2013-19791

[Federal Register Volume 78, Number 158 (Thursday, August 15, 2013)]

[Rules and Regulations]

[Pages 49663-49680]

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

[FR Doc No: 2013-19791]

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COMMODITY FUTURES TRADING COMMISSION

17 CFR Part 39

RIN 3038-AC98

Enhanced Risk Management Standards for Systemically Important

Derivatives Clearing Organizations

AGENCY: Commodity Futures Trading Commission.

ACTION: Final rule.

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

``CFTC'') is adopting final regulations to implement enhanced risk

management standards for systemically important derivatives clearing

organizations that include increased financial resources requirements

for systemically important derivatives clearing organizations that are

involved in activities with a more complex risk profile or that are

systemically important in multiple jurisdictions, the prohibited use of

assessments by systemically important derivatives clearing

organizations in calculating their available default resources, and

enhanced system safeguards for systemically important derivatives

clearing organizations for business continuity and disaster recovery

(``BC-DR''). This final rule also implements special enforcement

authority over systemically important derivatives clearing

organizations granted to the Commission under section 807(c) of the

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

Act'').

[[Page 49664]]

DATES: The rules will become effective October 15, 2013. Systemically

important derivatives clearing organizations must comply with Sec.

39.29 and Sec. 39.30 no later than December 31, 2013.

FOR FURTHER INFORMATION CONTACT: Ananda Radhakrishnan, Director, 202-

418-5188, [email protected], Robert B. Wasserman, Chief Counsel,

202-418-5092, [email protected], M. Laura Astrada, Associate Chief

Counsel, 202-418-7622, [email protected], or Tracey Wingate, Special

Counsel, 202-418-5319, [email protected], Division of Clearing and

Risk, Commodity Futures Trading Commission, Three Lafayette Centre,

1155 21st Street NW., Washington, DC 20581.

SUPPLEMENTARY INFORMATION:

Table of Contents

I. Background

A. Core Principles for DCOs

B. Designation of Systemically Important Derivatives Clearing

Organizations Under Title VIII of the Dodd-Frank Act

C. Standards for SIDCOs Under Title VIII of the Dodd-Frank Act

D. Principles for Financial Market Infrastructures

E. Existing Prudential Requirements

F. Risk Management Standards for SIDCOs

II. Regulation 39.29

A. Regulation 39.29(a)

B. Regulation 39.29(b)

III. Regulation 39.30

IV. Regulation 39.31

V. Compliance Dates

VI. Consideration of Costs and Benefits

A. Introduction

B. Background

C. Benefits and Costs of the Final Rule

D. Section 15(a) Factors

VII. Related Matters

A. Paperwork Reduction Act

B. Regulatory Flexibility Act

VIII. Text of Final Rules

I. Background

A. Core Principles for DCOs

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

Title VII of the Dodd-Frank Act, entitled the ``Wall Street

Transparency and Accountability Act of 2010,'' \2\ amended the

Commodity Exchange Act (``CEA'' or the ``Act'') \3\ to establish a

comprehensive regulatory framework for over-the-counter (``OTC'')

derivatives, including 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 mandatory clearing and trade execution

requirements on clearable swap contracts; (3) creating rigorous

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). The text of the

Dodd-Frank Act may be accessed at http://www.cftc.gov/idc/groups/public/@swaps/documents/file/hr4173_enrolledbill.pdf.

\2\ Section 701 of the Dodd-Frank Act.

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

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

the CEA, which sets forth core principles that a derivatives clearing

organization (``DCO'') must comply with to register and maintain

registration with the Commission. The core principles were originally

added to the CEA by the Commodity Futures Modernization Act of 2000

(``CFMA''),\4\ and in 2001, the Commission issued guidance on DCO

compliance with these core principles.\5\ However, in furtherance of

the goals of the Dodd-Frank Act to reduce risk, increase transparency,

and promote market integrity, the Commission, pursuant to the

Commission's enhanced rulemaking authority,\6\ withdrew the 2001

guidance and adopted regulations establishing standards for compliance

with the DCO core principles.\7\

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

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

\5\ See A New Regulatory Framework for Clearing Organizations,

66 FR 45604 (Aug. 29, 2001) (final rule) (adopting 17 CFR part 39,

app. A).

\6\ See section 725(c) of the Dodd-Frank Act (explicitly giving

the Commission authority to promulgate rules regarding the core

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

of the CEA, 7 U.S.C. 12a(5)).

\7\ See Derivatives Clearing Organization General Provisions and

Core Principles, 76 FR 69334 (Nov. 8, 2011) (final rule).

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As noted in the preamble to the adopting release for subparts A and

B of part 39 of the Commission's regulations, the regulations that

implement the DCO core principles, the Commission sought to provide

legal certainty for market participants, strengthen the risk management

practices of DCOs, and increase overall confidence in the financial

system by assuring the public that DCOs are meeting minimum risk

management standards.\8\ These risk management standards include, in

part:

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\8\ Id. at 69335.

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(1) With respect to financial resources, (a) Core Principle B,

which requires DCOs to have ``adequate financial, operational, and

managerial resources, as determined by the Commission, to discharge

each responsibility of the [DCO],'' \9\ and (b) Commission regulation

39.11, which requires a DCO to maintain sufficient financial resources

to meet its financial obligations to its clearing members

notwithstanding a default by the clearing member creating the largest

financial exposure for the DCO in extreme but plausible market

conditions,\10\ and permits the inclusion of assessment powers to meet

a limited portion of the DCO's default resources requirement; \11\ and

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\9\ Core Principle B also expressly requires DCOs to ``possess

financial resources that, at a minimum, exceed the total amount that

would (I) enable the organization to meet its financial obligations

to its members and participants notwithstanding a default by the

member or participant creating the largest financial exposure for

that organization in extreme but plausible market conditions; and

(II) enable the [DCO] to cover operating costs of the [DCO] for a

period of 1 year (as calculated on a rolling basis).'' Section

5b(c)(2)(B) of the CEA, 7 U.S.C. 7a-1(c)(2)(B) (emphasis added).

\10\ 17 CFR 39.11(a)(1) (implementing Core Principle B

pertaining to financial resources).

\11\ See 17 CFR 39.11(d)(2)(iii) (requiring a DCO to apply a 30

percent haircut to the value of potential assessments); see also 17

CFR 39.11(d)(2)(iv) (permitting a DCO to count the value of

assessments, after the 30 percent haircut, to meet up to 20 percent

of its default obligations).

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(2) with respect to business continuity, (a) Core Principle I,

which requires DCOs to ``establish and maintain emergency procedures,

backup facilities, and a plan for disaster recovery that allows for (I)

the timely recovery and resumption of operations of the [DCO], and (II)

the fulfillment of each obligation and responsibility of the [DCO],''

\12\ and (b) Commission regulation 39.18, which requires a DCO to

maintain a BC-DR plan, emergency procedures, and physical,

technological, and personnel resources sufficient to enable the DCO to

resume daily processing, clearing, and settlement no later than the

next business day following the disruption of its operations.\13\

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\12\ Core Principle I also requires DCOs to ``establish and

maintain a program of risk analysis and oversight to identify and

minimize sources of operational risk through the development of

appropriate controls and procedures, and automated systems, that are

reliable, secure, and have adequate scalable capacity,'' and

``periodically conduct tests to verify that the backup resources of

the [DCO] are sufficient to ensure daily processing, clearing, and

settlement.'' Section 5b(c)(2)(I) of the CEA, 7 U.S.C. 7a-

1(c)(2)(I).

\13\ 17 CFR 39.18(e)(3) (implementing Core Principle I

pertaining to system safeguards).

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B. Designation of Systemically Important Derivatives Clearing

Organizations Under Title VIII of the Dodd-Frank Act

Title VIII of the Dodd-Frank Act, entitled ``Payment, Clearing, and

Settlement Supervision Act of 2010,'' \14\

[[Page 49665]]

was enacted to mitigate systemic risk in the financial system and

promote financial stability.\15\ Section 804 of the Dodd-Frank Act

requires the Financial Stability Oversight Council (``Council'') \16\

to designate those financial market utilities (``FMUs'') that the

Council determines are, or are likely to become, systemically

important.\17\ An FMU includes ``any person that manages or operates a

multilateral system for the purpose of transferring, clearing, or

settling payments, securities, or other financial transactions among

financial institutions or between financial institutions and the

person.'' \18\ As noted by the Council,

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\14\ Section 801 of the Dodd-Frank Act.

\15\ Section 802(b) of the Dodd-Frank Act.

\16\ The Council was established by section 111 of the Dodd-

Frank Act. In general, the Council is tasked with identifying

``risks to the financial stability of the United States that could

arise from the material financial distress or failure, or ongoing

activities, of large, interconnected bank holding companies or

nonbank financial companies, or that could arise outside the

financial services marketplace,'' promoting ``market discipline, by

eliminating expectations on the part of shareholders, creditors, and

counterparties of such companies that the Government will shield

them from losses in the event of failure,'' and responding ``to

emerging threats to the stability of the United States financial

system.'' Section 112(a)(1) of the Dodd-Frank Act.

\17\ Section 804(a)(1) of the Dodd-Frank Act. The term

``systemically important'' means ``a situation where the failure of

or a disruption to the functioning of a financial market utility . .

. could create, or increase, the risk of significant liquidity or

credit problems spreading among financial institutions or markets

and thereby threaten the stability of the financial system of the

United States.'' Section 803(9) of the Dodd-Frank Act; see also

Authority to Designate Financial Market Utilities as Systemically

Important, 76 FR 44763, 44774 (July 27, 2011) (final rule).

\18\ Section 803(6)(A) of the Dodd-Frank Act. In section

803(6)(B) of the Dodd-Frank Act, the term expressly excludes

designated contract markets, registered futures associations, swap

data repositories, and swap execution facilities registered under

the Commodity Exchange Act (7 U.S.C. 1 et seq.), or national

securities exchanges, national securities associations, alternative

trading systems, security-based swap data repositories, and swap

execution facilities registered under the Securities Exchange Act of

1934 (15 U.S.C. 78a et seq.), solely by reason of their providing

facilities for comparison of data respecting the terms of settlement

of securities or futures transactions effected on such exchange or

by means of any electronic system operated or controlled by such

entities, provided that the exclusions in this clause apply only

with respect to the activities that require the entity to be so

registered; and any broker, dealer, transfer agent, or investment

company, or any futures commission merchant, introducing broker,

commodity trading advisor, or commodity pool operator, solely by

reason of functions performed by such institution as part of

brokerage, dealing, transfer agency, or investment company

activities, or solely by reason of acting on behalf of a financial

market utility or a participant therein in connection with the

furnishing by the financial market utility of services to its

participants or the use of services of the financial market utility

by its participants, provided that services performed by such

institution do not constitute critical risk management or processing

functions of the financial market utility.

FMUs form a critical part of the nation's financial

infrastructure. They exist in many markets to support and facilitate

the transfer, clearing or settlement of financial transactions, and

their smooth operation is integral to the soundness of the financial

system and the overall economy. However, their function and

interconnectedness also concentrate a considerable amount of risk in

the financial system due, in large part, to the interdependencies,

either directly through operational, contractual or affiliation

linkages, or indirectly through payment, clearing, and settlement

processes. In other words, problems at one FMU could trigger

significant liquidity and credit disruptions at other FMUs or

financial institutions.\19\

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\19\ 76 FR at 44763.

In determining whether an FMU is systemically important, the

Council uses a two-stage designation process, applying certain

statutory considerations \20\ and other metrics to assess, among other

things, ``whether possible disruptions [to the functioning of an FMU]

are potentially severe, not necessarily in the sense that they

themselves might trigger damage to the U.S. economy, but because such

disruptions might reduce the ability of financial institutions or

markets to perform their normal intermediation functions.'' \21\ On

July 18, 2012, the Council designated eight FMUs as systemically

important under Title VIII.\22\ Two of these designated FMUs are CFTC-

registered DCOs \23\ for which the Commission is the Supervisory

Agency.\24\ Such designated CFTC-registered DCOs are also known as

systemically important derivatives clearing organizations

(``SIDCOs'').\25\

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\20\ Under section 804(a)(2) of the Dodd-Frank Act, in

determining whether an FMU is or is likely to become systemically

important, the Council must take into consideration the following:

(A) The aggregate monetary value of transactions processed by the

FMU; (B) the aggregate exposure of an FMU to its counterparties; (C)

the relationship, interdependencies, or other interactions of the

FMU with other FMUs or payment, clearing, or settlement activities;

(D) the effect that the failure of or a disruption to the FMU would

have on critical markets, financial institutions, or the broader

financial system; and (E) any other factors the Council deems

appropriate.

\21\ 76 FR at 44766.

\22\ See Press Release, Financial Stability Oversight Council,

Financial Stability Oversight Council Makes First Designations in

Effort to Protect Against Future Financial Crises (July 18, 2012),

available at http://www.treasury.gov/press-center/press-releases/Pages/tg1645.aspx.

\23\ Chicago Mercantile Exchange, Inc. (``CME'') and ICE Clear

Credit LLC (``ICE Clear Credit'') are the CFTC-registered DCOs that

were designated systemically important by the Council, for which

CFTC is the Supervisory Agency. While The Options Clearing

Corporation (``OCC''), a CFTC-registered DCO, was designated

systemically important by the Council, the Securities and Exchange

Commission (``SEC'') serves as OCC's Supervisory Agency.

\24\ See section 803(8)(A) of the Dodd-Frank Act (defining

``Supervisory Agency'' as ``the Federal agency that has primary

jurisdiction over a designated [FMU] under Federal banking,

securities, or commodity futures laws'').

\25\ Specifically, under Commission regulations, a systemically

important derivatives clearing organization is a ``financial market

utility that is a derivatives clearing organization registered under

Section 5b of the Act, which has been designated by the Financial

Stability Oversight Council to be systemically important and for

which the Commission acts as the Supervisory Agency pursuant to

Section 803(8) of the [Dodd-Frank Act].'' See 17 CFR 39.2.

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C. Standards for SIDCOs Under Title VIII of the Dodd-Frank Act

Section 805 of the Dodd-Frank Act directs the Commission to

consider relevant international standards and existing prudential

requirements when prescribing risk management standards governing the

operations related to payment, clearing, and settlement activities for

FMUs that are (1) designated as systemically important by the Council,

and (2) engaged in activities for which the Commission is the

Supervisory Agency.\26\ Under Title VIII, the objectives and principles

for these risk management standards are to: (1) Promote risk

management; (2) promote safety and soundness; (3) reduce systemic

risks; and (4) support the stability of the broader financial

system.\27\ As outlined in section 805(c), these standards may address

such areas as: ``(1) Risk management policies and procedures; (2)

margin and collateral requirements; (3) participant or counterparty

default policies and procedures; (4) the ability to complete timely

clearing and settlement of financial transactions; (5) capital and

financial resources requirements for designated [FMUs]; and (6) other

areas that are necessary to achieve the objectives and principles in

[section 805(b) of the Dodd-Frank Act].''

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\26\ See section 805(a)(2) of the Dodd-Frank Act. The Commission

notes that it also has the authority to prescribe risk management

standards governing the operations related to payment, clearing, and

settlement activities for FMUs that are designated as systemically

important by the Council and that are engaged in activities for

which the Commission is the appropriate financial regulator.

Furthermore, section 805 establishes a review mechanism by which the

Council may intervene if the Board of Governors of the Federal

Reserve System (the ``Board'') determines that the existing risk

management standards set by the Commission ``are insufficient to

prevent or mitigate significant liquidity, credit, operational, or

other risks to the financial markets or to the financial stability

of the United States.'' Section 805(a)(2)(B) of the Dodd-Frank Act.

\27\ Section 805(b) of the Dodd-Frank Act.

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The Commission has reviewed the risk management standards set forth

in part 39 of the Commission's regulations in light of recently

promulgated relevant international standards and existing prudential

requirements to identify

[[Page 49666]]

those areas in which additional risk management standards for SIDCOs

would be necessary and appropriate.

D. Principles for Financial Market Infrastructures

1. Overview

The Commission has determined that the international standards most

relevant to the risk management of SIDCOs, for purposes of meeting the

Commission's obligation pursuant to section 805(a)(2)(A) of the Dodd-

Frank Act, are the Principles for Financial Market Infrastructures

(``PFMIs''), which were developed by the Bank for International

Settlements' Committee on Payment and Settlement Systems (``CPSS'') and

the Technical Committee of the International Organization of Securities

Commissions (``IOSCO'') (collectively, ``CPSS-IOSCO'').\28\ The

Commission notes that the adoption and implementation of the PFMIs by

numerous foreign jurisdictions highlights the role these principles

play in creating a global, unified set of international risk management

standards for central counterparties (``CCPs'').\29\ Moreover, the

Commission, which is a member of the Board of IOSCO, is working towards

implementing rules and regulations that are fully consistent with the

PFMIs by the end of 2013.\30\

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\28\ See Bank for International Settlements' Committee on

Payment and Settlement Systems and Technical Committee of the

International Organization of Securities Commissions, ``Principles

for Financial Market Infrastructures,'' (April 2012), available at

http://www.iosco.org/library/pubdocs/pdf/IOSCOPD377.pdf; see also

Financial Stability Board, ``OTC Derivatives Market Reforms: Third

Progress Report on Implementation,'' (June 15, 2012), available at

http://www.financialstabilityboard.org/publications/r_120615.pdf

(noting publication of the PFMIs as achieving ``an important

milestone in the global development of a sound basis for central

clearing of all standardised OTC derivatives'').

\29\ In Asia, Singapore has adopted the PFMIs into its financial

regulations pertaining to FMIs. See Monetary Authority of Singapore,

``Supervision of Financial Market Infrastructures in Singapore,''

(January 2013), available at http://www.mas.gov.sg/~/media/MAS/

About%20MAS/Monographs%20and%20information%20papers/MASMonograph--

Supervision--of--Financial--Market--Infrastructures--in--

Singapore%202.pdf. In addition, Australia, Canada and the European

Union have publicly indicated their intent to adopt the PFMIs. See

Reserve Bank of Australia, ``Consultation on New Financial Stability

Standards,'' (August 2012), available at http://www.rba.gov.au/payments-system/clearing-settlement/consultations/201208-new-fin-stability-standards/index.html; Canadian Securities Administrators

Consultation Paper 91-406 ``Derivatives: OTC Central Counterparty

Clearing,'' (June 20, 2012), available at http://www.osc.gov.on.ca/documents/en/Securities-Category9/csa_20120620_91-406_counterparty-clearing.pdf; and Regulation (EU) No 648/2012 of the

European Parliament and of the Council on OTC Derivatives, Central

Counterparties and Trade Repositories, preamble paragraph 90, 2012

O.J. (L 201), available at http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=OJ:L:2012:201:FULL:EN:PDF.

In the United States, the SEC adopted a final rule that

incorporates heightened risk management standards for CCPs that

clear security-based swaps, based on, in part, the PFMIs' ``cover

two'' standard for CCPs engaged in a more complex risk profile or

that are systemically important in multiple jurisdictions. See 17

CFR 240.17Ad-22(b)(3) (2013) (requiring, in relevant part, SEC-

registered clearing agencies (i.e., CCPs) to maintain sufficient

financial resources to withstand, at a minimum, a default by the

participant family to which they have the largest exposure in

extreme but plausible conditions, provided that a security-based

swap clearing agency, (i.e., a CCP that clears security-based swaps)

shall maintain sufficient financial resources to withstand, at a

minimum, a default by the two participant families to which it has

the largest exposure in extreme but plausible market conditions).

\30\ Part 39 of the Commission's regulations was informed by the

consultative report for the PFMIs and incorporates the vast majority

of the standards set forth in the PFMIs. See Financial Resources

Requirements for Derivatives Clearing Organizations, 75 FR 63113

(Oct. 14, 2010); Risk Management Requirements for Derivatives

Clearing Organizations, 76 FR 3698 (Jan. 20, 2011); see also Bank

for International Settlements' Committee on Payment and Settlement

Systems and Technical Committee of the International Organization of

Securities Commissions, ``Principles for Financial Market

Infrastructures: Consultative Report,'' (March 2011), available at

http://www.iosco.org/library/pubdocs/pdf/IOSCOPD350.pdf (``CPSS-

IOSCO Consultative Report'').

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The PFMIs establish international risk management standards for

financial market infrastructures (``FMIs''), including CCPs, that

facilitate clearing and settlement.\31\ In February 2010, CPSS-IOSCO

launched a review of the existing sets of international standards for

FMIs in support of a broader effort by the Financial Stability Board

(``FSB'') \32\ to strengthen core financial infrastructures and markets

by ensuring that gaps in international standards are identified and

addressed.\33\ CPSS-IOSCO endeavored to incorporate in its review

process lessons from the 2008 financial crisis and the experience of

using the existing international standards, as well as policy and

analytical work by other international committees including the Basel

Committee on Banking Supervision (``BCBS'').\34\ The PFMIs replace

CPSS-IOSCO's previous recommendations applicable to CCPs.\35\ In

issuing the PFMIs, CPSS-IOSCO sought to strengthen and harmonize

existing international standards and incorporate new specifications for

CCPs clearing OTC derivatives.\36\ The stated objectives of the PFMIs

are to enhance the safety and efficiency of FMIs and, more broadly,

reduce systemic risk and foster transparency and financial

stability.\37\

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\31\ The PFMIs define a ``financial market infrastructure'' as a

``multilateral system among participating institutions, including

the operator of the system, used for the purposes of clearing,

settling, or recording payments, securities, derivatives, or other

financial transactions.'' See PFMIs, Introduction, 1.8.

\32\ The FSB is an international organization that coordinates

with national financial authorities and international policy

organizations to develop and promote effective regulatory,

supervisory, and other financial sector policies. See generally

http://www.financialstabilityboard.org.

\33\ PFMIs, Background, 1.6.

\34\ Id.

\35\ The international standards for FMIs, prior to the

publication of the PFMIs, included the ``Recommendations for

Securities Settlement Systems'' published by CPSS in 2001, the

``Core Principles for Systemically Important Payment Systems''

published by CPSS-IOSCO in 2001, and the ``Recommendations for

Central Counterparties'' published by CPSS-IOSCO in 2004

(collectively the ``CPSS-IOSCO Principles and Recommendations'').

See PFMIs, Background, 1.4 and 1.5.

\36\ Id. at Introduction, 1.2.

\37\ Id. at Background, 1.15.

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The PFMIs set out 24 principles addressing various risk components

of an FMI's operations, including, as most relevant to this final rule,

credit and operational risk.\38\

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\38\ Pursuant to the PFMIs, key risks faced by FMIs include

legal, credit, liquidity, general business, custody, investment, and

operational risks. See id. at Overview of Key Risks in Financial

Market Infrastructures, 2.1.

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2. Principle 4: Credit Risk

Principle 4 addresses the risk that a counterparty to the CCP will

be unable to fully meet its financial obligations when due.\39\

Specifically, Principle 4 states that a ``CCP should cover its current

and potential future exposures to each participant fully with a high

degree of confidence using margin and other prefunded financial

resources.'' \40\ Additionally, Principle 4 provides that a CCP

involved in activities with a more complex risk profile \41\ or that is

systemically important in multiple jurisdictions should maintain

additional financial resources sufficient to cover a wide range of

potential stress scenarios, including, but not limited to, the default

of the two participants and their affiliates that would potentially

cause the largest aggregate credit exposure to the CCP in extreme but

plausible market conditions.\42\

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\39\ The PFMIs define ``credit risk'' as the ``risk that a

counterparty, whether a participant or other entity, will be unable

to meet fully its financial obligations when due, or at any time in

the future.'' Id. at Annex H: Glossary.

\40\ Id. at Principle 4: Credit Risk, Key Consideration 4.

\41\ Such activities ``with a more complex risk profile''

include clearing financial instruments that are characterized by

discrete jump-to-default price changes or that are highly correlated

with potential participant defaults. Id. at Principle 4: Credit

Risk, Explanatory Note 3.4.19.

\42\ Id. at Principle 4: Credit Risk. Financial resources

sufficient to cover the default of the two participants and their

affiliates creating the largest credit exposure in extreme but

plausible circumstances are sometimes referred to as cover two. All

other CCPs, under the PFMIs, are required to maintain financial

resources sufficient to cover a wide range of potential stress

scenarios, which includes, but is not limited to, the default of the

participant and its affiliates that would potentially cause the

largest aggregate credit exposure to the CCP in extreme but

plausible market conditions, otherwise known as ``cover one.'' Id.

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[[Page 49667]]

More generally, Principle 4 states that all FMIs should establish

explicit rules and procedures to address any credit losses they may

face as a result of an individual or combined default among its

participants with respect to any of their obligations to the FMI.\43\

These rules and procedures should also address how potentially

uncovered credit losses would be allocated, how the funds an FMI may

borrow from liquidity providers would be repaid, and how an FMI would

replenish the financial resources used during a stress event, such as a

default, so that the FMI can continue to operate in a safe and sound

manner.\44\

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\43\ Id. at Principle 4: Credit Risk, Key Consideration 7.

\44\ Id.

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3. Principle 17: Operational Risk

Principle 17 addresses the risk of deficiencies in information

systems or internal processes, human errors, management failures, or

disruptions from external events that will result in the reduction or

deterioration of services provided by the FMI.\45\ Principle 17 states

that ``[b]usiness continuity management should aim for timely recovery

of operations and fulfilment [sic] of the FMI's obligations, including

in the event of a wide-scale or major disruption.'' \46\ Additionally,

an FMI's business continuity plan ``should incorporate the use of a

secondary site and should be designed to ensure that critical

information technology (IT) systems can resume operations within two

hours following disruptive events.'' \47\

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\45\ Id. at Overview of Key Risks in Financial Market

Infrastructures, 2.9.

\46\ Id. at Principle 17: Operational Risk.

\47\ Id. at Key Consideration 6.

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4. The Role of the PFMIs in International Banking Standards

Where a CCP is prudentially supervised in a jurisdiction that does

not have domestic rules and regulations that are consistent with the

PFMIs, the implementation of certain international banking regulations

will have significant cost implications for that CCP and its market

participants.

In July 2012, the BCBS,\48\ the international body that sets

standards for the regulation of banks, published the ``Capital

Requirements for Bank Exposures to Central Counterparties'' (``Basel

CCP Capital Requirements''), which sets forth interim rules governing

the capital charges arising from bank exposures to CCPs related to OTC

derivatives, exchange-traded derivatives, and securities financing

transactions.\49\ The Basel CCP Capital Requirements create financial

incentives for banks \50\ to clear financial derivatives with CCPs that

are licensed in a jurisdiction where the relevant regulator has adopted

rules or regulations that are consistent with the PFMIs. Specifically,

the Basel CCP Capital Requirements introduce new capital charges based

on counterparty risk for banks conducting financial derivatives

transactions through a CCP.\51\ These new capital charges relate to a

bank's trade exposure and default fund exposure to a CCP.\52\

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\48\ The BCBS is comprised of senior representatives of bank

supervisory authorities and central banks from around the world,

including Argentina, Australia, Belgium, Brazil, Canada, China,

France, Germany, Hong Kong SAR, India, Indonesia, Italy, Japan,

Korea, Luxembourg, Mexico, the Netherlands, Russia, Saudi Arabia,

Singapore, South Africa, Spain, Sweden, Switzerland, Turkey, the

United Kingdom, and the United States. See Bank for International

Settlements' Basel Committee on Banking Supervision, ``Basel III: A

Global Regulatory Framework for More Resilient Banks and Banking

Systems,'' (December 2010; revised June 2011), available at http://www.bis.org/publ/bcbs189.htm (``Basel III: A Global Regulatory

Framework'').

\49\ See Bank for International Settlements' Basel Committee on

Banking Supervision, ``Capital Requirements for Bank Exposures to

Central Counterparties,'' (July 2012), available at www.bis.org/publ/bcbs227.pdf (``Basel CCP Capital Requirements''). The Basel CCP

Capital Requirements are one component of Basel III, a framework

that is part of ``a comprehensive set of reform measures, developed

by the [BCBS], to strengthen the regulation, supervision and risk

management of the banking sector.'' See Bank for International

Settlements' Web site for a compilation of documents that form the

regulatory framework of Basel III, available at http://www.bis.org/bcbs/basel3.htm.

\50\ ``Bank'' is defined in accordance with the Basel framework

to mean bank, banking group, or other entity (i.e., bank holding

company) whose capital is being measured. See Basel III: A Global

Regulatory Framework, Definition of Capital, paragraph 51, at 12.

The term ``bank,'' as used herein, also includes subsidiaries and

affiliates of the banking group or other entity. The Commission

notes that a bank may be a client and/or a clearing member of a

SIDCO.

\51\ See Basel CCP Capital Requirements, Annex 4, section II,

6(i).

\52\ ``Trade exposure'' is a measure of the amount of loss a

bank is exposed to based on the size of its position, given a CCP's

failure. Under the Basel CCP Capital Requirements, ``trade

exposure'' is defined to include the current and potential future

exposure of a bank acting as either a clearing member or a client to

a CCP arising from OTC derivatives, exchange traded derivatives

transactions, or securities financing transactions, as well as

initial margin. See Basel CCP Capital Requirements, Annex 4, section

I, A: General Terms. ``Current exposure'' includes variation margin

that is owed by the CCP but not yet been received by the clearing

member or client. Id. at n. 2. ``Default fund exposure'' is a

measure of the loss a bank acting as a clearing member is exposed to

arising from the use of its contributions to the CCP's mutualized

default fund resources. See Basel CCP Capital Requirements, Annex 4,

section I, A: General Terms. BIS defines ``potential future

exposure'' as ``the additional exposure that a counterparty might

potentially assume during the life of a contract or set of contracts

beyond the current replacement cost of the contract or set of

contracts.'' See Bank for International Settlements' Committee on

Payment and Settlement Systems, ``A Glossary of Terms Used in

Payment and Settlement Systems,'' (March 2003), available at http://www.bis.org/publ/cpss00b.pdf.

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The capital charges for trade exposure are based upon a function

that multiplies exposure by risk weight. Risk weight is a measure that

represents the likelihood that the loss to which the bank is exposed

will be incurred, and the extent of that loss. The risk weight assigned

under the BCBS standards varies significantly depending on whether or

not the counterparty is a ``qualified'' CCP (``QCCP'').\53\ A ``QCCP''

is defined as an entity that (1) is licensed to operate as a CCP, and

is permitted by the appropriate regulator to operate as such, and (2)

is prudentially supervised in a jurisdiction where the relevant

regulator has established and publicly indicated that it applies to the

CCP on an ongoing basis, domestic rules and regulations that are

consistent with the PFMIs.\54\ If a bank transacts through a QCCP

acting either as (1) a clearing member of a CCP for its own account or

for clients,\55\ or (2) a client of a clearing member that enters into

an OTC derivatives transaction with the clearing member acting as a

financial intermediary, then the risk weight is 2 percent for purposes

of calculating the counterparty risk.\56\ If

[[Page 49668]]

the CCP is non-qualifying, then the risk weight is the same as a

bilateral OTC derivative trade and the bank applies the corresponding

bilateral risk-weight treatment, which is at least 20 percent if the

CCP is a bank, or as high as 100 percent if the CCP is a corporate

financial institution.\57\

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\53\ See id. at Annex 4, section IX., Exposures to Qualifying

CCPs, paragraphs 110-119 (describing the methodology for calculating

a bank's trade exposure to a qualified CCP); see also id. at

paragraph 126 (describing the methodology for calculating a bank's

trade exposure to a non-qualifying CCP).

\54\ Id. at section I, A: General Terms.

\55\ The term ``client'' as used herein refers to a customer of

a bank.

\56\ Id. at section IX: Central Counterparties, paragraphs 110

and 114. Client trade exposures are risk-weighted at 2 percent if

the following two conditions are met: (1) the offsetting

transactions are identified by the CCP as client transactions and

collateral to support them is held by the CCP and/or clearing

member, as applicable, under arrangements that prevent losses to the

client due to the default or insolvency of the clearing member, or

the clearing member's other clients, or the joint default or

insolvency of the clearing member and any of its other clients, and

(2) relevant laws, regulations, contractual or administrative

arrangements provide that the offsetting transactions with the

defaulted or insolvent clearing member are highly likely to continue

to be indirectly transacted through the CCP, or by the CCP, should

the clearing member default or become insolvent. However, in certain

circumstances, risk weight may increase. Specifically, if the first

condition is not met (i.e., where a client is not protected from

losses in the case that the clearing member and another client of

the clearing member jointly default or become jointly insolvent),

but the second condition is met, the bank's trade exposure is risk-

weighted at 4 percent. If neither condition is met, the bank must

capitalize its exposure to the CCP as a bilateral trade. Id. at

paragraphs 115 and 116.

\57\ See Bank for International Settlements' Basel Committee on

Banking Supervision, ``Consultative Document: Capitalisation of Bank

Exposures to Central Counterparties,'' (November 2011; revised July

2012), paragraph 28, available at http://www.bis.org/publ/bcbs206.pdf (stating that ``the applicable risk weight [for clearing

member trades with a non-qualifying CCP] would be at least 20% (if

the CCP is a bank) or 100% (if it is a corporate financial

institution according to the definition included in paragraph 272 of

the Basel framework, revised by Basel III''); see also Basel III: A

global regulatory framework for more resilient banks and banking

systems (June 2011), paragraph 102, available at http://www.bis.org/publ/bcbs189.pdf (revising paragraph 272 of the Basel framework).

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With respect to default fund exposure, whenever a clearing member

bank is required to capitalize for exposures arising from default fund

contributions to a QCCP, the clearing member bank may apply one of two

methodologies for determining the capital requirement: The risk-

sensitive approach, or the 1250 percent risk-weight approach.\58\ The

risk-sensitive approach considers various factors in determining the

risk weight for a bank's default exposure to a QCCP, such as (1) the

size and quality of a QCCP's financial resources, (2) the counterparty

credit risk exposures of such CCP, and (3) the application of such

financial resources via the CCP's loss bearing waterfall in the event

one or more clearing members default.\59\ The 1250 percent risk-weight

approach allows a clearing member bank to apply a 1250 percent risk

weight to its default fund exposures to the QCCP, subject to an overall

cap of 20 percent on the risk-weighted assets from all trade exposures

to the QCCP.\60\ In other words, banks with exposures to QCCPs have a

cap on their default fund exposure. In contrast, a clearing member bank

with exposures to a non-qualified CCP must apply a risk weight of 1250

percent with no cap for default fund exposures.\61\

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\58\ See Basel CCP Capital Requirements, Annex 4, section IX,

paragraphs 121-125. The Commission notes that the 1250 percent risk

weight represents the reciprocal of the 8 percent capital ratio,

which is the percentage of a bank's capital to its risk-weighted

assets (i.e., 1250 percent times 8 percent equals 100 percent).

\59\ Id. at paragraph 122.

\60\ Id. at paragraph 125. See also Basel CCP Capital

Requirements, Annex 4, section IX, paragraphs 125 (explaining that

``More specifically, under [the 1250 percent risk-weight] approach,

the Risk Weighted Assets (RWA) for both bank i's trade and default

fund exposures to each CCP are equal to: Min {(2% * TEi + 1250% *

DFi); (20% * TEi){time} where TEi is bank i's trade exposure to the

CCP, as measured by the bank according to paragraphs 110 to 112 of

this Annex; and DFi is bank i's pre-funded contribution to the CCP's

default fund.'').

\61\ Id. at paragraph 127.

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Thus, the Basel CCP Capital Requirements provide incentives for

banks to clear derivatives through CCPs that are QCCPs by setting lower

capital charges for exposures arising from derivatives cleared through

a QCCP and setting significantly higher capital charges for exposures

arising from derivatives cleared through non-qualifying CCPs. The

increased capital charges for transactions through non-qualifying CCPs

may have significant business and operational implications for U.S.

DCOs, particularly SIDCOs that operate internationally and are not

QCCPs.\62\ Specifically, banks faced with much higher capital charges

might transfer their OTC derivatives business away from such SIDCO to a

QCCP in order to benefit from the preferential capital charges provided

by the Basel CCP Capital Requirements. Alternatively, banks might

reduce or discontinue their OTC business altogether. Banks might also

pass on to their customers the higher costs of transacting with a non-

qualifying DCO as a result of the higher capital treatment.

Accordingly, customers using such banks as intermediaries would have an

incentive to transfer their business to an intermediary that clears at

a QCCP. In short, a SIDCO's failure to be a QCCP may cause it to face a

competitive disadvantage retaining members and customers.

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\62\ The Commission notes that the failure of SIDCOs to be QCCPs

may negatively impact the broader US derivatives market as well. For

example, higher clearing costs may result in fewer transactions, and

less overall liquidity.

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As discussed further below in Section VI, the incentives noted in

the foregoing paragraph have important implications for the cost and

benefit considerations required by section 15(a) of the CEA.

E. Existing Prudential Requirements

In April 2011, a year before the PFMIs were published, the Board

proposed regulation HH, which sets forth, in part, risk management

standards for those FMUs, for which the Board is the Supervisory

Agency, that have been designated systemically important by the Council

under Title VIII.\63\ The Board, in proposing regulation HH, stated

that the risk management standards most relevant to the risk management

of FMUs, and the most appropriate basis for setting initial risk

management standards under Title VIII, were the then-current

international risk management standards set by CPSS-IOSCO's Principles

and Recommendations.\64\ The Board did note, in both its proposed and

final rulemaking, that CPSS-IOSCO intended to update and replace the

CPSS-IOSCO Principles and Recommendations with the PFMIs, and the Board

anticipated at that time that it would review the PFMIs, consult with

other appropriate agencies and the Council, and seek public comment on

the adoption of the revised international standards.\65\

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\63\ Notice of Proposed Rulemaking for Financial Market

Utilities (``Regulation HH''), 76 FR 18445 (April 4, 2011)

(Financial Market Utilities) (proposing regulation HH in accordance

with section 805 of the Dodd-Frank Act, which directed the Board to

establish risk management standards governing the operations related

to the payment, clearing, and settlement activities of those FMUs

that have been designated as systemically important by the Council

for which the Board is the Supervisory Agency. Note, however, that

FMUs that are registered as clearing agencies with the SEC under

section 17A of the Securities Exchange Act of 1934, or that are

registered as DCOs with the CFTC under section 5b of the CEA are

expressly exempt from regulation HH.).

\64\ Id. at 18447.

\65\ Id. at 18448; see also Financial Market Utilities

(``Regulation HH''), 77 FR 45907, 45908 (Aug. 2, 2012) (final rule).

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F. Risk Management Standards for SIDCOs

As noted above, the CEA specifies certain core principles that all

DCOs must comply with in order to register and maintain registration

with the Commission. Core Principle B sets out minimum financial

resources requirements for all DCOs and expressly states that a DCO

must have ``adequate financial, operational, and managerial resources,

as determined by the Commission, to discharge each responsibility of

the DCO.'' \66\ Moreover, under Core Principle I, a DCO must have

procedures, facilities, and a disaster recovery plan that allow it to,

on an emergency basis, have a ``timely recovery and resumption'' of its

operations, and fulfill each of its obligations and

responsibilities.\67\ In light of the statutory language described

above, and because the failure of or a disruption to the functioning of

a SIDCO could ``create, or increase, the risk of significant liquidity

or credit problems spreading among financial institutions or markets

and thereby threaten the stability of the financial system of the

United States,'' \68\ the Commission, in

[[Page 49669]]

accordance with section 5b(c)(2) of the Act \69\ and section 805 of the

Dodd-Frank Act,\70\ proposed heightened requirements to increase the

minimum financial resources requirements for SIDCOs,\71\ restrict the

use of assessments in meeting such obligations,\72\ enhance the system

safeguards for SIDCOs,\73\ and grant the Commission special enforcement

authority over SIDCOs pursuant to section 807 of the Dodd-Frank

Act.\74\

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\66\ Section 5b(c)(2)(B) of the CEA, 7 U.S.C. 7a-1(c)(2)(B)

(emphasis added).

\67\ Section 5b(c)(2)(I) of the CEA, 7 U.S.C. 7a-1(c)(2)(I).

\68\ See supra discussion in n.17.

\69\ Section 5b(c)(2) of the CEA, 7 U.S.C. 7a-1(c)(2).

\70\ See section 805(a)(2) of the Dodd-Frank Act.

\71\ See Financial Resources Requirements for Derivatives

Clearing Organizations, 75 FR 63113, 63119-63120 (Oct. 14, 2010).

\72\ Id.

\73\ See Risk Management Requirements for Derivatives Clearing

Organizations, 76 FR 3698, 3726-3727 (Jan. 20, 2011).

\74\ Id. at 3727.

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First, the Commission proposed to increase the amount of financial

resources a SIDCO must maintain in order to comply with Core Principle

B and Commission regulation 39.11.\75\ Regulation 39.11, in part, (1)

requires a DCO to maintain sufficient financial resources to meet its

financial obligations to its clearing members notwithstanding a default

by the clearing member creating the largest financial exposure for the

DCO in extreme but plausible market conditions, provided that if a

clearing member controls another clearing member or is under common

control with another clearing member, affiliated clearing members shall

be deemed to be a single clearing member for the purposes of this

provision; \76\ and (2) permits a DCO to include the value of potential

assessments, subject to a 30 percent haircut, in calculating up to 20

percent of the default resource requirements.\77\ For SIDCOs, the

Commission proposed a regulation that would require a SIDCO to (1)

maintain sufficient financial resources to meet the SIDCO's financial

obligations to its clearing members notwithstanding a default by the

two clearing members creating the largest combined financial exposure

for the SIDCO in extreme but plausible market conditions,\78\ and (2)

only count the value of assessments, after a 30 percent haircut, to

meet up to 20 percent of the resources required to meet obligations

arising from a default by the clearing member creating the second

largest financial exposure.\79\

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\75\ See section 5b(c)(2)(B)(ii)(I) of the CEA, 7 U.S.C. 7a-

1(c)(2)(B)(ii)(I); see also 75 FR at 63116.

\76\ See 17 CFR 39.11(a)(1); see also 75 FR 63114 (noting that

for purposes of determining the largest financial exposure for DCOs

under Core Principle B, the treatment of commonly controlled

affiliates as a single entity is necessary because the default of

one affiliate could have an impact on the ability of the other to

meet its financial obligations to the DCO).

\77\ 17 CFR 39.11(d)(2)(iii) and (iv).

\78\ 75 FR at 63119.

\79\ Id.

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In addition to financial resources requirements, the Commission

also proposed to improve system safeguards for SIDCOs by enhancing

certain BC-DR procedures.\80\ Core Principle I requires a DCO to

establish and maintain emergency procedures, backup facilities, and a

plan for disaster recovery that allows for the timely recovery and

resumption of operations.\81\ Pursuant to Commission regulation 39.18,

the required recovery time objective would be no later than the next

business day.\82\ However, because the systemic importance of SIDCOs

carries with it a responsibility to be reliably available on a near-

continuous basis to fulfill their obligations, the Commission proposed

a regulation that would require a SIDCO to have a BC-DR plan with the

objective of enabling, and the physical, technological, and personnel

resources sufficient to enable, the SIDCO to recover its operations and

resume daily processing, clearing, and settlement no later than two

hours following the disruption, including a wide-scale disruption.\83\

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\80\ See 76 FR at 3726-3727.

\81\ See section 5(c)(2)(I)(ii)(I) of the CEA, 7 U.S.C. 7a-

1(c)(2)(I)(ii)(I).

\82\ See 17 CFR 39.18(e)(3).

\83\ 76 FR at 3726. Chicago Mercantile Exchange Inc. (``CME

Clearing'') and ICC, the two existing SIDCOs, must comply with

regulation 39.30, including the two-hour recovery time objective

requirement, by December 31, 2013. Thereafter, any DCO that is

designated as systemically important by the Council for which the

Commission is the Supervisory Agency will be required to comply with

regulation 39.30 within one year after designation by the Council.

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As part of the Commission's proposed regulations for SIDCOs, the

Commission also included special enforcement authority over SIDCOs \84\

pursuant to section 807(c) of the Dodd-Frank Act, which would grant the

Commission authority under the provisions of subsections (b) through

(n) of section 8 of the Federal Deposit Insurance Act (``FDIA'') \85\

in the same manner and to the same extent as if the SIDCO were an

insured depository institution and the Commission were the appropriate

federal banking agency for such insured depository institution.\86\

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\84\ Id. at 3727.

\85\ See 12 U.S.C. 1818 (b)-(n) (granting authority for

enforcement powers).

\86\ 76 FR at 3727.

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The Commission requested comments on the proposed regulations,\87\

including comments on the potential competitive effects of imposing

higher risk standards on SIDCOs as a subset of DCOs.\88\ The Commission

received thirteen comment letters from the public regarding the

proposed SIDCO rules. Several commenters advocated that any new

Commission regulations correspond with applicable international

standards.\89\

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\87\ The comment period for the proposed rule on Financial

Resources Requirements for Derivatives Clearing Organizations, which

proposed the increased financial resources requirements for SIDCOs,

initially closed on December 13, 2010, but was extended until June

3, 2011. The comment period for the proposed rule on Risk Management

Requirements for Derivatives Clearing Organizations, which proposed

a two hour recovery time and special enforcement authority, closed

on April 25, 2011.

\88\ See 75 FR at 63117.

\89\ See infra n. 110 and 125.

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Because efforts to finalize the PFMIs were ongoing, new rules could

have put SIDCOs at a competitive disadvantage vis-[agrave]-vis foreign

CCPs not yet subject to comparable rules, and, at the time, no DCO had

been designated as systemically important by the Council, the

Commission concluded it would be premature to finalize the SIDCO

regulations in the Derivatives Clearing Organization Core Principles

adopting release.\90\ Instead, the Commission decided, consistent with

section 805(a)(1) of the Dodd-Frank Act,\91\ to monitor domestic and

international developments concerning CCPs and reconsider the proposed

SIDCO regulations in light of such developments.\92\

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\90\ See 76 FR at 69352 (Derivatives Clearing Organization Core

Principles) (final rule).

\91\ The Commission notes again that section 805(a)(1) of the

Dodd-Frank Act requires the Commission to consider international

standards in promulgating risk management rules.

\92\ Id.

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As discussed above, since the final adoption of subparts A and B of

part 39 of the Commission's regulations implementing the DCO core

principles, there have been significant domestic and international

developments, including (1) the publication of the final PFMIs in April

2012,\93\ (2) the designation of two registered DCOs for which the

Commission is the Supervisory Agency, as systemically important by the

Council,\94\ and (3) the adoption of the Basel CCP Capital Requirements

in July 2012,\95\ which provide for significantly less favorable

capital treatment for bank exposures to CCPs unless the relevant

regulator of the CCP establishes regulations that are consistent with

the PFMIs by the end of

[[Page 49670]]

2013.\96\ Given these developments and requests from market

participants to harmonize CFTC regulations with the PFMIs,\97\ the

Commission believes the time is ripe to finalize the previously

proposed SIDCO regulations.

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\93\ See supra n. 28.

\94\ See supra n. 23, 24.

\95\ See supra n. 48; see also discussion in section I. D. 4.

\96\ See Bank for International Settlements' Basel Committee on

Banking Supervision, ``Basel III Counterparty Credit Risk and

Exposures to Central Counterparties--Frequently Asked Questions,''

(November 2012; revised December 2012), available at http://www.bis.org/publ/bcbs237.pdf) (stating that if (1) a CCP regulator

has provided a public statement on the status of a CCP (QCCP or non-

qualifying), then banks will treat exposures to this CCP

accordingly. Otherwise, the bank will determine whether a CCP is

qualifying based on the criteria in the definition of a QCCP in

Annex 4, Section 1 of the Basel CCP Capital Requirements; (2) during

2013, if a CCP regulator has not yet implemented the PFMIs, but has

publicly stated that it is working towards implementing these

principles, the CCPs that are regulated by the CCP regulator may be

treated as QCCPs. However, a CCP regulator may still declare a

specific CCP non-qualifying; and (3) after 2013, if a CCP regulator

has yet to implement the PFMIs, then the bank will determine whether

a CCP subject to such a CCP regulator's jurisdiction is qualifying

on the basis of the criteria outlined in the definition of a QCCP in

Annex 4, Section 1 of the Basel CCP Capital Requirements.).

\97\ See, e.g., CME Group Inc., letter dated May 3, 2013 (``CME

2013 Letter'') (stating that the PFMIs establish ``more demanding

international risk management and related standards for payment,

clearing and settlement systems, including central counterparties''

and that in recognition of ``the systemic protections and robustness

of designated CCPs who adhere to the PFMIs,'' the Basel CCP Capital

Requirements provide ``capital incentives for exposures to such

QCCPs relative to non-Qualified CCPs.'' Moreover, the letter states

that it ``is important to [Chicago Mercantile Exchange Inc.] to be

designated a QCCP . . . in order for [its] market participants to

obtain optimal capital treatment for their business at [Chicago

Mercantile Exchange Inc. . . .]'').

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II. Regulation 39.29

A. Proposed Regulation 39.29(a)

Regulation 39.29(a), as proposed, would have required SIDCOs to

maintain sufficient financial resources to meet financial obligations

to its clearing members notwithstanding a default by the two clearing

members creating the largest combined financial exposure for the SIDCO

in extreme but plausible market conditions.\98\

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\98\ See 75 FR at 63119.

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The Commission received nine comment letters from market

participants regarding the specific requirements set forth in proposed

regulation 39.29(a).\99\ The majority of these commenters expressed

concern that heightened requirements for SIDCOs could place them at a

competitive disadvantage vis-[agrave]-vis other DCOs and foreign CCPs

that clear and settle similar OTC derivatives.\100\

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\99\ Comments on proposed regulation 39.29(a) include the

following: See The Options Clearing Corporation, December 10, 2010

letter (``OCC December Letter''); Michael Greenberger, December 10,

2010 letter (``Greenberger Letter''); CME Group Inc., letter dated

December 13, 2010 (``CME December Letter''); CME 2013 Letter;

International Swaps and Derivatives Association, Inc., letter dated

December 10, 2010) (``ISDA Letter''); Americans for Financial

Reform, letter dated December 13, 2010 (``AFR Letter''); Futures

Industry Association, letter dated December 13, 2010 (``FIA

Letter''); LCH. Clearnet Group Limited, letter dated December 10,

2010 (``LCH December Letter''); ICE Clear Credit LLC, letter dated

April 26, 2013 (``ICC Letter''). The comment files for each proposed

rulemaking can be found on the Commission's Web site at

www.cftc.gov.

\100\ See CME December Letter at 7; FIA Letter at 2; LCH

December Letter at 1. More broadly, Chris Barnard argued that all

DCOs are SIDCOs ``[g]iven their aggregate nature and high levels of

interconnectedness.'' See Chris Barnard, letter, dated May 10, 2011,

(``Barnard Letter'') at 2.

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Two commenters, Mr. Michael Greenberger and LCH. Clearnet Group

Limited (``LCH''), generally supported the proposed financial resources

requirements for SIDCOs.\101\ ICE Clear Credit LLC (``ICC''), one of

the two existing SIDCOs, stated that it currently is in compliance with

the proposed cover two requirement and acknowledged ``the importance of

clearing houses with more complex risk management requirements

maintaining robust financial resources.'' \102\ Both the International

Swaps and Derivatives Association (``ISDA'') and Americans for

Financial Reform (``AFR'') suggested alternative approaches to the

proposed cover two requirement for SIDCOs.\103\ ISDA encouraged the

Commission to consider ``whether the appropriate size of a SIDCO's

financial resources should be determined following an assessment by the

Commission of the specific risks posed by the relevant SIDCO and the

individual products it clears, rather than set to a uniform level that

may be either insufficient or overly conservative.'' \104\ AFR stated

that a SIDCO's minimum financial resources requirements should be based

on risk exposure as well as the number of defaults because while in ``a

concentrated market, a single default can have great consequence,'' and

in ``a more diverse market, the probability of multiple defaults is

greater and is a more meaningful scenario.'' \105\

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\101\ See Greenberger Letter at 6; LCH December Letter at 3.

\102\ See ICC Letter at 2.

\103\ See ISDA Letter at 8; AFR Letter at 3.

\104\ See ISDA Letter at 8.

\105\ See AFR Letter at 3.

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OCC, however, disagreed with the necessity to impose a cover two

requirement on all SIDCOs.\106\ OCC argued that the Commission should

not impose a rigid financial resources requirement on every SIDCO

because mandating the default of the two largest clearing members for

purposes of calculating the financial resources requirement does not

necessarily have a beneficial result in that ``it restricts the ability

of a DCO to measure its resources against those contingencies that it

deems to be the most likely threats to its liquidity and solvency.''

\107\ OCC agreed that all clearing organizations should consider

possible simultaneous defaults by multiple clearing members but that

the simultaneous defaults of a clearing organization's two largest

clearing members, at least in the context of how that might occur

within OCC, seem extremely implausible.\108\ OCC did state that ``the

clearing of OTC derivatives presents unique risk management concerns,

and, depending on the particular product and applicable risk management

framework, perhaps even heightened concerns that warrant special

regulatory treatment.'' \109\ Additionally, OCC argued for

international consistency on this issue, and encouraged the Commission

to follow the PFMIs and ``avoid taking final action on the Proposed

Rules prior to receiving greater clarity in terms of the positions and

proposals that European and U.K. legislators and regulators and CPSS[-

]IOSCO eventually adopt.'' \110\

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\106\ See OCC December Letter at 2, 5, and 6.

\107\ Id. at 2. In addition, OCC argued that the proposed

regulation did not fully consider the costs associated with meeting

the cover two standard nor the risk of driving clearing volume to

clearinghouses that are not required to meet the cover two standard.

Id.

\108\ Id. at 6.

\109\ Id. at 5.

\110\ Id. at 12.

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The Futures Industry Association (``FIA'') and, in its initial

comment letter, CME commented that the proposed cover two requirement

for SIDCOs could competitively disadvantage SIDCOs in both domestic and

international markets.\111\ FIA stated that the proposed regulation

would create a two-tier system between those DCOs designated as

systemically important and those DCOs that are not designated as

such.\112\ FIA believes that the two-tier system could put SIDCOs ``at

a competitive disadvantage to the extent that they need to increase

margin or guaranty fund requirements to cover the additional cost of

covering the risk of loss resulting from the default of the second

largest clearing member.'' \113\ In this regard, FIA recommended that

the Commission require all DCOs, not just SIDCOs, to maintain

sufficient financial resources to withstand the default of the two

clearing members creating the largest combined financial exposure for

[[Page 49671]]

the DCO in extreme but plausible market conditions.\114\

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\111\ See FIA Letter at 2, CME December Letter at 7-8.

\112\ See FIA Letter at 2.

\113\ Id.

\114\ Id.

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CME's initial comment letter echoed FIA's approach, arguing that

having lower financial resources requirements for DCOs that are not

SIDCOs would allow those DCOs to offer lower guaranty fund and margin

requirements.\115\ According to CME, this ``would likely attract

additional volume to at least some non-systemically important DCOs and

transform them into de facto SIDCOs.'' \116\ CME argued that until such

time as a ``de facto SIDCO'' was designated as systemically important

by the Council, SIDCOs would be competitively disadvantaged because the

``de facto SIDCO'' would be operating under the lower and less costly

general regulatory standards for DCOs.\117\ CME argued that such a

result would disregard the objectives of Title VIII.\118\ CME suggested

that the Commission, in lieu of adopting the proposed regulation, adopt

a regulation that subjects SIDCOs to more frequent stress testing

(e.g., bi-monthly rather than monthly) and reporting requirements

(e.g., monthly rather than quarterly).\119\ Following publication of

the PFMIs and the Basel CCP Capital Requirements, CME submitted a

supplemental comment letter stating that its subsidiary, CME Clearing

began offering clearing services for the interest rate swap and credit

default swap markets.\120\ As a result, CME Clearing has three distinct

guaranty funds: one for interest rate swap products (``IRS Guaranty

Fund''), one for credit default swap products (``CDS Guaranty Fund''),

and one for futures and other cleared OTC products (``Base Guaranty

Fund'').\121\ Moreover, CME stated that the IRS Guaranty Fund and the

CDS Guaranty Fund are already sized to the cover two standard.\122\

While CME stated that it is satisfied with the size of the Base

Guaranty Fund, which is currently set to meet a cover one standard, CME

anticipates that the Commission will promulgate a cover two standard as

part of the Commission's implementation of the standards set forth in

the PFMIs.\123\ As such, CME requested that the Commission ``consider

the impact to clearing firms when specifying the timelines associated

with compliance with the cover [two] standard and suggests as long a

time horizon as possible for implementation,'' with ``an effective date

of the end of 2013, or later to the extent practicable to maintain QCCP

status in accordance with BCBS 227, which we believe would assist in

minimizing the impact to the clearing firm community.'' \124\

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

\115\ See CME December Letter at 7.

\116\ Id.

\117\ Id. at 7-8.

\118\ Id. at 8.

\119\ Id.

\120\ CME 2013 Letter at 2.

\121\ CME 2013 Letter at 2-3.

\122\ CME 2013 Letter at 3.

\123\ Id.

\124\ Id.

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Additionally, LCH, which was supportive of the proposal, urged the

Commission ``to minimize the divergence'' between U.S.-regulated CCPs

and other CCPs and ensure a level playing field between SIDCOs and

other large CCPs around the world by conforming as much as possible the

Commission's final rules on SIDCOs to the global standards set forth by

the PFMIs.\125\

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\125\ See LCH December Letter at 1-2 (citing to the Bank for

International Settlements' Committee on Payment and Settlement

Systems September 2010 report entitled Market Structure Developments

in the Clearing Industry: Implications for Financial Stability for

the opinion that ``regulatory complexity, and with it the potential

for regulatory arbitrage, may increase, especially when competing

CCPs are regulated by different authorities and/or are located in

different jurisdictions.'' Id. at 4.

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The Commission notes that Core Principle B requires DCOs to have

``adequate financial, operational, and managerial resources, as

determined by the Commission, to discharge each responsibility of the

DCO.'' \126\ Pursuant to Core Principle B, at a minimum, DCOs must be

able to meet a cover one requirement. As discussed above, because of

the impact that the failure of or a disruption to the operations of a

SIDCO could have on the U.S. financial markets, the Commission proposed

increased standards for SIDCOs. However, after consideration of the

comments, and consistent with the directive in section 805 of the Dodd-

Frank Act to consider relevant international standards and existing

prudential requirements, the Commission is adopting regulation 39.29(a)

with a revision in order to harmonize U.S. regulations with

international CCP risk management standards.\127\

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\126\ Section 5b(c)(2)(B) of the CEA, 7 U.S.C. 7a-1(c)(2)(B).

\127\ The Commission finds the comments arguing for

international regulatory consistency to be persuasive and recognizes

the importance of harmonizing U.S. regulations with international

CCP risk management standards.

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Specifically, rather than apply the cover two requirement to all

SIDCOs, the revised regulation 39.29(a) would parallel the financial

resources standard in Principle 4 of the PFMIs and only require a SIDCO

that is systemically important in multiple jurisdictions or that is

involved in activities with a more complex risk profile to maintain

financial resources sufficient to enable it to meet its financial

obligations to its clearing members notwithstanding a default by the

two clearing members creating the largest combined financial exposure

for the SIDCO in extreme but plausible market conditions, provided that

if a clearing member controls another clearing member or is under

common control with another clearing member, affiliated clearing

members shall be deemed to be a single clearing member for the purposes

of this provision.\128\

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\128\ See supra n. 41, 42. Moreover, the same proviso regarding

the treatment of affiliate clearing members as set out in

39.11(a)(1), i.e., that ``if a clearing member controls another

clearing member or is under common control with another clearing

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

clearing member for the purposes of this provision'' is incorporated

in regulation 39.29(a) and is repeated in the rule text for clarity.

See also 75 FR 63116 (stating that as DCOs, SIDCOs are still subject

to Title VII and the regulations thereunder, except to the extent

that the Commission proposes higher standards pursuant to Title

VIII).

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Thus, regulation 39.29(a) will promote consistency and efficiency

in the financial markets by holding SIDCOs to the same cover two

standard as similarly situated foreign CCPs. Additionally, because the

PFMIs set forth international risk management standards for CCPs, this

international harmonization should mitigate some of the competition

concerns raised by the commenters. Moreover, adoption of this revised

regulation is part of the Commission's broader efforts to adopt and

implement regulations that are consistent with the PFMIs so that SIDCOs

operating internationally can be considered QCCPs. Such QCCP status

should help a SIDCO avoid competitive harm internationally by providing

bank clearing members and clients with the opportunity to obtain the

more favorable capital charges set forth by the Basel CCP Capital

Requirements.\129\

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\129\ See supra section I.D.4. for a more detailed discussion on

the role of the PFMIs in international banking. See also CME 2013

Letter at 2 (stating that ``it is important to CME [Clearing] to be

designated a QCCP . . . in order for [its] market participants to

obtain optimal capital treatment for their business at CME

[Clearing] . . .'').

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After careful review and consideration of the comments, and in

light of international standards and prudential regulations, the

Commission is adopting a regulation 39.29(a), as revised, to require

the cover two standard for those SIDCOs that are systemically important

in multiple jurisdictions or that are involved in activities with a

more complex risk profile.

[[Page 49672]]

B. Proposed Regulation 39.29(b)

Regulation 39.29(b), as proposed, would have precluded SIDCOs from

counting the value of assessments in calculating the resources

available to meet the obligations arising from a default by the

clearing member creating the single largest financial exposure,\130\

but would have permitted SIDCOs to count the value of assessments,

after a 30 percent haircut, in calculating the resources available to

meet up to 20 percent of the obligations arising from a default of the

clearing member creating the second largest financial exposure.\131\

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\130\ See 75 FR at 63117. Accordingly, SIDCOs would have to hold

a greater percentage of financial resources in margin and guaranty

funds. Id.

\131\ Id.

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The Commission received five comment letters from market

participants regarding the specific requirements set forth in proposed

regulation 39.29(b).\132\ FIA agreed with the Commission's proposed

limitation on the use of assessments by SIDCOs, stating that the

proposed limitation was reasonable, prudent, and sufficient to ensure

that a SIDCO does not unduly rely on its assessment power.\133\ In

contrast, AFR argued that the use of assessments in calculating the

resources available to meet a SIDCO's obligations under proposed

regulation 39.29(b) should be prohibited.\134\ AFR emphasized that a

DCO should be financially viable at all times, regardless of whether it

might be able to call on its members to provide additional

capital.\135\ In addition, ICC, one of the two existing SIDCOs, stated

that it does not rely upon its right of assessment to meet the cover

two standard \136\ and CME, the parent company of the other existing

SIDCO, stated that ``each of [CME Clearing's] guaranty funds are pre-

funded by the respective clearing members.'' \137\ More broadly, Chris

Barnard commented that the use of assessments by DCOs may cause pro-

cyclical problems and increase systemic risk in times of financial

stress.\138\

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

\132\ See AFR Letter; FIA Letter; Barnard Letter; ICC Letter;

CME 2013 Letter.

\133\ See FIA Letter at 3.

\134\ See AFR Letter at 3.

\135\ Id. AFR also argued that DCOs should be prohibited from

including assessments in meeting their financial resources

requirements as well.

\136\ See ICC Letter at 2.

\137\ See CME 2013 Letter at 3, n.7.

\138\ See Barnard Letter at 2.

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

The Commission recognizes the potential pro-cyclical effects of

assessments and agrees that a SIDCO should not be permitted to use the

value of assessments in calculating the resources available to meet its

obligations under regulation 39.29(a). ``Pro-cyclicality,'' as defined

in the PFMIs, refers to ``changes in risk-management practices that are

positively correlated with market, business, or credit cycle

fluctuations and that may cause or exacerbate financial instability.''

\139\ In the context of assessments, a SIDCO's call for additional

capital from its clearing members in order to cover any losses in a

default scenario (generally needed on an expedited basis) may trigger

greater distress on the financial markets, which presumably have

already been weakened. In other words, in a stressed market where

credit is tightening and margin calls are increased, a SIDCO's

assessment of additional claims upon its clearing members may well

exacerbate already weakened financial markets by potentially forcing

clearing members and/or their customers to deleverage in falling asset

markets, which will further drive down asset prices and stifle

liquidity, or force clearing members to default in their obligations to

the SIDCO. This in turn could start a downward spiral which, combined

with restricted credit, might lead to additional defaults of clearing

members and/or their customers, and would play a significant role in

the destabilization of the financial markets. In striking a balance

between the need for SIDCOs to effectively and efficiently use their

resources and the mitigation of pro-cyclical behaviors, the Commission

believes prefunding default obligations is the appropriate mechanism

for SIDCOs to meet their default resource obligations.

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

\139\ See PFMIs, Definitions; see also Principle 5: Collateral,

Explanatory Note 3.5.6; see also Bank for International Settlements'

Committee on the Global Financial System, ``The Role of Margin

Requirements and Haircuts in Procyclicality,'' CGFS Papers No. 36

(March 2010), available at http://www.bis.org/publ/cgfs36.htm.

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

As discussed above, Core Principle B requires DCOs to have

``adequate financial, operational, and managerial resources, as

determined by the Commission, to discharge each responsibility of the

DCO.'' \140\ Moreover, the PFMIs require a CCP to use prefunded

financial resources to cover current and potential future

exposures,\141\ which may include initial margin, contributions to a

prefunded default arrangement (e.g., a guaranty fund), and a specified

portion of the CCP's own funds.\142\ In addition, the PFMIs encourage

CCPs to address pro-cyclicality in their margin arrangements \143\ and

state that ``a CCP could consider increasing the size of its prefunded

default arrangements to limit the need and likelihood of large or

unexpected margin calls in times of market stress.'' \144\ Prefunding

financial resources requires market participants to pay more during

times of relative market stability and low-market volatility through

prefunded default arrangement contributions.\145\ However, paying more

during a period of economic stability or even an upturn may ``result in

additional protection and [be] potentially less costly and less

disruptive adjustments in periods of high market volatility.'' \146\

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

\140\ Section 5b(c)(2)(B) of the CEA, 7 U.S.C. 7a-1(c)(2)(B).

\141\ See supra n. 40 and accompanying text.

\142\ See PFMIs, Principle 4: Credit Risk, Explanatory Note

3.4.17 (stating that a CCP typically uses a sequence of prefunded

financial resources, often referred to as a ``waterfall,'' to manage

its losses caused by participant defaults. The waterfall may include

a defaulter's initial margin, the defaulter's contribution to a

prefunded default arrangement, a specified portion of the CCP's own

funds, and other participants' contributions to a prefunded default

arrangement).

\143\ Id. at Principle 6: Margin, Explanatory Note 3.6.10.

\144\ Id.

\145\ Id.

\146\ Id.

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The Commission believes the role of a SIDCO, in part, is to add

stability and confidence in the financial markets, and to the extent

that the prohibition of the inclusion of the value of assessments by

SIDCOs in meeting their default resource requirements helps to stem

pro-cyclicality and the potential weakening of financial markets, the

Commission is in favor of this approach. Moreover, prohibition of the

inclusion of the value of assessments will help ensure that a SIDCO

has, when needed, adequate resources to discharge each of its

responsibilities.

Accordingly, after consideration of the comments, relevant

international standards, and existing prudential requirements, the

Commission is adopting regulation 39.29(b) with a revision to prohibit

the use of assessments by SIDCOs in calculating financial resources

available to meet the SIDCO's obligations under regulation 39.29(a).

III. Regulation 39.30

Regulation 39.30(a), as proposed, would have required a SIDCO to

have a BC-DR plan, that has the objective of, and the physical,

technological, and personnel resources sufficient to, enable the SIDCO

to recover operations and resume daily processing, clearing, and

settlement no later than two hours following a disruption,\147\

including a wide-scale disruption.\148\

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\147\ See 76 FR at 3726.

\148\ The following definitions pertaining to system safeguards

were codified at 17 CFR 39.18(a):

A ``recovery time objective'' is defined as ``the time period

within which an entity should be able to achieve recovery and

resumption of clearing and settlement of existing and new products,

after those capabilities become temporarily inoperable for any

reason up to or including a wide-scale disruption.'' A ``wide-scale

disruption'' is defined as ``an event that causes a severe

disruption or destruction of transportation, telecommunications,

power, water, or other critical infrastructure components in a

relevant area, or an event that results in an evacuation or

unavailability of the population in a relevant area.'' ``Relevant

area'' is defined as ``the metropolitan or other geographic area

within which a derivatives clearing organization has physical

infrastructure or personnel necessary for it to conduct activities

necessary to the clearing and settlement of existing and new

products. The term `relevant area' also includes communities

economically integrated with, adjacent to, or within normal

commuting distance of that metropolitan or other geographic area.''

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[[Page 49673]]

In order to achieve the specified recovery time objective (``RTO'')

in proposed regulation 39.30(a), proposed regulation 39.30(b) would

have required SIDCOs to maintain a geographic dispersal of physical,

technological, and personnel resources.\149\ Pursuant to proposed

regulation 39.30(b)(1), physical and technological resources would have

to be located outside the relevant area of the infrastructure the

entity normally relies upon to conduct activities necessary to the

clearance and settlement of existing and new contracts, and the entity

could not rely on the same critical transportation, telecommunications,

power, water, or other critical infrastructure components the entity

normally relies upon for such activities.\150\ Additionally, proposed

regulation 39.30(b)(2) would have required SIDCOs to maintain personnel

sufficient to meet the RTO after interruption of normal clearing by a

wide-scale disruption affecting the relevant area, who live and work

outside the relevant area.\151\ To avoid duplication and maximize

flexibility, proposed regulation 39.30(b)(3) \152\ provided that SIDCOs

could use the outsourcing provisions applicable to non-SIDCO DCOs as

set forth in regulation 39.18(f).\153\

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\149\ See 76 FR at 3726-3727.

\150\ Id.

\151\ Id. at 3727.

\152\ Id.

\153\ See 17 CFR 39.18(f) (stating, in relevant part, that a DCO

may maintain the resources required under BC-DR procedures

enumerated in regulation 39.18(e)(1) by ``either (1) Using its own

employees as personnel, and property that it owns, licenses, or

leases (own property); or (2) Through written contractual

arrangements with another derivatives clearing organization or other

service provider (outsourcing).'')

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

Regulation 39.30(c), as proposed, would have required that each

SIDCO conduct regular, periodic tests of its BC-DR plans and resources,

and of its capacity to achieve the required RTO in the event of a wide-

scale disruption.\154\ Additionally, proposed regulation 39.30(c)

incorporated the provisions of regulation 39.18(j) concerning testing

by DCOs, including the purpose of the testing, the conduct of the

testing, and reporting and review of the testing.\155\

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

\154\ See 76 FR at 3727.

\155\ See id; see also 17 CFR 39.18(j).

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

The Commission received five comment letters regarding the specific

requirements set forth in proposed regulation 39.30(a).\156\ One

commenter stated that the recovery time for its technology systems is

currently approximately two hours based upon past disaster recovery

tests,\157\ and three commenters opposed the two-hour RTO.\158\ ICC,

one of the two existing SIDCOs, acknowledged ``the importance of

maintaining market integrity during disruptive events'' and noted that

a two-hour RTO is consistent with Principle 17 of the PFMIs.\159\ In

addition, ICC stated that the ``two-hour benchmark is unlikely to

require [it] to hire additional personnel or to require a different

level of cross-training related to its wide-scale disruption plan,''

and that it ``is unlikely that [ICC] will incur any additional backup

technology costs related to the CFTC's proposed RTO.\160\

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

\156\ Comments on proposed regulation 39.30 include the

following: See Intercontinental Exchange, Inc. letter dated March

21, 2011 (``ICE Letter''); OCC letter dated March 21, 2011 (``OCC

Letter''); CME Group Inc., letter dated March 21, 2011 (``CME March

Letter''); ICC Letter; and CME 2013 Letter. The Commission received

no comments regarding proposed regulation 39.30(b) or 39.30(c).

\157\ See ICC Letter at 2.

\158\ See ICE Letter at 7-8; CME March Letter at 14-15; OCC

Letter at 19-20.

\159\ ICC Letter at 2.

\160\ Id.

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Both Intercontinental Exchange, Inc. (``ICE'') and CME, on the

other hand, expressed concern that requiring a more stringent RTO for

SIDCOs would impose significant costs.\161\ ICE argued that ``assigning

an RTO to a SIDCO instead of assigning the objective the RTO is

intended to achieve adds significant cost to a SIDCO's business

continuity program but does not necessarily increase overall resilience

of the financial system.'' \162\ ICE and CME also highlighted the

approach referenced in the Interagency Paper on Sound Practices to

Strengthen the Resilience of the U.S. Financial System (the ``Sound

Practices Paper''),\163\ published in 2003, which argued for a same-

business-day RTO with a two-hour RTO as an aspirational goal for

clearing and settlement organizations.\164\ CME urged the Commission to

adopt the same approach as the Sound Practices Paper for SIDCOs, i.e.,

the same-business-day RTO with a two-hour RTO on a voluntary

basis.\165\ In addition, CME stated that ``[m]oving to a 2-hour RTO

would impose enormous costs on SIDCOs, and the CFTC has provided no

cost/benefit analysis in connection with this aspect of the proposed

Regulation.'' \166\ Nonetheless, in a supplemental comment letter, CME

stated that ``in light of the systemic importance of CME [Clearing]'s

clearing functions and the intended benefits, including compliance with

the PFMI requirements for critical information technology, CME

[Clearing] has obtained budget approval and allocated resources towards

a two hour RTO and will be working throughout 2013 towards achieving a

two hour RTO.'' \167\

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

\161\ See ICE Letter at 7; CME March Letter at 14.

\162\ ICE Letter at 8.

\163\ See the Federal Reserve Board, the Office of the

Comptroller of the Currency and the Securities and Exchange

Commission, ``Interagency Paper on Sound Practices to Strengthen the

Resilience of the U.S. Financial System'' (the ``Sound Practices

Paper''), 68 FR 17809 (April 11, 2003).

\164\ Id. at 17812 (stating that core clearing and settlement

organizations should develop the capacity to recover and resume

clearing and settlement activities within the business day on which

the disruption occurs with the overall goal of achieving recovery

and resumption within two hours after an event).

\165\ CME March Letter at 15.

\166\ CME March Letter at 14.

\167\ CME 2013 Letter at 4 (CME also acknowledges that

``Principle 17 of the PFMIs states that a BC-DR Plan should be

designed to ensure that critical information technology systems can

resume operations within two hours following disruptive events.'')

(emphasis added).

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

OCC commented that, though a laudable goal, a two-hour RTO was not

consistently achievable without sacrificing core DCO functions and

increasing the risks of error and backlogs.\168\ In addition, OCC

argued that in its experience, it often takes three hours to fully

recover and meet its responsibilities and avoid significant market

disruption.\169\ OCC also argued that further efforts to reduce RTO

would not be cost-effective and could increase rather than decrease

reliability risk.\170\

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

\168\ OCC Letter at 19.

\169\ Id.

\170\ Id.

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With respect to commenters' concerns that the proposed regulation

will significantly increase costs on SIDCOs, the Commission recognizes

these concerns but notes that a systemic importance designation under

Title VIII means that the failure of a SIDCO to meet its obligations

will have a greater impact on the U.S. financial system than the

failure of a DCO not so designated. Thus, the Commission believes the

financial system has a vested interest in enhancing risk management

requirements for SIDCOs to increase a SIDCO's financial resiliency and

to

[[Page 49674]]

mitigate the risk of significant liquidity or credit problems spreading

among financial institutions or markets, threatening the stability of

the U.S. financial system. In the event of a wide-scale disruption, the

resiliency of the U.S. financial markets might depend on the rapid

recovery of SIDCOs to support critical market functions and thereby

allow other market participants (i.e., the counterparties) to process

their transactions. In addition, in such a scenario, it is reasonable

to assume that there will be other market participants in locations not

affected by the disruption that will need to clear and settle pending

transactions as well. In short, the failure of a SIDCO to complete core

clearing and settlement functions within a rapid period could create

systemic liquidity and credit dislocations on a global scale.

Additionally, the Commission notes that while it may be true that a

two-hour RTO was an aspirational goal in 2003, standards and technology

have advanced in the last ten years. As discussed above, the current

international standard for CCPs, as set forth by the PFMIs, is to have

a BC-DR plan that incorporates a two-hour RTO.\171\ Specifically, the

PFMIs state that an FMI's business continuity plan ``should incorporate

the use of a secondary site and should be designed to ensure that

critical information technology systems can resume operations within

two hours following disruptive events.'' \172\ Because the two-hour RTO

is the international standard and foreign CCPs are anticipated to

operate under this timeframe, any competitive disadvantages to SIDCOs

in implementing this regulation should be mitigated because all

similarly situated CCPs will likely be operating under this standard.

Indeed, ICC, one of the two existing SIDCOs, has stated that it is

unlikely that it will need to hire additional personnel or incur

additional technology costs to meet this standard.\173\ Moreover, as

discussed above, CME Clearing, the other existing SIDCO, ``has obtained

budget approval and allocated resources towards a two hour RTO and will

be working throughout 2013 towards achieving a two hour RTO.'' \174\

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

\171\ See supra n. 46, 47 (referring to the PFMIs, Principle 17:

Operational Risk).

\172\ Id.

\173\ See supra n. 160 and accompanying text.

\174\ CME 2013 Letter at 4.

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The Commission believes that enhancing the system safeguard

requirements a SIDCO must maintain under Core Principle I will increase

stability in the financial markets and is therefore consistent with

Title VIII's objectives. Moreover, regulation 39.30(a) will promote

regulatory consistency for SIDCOs and similarly situated CCPs because

the two-hour RTO is the international standard, under the PFMIs, for

CCPs operating in other jurisdictions. As discussed above, the

Commission is fully committed to adopting and implementing regulations

that are consistent with the PFMIs to ensure that SIDCOs are QCCPs

under the Basel CCP Capital Requirements so that banks transacting

through SIDCOs can receive preferential capital treatment.\175\

Therefore, the Commission is adopting regulation 39.30(a) as proposed.

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\175\ See supra section I.D.4.

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The Commission did not receive any comments regarding proposed

regulations 39.30(b) or 39.30(c). Therefore, for reasons stated in the

proposal, the Commission is adopting regulations 39.30(b) and 39.30(c)

as proposed.\176\ However, to mitigate costs, the Commission notes that

regulation 39.30(b) should be interpreted in a manner consistent with

the PFMIs, which state ``[a] particular site may be primary for certain

functions and secondary for others. It is not intended that an FMI

would be required to have numerous separate secondary sites for each of

its essential functions.'' \177\

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\176\ See 76 FR at 3726-3727.

\177\ See PFMIs, Principle 17: Operations Risk.

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

IV. Regulation 39.31

Regulation 39.31 proposed to codify the special enforcement

authority granted to the Commission over SIDCOs pursuant to section

807(c) of the Dodd-Frank Act, which states that for purposes of

enforcing the provisions of Title VIII of the Dodd-Frank Act, a SIDCO

is subject to, and the Commission has authority under, provisions (b)

through (n) of section 8 of the FDIA\178\ in the same manner and to the

same extent as if the SIDCO were an insured depository institution and

the Commission were the appropriate Federal banking agency for such

insured depository institution.\179\ The Commission did not receive any

comment letters on this proposed regulation, which tracks the statutory

text in section 807 of the Dodd-Frank Act. Therefore, for reasons

stated in the proposal, the Commission is adopting regulation 39.31 as

proposed.

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

\178\ See also 12 U.S.C. 1818(b)-(n) (granting authority for

enforcement powers).

\179\ 76 FR at 3727. The Commission notes that Title VIII

preserved and expanded the CFTC's examination and enforcement

authority with respect to designated entities within its

jurisdiction. See Cong. Rec. 156 S5924-5 (daily ed. July 14, 2010)

(statement of Sen. Lincoln that Title VIII ``preserves and expands

the CFTC's and SEC's examination and enforcement authorities with

respect to designated entities within their respective

jurisdictions,'' and that ``the authorities granted in Title VIII

are intended to be both additive and complementary to the

authorities granted to the CFTC and SEC in Title VII and to those

agencies' already existing legal authorities. The authority provided

in Title VIII to the CFTC and SEC with respect to designated

clearing entities and financial institutions engaged in designated

activities would not and is not intended to displace the CFTC's and

SEC's regulatory regime that would apply to these institutions or

activities.'').

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V. Effective Date and Compliance Dates

For purposes of publication in the Code of Federal Regulations, all

of the rules adopted herein will have an effective date of 60 days

after publication in the Federal Register. The Commission received

three comments, however, requesting additional time to come into

compliance with these rules. Regarding the compliance date of

regulation 39.29, OCC requested that DCOs be afforded a reasonable

amount of time to raise ``any material amount of additional resources''

and requested a delayed implementation of two years.\180\ CME stated

that the financial resources that DCOs are required to maintain will

increase dramatically and requested an implementation period of no less

than 180 days.\181\ Regarding the compliance date of regulation 39.30,

the Commission had proposed a compliance date of one year after

publication of the final rules or July 12, 2012.\182\ OCC commented

that this is a short and burdensome deadline that will be difficult to

meet and encouraged the Commission to adopt a two-year compliance

period for the requirements applicable to SIDCOs.\183\ The Commission

received no comments regarding regulation 39.31.

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

\180\ OCC December Letter at 11.

\181\ CME December Letter at 8.

\182\ See 76 FR at 3714.

\183\ OCC March Letter at 21.

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Given the mandate to implement these standards, and the necessity

of SIDCOs to fulfill their obligations on a near continuous basis,

after careful consideration of the comments received, the Commission is

extending the compliance date for regulations 39.29 and 39.30 to

December 31, 2013.

VI. Consideration of Costs and Benefits

A. Introduction

Section 15(a) requires the Commission to consider the costs and

benefits of its actions before promulgating a regulation under the CEA

or issuing certain orders.\184\

[[Page 49675]]

Section 15(a) further specifies that the costs and benefits shall be

evaluated in light of five broad areas of market and public concern:

(1) Protection of market participants and the public; (2) efficiency,

competitiveness, and financial integrity of futures markets; (3) price

discovery; (4) sound risk management practices; and (5) other public

interest considerations. The Commission's cost and benefit

considerations in accordance with section 15(a) are discussed below.

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\184\ 7 U.S.C. 19(a).

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B. Background

In this final rulemaking, the Commission is adopting regulations to

implement enhanced risk management standards for SIDCOs.\185\

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\185\ See supra section I.A. through I.F. for a more detailed

discussion on the risk management standards for SIDCOs, including

the designation process for SIDCOs and standards for SIDCOs under

Title VIII of the Dodd-Frank Act.

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As noted above, consistent with the DCO core principles and section

805 of the Dodd-Frank Act, which requires the Commission to consider

relevant international and existing prudential requirements when

prescribing risk management standards for SIDCOs, the Commission

proposed the following enhanced requirements for SIDCOs: \186\

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\186\ See supra section I.F. for discussion on the risk

management standards for SIDCOs proposed by the Commission.

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(1) Regulation 39.29(a) which would require a SIDCO to maintain

sufficient resources to meet a ``cover two'' standard in order to

comply with Core Principle B; \187\ (2) regulation 39.29(b) which would

strictly limit the value of assessments that could be used in meeting

that requirement; \188\ (3) regulation 39.30 which would require a

SIDCO to have a BC-DR plan with a two-hour RTO in order to comply with

Core Principle I (``two-hour RTO''); \189\ and (4) regulation 39.31

which, under section 807(c) of the Dodd-Frank Act, grants the

Commission special enforcement authority over SIDCOs.\190\

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\187\ Id.

\188\ Id.

\189\ Id.

\190\ Id.

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As also discussed above, after the Commission proposed the SIDCO

risk management standards and received comments, the PFMIs were

published.\191\ The PFMIs establish international risk management

standards for FMIs, including CCPs, that facilitate clearing and

settlement.\192\ The PFMIs also play a significant role in the Basel

CCP Capital Requirements, which introduce new capital charges based on

counter party risk for banks conducting financial derivatives

transactions through a CCP.\193\ These capital charges vary

significantly depending on whether or not the counterparty is a QCCP,

that is, a CCP that is subject to regulations consistent with the

PFMIs.\194\ Effectively, the Basel CCP Capital Requirements incentivize

banks to clear derivatives through QCCPs by setting lower capital

charges for exposures arising from derivatives cleared through a QCCP

and setting significantly higher capital charges for exposures arising

from derivatives cleared through non-qualifying CCPs.\195\ As discussed

further below, these differences in capital charges are extremely

important in considering whether to adopt requirements for SIDCOs,

which are consistent with the PFMIs, or requirements that fall short of

that standard.

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\191\ See supra section I.D.1. for a general discussion on the

PFMIs.

\192\ Id.

\193\ See supra section I.D.4. for a discussion on the role of

the PFMIs in international banking standards.

\194\ Id.

\195\ Id.

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In light of the directive of section 805 of the Dodd-Frank Act to

consider relevant international standards and existing prudential

requirements when prescribing risk management standards for designated

systemically important FMUs, as well as the recent publication of the

PFMIs, and public comments on the proposed SIDCO regulations, the

Commission has determined it is necessary and appropriate to finalize

the proposed enhanced risk management standards for SIDCOs. However, in

order to harmonize the proposed regulations with the existing

international standards set forth by the PFMIs, as requested by some

commenters,\196\ the Commission has revised proposed regulation

39.29(a) and 39.29(b). Rather than apply the cover two requirement to

all SIDCOs, revised regulation 39.29(a) parallels the financial

resources standard in Principle 4 of the PFMIs and only requires a

SIDCO that is systemically important in multiple jurisdictions or that

is involved in activities with a more complex risk profile to maintain

financial resources sufficient to meet the cover two requirement.\197\

Revised regulation 39.29(b), which is also consistent with Principle 4

of the PFMIs, prohibits a SIDCO from the use of assessments in

calculating its financial resources available to meet the SIDCO's

obligations under regulation 39.29(a).\198\

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\196\ See OCC December Letter at 12 (OCC requesting that the

Commission avoid taking final action on the proposed SIDCO

regulations until the adoption of the PFMIs to ensure consistency

with international regulations) and LCH December Letter at 1-2 (LCH

urging the Commission to conform as much as possible the

Commission's final rules on SIDCOs to the global standards set forth

in the PFMIs).

\197\ See supra section II. for a discussion on the proposed and

revised rule text of regulation 39.29.

\198\ Id.

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The Commission considered the following alternatives: (1) Not to

adopt any of the proposed SIDCO risk management regulations, (2) to

adopt the SIDCO risk management regulations only as proposed, or (3) to

adopt the proposed SIDCO risk management regulations with revisions

consistent with relevant international standards and existing

prudential requirements. As detailed above, the Commission has

concluded it is necessary and appropriate in this final rulemaking to

adopt regulation 39.29, as revised, regulation 39.30, as proposed, and

regulation 39.31, as proposed.\199\

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\199\ See supra discussion I.C. and I.F.

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In the discussion that follows, the Commission considers the costs

and benefits of the final rulemaking in light of the comments it

received and section 15(a) of the CEA. As the requirement in regulation

39.31 is imposed by the Dodd-Frank Act, any associated costs and

benefits are the result of statutory directives as determined by

Congress, not an act of Commission discretion.

For the remaining regulations in this rulemaking, 39.29(a) (cover

two), 39.29(b) (prohibition of assessments) and 39.30 (two-hour RTO),

the Commission considers the costs and benefits attributable to these

enhanced requirements against the DCO regulatory framework established

in part 39, which provides minimum risk standards for DCOs and sets the

baseline for cost and benefit considerations. Specifically, regulation

39.11 (implementing DCO Core Principle B) sets a cover one standard as

the minimum financial resources requirement for all DCOs whereas

regulation 39.29(a) sets a cover two financial resources requirement

for all SIDCOs engaged activities with a more complex risk profile or

that are systemically important in multiple jurisdictions. Regulation

39.11 permits the inclusion of assessment powers, to a limited extent,

in calculating whether a DCO meets its default resources requirement,

whereas regulation 39.29(b) prohibits the use of assessments by SIDCOs

in meeting those obligations. Regulation 39.18 requires a DCO to have

an RTO of no later than the next business day following the disruption

of its operations whereas regulation 39.30 (implementing DCO Core

Principle I) requires SIDCOs to have a BC-DR plan with a two-hour

[[Page 49676]]

RTO following the disruption of its operations.

The Commission invited public comment on all aspects of the

proposed SIDCO rulemaking but did not receive any comments with

quantitative data from which the Commission could calculate the costs

and benefits of the proposed enhanced requirements. The Commission did

receive qualitative comments on the Commission's proposed consideration

of costs and benefits generally, as well as specifically to the

requirements central to this final rule: Cover two, use of assessments

and two-hour RTO. These comments are summarized below in connection

with the Commission's consideration of the costs and benefits of the

final rules being promulgated herein.

C. Benefits and Costs of the Final Rule

1. Benefits

As explained in the subsections that follow, this final rule

promotes the financial strength, operational security and reliability

of SIDCOs, reduces systemic risk, and increases the stability of the

broader U.S. financial system. In addition, the regulations harmonize

U.S regulations with international standards which will, in important

ways, place SIDCOs on a level playing field with their competitors in

the global financial markets:

a. Regulation 39.29(a): Cover Two

The cover two requirement increases the financial stability of

certain SIDCOs which, in turn, increases the overall stability of the

US financial markets. This is so because enhancing a SIDCO's financial

resources requirements from the minimum of cover one to a more

stringent cover two standard helps to ensure the affected SIDCO will

have greater financial resources to meet its obligations to market

participants, including in the case of defaults by multiple clearing

members. These added financial resources lessen the likelihood of the

SIDCO's failure which, given the designation of systemically important,

could threaten the stability of the US financial system.\200\ By

bolstering certain SIDCOs' resources, regulation 39.29(a) contributes

to the financial integrity of the financial markets and reduces the

likelihood of systemic risk from spreading through the financial

markets due to one of those SIDCOs' failure or disruption.

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\200\ See supra section I.B.

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According to commenters, existing SIDCOs already fund their default

resources using a cover two standard for products with a more complex

risk profile.\201\ Although the benefit associated with regulation

39.29(a) is somewhat lessened by the already established practice of

cover two by the relevant SIDCOs, there is a long-term benefit of

setting the cover two standard as the new regulatory minimum to ensure

that even in periods of apparent stability and low market volatility,

these SIDCOs will continue to have increased financial resource

requirements and, ultimately, greater financial stability. This

approach of obtaining resources in such low-stress periods avoids the

need to call for additional resources from clearing members during less

stable, more volatile times, which would have pro-cyclical effects on

the U.S. financial markets.\202\ In addition, the cover two requirement

will apply to SIDCOs deemed systemically important in multiple

jurisdictions.

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\201\ See ICC Letter at 1. See also CME 2013 Letter at 2-3.

\202\ See supra section II.B. for discussion on the pro-cyclical

impact of assessments.

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b. Regulation 39.29(b): Prohibited Use of Assessments To Meet

Regulation 39.29(a) Obligations

As discussed below and throughout this release, the Commission

believes that prohibiting the use of assessments by a SIDCO in meeting

its default resource obligations (i.e. those under regulations

39.11(a)(1) and 39.29(a)) increases the financial stability of the

SIDCO, which in turn, increases the overall stability of the U.S.

financial markets.

Assessment powers are more likely to be exercised during periods of

financial market stress. If during such a period, a clearing member

defaults and the loss to the SIDCO is sufficiently large to deplete (1)

the collateral posted by the defaulting entity, (2) the defaulting

entity's default fund contribution, and (3) the remaining pre-funded

default fund contributions, a SIDCO's exercise of assessment powers

over the non-defaulting clearing members may exacerbate a presumably

already weakened financial market. The demand by a SIDCO for more

capital from its clearing members could force one or more additional

clearing members into default because they cannot meet the assessment.

The inability to meet the assessment could lead clearing members and/or

their customers to de-leverage (i.e., sell off their positions) in

falling asset markets, which further drives down asset prices and may

result in clearing members and/or their customers defaulting on their

obligations to each other and/or to the SIDCO. In such extreme

circumstances, assessments could trigger a downward spiral and lead to

the destabilization of the financial markets. Prohibiting the use of

assessments by a SIDCO in meeting default resources obligations is

intended to require the SIDCO to retain more financial resources

upfront, i.e. to prefund its financial resources requirement to cover

its potential exposure.

The increase in prefunding of financial resources by a SIDCO may

increase costs to clearing members of that SIDCO (e.g. requiring

clearing members to post additional funds with the SIDCO),\203\ but it

also reduces the likelihood that the SIDCO will require additional

capital infusions during a time of financial stress when raising such

additional capital is expensive relative to market norms. By increasing

prefunded financial resources, a SIDCO becomes less reliant on the

ability of its clearing members to pay an assessment, more secure in

its ability to meets its obligations, and more viable in any given

situation, even in the case of multiple defaults of clearing members.

Accordingly, regulation 39.29(b) increases the financial security and

reliability of the SIDCO which will thereby further increase the

overall the stability of the U.S. financial markets.

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\203\ Id.

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c. Regulation 39.30: Two-Hour RTO

A two-hour RTO in a SIDCO's BC-DR plan increases the soundness and

operating resiliency of the SIDCO, which in turn, increases the overall

stability of the U.S. financial markets.

Given the significant role SIDCOs play within the financial market

infrastructure and the need to preserve, to the greatest extent

practicable, their near-continuous operation, regulation 39.30

prescribes an enhanced RTO of two hours. The two-hour RTO ensures that

even in the event of a wide-scale disruption, the potential negative

effects upon U.S. financial markets be minimized because the affected

SIDCO will recover rapidly and resume its critical market functions,

thereby allowing other market participants to process their

transactions, even those participants in locations not directly

affected by the disruption. The two-hour RTO increases a SIDCO's

operational resiliency by requiring the SIDCO to have the resources and

technology necessary to resume operations promptly. This resiliency, in

turn, increases the overall stability of the U.S. financial markets.

[[Page 49677]]

d. Benefits of QCCP Status

As discussed above,\204\ the international Basel CCP Capital

Requirements provide incentives for banks to clear derivatives through

CCPs that are qualified CCPs or ``QCCPs'' by setting lower capital

charges for exposures arising from derivatives cleared through a QCCP

and setting significantly higher capital charges for exposures arising

from derivatives cleared through non-qualifying CCPs.\205\ The enhanced

risk management standards for SIDCOs adopted in this final rulemaking

are consistent with the international standards set forth in the PFMIs

and address part of the remaining divergences between part 39 of the

Commission's regulations and the PFMIs, which will provide an

opportunity for SIDCOs to gain QCCP status. The Commission believes

there is a benefit for a SIDCO if it is able to offer to its clearing

members and their customers the favorable capital treatment under the

Basel CCP Capital Requirements.

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\204\ See supra section I. D. 4. for a discussion of the Basel

CCP Capital Requirements.

\205\ Id.

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2. Costs

The Commission requested but did not receive any quantitative data

or specific cost estimates associated with the proposed regulations.

However, in qualitative terms, the Commission recognizes that this

final rule may impose important costs on SIDCOs depending on the

financial resources requirements and system safeguards procedures the

SIDCOs currently implement. In other words, the costs range from

minimal (to the extent SIDCOs are already operating, or planning to

operate, consistent with the final rules) to significant (for those who

are not).\206\

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\206\ For example, ICC, one of the two existing SIDCOs, stated

that it already implements the ``cover two'' requirement, that it

does not rely upon its right of assessment in meeting that

requirement, and that it is unlikely to incur significant costs in

implementing the two hour RTO. See ICC Letter at 1-2. In addition,

CME Clearing, the other existing SIDCO, implements the ``cover two''

requirement for two of its three guaranty funds, has each of its

guaranty funds pre-funded by the respective clearing members, and,

though the cost will be significant, has already ``obtained budget

approval and allocated resources towards a two hour RTO.'' See CME

2013 Letter at 2-4.

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To the extent costs increase, the Commission has considered that

higher trading costs for market participants (i.e. increased clearing

fees, guaranty fund contributions, and margin fees, etc.) may

discourage market participation and result in decreased liquidity and

reduced price discovery. However, the Commission has also considered

the costs to market participants and the public if these regulations

are not adopted. Significantly, without these regulations to ensure

that SIDCOs operate under certain enhanced risk management standards,

in a manner that is consistent with internationally accepted standards,

the financial integrity and security of the U.S. financial markets

would be at a greater risk relative to international markets. This,

too, could adversely affect the attractiveness of the U.S. financial

markets subject to the Commission's jurisdiction as compared to foreign

competitors. In addition, without the final rule, SIDCOs would not have

the opportunity to gain QCCP status, thereby putting them at a

significant competitive disadvantage in the global financial markets

which, again, would be to the detriment of their clearing members and

their customers. The Commission notes that to the extent it addresses

the remaining divergences between part 39 of the Commission's

regulations and the PFMIs through future rulemakings, and these

rulemakings, along with the regulations adopted herein, do not provide

an opportunity for non-SIDCO DCOs to obtain QCCP status, this would

place such non-SIDCO DCOs at a competitive disadvantage to SIDCOs.

Moreover, the resulting cost to the DCOs would be the inability to

offer the favorable capital treatment under the Basel CCP Capital

Requirements to their customers and clearing members.

a. Regulation 39.29(a): Cover Two

The cost of the cover two requirement for certain SIDCOs includes

the opportunity cost of the additional financial resources needed to

satisfy the guaranty fund requirements for the risk of loss resulting

from the default of the second largest clearing member.\207\

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\207\ In the event that these additional resources need to be

raised by the SIDCO, as opposed to reallocated, this cost is the

funding cost for raising these additional resources. In addition, to

the extent that there is uncertainty over whether cover two applies

(for example, as in the case of whether a DCO gets deemed to be

systemically important in multiple jurisdictions or whether a given

product is, indeed, of a more complex risk profile), the cost of

cover two is the opportunity cost (funding cost) of the additional

financial resources weighted by the likelihood that cover two will

apply.

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As discussed above in more detail, the Commission received comments

from market participants addressing the costs associated with a cover

two standard.\208\ OCC argued that if heightened risk management

standards are imposed on a DCO in such a way as to substantially

increase the costs for clearing members and their customers to clear

transactions through a SIDCO rather than a non-SIDCO, there is risk of

undermining the goals of both Titles VII and VIII of the Dodd-Frank Act

by driving clearing volume to less-regulated clearinghouses.\209\ FIA

commented that the cover two requirement would put SIDCOs at a

competitive disadvantage to other DCOs to the extent that they need to

increase margin or guaranty fund requirements to cover the default of

the second largest clearing member.\210\ FIA recommended that the

Commission adopt an alternative approach by extending the cover two

requirement to all DCOs, not just SIDCOs, and allow ample time for DCOs

to come into compliance.\211\ CME stated that a cover two requirement

would allow some DCOs to offer lower guaranty fund and margin

requirements, which would attract additional volume to that DCO and

make it a de facto SIDCO. SIDCOs would then be at a competitive

disadvantage relative to the de facto SIDCO until such time as the de

facto SIDCO was designated as a SIDCO.\212\ ICC, one of the two

existing SIDCOs, on the other hand, is in compliance with the cover two

requirement and therefore, would not incur additional costs to meet the

cover two requirement.\213\

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\208\ See section II. for a discussion on comments received on

the proposed regulation 39.29(a).

\209\ Id.

\210\ Id.

\211\ Id.

\212\ Id.

\213\ ICC Letter at 2.

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As noted above, and in comment letters from CME and ICC,\214\

SIDCOs already implement the cover two standard for products with a

more complex risk profile, and therefore, the costs of compliance with

cover two should be mitigated given these existing practices.\215\

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\214\ See supra n. 23 (designation of CME and ICC as SIDCOs).

\215\ See ICC Letter at 1-2. See also CME 2013 Letter at 2-3.

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

However, there are likely to be costs associated with the

uncertainty as to whether a SIDCO is deemed systemically important in

multiple jurisdictions and what constitutes a product with a more

complex risk profile. These costs are associated with business

planning, i.e. how to fund a cover two requirement. In addition, the

possibility exists that some market participants will port their

positions from a SIDCO that either (1) is deemed systemically important

in multiple jurisdictions or (2) clears products of a more complex risk

profile to another SIDCO for which neither (1) nor (2) applies or to

another DCO that is not

[[Page 49678]]

systemically important because the value of the cover two protection to

these market participants is less than the price at which that

protection is being offered. These market participants will transact

with DCOs that operate under cover one, which is a lower financial

resources requirement, and thus, get the benefit of lower transactional

fees and forego the enhanced protections associated with the SIDCOs.

Such an event adversely impacts the reduction in systemic risk that the

cover two standard affords. However, the potential cost to the SIDCO

and to the goal of systemic risk reduction is likely mitigated because

(a) not every product offered by the SIDCO is available at other DCOs

and (b) a SIDCO may offer benefits not available to a DCO that is not

designated as systemically important,\216\ thereby reducing the

likelihood that market participants will port their positions to other

DCOs.

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\216\ For example under Title VIII, a SIDCO may establish and

maintain an account with the Federal Reserve Bank if permitted to do

so by such Federal Reserve Bank and by the Board. See section 806(a)

of the Dodd-Frank Act.

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b. Regulation 39.29(b): Prohibition on the Use of Assessments in

Calculation of Default Resources To Meet Obligations Under Regulation

39.29(a)

The costs associated with the prohibited use of assessments by

SIDCOs in calculating the SIDCO's obligations under regulation 39.29(a)

include the opportunity cost of the additional financial resources

needed to replace the value of such assessments. This may require an

infusion of additional capital. The cost of this regulation should be

mitigated for SIDCOs because neither CME Clearing nor ICC, the two

existing SIDCOs, rely on assessments to meet their default fund

obligations for products with a more complex risk profile.\217\

Additionally, analogous to the case with the cover two standard, market

participant demand may shift from a SIDCO to a DCO with a lower

capitalization requirement.

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\217\ See ICC Letter at 2 (stating that ICC ``does not rely upon

(count) [its] right of assessment to meet the [``cover two''

requirement]''). See also CME 2013 Letter at 3, n.7.

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c. Regulation 39.30: Two-Hour RTO

The Commission recognizes that a two-hour RTO may increase

operational costs for SIDCOs by requiring additional resources,

including personnel, technological and geographically dispersed

resources, in order to comply with the final rule. Moreover, the

implementation of a two-hour RTO is expected to impose one-time costs

to set up the enhanced resources as well as recurring costs to operate

the additional resources. However, as noted above, the Commission

requested but did not receive quantitative data from which to estimate

the dollar costs associated with implementing a two-hour RTO, and in

particular the costs of moving from a next day RTO, the minimum

standard established by the DCO core principles and regulation 39.18,

to a two-hour RTO as required by regulation 39.30. The Commission did,

however, receive qualitative comments regarding the costs associated

with the two-hour RTO, which are discussed in more detail above. For

example, CME, ICE and OCC all initially opposed the enhanced RTO,

citing to the increase of costs associated with the proposed regulation

39.30. However, more recently, the Commission received comments from

CME and ICC acknowledging the importance of the two-hour RTO and their

intent to implement a two-hour RTO.\218\

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\218\ See ICC Letter at 2 (noting that the two-hour RTO is

consistent with Principle 17 of the PFMIs, and stating that it is

unlikely to incur ``any significant additional personnel training

cost associated with the CFTC's proposed RTO of two hours'' or ``any

additional backup technology costs related to the CFTC's proposed

RTO.''). See also CME 2013 Letter at 4 (noting that ``in light of

the systemic importance of CME [Clearing]'s clearing functions and

the intended benefits, including compliance with the PFMI

requirements for critical information technology, CME [Clearing] has

obtained budget approval and allocated resources towards a two hour

RTO and will be working throughout 2013 towards achieving a two hour

RTO.'').

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D. Section 15(a) Factors

1. Protection of Market Participants and the Public

The enhanced financial resources requirements and system safeguard

requirements for SIDCOs, as set forth in this final rulemaking, will

further the protection of market participants and the public by

increasing the financial stability and operational security of SIDCOs,

and more broadly, increase the stability of the U.S. financial markets.

A designation of systemic importance under Title VIII means the failure

of a SIDCO or the disruption of its clearing and settlement activities

could create or increase the risk of significant liquidity or credit

problems spreading among financial institutions or markets, thereby

threatening the stability of the U.S. financial markets. The

regulations contained in this final rule are designed to help ensure

that SIDCOs continue to function even in extreme circumstances,

including multiple defaults by clearing members and wide-scale

disruptions. While there may be increased costs associated with the

implementation of the final rules, these costs are mitigated by the

countervailing benefits of the increased safety and soundness of the

SIDCOs and the reduction of systemic risk, which protect market

participants and the public form the adverse consequences that would

result from a SIDCO failure or a disruption in its functioning.

2. Efficiency, Competitiveness, and Financial Integrity

The regulations set forth in this final rulemaking will promote

financial strength and stability of SIDCOs, as well as, more broadly,

efficiency and greater competition in the global markets. The

regulations promote efficiency insofar as SIDCOs that operate with

enhanced financial resources as well as increased system safeguards are

more secure and are less likely to fail. The regulations promote

competition because they are consistent with the international

standards set forth in the PFMIs and will help to ensure that SIDCOs

are afforded the opportunity to gain QCCP status and thus avoid an

important competitive disadvantage relative to similarly situated

foreign CCPs that are QCCPs. Additionally, by increasing the stability

and strength of the SIDCOs, the regulations in the final rule help to

ensure that SIDCOs can meet their obligations in the most extreme

circumstances and can resume operations even in the face of wide-scale

disruption, which contributes to the financial integrity of the

financial markets. In requiring more SIDCO financial resources to be

pre-funded by (1) expanding the potential losses those resources are

intended to cover and (2) restricting the means for satisfying those

resource requirements, i.e. through prohibiting the use of assessments

in determining guarantee fund contributions, the requirements of this

final rule seek to lessen the incidence of pro-cyclical demands for

additional funding resources and, in so doing, promote both financial

integrity and market stability.\219\

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\219\ See supra n. 139 and accompanying text for a discussion of

pro-cyclicality.

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3. Price Discovery

The regulations in the final rulemaking enhance risk management

standards for SIDCOs which may result in increased public confidence,

which, in turn, might lead to expanded participation in the affected

markets, i.e. products with a more complex risk profile. The expanded

participation in these markets (i.e. greater transactional

[[Page 49679]]

volume) may have a positive impact on price discovery. Conversely, the

Commission notes that these enhanced risk management standards are also

associated with additional costs and to the extent that SIDCOs pass

along the additional costs to their clearing members and customers,

participation in the affected markets may decrease and have a negative

impact on price discovery. However, it is the Commission's belief that

such higher transactional costs should be greatly offset by the lower

capital charges granted to clearing members and customers clearing

derivative transactions through SIDCOs that are deemed QCCPs.

4. Sound Risk Management Practices

The regulations in the final rulemaking contribute to the sound

risk management practices of SIDCOs because the requirements promote

the safety and soundness of the SIDCOs by (1) enhancing the financial

resources requirements, which provide greater certainty for market

participants that all obligations will be honored by the SIDCOs and (2)

enhancing system safeguards to facilitate the continuous operation and

rapid recovery of activities, which provide certainty and security to

market participants that potential disruptions will be reduced and, by

extension, the risk of loss of capital and liquidity will be reduced.

5. Other Public Interest Considerations

The Commission notes the strong public interest for jurisdictions

to either adopt the PFMIs or establish standards consistent with the

PFMIs in order to allow CCPs licensed in the relevant jurisdiction to

gain QCCP status. As emphasized throughout this rulemaking, SIDCOs that

gain QCCP status will avoid a competitive disadvantage in the financial

markets by avoiding the much higher capital charges imposed by the

Basel CCP Capital Requirements. Moreover, because ``enhancements to the

regulation and supervision of systemically important financial market

utilities . . . are necessary . . . to support the stability of the

broader financial system,'' \220\ adopting these rules promotes the

public interest in a more stable broader financial system.

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\220\ See section 804(a)(4) of the Dodd-Frank Act (Congressional

findings).

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VII. Related Matters

A. Paperwork Reduction Act

The Commission may not conduct or sponsor, and a registered entity

is not required to respond to, a collection of information unless it

displays a currently valid Office of Management and Budget (OMB)

control number. The Commission's adoption of Sec. Sec. 39.28, 39.29,

39.30, and 39.31 (DCO) imposes no new information collection

requirements on registered entities within the meaning of the Paperwork

Reduction Act.\221\ The OMB has previously assigned control numbers for

the required collections of information under a prior related final

rulemaking to which this rulemaking relates.\222\ The titles for the

previous collections of information are ``Part 40, Provisions Common to

Registered Entities'', OMB control number 3038-0093, ``Financial

Resources Requirements for Derivatives Clearing Organizations, OMB

control number 3038-0066,'' ``Information Management Requirements for

Derivatives Clearing Organizations, OMB control number 3038-0069,''

``General Regulations and Derivatives Clearing Organizations, OMB

control number 3038-0081,'' and ``Risk Management Requirements for

Derivatives Clearing Organizations, OMB control number 3038-0076.''

This rulemaking is applicable to a subset of DCOs designated as SIDCOs,

who must comply with existing information collection requirements for

DCOs.

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\221\ 44 U.S.C. 3501 et seq.

\222\ 76 FR 69334 at 69428.

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B. Regulatory Flexibility Act

The Regulatory Flexibility Act (RFA) requires that agencies

consider whether the rules they propose will have a significant

economic impact on a substantial number of small entities and, if so,

provide a regulatory flexibility analysis respecting the impact. The

rules proposed by the Commission will affect only DCOs designated as

SIDCOs. The Commission has previously established certain definitions

of ``small entities'' to be used by the Commission in evaluating the

impact of its regulations on small entities in accordance with the RFA.

The Commission has previously determined that DCOs are not small

entities for the purpose of the RFA.\223\ Accordingly, the Chairman, on

behalf of the Commission, hereby certifies pursuant to 5 U.S.C. 605(b)

that the proposed rules will not have a significant economic impact on

a substantial number of small entities.

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\223\ See ``A New Regulatory Framework for Clearing

Organizations,'' 66 FR 45604, 45609 (Aug. 29, 2001), ``17 CFR part

40 Provisions Common to Registered Entities,'' 75 FR 67282 (November

2, 2010), and ``Provisions Common to Registered Entities,'' 76 FR

44776, 44789 (July 27, 2011).

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List of Subjects in 17 CFR Part 39

Commodity futures, Consumer protection, Enforcement authority,

Financial resources, Reporting and recordkeeping requirements, Risk

management.

For the reasons stated in the preamble, amend 17 CFR part 39 as

follows:

PART 39--DERIVATIVES CLEARING ORGANIZATIONS

0

1. The authority citation for part 39 is revised to read as follows:

Authority: 7 U.S.C. 2 and 7a-1 as amended by the Dodd-Frank Wall

Street Reform and Consumer Protection Act, Pub. L. 111-203, 124

Stat. 1376; Subpart C also issued under 12 U.S.C. 5464.

0

2. Add subpart C to read as follows:

Subpart C--Provisions Applicable to Systemically Important Derivatives

Clearing Organizations

Sec.

39.28 Scope.

39.29 Financial resources requirements.

39.30 System safeguards.

39.31 Special enforcement authority.

Subpart C--Provisions Applicable to Systemically Important

Derivatives Clearing Organizations

Sec. 39.28 Scope.

(a) The provisions of this subpart C apply to any derivatives

clearing organization, as defined in section 1a(15) of the Act and

Sec. 1.3(d) of this chapter,

(1) Which is registered or deemed to be registered with the

Commission as a derivatives clearing organization, is required to

register as such with the Commission pursuant to section 5b(a) of the

Act, or which voluntarily registers as such with the Commission

pursuant to section 5b(b) or otherwise; and

(2) Which is a systemically important derivatives clearing

organization as defined in Sec. 39.2.

(b) A systemically important derivatives clearing organization is

subject to the provisions of subparts A and B of this part 39 except to

the extent different requirements are imposed by provisions of this

subpart C.

(c) A systemically important derivatives clearing organization

shall provide notice to the Commission in advance of any proposed

change to its rules, procedures, or operations that could materially

affect the nature or level of risks presented by the systemically

important derivatives clearing organization, in accordance with the

requirements of Sec. 40.10 of this chapter.

[[Page 49680]]

Sec. 39.29 Financial resources requirements.

(a) General rule. Notwithstanding the requirements of Sec.

39.11(a)(1), a systemically important derivatives clearing organization

that is systemically important in multiple jurisdictions or that is

involved in activities with a more complex risk profile shall maintain

financial resources sufficient to enable it to meet its financial

obligations to its clearing members notwithstanding a default by the

two clearing members creating the largest combined financial exposure

for the systemically important derivatives clearing organization in

extreme but plausible market conditions; Provided that if a clearing

member controls another clearing member or is under common control with

another clearing member, affiliated clearing members shall be deemed to

be a single clearing member for the purposes of this provision.

(b) Valuation of financial resources. Notwithstanding the

requirements of Sec. 39.11(d)(2), assessments for additional guaranty

fund contributions (i.e., guarantee fund contributions that are not

pre-funded) shall not be included in calculating the financial

resources available to meet a systemically important derivatives

clearing organization's obligations under paragraph (a) of this

section.

Sec. 39.30 System safeguards.

(a) Notwithstanding Sec. 39.18(e)(3), the business continuity and

disaster recovery plan described in Sec. 39.18(e)(1) for each

systemically important derivatives clearing organization shall have the

objective of enabling, and the physical, technological, and personnel

resources described in Sec. 39.18(e)(1) shall be sufficient to enable,

the derivatives clearing organization to recover its operations and

resume daily processing, clearing, and settlement no later than two

hours following the disruption, for any disruption including a wide-

scale disruption.

(b) To ensure its ability to achieve the recovery time objective

specified in paragraph (a) of this section in the event of a wide-scale

disruption, each systemically important derivatives clearing

organization must maintain a degree of geographic dispersal of

physical, technological and personnel resources consistent with the

following:

(1) For each activity necessary to the clearance and settlement of

existing and new contracts, physical and technological resources,

sufficient to enable the entity to meet the recovery time objective

after interruption of normal clearing by a wide-scale disruption, must

be located outside the relevant area of the infrastructure the entity

normally relies upon to conduct that activity, and must not rely on the

same critical transportation, telecommunications, power, water, or

other critical infrastructure components the entity normally relies

upon for such activities;

(2) Personnel, sufficient to enable the entity to meet the recovery

time objective after interruption of normal clearing by a wide-scale

disruption affecting the relevant area in which the personnel the

entity normally relies upon to engage in such activities are located,

must live and work outside that relevant area;

(3) The provisions of Sec. 39.18(f) shall apply to these resource

requirements.

(c) Each systemically important derivatives clearing organization

must conduct regular, periodic tests of its business continuity and

disaster recovery plans and resources and its capacity to achieve the

required recovery time objective in the event of a wide-scale

disruption. The provisions of Sec. 39.18(j) apply to such testing.

(d) The requirements of this section shall apply to a derivatives

clearing organization not earlier than one year after such derivatives

clearing organization is designated as systemically important.

Sec. 39.31 Special enforcement authority.

For purposes of enforcing the provisions of Title VIII of the Dodd-

Frank Act, a systemically important derivatives clearing organization

shall be subject to, and the Commission has authority under the

provisions of subsections (b) through (n) of section 8 of the Federal

Deposit Insurance Act (12 U.S.C. 1818) in the same manner and to the

same extent as if the systemically important derivatives clearing

organization were an insured depository institution and the Commission

were the appropriate Federal banking agency for such insured depository

institution.

Issued in Washington, DC, on August 9, 2013, by the Commission.

Melissa D. Jurgens,

Secretary of the Commission.

Appendix to Final Rule on Enhanced Risk Management Standards for

Systemically Important Derivatives Clearing Organizations--Commission

Voting Summary

Note: The following appendix will not appear in the Code of

Federal Regulations

Appendix 1--Commission Voting Summary

On this matter, Chairman Gensler and Commissioners Chilton,

O'Malia, and Wetjen voted in the affirmative.

[FR Doc. 2013-19791 Filed 8-14-13; 8:45 am]

BILLING CODE 6351-01-P

Last Updated: August 15, 2013