions while maintaining a

flexible environment that facilitates innovation.

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

\602\ 75 FR 80572, 80584, Dec. 22, 2010.

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

Sec. 38.256 (Trade Reconstruction), Sec. 38.257 (Regulatory Service

Provider), and Sec. 38.258 (Additional Sources for Compliance)

Section 38.256 requires a DCM to have the ability to

comprehensively and accurately reconstruct all trading on its trading

facility. The requirement to have the ability to comprehensively and

accurately reconstruct trading appears in the statute itself and has

long been a part of the DCM requirements under former Core Principle

10.

Section 38.257 requires a DCM to comply with the regulations in

this subpart through a dedicated regulatory department, or by

delegation of that function to a regulatory service provider.

The Commission eliminated proposed rule 38.258 (which required a

DCM to adopt and enforce additional rules that are necessary to comply

with this core principle), and replaced it with new Sec. 38.258, which

allows a DCM to refer to the guidance and acceptable practices in

appendix B in order to demonstrate compliance with Core Principle 4.

The Commission received no comments discussing the costs or

benefits of Sec. Sec. 38.256, 35.257, and 38.258 and is adopting Sec.

38.256 with a minor modification, Sec. 35.257 as proposed, and Sec.

38.258 as noted above. In addition, these rules do not contain any

significant changes from existing DCM requirements, and thus it is

unlikely that additional costs will be incurred.

Section 15(a) Factors (Sec. Sec. 38.251-38.258)

1. Protection of market participants and the public. These rules

implementing Core Principle 4 reduce the likelihood that markets will

be subject to manipulation or other disruptions and ensure that market

participants are better able to hedge their risk by requiring that:

DCMs properly monitor their markets; market participants keep adequate

records; DCMs are able to adequately collect information on market

activity, including special considerations for physical-delivery

contracts and cash-settled contracts; and reasonable pre-trade risk

controls are in place that facilitate orderly markets and prevent

systemic disruptions that could harm market participants and the

public. Close monitoring of physical-delivery contracts helps prevent

the manipulation of prices, and the public benefits from futures prices

that reflect actual market conditions because those prices often form

the basis for transactions taking place in the physical market.

2. Efficiency, competitiveness and financial integrity of futures

markets. The rules for market monitoring and implementation of risk

controls, including pauses and halts, help to facilitate orderly,

efficient markets by requiring DCMs to establish and maintain risk

control mechanisms that would be able to prevent or reduce the risks

associated with a variety of market disruptions. By protecting against

disruptions and market manipulation, the rules enhance competitiveness

and promote the efficiency and financial integrity of DCM markets.

Market mispricing that is due to disruptions or manipulation interferes

with a market's efficiency by limiting its ability to reflect the value

of the underlying commodity. Markets that are prone to disruption or

manipulation have a severe competitive disadvantage to those without

such problems. These rules are designed to address and mitigate such

problems. Further, the rules are designed to prevent or mitigate

extreme volatility or other market disruptions that can lead to

unwarranted margin calls and losses of capital, which could otherwise

impair the financial integrity of the market and its participants.

3. Price discovery. Manipulation or other market disruptions

interfere with the discovery of a commodity's value in normal market

circumstances. These rules are designed to detect and, where possible,

prevent such market mispricing and to detect disconnects between

futures and underlying physical market prices. In physical-delivery

markets, such disconnects usually relate to market convergence. In

cash-settled markets, such disconnects usually relate to the integrity

of the index used to settle the futures contract. Under the new rules,

DCMs will need to monitor contract terms and resolve conditions that

are interfering with the price discovery process.

4. Sound risk management practices. Sound risk management relies

upon execution of hedge strategies at market prices that are free of

manipulation or other preventable disruptions. These rules are designed

to facilitate hedging at prices free of distortions that may be

preventable by adequate controls.

5. Other public interest considerations. The Commission has not

identified any effects that this rule will have on other public

interest considerations.

(6) Core Principle 5: Position Limitations or Accountability

Core Principle 5 requires that DCMs, for each contract and as

necessary and appropriate, adopt position limitation or position

accountability, and that, for any contract that is subject to a

position

[[Page 36683]]

limitation established by the Commission in part 151 of the

Commission's regulations,\603\ DCMs must set the position limit at a

level not higher than the position limitation established by the

Commission.

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\603\ See ``Position Limits for Futures and Swaps,'' 76 FR

71626, Nov. 18, 2011.

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

Summary of Comments and Discussion

The Commission received several comments pertaining to the

Commission's codification of part 151 of its regulations. These

comments were appropriately addressed in the relevant rulemaking for

Position Limits for Futures and Swaps.\604\

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

\604\ Id.

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(7) Core Principle 6: Emergency Authority

Sec. 38.351 (Additional Sources for Compliance and Appendix B)

Rule 38.351 refers applicants and DCMs to appendix B to part 38--

``Guidance on, and Acceptable Practices in, Compliance With Core

Principles'' for purposes of demonstrating compliance with the

requirements of Core Principle 6. The guidance for Core Principle 6

tracks the former guidance to previous Core Principle 6. As such, the

costs and benefits of administering emergency procedures pursuant to

current Core Principle 6 should be no different than the costs and

benefits of administering emergency procedures prior to the Dodd-Frank

Act. The Commission did not receive any comments discussing the costs

or benefits of these provisions.

(8) Core Principle 7: Availability of General Information

Sec. 38.401 (General Requirements)

Section 38.401(a) requires DCMs to have in place procedures for

disclosing to market authorities, market participants, and the public

accurate and relevant information pertaining to rules and regulations,

contract terms and conditions, and operations. Section 38.401(b)

requires that each DCM have procedures in place to ensure that, to the

best of its knowledge, any information or communication with the

Commission is accurate and complete. Section 38.401(c) requires DCMs to

post such information on their Web sites concurrent with the filing of

such information with the Commission. Section 38.401(d) requires DCMs

to update their rulebooks upon the effectiveness of a rule submission

or certification.

Costs

The few requirements in Sec. 38.401 that do not simply replicate

the statutory language were derived from previous guidance and

acceptable practices that reflect existing industry practices, and thus

should impose no new costs on DCMs or market participants. For example,

the accuracy requirement is unlikely to impose additional costs on

market participants because the statute already contains an accuracy

requirement; the rule simply adds additional context to the

requirement. The requirements for a DCM to place information on its web

site on the same business day as the filing of such information with

the Commission and to post new or amended rules on the date of

implementation are unlikely to result in additional costs to DCMs

because similar requirements existed in the guidance and acceptable

practices under the original Core Principle 7. No DCM commented on the

costs imposed by this rule.

Benefits

Market authorities, market participants, and the public all benefit

from access to accurate, relevant, and timely information pertaining to

contract terms and conditions, new product listings, new or amended

governance, trading and product rules, and other changes to information

previously disclosed by the DCM. The disclosure of accurate information

to the Commission will assist the Commission's oversight of the markets

by enabling the Commission to evaluate a DCM's compliance with the core

principles and to take prompt action to ensure transparent, fair, and

orderly markets.

Prompt posting of information pertaining to new product listings,

new rules, and rule amendments on the DCM's Web site will ensure that

market participants and the public have sufficient notice and time to

analyze proposed rule amendments, product listings/de-listings, and

rule certifications in advance of their taking effect and to be able to

plan their actions accordingly. Advance notice of rule amendments and

certifications is consistent with the goal of Core Principle 7 to make

pertinent information available to market participants and the public.

Section 15(a) Factors

1. Protection of market participants and the public. To protect

market participants and the public, the Commission has comprehensive

regulatory, surveillance, investigative, and enforcement programs. To

support these programs, the Commission must have access to accurate,

relevant, and timely information regarding contract terms and

conditions, new product listings, new or amended governance, trading

and product rules, and other changes to information previously

disclosed by the DCM. Additionally, prompt posting of information

pertaining to new product listings, new rules, and rule amendments on

the DCM's Web site will ensure that market participants and the public

have sufficient notice and time to analyze these changes and report any

problems to the Commission in advance of the changes taking effect.

2. Efficiency, competitiveness and financial integrity of futures

markets. In order to promote efficient, competitive, and financially

stable markets, the Commission must have access to accurate, relevant,

and timely information regarding contract terms and conditions, new

product listings, new or amended governance, trading and product rules,

and other changes to information previously disclosed by the DCM. The

Commission must have notice of these changes in order to analyze their

likely impact on the efficiency, competitiveness, and financial

integrity of the futures markets and to take action as necessary.

3. Price discovery. The disclosure of accurate information to the

Commission will assist the Commission's oversight of the markets and

protect market participants by enabling the Commission to evaluate a

DCM's compliance with the core principles.

4. Sound risk management practices. The disclosure of accurate

information to the Commission will assist the Commission's oversight of

the markets and protect market participants by enabling the Commission

to evaluate a DCM's compliance with the core principles, including Core

Principle 11 (Financial Integrity of Transactions). A detailed

discussion of Core Principle 11 in light of the section 15(a) factors

appears later in this release.

5. Other public interest considerations. The Commission has not

identified any effects that this rule will have on other public

interest considerations.

(9) Core Principle 8: Daily Publication of Trading Information

Sec. 38.451 (Reporting of Trade Information)

Core Principle 8 requires that a board of trade make public daily

information on settlement prices, volume, open interest, and opening

and closing ranges

[[Page 36684]]

for actively traded contracts on the contract market. Section 38.451

refers a DCM to part 16 of the Commission's regulations in order to

meet the compliance requirements of Core Principle 8. This rulemaking

also revises Sec. 16.01 with regards to the information a reporting

market must record and publish by adding swaps and options on swaps.

Also, Sec. 16.01 is revised to add the requirement that reporting

markets also report to the Commission information pertaining to ``the

total volume of block trades that are included in the total volume of

trading.''

Summary of Comments and Discussion

CME did not object to reporting block trades that are included in

the daily volume of trading, but noted that this new requirement will

require it to ascertain what systems changes will be necessary and how

long such changes will take to implement.\605\ CME did not provide any

cost or time estimates.

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

\605\ CME Comment Letter at 29 (Feb. 22, 2011).

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The Commission believes that it is necessary for DCMs to report

trade information; the regulation provides the reporting markets

flexibility to make the necessary and appropriate changes to their

systems in a cost-effective manner while providing transparency to the

markets by means of basic summary trading information of that day's

trading session.

Costs

The cost of reporting volume for swaps should be similar to the

cost of reporting volume for futures and options. The Commission did

not receive any comments that provide otherwise. Further, the

Commission does not anticipate that DCMs that choose to list swaps will

need to make any changes to systems beyond those needed to report

prices and volume for any new contract. The requirement to publish the

total volume of block trading at the end of the day will be an added

cost for the DCM. This provision may require some changes to DCMs'

current systems. However, because DCMs already have or will have to

have systems in place to provide daily trading volumes under Sec.

16.01, any costs to now include the reporting of blocks should be

minimal. It is not feasible to quantify the costs of necessary system

changes, largely because it is unclear what system changes will be

adopted by DCMs. The Commission did not receive any comments stating

that the regulation imposes an unnecessary burden.

Benefits

The Commission allows DCMs significant flexibility in complying

with this rule. As such, DCMs are free to design a system that provides

the transparency required by part 16 in the most cost effective manner.

This rule complies with the statute and provides transparency to the

markets by requiring DCMs to publish end of day price and volume

summary information to the public and to the Commission.

Section 15(a) Factors

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

complies with Core Principle 8 by ensuring that volume and price

information is publicly available on a daily basis. Market participants

and the public will be able to make economic decisions based on

accurate futures and swaps prices that are reported on a timely basis.

2. Efficiency, competitiveness, and financial integrity of futures

markets. The rule will promote the efficiency and competitiveness of

futures markets by ensuring that volume and price data for futures,

options, and swaps traded at all DCMs are publicly available.

Competitiveness may be enhanced to the extent that market participants

are able to compare prices of similar contracts at different DCMs.

3. Price discovery. The rule promotes price discovery by ensuring

that end of day trading data, including volume and prices, are

disseminated to the public. An important benefit of price discovery is

the availability of prices to market participants and the public who

may use this information to inform their economic decisions.

4. Sound risk management practices. The Commission has not

identified any effects that this rule will have on sound risk

management practices.

5. Other public interest considerations. The rule provides post-

trade transparency to the markets by requiring DCMs and SEFs to publish

end of day trading data including volume and prices to show the

activity that occurred during that day's trading session.

(10) Core Principle 9: Execution of Transactions

Sec. 38.501-38.506

The Commission received a number of comments pertaining to the

costs and/or benefits of proposed Sec. Sec. 38.501-38.506. As noted

above, the Commission is not finalizing these provisions at this time,

and expects and plans to take up the proposed rules under Core

Principle 9 when it considers the final SEF rulemaking. Comments

pertaining to these proposed rules, including those relative to costs

and/or benefits, will be considered in such future rulemaking.

(11) Core Principle 10: Trade Information

Sec. 38.551 (Audit Trail Required), Sec. 38.552 (Elements of an

Acceptable Audit Trail Program), and Sec. 38.553 (Enforcement of Audit

Trail Requirements)

Section 38.551 establishes the requirements of an acceptable audit

trail program to help ensure that DCMs can monitor and investigate any

customer or market abuses.

Section 38.552 sets forth the four program areas that a DCM must

address as part of an acceptable audit trail program, including

original source documents, transaction history database, electronic

analysis capability, and safe storage of all audit trail data.

Section 38.553(a) establishes the elements of an effective audit

trail enforcement program. Additionally, Sec. 38.553(b) requires that

an effective audit trail enforcement program must enable the DCM to

identify entities that are routinely non-compliant with the regulations

under Core Principle 10 and to levy meaningful sanctions when such

deficiencies are identified. The regulation prohibits DCMs from issuing

more than one warning letter for the same violation within a rolling

12-month time period.

Summary of Comments

CME and MGEX argued that the requirement for enforcement of an

audit trail program to annually audit all market participants would

essentially require the exchange to review every participant who enters

an order into the trading system, which would be onerous, costly, and

unproductive.\606\ MGEX suggested that DCMs should only be required to

review a sample of market participants.\607\

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

\606\ CME Comment Letter at 33-34 (Feb. 22, 2011), MGEX Comment

Letter at 7 (Feb. 22, 2011).

\607\ MGEX Comment Letter at 7 (Feb. 22, 2011).

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

Discussion

In response to comments that requiring exchanges to conduct annual

audits of all members and market participants would be onerous and

costly, the Commission is revising proposed Sec. 38.553 to apply only

to ``members and persons and firms subject to designated contract

market recordkeeping rules.'' With this change, the Commission limits

the universe of entities that a DCM must audit for compliance with Core

Principle 10. This

[[Page 36685]]

revision addresses commenters' concerns by making the annual audit

requirement less burdensome.

Additionally, this revision also responds to MGEX's comments that

the Commission should allow DCMs to test for audit trail compliance by

auditing only a sample of market participants. While the number of

persons and entities subject to audit has been reduced in the final

rule, the remaining population must still be audited annually to ensure

compliance. As explained above, this revision will decrease the burden

on DCMs.

The Commission believes it is essential for DCMs to have complete

and accurate access to trade information to facilitate trade

reconstructions and thereby detect customer and market abuses. The

Commission believes it is essential for DCMs to have complete and

accurate access to trade information to facilitate trade

reconstructions and thereby detect customer and market abuses. The

Commission has determined that the audit trail requirements and the

annual audits of members and entities subject to Commission or DCM

recordkeeping rules are the best way to achieve its policy objectives,

while providing DCMs with flexibility to achieve these objectives. The

Commission has considered the comments raised related to the cost of

ensuring that customer and market abuses can be detected, prosecuted,

and ultimately discouraged, and believes that the benefits of the rule

as finalized are substantial.

Costs

The costs associated with Core Principle 10 include the cost of

developing and maintaining an electronic history transaction database

to maintain a history of all orders and transactions entered into the

trading system and electronic analysis capability to permit the

exchange to reconstruct orders and trades. DCMs will also bear the cost

of developing and implementing a program to collect and maintain

original source documents for trades entered both manually and

electronically into the trading system. Core Principle 10 compliance

also imposes costs for developing and maintaining a safe storage system

for all the trade data collected and ensuring that such data is readily

accessible to exchange compliance staff. The Commission notes, however,

that almost all exchanges currently operating are in compliance with

these regulations. Therefore, existing DCMs should have already

established these programs and, as such, should have already borne the

costs necessary to comply with these requirements.

These requirements were previously explained in the guidance and

acceptable practices for Core Principle 10--Trade Information. The

Commission's RERs have frequently highlighted compliance with the

guidance and acceptable practices in the discussion of an exchange's

audit trail program. Specifically, past RERs have discussed exchanges'

practices regarding use of an electronic history transaction database,

electronic analysis capability, and safe storage systems. As such, the

Commission is simply codifying these existing practices and regulations

as rules.

DCMs will incur costs to ensure they employ appropriate resources

to enforce Core Principle 10's requirements, including the ability to

conduct annual compliance audits by hiring sufficient staff to review

the information and having in place adequate technology to retrieve and

store the information. It is not feasible to quantify the costs for

appropriate resources for audit trail and Core Principle 10 enforcement

because the factors necessary to determine what resources are

``appropriate'' vary widely from exchange to exchange, and the costs

for each variable depend upon the particular circumstances of each

exchange. For example, the number of participants who trade on a

particular exchange varies widely and the number of participants who

are members and persons and firms subject to Commission or DCM

recordkeeping rules directly corresponds to the number of annual

compliance audits a particular DCM will conduct to determine compliance

with all audit trail requirements.

While the Commission is imposing new requirements that specify

certain components that must be incorporated in audit trail reviews,

the Commission notes that most exchanges already have such resources in

place and conduct audit trail reviews in such a manner to comply with

these new regulations due to the RER process and recent

recommendations. What constitutes ``appropriate resources'' to oversee

and enforce the audit trail requirements is addressed on an

individualized basis in the specific RERs for each exchange.

Importantly, no DCM provided the Commission with information related to

the current cost of compliance and the estimated increase related to

codification of existing practices.

Benefits

Core Principle 10 and the associated regulations promote the

reliability, completeness, accuracy, and security of exchange order and

trade data. The ability of DCMs to recover, review, and reconstruct

trading transactions is imperative to monitor for potential customer

and market abuses. The requirements of Core Principle 10 ensure the

ability of DCMs to prosecute rule violations supported by evidence from

audit trail data and order and trade information. This furthers the

protection of market participants by requiring exchanges to have the

ability to adequately conduct market surveillance and prosecute rule

violations.

The requirement that exchanges issue no more than one warning

letter for the same violation within a rolling twelve-month time period

will ensure that instead of simply sending multiple warning letters,

exchanges levy meaningful fines and sanctions to deter recidivist

behavior and prevent future rule violations.

Section 15(a) Factors (Sec. Sec. 38.551-38.553)

1. Protection of market participants and the public. Sections

38.551-38.553 benefit the protection of market participants and the

public by requiring that DCMs maintain all order and trade information

so that rule violations that could harm market participants and the

public may be detected, reconstructed, investigated, and prosecuted. A

DCM cannot complete its surveillance and enforcement practices without

such audit trail data collection and requirements. The absence of these

regulations would result in an increased potential for violations to go

undetected. Such requirements strengthen DCMs' market oversight

capabilities and result in stronger protection of market participants

and the general public from rule violations and market abuses.

2. Efficiency, competitiveness, and financial integrity of futures

markets. The regulations under Core Principle 10 implemented in

Sec. Sec. 38.551-38.553 promote efficiency and competitiveness by

ensuring that DCMs can adequately monitor their markets for rule

violations and effectively prosecute and deter such rule violations.

These regulations strengthen market confidence by deterring such rule

violations, thereby promoting efficient pricing and a competitive

trading atmosphere.

3. Price discovery. Sections 38.551-38.553 benefit the price

discovery process of markets by allowing DCMs to detect and prosecute

rule violations that impede market prices from accurately reflecting

information pertaining to underlying fundamentals. Having a process by

which to detect, reconstruct, investigate, and prosecute rule

violations deters market participants

[[Page 36686]]

from engaging in activities which harm the market's price discovery

process.

4. Sound risk management practices. The Commission has not

identified any effects that this rule will have on sound risk

management practices.

5. Other public interest considerations. The Commission has not

identified any effects that this rule will have on other public

interest considerations.

(12) Core Principle 11: Financial Integrity of Transactions

Sec. 38.601-38.606

Section 38.601 provides that all transactions executed on or

through a DCM, other than transactions in security futures products,

must be cleared through a Commission-registered DCO. Section 38.602

provides that DCMs must adopt rules establishing minimum financial

standards for both member FCMs and IBs and non-intermediated market

participants. Section 38.603 provides that DCMs must adopt rules for

the protection of customer funds.

Section 38.604 requires that a DCM must routinely receive and

promptly review financial and related information from its members, and

conduct ongoing financial surveillance of the risk created by the

positions taken by an FCM's customers. Section 38.605 requires DCMs, as

self-regulatory organizations, to comply with the standards of amended

Sec. 1.52 to ensure the financial integrity of intermediaries by

establishing and carrying out an SRO program for the examination and

financial supervision of intermediaries. Section 38.606 provides that

DCMs may satisfy their financial surveillance responsibilities under

Sec. Sec. 38.604 and 38.605 by outsourcing such responsibilities to a

regulatory service provider if certain requirements are met.

Summary of Comments and Discussion

KCBT commented that because its rules incorporate by reference the

requirements of the CEA, the requirement to implement exchange rules

that mirror Commission regulations is duplicative, unnecessary and

burdensome.\608\

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

\608\ KCBT Comment Letter at 7 (Feb. 22, 2011).

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

The Commission believes the establishment of independent financial

integrity rules is important because it will provide evidence that: (i)

Each DCM has focused attention on the specific regulations promulgated

under the CEA; and (ii) such regulations are appropriately implemented.

Section 38.603 does not specify the exact rules to be implemented by

each DCM, but sets forth the substance of what the rules of each DCM

must address; therefore, a DCM would be unable to meet the requirements

of the rule by incorporating the CEA requirements by reference.

Costs

Section 38.601 imposes no new costs on DCMs, as all transactions on

a DCM are currently subject to mandatory clearing; this was required by

the former core principle, before it was amended by the Dodd-Frank Act.

Section 38.602 imposes no new costs as all DCMs are currently

required to have rules establishing minimum financial standards for

member FCMs and IBs pursuant to Core Principle 11. The Commission will

continue to review the financial standards that each DCM has

established to be certain that the DCM is in compliance with the rule.

The requirements of Sec. 38.603 relating to the protection of customer

funds are all existing requirements pursuant to former Designation

Criterion 5(b) and have been found to be effective in monitoring and

mitigating financial risk. By incorporating the substantive standards

from former designation criteria that have already been implemented by

registered DCMs, the Commission aims to minimize implementation costs.

However, the explicit requirement that DCMs adopt rules, as opposed to

solely incorporating the requirements of the CEA by reference, will

involve administrative costs on the part of DCMs, such as enacting the

appropriate rules and building the understanding within its staff of

those rules.

The requirements of Sec. 38.604 also reflect requirements pursuant

to former Designation Criterion 5(a). However, the rule does build on

the foundation of historical compliance by DCMs by explicitly requiring

intraday financial surveillance. The Commission believes that intraday

surveillance is necessary to account for possible intraday risk build-

up and to meet the requirements of the financial integrity core

principle. Because DCOs currently conduct intraday monitoring, DCMs

should already meet this requirement through the DCO(s) that provides

their clearing services. As the Commission notes in the preamble, an

arrangement between a DCO and a DCM, whereby the DCO is responsible to

a DCM for the performance of certain functions, including this

monitoring, will continue to be permitted by the Commission. Therefore,

intraday financial surveillance should not impose new costs on DCMs.

DCMs will not need to expend significant additional resources to

comply with Sec. 38.605 as all DCMs have existing SRO programs in

place and currently are in compliance with section 1.52, as well as the

guidance that has now been incorporated into section 1.52 from Division

of Trading and Markets Financial and Segregation Interpretations 4-1

and 4-2. Further, the JAC Agreement, as discussed above, is already in

place and operating effectively.

Section 38.606 provides DCMs with the option of outsourcing their

financial surveillance responsibilities if they would prefer not to do

such surveillance in house. Although Sec. Sec. 38.604 and 38.605

impose the actual surveillance requirements, those DCMs electing to

outsource such surveillance responsibilities will incur costs related

to conducting due diligence of the regulatory service provider and

making sure the DCM has adequate staff to monitor the provider. The

Commission is unable to quantify such costs because the rule does not

require a certain method of due diligence, and therefore the costs

would vary based on the practices and choices of each DCM.

Benefits

Section 38.601 is a codification of the statutory requirement in

Core Principle 11. Section 38.602 requires a DCM to establish and

maintain minimum financial standards for market participants, which is

essential to mitigating systemic risk. Implementing the requirements of

the core principle, which requires that each DCM has rules to ensure

the financial integrity of FCMs and IBs, achieves the Commission's

regulatory objectives by ensuring the financial integrity of the

transactions entered into by or through the facilities of the contract

market, while also providing flexibility as to how to meet the

requirements of the core principle.

Rule 38.603 implements the requirement of the core principle that

DCMs establish and enforce rules to ensure the protection of customer

funds. DCMs, as SROs, are well-positioned to undertake the

responsibility of establishing such rules and ensuring the compliance

of intermediaries with those rules. As a result, the requirements of

Sec. 38.603 enhance the protection of customers (who are both market

participants and members of the public) from the losses incurred by

fellow customers. This directly enhances the protection of market

participants and the public, and promotes sound risk management.

Moreover, by mitigating the loss of customer funds, which loss in turn

would damage all customers' confidence in the safety of the funds they

post as collateral for cleared

[[Page 36687]]

positions, these requirements mitigate systemic risk.

The intraday surveillance requirement in Sec. 38.604 requires that

a DCM continually survey each FCM's obligations created by its

customers. Satisfaction of this requirement is necessary for a DCM to

meet the requirements of the core principle to have rules ensuring the

financial integrity of market participants, as well as the protection

of customer funds. By conducting intraday surveillance and acting on

the results of the surveillance, DCMs will be able to address intraday

risks before they grow larger and therefore avoid losses to DCOs

carrying FCMs or customers.

For section 38.605, existing benefits include avoiding duplicative

review of members, as well as ensuring the financial integrity of FCMs

and IBs, protecting customer funds and contributing to market

confidence. In addition, because Sec. 38.606 provides a DCM with

options, it is more efficient and cost-effective as DCMs can choose

whether to allocate their own resources to this surveillance or to use

a regulatory service provider.

Section 15(a) Factors (Sec. Sec. 38.601-38.606)

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

protect market participants and the public by ensuring the financial

integrity of DCM transactions via clearing of all transactions on a

DCM, financial surveillance of members and minimum standards for

members. The protection of customer funds rules protect customers from

the losses incurred by either other market participants or fellow

customers, thereby strengthening the financial integrity of the markets

and decreasing potential systemic risks.

2. Efficiency, competitiveness and financial integrity of futures

markets. Since most of these rules codify pre-existing requirements,

DCMs are already in compliance. As a result, the rules do not require

significant changes (i.e., costs), and therefore have minimal effect on

the competitiveness of futures markets. The addition of rules requiring

intraday financial surveillance will benefit the financial integrity of

the markets by requiring DCMs to have procedures that will foster DCMs

addressing intraday risks before they grow larger, thereby avoiding

losses to DCOs carrying FCMs or customers.

3. Price discovery. The Commission has not identified any effects

that this rule will have on price discovery.

4. Sound risk management practices. The rules requiring the

establishment of minimum financial standards for DCM market

participants promote sound risk management practices by ensuring that

market participants have a certain level of sophistication and

resources, which in turn, mitigates systemic risk.

5. Other public interest considerations. The Commission has not

identified any effects that this rule will have on other public

interest considerations.

Sec. 38.607 (Direct Access)

Section 38.607 requires a DCM that allows customers direct access

to its contract market to implement certain direct access controls and

procedures (such as automated pre-trade controls) in order to provide

member FCMs with tools to manage their financial risk.

Costs

As discussed in the preamble, a recent Futures Industry Association

(``FIA'') report stated that the majority of exchanges have policies

and tools in place that comply with the recommendation that mandatory

pre-trade controls be set at the exchange level.\609\ As a result,

these requirements will not impose significant costs on a majority of

DCMs. Those DCMs that do not have controls and procedures in place, but

do allow customers direct access to the contract market, will incur

costs in implementing these controls and procedures, and FCMs will

incur costs in utilizing the controls and procedures. The Commission is

unable to quantify such costs because the rule does not require a

certain set of controls and procedures, and therefore the costs would

vary based on the controls adopted by the individual DCM. In addition,

such costs would also vary depending on the DCM's existing

infrastructure, which varies markedly across exchanges. Moreover,

commenters did not discuss the costs of this provision.

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

\609\ See FIA report on ``Market Access Risk Management

Recommendations'' (April 2010), available at: http://www.futuresindustry.org/downloads/Market_Access-6.pdf.

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

Benefits

The requirements of this rule will enable an FCM to protect itself

when a customer has direct access to a DCM and completes a trade before

an FCM's systems have an opportunity to prevent the execution of such

trade, thereby avoiding losses that could extend to customers or the

DCO from trades that would exceed the parameters set by the FCM on the

DCM. Further, as discussed in the preamble, the benefits of risk

controls at the FCM, DCO and DCM level, discussed above, have been

recognized both domestically and internationally.

Section 15(a) Factors

1. Protection of market participants and the public. The final rule

promotes the protection of market participants and the public because

it enables an FCM to protect itself from its customers with direct

access to the DCM, thereby preventing customers from undertaking risks

that could bankrupt an FCM.

2. Efficiency, competitiveness and financial integrity of futures

markets. Automated controls will permit an FCM to enforce limitations

on its customers' trading via direct access, which will serve to

protect all market participants, which will also promote the efficient,

competitive, and financial integrity of futures markets.

3. Price discovery. The Commission has not identified any effects

that this rule will have on price discovery.

4. Sound risk management practices. Without the aid of controls at

the DCM-level, an FCM will be unable to protect itself from its

customers with direct access to the DCM. Therefore, the final rule

serves sound risk management practices by enabling FCMs to manage risk.

5. Other public interest considerations. The Commission has not

identified any effects that this rule will have on other public

interest considerations.

(13) Core Principle 12: Protection of Markets and Market Participants

Section 38.651 provides that a DCM must have and enforce rules that

are designed to promote fair and equitable trading and to protect the

market and market participants from abusive practices including

fraudulent, noncompetitive or unfair actions, committed by any party.

Costs and Benefits

Section Sec. 38.651 specifies DCMs' obligations under Core

Principle 12 relating to their compliance with Core Principles 2, 4 and

9, and the associated regulations. Accordingly, Sec. 38.651 does not

impose any additional costs beyond those discussed under each of the

respective Core Principles 2, 4 and 9.

(14) Core Principle 13: Disciplinary Procedures

Core Principle 13 consists of a series of rules that, among other

things, seek to ensure a fair, prompt, and effective disciplinary

program.\610\ A more

[[Page 36688]]

detailed description of the Core Principle 13 rules themselves is

contained in the preamble.

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

\610\ CME and MGEX stated that a number of the rules

implementing Core Principle 13 are overly prescriptive. See CME

Comment Letter at 35-36 (Feb. 22, 2011) and MGEX Comment Letter at 9

(Feb. 22, 2011). The Commission considered these comments in

preparing this release and discusses the costs and benefits of the

codification of rules in lieu of guidance and acceptable practices

in further detail in section C(1) above.

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Sec. 38.701 (Enforcement Staff)

Rule 38.701 requires that a DCM must establish and maintain

sufficient enforcement staff and resources to effectively and promptly

prosecute possible rule violations.

Costs

The obligations imposed by Sec. 38.701 are not new; rather, the

requirements for DCMs to ensure adequate staff and resources stem from

recent RERs, in which Commission staff recommended that DCMs increase

their compliance staff levels and monitor the size of their staff and

increase the number of staff as appropriate.\611\ Accordingly, the

Commission does not anticipate that this provision will impose

additional costs on DCMs.

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

\611\ See Rule Enforcement Review of the Minneapolis Grain

Exchange (Aug. 27, 2009), Rule Enforcement Review of ICE Futures

U.S. (Feb. 2, 2010), and Rule Enforcement Review of the Chicago

Board of Trade and the Chicago Mercantile Exchange (Sept. 13, 2010)

for findings and recommendations pertaining to the adequate staff

size of DCM compliance departments.

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

Benefits

The Commission believes that adequate enforcement staff and

resources are essential to the effective performance of a DCM's

disciplinary program. Without an effective disciplinary program, a DCM

will be unable to effectively and promptly investigate and adjudicate

potential rule violations and deter future violations. Rule 38.701

ensures that DCMs monitor the size of their staff and increase the

number of staff appropriately as trading volume increases, new

responsibilities are assigned to compliance staff, or internal reviews

demonstrate that work is not completed in an effective or timely

manner. Rule 38.701 also ensures the independence of enforcement staff

and promotes disciplinary procedures that are free of potential

conflicts of interest by providing that a DCM's enforcement staff may

not include members of the exchange or persons whose interests conflict

with their enforcement duties.

Sec. 38.702 (Disciplinary Panels)

Rule 38.702 requires DCMs to have one or more ``review panels,

without imposing a specific requirement for DCMs to maintain a ``review

panel'' and a ``hearing panel.''

Costs

The requirement in the rule to establish disciplinary panels

reflects industry practices that have already been adopted by most

DCMs. Accordingly, the Commission anticipates that Sec. 38.702 will

not impose additional cost burdens on most DCMs. To the extent that the

rule does impose costs on DCMs, the Commission notes that since

disciplinary panel members are typically unpaid, any potential costs

associated with Sec. 38.702 would be limited to administrative costs

associated with establishing the disciplinary panel, which are likely

to vary by DCM. Finally, as described above, in response to concerns

raised by commenters, the Commission has removed the proposed

requirement to maintain distinct hearing panels and review panels,

thereby reducing the burden associated with the proposed rule.

Benefits

Rule 38.702 requires DCMs to establish one or more disciplinary

panels authorized to fulfill their obligations under the part 38 rules,

including, among other things, to issue notices of charges, conduct

hearings, render written decisions, and impose disciplinary sanctions.

These functions are critical components of a DCM's disciplinary program

and will deter violations of DCM rules, prevent recidivist behavior,

protect respondents by requiring procedural safeguards to ensure

fairness for all respondents in disciplinary actions, and protect

customers by requiring full customer restitution in any disciplinary

matter where customer harm is demonstrated.

In addition to providing these numerous benefits, Sec. 38.702

permits flexibility in the structure of DCMs' disciplinary bodies but

protects against conflicts of interest by ensuring that the same

individual is not invested with the authority to both issue and

adjudicate charges in the same manner.

Sec. 38.703-38.711 and Guidance

Rules 38.703-38.711, and the accompanying guidance, seek to ensure

a fair, prompt, and effective disciplinary program by, among other

things, requiring a notice of charges and providing respondents with a

right to representation, a reasonable period of time to file an answer

to charges, and the right to a fair hearing. The rules also outline

procedures for rendering disciplinary decisions and issuing

disciplinary sanctions and warning letters. In response to comments

requesting greater flexibility, the Commission is also converting

several proposed rules into guidance in order to reduce potential

incremental costs resulting from the final rules. This guidance will

cover notices of charges, the admission or failure to deny charges,

settlement offers, hearings, rights to appeal, summary fines, and

emergency disciplinary sanctions.

Summary of Comments and Discussion

The Commission did not receive any specific comments discussing

costs or benefits of proposed Sec. Sec. 38.703-38.716. However,

several commenters made general requests for greater flexibility across

all core principles. Accordingly, the Commission has modified certain

aspects of the proposed rules under Core Principle 13 where it believes

that flexibility can reasonably be afforded. To that end, the

Commission is converting the following proposed rules, in their

entirety, to guidance: proposed Sec. 38.707 (Admission or failure to

deny charges); proposed Sec. 38.709 (Settlement offers); proposed

Sec. 38.712 (Right to appeal); and proposed Sec. 38.716 (Emergency

disciplinary actions). In addition, the Commission is moving the

following specific requirements to guidance: the requirements under

paragraphs (a) and (b) of proposed Sec. 38.704, which allowed, but did

not require, a DCM to issue rules regarding failures to request a

hearing and expressly answer or deny a charge; the provision under

paragraph (b) of proposed Sec. 38.710, which provided that the DCM's

rules may provide that a sanction may be summarily imposed upon any

person whose actions impede the progress of a hearing; and the

provisions under proposed Sec. 38.715 that permitted, but did not

require, a DCM to adopt a summary fine schedule.

The Commission is also removing the following proposed provisions

from the final rules: paragraphs (a) and (b) under proposed Sec.

38.703 regarding the review of investigation reports when additional

evidence is needed or no reasonable basis exists for finding a

violation; the section of proposed Sec. 38.708 which was optional,

allowing a DCM's rule to provide that, except for good cause, a hearing

must be concerned only with those charges denied or sanctions set by

the panel for which a hearing has been requested; and the optional rule

under proposed Sec. 38.710(a)(7) which, in certain cases, allowed for

the cost of transcribing the record of the hearing to be borne by the

respondent.

Costs (Sec. 38.703-38.712 and Guidance)

While Sec. 38.701 and Sec. 38.702 impose specific requirements on

DCMs to have sufficient enforcement staff and

[[Page 36689]]

resources and to establish disciplinary panels, the remainder of the

Core Principle 13 regulations simply outline the policies and

procedures that a DCM's disciplinary program must follow. The

Commission notes that these Core Principle 13 regulations merely

reflect disciplinary concepts formerly found in Designation Criterion

6, part 8 of the Commission's regulations,\612\ and the guidance and

acceptable practices for former Core Principle 2. Accordingly, existing

exchanges generally have already established disciplinary programs and,

as such, have already expended the fees and costs necessary to comply

with the requirements under Sec. Sec. 38.703-38.712.

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\612\ Exchange Procedures for Disciplinary, Summary, and

Membership Denial Actions.

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

As discussed in the preamble, many of the new requirements

applicable to DCMs with respect to their disciplinary procedures were

derived from findings and recommendations made by Commission staff

through RERs.\613\ These recommendations represent what the Commission

staff believes are best practices and are typically adopted by DCMs as

the standard form of compliance. Therefore, while the codification of

certain disciplinary requirements may be new, Commission staff has

already expressed these expectations to the industry through RERs.

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

\613\ For example, the requirements in regulation 38.708

(Decisions) and regulation 38.710 (Disciplinary Sanctions) are based

on findings and recommendations in recent RERs.

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

The exact incremental costs incurred by DCMs to comply with the

specific requirements of final rules under Core Principle 13 cannot be

ascertained since they will vary depending on the DCM's current

disciplinary program. To ensure the effectiveness of their disciplinary

programs and provide procedural safeguards to potential respondents,

most DCMs already have disciplinary rules and procedures that are

similar to those required by the rules, even though they were not

previously required to do so by Commission regulation. Therefore, as a

practical matter, the rules may likely require DCMs to amend existing

disciplinary rules and procedures rather than creating them anew.

Accordingly, costs would likely be limited to the resources allocated

to amending existing rules and procedures to ensure compliance with the

final rules.

As described above, in response to commenters' request for greater

flexibility, the Commission has sought to reduce any incremental costs

imposed by the final rules by modifying certain rules where it believes

that flexibility can reasonably be afforded and the overall burden on

DCMs can be reduced. As described above, the Commission is moving

numerous proposed regulations from rules to guidance, as well as

removing certain provisions in their entirety. Finally, the Commission

expects the following additional modifications to the proposed rules to

also reduce the costs imposed by the rules on market participants: (1)

The rules regarding a respondent's answer to a notice of charges,

outlined in paragraphs (a), (b), and (c) of proposed Sec. 38.706, are

being replaced with a requirement that any rules adopted pursuant to

this rule be ``fair, equitable, and publically available;'' (2)

Proposed Sec. 38.714 is being modified so that it does not require

customer restitution if the amount of restitution, or the recipient,

cannot be reasonably determined.

Benefits

The regulations under Core Principle 13 protect market participants

and the public by ensuring that exchanges will discipline, suspend or

terminate the activities of members or market participants found to

have committed rule violations. To that end, the rules will ensure that

DCMs maintain fair, prompt, and effective disciplinary programs. The

rules will deter violations of DCM rules by requiring disciplinary

sanctions sufficient to deter recidivism underSec. 38.710 and by

restricting repeat warning letters in Sec. 38.711. The rules protect

respondents by requiring procedural safeguards to ensure fairness for

respondents. These include an adequate notice of charges under Sec.

38.703, the right to representation in Sec. 38.704, a reasonable

period of time to file an answer to charges under Sec. 38.705, right

to a hearing under Sec. 38.707, and a prompt written decision under

Sec. 38.708, among others. Finally, the rules protect customers by

requiring restitution where customer harm is demonstrated in Sec.

38.710.

The guidance provisions regarding settlement offers and Sec.

38.708 (Decisions) were based on the Commission's recommendation that

DCM disciplinary committees improve the documentation of their

disciplinary decisions. As discussed in the DCM NPRM, the Commission

believes that improved written documentation yields the following

benefits: (1) Disciplinary panels will be required to focus their

analysis more carefully in order to articulate the rationale for their

decisions; (2) DCM enforcement staff will gain a better understanding

of the evidentiary expectations to which different disciplinary panels

adhere; (3) DCM enforcement staff and respondents will both have an

improved record to base any appeals they may wish to file; and (4)

Improved review of the DCMs' disciplinary program by the Commission.

Section Sec. 38.710 (Disciplinary Sanctions), which provides that

all disciplinary penalties imposed by a DCM or its disciplinary panels

must be commensurate with the violations committed, and be sufficient

to deter recidivist activity, and Sec. 38.711 (Warning Letters), which

prohibits a DCM from issuing more than one warning letter in a rolling

12 month period, are also examples of recommendations made by the

Commission in RERs. As discussed in the DCM NPRM, these reflected DMO

staff's concern regarding the adequacy of sanctions.

Section 15(a) Factors (Sec. 38.701-38.712 and Guidance)

1. Protection of market participants and the public. The

regulations and guidance under Core Principle 13 benefit the protection

of market participants and the public by ensuring that exchanges

maintain sufficient enforcement staff and resources through Sec.

38.701 and will discipline, suspend or terminate the activities of

members or market participants found to have committed rule violations.

The regulations require that DCMs maintain fair, prompt, and effective

disciplinary programs to ensure fairness for all respondents in

disciplinary actions. Additionally, by requiring that DCMs levy

meaningful sanctions against persons and entities that violate DCM

rules under Sec. Sec. 38.710 and 38.711, the regulations seek to

promote the effectiveness of disciplinary sanctions and deter

recidivist behavior. Finally, to compensate customers who suffer harm,

the rules require full customer restitution in any disciplinary matter

where customer harm was demonstrated and where the amount of

restitution and the recipient can be reasonably determined under Sec.

38.710.

2. Efficiency, competitiveness and financial integrity of futures

markets. The regulations under Core Principle 13 promote the financial

integrity of the futures markets by ensuring that individuals and

entities that violate the rules of a DCM are appropriately sanctioned,

such sanctions are effective and discourage recidivist activity, and

customers who are harmed received full restitution under Sec. Sec.

38.710 and 38.711.

3. Price discovery. The Commission has not identified any effects

that these rules will have on price discovery other than those

identified above.

[[Page 36690]]

4. Sound risk management practices. The Commission has not

identified any effects that these rules will have on sound risk

management practices, other than those identified above.

5. Other public interest considerations. The regulations under Core

Principle 13 promote public interest considerations, such as market

integrity and customer protection, by establishing an enforcement

program through which DCMs can effectively prosecute members and market

participants who engage in abusive trading practices or violate other

DCM rules.

(15) Core Principle 14: Dispute Resolution

The new guidance for Core Principle 14 is essentially identical to

the prior guidance to former Core Principle 13. No comments were

provided related to the costs of Core Principle 14. Therefore, the

costs and benefits should be no different than the costs and benefits

of administering a dispute resolution program under former Core

Principle 13 prior to enactment of the Dodd-Frank Act.

(16) Core Principle 18: Recordkeeping

Sec. 38.951 (Additional Sources for Compliance)

Section 38.951 requires DCMs to maintain records, including trade

records and investigatory and disciplinary files, in accordance with

Commission regulations, Sec. 1.31, and in accordance with part 45 of

the Commission's regulations with respect to swap transactions.

Costs

The Commission did not receive any comments related to the costs of

this core principle. Although Sec. 38.951 incorporates by reference

the requirements of existing Sec. 1.31 and part 45, it does not impose

any additional burden or costs to which DCMs are not already subject

under current regulations. Regulation 38.951 merely references

recordkeeping obligations to which DCMs have always been subject under

Sec. 1.31 and to which DCMs are required to comply with respect to

swap transactions under part 45. Accordingly, DCMs will not bear any

new costs solely due to Sec. 38.951.

Benefits

Section Sec. 38.951 enables the Commission to obtain the books and

records of DCMs, which is essential to carrying out the Commission's

regulatory functions, including trade practice and market surveillance,

regulatory examinations, and enforcement examinations. Furthermore,

such books and records assist the Commission in prosecuting violations

of the CEA and Commission regulations.

(17) Core Principle 19: Antitrust Considerations

The guidance for Core Principle 19 is nearly identical to the

guidance for former Core Principle 18 and therefore the costs and

benefits of requiring DCMs to operate according to accepted antitrust

law should be no different than the costs and benefits associated with

the pre-existing guidance, prior to the enactment of the Dodd-Frank

Act.

(18) Core Principle 20: System Safeguards

Sec. 38.1051 (General Requirements)

Section 38.1051 establishes system safeguards requirements for all

DCMs, pursuant to new Core Principle 20 added under the Dodd-Frank Act.

The rules under Sec. 38.1051(a) and (b) require a DCM's program of

risk analysis and oversight to address six categories of risk analysis

and oversight and to follow generally accepted standards and best

practices with respect to the development, operation, reliability,

security, and capacity of automated systems. Section 38.1051(c)

specifically requires each DCM to maintain a business continuity-

disaster recovery (``BC-DR'') plan and BC-DR resources sufficient to

enable resumption of trading and of all of the responsibilities and

obligations of the DCM during the next business day following any

disruption of its operations. Section 38.1051(d) specifies the

requirement to be able to resume trading and clearing during the next

business day following a disruption for DCMs that are not determined to

be a critical financial market. The rules also require each DCM to

notify Commission staff of various system security-related events under

Sec. 38.1051(e) and (f), to provide relevant documents to the

Commission in Sec. 38.1051(g), and to conduct regular, periodic,

objective testing and review of automated systems under Sec.

38.1051(h). Finally, the rules under Sec. 38.1051(i) require each DCM

to coordinate its BC-DR plan with its members and market participants.

Summary of Comments

CME stated that the requirement for notice of all systems

malfunctions is overly broad and would require onerous reporting of

mundane and trivial incidents, and that the Commission should limit

required reporting only to material system failures.\614\ CME also

stated that the requirement that DCMs provide the Commission with

timely advance notice of all planned changes to automated systems that

may impact the reliability, security, or adequate scalable capacity of

such systems is an ``extremely onerous burden for DCMs'' and that the

requirement adds ``significant costs that are not at all commensurate

with any value created.'' \615\ CME claimed that any change to a system

could conceivably impact the operation of the system, and that it would

be inefficient and unproductive to report every planned change to their

automated systems.\616\ Finally, CME stated that the requirement that

DCMs provide timely advance notice of all planned changes to the DCM's

program of risk analysis and oversight is overly broad and is neither

necessary nor productive.\617\

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

\614\ CME Comment Letter at 36-37 (Feb. 22, 2011).

\615\ Id.

\616\ Id.

\617\ Id.

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

Discussion

In response to CME's concerns that the rule would require reporting

of insignificant system events, the Commission is adopting final rules

that require reporting only of significant system malfunctions and

advance notification only of material system changes.

Costs

Sec. 38.1051(a) and (b)

The Commission believes that DCMs generally will not incur

significant additional costs to achieve compliance with the

requirements described in Sec. 38.1051(a) and (b) because from the

time Core Principle 20 went into effect, all DCMs would need to have a

program addressing all six categories of risk analysis and oversight.

Former Core Principle 9 and Designation Criteria 4 provided for

essentially the same requirements which reflect activities that would

normally be conducted by the DCM in the course of following industry

standards, guidelines, and best practices for the management and

operation of automated systems. Additionally, the requirement to

maintain a program of risk analysis and oversight appears in Core

Principle 20 itself and was not the product of Commission discretion.

Sec. 38.1051(c)

The Commission believes that DCMs generally will not incur

significant additional costs to achieve compliance with the

requirements described in

[[Page 36691]]

Sec. 38.1051(c). The requirement to maintain a business continuity-

disaster recovery plan, business continuity disaster recovery

resources, emergency procedures, and backup facilities appears in the

core principle itself and was not the product of Commission discretion.

Additionally, the requirements in Sec. 38.1051(c) reflect industry

best practices; an exchange without the ability to resume operations

shortly after a disastrous event, which by definition implies that they

will not in that timeframe be able to operate out of their production

environment, cannot expect to retain its customer base. In the event

that an existing DCM is determined by the Commission to be a ``critical

financial market,'' substantial additional initial and ongoing costs

could be incurred due to the more stringent requirements in this

regard, set forth in Sec. 40.9. The Commission expects to notify a DCM

of its consideration of the DCM's status as a critical financial market

sufficiently in advance of any formal designation as such; further, the

Commission believes that any DCM subject to this designation would be

generating sufficient volume to reasonably support additional costs

incurred.

Sec. 38.1051(d)

The Commission does not believe that any additional material costs

will be incurred by DCMs in complying with the requirements listed in

Sec. 38.1051(d), as DCMs covered by this provision are already in

compliance with its requirements.

Sec. 38.1051(e)

The Commission does not believe that any material costs will be

incurred by DCMs in complying with the notification requirements listed

in Sec. 38.1051(e). Given the general operating stability of the

automated systems at existing DCMs, notification to Commission staff,

either via email or telephone, would be fairly infrequent and could

easily be combined with notifications distributed to market

participants. Several DCMs have automated notification systems; adding

an email address to these systems would not impose additional costs on

DCMs. Minimal additional cost due to DCM staff time could be incurred

in follow-up activities, including completing a systems outage

notification template developed by Commission staff. However, this

template closely follows standard technical post-mortem reporting

procedures, and is not expected to require more than one hour to

complete, at a cost of about $52. Additionally, the Commission notes

that it is reducing the burden of this provision by revising the

proposed rule to provide that DCMs must only promptly advise the

Commission of all significant system malfunctions, rather than all

system malfunctions.

Sec. 39.1051(f)

The Commission does not believe that any significant material costs

will be incurred by existing DCMs or applicants in complying with the

notification requirements listed in Sec. 38.1051(f). Commission staff

has developed notification templates for the notice requirements

contained in both (f)(1) and (2); these templates have been designed to

minimize additional work for DCM staff. As the templates largely follow

guidelines for best practices in automated systems management and

capacity planning, Commission staff believes that each notification

will require no more than two hours of DCM staff time (at a cost of

about $104). Commission notification of planned changes to a DCM's

program of risk analysis and oversight should also not impose

additional costs on DCMs, as copies of documents developed by DCM staff

for change planning purposes are expected to be sufficient in meeting

this requirement. Additionally, the Commission notes that it is

reducing the burden of this provision on DCMs by revising the proposed

rule to provide that, with respect to planned changes to automated

systems or risk analysis and oversight programs, a DCM must only

provide timely advance notification of material changes, rather than of

all changes.

Sec. 38.1051(g)

The Commission does not believe that any significant costs will be

incurred by existing DCMs or applicants in complying with the

requirements listed in Sec. 38.1051(g), as these documents and

procedures can be provided electronically with minimal additional DCM

staff effort, and would be produced by the DCM in the course of

following industry standards, guidelines and best practices for the

management and operation of automated systems. If the documents are

available electronically, the request can likely be met in under 15

minutes. Hardcopy responses would likely require no more than 30

minutes of DCM staff time.

Sec. 38.1051(h)

The Commission does not believe that any significant costs will be

incurred by existing DCMs in complying with the requirements listed in

Sec. 38.1051(h), as all DCMs should currently be performing this

testing and review in the course of following industry standards,

guidelines and best practices for the management and operation of

automated systems.

Sec. 38.1051(i)

The Commission does not believe that any significant costs will be

incurred by existing DCMs in complying with the requirements listed in

Sec. 38.1051(i), as all DCMs should meet the requirements of this

provision in the course of following industry standards (including

industry-wide tests conducted at least annually and sponsored by the

Futures Industry Association (``FIA'')), guidelines and best practices

for the management and operation of automated systems. Further,

compliance with sections (1) and (3) would generally result from the

development of contingency and disaster recovery plans following

generally accepted best practices and standards. Finally, industry-wide

testing currently conducted on an annual basis would result in

substantial compliance with part (2) of this section.

Benefits

Sophisticated computer systems are crucial to a DCM's ability to

meet its obligations and responsibilities. Safeguarding the

reliability, security, and capacity of such systems is essential to

mitigate systemic risk for the nation's financial sector as a whole.

The ability of DCMs to recover and resume trading promptly in the event

of a disruption of their operations is highly important to the U.S.

economy. Ensuring the resilience of the automated systems of DCMs is a

vitally important part of the Commission's mission and will be crucial

to the robust and transparent systemic risk management framework

established by the Dodd- Frank Act. DCM compliance with generally

accepted standards and best practices with respect to the development,

operation, reliability, security, and capacity of automated systems can

reduce the frequency and severity of automated system security breaches

or functional failures, thereby augmenting efforts to mitigate systemic

risk. Notice to the Commission concerning systems malfunctions, systems

security incidents, or any events leading to the activation of a DCM's

business continuity-disaster recovery (``BC-DR'') plan will assist the

Commission's oversight and its ability to assess systemic risk levels.

It would present unacceptable risks to the U.S. financial system if

futures and swaps markets that comprise critical components of the

world financial system were to become unavailable for an extended

period of time for any reason. Adequate system

[[Page 36692]]

safeguards are crucial to mitigate such risks and this regulation will

ensure such safeguards are in place.

Section 15(a) Factors

1. Protection of market participants and the public. Because

automated systems play a central and critical role in today's

electronic financial market environment, oversight of core principle

compliance by DCMs with respect to automated systems is an essential

part of effective oversight of both futures and swaps markets. Timely

reporting to the Commission of material system malfunctions, planned

changes to automated systems, and planned changes to programs of risk

analysis and oversight will facilitate the Commission's oversight of

futures and swaps markets, augment the Commission's efforts to monitor

systemic risk, and will further the protection of market participants

and the public by helping to ensure that automated systems are

available, reliable, secure, have adequate scalable capacity, and are

effectively overseen.

2. Efficiency, competitiveness, and financial integrity of futures

markets. Sophisticated computer systems are crucial to a DCM's ability

to meet its obligations and responsibilities. Safeguarding the

reliability, security, and capacity of such systems is also essential

to mitigation of system risk for the nation's financial sector as a

whole. This is particularly true in light of the fact that the over-

the-counter swaps market is estimated to have in excess of $600

trillion in outstanding contracts. The ability of DCMs to recover and

resume trading promptly in the event of a disruption of their

operations is highly important to the U.S. economy. Ensuring the

resilience of the automated systems of DCMs is a critical part of the

Commission's mission, and will be crucial to the robust and transparent

systemic risk management framework established by the Dodd-Frank Act.

Notice to the Commission concerning systems malfunctions, systems

security incidents, or any events leading to the activation of a DCM's

business continuity-disaster recovery plan will assist the Commission's

oversight and its ability to assess systemic risk levels. It would

present unacceptable risks to the U.S. financial system if futures and

swaps markets that comprise critical components of the world financial

system were to become unavailable for an extended period of time for

any reason, and adequate system safeguards and timely notice to the

Commission regarding the status of those safeguards are crucial to

mitigation of such risks.

3. Price discovery. The reliable function of sophisticated computer

systems and networks is vital to the fulfillment of a DCM's duties and

obligations, a crucial ingredient of adequate regulatory oversight, and

central to the robust, conservative, and transparent risk management

framework promulgated by the Dodd-Frank Act. Following generally

accepted standards and best practices with respect to the development,

operation, reliability, security, and capacity of automated systems

will reduce the incidence and severity of automated system security

breaches and functional failures, thereby providing reliable and

available venues for price discovery.

4. Sound risk management practices. Reliably functioning computer

systems and networks are crucial to comprehensive risk management, and

prompt notice to the Commission concerning systems malfunctions,

systems security incidents, or any events leading to the activation of

a DCM's business continuity-disaster recovery plan will assist the

Commission in its oversight role, and will bolster its ability to

assess systemic risk levels. Adequate system safeguards and timely

notice to the Commission regarding the status of those safeguards are

crucial to mitigation of potential systemic risks.

5. Other public interest considerations. The American economy and

the American public depend upon the availability of reliable and secure

markets for price discovery, hedging, and speculation. Ensuring the

adequate safeguarding and the reliability, security, and capacity of

the systems supporting these market functions is a core focus in the

Commission's role in monitoring and assessing the level of systemic

risk, and is central to its fulfillment of responsibilities given to it

by the Dodd-Frank Act.

(19) Core Principle 21: Financial Resources

Sec. 38.1101 (Financial Resources)

Section 38.1101(a) requires DCMs to maintain and calculate

sufficient financial resources to cover operating costs for at least

one year, calculated on a rolling basis, at all times, and requires any

entity operating as both a DCM and a DCO to comply with both the DCM

and DCO financial resources requirements.

Under section 38.1101(b), financial resources available to DCMs to

satisfy the applicable financial resources requirements would include

the DCM's own capital (assets in excess of liabilities) and any other

financial resource deemed acceptable by the Commission.

Sections 38.1101(c), (d), and (f) require each DCM, no less

frequently than at the end of each fiscal quarter, to calculate the

financial resources it needs to meet the requirements of Sec.

38.1101(a) and the current market value of each financial resource and

report this information to the Commission within a specified timeframe.

Section 38.1101(e) requires DCMs to maintain unencumbered liquid

financial assets, such as cash or highly liquid securities, equal to at

least six months' operating costs, or a committed line of credit or

similar facility.

Summary of Comments

GreenX stated that the proposed rules implementing Core Principle

21 could effectively require DCMs to maintain financial resources in

excess of one year's operating costs.\618\ GreenX suggested modifying

the rule so that the proposed six month liquidity requirement be

explicitly included in the financial resources required to cover a

DCM's operating costs for at least one year, or alternatively,

requested that the Commission perform a cost benefit analysis of the

proposed rule as written.\619\

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\618\ GreenX Comment Letter at 14-15 (Feb. 22, 2011).

\619\ Id. at 17-18.

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GreenX also stated that revising the proposed rule to permit DCMs

to include committed lines of credit as an acceptable financial

resource would permit a DCM to reduce its operating costs by avoiding

the need to incur unnecessary interest charges, while still ensuring

that it has adequate funds available to pay its operating

expenses.\620\

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\620\ Id. at 16.

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Several commenters requested an extended deadline for filing the

financial reports required as a result of Sec. 38.1101(f). CME stated

that the proposed 17 day filing deadline is not feasible and that

instead, the requirement should be consistent with the SEC's reporting

requirements.\621\ Similarly, GreenX stated that it has procedures in

place to comply with the SEC's requirements and that the proposed

requirements in this rule would require new programming and

resources.\622\ GreenX recommended extending the reporting deadline to

30 calendar days, noting that this is still more burdensome than the

requirements imposed by the SEC on national securities exchanges.\623\

The

[[Page 36693]]

Commission received no comments discussing the costs and benefits of

Sec. Sec. 38.1101(b) and 38.1101(d).

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

\621\ CME Comment Letter at 38 (Feb. 22, 2011).

\622\ GreenX Comment Letter at 20 (Feb. 22, 2011).

\623\ Id.

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

Discussion

As discussed in the preamble, the rule does not require each DCM to

maintain eighteen months of financial resources, but, rather, requires

each DCM to have at least twelve months of financial resources,

including six months of liquid financial resources. Each DCM has the

discretion to determine how to meet this requirement (e.g., six months

of illiquid financial resources combined with six months of liquid

ones, twelve months of illiquid financial resources with a line of

credit covering six months' worth of financial resources, or twelve

months of illiquid financial resources and six months of liquid ones).

There are similar proposed financial resources rules in the rulemakings

for each type of registered entity (i.e., SEFs, SDRs, and DCOs).

The provision in the rule text stating that acceptable financial

resources include a DCM's own capital and ``any other financial

resource deemed acceptable by the Commission'' was meant to capture

other types of resources on a case-by-case basis and provide

flexibility to both DCMs and the Commission. Accordingly, the

Commission has revised the rule text to state that a DCM's own capital

means its assets minus its liabilities calculated in accordance with

GAAP. The Commission believes that if a certain financial resource is

deemed to be an asset under GAAP, it is appropriate for inclusion in

the calculation for this rule. To the extent a certain financial

resource is not considered an asset under GAAP, but based upon the

facts and circumstances a DCM believes that the particular asset should

be so considered, Commission staff will work with the DCM to determine

whether such resource is acceptable.

The Commission is persuaded that the proposed 17 business day

filing deadline may be overly burdensome. The SEC requires its

quarterly reports on Form 10-Q to be filed with the SEC 40 calendar

days after the end of the fiscal quarter for accelerated filers and 45

calendar days after the end of the fiscal quarter for all other SEC-

registered entities. The SEC requires annual reports on Form 10-K to be

filed with the SEC 60 calendar days after the end of the fiscal year

for large accelerated filers, 75 calendar days for other accelerated

filers and 90 calendar days for non-accelerated filers. Accordingly,

the Commission is extending the 17 business day proposed filing

deadline to 40 calendar days for the required reports for the first

three quarters. This will harmonize the Commission's regulations with

the SEC's requirements for its Form 10-Q. Similarly, the Commission has

extended the filing deadline to 60 days for the fourth quarter report

to harmonize with the SEC deadlines for the Form 10-K. The Commission

does not believe that annual submissions are sufficient. The Commission

believes that prudent financial management requires DCMs to prepare and

review financial reports more frequently than annually, and expects

that DCMs currently are reviewing their finances on at least a

quarterly basis.

Costs

This is a new core principle for DCMs, so the requirement to

maintain and calculate the financial resources necessary to meet the

requirements of this rule may require an outlay of resources to achieve

compliance. However, the Commission has required recent DCM registrants

pursuant to their designation order to calculate and maintain a certain

level of financial resources and therefore some DCMs are already

generally in compliance with this requirement.

The Commission expects that most, if not all, DCMs already

calculate and prepare financial statements quarterly. Accordingly, the

Commission does not believe that the calculation of the financial

resources required to meet the requirements of this core principle

imposes a significant burden on DCMs. Extrapolation from the prepared

financial statements should be relatively straightforward, but will

require some resources on the part of DCMs, potentially including staff

and technology resources to calculate, monitor, and report financial

resources. Given the staffing and operational differences among DCMs,

the Commission is unable to accurately estimate or quantify the

additional costs DCMs may incur to comply with the new financial

resource rules, and no information was provided in the comments in

response to the NPRM. The proposed regulation imposes additional costs

on the Commission as staff will be required to review the filings

received from DCMs. However, once the first couple of filings have been

received and reviewed, Commission staff will be familiarized with the

financial resources of each DCM and the Commission expects that the

review will become increasingly more efficient.

Benefits

A DCM is obligated to ensure that trading occurs in a liquid, fair,

and financially secure trading facility. In order to fulfill its

responsibilities, a DCM must have appropriate minimum financial

resources on hand and on an ongoing basis to sustain operations for a

reasonable period of time. This includes a DCM having sufficient

resources to allow it to close out trading in a manner not disruptive

to the market, if necessary. The Commission believes that the benefits

of the rule requiring six months' worth of unencumbered liquid

financial assets are substantial. Specifically, this provision would

give a DCM time to liquidate the remaining financial assets it would

need to continue operating for the last six months of the required one

year period. If a DCM does not have six months' worth of unencumbered

liquid financial assets, it would be allowed to use a committed line of

credit or similar facility to satisfy the requirement. If a DCM does

not have the liquidity required under Sec. 38.1101(e), it is not

achieving the goal of the core principle, as it will be unable to pay

its creditors. Liquidity is implicit in the core principle requirement

that the financial resources be adequate. Additionally, the rules

ensure that the Commission can be certain that DCMs are in compliance

with the core principle as required by the Dodd-Frank Act. In addition,

the reporting requirements will facilitate the Commission's oversight

role of ensuring DCMs maintain sufficient financial resources, as

required by the core principle.

Section 15(a) Factors

1. Protection of market participants and the public. As discussed

herein, these rules implement the requirements of new Core Principle 21

pursuant to the Dodd-Frank Act. These requirements will enable a DCM to

fulfill its responsibilities of ensuring that trading occurs in a

liquid, fair, and financially secure trading facility by maintaining

appropriate minimum financial resources on hand and on an ongoing basis

to sustain operations for a reasonable period of time. As discussed, as

a result of these requirements, DCMs will also have the financial

resources necessary to close out trading in a manner not disruptive to

the market. By establishing uniform standards that further the goals of

avoiding market disruptions, financial losses, and systemic problems

that could arise from a DCM's failure to maintain adequate financial

resources, these rules will protect market participants and the public.

2. Efficiency, competitiveness and financial integrity of futures

markets. The rules also promote the financial

[[Page 36694]]

integrity of the futures markets by requiring DCMs to have adequate

operating resources (i.e., operating resources sufficient to fund both

current operations and ensure operations of sufficient length in the

future), and preventing those DCMs that lack these resources from

expanding in ways that may ultimately harm the broader financial market

(i.e., confining the operations of DCMs to levels their financial

resources can support).

3. Price discovery. The Commission has not identified any effects

that this rule will have on price discovery.

4. Sound risk management practices. By setting specific standards

with respect to how DCMs should assess and monitor the adequacy of

their financial resources, the rules promote sound risk management

practices and further the goal of minimizing systemic risk.

5. Other public interest considerations. The Commission has not

identified any effects that this rule will have on other public

interest considerations.

(20) Core Principle 23: Securities and Exchange Commission

The Dodd-Frank Act added new Core Principle 23, requiring that DCMs

keep any records relating to swaps defined in CEA section 1a(47)(A)(v),

as amended by the Dodd-Frank Act, open to inspection and examination by

the SEC. Consistent with the text of the core principle, the Commission

is adopting guidance that provides that each DCM should have

arrangements and resources for collecting and maintaining accurate

records pertaining to any swap agreements defined in section

1a(47)(A)(v) of the amended CEA, and should leave them open to

inspection and examination for a period of five years. The Commission

did not receive any comments discussing the costs or benefits of this

provision.

Costs

Core Principle 23 requires DCMs to keep records relating only to

security-based swaps open to inspection and examination by the SEC. The

accompanying guidance simply tracks the language of the Core Principle

and does not impose any additional substantive requirements on DCMs.

The five-year period is unlikely to impose significant costs on market

participants because the core principle already requires DCMs to keep

records relating to certain swaps open to inspection and examination by

the SEC; the guidance simply provides additional information with

respect to the duration of the obligation imposed by the core

principle. The Commission believes the five-year retention period is

reasonable and reflects industry standards; the recordkeeping

requirement under Core Principle 18 extends for a period of five years

and the SEC's relevant recordkeeping requirements typically extend for

a period of five years as well. Additionally, the requirement only

applies to security-based swaps.

Benefits

The Dodd-Frank Act was intended to establish a comprehensive, new

regulatory framework for swaps and security-based swaps. The

legislation was enacted to reduce risk, increase transparency, and

promote market integrity within the financial system. In order to

perform effective oversight and ensure the goals of Dodd-Frank are

realized, the regulatory agencies charged with overseeing the swaps

market must have access to accurate information regarding swap

transactions. The SEC shares jurisdiction over the regulation of the

swaps markets with the Commission and must have access to accurate

records relating to swaps in order to effectively oversee those

markets.

Section 15(a) Factors

1. Protection of market participants and the public. To protect

market participants and the public, the SEC has comprehensive

regulatory, surveillance, investigative, and enforcement programs. To

support these programs, the SEC must have access to accurate

information regarding swap agreements. Section 38.1201 and the

accompanying guidance ensure that DCMs keep accurate records relating

to certain swaps open to inspection and examination by the SEC for a

sufficient period of time of five years.

2. Efficiency, competitiveness and financial integrity of futures

markets. The SEC has comprehensive regulatory programs designed to

promote efficient, competitive, and financially stable markets. In

order to support these programs, the SEC must have access to accurate

information regarding swap agreements. Section 38.1201 and the

accompanying guidance ensure that DCMs keep accurate records relating

to certain swaps open to inspection and examination by the SEC for a

sufficient period of time of five years.

3. Price discovery. The Commission has not identified any effects

that this rule will have on price discovery.

4. Sound risk management practices. The Commission has not

identified any effects that this rule will have on sound risk

management practices.

5. Other public interest considerations. The Commission has not

identified any effects that this rule will have on other public

interest considerations.

IV. Text of Final Rules

List of Subjects

17 CFR Part 1

Commodity futures, Designated contract markets, Minimum financial

requirements for intermediaries, Reporting and recordkeeping

requirements.

17 CFR Part 16

Commodity futures, Reporting and recordkeeping requirements

17 CFR Part 38

Block transaction, Commodity futures, Designated contract markets,

Reporting and recordkeeping requirements, Transactions off the

centralized market.

For the reasons stated in the preamble, and under the authority of

7 U.S.C. 1, et seq., the Commodity Futures Trading Commission amends 17

CFR parts 1, 16, and 38 as follows:

PART 1--GENERAL REGULATIONS UNDER THE COMMODITY EXCHANGE ACT

0

1. Revise the authority citation for part 1 to read as follows:

Authority: 7 U.S.C. 1a, 2, 2a, 5, 6, 6a, 6b, 6c, 6d, 6e, 6f, 6g,

6h, 6i, 6k, 6l, 6m, 6n, 6o, 6p, 6r, 6s, 7, 7a-1, 7a-2, 7b, 7b-3, 8,

9, 10a, 12, 12a, 12c, 13a, 13a-1, 16, 16a, 19, 21, 23, and 24, as

amended by Title VII of the Dodd-Frank Wall Street Reform and

Consumer Protection Act, Pub. L. 111-203, 124 Stat. 1376 (2010).

0

2. Revise Sec. 1.52 to read as follows:

Sec. 1.52 Self-regulatory organization adoption and surveillance of

minimum financial requirements.

(a) Each self-regulatory organization must adopt rules prescribing

minimum financial and related reporting requirements for members who

are registered futures commission merchants, registered retail foreign

exchange dealers, or registered introducing brokers. The self-

regulatory minimum financial and related reporting requirements must be

the same as, or more stringent than, the requirements contained in

Sec. Sec. 1.10 and 1.17 of this chapter, for futures commission

merchants and introducing brokers, and Sec. Sec. 5.7 and 5.12 of this

chapter for retail foreign exchange dealers; provided, however, a self-

regulatory organization may permit its member registrants that are

registered with the Securities and Exchange Commission as securities

brokers or

[[Page 36695]]

dealers to file (in accordance with Sec. 1.10(h) of this chapter) a

copy of their Financial and Operational Combined Uniform Single Report

under the Securities Exchange Act of 1934, Part II, Part IIA, or Part

II CSE, in lieu of Form 1-FR. The definition of adjusted net capital

must be the same as that prescribed in Sec. 1.17(c) of this chapter

for futures commission merchants and introducing brokers, and Sec.

5.7(b)(2) of this chapter for futures commission merchants offering or

engaging in retail forex transactions and for retail foreign exchange

dealers. (b) Each self-regulatory organization must establish and

operate a supervisory program for the purpose of assessing whether each

member registrant is in compliance with the applicable self-regulatory

organization and Commission rules and regulations governing minimum net

capital and related financial requirements, the obligation to segregate

customer funds, financial reporting requirements, recordkeeping

requirements, and sales practice and other compliance requirements. The

supervisory program also must address the following elements:

(1) Adequate levels and independence of audit staff. A self-

regulatory organization must maintain staff of an adequate size,

training, and experience to effectively implement a supervisory

program. Staff of the self-regulatory organization, including officers,

directors and supervising committee members, must maintain independent

judgment and its actions must not impair its independence nor appear to

impair its independence in matters related to the supervisory program.

The self-regulatory organization must provide annual ethics training to

all staff with responsibilities for the supervisory program.

(2) Ongoing surveillance. A self-regulatory organization's ongoing

surveillance of member registrants must include the review and analysis

of financial reports and regulatory notices filed by member registrants

with the designated self-regulatory organization.

(3) High-risk firms. A self-regulatory organization's supervisory

program must include procedures for identifying member registrants that

are determined to pose a high degree of potential financial risk,

including the potential risk of loss of customer funds. High-risk

member registrants must include firms experiencing financial or

operational difficulties, failing to meet segregation or net capital

requirements, failing to maintain current books and records, or

experiencing material inadequacies in internal controls. Enhanced

monitoring for high risk firms should include, as appropriate, daily

review of net capital, segregation, and secured calculations, to assess

compliance with self-regulatory and Commission requirements.

(4) On-site examinations. (i) A self-regulatory organization must

conduct routine periodic on-site examinations of member registrants.

Member futures commission merchants and retail foreign exchange dealers

must be subject to on-site examinations no less frequently than once

every eighteen months. A self-regulatory organization may establish a

risk-based method of establishing the scope of each on-site

examination, provided however, that the scope of each on-site

examination of a futures commission merchant or retail foreign exchange

dealer must include an assessment of whether the registrant is in

compliance with applicable Commission and self-regulatory organization

minimum capital and customer fund protection requirements,

recordkeeping, and reporting requirements.

(ii) A self-regulatory organization must establish the frequency of

on-site examinations of member introducing brokers that do not operate

pursuant to guarantee agreements with futures commission merchants or

retail foreign exchange dealers using a risk-based approach, provided

however, that each introducing broker is subject to an on-site

examination no less frequently than once every three years.

(iii) A self-regulatory organization must conduct on-site

examinations of member registrants in accordance with uniform audit

programs and procedures that have been submitted to the Commission.

(5) Adequate documentation. A self-regulatory organization must

adequately document all aspects of the operation of the supervisory

program, including the conduct of risk-based scope setting and the

risk-based surveillance of high-risk member registrants, and the

imposition of remedial and punitive action(s) for material violations.

(c) Any two or more self-regulatory organizations may file with the

Commission a plan for delegating to a designated self-regulatory

organization, for any registered futures commission merchant, retail

foreign exchange dealer, or introducing broker that is a member of more

than one such self-regulatory organization, the responsibility of:

(1) Monitoring and auditing for compliance with the minimum

financial and related reporting requirements adopted by such self-

regulatory organizations and the Commission in accordance with

paragraphs (a) and (b) of this section; and

(2) Receiving the financial reports necessitated by such minimum

financial and related reporting requirements.

(d) Any plan filed under this section may contain provisions for

the allocation of expenses reasonably incurred by the designated self-

regulatory organization among the self-regulatory organizations

participating in such a plan.

(e) A plan's designated self-regulatory organization must report

to:

(1) That plan's other self-regulatory organizations any violation

of such other self-regulatory organizations' rules and regulations for

which the responsibility to monitor, audit or examine has been

delegated to such designated self-regulatory organization under this

section; and

(2) The Commission any violation of a self-regulatory

organization's rules and regulations or any violation of the

Commission's regulations for which the responsibility to monitor, audit

or examine has been delegated to such designated self-regulatory

organization under this section.

(f) The self-regulatory organizations may, among themselves,

establish programs to provide access to any necessary financial or

related information.

(g) After appropriate notice and opportunity for comment, the

Commission may, by written notice, approve such a plan, or any part of

the plan, if it finds that the plan, or any part of it:

(1) Is necessary or appropriate to serve the public interest;

(2) Is for the protection and in the interest of customers;

(3) Reduces multiple monitoring and multiple auditing for

compliance with the minimum financial rules of the self-regulatory

organizations submitting the plan of any futures commission merchant,

retail foreign exchange dealer, or introducing broker that is a member

of more than one self-regulatory organization;

(4) Reduces multiple reporting of the financial information

necessitated by such minimum financial and related reporting

requirements by any futures commission merchant, retail foreign

exchange dealer, or introducing broker that is a member of more than

one self-regulatory organization;

(5) Fosters cooperation and coordination among the self-regulatory

organizations; and

(6) Does not hinder the development of a registered futures

association under section 17 of the Act.

(h) After the Commission has approved a plan, or part thereof,

under Sec. 1.52(g), a self-regulatory organization

[[Page 36696]]

relieved of responsibility must notify each of its members that are

subject to such a plan:

(1) Of the limited nature of its responsibility for such a member's

compliance with its minimum financial and related reporting

requirements; and

(2) Of the identity of the designated self-regulatory organization

that has been delegated responsibility for such a member.

(i) The Commission may at any time, after appropriate notice and

opportunity for hearing, withdraw its approval of any plan, or part

thereof, established under this section, if such plan, or part thereof,

ceases to adequately effectuate the purposes of section 4f(b) of the

Act or of this section.

(j) Whenever a registered futures commission merchant, a registered

retail foreign exchange dealer, or a registered introducing broker

holding membership in a self-regulatory organization ceases to be a

member in good standing of that self-regulatory organization, such

self-regulatory organization must, on the same day that event takes

place, give electronic notice of that event to the Commission at its

Washington, DC, headquarters and send a copy of that notification to

such futures commission merchant, retail foreign exchange dealer, or

introducing broker.

(k) Nothing in this section shall preclude the Commission from

examining any futures commission merchant, retail foreign exchange

dealer, or introducing broker for compliance with the minimum financial

and related reporting requirements to which such futures commission

merchant, retail foreign exchange dealer, or introducing broker is

subject.

(l) In the event a plan is not filed and/or approved for each

registered futures commission merchant, retail foreign exchange dealer,

or introducing broker that is a member of more than one self-regulatory

organization, the Commission may design and, after notice and

opportunity for comment, approve a plan for those futures commission

merchants, retail foreign exchange dealers, or introducing brokers that

are not the subject of an approved plan (under paragraph (g) of this

section), delegating to a designated self-regulatory organization the

responsibilities described in paragraph (c) of this section.

PART 16--REPORTS BY CONTRACT MARKETS AND SWAP EXECUTION FACILITIES

0

3. The authority citation for part 16 is revised to read as follows:

Authority: 7 U.S.C. 2, 6a, 6c, 6g, 6i, and 7, and 7b-3, as

amended by Pub. L. 111-203, 124 Stat. 1376.

0

4. The heading for part 16 is revised to read as set forth above.

0

5. Revise Sec. 16.01 to read as follows:

Sec. 16.01 Publication of market data on futures, swaps and options

thereon: trading volume, open contracts, prices, and critical dates.

(a) Trading volume and open contracts. (1) Each reporting market,

as defined in part 15 of this chapter, must separately record for each

business day the information prescribed in paragraphs (a)(2)(i) through

(vi) of this section for each of the following contract categories:

(i) For futures, by commodity and by futures expiration date;

(ii) For options, by underlying futures contracts for options on

futures contracts or by underlying physical for options on physicals,

and by put, by call, by expiration date and by strike price;

(iii) For swaps or class of swaps, by product type and by term life

of the swap; and

(iv) For options on swaps or classes of options on swaps, by

underlying swap contracts for options on swap contracts or by

underlying physical for options on swaps on physicals, and by put, by

call, by expiration date and by strike price.

(2) Each reporting market must record for each trading session the

following trading volume and open interest summary data:

(i) The option delta, where a delta system is used;

(ii) The total gross open contracts for futures, excluding those

contracts against which delivery notices have been stopped;

(iii) For futures products that specify delivery, open contracts

against which delivery notices have been issued on that business day;

(iv) The total volume of trading, excluding transfer trades or

office trades:

(A) For swaps and options on swaps, trading volume shall be

reported in terms of the number of contracts traded for standard-sized

contracts (i.e., contracts with a set contract size for all

transactions) or in terms of notional value for non-standard-sized

contracts (i.e., contracts whose contract size is not set and can vary

for each transaction).

(v) The total volume of futures/options/swaps/swaptions exchanged

for commodities or for derivatives positions that are included in the

total volume of trading; and

(vi) The total volume of block trades included in the total volume

of trading.

(b) Prices. (1) Each reporting market must record the following

contract types separately

(i) For futures, by commodity and by futures expiration;

(ii) For options, by underlying futures contracts for options on

futures contracts or by underlying physical for options on physicals,

and by put, by call, by expiration date and by strike price;

(iii) For swaps, by product type and contract month or term life of

the swap; and

(iv) For options on swaps or classes of options on swaps, by

underlying swap contracts for options on swap contracts or by

underlying physical for options on swaps on physicals, and by put, by

call, by expiration date and by strike price.

(2) Each reporting market must record for the trading session and

for the opening and closing periods of trading as determined by each

reporting market:

(i) The opening and closing prices of each futures, option, swap or

swaption;

(ii) The price that is used for settlement purposes, if different

from the closing price; and

(iii) The lowest price of a sale or offer, whichever is lower, and

the highest price of a sale or bid, whichever is higher, that the

reporting market reasonably determines accurately reflects market

conditions. Bids and offers vacated or withdrawn shall not be used in

making this determination. A bid is vacated if followed by a higher bid

or price and an offer is vacated if followed by a lower offer or price.

(3) If there are no transactions, bids, or offers during the

opening or closing periods, the reporting market may record as

appropriate:

(i) The first price (in lieu of opening price data) or the last

price (in lieu of closing price data) occurring during the trading

session, clearly indicating that such prices are the first and last

prices; or

(ii) Nominal opening or nominal closing prices that the reporting

market reasonably determines to accurately reflect market conditions,

clearly indicating that such prices are nominal.

(4) Additional information. Each reporting market must record the

following information with respect to transactions in commodity

futures, commodity options, swaps or options on swaps on that reporting

market:

(i) The method used by the reporting market in determining nominal

prices and settlement prices; and

(ii) If discretion is used by the reporting market in determining

the opening and/or closing ranges or the settlement prices, an

explanation that certain discretion may be employed by

[[Page 36697]]

the reporting market and a description of the manner in which that

discretion may be employed. Discretionary authority must be noted

explicitly in each case in which it is applied (for example, by use of

an asterisk or footnote).

(c) Critical dates. Each reporting market must report to the

Commission, for each futures contract, the first notice date and the

last trading date, and for each option contract, the expiration date in

accordance with paragraph (d) of this section.

(d) Form, manner and time of filing reports. Unless otherwise

approved by the Commission or its designee, reporting markets must

submit to the Commission the information specified in paragraphs (a),

(b), and (c) of this section as follows:

(1) Using the format, coding structure and electronic data

transmission procedures approved in writing by the Commission or its

designee; provided however, that the information must be made available

to the Commission or its designee in hard copy upon request;

(2) When each such form of the data is first available, but not

later than 7:00 a.m. on the business day following the day to which the

information pertains for the delta factor and settlement price and not

later than 12:00 p.m. for the remainder of the information. Unless

otherwise specified by the Commission or its designee, the stated time

is U.S. eastern standard time for information concerning markets

located in that time zone, and U.S. central time for information

concerning all other markets; and

(3) For information on reports to the Commission for swap or

options on swap contracts, refer to part 20 of this chapter.

(e) Publication of recorded information. (1) Reporting markets must

make the information in paragraph (a) of this section readily available

to the news media and the general public without charge, in a format

that readily enables the consideration of such data, no later than the

business day following the day to which the information pertains. The

information in paragraphs (a)(2)(iv) through (vi) of this section shall

be made readily available in a format that presents the information

together.

(2) Reporting markets must make the information in paragraphs

(b)(2) and (3) of this section readily available to the news media and

the general public, and the information in paragraph (b)(4)(ii) of this

section readily available to the general public, in a format that

readily enables the consideration of such data, no later than the

business day following the day to which the information pertains.

Information in paragraph (b)(4)(i) of this section must be made

available in the registered entity's rulebook, which is publicly

accessible on its Web site.

PART 38--DESIGNATED CONTRACT MARKETS

0

6. The authority citation for part 38 is revised to read as follows:

Authority: 7 U.S.C. 1a, 2, 6, 6a, 6c, 6d, 6e, 6f, 6g, 6i, 6j,

6k, 6l, 6m, 6n, 7, 7a-2, 7b, 7b-1, 7b-3, 8, 9, 15, and 21, as

amended by the Dodd-Frank Wall Street Reform and Consumer Protection

Act, Pub. L. 111-203, 124 Stat. 1376 (2010).

0

7. Designate existing Sec. Sec. 38.1 through 38.6 as subpart A under

the following subpart heading:

Subpart A--General Provisions

* * * * *

Sec. 38.1 [Amended]

0

8. Amend Sec. 38.1 by removing the reference ``Parts 36 or 37 of this

chapter'' and adding in its place the reference ``parts 37 or 49 of

this chapter''.

0

9. Revise Sec. 38.2 to read as follows:

Sec. 38.2 Exempt provisions.

A designated contract market, the designated contract market's

operator and transactions traded on or through a designated contract

market under section 5 of the Act shall comply with all applicable

regulations under Title 17 of the Code of Federal Regulations, except

for the requirements of Sec. 1.35(e) through (j), Sec. 1.39(b), Sec.

1.44, Sec. 1.53, Sec. 1.54, Sec. 1.59(b) and (c), Sec. 1.62, Sec.

1.63(a) and (b) and (d) through (f), Sec. 1.64, Sec. 1.69, part 8,

Sec. 100.1, Sec. 155.2, and part 156.

0

10. Revise Sec. 38.3 to read as follows:

Sec. 38.3 Procedures for designation.

(a) Application procedures. (1) A board of trade seeking

designation as a contract market must file electronically, in a format

and manner specified by the Secretary of the Commission, the Form DCM

provided in appendix A of this part, with the Secretary of the

Commission at its Washington, DC headquarters at [email protected]

and the Division of Market Oversight at [email protected] The

Commission will review the application for designation as a contract

market pursuant to the 180-day timeframe and procedures specified in

section 6(a) of the Act. The Commission shall approve or deny the

application or, if deemed appropriate, designate the applicant as a

contract market subject to conditions.

(2) The application must include information sufficient to

demonstrate compliance with the core principles specified in section

5(d) of the Act. Form DCM consists of instructions, general questions

and a list of exhibits (documents, information and evidence) required

by the Commission in order to determine whether an applicant is able to

comply with the core principles. An application will not be considered

to be materially complete unless the applicant has submitted, at a

minimum, the exhibits required in Form DCM. If the application is not

materially complete, the Commission shall notify the applicant that the

application will not be deemed to have been submitted for purposes of

starting the 180-day review period set forth in paragraph (a)(1) of

this section.

(3) The applicant must identify with particularity any information

in the application that will be subject to a request for confidential

treatment pursuant to Sec. 145.9 of this chapter.

(4) Section 40.8 of this chapter sets forth those sections of the

application that will be made publicly available, notwithstanding a

request for confidential treatment pursuant to Sec. 145.9 of this

chapter.

(5) If any information contained in the application or in any

exhibit is or becomes inaccurate for any reason, an amendment to the

application or a submission filed under part 40 of this chapter must be

filed promptly correcting such information.

(b) Reinstatement of dormant designation. Before listing or

relisting products for trading, a dormant designated contract market as

defined in Sec. 40.1 of this chapter must reinstate its designation

under the procedures of paragraphs (a)(1) and (2) of this section;

provided, however, that an application for reinstatement may rely upon

previously submitted materials that still pertain to, and accurately

describe, current conditions.

(c) Delegation of authority. (1) The Commission hereby delegates,

until it orders otherwise, to the Director of the Division of Market

Oversight or such other employee or employees as the Director may

designate from time to time, upon consultation with the General Counsel

or the General Counsel's designee, authority to notify the 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.

(2) The Director may submit to the Commission for its consideration

any matter that has been delegated in this paragraph.

[[Page 36698]]

(3) Nothing in this paragraph prohibits the Commission, at its

election, from exercising the authority delegated in paragraph (c)(1)

of this section.

(d) Request for transfer of designation. (1) Request for transfer

of designation, listed contracts and open interest. A designated

contract market that wants to request the transfer of its designation

from its current legal entity to a new legal entity, as a result of a

corporate reorganization or otherwise, must file a request with the

Commission for approval to transfer the designation, listed contracts

and positions comprising all associated open interest. Such request

must be filed electronically, in a format and manner specified by the

Secretary of the Commission, with the Secretary of the Commission at

its Washington, DC headquarters at [email protected] and the

Division of Market Oversight at [email protected]

(2) Timing of submission. The request must be filed no later than

three months prior to the anticipated corporate change; provided that

the designated contract market may file a request with the Commission

later than three months prior to the anticipated corporate change if

the designated contract market does not know and reasonably could not

have known of the anticipated change three months prior to the

anticipated corporate change. In such event, the designated contract

market shall be required to immediately file the request with the

Commission as soon as it knows of such change, with an explanation as

to the timing of the request.

(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 designated contract market,

including its governance and operations, and its impact on the rights

and obligations of market participants holding the open interest

positions;

(iii) A discussion of the transferee's ability to comply with the

Act, including the core principles applicable to designated contract

markets, 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 designated contract market;

(vi) A list of contracts, agreements, transactions or swaps for

which the designated contract market requests transfer of open

interest;

(vii) A representation by the transferee that it:

(A) Will be the surviving legal entity and successor-in-interest to

the transferor designated contract market and will retain and assume,

without limitation, all the assets and liabilities of the transferor;

(B) Will assume responsibility for complying with all applicable

provisions of the Act and the Commission's regulations thereunder,

including part 38 and Appendices thereto;

(C) Will assume, maintain and enforce all rules implementing and

complying with these core principles, including the adoption of the

transferor's rulebook, as amended in the request, and that any such

amendments will be submitted to the Commission pursuant to section

5c(c) of the Act and part 40 of the Commission's regulations; and

(D) Will comply with all self-regulatory responsibilities except if

otherwise indicated in the request, and will maintain and enforce all

self-regulatory programs.

(viii) A representation by the transferee that upon the transfer:

(A) All open interest in all contracts listed on the transferor

will be transferred to and represent equivalent open interest in all

such contracts listed on the transferee;

(B) It will assume responsibility for and maintain compliance with

the core principles for all contracts previously listed for trading

through the transferor, whether by certification or approval; and

(C) That none of the proposed rule changes will affect the rights

and obligations of any market participant with open positions

transferred to it and that the proposed rule changes do not modify the

manner in which such contracts are settled or cleared.

(ix) A representation by the transferee that market participants

will be notified of all changes to the transferor's rulebook prior to

the transfer and will be further notified of the concurrent transfer of

the contract market designation, and the related transfer of all listed

contracts and all associated open interest, to the transferee upon

Commission approval and issuance of an order permitting this transfer.

(4) Commission determination. The Commission will review a request

as soon as practicable and such request will be approved or denied

pursuant to a Commission order and based on the Commission's

determination as to the transferee's ability to continue to operate the

designated contract market in compliance with the Act and the

Commission's regulations thereunder.

(e) Request for withdrawal of application for designation. An

applicant for designation may withdraw its application submitted

pursuant to paragraphs (a)(1) and (2) of this section by filing such a

request with the Commission. Such request must be filed electronically,

in a format and manner specified by the Secretary of the Commission,

with the Secretary of the Commission at its Washington, DC

headquarters, at [email protected], and the Division of Market

Oversight, at [email protected] Withdrawal of an application for

designation 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 designation was pending with the

Commission.

(f) Request for vacation of designation. A designated contract

market may vacate its designation under section 7 of the Act by filing

a request electronically, in a format and manner specified by the

Secretary of the Commission, with the Secretary of the Commission at

its Washington, DC headquarters at [email protected] and the

Division of Market Oversight at [email protected] Vacation of

designation 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 facility was designated by the Commission.

0

11. In Sec. 38.4, revise paragraphs (a) and (b) to read as follows:

Sec. 38.4 Procedures for listing products and implementing designated

contract market rules.

(a) Request for Commission approval of rules and products. (1) An

applicant for designation, or a designated contract market, may request

that the Commission approve under section 5c(c) of the Act, any or all

of its rules and contract terms and conditions, and subsequent

amendments thereto, prior to their implementation or, notwithstanding

the provisions of section 5c(c)(4) of the Act, at any time thereafter,

under the procedures of Sec. 40.3 or Sec. 40.5 of this chapter, as

applicable. A designated contract market may label a future, swap or

options product in its rules as ``Listed for trading pursuant to

Commission approval,'' if the future, swap or options product and its

terms or conditions have been approved by the Commission, and it may

label as ``Approved by the Commission'' only those rules that have been

so approved.

[[Page 36699]]

(2) Notwithstanding the timeline under Sec. Sec. 40.3(c) and

40.5(c) of this chapter, the operating rules, and terms and conditions

of futures, swaps and option products that have been submitted for

Commission approval at the same time as an application for contract

market designation or an application under Sec. 38.3(b) of this part

to reinstate the designation of a dormant designated contract market,

as defined in Sec. 40.1 of this chapter, or while one of the foregoing

is pending, will be deemed approved by the Commission no earlier than

when the facility is deemed to be designated or reinstated.

(b) Self-certification of rules and products. Rules of a designated

contract market and subsequent amendments thereto, including both

operational rules and the terms or conditions of futures, swaps and

option products listed for trading on the facility, 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 rule, rule amendment or futures, swap or options product

complies with the Act or rules thereunder pursuant to the procedures of

Sec. 40.6 of this chapter, as applicable. Provided, however, any rule

or rule amendment that would, for a delivery month having open

interest, materially change a term or condition of a swap or a contract

for future delivery in an agricultural commodity enumerated in section

1a(9) of the Act, or of an option on such contract or commodity, must

be submitted to the Commission prior to its implementation for review

and approval under Sec. 40.4 of this chapter.

* * * * *

0

12. Revise Sec. 38.5 to read as follows:

Sec. 38.5 Information relating to contract market compliance.

(a) Requests for information. Upon request by the Commission, a

designated contract market must file with the Commission information

related to its business as a designated contract market, including

information relating to data entry and trade details, in the form and

manner and within the time specified by the Commission in its request.

(b) Demonstration of compliance. Upon request by the Commission, a

designated contract market must file with the Commission a written

demonstration, containing supporting data, information and documents,

in the form and manner and within the time specified by the Commission,

that the designated contract market is in compliance with one or more

core principles as specified in the request, or that is requested by

the Commission to show that the designated contract market satisfies

its obligations under the Act.

(c) Equity interest transfers. (1) Equity interest transfer

notification. A designated contract market shall file with the

Commission a notification of each transaction that the designated

contract market enters into involving the transfer of ten percent or

more of the equity interest in the designated contract market.

(2) Timing of Notification. The equity transfer notice described in

paragraph (1) shall be filed electronically with the Secretary of the

Commission at its Washington, DC headquarters at [email protected]

and the Division of Market Oversight at [email protected], at the

earliest possible time but in no event later than the open of business

ten business days following the date upon which the designated contract

market enters into a firm obligation to transfer the equity interest.

(3) Rule filing. Notwithstanding the foregoing, any aspect of an

equity interest transfer described in paragraph (c)(1) of this section

that necessitates the filing of a rule as defined in part 40 of this

chapter shall comply with the requirements of 5c(c) of the Act and part

40 of this chapter, and all other applicable Commission regulations.

(d) Delegation of authority. The Commission hereby delegates, until

it orders otherwise, the authority set forth in paragraph (b) of this

section to the Director of the Division of Market Oversight or such

other employee or employees as the Director may designate from time to

time. The Director may submit to the Commission for its consideration

any matter that has been delegated in this paragraph. Nothing in this

paragraph prohibits the Commission, at its election, from exercising

the authority delegated in this paragraph.

0

13. Add Sec. 38.7 to subpart A to read as follows:

Sec. 38.7 Prohibited use of data collected for regulatory purposes.

A designated contract market may not use for business or marketing

purposes any proprietary data or personal information it collects or

receives, from or on behalf of any person, for the purpose of

fulfilling its regulatory obligations; provided however, that a

designated contract market may use such data or information for

business or marketing purposes if the person from whom it collects or

receives such data or information clearly consents to the designated

contract market's use of such data or information in such manner. A

designated contract market, where necessary, for regulatory purposes,

may share such data or information with one or more designated contract

markets or swap execution facilities registered with the Commission. A

designated contract market may not condition access to its trading

facility on a market participant's consent to the use of proprietary

data or personal information for business or marketing purposes.

0

14. Add Sec. 38.8 to subpart A to read as follows:

Sec. 38.8 Listing of swaps on a designated contract market.

(a) A designated contract market that lists for the first time a

swap contract for trading on its contract market must, either prior to

or at the time of such listing, file with the Commission a written

demonstration detailing how the designated contract market is

addressing its self-regulatory obligations and is fulfilling its

statutory and regulatory obligations with respect to swap transactions.

(b)(1) Prior to listing swaps for trading on or through a

designated contract market, each designated contract market must obtain

from the Commission a unique, alphanumeric code assigned to the

designated contract market by the Commission for the purpose of

identifying the designated contract market with respect to unique swap

identifier creation. (2) Each designated contract market must generate

and assign a unique swap identifier at, or as soon as technologically

practicable following, the time of execution of the swap, in a manner

consistent with the requirements of part 45.

0

15. Add Sec. 38.9 to subpart A to read as follows:

Sec. 38.9 Boards of trade operating both a designated contract market

and a swap execution facility.

(a) A board of trade that operates a designated contract market and

that intends to also operate a swap execution facility must separately

register, pursuant to the swap execution facility registration

requirements set forth in part 37 of this chapter, and on an ongoing

basis, comply with the core principles under section 5h of the Act, and

the swap execution facility rules under part 37 of this chapter.

(b) A board of trade that operates both a designated contract

market and a swap execution facility, and that uses the same electronic

trade execution system for executing and trading swaps that it uses in

its capacity as a designated contract market, must clearly identify to

market participants for each swap

[[Page 36700]]

whether the execution or trading of such swap is taking place on the

designated contract market or on the swap execution facility.

0

16. Add Sec. 38.10 to subpart A to read as follows:

Sec. 38.10 Reporting of swaps traded on a designated contract market.

With respect to swaps traded on and/or pursuant to the rules of a

designated contract market, each designated contract market must

maintain and report specified swap data as provided under parts 43 and

45 of this chapter.

0

17. Add subparts B through X to read as follows:

Subpart B--Designation as Contract Market

Sec.

38.100 Core Principle 1.

Subpart C--Compliance With Rules

38.150 Core Principle 2.

38.151 Access requirements.

38.152 Abusive trading practices prohibited.

38.153 Capacity to detect and investigate rule violations.

38.154 Regulatory services provided by a third party.

38.155 Compliance staff and resources.

38.156 Automated trade surveillance system.

38.157 Real-time market monitoring.

38.158 Investigations and investigation reports.

38.159 Ability to obtain information.

38.160 Additional sources for compliance.

Subpart D--Contracts Not Readily Subject to Manipulation

38.200 Core Principle 3.

38.201 Additional sources for compliance.

Subpart E--Prevention of Market Disruption

38.250 Core Principle 4.

38.251 General requirements.

38.252 Additional requirements for physical-delivery contracts.

38.253 Additional requirements for cash-settled contracts.

38.254 Ability to obtain information.

38.255 Risk controls for trading.

38.256 Trade reconstruction.

38.257 Regulatory service provider.

38.258 Additional sources for compliance.

Subpart F--Position Limitations or Accountability

38.300 Core Principle 5.

38.301 Position limitations and accountability.

Subpart G--Emergency Authority

38.350 Core Principle 6.

38. 351 Additional sources for compliance.

Subpart H--Availability of General Information

38.400 Core Principle 7.

38.401 General requirements.

Subpart I--Daily Publication of Trading Information

38.450 Core Principle 8.

38.451 Reporting of trade information.

Subpart J--Execution of Transactions

38.500 Core Principle 9.

Subpart K--Trade Information

38.550 Core Principle 10.

38.551 Audit trail required.

38.552 Elements of an acceptable audit trail program.

38.553 Enforcement of audit trail requirements.

Subpart L--Financial Integrity of Transactions

38.600 Core Principle 11.

38.601 Mandatory clearing.

38.602 General financial integrity.

38.603 Protection of customer funds.

38.604 Financial surveillance.

38.605 Requirements for financial surveillance program.

38.606 Financial regulatory services provided by a third party.

38.607 Direct access.

Subpart M--Protection of Markets and Market Participants

38.650 Core Principle 12.

38.651 Protection of Markets and Market Participants.

Subpart N--Disciplinary Procedures

38.700 Core Principle 13.

38.701 Enforcement staff.

38.702 Disciplinary panels.

38.703 Notice of charges.

38.704 Right to representation.

38.705 Answer to charges.

38.706 Denial of charges and right to hearing.

38.707 Hearings.

38.708 Decisions.

38.709 Final decisions.

38.710 Disciplinary sanctions.

38.711 Warning letters.

38.712 Additional sources for compliance.

Subpart O--Dispute Resolution

38.750 Core Principle 14.

38.751 Additional sources for compliance.

Subpart P--Governance Fitness Standards

38.800 Core Principle 15.

38.801 Additional sources for compliance.

Subpart Q--Conflicts of Interest

38.850 Core Principle 16.

38.851 Additional sources for compliance.

Subpart R--Composition of Governing Boards of Contract Markets

38.900 Core Principle 17.

Subpart S--Recordkeeping

38.950 Core Principle 18.

38.951 Additional sources for compliance.

Subpart T--Antitrust Considerations

38.1000 Core Principle 19.

38.1001 Additional sources for compliance.

Subpart U--System Safeguards

38.1050 Core Principle 20.

38.1051 General requirements.

Subpart V--Financial Resources

38.1100 Core Principle 21.

38.1101 General requirements.

Subpart W--Diversity of Boards of Directors

38.1150 Core Principle 22.

Subpart X--Securities and Exchange Commission

38.1200 Core Principle 23.

38.1201 Additional sources for compliance.

Subpart B--Designation as Contract Market

Sec. 38.100 Core Principle 1.

(a) In general. To be designated, and maintain a designation, as a

contract market, a board of trade shall comply with:

(1) Any core principle described in section 5(d) of the Act, and

(2) Any requirement that the Commission may impose by rule or

regulation pursuant to section 8a(5) of the Act.

(b) Reasonable discretion of the contract market. Unless otherwise

determined by the Commission by rule or regulation, a board of trade

described in paragraph (a) of this section shall have reasonable

discretion in establishing the manner in which the board of trade

complies with the core principles described in this subsection.

Subpart C--Compliance With Rules

Sec. 38.150 Core Principle 2.

(a) In general. The board of trade shall establish, monitor, and

enforce compliance with the rules of the contract market, including:

(1) Access requirements;

(2) The terms and conditions of any contracts to be traded on the

contract market; and

(3) Rules prohibiting abusive trade practices on the contract

market.

(b) Capacity of contract market. The board of trade shall have the

capacity to detect, investigate, and apply appropriate sanctions to any

person that violates any rule of the contract market.

(c) Requirement of rules. The rules of the contract market shall

provide the board of trade with the ability and authority to obtain any

necessary information to perform any function described in this

section, including the capacity to carry out such international

information-sharing agreements, as the Commission may require.

Sec. 38.151 Access requirements.

(a) Jurisdiction. Prior to granting any member or market

participant access to its markets, a designated contract market must

require that the member or market participant consent to its

jurisdiction.

[[Page 36701]]

(b) Impartial access by members, persons with trading privileges

and independent software vendors. A designated contract market must

provide its members, persons with trading privileges, and independent

software vendors with impartial access to its markets and services,

including:

(1) Access criteria that are impartial, transparent, and applied in

a non-discriminatory manner; and

(2) Comparable fee structures for members, persons with trading

privileges and independent software vendors receiving equal access to,

or services from, the designated contract market.

(c) Limitations on access. A designated contract market must

establish and impartially enforce rules governing denials, suspensions,

and revocations of a member's and a person with trading privileges'

access privileges to the designated contract market, including when

such actions are part of a disciplinary or emergency action by the

designated contract market.

Sec. 38.152 Abusive trading practices prohibited.

A designated contract market must prohibit abusive trading

practices on its markets by members and market participants. Designated

contract markets that permit intermediation must prohibit customer-

related abuses including, but not limited to, trading ahead of customer

orders, trading against customer orders, accommodation trading, and

improper cross trading. Specific trading practices that must be

prohibited by all designated contract markets include front-running,

wash trading, pre-arranged trading (except for certain transactions

specifically permitted under part 38 of this chapter), fraudulent

trading, money passes, and any other trading practices that a

designated contract market deems to be abusive. In addition, a

designated contract market also must prohibit any other manipulative or

disruptive trading practices prohibited by the Act or by the Commission

pursuant to Commission regulation.

Sec. 38.153 Capacity to detect and investigate rule violations.

A designated contract market must have arrangements and resources

for effective enforcement of its rules. Such arrangements must include

the authority to collect information and documents on both a routine

and non-routine basis, including the authority to examine books and

records kept by the designated contract market's members and by persons

under investigation. A designated contract market's arrangements and

resources must also facilitate the direct supervision of the market and

the analysis of data collected to determine whether a rule violation

occurred.

Sec. 38.154 Regulatory services provided by a third party.

(a) Use of third-party provider permitted. A designated contract

market may choose to utilize a registered futures association or

another registered entity, as such terms are defined under the Act,

(collectively, ``regulatory service provider''), for the provision of

services to assist in complying with the core principles, as approved

by the Commission. Any designated contract market that chooses to

utilize a regulatory service provider must ensure that its regulatory

service provider has the capacity and resources necessary to provide

timely and effective regulatory services, including adequate staff and

automated surveillance systems. A designated contract market will at

all times remain responsible for the performance of any regulatory

services received, for compliance with the designated contract market's

obligations under the Act and Commission regulations, and for the

regulatory service provider's performance on its behalf.

(b) Duty to supervise third party. A designated contract market

that elects to utilize a regulatory service provider must retain

sufficient compliance staff to supervise the quality and effectiveness

of the services provided on its behalf. Compliance staff of the

designated contract market must hold regular meetings with the

regulatory service provider to discuss ongoing investigations, trading

patterns, market participants, and any other matters of regulatory

concern. A designated contract market also must conduct periodic

reviews of the adequacy and effectiveness of services provided on its

behalf. Such reviews must be documented carefully and made available to

the Commission upon request.

(c) Regulatory decisions required from the designated contract

market. A designated contract market that elects to utilize a

regulatory service provider must retain exclusive authority in

decisions involving the cancellation of trades, the issuance of

disciplinary charges against members or market participants, and the

denials of access to the trading platform for disciplinary reasons. A

designated contract market may also retain exclusive authority in other

areas of its choosing. A designated contract market must document any

instances where its actions differ from those recommended by its

regulatory service provider, including the reasons for the course of

action recommended by the regulatory service provider and the reasons

why the designated contract market chose a different course of action.

Sec. 38.155 Compliance staff and resources.

(a) Sufficient compliance staff. A designated contract market must

establish and maintain sufficient compliance department resources and

staff to ensure that it can conduct effective audit trail reviews,

trade practice surveillance, market surveillance, and real-time market

monitoring. The designated contract market's compliance staff also must

be sufficient to address unusual market or trading events as they

arise, and to conduct and complete investigations in a timely manner,

as set forth in Sec. 38.158(b) of this part.

(b) Ongoing monitoring of compliance staff resources. A designated

contract market must monitor the size and workload of its compliance

staff annually, and ensure that its compliance resources and staff are

at appropriate levels. In determining the appropriate level of

compliance resources and staff, the designated contract market should

consider trading volume increases, the number of new products or

contracts to be listed for trading, any new responsibilities to be

assigned to compliance staff, the results of any internal review

demonstrating that work is not completed in an effective or timely

manner, and any other factors suggesting the need for increased

resources and staff.

Sec. 38.156 Automated trade surveillance system.

A designated contract market must maintain an automated trade

surveillance system capable of detecting and investigating potential

trade practice violations. The automated system must load and process

daily orders and trades no later than 24 hours after the completion of

the trading day. In addition, the automated trade surveillance system

must have the capability to detect and flag specific trade execution

patterns and trade anomalies; compute, retain, and compare trading

statistics; compute trade gains, losses, and futures-equivalent

positions; reconstruct the sequence of market activity; perform market

analyses; and support system users to perform in-depth analyses and ad

hoc queries of trade-related data.

[[Page 36702]]

Sec. 38.157 Real-time market monitoring.

A designated contract market must conduct real-time market

monitoring of all trading activity on its electronic trading

platform(s) to identify disorderly trading and any market or system

anomalies. A designated contract market must have the authority to

adjust trade prices or cancel trades when necessary to mitigate market

disrupting events caused by malfunctions in its electronic trading

platform(s) or errors in orders submitted by members and market

participants. Any trade price adjustments or trade cancellations must

be transparent to the market and subject to standards that are clear,

fair, and publicly available.

Sec. 38.158 Investigations and investigation reports.

(a) Procedures. A designated contract market must establish and

maintain procedures that require its compliance staff to conduct

investigations of possible rule violations. An investigation must be

commenced upon the receipt of a request from Commission staff or upon

the discovery or receipt of information by the designated contract

market that indicates a reasonable basis for finding that a violation

may have occurred or will occur.

(b) Timeliness. Each compliance staff investigation must be

completed in a timely manner. Absent mitigating factors, a timely

manner is no later than 12 months after the date that an investigation

is opened. Mitigating factors that may reasonably justify an

investigation taking longer than 12 months to complete include the

complexity of the investigation, the number of firms or individuals

involved as potential wrongdoers, the number of potential violations to

be investigated, and the volume of documents and data to be examined

and analyzed by compliance staff.

(c) Investigation reports when a reasonable basis exists for

finding a violation. Compliance staff must submit a written

investigation report for disciplinary action in every instance in which

compliance staff determines from surveillance or from an investigation

that a reasonable basis exists for finding a rule violation. The

investigation report must include the reason the investigation was

initiated; a summary of the complaint, if any; the relevant facts;

compliance staff's analysis and conclusions; and a recommendation as to

whether disciplinary action should be pursued.

(d) Investigation reports when no reasonable basis exists for

finding a violation. If after conducting an investigation, compliance

staff determines that no reasonable basis exists for finding a

violation, it must prepare a written report including the reason(s) the

investigation was initiated; a summary of the complaint, if any; the

relevant facts; and compliance staff's analysis and conclusions.

(e) Warning letters. No more than one warning letter may be issued

to the same person or entity found to have committed the same rule

violation within a rolling twelve month period.

Sec. 38.159 Ability to obtain information.

A designated contract market must have the ability and authority to

obtain any necessary information to perform any function required under

this subpart C of the Commission's regulations, including the capacity

to carry out international information-sharing agreements as the

Commission may require. Appropriate information-sharing agreements can

be established with other designated contract markets and swap

execution facilities, or the Commission can act in conjunction with the

designated contract market to carry out such information sharing.

Sec. 38.160 Additional sources for compliance.

Applicants and designated contract markets may refer to the

guidance in appendix B of this part to demonstrate to the Commission

compliance with the requirements of Sec. 38.150 of this part.

Subpart D--Contracts Not Readily Subject to Manipulation

Sec. 38.200 Core Principle 3.

The board of trade shall list on the contract market only contracts

that are not readily susceptible to manipulation.

Sec. 38.201 Additional sources for compliance.

Applicants and designated contract markets may refer to the

guidance in appendix C of this part to demonstrate to the Commission

compliance with the requirements of Sec. 38.200 of this part.

Subpart E--Prevention of Market Disruption

Sec. 38.250 Core Principle 4.

The board of trade shall have the capacity and responsibility to

prevent manipulation, price distortion, and disruptions of the delivery

or cash-settlement process through market surveillance, compliance, and

enforcement practices and procedures, including:

(a) Methods for conducting real-time monitoring of trading; and

(b) Comprehensive and accurate trade reconstructions.

Sec. 38.251 General requirements.

A designated contract market must:

(a) Collect and evaluate data on individual traders' market

activity on an ongoing basis in order to detect and prevent

manipulation, price distortions and, where possible, disruptions of the

physical-delivery or cash-settlement process;

(b) Monitor and evaluate general market data in order to detect and

prevent manipulative activity that would result in the failure of the

market price to reflect the normal forces of supply and demand;

(c) Demonstrate an effective program for conducting real-time

monitoring of market conditions, price movements and volumes, in order

to detect abnormalities and, when necessary, make a good-faith effort

to resolve conditions that are, or threaten to be, disruptive to the

market; and

(d) Demonstrate the ability to comprehensively and accurately

reconstruct daily trading activity for the purposes of detecting

trading abuses and violations of exchange-set position limits,

including those that may have occurred intraday.

Sec. 38.252 Additional requirements for physical-delivery contracts.

For physical-delivery contracts, the designated contract market

must demonstrate that it:

(a) Monitors a contract's terms and conditions as they relate to

the underlying commodity market and to the convergence between the

contract price and the price of the underlying commodity and show a

good-faith effort to resolve conditions that are interfering with

convergence; and

(b) Monitors the supply of the commodity and its adequacy to

satisfy the delivery requirements and make a good-faith effort to

resolve conditions that threaten the adequacy of supplies or the

delivery process.

Sec. 38.253 Additional requirements for cash-settled contracts.

(a) For cash-settled contracts, the designated contract market must

demonstrate that it:

(1) Monitors the pricing of the index to which the contract will be

settled; and

(2) Monitors the continued appropriateness of the methodology for

deriving the index and makes a good-faith effort to resolve conditions,

including amending contract terms where necessary, where there is a

threat of market manipulation, disruptions, or distortions.

(b) If a contract listed on a designated contract market is settled

by reference to

[[Page 36703]]

the price of a contract or commodity traded in another venue, including

a price or index derived from prices on another designated contract

market, the designated contract market must have rules or agreements

that allow the designated contract market access to information on the

activities of its traders in the reference market.

Sec. 38.254 Ability to obtain information.

(a) The designated contract market must have rules that require

traders in its contracts to keep records of their trading, including

records of their activity in the underlying commodity and related

derivatives markets, and make such records available, upon request, to

the designated contract market.

(b) A designated contract market with participants trading through

intermediaries must either use a comprehensive large-trader reporting

system (LTRS) or be able to demonstrate that it can obtain position

data from other sources in order to conduct an effective surveillance

program.

Sec. 38.255 Risk controls for trading.

The designated contract market must establish and maintain risk

control mechanisms to prevent and reduce the potential risk of price

distortions and market disruptions, including, but not limited to,

market restrictions that pause or halt trading in market conditions

prescribed by the designated contract market.

Sec. 38.256 Trade reconstruction.

The designated contract market must have the ability to

comprehensively and accurately reconstruct all trading on its trading

facility. All audit-trail data and reconstructions must be made

available to the Commission in a form, manner, and time that is

acceptable to the Commission.

Sec. 38.257 Regulatory service provider.

A designated contract market must comply with the regulations in

this subpart through a dedicated regulatory department, or by

delegation of that function to a registered futures association or a

registered entity (collectively, ``regulatory service provider''), as

such terms are defined in the Act and over which the designated

contract market has supervisory authority.

Sec. 38.258 Additional sources for compliance.

Applicants and designated contract markets may refer to the

guidance and acceptable practices in appendix B of this part to

demonstrate to the Commission compliance with the requirements of Sec.

38.250 of this part.

Subpart F--Position Limitations or Accountability

Sec. 38.300 Core Principle 5.

To reduce the potential threat of market manipulation or congestion

(especially during trading in the delivery month), the board of trade

shall adopt for each contract of the board of trade, as is necessary

and appropriate, position limitations or position accountability for

speculators. For any contract that is subject to a position limitation

established by the Commission, pursuant to section 4a(a), the board of

trade shall set the position limitation of the board of trade at a

level not higher than the position limitation established by the

Commission.

Sec. 38.301 Position limitations and accountability.

A designated contract market must meet the requirements of parts

150 and 151 of this chapter, as applicable.

Subpart G--Emergency Authority

Sec. 38.350 Core Principle 6.

The board of trade, in consultation or cooperation with the

Commission, shall adopt rules to provide for the exercise of emergency

authority, as is necessary and appropriate, including the authority:

(a) To liquidate or transfer open positions in any contract;

(b) To suspend or curtail trading in any contract; and

(c) To require market participants in any contract to meet special

margin requirements.

Sec. 38.351 Additional sources for compliance.

Applicants and designated contract markets may refer to the

guidance and/or acceptable practices in appendix B of this part to

demonstrate to the Commission compliance with the requirements of Sec.

38.350.

Subpart H--Availability of General Information

Sec. 38.400 Core Principle 7.

The board of trade shall make available to market authorities,

market participants, and the public accurate information concerning:

(a) The terms and conditions of the contracts of the contract

market; and

(b)(1) The rules, regulations and mechanisms for executing

transactions on or through the facilities of the contract market, and

(2) The rules and specifications describing the operation of the

contract market's:

(i) Electronic matching platform, or

(ii) Trade execution facility.

Sec. 38.401 General requirements.

(a) General. (1) A designated contract market must have procedures,

arrangements and resources for disclosing to the Commission, market

participants and the public accurate information pertaining to:

(i) Contract terms and conditions;

(ii) Rules and regulations pertaining to the trading mechanisms;

and

(iii) Rules and specifications pertaining to operation of the

electronic matching platform or trade execution facility.

(2) Through the procedures, arrangements and resources required in

paragraph (a) of this section, the designated contract market must

ensure public dissemination of information pertaining to new product

listings, new rules, rule amendments or other changes to previously-

disclosed information, in accordance with the timeline provided in

paragraph (c) of this section.

(3) A designated contract market shall meet the requirements of

this paragraph (a), by placing the information described in this

paragraph (a) on the designated contract market's Web site within the

time prescribed in paragraph (c) of this section.

(b) Accuracy requirement. With respect to any communication with

the Commission, and any information required to be transmitted or made

available to market participants and the public, including on its Web

site or otherwise, a designated contract market must provide

information that it believes, to the best of its knowledge, is accurate

and complete, and must not omit material information.

(c) Notice of regulatory submissions. (1) A designated contract

market, in making available on its Web site information pertaining to

new product listings, new rules, rule amendments or other changes to

previously-disclosed information, must place such information and

submissions on its Web site concurrent with the filing of such

information or submissions with the Secretary of the Commission.

(2) To the extent that a designated contract market requests

confidential treatment of any information filed with the Secretary of

the Commission, the designated contract market must post on its Web

site the public version of such filing or submission.

(d) Rulebook. A designated contract market must ensure that the

rulebook posted on its Web site is accurate,

[[Page 36704]]

complete, current and readily accessible to the public. A designated

contract market must publish or post in its rulebook all new or amended

rules, both substantive and non-substantive, on the date of

implementation of such new or amended rule, on the date a new product

is listed, or on the date any changes to previously-disclosed

information take effect.

Subpart I--Daily Publication of Trading Information

Sec. 38.450 Core Principle 8.

The board of trade shall make public daily information on

settlement prices, volume, open interest, and opening and closing

ranges for actively traded contracts on the contract market.

Sec. 38.451 Reporting of trade information.

A designated contract market must meet the reporting requirements

set forth in part 16 of this chapter.

Subpart J--Execution of Transactions

Sec. 38.500 Core Principle 9.

The board of trade shall provide a competitive, open, and efficient

market and mechanism for executing transactions that protects the price

discovery process of trading in the centralized market of the board of

trade. The rules of the board of trade may authorize, for bona fide

business purposes:

(a) Transfer trades or office trades;

(b) An exchange of:

(1) Futures in connection with a cash commodity transaction;

(2) Futures for cash commodities; or

(3) Futures for swaps; or

(c) A futures commission merchant, acting as principal or agent, to

enter into or confirm the execution of a contract for the purchase or

sale of a commodity for future delivery if the contract is reported,

recorded, or cleared in accordance with the rules of the contract

market or a derivatives clearing organization.

Subpart K--Trade Information

Sec. 38.550 Core Principle 10.

The board of trade shall maintain rules and procedures to provide

for the recording and safe storage of all identifying trade information

in a manner that enables the contract market to use the information:

(a) To assist in the prevention of customer and market abuses; and

(b) To provide evidence of any violations of the rules of the

contract market.

Sec. 38.551 Audit trail required.

A designated contract market must capture and retain all audit

trail data necessary to detect, investigate, and prevent customer and

market abuses. Such data must be sufficient to reconstruct all

transactions within a reasonable period of time and to provide evidence

of any violations of the rules of the designated contract market. An

acceptable audit trail must also permit the designated contract market

to track a customer order from the time of receipt through fill,

allocation, or other disposition, and must include both order and trade

data.

Sec. 38.552 Elements of an acceptable audit trail program.

(a) Original source documents. A designated contract market's audit

trail must include original source documents. Original source documents

include unalterable, sequentially identified records on which trade

execution information is originally recorded, whether recorded manually

or electronically. Records for customer orders (whether filled,

unfilled, or cancelled, each of which shall be retained or

electronically captured) must reflect the terms of the order, an

account identifier that relates back to the account(s) owner(s), and

the time of order entry. For open-outcry trades, the time of report of

execution of the order shall also be captured.

(b) Transaction history database. A designated contract market's

audit trail program must include an electronic transaction history

database. An adequate transaction history database includes a history

of all trades executed via open outcry or via entry into an electronic

trading system, and all orders entered into an electronic trading

system, including all order modifications and cancellations. An

adequate transaction history database also includes:

(1) All data that are input into the trade entry or matching system

for the transaction to match and clear;

(2) The customer type indicator code;

(3) Timing and sequencing data adequate to reconstruct trading; and

(4) Identification of each account to which fills are allocated.

(c) Electronic analysis capability. A designated contract market's

audit trail program must include electronic analysis capability with

respect to all audit trail data in the transaction history database.

Such electronic analysis capability must ensure that the designated

contract market has the ability to reconstruct trading and identify

possible trading violations with respect to both customer and market

abuse.

(d) Safe storage capability. A designated contract market's audit

trail program must include the capability to safely store all audit

trail data retained in its transaction history database. Such safe

storage capability must include the capability to store all data in the

database in a manner that protects it from unauthorized alteration, as

well as from accidental erasure or other loss. Data must be retained in

accordance with the recordkeeping requirements of Core Principle 18 and

the associated regulations in subpart S of this part.

Sec. 38.553 Enforcement of audit trail requirements.

(a) Annual audit trail and recordkeeping reviews. A designated

contract market must enforce its audit trail and recordkeeping

requirements through at least annual reviews of all members and persons

and firms subject to designated contract market recordkeeping rules to

verify their compliance with the contract market's audit trail and

recordkeeping requirements. Such reviews must include, but are not

limited to, the following:

(1) For electronic trading, audit trail and recordkeeping reviews

must include reviews of randomly selected samples of front-end audit

trail data for order routing systems; a review of the process by which

user identifications are assigned and user identification records are

maintained; a review of usage patterns associated with user

identifications to monitor for violations of user identification rules;

and reviews of account numbers and customer type indicator codes in

trade records to test for accuracy and improper use.

(2) For open outcry trading, audit trail and recordkeeping reviews

must include reviews of members' and market participants' compliance

with the designated contract market's trade timing, order ticket, and

trading card requirements.

(b) Enforcement program required. A designated contract market must

establish a program for effective enforcement of its audit trail and

recordkeeping requirements for both electronic and open-outcry trading,

as applicable. An effective program must identify members and persons

and firms subject to designated contract market recordkeeping rules

that have failed to maintain high levels of compliance with such

requirements, and levy meaningful sanctions when deficiencies are

found. Sanctions must be sufficient to deter recidivist behavior. No

more than one warning letter may be issued to the

[[Page 36705]]

same person or entity found to have committed the same rule violation

within a rolling twelve month period.

Subpart L--Financial Integrity of Transactions

Sec. 38.600 Core Principle 11.

The board of trade shall establish and enforce:

(a) Rules and procedures for ensuring the financial integrity of

transactions entered into on or through the facilities of the contract

market (including the clearance and settlement of the transactions with

a derivatives clearing organization); and

(b) Rules to ensure:

(1) The financial integrity of any:

(i) Futures commission merchant, and

(ii) Introducing broker; and

(2) The protection of customer funds.

Sec. 38.601 Mandatory clearing.

(a) Transactions executed on or through the designated contract

market must be cleared through a Commission-registered derivatives

clearing organization, in accordance with the provisions of part 39 of

this chapter. Notwithstanding the foregoing, transactions in security

futures products executed on or through the designated contract market

may alternatively be cleared through a clearing agency, registered

pursuant to section 17A of the Securities Exchange Act of 1934.

(b) [Reserved]

Sec. 38.602 General financial integrity.

A designated contract market must provide for the financial

integrity of its transactions by establishing and maintaining

appropriate minimum financial standards for its members and non-

intermediated market participants.

Sec. 38.603 Protection of customer funds.

A designated contract market must have rules concerning the

protection of customer funds. These rules shall address appropriate

minimum financial standards for intermediaries, the segregation of

customer and proprietary funds, the custody of customer funds, the

investment standards for customer funds, intermediary default

procedures and related recordkeeping. A designated contract market must

review the default rules and procedures of the derivatives clearing

organization that clears for such designated contract market to wind

down operations, transfer customers, or otherwise protect customers in

the event of a default of a clearing member or the derivatives clearing

organization.

Sec. 38.604 Financial surveillance.

A designated contract market must monitor members' compliance with

the designated contract market's minimum financial standards and,

therefore, must routinely receive and promptly review financial and

related information from its members, as well as continuously monitor

the positions of members and their customers. A designated contract

market must have rules that prescribe minimum capital requirements for

member futures commission merchants and introducing brokers. A

designated contract market must:

(a) Continually survey the obligations of each futures commission

merchant created by the positions of its customers;

(b) As appropriate, compare those obligations to the financial

resources of the futures commission merchant; and

(c) Take appropriate steps to use this information to protect

customer funds.

Sec. 38.605 Requirements for financial surveillance program.

A designated contract market's financial surveillance program for

futures commission merchants, retail foreign exchange dealers, and

introducing brokers must comply with the requirements of Sec. 1.52 of

this chapter to assess the compliance of such entities with applicable

contract market rules and Commission regulations.

Sec. 38.606 Financial regulatory services provided by a third party.

A designated contract market may comply with the requirements of

Sec. 38.604 (Financial Surveillance) and Sec. 38.605 (Requirements

for Financial Surveillance Program) of this part through the regulatory

services of a registered futures association or a registered entity

(collectively, ``regulatory service provider''), as such terms are

defined under the Act. A designated contract market must ensure that

its regulatory service provider has the capacity and resources

necessary to provide timely and effective regulatory services,

including adequate staff and appropriate surveillance systems. A

designated contract market will at all times remain responsible for

compliance with its obligations under the Act and Commission

regulations, and for the regulatory service provider's performance on

its behalf. Regulatory services must be provided under a written

agreement with a regulatory services provider that shall specifically

document the services to be performed as well as the capacity and

resources of the regulatory service provider with respect to the

services to be performed.

Sec. 38.607 Direct access.

A designated contract market that permits direct electronic access

by customers (i.e., allowing customers of futures commission merchants

to enter orders directly into a designated contract market's trade

matching system for execution) must have in place effective systems and

controls reasonably designed to facilitate the FCM's management of

financial risk, such as automated pre-trade controls that enable member

futures commission merchants to implement appropriate financial risk

limits. A designated contract market must implement and enforce rules

requiring the member futures commission merchants to use the provided

systems and controls.

Subpart M--Protection of Markets and Market Participants

Sec. 38.650 Core Principle 12.

The board of trade shall establish and enforce rules:

(a) To protect markets and market participants from abusive

practices committed by any party, including abusive practices committed

by a party acting as an agent for a participant; and

(b) To promote fair and equitable trading on the contract market.

Sec. 38.651 Protection of markets and market participants.

A designated contract market must have and enforce rules that are

designed to promote fair and equitable trading and to protect the

market and market participants from abusive practices including

fraudulent, noncompetitive or unfair actions, committed by any party.

The designated contract market must have methods and resources

appropriate to the nature of the trading system and the structure of

the market to detect trade practice and market abuses and to discipline

such behavior, in accordance with Core Principles 2 and 4, and the

associated regulations in subparts C and E of this part, respectively.

The designated contract market also must provide a competitive, open

and efficient market and mechanism for executing transactions in

accordance with Core Principle 9 and the associated regulations under

subpart J of this part.

Subpart N--Disciplinary Procedures

Sec. 38.700 Core Principle 13.

The board of trade shall establish and enforce disciplinary

procedures that authorize the board of trade to discipline, suspend, or

expel members or market participants that violate the rules of the

board of trade, or similar methods for performing the same functions,

including delegation of the functions to third parties.

[[Page 36706]]

Sec. 38.701 Enforcement staff.

A designated contract market must establish and maintain sufficient

enforcement staff and resources to effectively and promptly prosecute

possible rule violations within the disciplinary jurisdiction of the

contract market. A designated contract market must also monitor the

size and workload of its enforcement staff annually, and ensure that

its enforcement resources and staff are at appropriate levels. The

enforcement staff may not include either members of the designated

contract market or persons whose interests conflict with their

enforcement duties. A member of the enforcement staff may not operate

under the direction or control of any person or persons with trading

privileges at the contract market. A designated contract market's

enforcement staff may operate as part of the designated contract

market's compliance department.

Sec. 38.702 Disciplinary panels.

A designated contract market must establish one or more

disciplinary panels that are authorized to fulfill their obligations

under the rules of this subpart. Disciplinary panels must meet the

composition requirements of part 40 of this chapter, and must not

include any members of the designated contract market's compliance

staff or any person involved in adjudicating any other stage of the

same proceeding.

Sec. 38.703 Notice of charges.

If compliance staff authorized by a designated contract market or a

designated contract market disciplinary panel determines that a

reasonable basis exists for finding a violation and that adjudication

is warranted, it must direct that the person or entity alleged to have

committed the violation be served with a notice of charges and must

proceed in accordance with the rules of this section. A notice of

charges must adequately state the acts, conduct, or practices in which

the respondent is alleged to have engaged; state the rule, or rules,

alleged to have been violated (or about to be violated); and prescribe

the period within which a hearing on the charges may be requested. The

notice must also advise that the charged respondent is entitled, upon

request, to a hearing on the charges.

Sec. 38.704 Right to representation.

Upon being served with a notice of charges, a respondent must have

the right to be represented by legal counsel or any other

representative of its choosing in all succeeding stages of the

disciplinary process, except any member of the designated contract

market's board of directors or disciplinary panel, any employee of the

designated contract market, or any person substantially related to the

underlying investigations, such as material witness or respondent.

Sec. 38.705 Answer to charges.

A respondent must be given a reasonable period of time to file an

answer to a notice of charges. The rules of a designated contract

market governing the requirements and timeliness of a respondent's

answer to charges must be fair, equitable, and publicly available.

Sec. 38.706 Denial of charges and right to hearing.

In every instance where a respondent has requested a hearing on a

charge that is denied, or on a sanction set by the disciplinary panel,

the respondent must be given an opportunity for a hearing in accordance

with the requirements of Sec. 38.707 of this part.

Sec. 38.707 Hearings.

(a) A designated contract market must adopt rules that provide for

the following minimum requirements for any hearing conducted pursuant

to a notice of charges:

(1) The hearing must be fair, must be conducted before members of

the disciplinary panel, and must be promptly convened after reasonable

notice to the respondent. The formal rules of evidence need not apply;

nevertheless, the procedures for the hearing may not be so informal as

to deny a fair hearing. No member of the disciplinary panel for the

matter may have a financial, personal, or other direct interest in the

matter under consideration.

(2) In advance of the hearing, the respondent must be entitled to

examine all books, documents, or other evidence in the possession or

under the control of the designated contract market. The designated

contract market may withhold documents that are privileged or

constitute attorney work product, documents that were prepared by an

employee of the designated contract market but will not be offered in

evidence in the disciplinary proceedings, documents that may disclose a

technique or guideline used in examinations, investigations, or

enforcements proceedings, and documents that disclose the identity of a

confidential source.

(3) The designated contract market's enforcement and compliance

staffs must be parties to the hearing, and the enforcement staff must

present their case on those charges and sanctions that are the subject

of the hearing.

(4) The respondent must be entitled to appear personally at the

hearing, must be entitled to cross-examine any persons appearing as

witnesses at the hearing, and must be entitled to call witnesses and to

present such evidence as may be relevant to the charges.

(5) The designated contract market must require persons within its

jurisdiction who are called as witnesses to participate in the hearing

and to produce evidence. It must make reasonable efforts to secure the

presence of all other persons called as witnesses whose testimony would

be relevant.

(6) If the respondent has requested a hearing, a copy of the

hearing must be made and must become a part of the record of the

proceeding. The record must be one that is capable of being accurately

transcribed; however, it need not be transcribed unless the transcript

is requested by Commission staff or the respondent, the decision is

appealed pursuant to the rules of the designated contract market, or is

reviewed by the Commission pursuant to section 8c of the Act or part 9

of this chapter. In all other instances a summary record of a hearing

is permitted.

(b) [Reserved]

Sec. 38.708 Decisions.

Promptly following a hearing conducted in accordance with Sec.

38.707 of this part, the disciplinary panel must render a written

decision based upon the weight of the evidence contained in the record

of the proceeding and must provide a copy to the respondent. The

decision must include:

(a) The notice of charges or a summary of the charges;

(b) The answer, if any, or a summary of the answer;

(c) A summary of the evidence produced at the hearing or, where

appropriate, incorporation by reference of the investigation report;

(d) A statement of findings and conclusions with respect to each

charge, and a complete explanation of the evidentiary and other basis

for such findings and conclusions with respect to each charge;

(e) An indication of each specific rule that the respondent was

found to have violated; and

(f) A declaration of all sanctions imposed against the respondent,

including the basis for such sanctions and the effective date of such

sanctions.

Sec. 38.709 Final decisions.

Each designated contract market must establish rules setting forth

when a decision rendered pursuant to this

[[Page 36707]]

section will become the final decision of such designated contract

market.

Sec. 38.710 Disciplinary sanctions.

All disciplinary sanctions imposed by a designated contract market

or its disciplinary panels must be commensurate with the violations

committed and must be clearly sufficient to deter recidivism or similar

violations by other market participants. All disciplinary sanctions,

including sanctions imposed pursuant to an accepted settlement offer,

must take into account the respondent's disciplinary history. In the

event of demonstrated customer harm, any disciplinary sanction must

also include full customer restitution, except where the amount of

restitution, or to whom it should be provided, cannot be reasonably

determined.

Sec. 38.711 Warning letters.

Where a rule violation is found to have occurred, no more than one

warning letter may be issued per rolling 12-month period for the same

violation.

Sec. 38.712 Additional sources for compliance.

Applicants and designated contract markets may refer to the

guidance in appendix B of this part to demonstrate to the Commission

compliance with the requirements of Sec. 38.700 of this part.

Subpart O--Dispute Resolution

Sec. 38.750 Core Principle 14.

The board of trade shall establish and enforce rules regarding, and

provide facilities for alternative dispute resolution as appropriate

for, market participants and any market intermediaries.

Sec. 38.751 Additional sources for compliance.

Applicants and designated contract markets may refer to the

guidance and acceptable practices in appendix B of this part to

demonstrate to the Commission compliance with the requirements of Sec.

38.750 of this part.

Subpart P--Governance Fitness Standards

Sec. 38.800 Core Principle 15.

The board of trade shall establish and enforce appropriate fitness

standards for directors, members of any disciplinary committee, members

of the contract market, and any other person with direct access to the

facility (including any party affiliated with any person described in

this paragraph).

Sec. 38.801 Additional sources for compliance.

Applicants and designated contract markets may refer to the

guidance in appendix B of this part to demonstrate to the Commission

compliance with the requirements of Sec. 38.800 of this part.

Subpart Q--Conflicts of Interest

Sec. 38.850 Core Principle 16.

The board of trade shall establish and enforce rules:

(a) To minimize conflicts of interest in the decision-making

process of the contract market; and

(b) To establish a process for resolving conflicts of interest

described in paragraph (a) of this section.

Sec. 38.851 Additional sources for compliance.

Applicants and designated contract markets may refer to the

guidance and/or acceptable practices in appendix B of this part to

demonstrate to the Commission compliance with the requirements of Sec.

38.850 of this part.

Subpart R--Composition of Governing Boards of Contract Markets

Sec. 38.900 Core Principle 17.

The governance arrangements of the board of trade shall be designed

to permit consideration of the views of market participants.

Subpart S--Recordkeeping

Sec. 38.950 Core Principle 18.

The board of trade shall maintain records of all activities

relating to the business of the contract market:

(a) In a form and manner that is acceptable to the Commission; and

(b) For a period of at least 5 years.

Sec. 38.951 Additional sources for compliance.

A designated contract market must maintain such records, including

trade records and investigatory and disciplinary files, in accordance

with the requirements of Sec. 1.31 of this chapter, and in accordance

with part 45 of this chapter, if applicable.

Subpart T--Antitrust Considerations

Sec. 38.1000 Core Principle 19.

Unless necessary or appropriate to achieve the purposes of this

Act, the board of trade shall not:

(a) Adopt any rule or taking any action that results in any

unreasonable restraint of trade; or

(b) Impose any material anticompetitive burden on trading on the

contract market.

Sec. 38.1001 Additional sources for compliance.

Applicants and designated contract markets may refer to the

guidance and acceptable practices in appendix B of this part to

demonstrate to the Commission compliance with the requirements of Sec.

38.1000 of this part.

Subpart U--System Safeguards

Sec. 38.1050 Core Principle 20.

Each designated contract market shall:

(a) Establish and maintain a program of risk analysis and oversight

to identify and minimize sources of operational risk, through the

development of appropriate controls and procedures, and the development

of automated systems, that are reliable, secure, and have adequate

scalable capacity;

(b) Establish and maintain emergency procedures, backup facilities,

and a plan for disaster recovery that allow for the timely recovery and

resumption of operations and the fulfillment of the responsibilities

and obligations of the board of trade; and

(c) Periodically conduct tests to verify that backup resources are

sufficient to ensure continued order processing and trade matching,

transmission of matched orders to a designated clearing organization

for clearing, price reporting, market surveillance, and maintenance of

a comprehensive and accurate audit trail.

Sec. 38.1051 General requirements.

(a) A designated contract market's program of risk analysis and

oversight with respect to its operations and automated systems must

address each of the following categories of risk analysis and

oversight:

(1) Information security;

(2) Business continuity-disaster recovery planning and resources;

(3) Capacity and performance planning;

(4) Systems operations;

(5) Systems development and quality assurance; and

(6) Physical security and environmental controls.

(b) In addressing the categories of risk analysis and oversight

required under paragraph (a) of this section, a designated contract

market should follow generally accepted standards and best practices

with respect to the development, operation, reliability, security, and

capacity of automated systems.

(c) A designated contract market must maintain a business

continuity-disaster recovery plan and business continuity-disaster

recovery resources, emergency procedures, and backup facilities

[[Page 36708]]

sufficient to enable timely recovery and resumption of its operations

and resumption of its ongoing fulfillment of its responsibilities and

obligations as a designated contract market following any disruption of

its operations. Such responsibilities and obligations include, without

limitation, order processing and trade matching; transmission of

matched orders to a designated clearing organization for clearing;

price reporting; market surveillance; and maintenance of a

comprehensive audit trail. The designated contract market's business

continuity-disaster recovery plan and resources generally should enable

resumption of trading and clearing of the designated contract market's

products during the next business day following the disruption.

Designated contract markets determined by the Commission to be critical

financial markets are subject to more stringent requirements in this

regard, set forth in Sec. 40.9 of this chapter. Electronic trading is

an acceptable backup for open outcry trading in the event of a

disruption.

(d) A designated contract market that is not determined by the

Commission to be a critical financial market satisfies the requirement

to be able to resume trading and clearing during the next business day

following a disruption by maintaining either:

(1) Infrastructure and personnel resources of its own that are

sufficient to ensure timely recovery and resumption of its operations

and resumption of its ongoing fulfillment of its responsibilities and

obligations as a designated contract market following any disruption of

its operations; or

(2) Contractual arrangements with other designated contract markets

or disaster recovery service providers, as appropriate, that are

sufficient to ensure continued trading and clearing of the designated

contract market's products, and ongoing fulfillment of all of the

designated contract market's responsibilities and obligations with

respect to those products, in the event that a disruption renders the

designated contract market temporarily or permanently unable to satisfy

this requirement on its own behalf.

(e) A designated contract market must notify Commission staff

promptly of all:

(1) Electronic trading halts and significant systems malfunctions;

(2) Cyber security incidents or targeted threats that actually or

potentially jeopardize automated system operation, reliability,

security, or capacity; and

(3) Activation of the designated contract market's business

continuity-disaster recovery plan.

(f) A designated contract market must give Commission staff timely

advance notice of all material:

(1) Planned changes to automated systems that may impact the

reliability, security, or adequate scalable capacity of such systems;

and

(2) Planned changes to the designated contract market's program of

risk analysis and oversight.

(g) A designated contract market must provide to the Commission

upon request current copies of its business continuity-disaster

recovery plan and other emergency procedures, its assessments of its

operational risks, and other documents requested by Commission staff

for the purpose of maintaining a current profile of the designated

contract market's automated systems.

(h) A designated contract market must conduct regular, periodic,

objective testing and review of its automated systems to ensure that

they are reliable, secure, and have adequate scalable capacity. It must

also conduct regular, periodic testing and review of its business

continuity-disaster recovery capabilities. Both types of testing should

be conducted by qualified, independent professionals. Such qualified

independent professionals may be independent contractors or employees

of the designated contract market, but should not be persons

responsible for development or operation of the systems or capabilities

being tested. Pursuant to Core Principle 18 (Recordkeeping) and

Sec. Sec. 38.950 and 38.951 of this part, the designated contract

market must keep records of all such tests, and make all test results

available to the Commission upon request.

(i) To the extent practicable, a designated contract market should:

(1) Coordinate its business continuity-disaster recovery plan with

those of the members and other market participants upon whom it depends

to provide liquidity, in a manner adequate to enable effective

resumption of activity in its markets following a disruption causing

activation of the designated contract market's business continuity-

disaster recovery plan;

(2) Initiate and coordinate periodic, synchronized testing of its

business continuity-disaster recovery plan and the business continuity-

disaster recovery plans of the members and other market participants

upon whom it depends to provide liquidity; and

(3) Ensure that its business continuity-disaster recovery plan

takes into account the business continuity-disaster recovery plans of

its telecommunications, power, water, and other essential service

providers.

(j) Part 46 of this chapter governs the obligations of those

registered entities that the Commission has determined to be critical

financial markets, with respect to maintenance and geographic dispersal

of disaster recovery resources sufficient to meet a same-day recovery

time objective in the event of a wide-scale disruption. Section 40.9 of

this chapter establishes the requirements for core principle compliance

in that respect.

Subpart V--Financial Resources

Sec. 38.1100 Core Principle 21.

(a) In General. The board of trade shall have adequate financial,

operational, and managerial resources to discharge each responsibility

of the board of trade.

(b) Determination of adequacy. The financial resources of the board

of trade shall be considered to be adequate if the value of the

financial resources exceeds the total amount that would enable the

contract market to cover the operating costs of the contract market for

a 1-year period, as calculated on a rolling basis.

Sec. 38.1101 General requirements.

(a) General rule. (1) A designated contract market must maintain

financial resources sufficient to enable it to perform its functions in

compliance with the core principles set forth in section 5 of the Act

and regulations thereunder.

(2) Financial resources shall be considered sufficient if their

value is at least equal to a total amount that would enable the

designated contract market, or applicant for designation as such, to

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

on a rolling basis.

(3) An entity that is registered with the Commission as both a

designated contract market and a derivatives clearing organization also

shall comply with the financial resource requirements of Sec. 39.11 of

this chapter, demonstrating that it has sufficient financial resources

to operate the single, combined entity as both a designated contract

market and a derivatives clearing organization. In lieu of filing

separate quarterly reports under paragraph (a)(2) of this section and

Sec. 39.11(f) of this chapter, such entity shall file single quarterly

reports in accordance with Sec. 39.11.

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

satisfy the requirements of paragraph (a) of this section may include:

(1) The designated contract market's own capital, calculated in

accordance with U.S. generally accepted accounting principles; and

[[Page 36709]]

(2) Any other financial resource deemed acceptable by the

Commission.

(c) Computation of financial resource requirement. A designated

contract market must, on a quarterly basis, based upon its fiscal year,

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) of this section. The designated contract

market shall have reasonable discretion in determining the methodology

used to compute such projected operating costs. The Commission may

review the methodology and require changes as appropriate.

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

not less than quarterly, a designated contract market must compute the

current market value of each financial resource used to meet its

obligations under paragraph (a) of this section. Reductions in value to

reflect market and credit risk (``haircuts'') must be applied as

appropriate.

(e) Liquidity of financial resources. The financial resources

allocated by the designated contract market to meet the requirements of

paragraph (a) 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 designated contract market

may take into account a committed line of credit or similar facility

for the purpose of meeting this requirement.

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

upon Commission request, a designated contract market must:

(i) Report to the Commission:

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

requirements of paragraph (a) of this section; and

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

accordance with the requirements of paragraph (d) of this section; and

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

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

designated contract market or of its parent company.

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

the last business day of the designated contract market's fiscal

quarter.

(3) The designated contract market must provide the Commission

with:

(i) Sufficient documentation explaining the methodology used to

compute its financial 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 designated contract market's conclusions.

(4) The reports shall be filed not later than 40 calendar days

after the end of the designated contract market's first three fiscal

quarters, and not later than 60 calendar days after the end of the

designated contract market's fourth fiscal quarter, or at such later

time as the Commission may permit, in its discretion, upon request by

the designated contract market.

(g) Delegation of authority. (1) The Commission hereby delegates,

until it orders otherwise, the authority to the Director of the

Division of Market Oversight or such other employee or employees as the

Director may designate from time to time, to:

(i) Determine whether a particular financial resource under

paragraph (b)(2) may be used to satisfy the requirements of paragraph

(a)(1) and (2) of this section;

(ii) Review and make changes to the methodology used to compute the

requirements of paragraph (c) of this section;

(iii) Request financial reporting from a designated contract market

(in addition to quarterly reports) under paragraph (f)(1) of this

section; and

(iv) Grant an extension of time for a designated contract market to

file its quarterly financial report under paragraph (f)(4) of this

section.

(2) The Director may submit to the Commission for its consideration

any matter that has been delegated in this paragraph. Nothing in this

paragraph prohibits the Commission, at its election, from exercising

the authority delegated in this paragraph.

Subpart W--Diversity of Board of Directors

Sec. 38.1150 Core Principle 22.

The board of trade, if a publicly traded company, shall endeavor to

recruit individuals to serve on the board of directors and the other

decision-making bodies (as determined by the Commission) of the board

of trade from among, and to have the composition of the bodies reflect,

a broad and culturally diverse pool of qualified candidates.

Subpart X--Securities and Exchange Commission

Sec. 38.1200 Core Principle 23.

The board of trade shall keep any such records relating to swaps

defined in section 1a(47)(A)(v) of the Act open to inspection and

examination by the Securities and Exchange Commission.

Sec. 38.1201 Additional sources for compliance.

Applicants and designated contract markets may refer to the

guidance and/or acceptable practices in appendix B of this part to

demonstrate to the Commission compliance with the requirements of Sec.

38.1200 of this part.

0

18. Revise appendix A to part 38 to read as follows:

BILLING CODE 6351-01-P

[[Page 36710]]

[GRAPHIC] [TIFF OMITTED] TR19JN12.067

[[Page 36711]]

[GRAPHIC] [TIFF OMITTED] TR19JN12.068

[[Page 36712]]

[GRAPHIC] [TIFF OMITTED] TR19JN12.069

[[Page 36713]]

[GRAPHIC] [TIFF OMITTED] TR19JN12.070

[[Page 36714]]

[GRAPHIC] [TIFF OMITTED] TR19JN12.071

[[Page 36715]]

[GRAPHIC] [TIFF OMITTED] TR19JN12.072

[[Page 36716]]

[GRAPHIC] [TIFF OMITTED] TR19JN12.073

[[Page 36717]]

[GRAPHIC] [TIFF OMITTED] TR19JN12.074

BILLING CODE 6351-01-C

0

19. Revise appendix B to part 38 to read as follows:

Appendix B to Part 38--Guidance on, and Acceptable Practices in,

Compliance With Core Principles

1. This appendix provides guidance on complying with core

principles, both initially and on an ongoing basis, to obtain and

maintain designation under section 5(d) of the Act and this part 38.

Where provided, guidance is set forth in paragraph (a) following the

relevant heading and can be used to demonstrate to the Commission

compliance with the selected requirements of a core principle, under

Sec. Sec. 38.3 and 38.5 of this part. The guidance for the core

principle is illustrative only of the types of matters a designated

contract market may address, as applicable, and is not intended to

be used as a mandatory checklist. Addressing the issues set forth in

this appendix would help the Commission in its consideration of

whether the designated contract market is in compliance with the

selected requirements of a core principle; provided however, that

the guidance is not intended to diminish or replace, in any event,

the obligations and requirements of applicants and designated

contract markets to comply with the regulations provided under this

part.

2. Where provided, acceptable practices meeting selected

requirements of core principles are set forth in paragraph (b)

following guidance. Designated contract markets that follow specific

practices outlined in the acceptable practices for a core principle

in this appendix will meet the selected requirements of the

applicable core principle; provided however, that the acceptable

practice is not intended to diminish or replace, in any event, the

obligations and requirements of applicants and designated contract

markets to comply with the regulations provided under this part 38.

The acceptable practices are for illustrative purposes only and do

not state the exclusive means for satisfying a core principle.

Core Principle 1 of section 5(d) of the Act: DESIGNATION AS

CONTRACT MARKET.--(A) IN GENERAL.--To be designated, and maintain a

designation, as a contract market, a board of trade shall comply

with--

(i) Any core principle described in this subsection; and

(ii) Any requirement that the Commission may impose by rule or

regulation pursuant to section 8a(5).

(B) REASONABLE DISCRETION OF CONTRACT MARKET.--Unless otherwise

determined by the Commission by rule or regulation, a board of trade

described in subparagraph (A) shall have reasonable discretion in

establishing the manner in which the board of trade complies with

the core principles described in this subsection.

(a) Guidance. [Reserved.]

(b) Acceptable Practices. [Reserved.]

Core Principle 2 of section 5(d) of the Act: COMPLIANCE WITH

RULES--(A) IN GENERAL.--The board of trade shall establish, monitor,

and enforce compliance with the rules of the contract market,

including--

(i) Access requirements;

(ii) The terms and conditions of any contracts to be traded on

the contract market; and

(iii) Rules prohibiting abusive trade practices on the contract

market.

(B) CAPACITY OF CONTRACT MARKET.--The board of trade shall have

the capacity to detect, investigate, and apply appropriate sanctions

to any person that violates any rule of the contract market.

(C) REQUIREMENT OF RULES.--The rules of the contract market

shall provide the board of trade with the ability and authority to

obtain any necessary information to perform any function described

in this subsection, including the capacity to carry out such

international information-sharing agreements as the Commission may

require.

(a) Guidance. (1) Investigations and investigation reports--

Warning letters. The rules of a designated contract market may

authorize compliance staff to issue a warning letter to a person or

entity under investigation or to recommend that a disciplinary panel

take such an action.

(2) Additional rules required. A designated contract market

should adopt and enforce any additional rules that it believes are

necessary to comply with the requirements of subpart C of this

chapter

(b) Acceptable Practices. [Reserved.]

Core Principle 3 of section 5(d) of the Act: CONTRACTS NOT

READILY SUBJECT TO MANIPULATION.--The board of trade shall list on

the contract market only contracts that are not readily susceptible

to manipulation.

(a) Guidance. (1) Designated contract markets may list new

products for trading by self-certification under Sec. 40.2 of this

chapter or may submit products for Commission approval under Sec.

40.3 of this chapter.

(2) Guidance in appendix C to this part may be used as guidance

in meeting this core principle for both new products listings and

existing listed contracts.

(b) Acceptable Practices. [Reserved.]

Core Principle 4 of section 5(d) of the Act: PREVENTION OF

MARKET DISRUPTION.--The board of trade shall have the capacity and

responsibility to prevent manipulation, price distortion, and

disruptions of the delivery or cash-settlement process through

market surveillance, compliance, and enforcement practices and

procedures, including--

(A) Methods for conducting real-time monitoring of trading; and

(B) Comprehensive and accurate trade reconstructions.

(a) Guidance. The detection and prevention of market

manipulation, disruptions, and distortions should be incorporated

into the design of programs for monitoring trading activity.

Monitoring of intraday trading should include the capacity to detect

developing market anomalies, including abnormal price movements and

unusual trading volumes, and position-limit violations. The

designated contract market should have rules in place that allow it

broad powers to intervene to prevent or reduce market disruptions.

Once a threatened or actual disruption is detected, the designated

contract market should take steps to prevent the disruption or

reduce its severity.

(2) Additional rules required. A designated contract market

should adopt and enforce any additional rules that it believes are

necessary to comply with the requirements of subpart E of this part.

(b) Acceptable Practices. (1) General Requirements. Real-time

monitoring for market anomalies and position-limit violations are

the most effective, but the designated contract market may also

demonstrate that it has an acceptable program if some of the

monitoring is accomplished on a T+1 basis. An acceptable

[[Page 36718]]

program must include automated trading alerts to detect market

anomalies and position-limit violations as they develop and before

market disruptions occur or become more serious. In some cases, a

designated contract market may demonstrate that its manual processes

are effective.

(2) Physical-delivery contracts. For physical-delivery

contracts, the designated contract market must demonstrate that it

is monitoring the adequacy and availability of the deliverable

supply, which, if such information is available, includes the size

and ownership of those supplies and whether such supplies are likely

to be available to short traders and saleable by long traders at the

market value of those supplies under normal cash marketing

conditions. Further, for physical-delivery contracts, the designated

contract market must continually monitor the appropriateness of a

contract's terms and conditions, including the delivery instrument,

the delivery locations and location differentials, and the commodity

characteristics and related differentials. The designated contract

market must demonstrate that it is making a good-faith effort to

resolve conditions that are interfering with convergence of its

physical-delivery contract to the price of the underlying commodity

or causing price distortions or market disruptions, including, when

appropriate, changes to contract terms.

(3) Cash-settled contracts. At a minimum, an acceptable program

for monitoring cash-settled contracts must include access, either

directly or through an information-sharing agreement, to traders'

positions and transactions in the reference market for traders of a

significant size in the designated contract market near the

settlement of the contract.

(4) Ability to obtain information. With respect to the

designated contract market's ability to obtain information, a

designated contract market may limit the application of the

requirement to keep and provide such records only to those that are

reportable under its large-trader reporting system or otherwise hold

substantial positions.

(5) Risk controls for trading. An acceptable program for

preventing market disruptions must demonstrate appropriate trade

risk controls, in addition to pauses and halts. Such controls must

be adapted to the unique characteristics of the markets to which

they apply and must be designed to avoid market disruptions without

unduly interfering with that market's price discovery function. The

designated contract market may choose from among controls that

include: pre-trade limits on order size, price collars or bands

around the current price, message throttles, and daily price limits,

or design other types of controls. Within the specific array of

controls that are selected, the designated contract market also must

set the parameters for those controls, so long as the types of

controls and their specific parameters are reasonably likely to

serve the purpose of preventing market disruptions and price

distortions. If a contract is linked to, or is a substitute for,

other contracts, either listed on its market or on other trading

venues, the designated contract market must, to the extent

practicable, coordinate its risk controls with any similar controls

placed on those other contracts. If a contract is based on the price

of an equity security or the level of an equity index, such risk

controls must, to the extent practicable, be coordinated with any

similar controls placed on national security exchanges.

Core Principle 5 of section 5(d) of the Act: POSITION

LIMITATIONS OR ACCOUNTABILITY--(A) IN GENERAL.--To reduce the

potential threat of market manipulation or congestion (especially

during trading in the delivery month), the board of trade shall

adopt for each contract of the board of trade, as is necessary and

appropriate, position limitations or position accountability for

speculators.

(B) MAXIMUM ALLOWABLE POSITION LIMITATION.--For any contract

that is subject to a position limitation established by the

Commission pursuant to section 4a(a), the board of trade shall set

the position limitation of the board of trade at a level not higher

than the position limitation established by the Commission.

(a) Guidance. [Reserved.]

(b) Acceptable Practices. [Reserved.]

Core Principle 6 of section 5(d) of the Act: EMERGENCY

AUTHORITY--The board of trade, in consultation or cooperation with

the Commission, shall adopt rules to provide for the exercise of

emergency authority, as is necessary and appropriate, including the

authority--

(A) To liquidate or transfer open positions in any contract;

(B) To suspend or curtail trading in any contract; and

(C) To require market participants in any contract to meet

special margin requirements.

(a) Guidance. In consultation and cooperation with the

Commission, a designated contract market should have the authority

to intervene as necessary to maintain markets with fair and orderly

trading and to prevent or address manipulation or disruptive trading

practices, whether the need for intervention arises exclusively from

the DCM's market or as part of a coordinated, cross-market

intervention. DCM rules should include procedures and guidelines to

avoid conflicts of interest in accordance with the provisions of

Sec. 40.9 of this chapter, and include alternate lines of

communication and approval procedures to address emergencies

associated with real-time events. To address perceived market

threats, the designated contract market should have rules that allow

it to take certain actions in the event of an emergency, as defined

in Sec. 40.1(h) of this chapter, including: imposing or modifying

position limits, price limits, and intraday market restrictions;

imposing special margin requirements; ordering the liquidation or

transfer of open positions in any contract; ordering the fixing of a

settlement price; extending or shortening the expiration date or the

trading hours; suspending or curtailing trading in any contract;

transferring customer contracts and the margin or altering any

contract's settlement terms or conditions; and, where applicable,

providing for the carrying out of such actions through its

agreements with its third-party provider of clearing or regulatory

services. In situations where a contract is fungible with a contract

on another platform, emergency action to liquidate or transfer open

interest must be as directed, or agreed to, by the Commission or the

Commission's staff. The DCM has the authority to independently

respond to emergencies in an effective and timely manner consistent

with the nature of the emergency, as long as all such actions taken

by the DCM are made in good faith to protect the integrity of the

markets. The Commission should be notified promptly of the DCM's

exercise of emergency action, explaining how conflicts of interest

were minimized, including the extent to which the DCM considered the

effect of its emergency action on the underlying markets and on

markets that are linked or referenced to the contract market and

similar markets on other trading venues. Information on all

regulatory actions carried out pursuant to a DCM's emergency

authority should be included in a timely submission of a certified

rule pursuant to part 40 of this chapter.

(b) Acceptable Practices. A designated contract market must have

procedures and guidelines for decision-making and implementation of

emergency intervention in the market. At a minimum, the DCM must

have the authority to liquidate or transfer open positions in the

market, suspend or curtail trading in any contract, and require

market participants in any contract to meet special margin

requirements. In situations where a contract is fungible with a

contract on another platform, emergency action to liquidate or

transfer open interest must be directed, or agreed to, by the

Commission or the Commission's staff. The DCM must promptly notify

the Commission of the exercise of its emergency authority,

documenting its decision-making process, including how conflicts of

interest were minimized, and the reasons for using its emergency

authority. The DCM must also have rules that allow it to take such

market actions as may be directed by the Commission.

Core Principle 7 of section 5(d) of the Act: AVAILABILITY OF

GENERAL INFORMATION.--The board of trade shall make available to

market authorities, market participants, and the public accurate

information concerning--

(A) The terms and conditions of the contracts of the contract

market; and

(B)(i) The rules, regulations, and mechanisms for executing

transactions on or through the facilities of the contract market;

and

(ii) The rules and specifications describing the operation of

the contract market's--

(I) Electronic matching platform; or

(II) Trade execution facility.

(a) Guidance. [Reserved.]

(b) Acceptable Practices. [Reserved.]

Core Principle 8 of section 5(d) of the Act: DAILY PUBLICATION

OF TRADING INFORMATION.--The board of trade shall make public daily

information on settlement prices, volume, open interest, and opening

and closing ranges for actively traded contracts on the contract

market.

(a) Guidance. [Reserved.]

(b) Acceptable Practices. [Reserved.]

Core Principle 9 of section 5(d) of the Act: EXECUTION OF

TRANSACTIONS.--``(A) IN

[[Page 36719]]

GENERAL.--The board of trade shall provide a competitive, open, and

efficient market and mechanism for executing transactions that

protects the price discovery process of trading in the centralized

market of the board of trade.

(B) RULES.--The rules of the board of trade may authorize, for

bona fide business purposes--

(i) Transfer trades or office trades;

(ii) An exchange of--

(I) Futures in connection with a cash commodity transaction;

(II) Futures for cash commodities; or

(III) Futures for swaps; or

(iii) A futures commission merchant, acting as principal or

agent, to enter into or confirm the execution of a contract for the

purchase or sale of a commodity for future delivery if the contract

is reported, recorded, or cleared in accordance with the rules of

the contract market or a derivatives clearing organization.

(a) Guidance. [Reserved]

(b) Acceptable Practices. [Reserved]

Core Principle 10 of section 5(d) of the Act: TRADE

INFORMATION.--The board of trade shall maintain rules and procedures

to provide for the recording and safe storage of all identifying

trade information in a manner that enables the contract market to

use the information--

(A) To assist in the prevention of customer and market abuses;

and

(B) To provide evidence of any violations of the rules of the

contract market.

(a) Guidance. [Reserved.]

(b) Acceptable Practices. [Reserved.]

Core Principle 11 of section 5(d) of the Act: FINANCIAL

INTEGRITY OF TRANSACTIONS.--The board of trade shall establish and

enforce--

(A) Rules and procedures for ensuring the financial integrity of

transactions entered into on or through the facilities of the

contract market (including the clearance and settlement of the

transactions with a derivatives clearing organization); and

(B) Rules to ensure--

(i) The financial integrity of any--

(I) Futures commission merchant; and

(II) Introducing broker; and

(ii) The protection of customer funds.

(a) Guidance. [Reserved.]

(b) Acceptable Practices. [Reserved.]

Core Principle 12 of section 5(d) of the Act: PROTECTION OF

MARKETS AND MARKET PARTICIPANTS--The board of trade shall establish

and enforce rules--

(A) To protect markets and market participants from abusive

practices committed by any party, including abusive practices

committed by a party acting as an agent for a participant; and

(B) To promote fair and equitable trading on the contract

market.

(a) Guidance. [Reserved.]

(b) Acceptable Practices. [Reserved.]

Core Principle 13 of section 5(d) of the Act: DISCIPLINARY

PROCEDURES.--The board of trade shall establish and enforce

disciplinary procedures that authorize the board of trade to

discipline, suspend, or expel members or market participants that

violate the rules of the board of trade, or similar methods for

performing the same functions, including delegation of the functions

to third parties.

(a) Guidance. (1) Notice of charges. If the rules of the

designated contract market so provide, a notice may also advise: (i)

That failure to request a hearing within the period prescribed in

the notice, except for good cause, may be deemed a waiver of the

right to a hearing; and (ii) That failure to answer or to deny

expressly a charge may be deemed to be an admission of such charge.

(2) Admission or failure to deny charges. The rules of a

designated contract market may provide that if a respondent admits

or fails to deny any of the charges, a disciplinary panel may find

that the violations alleged in the notice of charges for which the

respondent admitted or failed to deny any of the charges have been

committed. If the designated contract market's rules so provide,

then:

(i) The disciplinary panel should impose a sanction for each

violation found to have been committed;

(ii) The disciplinary panel should promptly notify the

respondent in writing of any sanction to be imposed pursuant to

paragraph (2)(i) of this section and shall advise the respondent

that it may request a hearing on such sanction within the period of

time, which shall be stated in the notice;

(iii) The rules of a designated contract market may provide that

if a respondent fails to request a hearing within the period of time

stated in the notice, the respondent will be deemed to have accepted

the sanction.

(3) Settlement offers. (i) The rules of a designated contract

market may permit a respondent to submit a written offer of

settlement at any time after an investigation report is completed.

The disciplinary panel presiding over the matter may accept the

offer of settlement, but may not alter the terms of a settlement

offer unless the respondent agrees.

(ii) The rules of a designated contract market may provide that,

in its discretion, a disciplinary panel may permit the respondent to

accept a sanction without either admitting or denying the rule

violations upon which the sanction is based.

(iii) If an offer of settlement is accepted, the panel accepting

the offer should issue a written decision specifying the rule

violations it has reason to believe were committed, including the

basis or reasons for the panel's conclusions, and any sanction to be

imposed, which should include full customer restitution where

customer harm is demonstrated, except where the amount of

restitution and to whom it should be provided cannot be reasonably

determined. If an offer of settlement is accepted without the

agreement of the enforcement staff, the decision should adequately

support the disciplinary panel's acceptance of the settlement. Where

applicable, the decision should also include a statement that the

respondent has accepted the sanctions imposed without either

admitting or denying the rule violations.

(iv) The respondent may withdraw his or her offer of settlement

at any time before final acceptance by a disciplinary panel. If an

offer is withdrawn after submission, or is rejected by a

disciplinary panel, the respondent should not be deemed to have made

any admissions by reason of the offer of settlement and should not

be otherwise prejudiced by having submitted the offer of settlement.

(4) Hearings. The rules of a designated contract market may

provide that a sanction may be summarily imposed upon any person

within its jurisdiction whose actions impede the progress of a

hearing.

(5) Right to appeal. The rules of a designated contract market

may permit the parties to a proceeding to appeal promptly an adverse

decision of a disciplinary panel in all or in certain classes of

cases. Such rules may require a party's notice of appeal to be in

writing and to specify the findings, conclusions, or sanctions to

which objection are taken. If the rules of a designated contract

market permit appeals, then both the respondent and the enforcement

staff should have the opportunity to appeal and the designated

contract market should provide for the following:

(i) The designated contract market should establish an appellate

panel that should be authorized to hear appeals of respondents. In

addition, the rules of a designated contract market may provide that

the appellate panel may, on its own initiative, order review of a

decision by a disciplinary panel within a reasonable period of time

after the decision has been rendered.

(ii) The composition of the appellate panel should be consistent

with the requirements set forth in part 40 of this chapter and

paragraph (4) of the acceptable practices for Core Principle 16, and

should not include any members of the designated contract market's

compliance staff, or any person involved in adjudicating any other

stage of the same proceeding. The rules of a designated contract

market should provide for the appeal proceeding to be conducted

before all of the members of the appellate panel or a panel thereof.

(iii) Except for good cause shown, the appeal or review should

be conducted solely on the record before the disciplinary panel, the

written exceptions filed by the parties, and the oral or written

arguments of the parties.

(iv) Promptly following the appeal or review proceeding, the

appellate panel should issue a written decision and should provide a

copy to the respondent. The decision issued by the appellate panel

should adhere to all the requirements of Sec. 38.708 of this part,

to the extent that a different conclusion is reached from that

issued by the disciplinary panel.

(6) Summary fines for violations of rules regarding timely

submission of records, decorum, or other similar activities. A

designated contract market may adopt a summary fine schedule for

violations of rules relating to the timely submission of accurate

records required for clearing or verifying each day's transactions,

decorum, attire, or other similar activities. A designated contract

market may permit its compliance staff, or a designated panel of

contract market officials, to summarily impose minor sanctions

against persons within the designated contract market's jurisdiction

for violating such rules. A designated contract market's summary

fine schedule may allow for warning letters to be issued for first-

time violations or violators. If

[[Page 36720]]

adopted, a summary fine schedule should provide for progressively

larger fines for recurring violations.

(7) Emergency disciplinary actions. (i) A designated contract

market may impose a sanction, including suspension, or take other

summary action against a person or entity subject to its

jurisdiction upon a reasonable belief that such immediate action is

necessary to protect the best interest of the marketplace.

(ii) Any emergency disciplinary action should be taken in

accordance with a designated contract market's procedures that

provide for the following:

(A) If practicable, a respondent should be served with a notice

before the action is taken, or otherwise at the earliest possible

opportunity. The notice should state the action, briefly state the

reasons for the action, and state the effective time and date, and

the duration of the action.

(B) The respondent should have the right to be represented by

legal counsel or any other representative of its choosing in all

proceedings subsequent to the emergency action taken. The respondent

should be given the opportunity for a hearing as soon as reasonably

practicable and the hearing should be conducted before the

disciplinary panel pursuant to the requirements of Sec. 38.707 of

this part.

(C) Promptly following the hearing provided for in this rule,

the designated contract market should render a written decision

based upon the weight of the evidence contained in the record of the

proceeding and should provide a copy to the respondent. The decision

should include a description of the summary action taken; the

reasons for the summary action; a summary of the evidence produced

at the hearing; a statement of findings and conclusions; a

determination that the summary action should be affirmed, modified,

or reversed; and a declaration of any action to be taken pursuant to

the determination, and the effective date and duration of such

action.

(b) Acceptable Practices. [Reserved.]

Core Principle 14 of section 5(d) of the Act: DISPUTE

RESOLUTION.--The board of trade shall establish and enforce rules

regarding, and provide facilities for alternative dispute resolution

as appropriate for, market participants and any market

intermediaries.

(a) Guidance. A designated contract market should provide

customer dispute resolution procedures that are: appropriate to the

nature of the market; fair and equitable; and available on a

voluntary basis, either directly or through another self-regulatory

organization, to customers that are non-eligible contract

participants.

(b) Acceptable Practices.

(1) Fair and equitable procedure. Every contract market shall

provide customer dispute resolution procedures that are fair and

equitable. An acceptable customer dispute resolution mechanism

would:

(i) Provide the customer with an opportunity to have his or her

claim decided by an objective and impartial decisionmaker;

(ii) Provide each party with the right to be represented by

counsel at the commencement of the procedure, at the party's own

expense;

(iii) Provide each party with adequate notice of the claims

presented against such party, an opportunity to be heard on all

claims, defenses and permitted counterclaims, and an opportunity for

a prompt hearing;

(iv) Authorize prompt, written, final settlement awards that are

not subject to appeal within the designated contract market; and

(v) Notify the parties of the fees and costs that may be

assessed.

(2) Voluntary Procedures. The use of dispute settlement

procedures shall be voluntary for customers other than eligible

contract participants as defined in section 1a(18) of the Dodd-Frank

Act, and may permit counterclaims as provided in Sec. 166.5 of this

chapter.

(3) Member-to-Member Procedures. If the designated contract

market also provides procedures for the resolution of disputes that

do not involve customers (i.e., member-to-member disputes), the

procedures for resolving such disputes must be independent of and

shall not interfere with or delay the resolution of customers'

claims or grievances.

(4) Delegation. A designated contract market may delegate to

another self-regulatory organization or to a registered futures

association its responsibility to provide for customer dispute

resolution mechanisms, provided, however, that in the event of such

delegation, the designated contract market shall in all respects

treat any decision issued by such other organization or association

with respect to such dispute as if the decision were its own,

including providing for the appropriate enforcement of any award

issued against a delinquent member.

Core Principle 15 of section 5(d) of the Act: GOVERNANCE FITNESS

STANDARDS.--The board of trade shall establish and enforce

appropriate fitness standards for directors, members of any

disciplinary committee, members of the contract market, and any

other person with direct access to the facility (including any party

affiliated with any person described in this paragraph).

(a) Guidance. (1) A designated contract market should have

appropriate eligibility criteria for the categories of persons set

forth in the Core Principle that should include standards for

fitness and for the collection and verification of information

supporting compliance with such standards. Minimum standards of

fitness for persons who have member voting privileges, governing

obligations or responsibilities, or who exercise disciplinary

authority are those bases for refusal to register a person under

section 8a(2) of the Act. In addition, persons who have governing

obligations or responsibilities, or who exercise disciplinary

authority, should not have a significant history of serious

disciplinary offenses, such as those that would be disqualifying

under Sec. 1.63 of this chapter. Members with trading privileges

but having no, or only nominal, equity, in the facility and non-

member market participants who are not intermediated and do not have

these privileges, obligations, responsibilities or disciplinary

authority could satisfy minimum fitness standards by meeting the

standards that they must meet to qualify as a ``market

participant.'' Natural persons who directly or indirectly have

greater than a ten percent ownership interest in a designated

contract market should meet the fitness standards applicable to

members with voting rights.

(2) The Commission believes that such standards should include

providing the Commission with fitness information for such persons,

whether registration information, certification to the fitness of

such persons, an affidavit of such persons' fitness by the contract

market's counsel or other information substantiating the fitness of

such persons. If a contract market provides certification of the

fitness of such a person, the Commission believes that such

certification should be based on verified information that the

person is fit to be in his or her position.

(b) Applicable Practices. [Reserved.]

Core Principle 16 of section 5(d) of the Act: CONFLICTS OF

INTEREST.--The board of trade shall establish and enforce rules--

(A) to minimize conflicts of interest in the decisionmaking

process of the contract market; and

(B) to establish a process for resolving conflicts of interest

described in subparagraph (A).

(a) Guidance. The means to address conflicts of interest in

decisionmaking of a contract market should include methods to

ascertain the presence of conflicts of interest and to make

decisions in the event of such a conflict. In addition, the

Commission believes that the contract market should provide for

appropriate limitations on the use or disclosure of material non-

public information gained through the performance of official duties

by board members, committee members and contract market employees or

gained through an ownership interest in the contract market.

(b) Acceptable Practices. All designated contract markets

(``DCMs'' or ``contract markets'') bear special responsibility to

regulate effectively, impartially, and with due consideration of the

public interest, as provided for in section 3 of the Act. Under Core

Principle 15, they are also required to minimize conflicts of

interest in their decisionmaking processes. To comply with this Core

Principle, contract markets should be particularly vigilant for such

conflicts between and among any of their self-regulatory

responsibilities, their commercial interests, and the several

interests of their management, members, owners, customers and market

participants, other industry participants, and other constituencies.

Acceptable practices for minimizing conflicts of interest shall

include the following elements:

(1) Board composition for contract markets

(i) At least thirty-five percent of the directors on a contract

market's board of directors shall be public directors; and

(ii) The executive committees (or similarly empowered bodies)

shall be at least thirty-five percent public.

(2) Public director

(i) To qualify as a public director of a contract market, an

individual must first be found, by the board of directors, on the

record, to have no material relationship with the contract market. A

``material relationship'' is one that reasonably could

[[Page 36721]]

affect the independent judgment or decisionmaking of the director.

(ii) In addition, a director shall be considered to have a

``material relationship'' with the contract market if any of the

following circumstances exist:

(A) The director is an officer or employee of the contract

market or an officer or employee of its affiliate. In this context,

``affiliate'' includes parents or subsidiaries of the contract

market or entities that share a common parent with the contract

market;

(B) The director is a member of the contract market, or an

officer or director of a member. ``Member'' is defined according to

section 1a(34) of the Commodity Exchange Act and Commission

Regulation 1.3(q);

(C) The director, or a firm with which the director is an

officer, director, or partner, receives more than $100,000 in

combined annual payments from the contract market, or any affiliate

of the contract market (as defined in subsection (2)(ii)(A)), for

legal, accounting, or consulting services. Compensation for services

as a director of the contract market or as a director of an

affiliate of the contract market does not count toward the $100,000

payment limit, nor does deferred compensation for services prior to

becoming a director, so long as such compensation is in no way

contingent, conditioned, or revocable;

(D) Any of the relationships above apply to a member of the

director's ``immediate family,'' i.e., spouse, parents, children and

siblings.

(iii) All of the disqualifying circumstances described in

subsection (2)(ii) shall be subject to a one-year look back.

(iv) A contract market's public directors may also serve as

directors of the contract market's affiliate (as defined in

subsection (2)(ii)(A)) if they otherwise meet the definition of

public director in this section (2).

(v) A contract market shall disclose to the Commission which

members of its board are public directors, and the basis for those

determinations.

(3) Regulatory oversight committee

(i) A board of directors of any contract market shall establish

a Regulatory Oversight Committee (``ROC'') as a standing committee,

consisting of only public directors as defined in section (2), to

assist it in minimizing actual and potential conflicts of interest.

The ROC shall oversee the contract market's regulatory program on

behalf of the board. The board shall delegate sufficient authority,

dedicate sufficient resources, and allow sufficient time for the ROC

to fulfill its mandate.

(ii) The ROC shall:

(A) Monitor the contract market's regulatory program for

sufficiency, effectiveness, and independence;

(B) Oversee all facets of the program, including trade practice

and market surveillance; audits, examinations, and other regulatory

responsibilities with respect to member firms (including ensuring

compliance with financial integrity, financial reporting, sales

practice, recordkeeping, and other requirements); and the conduct of

investigations;

(C) Review the size and allocation of the regulatory budget and

resources; and the number, hiring and termination, and compensation

of regulatory personnel;

(D) Supervise the contract market's chief regulatory officer,

who will report directly to the ROC;

(E) Prepare an annual report assessing the contract market's

self-regulatory program for the board of directors and the

Commission, which sets forth the regulatory program's expenses,

describes its staffing and structure, catalogues disciplinary

actions taken during the year, and reviews the performance of

disciplinary committees and panels;

(F) Recommend changes that would ensure fair, vigorous, and

effective regulation; and

(G) Review regulatory proposals and advise the board as to

whether and how such changes may impact regulation.

(4) Disciplinary panels

All contract markets shall minimize conflicts of interest in

their disciplinary processes through disciplinary panel composition

rules that preclude any group or class of industry participants from

dominating or exercising disproportionate influence on such panels.

Contract markets can further minimize conflicts of interest by

including in all disciplinary panels at least one person who would

qualify as a public director, as defined in subsections (2)(ii) and

(2)(iii) above, except in cases limited to decorum, attire, or the

timely submission of accurate records required for clearing or

verifying each day's transactions. If contract market rules provide

for appeal to the board of directors, or to a committee of the

board, then that appellate body shall also include at least one

person who would qualify as a public director as defined in

subsections (2)(ii) and (2)(iii) above.

Core Principle 17 of section 5(d) of the Act: COMPOSITION OF

GOVERNING BOARDS OF CONTRACT MARKETS.--The governance arrangements

of the board of trade shall be designed to permit consideration of

the views of market participants.

(a) Guidance. [Reserved.]

(b) Acceptable Practices. [Reserved.]

Core Principle 18 of section 5(d) of the Act: RECORDKEEPING.--

The board of trade shall maintain records of all activities relating

to the business of the contract market--

(A) In a form and manner that is acceptable to the Commission;

and

(B) For a period of at least 5 years.

(a) Guidance. [Reserved.]

(b) Acceptable Practices. [Reserved.]

Core Principle 19 of section 5(d) of the Act: ANTITRUST

CONSIDERATIONS.--Unless necessary or appropriate to achieve the

purposes of this Act, the board of trade shall not--

(A) Adopt any rule or taking any action that results in any

unreasonable restraint of trade; or

(B) Impose any material anticompetitive burden on trading on the

contract market.

(a) Guidance. An entity seeking designation as a contract market

may request that the Commission consider under the provisions of

section 15(b) of the Act, any of the entity's rules, including

trading protocols or policies, and including both operational rules

and the terms or conditions of products listed for trading, at the

time of designation or thereafter. The Commission intends to apply

section 15(b) of the Act to its consideration of issues under this

core principle in a manner consistent with that previously applied

to contract markets.

(b) Acceptable Practices. [Reserved.]

Core Principle 20 of section 5(d) of the Act: SYSTEM

SAFEGUARDS.--The board of trade shall--

(A) Establish and maintain a program of risk analysis and

oversight to identify and minimize sources of operational risk,

through the development of appropriate controls and procedures, and

the development of automated systems, that are reliable, secure, and

have adequate scalable capacity;

(B) Establish and maintain emergency procedures, backup

facilities, and a plan for disaster recovery that allow for the

timely recovery and resumption of operations and the fulfillment of

the responsibilities and obligations of the board of trade; and

(C) Periodically conduct tests to verify that backup resources

are sufficient to ensure continued order processing and trade

matching, price reporting, market surveillance, and maintenance of a

comprehensive and accurate audit trail.

(a) Guidance. [Reserved.]

(b) Acceptable Practices. [Reserved.]

Core Principle 21 of section 5(d) of the Act: FINANCIAL

RESOURCES.--

(A) IN GENERAL.--The board of trade shall have adequate

financial, operational, and managerial resources to discharge each

responsibility of the board of trade.

(B) DETERMINATION OF ADEQUACY.--The financial resources of the

board of trade shall be considered to be adequate if the value of

the financial resources exceeds the total amount that would enable

the contract market to cover the operating costs of the contract

market for a 1-year period, as calculated on a rolling basis.

(a) Guidance. [Reserved.]

(b) Acceptable Practices. [Reserved.]

Core Principle 22 of section 5(d) of the Act: DIVERSITY OF BOARD

OF DIRECTORS.--The board of trade, if a publicly traded company,

shall endeavor to recruit individuals to serve on the board of

directors and the other decision-making bodies (as determined by the

Commission) of the board of trade from among, and to have the

composition of the bodies reflect, a broad and culturally diverse

pool of qualified candidates.

(a) Guidance. [Reserved.]

(b) Acceptable Practices. [Reserved.]

Core Principle 23 of section 5(d) of the Act: SECURITIES AND

EXCHANGE COMMISSION.--The board of trade shall keep any such records

relating to swaps defined in section 1a(47)(A)(v) open to inspection

and examination by the Securities and Exchange Commission.

(a) Guidance. A designated contract market should have

arrangements and resources for collecting and maintaining accurate

records pertaining to any swaps agreements defined in section

1a(47)(A)(v) of the Act, and should leave them open to inspection

and examination for a period of five years.

(b) Acceptable Practices. [Reserved.]

[[Page 36722]]

Appendix C--Demonstration of Compliance That a Contract Is Not Readily

Susceptible to Manipulation

(a) Futures Contracts--General Information. When a designated

contract market certifies or submits for approval contract terms and

conditions for a new futures contract, that submission should

include the following information:

(1) A narrative describing the contract, including data and

information to support the contract's terms and conditions, as set

by the designated contract market. When designing a futures

contract, the designated contract market should conduct market

research so that the contract design meets the risk management needs

of prospective users and promotes price discovery of the underlying

commodity. The designated contract market should consult with market

users to obtain their views and opinions during the contract design

process to ensure the contract's term and conditions reflect the

underlying cash market and that the futures contract will perform

the intended risk management and/or price discovery functions. A

designated contract market should provide a statement indicating

that it took such steps to ensure the usefulness of the submitted

contract.

(2) A detailed cash market description for physical and cash-

settled contracts. Such descriptions should be based on government

and/or other publicly-available data whenever possible and be

formulated for both the national and regional/local market relevant

to the underlying commodity. For tangible commodities, the cash

market descriptions for the relevant market (i.e., national and

regional/local) should incorporate at least three full years of data

that may include, among other factors, production, consumption,

stocks, imports, exports, and prices. Each of those cash market

variables should be fully defined and the data sources should be

fully specified and documented to permit Commission staff to

replicate the estimates of deliverable supply (defined in paragraph

(b)(1)(A) of this appendix C). Whenever possible, the Commission

requests that monthly or daily prices (depending on the contract)

underlying the cash settlement index be submitted for the most

recent three full calendar years and for as many of the current

year's months for which data are available. For contracts that are

cash settled to an index, the index's methodology should be provided

along with supporting information showing how the index is

reflective of the underlying cash market, is not readily subject to

manipulation or distortion, and is based on a cash price series that

is reliable, acceptable, publicly available and timely (defined in

paragraphs (c)(2) and (c)(3) of this appendix C). The Commission

recognizes that the data necessary for accurate and cogent cash

market analyses for an underlying commodity vary with the nature of

the underlying commodity. The Commission may require that the

designated contract market submit a detailed report on commodity

definitions and uses.

(b) Futures Contracts Settled by Physical Delivery. (1) For

listed contracts that are settled by physical delivery, the terms

and conditions of the contract should conform to the most common

commercial practices and conditions in the cash market for the

commodity underlying the futures contract. The terms and conditions

should be designed to avoid any impediments to the delivery of the

commodity so as to promote convergence between the price of the

futures contract and the cash market value of the commodity at the

expiration of a futures contract.

(i) Estimating Deliverable Supplies.

(A) General definition. The specified terms and conditions,

considered as a whole, should result in a ``deliverable supply''

that is sufficient to ensure that the contract is not susceptible to

price manipulation or distortion. In general, the term ``deliverable

supply'' means the quantity of the commodity meeting the contract's

delivery specifications that reasonably can be expected to be

readily available to short traders and salable by long traders at

its market value in normal cash marketing channels at the contract's

delivery points during the specified delivery period, barring

abnormal movement in interstate commerce. Typically, deliverable

supply reflects the quantity of the commodity that potentially could

be made available for sale on a spot basis at current prices at the

contract's delivery points. For a non-financial physical-delivery

commodity contract, this estimate might represent product which is

in storage at the delivery point(s) specified in the futures

contract or can be moved economically into or through such points

consistent with the delivery procedures set forth in the contract

and which is available for sale on a spot basis within the marketing

channels that normally are tributary to the delivery point(s).

Furthermore, an estimate of deliverable supply would not include

supply that is committed for long-term agreements (i.e., the amount

of deliverable supply that would not be available to fulfill the

delivery obligations arising from current trading). The size of

commodity supplies that are committed to long-term agreements may be

estimated by consulting with market participants. However, if the

estimated deliverable supply that is committed for long-term

agreements, or significant portion thereof, can be demonstrated by

the designated contract market to be consistently and regularly made

available to the spot market for shorts to acquire at prevailing

economic values, then those ``available'' supplies committed for

long-term contracts may be included in the designated contract

market's estimate of deliverable supply for that commodity. An

adequate measure of deliverable supply would be an amount of the

commodity that would meet the normal or expected range of delivery

demand without causing futures prices to become distorted relative

to cash market prices. Given the availability of acceptable data,

deliverable supply should be estimated on a monthly basis for at

least the most recent three years for which data are available. To

the extent possible and that data resources permit, deliverable

supply estimates should be constructed such that the data reflect,

as close as possible, the market defined by the contract's terms and

conditions, and should be formulated, whenever possible, with

government or publicly available data. All deliverable supply

estimates should be fully defined, have all underlying assumptions

explicitly stated, and have documentation of all data/information

sources in order to permit estimate replication by Commission staff.

(B) Accounting for variations in deliverable supplies. To assure

the availability of adequate deliverable supplies and acceptable

levels of commercial risk management utility, contract terms and

conditions should account for variations in the patterns of

production, consumption and supply over a period of years of

sufficient length to assess adequately the potential range of

deliverable supplies. This assessment also should consider

seasonality, growth, and market concentration in the production/

consumption of the underlying cash commodity. Deliverable supply

implications of seasonal effects are more straightforwardly

delineated when deliverable supply estimates are calculated on a

monthly basis and when such monthly estimates are provided for at

least the most recent three years for which data resources permit.

In addition, consideration should be given to the relative roles of

producers, merchants, and consumers in the production, distribution,

and consumption of the cash commodity and whether the underlying

commodity exhibits a domestic or international export focus. Careful

consideration also should be given to the quality of the cash

commodity and to the movement or flow of the cash commodity in

normal commercial channels and whether there exist external factors

or regulatory controls that could affect the price or supply of the

cash commodity.

(C) Calculation of deliverable supplies. Designated contract

markets should derive a quantitative estimate of the deliverable

supplies for the delivery period specified in the proposed contract.

For commodities with seasonal supply or demand characteristics, the

deliverable supply analysis should include that period when

potential supplies typically are at their lowest levels. The

estimate should be based on statistical data, when reasonably

available, covering a period of time that is representative of the

underlying commodity's actual patterns of production, patterns of

consumption, and patterns of seasonal effects (if relevant). Often,

such a relevant time period should include at least three years of

monthly deliverable supply estimates permitted by available data

resources. Deliverable supply estimates should also exclude the

amount of the commodity that would not be otherwise deliverable on

the futures contract. For example, deliverable supplies should

exclude quantities that at current price levels are not economically

obtainable or deliverable or were previously committed for long-term

agreements.

(2) Contract terms and conditions requirements for futures

contracts settled by physical delivery.

(i) For physical delivery contracts, an acceptable specification

of terms and conditions would include, but may not be limited to,

rules that address, as appropriate,

[[Page 36723]]

the following criteria and comply with the associated standards:

(A) Quality Standards. The terms and conditions of a commodity

contract should describe or define all of the economically

significant characteristics or attributes of the commodity

underlying the contract. In particular, the quality standards should

be described or defined so that such standards reflect those used in

transactions in the commodity in normal cash marketing channels.

Documentation establishing that the quality standards of the

contract's underlying commodity comply with those accepted/

established by the industry, by government regulations, and/or by

relevant laws should also be submitted. For any particular commodity

contract, the specific attributes that should be enumerated depend

upon the individual characteristics of the underlying commodity.

These may include, for example, the following items: grade, quality,

purity, weight, class, origin, growth, issuer, originator, maturity

window, coupon rate, source, hours of trading, etc. If the terms of

the contract provide for the delivery of multiple qualities of a

specific attribute of the commodity having different cash market

values, then a ``par'' quality should be specified with price

differentials applicable to the ``non-par'' qualities that reflect

discounts or premiums commonly observed or expected to occur in the

cash market for that commodity.

(B) Delivery Points and Facilities. Delivery point/area

specifications should provide for futures delivery at a single

location or at multiple locations where the underlying cash

commodity is normally transacted or stored and where there exists a

viable cash market(s). If multiple delivery points are specified and

the value of the commodity differs between these locations, contract

terms should include price differentials that reflect usual

differences in value between the different delivery locations. If

the price relationships among the delivery points are unstable and a

designated contract market chooses to adopt fixed locational price

differentials, such differentials should fall within the range of

commonly observed or expected commercial price differences. In this

regard, any price differentials should be supported with cash price

data for the delivery location(s). The terms and conditions of the

contracts also should specify, as appropriate, any conditions the

delivery facilities and/or delivery facility operators should meet

in order to be eligible for delivery. Specification of any

requirements for delivery facilities also should consider the extent

to which ownership of such facilities is concentrated and whether

the level of concentration would be susceptible to manipulation of

the futures contract's prices. Commodity contracts also should

specify appropriately detailed delivery procedures that describe the

responsibilities of deliverers, receivers and any required third

parties in carrying out the delivery process. Such responsibilities

could include allocation between buyer and seller of all associated

costs such as load-out, document preparation, sampling, grading,

weighing, storage, taxes, duties, fees, drayage, stevedoring,

demurrage, dispatch, etc. Required accreditation for third-parties

also should be detailed. These procedures should seek to minimize or

eliminate any impediments to making or taking delivery by both

deliverers and takers of delivery to help ensure convergence of cash

and futures at the expiration of a futures delivery month.

(C) Delivery Period and Last Trading Day. An acceptable

specification of the delivery period would allow for sufficient time

for deliverers to acquire the deliverable commodity and make it

available for delivery, considering any restrictions or requirements

imposed by the designated contract market. Specification of the last

trading day for expiring contracts should consider whether adequate

time remains after the last trading day to allow for delivery on the

contract.

(D) Contract Size and Trading Unit. An acceptable specification

of the delivery unit and/or trading unit would be a contract size

that is consistent with customary transactions, transportation or

storage amounts in the cash market (e.g., the contract size may be

reflective of the amount of the commodity that represents a

pipeline, truckload or railcar shipment). For purposes of increasing

market liquidity, a designated contract market may elect to specify

a contract size that is smaller than the typical commercial

transaction size, storage unit or transportation size. In such

cases, the commodity contract should include procedures that allow

futures traders to easily take or make delivery on such a contract

with a smaller size, or, alternatively, the designated contract

market may adopt special provisions requiring that delivery be made

only in multiple contracts to accommodate reselling the commodity in

the cash market. If the latter provision is adopted, contract terms

should be adopted to minimize the potential for default in the

delivery process by ensuring that all contracts remaining open at

the close of trading in expiring delivery months can be combined to

meet the required delivery unit size. Generally, contract sizes and

trading units should be determined after a careful analysis of

relevant cash market trading practices, conditions and deliverable

supply estimates, so as to ensure that the underlying market

commodity market and available supply sources are able to support

the contract sizes and trading units at all times.

(E) Delivery Pack. The term ``delivery pack'' refers to the

packaging standards (e.g., product may be delivered in burlap or

polyethylene bags stacked on wooden pallets) or non-quality related

standards regarding the composition of commodity within a delivery

unit (e.g., product must all be imported from the same country or

origin). An acceptable specification of the delivery pack or

composition of a contract's delivery unit should reflect, to the

extent possible, specifications commonly applied to the commodity

traded or transacted in the cash market.

(F) Delivery Instrument. An acceptable specification of the

delivery instrument (e.g., warehouse receipt, depository certificate

or receipt, shipping certificate, bill of lading, in-line transfer,

book transfer of securities, etc.) would provide for its conversion

into the cash commodity at a commercially-reasonable cost.

Transportation terms (e.g., FOB, CIF, freight prepaid to

destination) as well as any limits on storage or certificate daily

premium fees should be specified. These terms should reflect cash

market practices and the customary provision for allocating delivery

costs between buyer and seller.

(G) Inspection Provisions. Any inspection/certification

procedures for verifying compliance with quality requirements or any

other related delivery requirements (e.g., discounts relating to the

age of the commodity, etc.) should be specified in the contract

rules. An acceptable specification of inspection procedures would

include the establishment of formal procedures that are consistent

with procedures used in the cash market. To the extent that formal

inspection procedures are not used in the cash market, an acceptable

specification would contain provisions that assure accuracy in

assessing the commodity, that are available at a low cost, that do

not pose an obstacle to delivery on the contract and that are

performed by a reputable, disinterested third party or by qualified

designated contract market employees. Inspection terms also should

detail which party pays for the service, particularly in light of

the possibility of varying inspection results.

(H) Delivery (Trading) Months. Delivery months should be

established based on the risk management needs of commercial

entities as well as the availability of deliverable supplies in the

specified months.

(I) Minimum Price Fluctuation (Minimum Tick). The minimum price

increment (tick) should be set at a level that is equal to, or less

than, the minimum price increment commonly observed in cash market

transactions for the underlying commodity. Specifying a futures'

minimum tick that is greater than the minimum price increment in the

cash market can undermine the risk management utility of the futures

contract by preventing hedgers from efficiently establishing and

liquidating futures positions that are used to hedge anticipated

cash market transactions or cash market positions.

(J) Maximum Price Fluctuation Limits. Designated contract

markets may adopt price limits to: (1) Reduce or constrain price

movements in a trading day that may not be reflective of true market

conditions but might be caused by traders overreacting to news; (2)

Allow additional time for the collection of margins in times of

large price movements; and (3) Provide a ``cooling-off'' period for

futures market participants to respond to bona fide changes in

market supply and demand fundamentals that would lead to large cash

and futures price changes. If price limit provisions are adopted,

the limits should be set at levels that are not overly restrictive

in relation to price movements in the cash market for the commodity

underlying the futures contract.

(K) Speculative Limits. Specific information regarding the

establishment of speculative position limits are set forth in part

150, and/or part 151, as applicable, of the Commission's

regulations.

(L) Reportable Levels. Refer to Sec. 15.03 of the Commission's

regulations.

[[Page 36724]]

(M) Trading Hours. Should be set by the designated contract

market to delineate each trading day.

(c) Futures Contracts Settled by Cash Settlement. (1) Cash

settlement is a method of settling certain futures or option

contracts whereby, at contract expiration, the contract is settled

by cash payment in lieu of physical delivery of the commodity or

instrument underlying the contract. An acceptable specification of

the cash settlement price for commodity futures and option contracts

would include rules that fully describe the essential economic

characteristics of the underlying commodity (e.g., grade, quality,

weight, class, growth, issuer, maturity, source, rating, description

of the underlying index and index's calculation methodology, etc.),

as well as how the final settlement price is calculated. In

addition, the rules should clearly specify the trading months and

hours of trading, the last trading day, contract size, minimum price

change (tick size) and any limitations on price movements (e.g.,

price limits or trading halts).

(2) Cash settled contracts may be susceptible to manipulation or

price distortion. In evaluating the susceptibility of a cash-settled

contract to manipulation, a designated contract market should

consider the size and liquidity of the cash market that underlies

the listed contract in a manner that follows the determination of

deliverable supply as noted above in (b)(1). In particular,

situations susceptible to manipulation include those in which the

volume of cash market transactions and/or the number of participants

contacted in determining the cash-settlement price are very low.

Cash-settled contracts may create an incentive to manipulate or

artificially influence the data from which the cash-settlement price

is derived or to exert undue influence on the cash-settlement

price's computation in order to profit on a futures position in that

commodity. The utility of a cash-settled contract for risk

management and price discovery would be significantly impaired if

the cash settlement price is not a reliable or robust indicator of

the value of the underlying commodity or instrument. Accordingly,

careful consideration should be given to the potential for

manipulation or distortion of the cash settlement price, as well as

the reliability of that price as an indicator of cash market values.

Appropriate consideration also should be given to the commercial

acceptability, public availability, and timeliness of the price

series that is used to calculate the cash settlement price.

Documentation demonstrating that the settlement price index is a

reliable indicator of market values and conditions and is commonly

used as a reference index by industry/market agents should be

provided. Such documentation may take on various forms, including

carefully documented interview results with knowledgeable agents.

(3) Where an independent, private-sector third party calculates

the cash settlement price series, a designated contract market

should consider the need for a licensing agreement that will ensure

the designated contract market's rights to the use of the price

series to settle the listed contract.

(i) Where an independent, private-sector third party calculates

the cash settlement price series, the designated contract market

should verify that the third party utilizes business practices that

minimize the opportunity or incentive to manipulate the cash-

settlement price series. Such safeguards may include lock-downs,

prohibitions against derivatives trading by employees, or public

dissemination of the names of sources and the price quotes they

provide. Because a cash-settled contract may create an incentive to

manipulate or artificially influence the underlying market from

which the cash-settlement price is derived or to exert undue

influence on the cash-settlement computation in order to profit on a

futures position in that commodity, a designated contract market

should, whenever practicable, enter into an information-sharing

agreement with the third-party provider which would enable the

designated contract market to better detect and prevent manipulative

behavior.

(ii) Where a designated contract market itself generates the

cash settlement price series, the designated contract market should

establish calculation procedures that safeguard against potential

attempts to artificially influence the price. For example, if the

cash settlement price is derived by the designated contract market

based on a survey of cash market sources, the designated contract

market should maintain a list of such entities which all should be

reputable sources with knowledge of the cash market. In addition,

the sample of sources polled should be representative of the cash

market, and the poll should be conducted at a time when trading in

the cash market is active.

(iii) The cash-settlement calculation should involve

computational procedures that eliminate or reduce the impact of

potentially unrepresentative data.

(iv) The cash settlement price should be an accurate and

reliable indicator of prices in the underlying cash market. The cash

settlement price also should be acceptable to commercial users of

the commodity contract. The registered entity should fully document

that the settlement price is accurate, reliable, highly regarded by

industry/market agents, and fully reflects the economic and

commercial conditions of the relevant designated contract market.

(v) To the extent possible, the cash settlement price should be

based on cash price series that are publicly available and available

on a timely basis for purposes of calculating the cash settlement

price at the expiration of a commodity contract. A designated

contract market should make the final cash settlement price and any

other supporting information that is appropriate for release to the

public, available to the public when cash settlement is accomplished

by the derivatives clearing organization. If the cash settlement

price is based on cash prices that are obtained from non-public

sources (e.g., cash market surveys conducted by the designated

contract market or by third parties on behalf of the designated

contract market), a designated contract market should make available

to the public as soon as possible after a contract month's

expiration the final cash settlement price as well as any other

supporting information that is appropriate or feasible to make

available to the public.

(4) Contract terms and conditions requirements for futures

contracts settled by cash settlement.

(i) An acceptable specification of the terms and conditions of a

cash-settled commodity contract will also set forth the trading

months, last trading day, contract size, minimum price change (tick

size) and daily price limits, if any.

(A) Commodity Characteristics: The terms and conditions of a

commodity contract should describe the commodity underlying the

contract.

(B) Contract Size and Trading Unit: An acceptable specification

of the trading unit would be a contract size that is consistent with

customary transactions in the cash market. A designated contract

market may opt to set the contract size smaller than that of

standard cash market transactions.

(C) Cash Settlement Procedure: The cash settlement price should

be reliable, acceptable, publicly available, and reported in a

timely manner as described in paragraphs (c)(3)(iv) and (c)(3)(v) of

this appendix C.

(D) Pricing Basis and Minimum Price Fluctuation (Minimum Tick):

The minimum price increment (tick) should be set a level that is

equal to, or less than, the minimum price increment commonly

observed in cash market transactions for the underlying commodity.

Specifying a futures' minimum tick that is greater than the minimum

price increment in the cash market can undermine the risk management

utility of the futures contract by preventing hedgers from

efficiently establishing and liquidating futures positions that are

used to hedge anticipated cash market transactions or cash market

positions.

(E) Maximum Price Fluctuation Limits: Designated contract

markets may adopt price limits to: (1) Reduce or constrain price

movements in a trading day that may not be reflective of true market

conditions but might be caused by traders overreacting to news; (2)

Allow additional time for the collection of margins in times of

large price movements; and (3) Provide a ``cooling-off'' period for

futures market participants to respond to bona fide changes in

market supply and demand fundamentals that would lead to large cash

and futures price changes. If price-limit provisions are adopted,

the limits should be set at levels that are not overly restrictive

in relation to price movements in the cash market for the commodity

underlying the futures contract. For broad-based stock index futures

contracts, rules should be adopted that coordinate with New York

Stock Exchange (``NYSE'') declared Circuit Breaker Trading Halts (or

other market coordinated Circuit Breaker mechanism) and would

recommence trading in the futures contract only after trading in the

majority of the stocks underlying the index has recommenced.

(F) Last Trading Day: Specification of the last trading day for

expiring contracts should be established such that it occurs before

publication of the underlying third-party price index or

determination of the final settlement price. If the designated

contract market chooses to allow trading to occur through the

determination of the final

[[Page 36725]]

settlement price, then the designated contract market should show

that futures trading would not distort the final settlement price

calculation.

(G) Trading Months: Trading months should be established based

on the risk management needs of commercial entities as well as the

availability of price and other data needed to calculate the cash

settlement price in the specified months. Specification of the last

trading day should take into consideration whether the volume of

transactions underlying the cash settlement price would be unduly

limited by occurrence of holidays or traditional holiday periods in

the cash market. Moreover, a contract should not be listed past the

date for which the designated contract market has access to use a

proprietary price index for cash settlement.

(H) Speculative Limits: Specific rules and policies for

speculative position limits are set forth in part 150 and/or part

151, as applicable, of the Commission's regulations.

(I) Reportable Levels: Refer to Sec. 15.03 of the Commission's

regulations.

(J) Trading Hours: Should be set by the designated contract

market to delineate each trading day.

(d) Options on a Futures Contract. (1) The Commission's

experience with the oversight of trading in futures option contracts

indicates that most of the terms and conditions associated with such

trading do not raise any regulatory concerns or issues. The

Commission has found that the following terms do not affect an

option contract's susceptible to manipulation or its utility for

risk management. Thus, the Commission believes that, in most cases,

any specification of the following terms would be acceptable; the

only requirement is that such terms be specified in an automatic and

objective manner in the option contract's rules:

[cir] Exercise method;

[cir] Exercise procedure (if positions in the underlying futures

contract are established via book entry);

[cir] Strike price listing provisions, including provisions for

listing strike prices on a discretionary basis;

[cir] Strike price intervals;

[cir] Automatic exercise provisions;

[cir] Contract size (unless not set equal to the size of the

underlying futures contract); and

[cir] Option minimum tick should be equal to or smaller than

that of the underlying futures contract.

(2) Option Expiration & Last Trading Day. For options on futures

contracts, specification of expiration dates should consider the

relationship of the option expiration date to the delivery period

for the underlying futures contract. In particular, an assessment

should be made of liquidity in the underlying futures market to

assure that any futures contracts acquired through exercise can be

liquidated without adversely affecting the orderly liquidation of

futures positions or increasing the underlying futures contract's

susceptibility to manipulation. When the underlying futures contract

exhibits a very low trading activity during an expiring delivery

month's final trading days or has a greater risk of price

manipulation than other contracts, the last trading day and

expiration day of the option should occur prior to the delivery

period or the settlement date of the underlying future. For example,

the last trading day and option expiration day might appropriately

be established prior to first delivery notice day for option

contracts with underlying futures contracts that have very limited

deliverable supplies. Similarly, if the futures contract underlying

an option contract is cash settled using cash prices from a very

limited number of underlying cash market transactions, the last

trading and option expiration days for the option contract might

appropriately be established prior to the last trading day for the

futures contract.

(3) Speculative Limits. In cases where the terms of an

underlying futures contract specify a spot-month speculative

position limit and the option contract expires during, or at the

close of, the futures contract's delivery period, the option

contract should include a spot-month speculative position limit

provision that requires traders to combine their futures and option

position and be subject to the limit established for the futures

contract. Specific rules and policies for speculative position

limits are set forth in part 150 and/or part 151, as applicable, of

the Commission's regulations.

(4) Options on Physicals Contracts.

(i) Under the Commission's regulations, the term ``option on

physicals'' refers to option contracts that do not provide for

exercise into an underlying futures contract. Upon exercise, options

on physicals can be settled via physical delivery of the underlying

commodity or by a cash payment. Thus, options on physicals raise

many of the same issues associated with trading in futures contracts

regarding adequacy of deliverable supplies or acceptability of the

cash settlement price series. In this regard, an option that is cash

settled based on the settlement price of a futures contract would be

considered an ``option on physicals'' and the futures settlement

price would be considered the cash price series.

(ii) In view of the above, acceptable practices for the terms

and conditions of options on physicals contracts include, as

appropriate, those practices set forth above for physical-delivery

or cash-settled futures contracts plus the practices set forth for

options on futures contracts.

(e) Security Futures Products. The listing of security futures

products are governed by the special requirements of part 41 of the

Commission's regulations.

(f) Non-Price Based Futures Contracts. (1) Non-price based

contracts are typically construed as binary options, but also may be

designed to function similar to traditional futures or option

contracts.

(2) Where the contract is settled to a third party cash-

settlement series, the designated contract market should consider

the nature and sources of the data comprising the cash-settlement

calculation, the computational procedures, and the mechanisms in

place to ensure the accuracy and reliability of the index value. The

evaluation also considers the extent to which the third party has,

or will adopt, safeguards against unauthorized or premature release

of the index value itself or any key data used in deriving the index

value.

(3) The designated contract market should follow the guidance in

paragraph (c)(4) (Contract Terms and Conditions Requirements for

Futures Contracts Settled by Cash Settlement) of this appendix C to

meet compliance.

(g) Swap Contracts. (1) In general, swap contracts are an

agreement to exchange a series of cash flows over a period of time

based on reference price indices. When listing a swap for trading, a

swap execution facility or designated contract market should

determine that the reference price indices used for its contracts

are not readily susceptible to manipulation. Accordingly, careful

consideration should be given to the potential for manipulation or

distortion of the cash settlement price, as well as the reliability

of that price as an indicator of cash market values. Appropriate

consideration also should be given to the commercial acceptability,

public availability, and timeliness of the price series that is used

to calculate the cash settlement price. Documentation demonstrating

that the settlement price index is a reliable indicator of market

values and conditions and is highly regarded by industry/market

agents should be provided. Such documentation may take on various

forms, including carefully documented interviews with principal

market trading agents, pricing experts, marketing agents, etc.

Appropriate consideration also should be given to the commercial

acceptability, public availability, and timeliness of the price

series that is used to calculate the cash flows of the swap.

(i) Where an independent, private-sector third party calculates

the referenced price index, the designated contract market should

verify that the third party utilizes business practices that

minimize the opportunity or incentive to manipulate the cash-

settlement price series. Such safeguards may include lock-downs,

prohibitions against derivatives trading by employees, or public

dissemination of the names of sources and the price quotes they

provide. Because a cash-settled contract may create an incentive to

manipulate or artificially influence the underlying market from

which the cash-settlement price is derived or to exert undue

influence on the cash-settlement computation in order to profit on a

futures position in that commodity, a designated contract market

should, whenever practicable, enter into an information-sharing

agreement with the third-party provider which would enable the

designated contract market to better detect and prevent manipulative

behavior.

(ii) Where a designated contract market itself generates the

cash settlement price series, the designated contract market should

establish calculation procedures that safeguard against potential

attempts to artificially influence the price. For example, if the

cash settlement price is derived by the designated contract market

based on a survey of cash market sources, the designated contract

market should maintain a list of such entities which all should be

reputable sources with knowledge of the cash market. In addition,

the sample of sources polled should be representative of the cash

market, and the poll should be conducted at a time when trading in

the cash market is active.

[[Page 36726]]

(iii) The cash-settlement calculation should involve appropriate

computational procedures that eliminate or reduce the impact of

potentially unrepresentative data.

(2) Speculative Limits: Specific rules and policies for

speculative position limits are set forth in part 151 and/or part

151, as applicable, of the Commission's regulations.

(3) Intraday Market Restrictions: Designated contract markets or

swap execution facilities should have in place intraday market

restrictions that pause or halt trading in the event of

extraordinary price moves that may result in distorted prices. Such

restrictions need to be coordinated with other markets that may be a

proxy or a substitute for the contracts traded on their facility.

For example, coordination with NYSE rule 80.B Circuit Breaker

Trading Halts. The designated contract market or swap execution

facility should adopt rules to specifically address who is

authorized to declare an emergency; how the designated contract

market or swap execution facility will notify the Commission of its

decision that an emergency exists; how it will address conflicts of

interest in the exercise of emergency authority; and how it will

coordinate trading halts with markets that trade the underlying

price reference index or product.

(4) Settlement Method. The designated contract market or swap

execution facility should follow the guidance in paragraph (c)(4)

(Contract Terms and Conditions Requirements for Futures Contracts

Settled by Cash Settlement) of this appendix C to meet compliance,

or paragraph (b)(2) (Contract Terms and Conditions Requirements for

Futures Contracts Settled by Physical Delivery) of this appendix C,

as appropriate.

Issued in Washington, DC, on May 10, 2012, by the Commission.

David A. Stawick,

Secretary of the Commission.

Note: The following appendices will not appear in the Code of

Federal Regulations.

Appendices to Core Principles and Other Requirements for Designated

Contract Markets--Commission Voting Summary and Statements of

Commissioners

Appendix 1--Commission Voting Summary

On this matter, Chairman Gensler and Commissioners Sommers,

Chilton, O'Malia and Wetjen voted in the affirmative; no

Commissioner voted in the negative.

Appendix 2--Statement of Chairman Gary Gensler

I support the final rulemaking on designated contract markets

DCMs, which includes rules, guidance and acceptable practices. It

advances important Dodd-Frank transparency reforms. The Dodd-Frank

Act squarely addresses the historically opaque swaps market though

its strong transparency provisions. A critical element is pre-trade

transparency--requiring standardized swaps between financial firms--

those that are cleared, made available for trading and not blocks--

to be traded on exchanges, such as DCMs, swap execution facilities

(SEFs) or foreign boards of trade (FBOTs). When markets are open and

transparent, prices are more competitive, markets are more efficient

and liquid, and costs are lowered for companies and their customers.

DCMs have long demonstrated the value of open and competitive

trading. DCMs, for the first time, will be able to list and trade

swaps, helping to bring the benefit of pre-trade transparency to the

swaps marketplace.

In addition, the Dodd-Frank Act incorporated the previously

existing eight statutory designation criteria for DCMs into the DCM

core principles and expanded the principles from 18 to 23. The final

rulemaking the Commission will consider today conforms to the Dodd-

Frank transparency reforms.

The final rulemaking benefits from extensive public comment and

provides exchanges rules, guidance and acceptable practices on

complying with Dodd-Frank's 23 core principles. In many instances,

we're codifying industry practices that the Commission has observed

and found appropriate to comply with these core principles. While

preserving a principles-based regime, these regulations will provide

greater legal certainty and transparency to DCMs in determining

their compliance obligations, and to market participants in

determining their obligations as DCM members, and will facilitate

the enforcement of such provisions.

The final rulemaking is consistent with the core principles-

based regime of the Commodity Exchange Act. It provides each DCM

with the flexibility to employ additional measures to address core

principle requirements.

As an example, the final rulemaking requires DCMs to put in

place effective pre-trade risk filters, including pauses and/or

trading halts to address extraordinary price movements that may

result in distorted prices or trigger market disruptions. The

rulemaking, though, also recognizes that pauses and halts comprise

only one category of risk controls, and that additional controls may

be necessary to be put in place by exchanges to reduce the potential

for market disruptions. The final guidance included in today's

rulemaking lists that exchanges may possibly implement price collars

or bands, maximum order size limits, and message throttles.

This rulemaking does not yet finalize the Commission's proposal

relating to core principle 9--which requires DCMs to provide an

open, competitive and efficient market and mechanism for

transactions that protects the price discovery process of the DCM's

central marketplace. I expect the Commission to consider a final

rule on this matter when it takes up the SEF rule this summer. The

additional time will allow the Commission to more fully analyze the

many public comments on these provisions, including comments on the

implications of exchange of futures for swap transactions, or so-

called ``EFS transactions,'' in relation to the transparency reforms

of Dodd-Frank, as well as the requirement for non-discriminatory

open access to clearing.

[FR Doc. 2012-12746 Filed 6-18-12; 8:45 am]

BILLING CODE 6351-01-P

Last Updated: June 19, 2012