2010-31458

FR Doc 2010-31458[Federal Register: December 22, 2010 (Volume 75, Number 245)]

[Proposed Rules]

[Page 80571-80636]

From the Federal Register Online via GPO Access [wais.access.gpo.gov]

[DOCID:fr22de10-31]

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Part II

Commodity Futures Trading Commission

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17 CFR Parts 1, 16, and 38

Core Principles and Other Requirements for Designated Contract Markets;

Proposed Rule

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COMMODITY FUTURES TRADING COMMISSION

17 CFR Parts 1, 16, and 38

RIN 3038-AD09

Core Principles and Other Requirements for Designated Contract

Markets

AGENCY: Commodity Futures Trading Commission.

ACTION: Notice of proposed rulemaking.

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

``CFTC'') is proposing new rules and amended guidance and acceptable

practices to implement the new statutory provisions enacted by Title

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

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

practices, which apply to the designation and operation of contract

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

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

(``CEA'') concerning designation and operation of contract markets, and

adds a new CEA Section 2(h)(8) to include the listing, trading and

execution of swaps on designated contract markets. The Commission

requests comment on all aspects of the proposed rules, guidance and

acceptable practices.

DATES: Comments must be received on or before February 22, 2011.

ADDRESSES: You may submit comments, identified by RIN number 3038-AD09,

by any of the following methods:

Agency Web site, via its Comments Online process: http://

comments.cftc.gov. Follow the instructions for submitting comments

through the Web site.

Mail: David A. Stawick, Secretary of the Commission,

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

Street, NW., Washington, DC 20581.

Hand Delivery/Courier: Same as mail above.

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

Follow the instructions for submitting comments.

Please submit your comments using only one method.

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

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

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

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

information that you believe is exempt from disclosure under the

Freedom of Information Act, a petition for confidential treatment of

the exempt information may be submitted according to the procedures

established in Sec. 145.9 of the Commission's regulations, 17 CFR

145.9.

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

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

submission from www.cftc.gov that it may deem to be inappropriate for

publication, such as obscene language. All submissions that have been

redacted or removed that contain comments on the merits of the

rulemaking will be retained in the public comment file and will be

considered as required under the Administrative Procedure Act and other

applicable laws, and may be accessible under the Freedom of Information

Act.

FOR FURTHER INFORMATION CONTACT: Nancy Markowitz, Assistant Deputy

Director, 202-418-5453, [email protected], or Nadia Zakir, Attorney-

Advisor, 202-418-5720, [email protected], Division of Market Oversight,

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

Street, NW., Washington, DC 20581.

SUPPLEMENTARY INFORMATION:

Table of Contents

I. Background

A. Overview

B. The Current Statutory Framework

C. The Dodd-Frank Act Amendments

II. The Proposed Rules

A. Proposed Repeal of Appendix A to Part 38

B. Adoption of New Regulations and Revised Guidance and

Acceptable Practices

C. Proposed Amendments to General Regulations Under Part 38 (New

Subpart A)

1. Proposed Sec. 38.1--Scope

2. Proposed Sec. 38.2--Applicable Provisions

3. Proposed Sec. 38.3--Procedures for Designation

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

Implementing Designated Contract Market Rules

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

Compliance

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

Regulatory Purposes

7. Proposed Sec. 38.8--Listing of Swaps on a Designated

Contract Market

8. Proposed Sec. 38.9--Designated Contract Markets Operating as

Swap Execution Facilities

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

Designated Contract Market

D. Proposed New Regulations and Revised Guidance and Acceptable

Practices for Compliance With Core Principles

1. Subpart B--Designation as Contract Market

2. Subpart C--Compliance With Rules

i. Proposed Sec. 38.151--Access Requirements

ii. Proposed Sec. 38.152--Abusive Trading Practices Prohibited

iii. Proposed Sec. 38.153--Capacity To Detect and Investigate

Rule Violations

iv. Proposed Sec. 38.154--Regulatory Services Provided by a

Third Party

v. Proposed Sec. 38.155--Compliance Staff and Resources

vi. Proposed Sec. 38.156--Automated Trade Surveillance System

vii. Proposed Sec. 38.157--Real-Time Market Monitoring

viii. Proposed Sec. 38.158--Investigations and Investigation

Reports

ix. Proposed Sec. 38.159--Ability To Obtain Information

x. Proposed Sec. 38.160--Additional Rules Required

3. Subpart D-Contracts Not Readily Susceptible to Manipulation

4. Subpart E-Prevention of Market Disruption

i. Proposed Sec. 38.251--General Requirements

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

Delivery Contracts

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

Settled Contracts

iv. Proposed Sec. 38.254--Ability to Obtain Information

v. Proposed Sec. 38.255--Risk Controls for Trading

vi. Proposed Sec. 38.256--Trade Reconstruction

vii. Proposed Sec. 38.257--Regulatory Service Provider

viii. Proposed Sec. 38.258--Additonal Rules Required

5. Subpart F--Position Limitations or Accountability

6. Subpart G--Emergency Authority

7. Subpart H--Availability of General Information

i. Proposed Sec. 38.401(a)--General

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

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

iv. Proposed Sec. 38.401(d)--Rulebook

8. Subpart I--Daily Publication of Trading Information

9. Subpart J--Execution of Transactions

i. Proposed Sec. 38.501--General Requirements

ii. Proposed Sec. 38.502--Minimum Centralized Market Trading

Requirement

a. Minimum Centralized Market Trading Percentage Requirement

b. Centralized Market Trading Percentage Calculation

c. Mandatory Delisting

d. Treatment of Contracts Listed as of the Effective Date of

this Section

e. Exemptions

iii. Proposed Sec. 38.501--Block Trades on Futures Contracts

iv. Proposed Sec. 38.504--Block Trades on Swap Contracts

v. Proposed Sec. 38.505--Exchange of Derivatives For Related

Positions

vi. Proposed Sec. 38.506--Office Trades and Transfer Trades

10. Subpart K--Trade Information

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i. Proposed Sec. 38.551--Audit Trail Required

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

Program

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

Requirements

11. Subpart L--Financial Integrity of Transactions

12. Subpart M--Protection of Market Participants

13. Subpart N--Disciplinary Procedures

i. Proposed Sec. 38.701--Enforcement Staff

ii. Proposed Sec. 38.702--Disciplinary Panels

iii. Proposed Sec. 38.703--Review of Investigation Report

iv. Proposed Sec. 38.704--Notice of Charges

v. Proposed Sec. 38.705--Right to Representation

vi. Proposed Sec. 38.706--Answer to Charges

vii. Proposed Sec. 38.707--Admission or Failure to Deny Charges

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

Hearing

ix. Proposed Sec. 38.709--Settlement Offers

x. Proposed Sec. 38.710--Hearings

xi. Proposed Sec. 38.711--Decisions

xii. Proposed Sec. 38.712--Right to Appeal

xiii. Proposed Sec. 38.13--Final Decisions

xiv. Proposed Sec. 38.714--Disciplinary Sanctions

xv. Proposed Sec. 38.715--Summary of Fines for Violations of

Rules Regarding Timely Submission of Records, Decorum or Other

Similar Activities

xvi. Proposed Sec. 38.716--Emergency Disciplinary Actions

14. Subpart O--Dispute Resolution

15. Subpart P--Governance Fitness Standards

16. Subpart Q--Conflicts of Interest

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

Markets

18. Subpart S--Recordkeeping

19. Subpart T--Antitrust Considerations

20. Subpart U--System Safeguards

21. Subpart V--Financial Resources

i. Proposed Sec. 38.1101(a)--General Requirements

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

iii. Proposed Sec. 38.1101(c)--Computation of Financial

Resource Requirement

iv. Proposed Sec. 38.1101(d)--Valuation of Financial Resources

v. Proposed Sec. 38.1101(e)--Liquidity of Financial Resources

vi. Proposed Sec. 38.1101(f)--Reporting Requirements

22. Subpart W--Diversity of Boards of Directors

23. Subpart X--Securities and Exchange Commission

III. Related Matters

A. Regulatory Flexibility Act

B. Paperwork Reduction Act

1. Additional Information Provided by Designated Contract

Markets

2. Information Collection Comments

C. Cost Benefit Analysis

IV. Text of Proposed Rules

I. Background

A. Overview

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

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

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

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

enacted to reduce risk, increase transparency, and promote market

integrity within the financial system by, among other things: (1)

Providing for the registration and comprehensive regulation of swap

dealers and major swap participants; (2) imposing clearing and trade

execution requirements on standardized derivative products; (3)

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

enhancing the Commission's rulemaking and enforcement authorities with

respect to, among others, all registered entities and intermediaries

subject to the Commission's oversight.

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

Act, Public Law 111-203, 124 Stat. 1376 (2010) (``Dodd-Frank Act'').

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

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

2010.''

\3\ 7 U.S.C. 1 et seq. (amended 2010).

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

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

(i) Eliminating the stand-alone designation criteria contained in

former Section 5(b) of the CEA; (ii) revising the existing core

principles, including incorporating therein most of the substantive

elements of the former designation criteria; and (iii) adding five new

core principles, thereby requiring applicants and designated contract

markets (``DCMs'') to comply with a total of 23 core principles as a

condition of obtaining and maintaining designation as a contract

market.

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

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

swaps subject to the clearing requirement of Section 2(h)(1) of the CEA

must occur either on a DCM or on a new type of regulated facility

called a Swap Execution Facility (``SEF'').\4\ Also, Section 733 of the

Dodd-Frank Act added Section 5h(a)(1), requiring that no person may

operate a facility for the trading or processing of swaps unless the

facility is registered as a SEF or as a DCM. Accordingly, the rules

proposed in this release also implement provisions related to the

processing, trading and execution of swaps on DCMs.

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\4\ The Commission will be proposing rules governing the

registration and operation of SEFs in a separate, forthcoming

rulemaking. See CFTC Web site for additional information on the

``SEF Registration Requirements and Core Principle Rulemaking,

Interpretation & Guidance'' rulemaking, at http://www.cftc.gov/

LawRegulation/DoddFrankAct/Rulemakings/DF_13_SEFRules/index.htm

(last visited Dec. 14, 2010).

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In enacting the Dodd-Frank Act, Congress directed that rules and

regulations required by the provisions of Title VII take effect the

later of 360 days after enactment of the bill or to the extent that a

rulemaking is required by the Dodd-Frank Act, not less than 60 days

after the publication of that final rule.\5\ Consistent with Congress'

directive, this release proposes amendments to parts 38, 16 and 1 of

the Commission's regulations to implement Section 5 of the CEA, as well

as the requirements of Sections 2(h)(8) and 5h(a)(1) of the CEA, as

amended by the Dodd-Frank Act, as applicable to DCMs.

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\5\ See Section 754 of the Dodd-Frank Act.

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B. The Current Statutory Framework

Section 5 of the CEA governs the designation and operation of

DCMs.\6\ DCMs were first established under the Commodity Futures

Modernization Act of 2000 (``CFMA'') \7\ as one of two forms of

Commission-regulated markets for the trading of contracts for sale of a

commodity for future delivery or commodity options.\8\

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\6\ 7 U.S.C. 7; see also, Section 5 of the CEA, as amended by

the Dodd-Frank Act.

\7\ Commodity Futures Modernization Act of 2000, Public Law 106-

554, 114 Stat. 2763 (2000) (``CFMA'').

\8\ The CFMA established two tiers of regulated markets--

designated contract markets and registered derivatives transaction

execution facilities (``DTEFs''). In addition, the CFMA provided for

two markets exempt from regulation, exempt boards of trade

(``EBOTs'') and exempt commercial markets (``ECMs''). A description

of the categories, requirements and functions of each of these

markets as first established under the CFMA is provided in the

Commission's notice of proposed rulemaking and final rulemaking

implementing the CFMA. See A New Regulatory Framework for Trading

Facilities, Intermediaries and Clearing Organizations, Notice of

Proposed Rulemaking, 66 FR 14,262, March 9, 2001; Final Rulemaking,

66 FR 42,256, Aug. 10, 2001. In addition, a new type of regulated

market was created under the CFTC Reauthorization Act of 2008

(``Farm Bill''), Incorporated as Title XIII of the Food,

Conservation and Energy Act of 2008, Public Law 110-246, 122 Stat.

1651 (June 18, 2008). Under the Farm Bill, the Commission was

required to determine and make public its determination whether a

particular agreement, contract or transaction executed or traded on

an ECM serves a significant price discovery function (``SPDC'').

Once a contract was identified as a SPDC, the ECM on which the

contract was traded was required to demonstrate to the Commission

that the ECM had a regulatory system in place that satisfied the

requirements of the core principles under current Section 2(h)(7) of

the current CEA and the applicable provisions of Sec. 36.3 of the

Commission's regulations. Section 723 of the Dodd-Frank Act repealed

the ECM SPDC provisions.

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The CEA, as amended by the CFMA, requires a DCM applicant to

demonstrate that it satisfies each of

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eight designation criteria as a condition of obtaining designation as a

contract market.\9\ In addition, each applicant is required to

demonstrate its ability to comply with 18 core principles at the time

of application, and on an ongoing basis after designation.\10\

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\9\ The eight designation criteria under current Section 5(b) of

the CEA are titled the following: (1) In General; (2) Prevention of

Market Manipulation; (3) Fair and Equitable Trading; (4) Trade

Execution Facility; (5) Financial Integrity of Transactions; (6)

Disciplinary Procedures; (7) Public Access; and (8) Ability to

Obtain Information.

\10\ 7 U.S.C. 7(d). The Commission also undertakes due diligence

reviews of each contract market's compliance with the core

principles during rule and product certification reviews and

periodic examinations of DCMs' compliance with the core principles

under Rule Enforcement Reviews (``RERs'').

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

Markets

Section 735 of the Dodd-Frank Act amends Section 5 of the CEA by:

(i) Eliminating the eight criteria for designation as a contract

market; (ii) amending many of the core principles, including

incorporating most of the substantive requirements of the current

designation criteria, and requiring that all DCMs demonstrate

compliance with each of the core principles as a condition of obtaining

and maintaining designation as a contract market; and (iii) adding five

new core principles, specifically Core Principle 13 (Disciplinary

Procedures), Core Principle 20 (System Safeguards), Core Principle 21

(Financial Resources), Core Principle 22 (Diversity of Boards of

Directors), and Core Principle 23 (Securities and Exchange

Commission).\11\

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\11\ New Core Principle 13 is verbatim of current Designation

Criterion 6.

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As noted above, the Dodd-Frank Act also specifically requires under

Section 2(h)(8) of the CEA, as amended,\12\ that execution of swaps

that are required to be cleared must occur on either a DCM or a SEF,

except where no DCM or SEF makes the swap available for trading.\13\

Accordingly, unless otherwise specified in this release, each of the 23

core principles and the proposed regulations, guidance and acceptable

practices, apply to all ``contracts'' listed on a DCM, which will

include swaps, futures and options contracts.

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\12\ See Section 723 of the Dodd-Frank Act.

\13\ Section 5h(a)(1) of the CEA, as amended by Dodd-Frank Act,

also prohibits any person from operating a facility for the trading

and processing of swaps unless the facility is registered as a SEF

or DCM.

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In sum, the new and revised regulations, guidance and acceptable

practices proposed in this release will implement the regulatory

obligations that each DCM must meet in order to comply with Section 5

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

designation and thereafter on an ongoing basis. The Commission requests

comments on all aspects of the proposed rules, guidance and acceptable

practices.

II. The Proposed Rules

A. Proposed Repeal of Appendix A to Part 38

Section 735 of the Dodd-Frank Act eliminates the criteria for

designation as a contract market in current CEA Section 5(b), creates a

new core principle from one of the criterion, and incorporates most of

the substance of the remaining designation criteria into the core

principles. Because the designation criteria are eliminated under the

Dodd-Frank Act, the Commission proposes to eliminate the guidance on

compliance with the designation criteria for DCMs contained in Appendix

A to part 38. As noted below, this release further proposes to

redesignate Appendix A as the application form for contract market

designation.

B. Adoption of New Regulations and Revised Guidance and Acceptable

Practices

In implementing the provisions of the CFMA, the Commission adopted

a regulatory framework for part 38 of its regulations that consisted

largely of general application guidance and acceptable practices

consistent with the CFMA's principles-based regime.\14\ The Dodd-Frank

Act amends Section 5(d)(1)(B) of the CEA generally to provide that the

Commission, in its discretion, may determine by rule or regulation the

manner in which boards of trade comply with the core principles.\15\

Accordingly, the Commission undertook a comprehensive evaluation of its

existing regulations, guidance and acceptable practices associated with

each of the core principles in order to update those provisions and to

determine which core principles would benefit from new or revised

regulations and new or revised guidance or acceptable practices. Based

on that review, the Commission is proposing both new and revised

regulations and revised guidance and acceptable practices for some core

principles, as set forth in this release.

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\14\ Guidance provides DCMs and DCM applicants with contextual

information regarding the core principles, including important

concerns which the Commission believes must be taken into account in

complying with specific core principles. In contrast, the acceptable

practices are more specific than guidance and provide examples of

how DCMs may satisfy particular requirements of the core principles;

they do not, however, establish mandatory means of compliance.

Acceptable practices are intended to assist DCMs by establishing

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

compliance with specific aspects of the core principle, and do not

protect the contract market with respect to charges of violations of

other sections of the CEA or other aspects of the core principle.

\15\ Current Core Principle 1 states, among other things, that

boards of trade ``shall have reasonable discretion in establishing

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

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

of core principle guidance and acceptable practices. Section 735 of

the Dodd-Frank Act amends this provision to include the proviso that

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

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

in establishing the manner in which they comply with the core

principles. See Section 735(b) of the Dodd-Frank Act, amending

Section 5(d)(1)(B) of the CEA.

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The proposed new regulations codify certain requirements and

practices that are commonly accepted in the industry and have been

found, based on the Commission's administrative experience in

overseeing the futures markets since passage of the CFMA, to represent

the best practice means of complying with the core principles.\16\

Indeed, some of these requirements are the off-shoot of the Rule

Enforcement Reviews (``RERs'') periodically carried out by Commission

staff.

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\16\ The Commission's oversight of DCMs' compliance with the

core principles includes the evaluation of applications for contract

market designation, periodic RERs of DCMs' compliance with various

statutory requirements, and the review of rule and product

certifications implicating all aspects of the core principles.

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The RERs are the cornerstone of the Commission's oversight program,

serving as a key tool for monitoring a DCM's compliance with the core

principles, and also as a primary means for identifying industry trends

and DCM best practices for self-regulation. Essentially, RER findings

and recommendations communicate to the industry what Commission staff

believes are best practices for compliance and such recommendations

typically are then adopted industry-wide as the standard form of

compliance.

The RERs, which are conducted periodically at all DCMs, typically

examine DCMs' compliance with specific core principles relating to

audit trail, trade practice surveillance, market surveillance,

disciplinary programs, and dispute resolution.\17\ Commission staff's

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findings and any recommendations for improvement are included in a

report that is presented to the Commission, and the Commission votes on

whether to accept the report. The RER report is publicly released and

published on the Commission's Web site and also sent to the DCM.

Although a DCM may not fully agree with the Commission staff's

findings, responses from DCMs, which are required within 30 days,

almost always explain how the DCM intends to implement staff's

recommendations, if any. Because RER reports are public,

recommendations for one DCM invariably lead to all DCMs that suffer

from the same identified shortfall taking timely corrective action.

Such corrective action usually includes modifying compliance procedures

and/or adopting or modifying existing rules.

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\17\ Staff typically review a one-year target period and,

depending on the core principles covered, thoroughly examine a DCM's

audit trail reviews, trade practice and market surveillance

investigations, investigation logs, hedge exemptions, surveillance

systems, compliance manuals, summary fine schedules, disciplinary

files, settlement agreements, and arbitration files. Staff also

conducts on-the-record interviews with DCM compliance officials.

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The Commission believes that the promulgation of clear-cut and

definite requirements or practices in those instances where a standard

industry practice has developed would provide greater legal certainty

to the industry in demonstrating compliance with the CEA. Accordingly,

in certain circumstances, the Commission is proposing to replace the

general application guidance and acceptable practices in part 38 with

regulations that codify the relevant practices and requirements for

those core principles. For some of the new core principles, the

Commission also is proposing regulations that represent the best

practice for complying with the core principle. For several core

principles, the Commission is proposing to maintain the guidance and

acceptable practices, albeit with proposed revisions that reflect

developments in the industry since the passage of the CFMA, and the

Commission's considerable experience since the passage of the CFMA with

matters involving compliance with the core principles by a broad range

of DCMs.

C. Proposed Amendments to General Regulations Under Part 38 (New

Subpart A)

The Commission is proposing to reorganize part 38 to include new

subparts A through X. Proposed subpart A would include the general

regulation Sec. Sec. 38.1 through 38.10,\18\ applicable both to DCM

applicants and to existing DCMs. Subparts B through X would each

include relevant regulations applicable to each core principle.\19\

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\18\ This release does not propose any revisions to Sec. 38.6

of the Commission's regulations.

\19\ Each of these subparts begins with a regulation containing

the language of the core principle.

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1. Proposed Sec. 38.1--Scope

The proposed revisions to Sec. 38.1 are non-substantive as they

simply eliminate cross-references to other sections of the Commission's

regulations that are no longer applicable, and add references to

sections, most of them new, that are now applicable.

2. Proposed Sec. 38.2--Applicable Provisions

Section 38.2 sets forth the Commission regulations that DCMs must

comply with in addition to those in part 38. The proposed revisions to

Sec. 38.2 include a change to the title of the section to more

accurately describe the regulation, and further updates the list of

Commission regulations that are applicable to DCMs based on the new

provisions under the Dodd-Frank Act, including the proposed provisions

relating to real time reporting of swaps and the determination of

appropriate block size for swaps which will be proposed under part 43,

requirements for data element, recordkeeping and reporting of swap

information to swap data repositories which will be proposed under part

45, business continuity and disaster recovery which will be proposed

under part 46, designation requirements for swap data repositories

which will be proposed under part 49, and position limits which will be

proposed under part 151.\20\

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\20\ The Commission notes that because some of the proposed

rulemakings are either ongoing or forthcoming, this proposed list of

reserved sections under Sec. 38.2 may be subject to further

revisions pending the final rules for each respective rulemaking.

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3. Proposed Sec. 38.3--Procedures for Designation

Current Sec. 38.3 sets forth the application and approval

procedures for new DCM applications.\21\ The Commission is proposing in

Sec. 38.3 that all DCM applications, reinstatements, requests for

transfer of designations, requests for withdrawal of application for

designation, and vacation of designations be filed with the Secretary

of the Commission in an electronic format, via the Internet, e-mail, or

other means of direct electronic submission as approved by the

Commission.\22\

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\21\ In addition to these substantive revisions, many of the

proposed revisions to Sec. 38.3 are non-substantive and are

intended to clarify the rule.

\22\ This amendment also would ensure consistency with the

electronic process used for filing rule and product submissions

under parts 39 and 40 of the Commission's regulations. See 17 CFR

parts 39 and 40.

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The Commission also is proposing to eliminate the expedited

approval procedures for DCM applications, such that the timing of such

reviews will be governed only by the 180-day statutory review period

and procedures specified in Section 6(a) of the CEA.\23\ Based upon its

experience since 2001, the Commission has determined that the 90-day

accelerated review process is inefficient and impracticable.

Specifically, the Commission has found that applicants seeking

expedited review often file incomplete or draft applications, without

adequate supporting materials, in the interest of meeting the expedited

approval timeline. This, in turn, has required Commission staff to

expend significant amounts of time reviewing incomplete or draft

applications, necessitating numerous follow-up conversations with

applicants, usually resulting in removal of applications from the

expedited review timeline. The Commission believes that by requiring

all applications to be reviewed within the 180-day review period,

applicants will have sufficient time to submit complete applications

for review, and to respond to Commission staff requests for additional

information, resulting in a more efficient review process.\24\

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\23\ 7 U.S.C. 8(a); see also, Section 6(a) of the CEA, as

amended by the Dodd-Frank Act.

\24\ This proposal also is consistent with the Commission's

proposal to eliminate the 90-day expedited review procedures for

derivatives clearing organization applications under part 39 in a

separate rulemaking.

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To provide an applicant with more certainty of the types of

information that are required to support its DCM application, the

Commission proposes to redesignate Appendix A to part 38 \25\ to

include a new application form with comprehensive instructions to guide

DCM applicants and a specified lists of documents and information that

must be provided as exhibits.\26\ Other than the specific requirements

necessitated by the revised and newly added core principles, the

majority of information required under the form application consists of

information that historically has been required by the Commission staff

in its reviews of DCM applications under the Commission's regulations.

Accordingly, proposed Sec. 38.3(a)(1) requires that, at a minimum, all

applicants must complete the application form and provide the necessary

information and documentation, in accordance with the associated

instructions, in order to

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initiate the 180-day designation review process.

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\25\ Appendix A currently contains the stand alone designation

criteria now eliminated under the Dodd-Frank Act.

\26\ The Commission also is requiring tailored application forms

for the registration of Designated Clearing Organizations, Swap

Execution Facilities and Swap Data Repositories.

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

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

DCM designation and positions comprising open interest, in anticipation

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

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

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

proposed Sec. 38.3(d)(2), the DCM would submit to the Commission a

request for transfer no later than three months prior to the

anticipated corporate change, with a limited exception.\27\ The request

shall include: (1) The underlying agreement that governs the corporate

change; (2) a narrative description of the corporate change, including

the reason for the change and its impact on the DCM, including its

governance and operations, and its impact on the rights and obligations

of market participants holding the open positions; (3) a discussion of

the transferee's ability to comply with the CEA, including the core

principles applicable to DCMs, and the Commission's regulations

thereunder; (4) the governing documents of the transferee, including

but not limited to, articles of incorporation, bylaws, operating

agreements and/or partnership agreements, as applicable; (5) the

transferee's rules marked to show changes from the current rules of the

DCM; and (6) a list of contracts, agreements, transactions or swaps for

which the DCM requests transfer of open interest.

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\27\ The proposed rule would require that where a DCM does not

know or could not have reasonably known three months prior to the

anticipated change, it shall be required to file the request as soon

as it knows of the change.

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Proposed Sec. 38.3(d) also would require, as a condition of

approval, that the DCM submit a representation that it is in compliance

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

regulations. In addition, the DCM would have to submit various

representations by the transferee, including but not limited to: (1)

That the transferee will assume responsibility for complying with all

applicable provisions of the CEA and the Commission's regulations

promulgated thereunder, including part 38 and Appendices thereto; (2)

that the transferee will assume, maintain and enforce all rules

implementing and complying with these core principles, including the

adoption of the transferor's rulebook; (3) upon the transfer, all open

interest in all contracts listed on the transferor will be transferred

to and represent equivalent open interest in all such contracts listed

on the transferee, (4) that none of the proposed rule changes will

affect the rights and obligations of any participant with open

positions transferred to it; and (5) it will notify market participants

of any changes to the rulebook and of the transfer.

Proposed Sec. 38.3(d) also provides that the Commission will

review any requests for transfer of designation and open interest as

soon as practicable, and such request will be approved or denied

pursuant to a Commission order.

Proposed Sec. 38.3(g) \28\ is a new rule that is intended to

ensure that all DCMs designated before the effective date of the rules

proposed in this part 38 are in compliance with both the five new core

principles and the revised core principles. As noted above, the Dodd-

Frank Act significantly changes some of the compliance obligations of

DCMs under current Section 5 of the CEA by amending the majority of the

existing core principles and adding five new core principles.\29\ All

DCMs, including existing DCMs, must comply with the requirements of

Section 5 of the CEA, as amended, as well as the applicable

requirements under the Commission's regulations, including this

release, upon their effective date. Accordingly, in proposed Sec.

38.3(g), the Commission would require that each existing DCM provide

the Commission with a signed certification of its compliance with each

of the 23 core principles and the Commission's regulations under part

38 as amended in this release, within 60 days of the effective date of

the publication of the final rules proposed in this release. The

failure of any existing DCM to provide such certification shall be

grounds for revocation of the DCM's designation status. While the

Commission believes that 60 days is a sufficient period of time for

DCMs to have rules and procedures in place to ensure compliance with

the core principles and the rules proposed in this release, the

Commission requests comments on whether the 60 day period is

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

why.

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\28\ In addition, proposed Sec. Sec. 38.3(e) and 38.3(f)

restate existing requirements with certain non-substantive,

clarifying changes.

\29\ Compare 7 U.S.C. 7(d) with section 5(d) of the CEA, as

amended by the Dodd-Frank Act.

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

Implementing Designated Contract Market Rules

The proposed amendments to Sec. 38.4 are largely intended to

conform this rule to the proposed changes to existing Sec. Sec. 40.3

(Voluntary submission of new products for Commission review and

approval) and 40.5(b) (Voluntary submission of rules for Commission

review and approval).\30\ The proposed amendments to those rules are

made in the separate release pertaining to ``Provisions Common to

Registered Entities.'' \31\

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\30\ Proposed Sec. 40.3 is amended to require additional

information to be provided by registered entities submitting new

products for the Commission's review and approval. Proposed Sec.

40.5(b) codifies a new standard for the review of new rules or rule

amendments as established under the Dodd-Frank Act.

\31\ 75 FR 67482, Nov. 2, 2010.

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

Compliance

On occasion, DCMs enter into equity interest transfers that result

in a change in ownership. In those situations, Commission staff must

determine whether the change in ownership will impact adversely the

operations of the DCM or the DCM's ability to comply with the core

principles and the Commission's regulations. The Commission is

proposing to amend Sec. 38.5 to ensure that DCMs remain mindful of

their self-regulatory responsibilities when negotiating the terms of

significant equity interest transfers, and to improve the Commission

staff's ability to undertake a timely and effective due diligence

review of the impact, if any, of such transfers.

In this regard, proposed Sec. 38.5(c) would require DCMs to file

with the Commission a notice of the equity interest transfer of ten

percent or more, no later than the business day, as defined in Sec.

40.1, following the date on which the DCM enters into a firm obligation

to transfer the equity interest.\32\ The notification must include and

be accompanied by: (i) Any relevant agreement(s), including preliminary

agreements; (ii) any associated changes to relevant corporate

documents; (iii) a chart outlining any new ownership or corporate or

organizational structure;

[[Page 80577]]

(iv) a brief description of the purpose and any impact of the equity

interest transfer; and (v) a representation from the DCM that it meets

all of the requirements of Section 5(d) of the Act and Commission

regulations adopted thereunder. The proposed rule requires that the DCM

keep the Commission apprised of the projected date that the transaction

resulting in the equity interest transfer will be consummated, and must

provide to the Commission any new agreements or modifications to the

original agreement(s) filed pursuant to Sec. 38.5(c). The DCM must

notify the Commission of the consummation of the transaction on the day

in which it occurs. The proposed rule will enable staff to consider

whether any conditions contained in an equity transfer agreement(s) are

inconsistent with the self-regulatory responsibilities of a DCM or with

any of the core principles.\33\

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\32\ The Commission is proposing a 10 percent threshold because

it believes that a change in ownership of such magnitude may have an

impact on the operations of the DCM. The Commission believes that

such impact may be present even if the change in ownership does not

constitute a change in control. For example, if one entity holds a

minority 10 percent equity share in the DCM, it may have a more

significant voice in the operation of the DCM than five entities

each with a minority 2 percent equity share. Given the potential

impact that a change in ownership might have on the operations of a

DCM, the Commission believes that it is appropriate to require such

DCM to certify after such change that it continues to comply with

all obligations under the CEA and Commission regulations.

\33\ The Commission also maintains the existing provisions of

Sec. 38.5 that allow the Commission at any time to request a DCM to

file a written demonstration with the Commission that it is in

compliance with one or more of the core principles.

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Section 38.5(d) currently requires that upon a change in ownership,

an acquirer of an existing DCM must certify that the exchange meets all

of the requirements of the current Sections 5(b) and 5(d) of the Act,

and the provisions of part 38 of the Commission's regulations. The

Commission believes when there is a 10% or greater change in ownership,

the DCM itself is the more appropriate entity to provide a

certification of its continued compliance with all regulatory

obligations. Accordingly, proposed Sec. 38.5(c)(3) \34\ would require

that if there is a change in ownership \35\ the DCM must certify, no

later than two business days following the date on which the change in

ownership occurs, that the DCM meets all of the requirements of Section

5(d) of the CEA, as amended by the Dodd-Frank Act, and the provisions

of part 38 of the Commission's regulations. The proposed rule also

requires that the DCM include as part of its certification whether any

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

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

changes. Finally, proposed Sec. 38.5(c) provides that the

certification may rely on, and be supported by, prior materials and

information submitted as part of an application for designation or a

required product or rule filing or new filings if necessary to update

its previous filings.

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\34\ The Commission is proposing to redesignate Sec. 38.5(d) as

Sec. 38.5(c).

\35\ The Commission's regulations consistently identify a

financial or ownership interest of ten percent or more as material

and indicative of the ability to influence the activities of an

entity or trading in an account. See, e.g., Core Principle 5,

Acceptable Practices, and Core Principle 14, Application Guidance,

in appendix B to part 38 of the Commission's regulations. 17 CFR

part 38, appendix B.

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6. Proposed Sec. 38.7 \36\--Prohibited Use of Data Collected for

Regulatory Purposes

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\36\ Current Sec. 38.6 (Enforceability) remains unchanged.

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To fulfill their regulatory and compliance obligations, DCMs often

require market participants to provide proprietary data or personal

information. Proposed Sec. 38.7 would prohibit DCMs from using such

information for business or marketing purposes.\37\ The Commission

notes that nothing in this provision should be viewed as prohibiting a

DCM from sharing such information with another DCM or SEF for

regulatory purposes, where necessary.

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\37\ The Commission notes that in the recent notice of proposed

rulemaking for Business Affiliate Marketing and Disposal of Consumer

Information Rules, 75 FR 66018-01, Oct. 27, 2010 (to be codified at

17 CFR part 163) rules are proposed prohibiting FCMs (and other

intermediaries) from using certain consumer information received

from an affiliate to make a solicitation for marketing purposes. In

addition, rules were proposed requiring FCMs to develop a written

disposal program to the extent that such FCMs possess consumer

information. The underlying policy for these rules is to protect the

privacy of customer information. Similarly, this proposed rule is

intended to protect market participant's information provided to a

DCM for regulatory purposes from its use to advance the commercial

interests of the DCM.

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

Market

The Dodd-Frank Act permits existing DCMs to list, trade and execute

swaps, provided that the DCMs do so in a manner that complies with the

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

as amended. Proposed Sec. 38.8(a) requires a DCM to notify the

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

manner in which it will fulfill each of the requirements under amended

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

reporting of swap transactions.

Proposed Sec. 38.8(b) requires a DCM to request and obtain from

the Commission a unique, extensible, alphanumeric code for the purpose

of identifying the DCM before it lists swaps. A DCM will do so pursuant

to the swap recordkeeping and reporting requirements under proposed

part 45 of the Commission's regulations. This requirement stems from

the Commission's authority, under Section 728 of the Dodd-Frank Act, to

establish standards and requirements related to reporting and

recordkeeping for swaps.\38\ In particular, the Commission is required

to adopt consistent data element standards for ``registered entities,''

which includes DCMs. part 45, which is being proposed in the separate

Commission release ``Data Recordkeeping and Reporting Requirements,''

will set forth the recordkeeping and reporting requirements for DCMs

with respect to swaps.\39\ Proposed Sec. 38.8(b) codifies the

obligations of DCMs to comply with the provisions of proposed part 45.

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\38\ See Section 21 of the CEA, as amended by the Dodd-Frank

Act.

\39\ See ``Swap Data Recordkeeping and Reporting Requirements,''

Proposed Rule, 75 FR 76574 (Dec. 8, 2010).

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

Contract Market and a Swap Execution Facility

As noted above, the Dodd-Frank Act created a new regulated entity,

the SEF, for the listing, trading and processing of swaps. The

registration and compliance requirements for SEFs will be proposed in

redesignated part 37, in a forthcoming release.\40\ Under the Dodd-

Frank Act, a DCM may list and trade swaps pursuant to its designation

as a contract market. In addition, a board of trade that operates a DCM

also may operate a SEF, provided that the board of trade separately

registers as a SEF and complies with the applicable SEF core principles

and any Commission regulations thereunder. Proposed Sec. 38.9 codifies

the requirement that a board of trade that operates a DCM and that

intends to operate a SEF must separately register pursuant to the SEF

registration requirements and, on an ongoing basis, must separately

comply with the SEF rules and core principles under Section 5h of the

CEA, as amended by the Dodd-Frank Act, and part 37 of the Commission's

regulations.

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\40\ See CFTC Web site for additional information on the ``SEF

Registration Requirements and Core Principle Rulemaking,

Interpretation & Guidance,'' at http://www.cftc.gov/LawRegulation/

DoddFrankAct/Rulemakings/DF_13_SEFRules/index.htm (last visited

Dec. 14, 2010).

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Moreover, section 5h(c) of the CEA, as amended by the Dodd-Frank

Act, provides that any board of trade that is a DCM and intends to

operate as an independent SEF may use the same electronic trade

execution system for listing and executing swaps, provided that the

board of trade makes it clear to market participants whether the

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

or the SEF.\41\ Proposed Sec. 38.9(b) codifies this statutory

requirement.

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\41\ Section 5h(c) of the CEA, as amended by the Dodd-Frank Act,

provides:

IDENTIFICATION OF FACILITY USED TO TRADE SWAPS BY CONTRACT

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

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

facility and uses the same electronic trade execution system for

listing and executing trades of swaps on or through the contract

market and the swap execution facility, identify whether the

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

contract market or the swap execution facility.

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[[Page 80578]]

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

Contract Market

Section 727 of the Dodd-Frank Act directs the Commission to adopt

rules providing for the public availability of swap transaction and

pricing data in real-time.\42\ To the extent that they make swaps

available for trading and execution either on a SEF or a DCM, DCMs will

have real-time public reporting obligations pursuant to the Dodd-Frank

Act and, therefore, must comply with the applicable provisions

governing real time reporting. The Commission is proposing regulations

applicable to the real time swap reporting obligations of certain

entities under a separate release.\43\ The real time reporting

regulations are proposed to be codified under part 43 of the

Commission's regulations. In addition to the real time reporting

obligations, the proposed rule also requires DCMs to comply with the

swap reporting and recordkeeping requirements that are being proposed

by the Commission in a separate release, and are proposed to be

codified under part 45 of the Commission's regulations. Accordingly,

proposed Sec. 38.10 would codify the compliance obligations of DCMs

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

recordkeeping and reporting obligations, as may be required under

proposed parts 43 and 45 of the Commission's regulations, respectively.

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\42\ See Sections 2(a)(13)-(14) of the CEA, as amended by the

Dodd-Frank Act.

\43\ See ``Real Time Public Reporting of Swap Transaction

Data,'' Proposed Rule, 75 FR 76140 (Dec. 7, 2010).

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D. Proposed New Regulations and Revised Guidance and Acceptable

Practices For Compliance With the Core Principles

As noted above, this release proposes to reorganize part 38 to

include subparts A through X. As proposed, each of subparts B through X

will include relevant regulations applicable to the 23 core principles.

In addition to the proposed new regulations, the Commission proposes to

codify within each subpart the statutory language of the respective

core principle.\44\

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\44\ In two instances, the language of the core principle, as

codified, was slightly revised to add references to the CEA where

the statutory language simply cited to the CEA section without

citing to the statute. These non-substantive edits were made to

Sec. Sec. 38.100 and 38.1200.

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1. Subpart B--Designation as Contract Market

The Dodd-Frank Act amends Core Principle 1 to make clear that

compliance with the core principles, and any other rule or regulation

that the Commission may impose under Section 8a(5) of the CEA, is a

necessary condition to obtain and maintain designation as a contract

market.\45\ Amended Core Principle 1 provides that unless otherwise

determined by the Commission by rule or regulation, DCMs will continue

to have reasonable discretion in establishing the manner in which they

comply with the core principles. The Commission proposes to codify the

statutory text of Core Principle 1 in proposed Sec. 38.100.

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\45\ 7 U.S.C. 7; see also Section 5(d)(1) of the CEA, as amended

by the Dodd-Frank Act.

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2. Subpart C--Compliance With Rules

Core Principle 2, as amended by the Dodd-Frank Act, requires that a

DCM establish, monitor, and enforce its rules, including rules relating

to access requirements, rules regarding the terms and conditions of any

contract to be traded on the contract market, and rules prohibiting

abusive trading practices. A DCM also must have the capacity to detect

and investigate potential rule violations, and to sanction any person

that violates its rules.\46\ In addition, a DCM's rules must provide it

with the ability and authority to perform the obligations and

responsibilities required under Core Principle 2, including the

capacity to carry-out such international information sharing agreements

that the Commission may require. Proposed Sec. 38.150 implements these

requirements.

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\46\ As noted above, Section 735 of the Dodd-Frank Act amends

Section 5 of the CEA to eliminate DCM designation criteria and

amends several core principles, including Core Principle 2. Core

Principle 2 was amended to include language formerly found in

Designation Criterion 8--Ability to Obtain Information, and to

specifically require that a DCM have the ability to detect,

investigate, and sanction rule violations.

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For the most part, the Commission is codifying: (1) Language found

in the guidance and acceptable practices for Core Principle 2 and

former designation criterion 8; (2) existing DCM compliance practices

that the Commission believes constitute best practices; and (3)

recommendations made over the past several years by the Commission in

rule enforcement reviews.\47\ In addition, the Commission is proposing

some practices and requirements that are new for DCMs. The Commission

also looked to and incorporated into the proposed rules for Core

Principle 2 certain concepts that are currently contained in part 8 of

its regulations-- Exchange Procedures for Disciplinary, Summary, and

Membership Denial Actions. In this regard, the Commission notes that

most DCMs' compliance and enforcement practices relating to Core

Principle 2 obligations historically have been consistent with the

rules contained in part 8.\48\ Each of the proposed rules under subpart

C is discussed below.

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\47\ Commission staff conducts periodic RERs of all DCMs. RERs

examine DCM compliance with specific core principles over a one-year

target period. Commission staff's analyses, conclusions and

recommendations regarding any identified deficiencies are included

in a publicly available written report.

\48\ Section 38.2 of the Commission's regulations exempts DCMs

from all Commission rules not specifically reserved. The part 8

rules were not reserved.

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i. Proposed Sec. 38.151--Access Requirements

Proposed Sec. 38.151 is an example of a rule in which the

Commission proposes a new requirement for DCMs.\49\ Proposed Sec.

38.151(a) requires that prior to granting a member or market

participant access to its markets, the DCM must require the member or

market participant to consent to its jurisdiction. The growth of

electronic trading in the futures industry and the transformation of

futures exchanges from traditional membership organizations to

demutualized for-profit entities has changed how individuals and firms

access the markets and execute trades. When open outcry dominated

trading, orders were typically called in to a desk on the trading floor

and members on the floor executed trades. Today, on most DCMs, one does

not need to be a ``member'' to enter an order on an electronic trading

system. Rather, clearing members can provide their customers with

access to a DCM's electronic trading system and customers can enter

their own orders. Depending on the type of access granted by the

clearing member, the customer's order either will go through the

clearing member's system for risk management before hitting the DCM's

electronic trading system or directly go into the DCM's trading system.

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\49\ Generally, Sec. 38.151 is being proposed pursuant to the

Commission's general rulemaking authority under Section 8a(5) of the

CEA (providing the authority to ``promulgate such rules * * *

reasonably necessary * * * to accomplish any of the purposes of''

the CEA), and Section 3 of the CEA (providing that the purposes of

the Act include the promotion of ``fair competition among boards of

trade, other markets and market participants''). 7 U.S.C. 5, 12a(5).

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DCMs generally require through rule and/or clearing firm connection

[[Page 80579]]

agreements that prior to a clearing member granting a customer access

to the DCM's electronic trading system, the clearing member secure its

customer's agreement to abide by, and be subject to, the DCM's rules.

Nevertheless, DCMs do not view themselves as having the jurisdiction

needed to compel these market participants to participate in the

investigation and disciplinary process. Although DCMs have the option

of requiring a clearing firm to bar a customer from accessing the DCM

if the DCM believes that the customer committed a rule violation, most

DCMs will first request that the customer submit to its jurisdiction

and participate in the investigation and disciplinary process before

exercising this option.

Trading on a DCM is a privilege that is subject to conditions and

entails certain responsibilities. The Commission believes that if a

participant is granted the privilege of trading on a DCM, the

participant should not only be required to abide by the DCM's rules,

but the participant also must consent to the DCM's jurisdiction and

participate in both the investigatory and disciplinary process. The

Commission recognizes that this requirement will require clearing firms

to amend their existing customer agreements to secure customers'

agreements to submit to a DCM's jurisdiction. Accordingly, although

DCMs would be required to implement proposed Sec. 38.151(a) either by

rule and/or modification of connection agreements by the effective date

of the final rule, the proposed rule permits DCMs to allow their

clearing firms up to 180 days to secure the necessary modifications to

existing customer agreements.

Proposed Sec. 38.151(b) requires that a DCM provide its members,

market participants and ISVs with impartial access to its markets and

services. This includes: 1) access criteria that are impartial,

transparent, and applied in a non-discriminatory manner, and 2)

comparable fee structures for members, market participants and

independent software vendors (``ISV''),\50\ receiving equal access to,

or services from the DCM. The purpose of the proposed impartial access

requirements is to prevent DCMs from using discriminatory access

requirements as a competitive tool against certain participants. Access

to a DCM should be based on the financial and operational soundness of

a participant, rather than discriminatory or other improper

motives.\51\ Any participant should be able to demonstrate financial

soundness either by showing that it is a clearing member of a DCO that

clears products traded on that DCM or by showing that it has clearing

arrangements in place with such a clearing member. Furthermore,

granting impartial access to participants that satisfy a DCM's access

requirements may enhance the DCM's liquidity and the overall

transparency of the swaps and futures markets.

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\50\ The Commission notes that examples of independent software

vendors include: smart order routers, trading software companies

that develop front-end trading applications, and aggregators of

transaction data. Smart order routing generally involves scanning of

the market for the best-displayed price and then routing orders to

that market for execution. Software that serves as a front-end

trading application is typically used by traders to input orders,

monitor quotations and view a record of the transactions completed

during a trading session. Aggregators of transaction data provide

access to news, analytics and execution services. The Commission

believes that transparency and trading efficiency would be enhanced

as a result of innovations in this field for market services. For

instance, certain providers of market services with access to

multiple trading systems or platforms could provide consolidated

transaction data from such trading systems or platforms to market

participants.

\51\ The Commission believes that the requirement to provide

impartial access requires DCMs to avoid the creation of exclusive

membership standards that focus on high net worth. Therefore, any

participant should be able to demonstrate financial soundness either

by showing that it is a clearing member of a DCO that clears

products traded on that DCM or by showing that it has clearing

arrangements in place with such a clearing member.

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A DCM can satisfy the requirement that membership and participation

criteria are impartial, transparent, and non-discriminatory by

establishing clear and impartial guidelines and procedures for granting

access to its facilities and publishing such guidelines and procedures

on its Web site. Such requirements may establish different categories

of market participants, but may not discriminate within a particular

category. Fee structures may differ among categories if such fee

structures are reasonably related to the cost of providing access or

services to a particular category. For example, if a certain category

requires greater information technology or administrative expenses on

the part of the DCM, then a DCM may recoup those costs in establishing

fees for that category of member or market participant.

Proposed Sec. 38.151(c) (Limitations on Access) requires a DCM to

establish and impartially enforce rules governing any decision by the

DCM to deny, suspend, or permanently bar a member's or market

participant's access to the contract market. While paragraph (b) of

proposed Sec. 38.151 requires impartiality in a DCM's decision to

grant access, paragraph (c) addresses the converse situation where a

DCM wishes to deny access, or to revoke the access of members or market

participants who already possess it. Proposed Sec. 38.151(c) gives

specific examples of when such situations might arise, including DCM

disciplinary proceedings or emergency actions. As with decisions to

grant access, any decision by a DCM to deny, suspend, or permanently

bar a member's or market participant's access to the DCM must be

impartial and applied in a non-discriminatory manner.

ii. Proposed Sec. 38.152--Abusive Trading Practices Prohibited

Proposed Sec. 38.152 requires that a DCM prohibit enumerated

abusive trading practices. The listed practices are a compilation of

abusive trading practices that DCMs already prohibit. A DCM permitting

intermediation must prohibit specific trading practices, including

trading ahead of customer orders, trading against customer orders,

accommodation trading, and improper cross-trading. Specific trading

practices that must be prohibited by all DCMs include front-running,

wash trading, pre-arranged trading, fraudulent trading, money passes

and any other trading practices that the DCM deems to be abusive. In

addition, a DCM also must prohibit any other manipulative or disruptive

trading practices prohibited by the CEA or by the Commission pursuant

to Commission regulation.\52\

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\52\ Section 747 of the Dodd-Frank Act amends Section 4c(a) of

the CEA by adding three disruptive practices which make it: unlawful

for any person to engage in any trading, practice, or conduct on or

subject to the rules of a registered entity that-

(A) Violates bids or offers;

(B) Demonstrates intentional or reckless disregard for the

orderly execution of transactions during the closing period; or

(C) Is, is of the character of, or is commonly known to the

trade as, `spoofing' (bidding or offering with the intent to cancel

the bid or offer before execution).

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iii. Proposed Sec. 38.153--Capacity To Detect and Investigate Rule

Violations

Proposed Sec. 38.153 is based on the current application guidance

for Core Principle 2.\53\ The proposed rule requires that a DCM have

arrangements and resources for effective rule enforcement. This

includes the authority to collect information and examine books and

records of members and market participants.\54\ By its terms, Core

Principle 2 requires a DCM to have, in addition to appropriate

resources for trade practice surveillance

[[Page 80580]]

programs, appropriate resources to enforce all of its rules.

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\53\ 17 CFR part 38, App. B, Core Principle 2, Application

Guidance at ] 1.

\54\ The language in the current application guidance requires

that a DCM ``have arrangements and resources for effective trade

practice surveillance programs[.]'' Id.

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The proposed rule also requires a DCM to have the authority to

examine books and records for all market participants rather than

limiting that authority to ``non-intermediated market participants'' as

such authority was limited in the former application guidance. A DCM

can best administer its compliance and rule enforcement obligations if

it has the ability to reach the books and records of all market

participants, rather than a subset of market participants.

iv. Proposed Sec. 38.154--Regulatory Services Provided by a Third

Party

The CEA provides that a DCM may comply with applicable core

principles by delegating relevant functions to a registered futures

association or another registered entity.\55\ The Commission also has

described acceptable ``contracting'' arrangements for the performance

of core principle functions by third-parties.\56\ In this context, the

term ``contracting'' implies a lesser transference of authority to the

third-party than does ``delegating.'' In all cases, however, the

Commission has specified, as required under the CEA,\57\ that DCMs

remain responsible for carrying out any function delegated or

contracted to a third party and that DCMs must ensure that the services

received will enable them to remain in compliance with the CEA's

requirements.

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\55\ 7 U.S.C. 7a-2(b); see also, section 5c(b)(1) of the CEA, as

amended by the Dodd-Frank Act.

\56\ See 66 FR 42256, 42266, Aug. 10, 2001.

\57\ See 7 U.S.C. 7a-2(b)(2); see also, Section 5c(b)(2) of the

CEA, as amended by the Dodd-Frank Act.

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In recent years, the Commission has gained much experience in

administering the delegation and contracting regime for regulatory

services. Many DCMs, especially those that were designated after

passage of the CFMA, employ third-party regulatory service providers to

meet one or more core principle obligations. In administering this

regime, the Commission has found that DCM applicants have questions as

to the manner and degree to which their staffs must remain involved in

regulatory decisions when they utilize third-party providers.

Accordingly, the Commission is proposing new Sec. 38.154 to supplement

its previous guidance on delegation and contracting arrangements to

clarify its expectations in this regard. The proposed rule is equally

applicable to delegations and contracting, and to arrangements DCMs

have with regulatory service providers that are registered futures

associations or other registered entities. For purposes of proposed

Sec. 38.154, the applicable self-regulatory functions include: trade

practice surveillance; market surveillance; real-time market

monitoring; investigations of possible rule violations; and

disciplinary actions.

The proposed rule requires that DCMs utilizing third-party

regulatory service providers must ensure that their providers have

sufficient capacity and resources to render timely and effective

regulatory services. The DCM also must oversee the quality of the

contracted regulatory services and must retain exclusive authority with

respect to certain regulatory decisions. These regulatory decisions

include cancellation of trades, the issuance of disciplinary charges

against members or market participants, and denials of access to the

trading platform for disciplinary reasons. Conversely, the proposed

rule also specifies that a decision to open an investigation of a

possible rule violation must be made solely by a regulatory service

provider, and all instances where a DCM's actions differ from those

recommended by its regulatory provider must be documented and explained

in writing.

v. Proposed Sec. 38.155--Compliance Staff and Resources

As noted above, Core Principle 2 requires that a DCM enforce

compliance with its rules and have the capacity to detect, investigate,

and sanction violations. Having adequate staff to perform a DCM's

compliance and enforcement responsibilities is essential to the

effectiveness of its self-regulatory programs, including market

surveillance, audit trail, trade practice surveillance, and

disciplinary programs.

A DCM's ability to enforce speculative limits, monitor for

manipulation, complete timely investigations, conduct annual open

outcry and electronic audit trail reviews, as well as perform other

regulatory duties, is compromised if a DCM does not have sufficient

staff. Thus, examining the size and experience of a DCM's compliance

staff is a critical component of RERs carried out by Commission staff.

In several RERs, staff has recommended, and the Commission has

accepted, findings that DCMs: (1) increase their compliance staff

levels, and (2) monitor the size of their staffs and increase the

number of staff appropriately as trading volume increases, new

responsibilities are assigned to compliance staff, or internal reviews

demonstrate that work is not completed in an effective or timely

manner.\58\

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\58\ See Rule Enforcement Review of the Minneapolis Grain

Exchange (Aug. 27, 2009); Rule Enforcement Review of ICE Futures

U.S. (Feb. 2, 2010); and Rule Enforcement Review of the Chicago

Board of Trade and the Chicago Mercantile Exchange (Sep. 13, 2010).

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Those recommendations have formed the basis for proposed Sec.

38.155. The proposed rule requires that a DCM maintain sufficient

compliance resources to conduct effective audit trail reviews, trade

practice surveillance, market surveillance, and real-time monitoring.

It also requires that a DCM monitor its staff size annually to ensure

that it is appropriate to effectively perform those functions. Staff

size also must be sufficient to address market or trading events and to

complete investigations in a timely manner.

The Commission is not proposing that staff size be determined based

on a specific formula. Rather, the Commission proposes to leave to the

discretion of each individual DCM to determine the size of the staff it

needs to effectively perform its self-regulatory responsibilities. In

making this determination, the proposed rule requires that a DCM take

into account specific facts and circumstances (e.g., volume, the number

of new contracts, etc.), as well as any other factors suggesting the

need for increased resources. Factors that may suggest the need for

increased compliance resources are a prolonged surge in trading volume

or a prolonged period of price volatility. A DCM must have sufficient

staff to address unusual or unanticipated events while continuing to

effectively conduct its routine self-regulatory duties.

vi. Proposed Sec. 38.156--Automated Trade Surveillance System

All currently active DCMs, or their third-party service providers,

maintain automated surveillance systems to conduct trade practice

surveillance. These systems vary in degree of sophistication, but

typically generate alerts on a trade date plus one day (T+1) basis to

help staff focus on potential violations and anomalies found in trade

data.\59\ They also provide a DCM's compliance staff the ability to

sort and query voluminous amounts of data. In performing their

surveillance responsibilities, DCMs engage in various analyses to

profile trading activity and conduct investigations to detect and

prosecute possible trading abuses. These functions all require the

collection of order and trade data and the ability to

[[Page 80581]]

process that data in various ways for analysis.

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\59\ These systems typically differ from those systems used for

real-time market monitoring. The requirements for real-time market

monitoring can be found in proposed Sec. 38.157.

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Proposed Sec. 38.156 reflects the substantial growth in U.S.

futures trading volume since the CFMA was adopted in 2000. The

approximate trading volume for U.S. futures exchanges (including

futures and options on futures) was 596 million contracts in 2000, 2

billion contracts in 2005, and 3.2 billion contracts in 2010. In view

of this growth in volume, combined with new participants in the

markets, such as high frequency traders, it is critical that DCMs have

automated tools that, at a minimum, have the capability to generate

alerts, profile trading activity, and sort and query data to conduct

trade practice surveillance. The Commission has found, in performing

its oversight responsibility of monitoring the markets to ensure market

integrity and customer protection, that effectively monitoring this

large amount of volume requires automated tools.\60\ A DCM's automated

surveillance system must have specific characteristics for it to be

able to detect and prosecute the abusive trading practices enumerated

in proposed Sec. 38.152. A DCM's automated surveillance system must

maintain all trade and order data, including order modifications and

cancellations. The system must process this data on a T+1 basis. In

addition, a DCM's automated trade surveillance system must provide

users with the ability to compute, retain and compare trading

statistics; compute profit and loss; and reconstruct the sequence of

trading activity.

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\60\ In this regard, the Commission is in the midst of modifying

its own automated surveillance systems for both trade practice

surveillance and market surveillance.

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vii. Proposed Sec. 38.157--Real-time Market Monitoring

Proposed Sec. 38.157 codifies existing practices at DCMs for real-

time monitoring of electronic trading. The practices codified in

proposed Sec. 38.157 reflect the growth of electronic trading in the

U.S. futures markets, as well as the Commission's experience in

designating new contract markets since passage of the CFMA. All DCMs

that were designated post-CFMA trade exclusively on electronic trading

platforms.

The purpose of real-time monitoring of electronic trading is to

ensure orderly trading and to identify and correct any market or system

anomalies promptly. The proposed rule requires that any DCM price

adjustment or trade cancellation process be clear and transparent to

the market and subject to clear, fair and publicly-available standards.

viii. Proposed Sec. 38.158--Investigations and Investigation Reports

Proposed Sec. 38.158 is largely a compilation of requirements

found in Sec. Sec. 8.06 and 8.07 of the Commission's regulations, with

some modifications. Paragraph (a) of the proposed rule requires that a

DCM have procedures to conduct investigations of possible rule

violations. Paragraph (b) requires that an investigation be completed

within a timely manner. A timely manner is defined to be 12 months

after an investigation is opened, absent mitigating circumstances. This

differs from Sec. 8.06(b) of the Commission's regulations, which

provides that an investigation be ``completed within four months,

unless significant reasons exist to extend it beyond such period.'' In

its experience in conducting RERs, the Commission has found that while

simple, straight-forward investigations typically are completed in less

than four months, many DCM investigations involve fact patterns

requiring more in-depth and sophisticated analysis. Depending on the

complexity of a matter, an investigation frequently may take between

four and 12 months to complete.

While it is not typical for an investigation to take longer than

one year to complete, certain circumstances may justify an

investigation taking longer than one year. These include the complexity

of the investigation, the number of firms or individuals involved, the

number of potential violations, the amount of trade data requiring

analysis and, in some instances, the amount of video recordings to be

reviewed and analyzed.\61\

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\61\ See Rule Enforcement Review of ICE Futures U.S. (Feb. 2,

2010), and Rule Enforcement Review of the Chicago Board of Trade and

the Chicago Mercantile Exchange (Sep. 13, 2010). Some exchanges,

such as CBOT and CME, have video cameras on their open outcry

trading floors.

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Paragraphs (c) and (d) of proposed Sec. 38.158 set forth the

elements and information that must be included in an investigation

report when there is or there is not a reasonable basis for finding a

rule violation. While the proposed language is similar to Sec. Sec.

8.07(a) and (b) of the Commission's regulations, there are two notable

differences.

First, proposed Sec. 38.158(c) requires that when DCM compliance

staff believes there is a reasonable basis for finding a violation, the

investigation report must include the potential wrongdoer's

disciplinary history. Second, proposed Sec. 38.158(d) requires that if

a DCM's compliance staff recommends that a warning letter be issued,

the investigation report must also include the potential wrongdoer's

disciplinary history.\62\ Requiring disclosure of a member's or market

participant's prior disciplinary history in the above-described

circumstances is consistent with recommendations made in RERs.\63\ The

Commission believes that prior disciplinary history is critical

information that a disciplinary committee should consider when either

issuing a warning letter or assessing an appropriate penalty as part of

any settlement decision or hearing.\64\ In practice, when a DCM's

compliance department believes there is a reasonable basis to find a

violation, the investigation report is forwarded to a disciplinary

committee for action. Therefore, the Commission believes that the

investigation report is the most logical place to include disciplinary

history.

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\62\ In some instances, even though there is not sufficient

evidence to recommend disciplinary action, a DCM's compliance staff

may believe that a rule violation occurred.

\63\ See 2000 Rule Enforcement Review of the New York Mercantile

Exchange.

\64\ As noted below in the discussion of proposed Sec.

38.158(c), a DCM's disciplinary committee should review a member's

complete disciplinary history when determining appropriate sanctions

and impose meaningful sanctions on members who repeatedly violate

the same or similar rules to discourage recidivist activity.

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Proposed Sec. 38.158(e) provides that a DCM may authorize its

compliance staff to issue a warning letter or to recommend that a

disciplinary committee issue a warning letter. The proposed rule is

substantively identical to Commission Sec. 8.07(c), except that it

prohibits a DCM from issuing more than one warning letter for the same

violation during a rolling 12-month period. Currently, many DCMs use

summary fine programs to enforce their audit trail rules. Typically,

such programs allow compliance staff to issue summary fines for trade

timing, order ticket and trading card violations. Such summary fine

schemes generally start with a warning letter for the first offense.

While a warning letter may be appropriate for a first-time violation,

the Commission does not believe that more than one warning letter in a

rolling 12-month period for the same or similar violation is ever

appropriate. A policy of issuing repeated warning letters, rather than

issuing meaningful sanctions, to members and market participants who

repeatedly violate the same or similar rules denigrates the

effectiveness of a

[[Page 80582]]

DCM's rule enforcement program.\65\ The proposed rule is consistent

with what Commission staff has advised DCM applicants and

recommendations made in RERs.\66\

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\65\ For purposes of this rule, the Commission does not consider

a ``reminder letter'' or such other similar letter to be any

different than a warning letter.

\66\ See 1998 Rule Enforcement Review of Kansas City Board of

Trade; and, Rule Enforcement Review of the Minneapolis Grain

Exchange (Aug. 27, 2009).

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ix. Proposed Sec. 38.159--Ability To Obtain Information

Proposed Sec. 38.159 expands on the Core Principle 2 requirement

that a DCM have the ability and authority to obtain necessary

information to perform its rule enforcement obligations, including the

capacity to carry out any international information sharing agreements

required by the Commission. The proposed rule provides that information

sharing agreements can be established with other DCMs or SEFs, or that

the Commission can act in conjunction with a DCM to carry out such

information sharing. This language is virtually identical to the

language found in the guidance for former Designation Criterion 8.\67\

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\67\ 17 CFR Part 38, App. A, Designation Criterion 8, Guidance.

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x. Proposed Sec. 38.160--Additional Rules Required

Proposed Sec. 38.160 requires a DCM to adopt and enforce any

additional rules that it believes are necessary to comply with the

requirements of this subpart C.

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

The Dodd-Frank Act did not make any amendments to current Core

Principle 3--Contracts Not Readily Subject to Manipulation.

Historically, DCMs complied with the requirements of Core Principle 3

by using as guidance the provisions of Guideline No. 1, contained in

Appendix A to part 40. The Commission proposes certain revisions to the

former Guideline No. 1, including: (1) Amending the provision to

include swap transactions, (2) re-titling the guidance as

``Demonstration of compliance that a contract is not readily

susceptible to manipulation,'' and (3) redesignating the provision as

Appendix C of part 38. Proposed Sec. 38.201 refers applicants and DCMs

to the guidance in Appendix C to part 38 for purposes of demonstrating

to the Commission their compliance with the requirements of Sec.

38.200. Proposed guidance under Appendix C to part 38 would replace

Guideline No. 1 under Appendix A to part 40.

The amended guidance provides greater detail to DCMs regarding the

relevant considerations in demonstrating compliance with Core Principle

3 when designing a contract and submitting supporting documentation and

data to the Commission at the time the DCM submits: (1) The terms and

conditions of a new contract under Sec. Sec. 40.2 or 40.3, or (2)

amendments to terms and conditions under Sec. Sec. 40.5 or 40.6.

In general, the guidance provides that the settlement or delivery

procedures adopted by a DCM for a futures contract should reflect the

underlying cash market. The objective is to ensure that a given futures

contract is not readily susceptible to manipulation and that it will

provide a reliable pricing basis and promote cash/futures price

convergence. Accordingly, the terms and conditions should conform to

prevailing commercial practices and provide for adequate deliverable

supply.

For cash-settled contracts, the cash-settlement procedure should be

based on a reliable price reference series that accurately reflects the

underlying market value, is not readily susceptible to manipulation,

and is commonly used by industry/market participants as a price

reference. Therefore, the calculation methodology of the price

reference series, if applicable, must be submitted as supporting

documentation. In that regard, for a price reference series that is

based on an index or survey of prices or rates, this would include the

index or survey methodology used to determine the level of the index

used as the price reference. Furthermore, the views and opinions of

prospective market users of the contracts should be given considerable

weight in the contract design process. The more accurately a listed

contract's terms and conditions reflect the underlying cash market in

that commodity, the more likely the contract will perform the intended

risk management and/or price discovery functions. Finally, a DCM should

ensure that the terms and conditions of listed contracts remain

consistent with the guidance set forth herein. These concepts are set

forth in the guidance in Appendix C to part 38.

The guidance in Appendix C to part 38 is comprised of best

practices that were developed over the past three decades by the

Commission and other market regulators in their review of product

submissions. The Commission first adopted a Guideline for product

submissions on November 3, 1982 \68\ and since then has modified it

from time to time. Furthermore, the Commission's Guideline served as

the basis for ``Guidance on Standards of Best Practice for the Design

and/or Review of Commodity Contracts,'' endorsed by the International

Organization of Securities Commissioners (``IOSCO'') in its Tokyo

Communiqu[eacute] (October 1997).\69\ The Guidance recognizes that the

proper design of the terms and conditions of contracts reduces the

susceptibility of such contracts to market abuses, including

manipulation, and enhances the economic utility of such contracts to

commercial users. Accordingly, the Guidance for designing futures

contracts focuses on such issues as a contract's economic utility

(i.e., a contract should meet risk management needs of potential users

and/or promote price discovery of the underlying commodity), the

contract's correlation with the cash market (i.e., the contract terms

and conditions generally should reflect the operation of the underlying

cash market and avoid impediments to delivery), a contract's settlement

and delivery reliability (i.e., the settlement and delivery procedures

should reflect the underlying cash market and promote price

convergence), the contract's responsiveness to the views of potential

market users, and the contract's transparency (i.e., the contract's

terms and conditions, as well as relevant information concerning

delivery and pricing, should be readily available to market authorities

and to market users).

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\68\ See 47 FR 49832, 49838, Nov. 3, 1982.

\69\ See Tokyo Commodity Futures Markets Regulators' Conference

(October, 1997), http://www.cftc.gov/idc/groups/public/

@internationalaffairs/documents/file/oia_tokyorpt.pdf (last visited

Oct. 25, 2010).

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Appendix C to part 38 is intended to act as a source for new and

existing DCMs to reference for best practices when developing new

products to list for trading. Specifically, Appendix C to part 38

provides guidance regarding: (1) The forms of supporting information a

new contract submission should include; (2) how to estimate deliverable

supplies; (3) the contract terms and conditions that should be

specified for physically delivered contracts; (4) how to demonstrate

that a cash-settled contract is reflective of the underlying cash

market, is not readily subject to manipulation or distortion, and is

based on a cash price series that is reliable, acceptable, publicly

available and timely; (5) the contract terms and conditions that should

be specified for cash-settled contracts; (6) the requirements for

options on futures contracts; (7) the terms and conditions for non-

price based futures contracts; and (8) the terms and conditions for

[[Page 80583]]

swap contracts. Currently, DCMs generally conduct market research in a

manner discussed in Appendix C.

4. Subpart E--Prevention of Market Disruption

The Dodd-Frank Act amended current Core Principle 4 by: (i)

Changing the title of the core principle from ``Monitoring of Trading''

to ``Prevention of Market Disruptions;'' and (ii) specifying the

methods and procedures DCMs must employ in discharging their

obligations under Core Principle 4. The amendments to Core Principle 4

emphasize that DCMs must take an active role, not only in monitoring

trading activities within their markets, but in preventing market

disruptions. Accordingly, the proposed rules under subpart E of part 38

codify the relevant provisions of the current Application Guidance and

Acceptable Practices for Core Principle 4 in current Appendix B to part

38, and include new requirements that clarify and strengthen a DCM's

responsibilities under the amended core principle.

i. Proposed Sec. 38.251--General Requirements

As noted above, the Dodd-Frank Act amended Section 5(d)(4) of the

CEA by adding new language to Core Principle 4 to require DCMs to

conduct real-time monitoring of trading and to have the ability to

comprehensively and accurately reconstruct trading.\70\ Accordingly,

proposed Sec. 38.251 (General Requirements) would require that the DCM

have the ability to conduct real-time monitoring of trading and

comprehensive and accurate trade reconstructions. Intra-day trade

monitoring must include the capacity to detect abnormal price

movements, unusual trading volumes, impairments to market liquidity,

and position-limit violations.

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\70\ See Section 735 of the Dodd-Frank Act.

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As noted above in its discussion of the need for automated tools in

connection with Core Principle 2 requirements, the Commission believes

that it would be difficult, if not impossible, to monitor for market

disruptions in contract markets with high transaction volume and a

large number of trades unless the DCM has installed automated trading

alerts to detect many types of potential violations of exchange or

Commission rules. Accordingly, the Commission proposes in Sec. 38.251

to require that, where the DCM cannot reasonably demonstrate that its

manual processes are effective in detecting and preventing abuses, the

DCM must implement automated trading alerts to detect potential

problems.

We invite comment on whether in any rule the Commission may adopt

in this matter DCMs should be required to monitor the extent of high

frequency trading, and whether automated trading systems should include

the ability to detect and flag high frequency trading anomalies.

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

Delivery Contracts

The Commission has observed a number of physically-delivered

futures contracts where the convergence of the futures price and the

cash market price of the underlying commodity have been

problematic.\71\ Price convergence refers to the process whereby the

price of a physically-delivered futures contract converges to the spot

price of the underlying commodity, as the futures contract nears

expiration (a cash-settled contract, by definition, converges to the

underlying price series at expiration). The hedging effectiveness of a

physically-delivered futures contract depends in part upon the extent

to which the futures price reliably converges to the comparable cash

market price, or to a predictable differential to the comparable cash

market price. The delivery mechanism for physically-delivered futures

contracts is the critical link that drives price convergence. To the

extent that delivery of a commodity at futures expiration occurs and

the delivered commodity is merchandised in the physical marketing

channel, arbitrage should ensure that the price of the futures contract

converges to the price of the commodity in the physical marketing

channel. Impediments to futures delivery, or the delivery of an

instrument that permits a long futures position holder to defer moving

the physical commodity into normal marketing channels, may weaken the

crucial link between cash markets and the futures market, resulting in

a lack of reliable price convergence.\72\

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\71\ The Commission notes that the lack of convergence and its

adverse impact on the ability to effectively hedge in some

agricultural futures markets has been the subject of several

meetings of the Commission's Agricultural Advisory Committee. Where

there is a lack of convergence, this has resulted in extremely weak

bases, i.e., cash prices well below equivalent futures prices,

disadvantaging short hedgers and resulting in abnormally large

quantities of futures deliveries that diverted grain from normal

commercial channels and tied up warehouse space. The lack of

convergence likely sends the wrong price discovery signals to the

market. See, Materials from Meeting of the CFTC's Agricultural

Advisory Committee (AAC) (October 29, 2009), http://www.cftc.gov/

About/CFTCCommittees/AgriculturalAdvisory/aac_102909agenda.html;

see also, the AAC Subcommittee on Convergence in Agricultural

Commodity Markets Report and Recommendations (October 29, 2009),

http://www.cftc.gov/idc/groups/public/@aboutcftc/documents/file/

reportofthesubcommitteeonconve.pdf.

\72\ For example, specifying a shipping certificate with an

indefinite life as the futures delivery instrument that permits a

long futures position holder to avoid taking delivery in the

physical marketing channel, which, in certain circumstances, may

result in weak or erratic convergence between the futures price and

the cash price.

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Therefore, for physical delivery contracts, proposed Sec. 38.252

specifically requires that, among other things, DCMs must monitor each

contract's terms and conditions as to whether there is convergence of

the futures price to the cash price of the underlying commodity and

take meaningful corrective action, including to address conditions that

interfere with convergence, or if appropriate, change contract terms

and conditions, when lack of convergence impacts the ability to use the

markets for making hedging decisions and for price discovery.

The Commission requests comments on what other factors, in addition

to the delivery mechanism, a DCM should be required to consider in

determining whether convergence is occurring.

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

Contracts

Over the past several years, there has been a growth in markets

that are linked, for example, where the settlement price of one market

is linked to the prices established in another market. As a result,

traders may have incentives to disrupt or manipulate prices in the

reference market in order to influence the prices in the linked market.

Accordingly, proposed Sec. 38.253 would require that, where a DCM

contract is settled by reference to the price of a contract or

instrument traded in another venue, including a price or index derived

from prices on another exchange, the DCM must have rules that require

the traders on the DCM's market to provide the DCM with their positions

in the reference market as the traders' contracts approach settlement.

In the alternative, Sec. 38.253 provides that the DCM may have an

information sharing agreement with the other venue or designated

contract market.

iv. Proposed Sec. 38.254--Ability To Obtain Information

The current acceptable practice for Core Principle 4 provides that

DCMs, at a minimum, should have routine access to the positions and

trading of their market participants. To ensure that the DCM has the

ability to properly assess

[[Page 80584]]

the potential for price manipulation, price distortions, and the

disruption of the delivery or cash-settlement process, proposed Sec.

38.254 provides that each DCM require that traders in their market keep

records, including records of their activity in the underlying

commodity and related derivative markets and contracts, and make such

records available, upon request, to the designated contract market. The

Commission's own market surveillance staff, which has similar authority

to obtain information from large traders (under Sec. 18.05 for futures

and options and proposed Sec. 20.6 for swaps), has found that access

to such information is vital to an effective surveillance program.

v. Proposed Sec. 38.255--Risk Controls for Trading

Proposed Sec. 38.255 requires that a DCM have effective risk

controls to reduce the potential risk of market disruptions and ensure

orderly market conditions. In the current futures markets, DCMs have

implemented a variety of risk controls to avoid market disruptions

through restrictions on order entry, including daily price limits,

price/quantity bands, and trading pauses. Most commonly used by DCMs

for futures contracts in physical commodities (outside of the spot

month) and futures contracts in broad-based equity indexes (in

coordination with circuit breakers on national security exchanges) are

daily price limits, which restrict the total price movement allowed on

any given trading day, calculated as a limit above and below the prior

day's futures settlement price.\73\ Under daily price limits, futures

can continue to trade within the limit up/down prices, but no trading

can take place above or below the daily price limit. Some DCMs also

have rules for the automatic expansion of the daily price limit after

consecutive days of limit bid/offer prices. Some electronic trading

platforms also have ``reasonability tests'' and/or ``price bands'' for

order entry, which do not allow an order to enter the trade matching

system if it is outside a predetermined price range or is of a

particularly large size.\74\ Finally, some trading platforms use

trading pauses to halt trading for a short period of time during

certain market conditions. Trading pauses are used,\75\ most commonly,

for trading in equity index products.

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\73\ Option contracts on futures may have different daily price

limits than the underlying futures.

\74\ For example, the GLOBEX electronic trading system for the

NYMEX crude oil futures contract generally will not accept an order

75 points above or below the last traded price nor will it accept an

order for a quantity larger than 999 contracts.

\75\ The NYMEX Henry Hub Natural Gas (NG) futures has a 5 minute

pause in trading when a daily price limit--up or down--is hit, then

trading resumes at a higher limit. However, this provision does not

apply during the last 60 minutes of regular trading hours. See NYMEX

rule 220.08.

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The CME's GLOBEX system also has a risk control, commonly referred

to as ``stop logic functionality,'' that implements a pause of a few

seconds in the order matching system to protect against cascading stop

orders--the domino effect of one stop order triggering others. The stop

logic functionality pauses trading when the last transaction price

would have triggered a series of stop loss orders that, if executed,

would cause the market to trade outside of predefined values, which

typically consist of values that are the same as the ``no bust'' range

\76\ established for a market.

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\76\ Under most exchanges' trade cancellation rules, trades

considered to have been executed in error may be cancelled. Where

the trade is within the ``no bust range'' for the specified futures

contract, which range is determined by the exchange under its rules,

the exchange will allow the trade to stand.

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In order to prevent market disruptions due to sudden volatile price

movements, proposed Sec. 38.255 requires DCMs to have in place

effective risk controls, including but not limited to pauses and/or

halts to trading in the event of extraordinary price movements that may

result in distorted prices or trigger market disruptions. Risk controls

such as trading pauses and halts can, among other things, allow time

for participants to analyze the market impact of new information that

may have caused a sudden market move, allow new orders to come into a

market that has moved dramatically, and allow traders to assess and

secure their capital needs in the face of potential margin calls.

Moreover, where a contract market can be a proxy or substitute for

similar markets on the DCM or on other trading venues, including where

a contract is based on the price of an equity security or the level of

an equity index, risk controls should be coordinated with those on the

similar markets or trading venues, to the extent possible. The

desirability of coordination of various risk controls, for example,

``circuit breakers'' in equities and their various derivatives

including futures and options, recently has been the subject of

discussions by regulators and the industry.

The Commission believes that pauses and halts are effective risk

management tools and must be implemented by DCMs to facilitate orderly

markets. These basic risk controls also have proven to be effective and

necessary in preventing market disruptions. The Commission requests

comments on what types of pauses and halts are necessary and

appropriate for particular market conditions. The Commission recognizes

that pauses and halts are only one category of risk controls and that

additional controls may be necessary to further reduce the potential

for market disruptions. Such controls may include price collars or

bands,\77\ maximum order size limits,\78\ stop loss order

protections,\79\ kill button,\80\ and others. The Commission is

considering mandating in this rulemaking risk controls that are

appropriate and/or necessary. Accordingly, the Commission invites

comments on the appropriateness of these and other controls that could

supplement trading halts or pauses. The Commission also invites

comments on the following additional questions:

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\77\ Price bands would prevent clearly erroneous orders from

entering the trading system, including ``fat finger'' errors, by

automatically rejecting orders priced outside of a range of

reasonability.

\78\ Maximum order size limitations prevent entry into the

trading system of an order that exceeds a maximum quantity

established by the DCM.

\79\ Stop loss orders would be triggered if the market declines

to a level pre-selected by the person entering the order. This

mechanism would provide that when the market declines to the

trader's pre-selected stop level for such an order, the order would

become a limit order executable only down to a price within the

range of reasonability permitted by the system, instead of becoming

a market order.

\80\ The kill button gives clearinghouses associated with the

DCM the ability to delete open orders and quotes and reject entry of

new orders or quotes in instances where a trader breaches its

obligations with the clearinghouse. FIA Market Access Risk

Management Recommendations, p. 10 (April 2010).

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What other DCM risk controls are appropriate or necessary

to reduce the risk of market disruptions?

Which risk controls should be mandated and how?

vi. Proposed Sec. 38.256--Trade Reconstruction

The Dodd-Frank Act added language to Core Principle 4 that

designated contract markets must have the ability to comprehensively

and accurately reconstruct all trading on its trading facility. These

audit-trail data and reconstructions must also be made available to the

Commission in a form, manner, and time as determined by the Commission.

Proposed Sec. 38.256 codifies these requirements.

vii. Proposed Sec. 38.257--Regulatory Service Provider

Proposed Sec. 38.257 provides that a designated contract market

must comply with the regulations in this section

[[Page 80585]]

through a dedicated regulatory department, or by delegation of that

function to a regulatory service provider, over which the designated

market has supervisory authority.

viii. Proposed Sec. 38.258--Additional Rules Required

Proposed Sec. 38.258 requires a DCM to adopt and enforce any

additional rules that it believes are necessary to comply with the

requirements of subpart E.

5. Subpart F--Position Limitations or Accountability

Core Principle 5 under Section 5(d)(5) requires that DCMs adopt for

each contract, as is necessary and appropriate, position limitations or

position accountability. The Dodd-Frank Act amended Core Principle 5 by

adding that for any contract that is subject to a position limitation

established by the Commission pursuant to Section 4a(a) of the CEA, the

DCM shall set the position limitation of the board of trade at a level

not higher than the position limitation established by the Commission.

The Federal position limits established by the Commission currently are

codified in part 150. In a separate release, as required by the Dodd-

Frank Act, the Commission will consider replacing part 150 (Limits on

Positions) with new part 151 (Limits on Positions) to establish Federal

position limits for certain exempt and agricultural commodities that

currently are not subject to Federal position limits.\81\ In that

release, the Commission will propose to require that exchanges adopt

their own position limits for all commodities (whether such commodities

are subject to Federal limits or not), with an alternative of adopting

position accountability rules in lieu of position limits for contracts

in major currencies and certain excluded commodities. Proposed Sec.

38.301 requires that each DCM must comply with the requirements of part

151 that the Commission adopts in order to be in compliance with Core

Principle 5.

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\81\ See CFTC Web site for additional information on the

Position Limits rulemaking, at http://www.cftc.gov/LawRegulation/

DoddFrankAct/Rulemakings/DF_26_PosLimits/index.htm (last visited

Dec. 14, 2010).

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6. Subpart G--Emergency Authority

The Dodd-Frank Act made minor, non-substantive changes to Core

Principle 6 under Section 5(d)(6) of the CEA. Based upon its

experience, and in recognition of the fact that DCMs may have different

procedures and guidelines for taking emergency action, the Commission

believes that it is appropriate to maintain an expanded version of the

existing guidance and add an acceptable practice under its regulations

for purposes of complying with this core principle. As a result, the

Commission proposes to retain most of the former Application Guidance

found in Appendix B to part 38 of the Commission's regulations, with

some revisions and additions. Proposed Sec. 38.351 refers applicants

and DCMs to the guidance and acceptable practices in Appendix B to part

38 for purposes of demonstrating to the Commission their compliance

with the requirements of subpart G. Specifically, a DCM is required to

have rules providing it with the authority to intervene as necessary to

maintain fair and orderly trading and to prevent or address

manipulation or disruptive trading practices, whether the need for

intervention arises exclusively from the DCM's own market or as part of

a coordinated, cross-market intervention. The increased tendency for

similar, if not identical, contracts to be traded on more than one

venue, that in the future may include a SEF, demonstrates the

importance of coordinated interventions. Accordingly, the Commission

believes that there should be an increased emphasis on cross-market

coordination of emergency actions. The guidance also provides that the

DCM rules should include procedures and guidelines to avoid conflicts

of interest in accordance with new provisions proposed in Sec. 40.9

and to include alternate lines of communication and approval procedures

in order to be able to address, in real time, emergencies that may

arise. This latter provision is a result of the expansion of electronic

markets and the speed of order execution. As a result of fast-paced

trading systems, there is a need for DCMs to be able to react quickly

to market events and intervene without delay. Thus, the proposed

guidance acknowledges this trend with this provision. The proposed

guidance also clarifies that the DCM must also have rules that allow it

to take such market actions as may be directed by the Commission.

The Commission's experience and industry practice have demonstrated

that there are some specific best practices that should be followed,

and these best practices are incorporated in an acceptable practice.

Specifically, the DCM should have procedures and guidelines for

decision-making and implementation of emergency intervention in the

market. The DCM should have the authority to liquidate or transfer open

positions in the market,\82\ suspend or curtail trading in any

contract, require market participants in any contract to meet special

margin requirements and allow it to take such market actions as the

Commission may direct.

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\82\ In situations where a swap is traded on more than one

platform, emergency action to liquidate or transfer open interest

must be directed, or agreed to, by the Commission or Commission

staff.

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7. Subpart H--Availability of General Information

Core Principle 7 requires that DCMs make available to the public

accurate information concerning the contract market's rules and

regulations, contracts and operations. The Dodd-Frank Act amended Core

Principle 7 by adding a provision requiring the board of trade to make

public the rules and specifications describing the operation of the

DCM's electronic matching platform or trade execution facility.\83\

Since passage of the CFMA, the types of information and the various

practices for providing information have become standardized across the

industry as DCMs have adopted practices that comply with the current

guidance and acceptable practices for Core Principle 7. Accordingly,

proposed Sec. 38.401 in subpart H codifies these practices. In

addition, the Commission proposes several additional provisions to

ensure that pertinent information is available to the Commission,

market participants and the public, as described below.

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\83\ This requirement, while new to the text of Core Principle

7, was previously required as part of former Designation Criteria 4.

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i. Proposed Sec. 38.401(a)--General

Proposed Sec. 38.401(a) requires DCMs to have in place procedures,

arrangements and resources for disclosing to market authorities, market

participants and the public accurate and relevant information

pertaining to: (i) Contract terms and conditions, (ii) rules and

regulations applicable to the trading mechanism, and (iii) rules and

specifications pertaining to the operation of the electronic matching

platform or trade execution facility. Among other types of information,

DCMs must ensure that market authorities, market participants and the

public have available all material information pertaining to new

product listings, new or amended governance, trading and product rules,

or other changes to information previously disclosed by the DCM, within

the time period prescribed in proposed Sec. 38.401. As described in

Sec. 38.401(a) of the regulation, DCMs must provide the required

information to market

[[Page 80586]]

participants and the public by posting such information on their Web

site, as set forth in proposed Sec. 38.401(c).

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

Proposed Sec. 38.401(b) requires that each DCM have procedures in

place to ensure that any information or communication with the

Commission is accurate and complete, and further that no false or

misleading information is submitted and that no material information is

omitted. Similarly, each DCM must have procedures in place to ensure

the accuracy and completeness of any information made available to

market participants and the public, including information that is made

available on its Web site.

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

The Commission historically has required DCMs to update their

rulebooks upon the effectiveness of a rule amendment, product listing

or rule certification that has been filed with the Commission. While

proposed Sec. 38.401(c) maintains the general requirement for posting

rules in the DCM rulebook upon their effectiveness, the Commission

believes that market participants and the public would benefit from

notifications of proposed rule amendments, product listing (or de-

listings) and rule certifications in advance of their taking

effect.\84\ Accordingly, proposed Sec. 38.401(c) requires each DCM to

post on its Web site all rule filings and submissions that it makes to

the Secretary of the Commission. This information should be posted on

the DCM's Web site on the same day that such information is transmitted

to the Commission. Where applicable, the DCM Web site should make clear

that the posted submissions are pending before the Commission. For

example, a DCM's Web site may contain a separate Web page for

``regulatory filings'' or ``rule certifications'' for posting

submissions or certifications pertaining to new product listings, new

rules, rule amendments or changes to previously-disclosed information.

This requirement will provide market participants with advance notice

of rule amendments and certifications, consistent with the goal of Core

Principle 7 to make pertinent information available to market

participants and the public. This posting requirement is in addition to

the obligation of DCMs to update their Rulebooks upon the effectiveness

of a rule submission or certification.

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\84\ This is especially relevant when the Commission determines

to stay the certification of a DCM submission, as provided by the

Dodd-Frank Act, for a 90-day review period, thereby triggering a

public comment period.

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To the extent that a DCM requests confidential treatment of certain

information filed or submitted to the Commission, the proposed rule

requires the DCM to post the public portions of the filing or

submission.

iv. Proposed Sec. 38.401(d)--Rulebook

As noted above, consistent with the current acceptable practices

for Core Principle 7, all DCMs must post and routinely update their

rulebooks, which appear on their Web sites. Currently, each DCM updates

its rulebook the day that a new product is listed or a new or amended

rule takes effect. The vast majority of DCM Web sites also are readily

accessible to the public and the information is available by visitors

to the Web site without requiring registration, log-in, or user name or

password. Proposed Sec. 38.401(d) merely codifies these existing

practices.\85\

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\85\ As noted above, the requirement to maintain an accurate and

updated rulebook does not relieve DCMs of their obligations under

paragraph (c) to post on their Web sites all rule filings and

submissions submitted to the Commission.

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8. Subpart I--Daily Publication of Trading Information

Core Principle 8 requires that DCMs make available to the public

accurate information on settlement prices, volume, open interest, and

opening and closing ranges for actively traded contracts on the

contract market. The Dodd-Frank Act did not amend Core Principle 8.

Accordingly, in proposed Sec. 38.451, the Commission reiterates the

current acceptable practice that requires mandatory compliance with

Sec. 16.01, ``Trading volume, open contracts, prices and critical

dates.''

However, in order to conform to the Dodd-Frank Act, certain changes

were made to Sec. 16.01 regarding the information a reporting market

will record and publish on futures and options contracts, and on swap

and swaption contracts.

Specifically, the Commission proposes to amend Sec. 16.01(d) to

require reporting markets to report information in paragraphs (a)(1)

through (6) of Sec. 16.01. Prior to the enactment of the Dodd-Frank

Act, reporting markets were required only to report separately the

following information enumerated in paragraphs (a)(1) through (5) of

current Sec. 16.01 for futures and options: The option delta, where

delta system is used, total gross open contracts, excluding from

futures those contracts against which notices have been stopped; for

futures, open contracts against which delivery notices have been

stopped on that business day; the total volume of trading, excluding

transfer trades or office trades; and the total volume of futures

exchanged for commodities or for derivatives positions that are

included in the total volume of trading.

The Commission proposes to require reporting markets to also report

to the Commission the information found in paragraph (a)(6) that is

``the total volume of block trades that are included in the total

volume of trading.'' Previously such information was only required to

be reported to the public but not separately to the Commission. The

Commission believes that having block trade volumes reported separately

to it would be useful, particularly in analyzing whether a contract

market is in compliance with Core Principle 9 (Execution of

Transactions). Because reporting markets currently are required to make

block trade volumes available to the public, it should not be an

unreasonable burden for the reporting market to submit that information

separately to the Commission.

Under the Dodd-Frank Act, DCMs are able to list and trade swaps.

Accordingly, amendments to part 16 specify the type of information that

DCMs or SEFs must publish daily regarding the swaps contracts traded.

Specifically, DCMs and SEFs would be required to publish for their

swaps contracts all the information included in proposed Sec. 16.01

(a) (1) through (6) for each trading day for each swap, class of swaps,

swaption or class of swaptions as appropriate. For swap contracts that

are standard-sized contracts (i.e., contracts that have a set contract

size for all contracts), volume and open interest for swaps and

swaptions shall be reported in terms of number of contracts traded,

just as futures contracts currently are reported. For swap contracts

that are non-standard-sized contracts (i.e., contracts whose contract

size can vary for each transaction) the volume and open interest should

be reported in terms of total notional value traded for that trading

day. In addition, Sec. 16.01(b) is amended to require each DCM or SEF

to publish for each trading day, by commodity and contract month or by

tenor of the swap, the opening price, high price, low price and

settlement price of the swap or swaption contract. The Commission is

seeking comments on end-of-day price reporting for swaps. Specifically,

the Commission seeks comments on the following issues:

For interest rate swaps, because the tenor on an interest

rate swap can be one of thousands of possible periods, what would be an

appropriate manner

[[Page 80587]]

to display end-of-day prices for each interest rate swap?

Would certain end-of-day swap price reporting be more

meaningful than others? If so, which methods of price reporting would

be more meaningful and why?

Would certain end-of-day swap price reporting be

misleading? If so, which methods of price reporting would be misleading

and why?

9. Subpart J--Execution of Transactions

The Dodd-Frank Act amended Core Principle 9 to require, among other

things, that a board of trade must provide a competitive, open and

efficient market and mechanism for executing transactions ``that

protects the price discovery process of trading in the centralized

market of the board of trade.\86\ The amended core principle also

provides that off exchange transactions are permitted for bona fide

business purposes if authorized by the board of trade's rules.\87\

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\86\ 7 U.S.C. 7; see also Section 5(d)(9) of the CEA, as amended

by the Dodd-Frank Act.

\87\ This language was taken from former Designation Criterion

3.

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In assessing a DCM's initial and ongoing compliance with Core

Principle 9, the Commission currently considers several criteria,

including, among others, the methodology and mechanisms of the DCM's

trading system to ensure fair and orderly trading and the rules the DCM

may have for permissible transactions executed off the centralized

market. In so doing, the Commission has looked at Sec. 1.38 of the

Commission's regulations, which sets forth a requirement that all

purchases and sales of a commodity for future delivery or a commodity

option on or subject to the rules of a DCM should be executed by open

and competitive methods. There is an exception to this ``open and

competitive'' requirement if the transaction is in compliance with the

rules of the DCM that specifically provide for the non-competitive

execution of such transactions.\88\ In addition, the current guidance

for Core Principle 9 provides that a competitive, open and efficient

market and mechanism for execution of transactions includes: (1) The

DCM's methodology for entering orders and executing transactions; (2)

that appropriate objective testing and review of automated systems

should occur initially and periodically to ensure proper system

functioning, adequate capacity and security; and (3) that a DCM that

determines to allow block trades should ensure that such trades do not

operate in a manner that compromises the integrity of prices or price

discovery in the relevant market.\89\

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\88\ The Commission notes that the CFMA, which was enacted after

promulgation of Sec. 1.38, modified Section 3 of the current CEA to

require that transactions subject to the CEA provide ``a means for

managing and assuming price risks, discovering prices, or

disseminating pricing information through trading in liquid, fair

and financially secure trading facilities.'' The CFMA also

specifically listed some of the types of transactions that could be

executed off the centralized market, including exchange of futures

for swaps, and allowing a futures commission merchant, acting as

principal or agent, to enter into or confirm the execution of a

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

if the contract is reported, recorded, or cleared in accordance with

the rules of a contract market or derivatives clearing organization.

7 U.S.C. 7(b)(3).

\89\ The current acceptable practice for Core Principle 9

identifies an example of the type of party that would be an

acceptable party to carry out the testing and review of an

electronic trading system. The Commission notes that under its

proposed rulemaking, all rules relating to the type of testing and

review required for trading systems would be set forth under new

Core Principle 20, System Safeguards, discussed infra at Section

II.D.20.

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In light of the Dodd-Frank Act amendments to Core Principle 9 and

the Commission's experience in implementing Core Principle 9 since

enactment of the CFMA, the Commission proposes to adopt certain

regulations in subpart J of the Commission's regulations to establish

requirements that a DCM must meet in order to comply with amended Core

Principle 9. Specifically, new regulations are proposed to clarify the

amended core principle's mandate requiring the protection of the price

discovery function of trading on a DCM's centralized market. Other

regulations codify practices that have become standard and adopted over

the years by the industry. In addition, the Commission re-proposes

certain guidance and acceptable practices that were published by the

Commission in the September 2008 Notice of Proposed Rulemaking

pertaining to ``Execution of Transactions: Regulation 1.38 and Guidance

on Core Principle 9'' \90\ (hereafter ``2008 Core Principle 9 Proposed

Rulemaking'') for purposes of informing DCMs of how they may comply

with certain other aspects of amended Core Principle 9.\91\

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\90\ 73 FR 54097, Sep. 18, 2008. That proposed rulemaking was a

re-proposal of some rules, guidance and acceptable practices

pertaining to Regulation 1.38 and Core Principle 9, initially

proposed on July 1, 2004. See 69 FR 39880, July 1, 2004. There were

no final rulemakings to either of these proposals.

\91\ In 2009, before those proposed rules were finalized,

Congress initiated the legislative process that culminated in the

Dodd-Frank Act. Accordingly, a number of the proposed rules

contained in this release consist of regulations that were initially

proposed in the 2008 Core Principle 9 Proposed Rulemaking, with

relevant updates.

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In short, the Commission proposes to adopt the following

regulations, guidance and acceptable practices for Core Principle 9, as

amended by the Dodd-Frank Act:

New Sec. 38.501 proposes to codify in part 38 the

requirements that are currently contained in Sec. 1.38 of the

Commission's regulations, with amendments that were initially proposed

in the 2008 Core Principle 9 Proposed Rulemaking along with relevant

updates. Section 1.38 of the Commission's regulations would be

eliminated.

New Sec. 38.502 addresses the specific requirements

associated with protecting the price discovery function of trading on a

DCM's centralized market as now specifically imposed by the Dodd-Frank

Act. The proposed rule imposes: (i) Minimum requirements for trading on

the centralized market for contracts listed on DCMs, (ii) mandatory

delisting of contracts if the requirements of trading are not met,

(iii) specified procedures for treatment of contracts existing prior to

the effective date of this section, and (iv) limited exemptions for

certain contracts that the Commission, upon a petition of the DCM,

permits to remain listed under specified circumstances.

New Sec. Sec. 38.503 and 38.504 propose to codify certain

requirements for block trades for futures and swaps and Sec. 38.505

addresses other off-exchange transactions. These provisions codify

practices that Commission staff has previously required and that have

become industry practices. In particular, these proposed rules set

forth block trade requirements for futures contracts and options,

including who may enter into block trade transactions, conditions for

block trades between affiliated parties, aggregation, recordkeeping and

reporting procedures. In addition, in proposed Sec. 38.505, the

Commission proposes to adopt rules for off-exchange transactions that

involve exchange of derivatives for related position, specifically

describing what constitutes a bona fide trade and reporting

requirements for such trades. Proposed Sec. 38.504 addresses certain

block trading requirements specifically for swaps traded on the DCM,

and proposed Sec. 38.506 addresses transfer and office trades.

A new acceptable practice would provide a safe harbor

methodology for DCMs to follow in determining the minimum size of block

transactions for individual contracts. The acceptable practice also

would provide a safe harbor relating to the manner of pricing block

trades. By proposing this acceptable practice the Commission

[[Page 80588]]

recognizes the need for flexibility as the appropriate minimum size and

pricing of block trades vary among contracts and across DCMs.

i. Proposed Sec. 38.501--General Requirements

Current Sec. 1.38 of the Commission's regulations requires,

subject to certain exceptions, ``that all purchases and sales of a

commodity for future delivery, and of any commodity option, on or

subject to the rules of a DCM shall be executed openly and

competitively by open outcry or posting of bids and offers or by other

equally open and competitive methods * * * provided, however, that this

requirement shall not apply to transactions that are executed

noncompetitively in accordance with written rules of the contract

market * * *'' \92\ The 2008 Core Principle 9 Proposed Rulemaking

proposed certain revisions to Sec. 1.38. Specifically, in addition to

simplifying the language, the 2008 Core Principle 9 Proposed Rulemaking

proposed to update the language of Sec. 1.38 to more accurately

identify the types of transactions that may be executed off a contract

market's centralized market under the rules of a DCM.\93\ The 2008 Core

Principle 9 Proposed Rulemaking also would make it clear that under

Sec. 1.38, DCMs may self-certify (not just seek approval for) rules or

rule amendments related to transactions off the centralized

marketplace. Both of these changes were proposed to the language of

regulation Sec. 1.38 to incorporate updates made to the CEA in 2000 by

the CFMA.

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\92\ 17 CFR 1.38 (2009).

\93\ The proposed language for Sec. 1.38(b)(1) identified

``transfer trades, office trades, block trades, inter-exchange

spread transactions, or trades involving the exchange of futures for

commodities or for derivatives positions, if transacted in

accordance with written rules of a contract market that provide for

execution away from the centralized market and that have been

certified to or approved by the Commission.'' This release proposes

updates to this list.

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As noted above, the existing provisions of current Sec. 1.38 will

be incorporated in proposed Sec. 38.501, including previously proposed

amendments, with some updates. These updates include language that adds

to the types of transactions that may be executed off of a DCM's

centralized market. In addition, the proposed rule replaces the term

``exchange of futures for commodities or for derivatives positions''

with the term ``exchange of derivatives for a related position.'' This

term is more descriptive of the panoply of off-exchange transactions

currently offered by DCMs, including exchange for physicals, exchange

for swaps, exchange for risk or exchange of futures for futures. This

term also will encompass other types of off-exchange transactions, not

limited to futures. Finally, because swaps may now be traded on DCMs,

the proposed rule will reference swaps.

ii. Proposed Sec. 38.502--Minimum Centralized Market Trading

Requirement

As noted, the Dodd-Frank Act amended Core Principle 9 to

specifically require that in the execution of transactions, ``the price

discovery function of trading in the centralized market'' must be

protected.\94\ The amended core principle recognizes that trading in

the centralized market provides a price discovery function, and

specifically requires that the execution of transactions be in a manner

that protects that price discovery process.

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\94\ 7 U.S.C. 7; see also section 5(d)(9) of the CEA, as amended

by the Dodd-Frank Act.

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The Commission notes that, under the current regulatory landscape,

some DCMs have listed contracts for the purpose of providing a clearing

solution for privately negotiated bi-lateral swap trades or trades made

on exempt commercial markets. The DCMs accept these trades as futures

contracts by converting them, through their block trade or exchange-

for-swaps (or other exchange of derivatives for a related position)

rules, to economically equivalent futures contracts in order for them

to be cleared by their derivatives clearing organization. The vast

majority of those contracts are not executed openly or competitively on

the centralized market, but rather are effected away from the DCM's

centralized market.\95\ Despite the lack of trading on the centralized

market these contracts still manage to achieve open interest over

sustained periods of time.

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\95\ Under current CEA section 4d(a)(2), funds supporting

customer trades executed on a designated contract market must be

segregated from other funds, including proprietary funds, of a

future commission merchant (``FCM'') or clearinghouse. Customers

often desire to comingle funds in this segregated account primarily

to take advantage of lower margins due to off-setting positions.

Current CEA section 4d(a)(2) provides a venue for achieving this by

allowing the Commission to issue orders exempting an FCM or

clearinghouse from the segregation requirement in appropriate

situations. The DCM must go through the process of petitioning the

Commission for an exemption, and providing the necessary information

and data for the Commission to make a decision. The Commission's

process for issuing Section 4d orders necessarily entails careful

and measured review, and accordingly, can be time-intensive. The

Commission believes that rather than seeking 4d orders for off-

exchange products, certain DCMs have resorted to listing those

products as futures despite their unlikely prospects for central

marketplace trading, to achieve the same results as the Section 4d

process to the possible detriment of the centralized market. See

also, section 4d(a)(2) of the CEA, as amended by the Dodd-Frank Act.

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A DCM that trades contracts that have a disproportionate percentage

of their trading volume attributable to off-exchange activity and

little or no open and competitive, centralized market trading would not

appear to be in compliance with amended Core Principle 9. Specifically,

where all or most transactions in a DCM contract are executed off the

centralized market, there is no price discovery taking place on the DCM

such that the protection of the price discovery process of trading in

the centralized market is not satisfied.

The Commission notes that, while amended Core Principle 9

recognizes the primacy of trading on the centralized market for price

discovery, it does not bar off exchange transactions. Congress

reaffirmed that the rules of the DCM may authorize bona fide off-

exchange transactions. Thus, in implementing the provisions of the

Dodd-Frank Act, the Commission seeks to protect the price discovery

process of trading on the DCM's centralized market while permitting

DCMs to authorize off-exchange transactions where necessary and

appropriate for bona fide business purposes. Accordingly, the

Commission's proposal provides for permissible off-exchange

transactions, but only to the extent that such transactions do not

compromise the price discovery process of trading in the centralized

market. If off-exchange transactions become the exclusive or

predominant method of establishing or offsetting positions in a

particular market, the price discovery process in the centralized

market will be jeopardized.

a. Minimum Centralized Market Trading Percentage Requirement

The Commission believes that a significant amount of trading in any

contract listed on a DCM must occur on the centralized market in order

to meet the requirements of Core Principle 9. The Commission believes

that setting a minimum percentage of trading that must take place on

the centralized market is an appropriate method of implementing this

provision in order to provide clarity and legal certainty to DCMs.

Accordingly, the Commission is proposing to establish a minimum on-

exchange trading threshold of 85 percent.

In considering the minimum threshold of trading on the centralized

market, the Commission reviewed data regarding the amount of off-

exchange transactions in 570 listed DCM

[[Page 80589]]

contracts.\96\ Those contracts represented actively traded futures

products on eight DCMs and included a wide cross-section of products

with open interest. The data illustrated that the trading volume in the

570 contracts could be grouped into two main categories.\97\ In one

category, involving 410 of the contracts, mostly involving energy,

forex and weather contracts, almost all or all of the trading over a

three month period occurred off-exchange. As noted above, the

Commission believes that the price discovery process in the centralized

market is jeopardized where off-exchange transactions become the

exclusive or predominant method of establishing or offsetting positions

in a particular market. Since there was no centralized market trading

in those contracts, the Commission did not consider these 410 contracts

in its analysis of the appropriate minimum centralized market trading

requirement. In the second largest category, involving 128 contracts

from all asset classes which included contracts with large and small

open interest, the average amount of off-exchange trading over the

three-month period ranged from 0% to 15%. The Commission believes that

this second category of contracts, where there was actual centralized

market trading to observe, provides a reasonable basis for establishing

a minimum centralized market trading requirement. Accordingly, from

this second category the Commission took the upper range of the maximum

average amount of off-exchange trading, and proposes that a maximum of

15% of total trading volume of a contract would be an allowable amount

of off-exchange trading in order to protect the price discovery process

of trading on the centralized market.

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\96\ Commission staff collected data on the amount of off-

exchange trading that took place over the three month period from

May 2010 through July 2010, for 570 contracts listed on eight

designated contract markets (CME, CBOT, NYMEX, COMEX, ICEUS, One

Chicago, Kansas City Board of Trade and the Minneapolis Grain

Exchange) and covering 10 asset classes (agricultural, alternative

markets (i.e., environmental products), currency, energy, financial,

index, interest rates, metal, real estate and weather). In

collecting data, Commission staff attempted to sample a cross-

section of trading data from the eight DCMs. The data collected

represents samples of: (i) Active contracts in the main asset

classes (financials, energy, agricultural, index, currency, weather,

real estate, and metals); (ii) particular contracts that

historically have not traded on the centralized market (i.e.,

certain energy contracts, currency); (iii) commodities that as a

group trade differently from other commodities (i.e., cocoa,

coffee); (iv) commodities that are prominent on certain exchanges

(i.e., wheat on the Kansas City Board of Trade and the Minneapolis

Grain Exchange), (v) ``softs'' and (vi) other products on ICE

Futures U.S. Commission staff began collecting data in early August

2010 for the period May 2010 through July 2010. This time period was

chosen because it represented the most current and straightforward

data available at the time Commission staff began collecting data.

\97\ A third category, consisting of a small number of contracts

with trading volume between 15-60%, is discussed further below.

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The Commission believes that requiring at least 85% of a contract's

volume to be traded on the centralized market will balance the goal of

protecting the price discovery process of trading in the centralized

market, with the goal of allowing off-exchange transactions for bona

fide business purposes. The Commission invites comments on the minimum

centralized market trading percentage requirement proposed herein. In

particular, the Commission requests that commenters providing

alternative percentage requirements or alternative approaches also

provide data that supports any alternative percentage or other

approach.

b. Centralized Market Trading Percentage Calculation

In order to determine the percentage of on and off exchange trading

in a contract, DCMs must measure the average percentage of trading in

each contract over a sufficient period of time. Indeed, the data

collected by the Commission indicates that for those contracts that

have significant trading on the centralized market, the amount of off-

exchange trading varies from day to day. The Commission proposes that a

reasonable time period over which to measure and determine a contract's

on-exchange trading volume is 12 months.

Thus, for new contracts listed after the effective date of the

minimum centralized market trading percentage requirement in 38.502(a),

the Commission proposes that DCMs determine the amount of on-exchange

trading in each contract at the conclusion of the 12 month period

following the contract's initial listing on the exchange, and again on

every 12 month anniversary going forward. The designated contract

market must calculate the centralized market trading percentage for

each listed contract within thirty days following the conclusion of the

12 month anniversary of each contract's listing. The Commission notes

that in order to be in compliance with Core Principle 9, the DCM has

the burden of reviewing the on and off-exchange trading for each of its

contracts over the relevant period to determine whether it is subject

to delisting. The Commission notes that as part of its oversight, it

also will be reviewing trading data of contracts. For contracts and

contract months listed prior to the effective date of Sec. 38.502(a),

the Commission proposes that the DCM must initially calculate the

centralized market trading percentage in each of its contracts within

thirty days of the effective date of this minimum centralized market

trading rule. The initial calculation for each existing contract must

be based on the trading volume in the contract during the 12 month

period immediately preceding the effective date of this rule.\98\

Thereafter, the DCM must calculate the centralized market trading

percentage in each such contract within thirty days of the 12 month

anniversary of the initial calculation.

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\98\ As noted in the discussion under subpart J of this release,

if a contract has been listed for less than a 12 month period, the

Commission proposes that a DCM may seek an exemption as to that

contract(s) and obtain a maximum of 12 additional months to

calculate its centralized market trading for that contract(s).

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c. Mandatory Delisting

As noted above, the minimum centralized market trading requirement

would permit DCMs to list only those contracts that have a minimum

average over a 12 month period of 85% trading on the centralized

market. Accordingly, subject to the relief provided for existing

contracts and the other limited exemptions noted in paragraphs (d) and

(e) of proposed Sec. 38.502 below, proposed Sec. 38.502(c) requires

that for those contracts that do not meet the minimum centralized

market trading percentage requirement, the DCM has the following

options, which it must effectuate within ninety days of the centralized

market trading percentage calculation: (i) If the DCM operates a SEF,

it can delist the swap contract from the DCM and transfer open swap

positions to the SEF; (ii) the DCM can transfer the swap contract(s) to

another SEF that accepts the contract; or (iii) the DCM can trade the

contract on the DCM for liquidation purposes only.

The Commission notes that contracts that may be required to be

delisted have a potential alternative venue as Congress created, in the

Dodd-Frank Act, the SEF,\99\ a new trading facility for the trading,

processing and execution of swaps.\100\ Among other requirements,

[[Page 80590]]

the Dodd-Frank Act requires SEFs to facilitate the clearing and

settlement of swaps.\101\ Accordingly, parties seeking clearing and

segregated account status for swaps may achieve these objectives on a

SEF.\102\ The Commission invites comments as to these proposals.

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\99\ The SEF Core Principles, under Section 5h of the CEA, as

amended by the Dodd-Frank Act, do not include a counterpart to the

DCM Core Principle 9 requirement to protect the ``price discovery

process of trading in the centralized market of the board of

trade.''

\100\ The Commission notes that based upon a letter sent to

Chairman Gensler from the Wholesale Markets Brokers' Association

(``WMBA''), the Commission understands that many of the participants

that currently facilitate the privately negotiated contracts that

are listed, but not traded, on a designated contract market intend

to establish SEFs, confirming that this is an appropriate

alternative forum for such contracts. The Commission, however, takes

notice of the fact that the WMBA also proposes a much broader

reading of Core Principle 9 contending, among other things, that the

requirements of Core Principle 9 apply only to transactions that are

traded on a DCM and not to transactions, such as exchanges of

futures for swaps, that are submitted in compliance with DCM rules;

that the Commission should consider other execution models that are

competitive open and efficient; that compliance with Core Principle

9 does not require that all trades submitted to a DCM be executed on

the DCM's proprietary electronic trading network; and that Core

Principle 9 should not be applied in the same way to futures, which

may be traded by retail investors, as it may be applied to OTC

products that are only eligible to be traded by Eligible Contract

Participants. Letter to Chairman Gary Gensler from WMBA dated

September 10, 2010.

\101\ CEA Section 5h(f)(7), as amended by the Dodd-Frank Act. In

addition, this requirement accommodates the creation of Cleared

Swaps Customer Collateral account with bankruptcy protection.

Additionally, the Commission may permit the netting of futures and

swaps within such account. See CEA Section 4d(f)(3)(B), as amended

by the Dodd-Frank Act.

\102\ The Commission notes that swaps cleared through an FCM and

associated collateral are protected in bankruptcy as commodity

contracts. See section 724(b) of the Dodd Frank Act (to be codified

at 11 U.S.C. 761(4)(F)). Moreover, to achieve benefits of portfolio

margining, a designated contract market may still petition for an

order pursuant to section 4d(a)(2) of the CEA to permit such swap

transactions to be commingled in the segregated customer account for

exchange traded transactions, or an order pursuant to CEA section

4d(f)(3)(B) to permit related exchange traded futures transactions

to be commingled in the segregated customer account for swaps.

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d. Treatment of Contracts Listed as of the Effective Date of This

Section

Proposed Sec. 38.502(d) provides relief from the provisions of

Sec. 38.502(c) for contracts listed on a DCM as of the effective date

of this section. The Commission understands that many contracts and

contract months listed on a DCM before the effective date of the

proposed rule may not meet the proposed minimum centralized market

trading percentage requirement and, therefore, would be subject to

mandatory delisting upon the effective date of the rules in this

section (``affected contracts''). The Commission also notes that

delisting a large number of these affected contracts within a short

period of time may be difficult and result in potential financial

consequences. Accordingly, the Commission proposes a transition process

for the affected contracts to be liquidated in a fair and orderly

manner. Specifically, the Commission proposes in Sec. 38.502(d) that

affected contracts that do not meet the minimum centralized market

trading requirement may continue to be listed on the DCM until all open

positions in such contracts and contract months are closed or

liquidated. Trading in such contracts will be allowed but only to close

or liquidate a position.\103\

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\103\ It is possible that a trader may not desire to close out a

position. Since the position is carried at the clearing house, a

trader may instead decide to keep the position in the clearing house

until expiration. Traders with existing positions as of the

effective date of the rules in this section will be permitted to

maintain these positions in the respective margin account.

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In essence then, after the effective date of the proposed rules in

this section, affected contracts that are listed before the effective

date of this rule and that do not meet the minimum centralized market

trading requirement will not be required to delist or liquidate within

90 days as required by the proposed rule. Instead, all affected

contracts will be allowed to continue to be listed, and either traded

on the DCM for liquidation purposes only, through offsetting trades, or

held until settlement at contract expiration. These affected contracts

would, therefore, either close out at contract expiration or when open

interest in the contract reaches zero. For any affected contracts that

may not have been listed and traded for a full 12 month period on the

effective date of the proposed rule, proposed Sec. 38.502(e) proposes

additional relief, as described below.

The Commission points out that with respect to this transition

period, trades in the affected contracts must comply with the

provisions of Section 2(h)(8) of the CEA, as amended by the Dodd-Frank

Act, once effective. Thus, while a DCM will be allowed to continue to

list and trade in its existing contracts for purposes of liquidating

respective futures positions, upon the effective date of amended CEA

Section 2(h)(8), the closing out of that position with an associated

swaps position must be accomplished in compliance with the requirements

of amended CEA Section 2(h)(8). To that end, such swaps positions can

only be executed on a SEF or DCM, or with a bilateral off-exchange

trade either as a block trade, or where the trade is exempt from the

provisions of amended CEA Section 2(h)(8) because one party to the

trade includes an end user.\104\

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\104\ See generally, section 2(h) of the CEA, as amended by the

Dodd-Frank Act.

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The Commission invites comments on its proposal and also invites

alternative proposals on how to address those DCM contracts listed

prior to the effective date of these rules.

e. Exemption Upon Petition

As noted above, the data collected by the Commission illustrates a

category of contracts that experienced an average off-exchange trading

volume greater than 15% but less than 100% over the three month period.

The Commission recognizes that there are contracts that may experience

off-exchange trading averages that are above the proposed 15% maximum

off-exchange trading and that circumstances surrounding those contracts

may warrant an exemption from the minimum centralized market trading

percentage requirement. For example, there may be situations where a

newly-listed contract initially may have little on-exchange trading,

and may fail to meet the minimum centralized market trading requirement

for the initial 12 month period despite experiencing a steady increase

in trading volume over time. In those situations, it may be appropriate

to provide the DCM with an opportunity to petition for an exemption to

this requirement for a maximum of a 12 month period. Proposed Sec.

38.502(e)(1) reflects such an exemption.

In order to promote legitimate petitions, the proposed rule

specifically provides that the DCM must demonstrate in its petition

that such contract has achieved an average of at least 50% trading

volume on the centralized market over the preceding 12 month period,

and also must make an adequate showing that the contract, if granted

the exception, is likely to attain the minimum trading requirement

within the following 12 month period. The Commission also recognizes

that some affected contracts that are listed as of the effective date

of the proposed rule may not have been listed and traded for a full 12

month period at such time, potentially requiring the DCM to calculate

the contract's on-exchange trading based on some shorter period of

time. In those situations, the Commission believes it is only fair to

allow such contracts additional time, if desired, to determine whether

the minimum centralized market trading percentage requirement is met.

As such, the Commission proposes in Sec. 38.502(e)(2) to allow a DCM

in this situation to petition the Commission to exempt a contract from

the requirements of proposed Sec. 38.502(d) for a maximum period of 12

months. Under proposed Sec. 38.502(e)(3) petitions seeking an

exemption from the mandatory delisting requirement in Sec. 38.502(c)

must be submitted to the Commission within thirty-five days of the 12

month anniversary of the listing of such contract, or for affected

contracts

[[Page 80591]]

seeking an exemption because they have been listed for less than 12

months, thirty-five days after the effective date of this section. The

filing of a petition shall toll the mandatory delisting requirement

until such time that a decision is made. The Commission invites

comments on all aspects of this proposed rule.

We specifically request comment on how the proposals related to the

requirement that 85 percent or greater of volume of a contract must be

traded on the DCM's centralized market will affect the ability of

market participants to take advantage of efficiencies like portfolio

margining for swaps and futures positions. We also request comment on

any negative consequences this proposal may have on the trading of

swaps and related transactions like exchange of futures for swaps? The

Commission also is requesting comments on whether any other exemptions

should be considered for contracts that do not meet the minimum

centralized market trading percentage threshold of on-exchange trading

volume but nevertheless appear to serve a price discovery function, and

what factors should be considered in making the exemption

determination. For example, would it be acceptable for a contract

market to provide evidence of the frequency to which cash market bids,

offers or transactions in a commodity are directly based on, or are

determined by referencing the prices generated by trading the subject

contract on the designated contract market? Finally, the Commission

also requests comments, with supporting information, on whether the

Commission should consider any other exemptions from proposed Sec.

38.502.

iii. Proposed Sec. 38.503--Block Trades on Futures Contracts

As noted above, in addition to updates to Sec. 1.38, the 2008 Core

Principle 9 Proposed Rulemaking \105\ proposed revised guidance and

acceptable practices relating to block transactions for futures and

options. The Commission proposes to codify some of the provisions in

the guidance and acceptable practices relating to block trading that

are, to a large degree, already current industry practice. The

Commission believes that codifying these block trading requirements

will result in greater regulatory certainty and consistency for DCMs.

As discussed below, the Commission proposes, however, to maintain

guidance and acceptable practices with respect to a DCM's determination

of block sizes and block pricing for futures contracts, as it is

expected that the determination of block sizes and pricing will evolve

as both the industry and the Commission continue to gain experience in

this area.

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\105\ The Commission first proposed amendments to section 1.38

and guidance with respect to Core Principle 9 in July 2004. See 69

FR 39,880, Jul. 1, 2004.

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Consistent with the requirements set forth in current Sec. 1.38

and amended Core Principle 9, proposed Sec. 38.503(a) would require

that a board of trade that permits block trade transactions on futures

contracts must have rules governing such transactions. As proposed in

the 2008 Core Principle 9 Proposed Rulemaking, this regulation will

require that the rules limit block trades to large transactions and

impose minimum size requirements. The proposed rule also states that

the block trade size must be certified or approved by the Commission.

The Commission recognizes that the minimum size thresholds for

block trades in a contract may change over time due to changes in sizes

of trades in the centralized market and the market's volume and

liquidity. Accordingly, proposed Sec. 38.503(b) proposes that block

trade size must be reviewed on an annual basis. Any necessary

adjustments must be made to new and existing contracts.

Proposed Sec. 38.503(c) codifies the 2008 Core Principle 9

Proposed Rulemaking proposal to limit block trade parties for futures,

options and swaps to eligible contract participants (``ECPs'') as that

term is defined in Section 1a(18) of the CEA, as amended by the Dodd-

Frank Act. However, the rule makes clear that commodity trading

advisors acting in an asset managerial capacity and investment advisors

that have over $25 million in assets under management, including

foreign persons performing equivalent roles, are allowed to carry out

block trades for non-ECP customers. The proposed rule also prohibits

any person from conducting a block trade on behalf of a customer,

unless the person receives instruction or prior consent to do so from

the customer.\106\

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\106\ All of these requirements mirror block trade rules

previously approved by the Commission. The Commission approved block

trade rules of the Cantor Financial Futures Exchange, Inc. on

February 11, 2000; the Commission also approved Chicago Mercantile

Exchange block trade rules on May 19, 2000.

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Proposed Sec. 38.503(d) codifies the concepts in the 2008 Core

Principle 9 Proposed Rulemaking with respect to affiliated parties for

futures, options on futures and options on commodities. The proposed

rule defines an ``affiliated party,'' for purposes of block trades on

futures, as a party that directly or indirectly through one or more

persons, controls, is controlled by, or is under common control with

another party. As noted in the 2008 Core Principle 9 Proposed

Rulemaking, appropriate safeguards are important for block trades

between affiliated parties, because transactions between two closely

related parties are more susceptible to abuse, such as setting

unreasonable prices, artificially boosting volume, money passing, or

wash trading. This is because it is possible that two related parties

are not motivated by their own separate interests, but by the interests

of a person or entity that may control both of the parties. Thus, under

proposed Sec. 38.502(d)(3), block trades can take place between

affiliated parties under the following conditions: (i) The block trade

prices must be based on a competitive market price, either by falling

within the contemporaneous bid/ask spread on the centralized market or

calculated based on a contemporaneous market price in a related cash

market; (ii) each party must have a separate and independent bona fide

business purpose for engaging in the trades; and (iii) each party's

decision to enter into the block trade must be made by a separate and

independent decision-maker. As noted in the 2008 Core Principle 9

Proposed Rulemaking, the Commission believes that the proposed rules

for block trades between affiliated parties strike an appropriate

balance between allowing such trades and ensuring that each party is

acting independently when it agrees to enter into such a transaction.

Proposed Sec. 38.503(e) codifies the practices proposed in the

2008 Core Principle 9 Proposed Rulemaking relating to aggregation of

orders. The proposed rule prohibits aggregation of orders for different

trading accounts in order to satisfy the minimum block size

requirement, except if done by a commodity trading advisor acting in an

asset manager capacity or an investment advisor who has $25 million in

total assets under management.

Proposed Sec. 38.503(f) and (g) set forth the requirements for

recordkeeping and reporting of block trades for futures and options. As

to recordkeeping, proposed Sec. 38.502(f) reflects the provisions

contained in Sec. 1.38(b) with certain updates. Thus, as is the

current requirement, persons handling, executing, clearing, or carrying

transactions off the centralized market must follow the rules of the

DCM, including providing the appropriate identification of such

transactions to the DCM. In addition, the proposed rule codifies the

concept initially proposed in the 2008 Core Principle 9 Proposed

Rulemaking that the DCM must have rules for keeping appropriate

records.

[[Page 80592]]

Proposed Sec. 38.503(f) requires that parties to, and members

facilitating, block trades keep accurate block trade records that

comply with Core Principles 10 and 18 and the associated

regulations.\107\ The proposed rule also requires that block trade

orders and records must be accessible to the DCM, the Commission or the

Department of Justice, upon request.

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\107\ An acceptable practice under this regulation is set forth

in proposed appendix B of part 38 and provides that records kept in

accordance with the requirements of FASB Statement No. 133

(``Accounting for Derivative Instruments and Hedging Activities''),

as amended by FASB Statement No. 161 (``Disclosures About Derivative

Instruments and Hedging Activities--An amendment of FASB Statement

No. 133'') are acceptable records.

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Proposed Sec. 38.503(g) reflects a revised approach from the 2008

Core Principle 9 Proposed Rulemaking pertaining to the reporting of

block trades. While the 2008 Core Principle 9 Proposed Rulemaking

proposed that block trades be reported to the contract market within a

reasonable time, proposed Sec. 38.503(g) codifies the practice already

enforced by a great majority of DCMs by requiring that DCMs have up to

5 \108\ minutes to report block trades.\109\ The Commission believes

that this is an appropriate amount of time for reporting block trades

and balances the goals of providing transparency while enabling market

participants involved in block trades with time to hedge risks

associated with such trades. The Commission seeks comments as to

whether this is an appropriate time period or whether and why another

time period is more appropriate.

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\108\ The Commission notes that for a few contracts with lower

liquidity, such as weather and housing, CME allows for a 15 minute

reporting time.

\109\ See 73 FR 54,097, at note 18, Sep. 18, 2008 (noting CBOT

Rule 331.05(d), CMD Rule 526(F); NYMEX Rule 6.21C).

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In addition, proposed Sec. 38.503(g) requires DCMs to publicize

the details on block trades immediately upon the receipt of the

transaction report, and to publicize daily the total quantity of the

block trades that are included in the total volume of trading under the

procedures set forth in Sec. 16.01.

Proposed Sec. 38.503(h) refers applicants and DCMs to the guidance

in Appendix B to part 38 for purposes of determining block size and

pricing determinations. As noted above, the Commission is proposing

amended guidance and acceptable practices in Appendix B of part 38

pertaining to block size and block pricing. The Commission believes

that a one-size fits all approach to determining block size and pricing

is inappropriate for block trades as it is expected, as noted above,

that the determination of block sizes and pricing will evolve as both

the industry and the Commission continue to gain experience in this

area. Accordingly, the Commission is re-proposing, with some changes,

the acceptable practices that were proposed in the 2008 Core Principle

9 Proposed Rulemaking regarding establishing an acceptable minimum

block size.

The 2008 Core Principle 9 Proposed Rulemaking proposed replacing an

earlier-proposed numerical test with the concept that, in establishing

requirements for minimum block size, it was more appropriate to utilize

a procedural approach that takes into consideration the purposes for

allowing blocks and the trading in the particular contract. The 2008

Core Principle 9 Proposed Rulemaking explained that one of the bases

for permitting block trades to be transacted off the centralized market

is that prices attendant to the execution of large transactions on the

centralized market may diverge from prevailing market prices that

reflect supply and demand of the commodity. This is because the

centralized market may not provide sufficient liquidity to execute

large transactions without additional costs that may reflect the cost

of executing the trade. Consequently, reporting these prices as

conventional market trades would be misleading to the public. As

explained in the 2008 Core Principle 9 Proposed Rulemaking, another

basis for allowing block trades is that such trades facilitate hedging

by providing a means for commercial firms to transact large orders

without the need for significant price concessions, and resulting price

uncertainty for parties to the transaction that would occur if

transacted on the centralized market. Finally, a procedural approach is

more appropriate because the size of a typical trade varies between

contracts, and is dependent on the liquidity in the centralized market

and other commercial factors.

Given these reasons, the Commission previously proposed a standard

whereby the minimum block trade sizes should be larger than the size at

which a single buy or sell order is customarily able to be filled in

its entirety at a single price in that contract's centralized market,

and exchanges should determine a fixed minimum number of contracts

needed to meet this threshold. The Commission is re-proposing this

acceptable practice with some modifications. Specifically, the

Commission proposes that block trade sizes should be a number larger

than the size at which a single buy or sell order is customarily able

to be filled in its entirety without incurring a substantial price

concession. The Commission believes this is a more appropriate

threshold because in less liquid markets even a small number of trades

could have a slight movement on price and would not present an accurate

picture of the market.

In the 2008 Core Principle 9 Proposed Rulemaking, the Commission

also proposed, as part of the acceptable practice, certain factors that

the DCM could consider in determining the appropriate minimum block

size. These factors included the market's volume, liquidity and depth,

a review of typical trade sizes and/order sizes and any input it may

receive from floor brokers, floor traders and/or market users

regarding, for example, what size order is generally too large to fill

without major price concessions. The Commission believes that these

factors are likely to lead to an appropriate block size and thus

proposes them as acceptable practices in this release. In addition, the

Commission is proposing that DCMs also take into account, as an

additional factor, the block sizes on comparable swap products. This

additional factor is necessary and appropriate in light of the

inclusion of swap trading and execution on DCMs and SEFs, and the

corresponding swap block rules discussed below.

The Commission proposes similar acceptable practices for

determining the acceptable minimum size for block trades in new futures

contracts and options. However, because a new contract will not have

any trading history, the Commission proposes that the acceptable

minimum block trade size in such contracts is the trade size that the

DCM reasonably anticipates will not be able to be filled in its

entirety in the contract's centralized market, without major price

concessions. In determining an acceptable block size, the DCM should

consider centralized market data in a related futures contract, the

same contract traded on another exchange, or trading activity in the

underlying cash market. For the reasons discussed above, the DCM should

also consider, as an additional factor, the block sizes on comparable

swap products.

The Commission also re-proposes in this release the acceptable

practices proposed in the 2008 Core Principle 9 Proposed Rulemaking

relating to the pricing of blocks. The proposed acceptable practice

requires that block trades between non-affiliated parties must be at a

fair and reasonable price. The proposed acceptable practices set forth

the factors that could be considered by DCMs in determining what is

fair and reasonable, including:

[[Page 80593]]

(1) The size of the block, (2) the price and size of other block trades

in any relevant markets at the applicable time, and (3) the

circumstances of the market or the parties to the block trade. The

proposed acceptable practice states that relevant markets include the

DCM itself, the underlying cash markets and/or related futures or

option markets. As noted in the proposed acceptable practices, if the

contract market rule requiring a fair and reasonable price includes the

circumstances of the parties or of the market, a block trade

participant can execute a block transaction at a price that is away

from the market provided that the participant retains documentation to

demonstrate that the price was indeed fair and reasonable under the

participant's or market's particular circumstances. In addition, the

proposed acceptable practices note that block trades between affiliated

parties are subject to the pricing requirements in Sec. 38.503(d).

iv. Proposed Sec. 38.504--Block Trades on Swap Contracts

The Dodd-Frank Act amended the CEA to expand the list of products

that may be traded on a DCM to include swaps, in addition to futures

and options contracts. The Commission recognizes that there exists

certain inherent differences between futures and options, on the one

hand, and swaps on the other, which may necessitate that DCMs apply

different rules to these products. While the Commission generally

believes that the same block trade rules should apply to futures,

options and swaps listed and traded on the DCM, the Commission proposes

that characteristics of swaps do warrant a different approach for

purposes of determining minimum block size. In addition, the Dodd-Frank

Act provides specific statutory requirements for reporting of swap

block transactions. The rules governing each of these requirements are

currently being addressed in a forthcoming Commission release titled

``Real Time Reporting,'' which is proposing rules that will be codified

in part 43 of the Commission's regulations.\110\ Accordingly, DCMs must

comply with the provisions of proposed part 43 for purposes of setting

the minimum size of swap block trades, and for reporting swap block

trades. Proposed Sec. 38.504 provides that DCMs must have rules that

require compliance with these rules for swaps traded on their markets.

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\110\ See supra note 43.

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v. Proposed Sec. 38.505--Exchange of Derivatives for Related Position

In the 2008 Core Principle 9 Proposed Rulemaking, the Commission

proposed acceptable practices relating to exchange of futures for

related position transactions. The acceptable practices proposed in

that rulemaking were based on previous publications by the Commission,

including the 1987 EFP Report prepared by the Commission's then-

Division of Trading and Markets and the Commission's 1998 EFP Concept

Release.\111\ Proposed Sec. 38.505 codifies the practices that the

Commission historically has required from DCMs with respect to these

types of transactions.

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\111\ See Division of Trading and Markets, Report on Exchanges

of Futures for Physicals (1987) (the ``1987 EFP Report'');

Regulation of Non-Competitive Transactions Executed on or Subject to

the Rules of a Contract Market, 63 FR 3708, Jan. 26, 1998 (the

``1998 EFP Concept Release'').

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As an initial matter, proposed Sec. 38.505 (a) revises the

nomenclature for referring to transactions that have been referred to

in the past as ``exchange of futures for commodities or derivatives

positions,'' to refer to all such transactions under the umbrella term

``exchange of derivatives for related position'' (``EDRP''). The

Commission believes that this is a more accurate and descriptive term

as it will include transactions not limited to futures, such as swaps.

Proposed Sec. 38.505(a) codifies the requirements and characteristics

of a bona fide EDRP and is based on Commission standards that have

developed over the years. Specifically, the proposed rule sets forth

the elements of a bona fide EDRP to include separate but integrally

related transactions, price correlation and quantitative equivalence of

the two legs, an actual transfer of ownership of the commodity or

derivatives position and both legs transacted between the same two

parties.

As to pricing of these transactions, proposed Sec. 38.505

maintains the methodology set forth in the acceptable practices

proposed in the 2008 Core Principle 9 Proposed Rulemaking.\112\

Accordingly, the proposed rule provides that the price differential

between the two legs should reflect commercial realities, and at least

one leg of the transaction should be priced at the prevailing market

price.

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\112\ The Commission is codifying the EDRP pricing methodology

based on its experience over the past years in determining the

reasonability of EDRP pricing.

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Further, proposed Sec. 38.505(b) codifies the requirements

applicable to bona fide transitory exchange of derivatives for related

position transactions. A transitory exchange of derivatives for a

related position transaction involves both an EDRP and an off-setting

transaction to one of the legs of that transaction. As codified in

Sec. 38.504(b), the proposed rule will permit parties to an EDRP to

engage in a separate transaction that offsets a leg of the EDRP if the

offsetting transaction results in an actual transfer of ownership and

demonstrates other indicia of being a bona fide transaction, and the

offsetting transaction is able to stand on its own as a commercially

appropriate transaction; that is, there must be no obligation on either

party that the offsetting transaction will require the execution of a

related EDRP, or vice versa.

Proposed Sec. 38.505(c) prohibits DCMs from permitting a

contingent exchange of derivative for a related position transaction

where the exchange of derivative for the related position is contingent

upon an offsetting transaction.

In the 2008 Core Principle 9 Proposed Rulemaking, the Commission

proposed that EDRP transactions be reported to the DCM within a

reasonable time. Given the continuous changes and advancements in

electronic trading over the years, the Commission believes that such

trades also should be reported in a five minute time period, as is

proposed for block trades. Thus, proposed Sec. 38.505(d) requires that

such trades be reported to the market within five minutes of

consummation. The Commission invites comments on this proposal and, in

particular, if and why any other time period should be allowed.

Proposed Sec. 38.505(e) codifies the acceptable practice proposed

in the 2008 Core Principle 9 Proposed Rulemaking requiring the DCM to

follow procedures set forth in current section 16.01 to publicize daily

the total quantity of exchange for derivatives for related position.

vi. Proposed Sec. 38.506--Office Trades and Transfer Trades

In the 2008 Core Principle 9 Proposed Rulemaking, the Commission

noted that transfer trades and office trades move existing positions

between accounts and are bookkeeping in nature. Such transactions,

therefore, do not affect the price discovery process of the centralized

market because they do not establish or offset positions. The

Commission will not require these transactions to follow the

publication requirements under Sec. 16.01 as required for blocks and

EDRPs. Instead, proposed Sec. 38.506 requires that records of such

[[Page 80594]]

transactions be kept in accordance with the recordkeeping regulation

Sec. 1.31.

10. Subpart K--Trade Information

Section 5(d)(10) of the CEA, as amended by the Dodd-Frank Act,

requires DCMs to capture, verify, and retain detailed trade information

(i.e., audit trail data) for all transactions in their markets. Amended

Core Principle 10--Trade Information is almost identical to the

requirements contained in the current Core Principle 10. Both the

amended and current Core Principle 10 require DCMs to maintain rules

and procedures that provide for the recording and safe storage of all

identifying trade information in a manner that enables the DCM to

assist in the prevention of customer and market abuses and provide

evidence of any rule violations. Because the amended core principle has

almost identical statutory text, the Commission interprets amended Core

Principle 10 as imposing the same substantive content as its

predecessor.\113\

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\113\ The Commission previously expressed the regulatory

requirements of former Core Principle 10 through its application

guidance for that core principle. See 17 CFR part 38, App. B,

Application Guidance and Acceptable Practices for Core Principle 10.

It also provided additional insight regarding the core principle

through detailed acceptable practices that all DCMs could use to

demonstrate compliance with former Core Principle 10. The acceptable

practices explained that ``the goal of an audit trail is to detect

and deter customer and market abuse.'' Id. at (b)(1). It also

outlined the elements of an effective audit trail. Those elements

included original source documents, which help to establish the

accuracy and authenticity of an audit trail. They also included a

transaction history database and electronic analysis capability,

which allow a DCM to more easily access and review audit trail data

to identify possible trading abuses and rule violations. Finally,

the acceptable practices pointed to a DCM's safe storage capability,

emphasizing that audit trail data must be stored in a manner that

protects it from unauthorized alteration, accidental erasure, or

other loss.

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The application guidance and acceptable practices for current Core

Principle 10 provide the basis of the Commission's proposed audit trail

regulations in proposed subpart K, particularly proposed Sec. Sec.

38.551 (Audit Trail Required) and 38.552 (Elements of an Acceptable

Audit Trail Program), summarized below. In addition, the proposed rules

update the guidance and acceptable practices in that the proposed

regulations address audit trail requirements for electronic trading.

The Commission notes that the proposed rules for electronic trading

audit trails are substantially similar to the long-standing

requirements for open-outcry trading. However, because those

requirements reflected a time when electronic trading accounted for

less than 10 percent of U.S. futures volume, they did not explicitly

address electronic trading.\114\

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\114\ This figure is based on fiscal year 2000, as reported in

the Commission's FY 2009 Performance and Accountability Report, p.

14.

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The proposed rules also draw on recent RERs analyzing DCMs'

compliance with former Core Principle 10. In the context of RERs, staff

has made a number of findings and recommendations regarding DCMs' audit

trail enforcement programs, including recommendations regarding more

frequent audit trail reviews and larger sanctions for audit trail

violations. Staff also has directed DCMs to develop audit trail

programs for electronic trading that are comparable in rigor and scope

to their audit trail programs for open-outcry trading.\115\ These

findings and recommendations, including those with respect to

electronic trading audit trails, are reflected in proposed Sec.

38.553, also summarized below.

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\115\ See Rule Enforcement Review of the Minneapolis Grain

Exchange (August 27, 2009), and Rule Enforcement Review of ICE

Futures U.S. (Feb. 2, 2010).

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Whether applicable to open-outcry or to electronic trading, the

proposed rules in subpart K seek to ensure that DCMs capture, verify,

and retain sufficient order and trade-related information for DCM staff

to detect possible trading violations and other market and customer

abuses. They also require DCMs to possess specific resources and

capabilities with respect to their audit trails. These include the

ability to promptly reconstruct all transactions and the ability to

track customer orders from the time of receipt through fill,

allocation, or any other disposition. The proposed rules also require a

DCM's audit trail program to collect original source documents, to

build a transaction history database, and to develop an electronic

analysis capability with respect to all trade information in that

database. DCMs also must possess a safe storage capability with respect

to their audit trail data. Finally, they must develop meaningful

enforcement programs to ensure member and market participant compliance

with all applicable audit trail requirements. In each respect, the

Commission's proposed rules are consistent with its long-standing

requirements and expectations regarding reliable, complete, and

effective audit trails. The specific requirements of the proposed rules

implementing amended Core Principle 10 are summarized below.

i. Proposed Sec. 38.551--Audit Trail Required

Proposed Sec. 38.551 is based on the application guidance and

acceptable practices for former Core Principle 10.\116\ It establishes

the overarching requirements for DCMs' audit trail programs to ensure

that DCMs can appropriately monitor and investigate any potential

customer and market abuse. Proposed Sec. 38.551 provides that the

audit trail data captured by DCMs must be sufficient to reconstruct all

transactions within a reasonable period of time, and to provide

evidence of any rule violations that may have occurred. The proposed

rule also provides that audit trails must be sufficient to track

customer orders from the time of receipt through fill, allocation, or

other disposition. Audit trail data must include both order and trade

information. Proposed Sec. 38.551 applies equally to open-outcry and

electronic trading.

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\116\ 17 CFR Part 38, App. B, Core Principle 10, Application

Guidance and Acceptable Practices.

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

Program

Proposed Sec. 38.552 prescribes the four elements of an acceptable

audit trail program. These elements are necessary to ensure that a DCM

can capture and retain sufficient trade-related information, can

reconstruct trading promptly, and has the necessary tools to detect and

deter potential customer and market abuses through its audit trail.

First, proposed Sec. 38.552(a) requires that a DCM's audit trail

include original source documents, defined to include unalterable,

sequentially-identified records on which trade execution information is

originally recorded, whether manually or electronically. It also

requires that customer order records demonstrate the terms of the

order, the account identifier that relates to the account owner, and

the time of the order entry. Finally, proposed Sec. 38.552(a) requires

that, for open-outcry trades, the time of report of order of execution

must also be captured in the audit trail.

Second, proposed Sec. 38.552(b) requires that a DCM's audit trail

program must include a transaction history database. A transaction

history database facilitates rapid access and analysis of all original

source documents, thereby aiding DCMs in monitoring for customer and

market abuses. Proposed Sec. 38.552(b) also specifies the trade

information that must be included in a transaction history database.

Mandatory information includes a history of all orders and trades; all

data input in the trade

[[Page 80595]]

matching system for clearing; the categories of participants for which

trades are executed (i.e., customer type indicator or ``CTI'' codes);

timing and sequencing data sufficient to reconstruct trading; and

identification of each account to which fills are allocated.

Third, proposed Sec. 38.552(c) requires that a DCM's audit trail

program have electronic analysis capability for all data in its

transaction history database. This requirement helps ensure effective

use of audit trail data by requiring appropriate tools to use in

conjunction with a DCM's transaction history database. Proposed Sec.

38.552(c) also provides that a DCM's electronic analysis capability

must allow it to reconstruct trades in order to identify possible rule

violations.

Finally, proposed Sec. 38.552(d) requires that a DCM's audit trail

program include the ability to safely store all audit trail data, and

to retain it in accordance with the recordkeeping requirements of DCM

Core Principle 18 and the associated regulations under part 38. Safe

storage capability enables a DCM to properly preserve and protect the

audit trail data so that it is readily available for the DCM to use in

any future investigation or inquiry into possible violations of DCM

rules. Safe storage capability requires a DCM to protect its audit

trail data from unauthorized alteration, accidental erasure or other

loss.

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

Proposed Sec. 38.553 prescribes the elements of an effective audit

trail enforcement program. The proposed rule is organized in two parts.

First, proposed Sec. 38.553(a) requires a DCM to develop an effective

audit trail enforcement program. An effective enforcement program must,

at a minimum, review all members and market participants annually to

verify their compliance with all applicable audit trail requirements.

Proposed Sec. 38.553(a) is further divided into two paragraphs.

Paragraph (a)(2) of proposed Sec. 38.553 establishes minimum review

criteria for open-outcry trading. It requires that DCMs conduct annual

reviews of all members and market participants to verify their

compliance with their trade timing, order ticket and trading card

requirements. Similarly, paragraph (a)(1) sets forth minimum review

criteria for an electronic trading audit trail. It requires annual

examinations by DCMs of randomly selected samples of front-end audit

trail data from order routing systems to ensure the presence and

accuracy of required audit trail data. In addition, paragraph (a)(1)

requires that DCMs: Review the processes used by members and market

participants to assign and maintain exchange user identifications;

review usage patterns of the user identifications; and review account

numbers and Customer Trading Identification codes in trade records to

test for accuracy and improper usage. The Commission notes that,

compared to the corresponding requirements for open-outcry trading,

audit trail and audit trail enforcement requirements for electronic

trading are still evolving, and that the Commission's expectations in

this area, pursuant to amended Core Principle 10, are likely to evolve

as well.

Second, proposed Sec. 38.553(b) requires DCMs to develop programs

to ensure effective enforcement of their audit trail and recordkeeping

requirements. It applies equally to both open-outcry and electronic

trading. Proposed Sec. 38.553(b) requires DCMs' enforcement programs

to identify members and market participants that routinely fail to

comply with the requirements of Core Principle 10. DCMs also must levy

meaningful sanctions when deficiencies are found. Sanctions may not

include more than one warning letter or other non-financial penalty for

the same violation within a rolling twelve-month period.

11. Subpart L--Financial Integrity of Transactions

Core Principle 11, as amended by the Dodd-Frank Act, retains the

provisions of current Core Principle 11.\117\ This core principle

requires that a DCM establish and enforce rules and procedures for

ensuring the financial integrity of transactions entered into, on or

through the facilities of the contract market, including the clearing

and settlement of the transactions with a DCO. Amended Core Principle

11 also requires that a DCM establish and enforce rules to ensure: (i)

The financial integrity of any futures commission merchant (``FCM'')

and introducing broker (``IB''); and (ii) the protection of customer

funds. Because textually the language is almost the same, the

Commission is interpreting the provisions as it has in the past.

Proposed Sec. Sec. 38.600 through 38.607, largely codify language

found in the existing application guidance for current Core Principle

11 and former Designation Criterion 5.\118\ However, based upon its

past experience, the Commission is proposing some new practices and

requirements for DCMs in implementing amended Core Principle 11.

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\117\ There were no substantive changes to the amended Core

Principle 11 from the current one. The amended core principle reads

as follows: The board of trade shall establish and enforce--(A)

rules and procedures for ensuring the financial integrity of

transactions entered into on or through the facilities of the

contract market (including the clearance and settlement of the

transactions with a derivatives clearing organization); and (B)

rules to ensure: (i) The financial integrity of any (I) futures

commission merchant, and (II) introducing broker; and (ii) the

protection of customer funds.

\118\ Former Designation Criterion 5 stated that ``the board of

trade shall establish and enforce rules and procedures for ensuring

the financial integrity of transactions entered into by or through

the facilities of the contract market, including the clearance and

settlement of the transactions with a derivatives clearing

organization.'' 17 CFR part 38, App. A.

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Proposed Sec. 38.601 would require that all transactions executed

on or through a DCM, other than transactions in security futures

products, be cleared through a Commission-registered DCO. This proposed

rule codifies current practice, as well as the requirements of amended

Core Principle 11 to mandate clearing. The Commission interprets the

mandatory clearing requirement in Section 723(a)(3) of the Dodd-Frank

Act \119\ to mean that a DCO must clear a swap for any DCM or SEF that

requests such clearing services, so long as the DCO offers the swap for

clearing. In addition, a DCO that is clearing particular swaps must

also clear the same swaps when listed on DCMs or SEFs, whether

affiliated or unaffiliated, on a nondiscriminatory basis.

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\119\ Among other things, section 723(a)(3) of the Dodd-Frank

Act adds a new section 2(h)(1) to the CEA that provides that: (i)

All swaps that are required to be cleared be cleared by a

Commission-registered DCO; and (ii) a DCO must have open access

rules, including rules providing for the non-discriminatory clearing

of a swap executed bilaterally on or through the rules of an

unaffiliated DCM or SEF.

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Proposed Sec. Sec. 38.602 and 38.603 provide that DCMs must adopt

rules establishing minimum financial standards for both member FCMs and

IBs and non-intermediated market participants, as well as rules for the

protection of customer funds, including the segregation of customer and

proprietary funds, the custody of customer funds, the investment

standards for customer funds, intermediary default procedures and

related recordkeeping. Proposed Sec. 38.604 requires that a DCM must

routinely receive and promptly review financial and related information

from its members and conduct ongoing financial surveillance of the risk

created by the positions the customers of an FCM take on the DCM. To

meet this requirement, the DCM must have rules pertaining to minimum

financial standards of intermediaries that include, among other things,

rules prescribing minimum capital requirements for

[[Page 80596]]

member FCMs and IBs.\120\ Rules or procedures pertaining to protection

of customer funds must include, among other things, that each DCM must

continually survey the obligations of each FCM created by the positions

of its customers, and, as appropriate, compare those obligations to the

financial resources of the FCM. The DCM should use this information to

protect customer funds by, for example, taking appropriate steps to

verify that its member FCMs have sufficient capital to continue to

guarantee the positions of each customer. If the obligations of a

member FCM appear excessive as compared to the capital of such FCM, a

DCM should take appropriate action, including contacting the FCM or the

FCM's designated self-regulatory organization.

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\120\ An FCM that is a clearing member will also have additional

obligations to the DCO as a result of its clearing membership.

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Proposed Sec. 38.605 requires DCMs as self-regulatory

organizations (``SRO'') to comply with the standards of amended Sec.

1.52 to ensure the financial integrity of intermediaries by

establishing and carrying out an SRO program for the examination and

financial supervision of intermediaries. Section 1.52, as proposed to

be amended in this release, sets forth the required elements of SRO

supervisory programs and permits one or more SROs to establish, subject

to Commission approval, a joint audit plan to provide for the SRO

supervision of members of more than one SRO. Proposed amendments to

Sec. 1.52 include references to existing guidance to SROs contained in

the Division of Trading and Markets Financial and Segregation

Interpretations 4-1 and 4-2, which currently guide the practices of

members of the Joint Audit Committee operating a joint audit plan that

has been approved by the Commission.\121\

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\121\ See 73 FR 52832, Sept. 11, 2008 (requesting comments prior

to the Commission's approval of the most recent Joint Audit

Committee agreement, which approval was granted March 18, 2009).

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Proposed Sec. 38.606 would provide that DCMs may satisfy their

financial surveillance responsibilities under proposed Sec. Sec.

38.604 and 38.605 by outsourcing such responsibilities to a registered

futures association or other regulated entity. Proposed Sec. 38.606

would provide that a DCM must ensure that the regulatory service

provider has the capacity and resources to conduct the necessary

financial surveillance, and would further provide that the DCM remains

responsible for compliance with its financial surveillance obligations

notwithstanding the use of a regulatory service provider.

As noted above, amended Core Principle 11 provides that a DCM must

establish and enforce rules to, among other things, ensure both the

financial integrity of any FCM, and the protection of customer funds.

With an increasing number of DCMs permitting the customers of an FCM to

transmit orders directly to the DCM in real time, the ability of an FCM

to control and monitor its level of risk may become compromised. In

this automated trading environment, the only controls that effectively

can enforce limitations on risk are automated controls.\122\ Proposed

Sec. 38.607 would require a DCM that allows customers direct access to

its contract market to implement certain direct access controls and

procedures in order to provide member FCMs with tools to manage their

financial risk. The proposed rule contemplates that an FCM would

continue to have primary responsibility for overall risk management,

but that the DCM would be required to establish an automated risk

management system permitting an FCM to set appropriate risk limits for

each customer with direct access to the contract market. As an SRO, the

DCM would be responsible for implementing and enforcing rules requiring

the FCM to use the provided controls and procedures appropriately. The

specific type of pre-trade controls implemented by a DCM shall be a

matter for determination by the DCM, its member FCMs, and the DCM's

DCO. This proposed rule requiring direct access controls and procedures

where direct access is permitted is consistent with current

international guidance.\123\ The Commission requests comments on the

proposed rule, and specifically on the following questions:

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\122\ International Organization of Security Commissions

[IOSCO], Final Report of the IOSCO Technical Committee, Principles

for Direct Electronic Access to Markets, at 4, IOSCO Doc. FR08/10

(August 12, 2010).

\123\ Id.

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Whether DCMs should provide additional controls to permit

FCMs to manage their risks? If so, what specific direct access controls

and procedures should DCMs implement?

Should such controls be mandatory?

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

Section 735 of the Dodd-Frank Act amends Core Principle 12. Current

Core Principle 12 states that the board of trade shall establish and

enforce rules to protect market participants from abusive practices

committed by any party acting as an agent for the participants. The

amended Core Principle 12 requires that the DCM establish and enforce

rules to protect markets and market participants from abusive practices

committed by any party, including abusive practices committed by a

party acting as an agent for a participant, and promote fair and

equitable trading on the contract market. The current guidance for this

core principle \124\ provides that a DCM should have methods and

resources appropriate to the nature of the trading system and the

structure of the market to detect trade practice and market abuses, and

to prohibit, detect and discipline intermediary behavior that is

abusive, fraudulent, noncompetitive or unfair, in connection with the

execution of trades.

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\124\ The current guidance for Core Principle 12 provides that

``a designated contract market should have rules prohibiting conduct

by intermediaries that is fraudulent, noncompetitive, unfair, or an

abusive practice in connection with the execution of trades and a

program to detect and discipline such behavior. The contract market

should have methods and resources appropriate to the nature of the

trading system and the structure of the market to detect trade

practice abuses.'' 17 CFR part 38, App. B.

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The Commission believes that compliance with this core principle

requires the DCM to implement trade practice and market surveillance

programs and provide a competitive, open and efficient market and

mechanism for executing transactions in accordance with other core

principles and the regulations thereunder. To provide clarity and

certainty of these requirements, the Commission proposes Sec. 38.651

that specifically states compliance requirements, including the core

principles that must be followed. Specifically, a trade practice

surveillance program should be conducted in accordance with Core

Principle 2 and the associated regulations in subpart C of this part

38, which would require, among other things, that a DCM prohibit

certain enumerated abusive and disruptive trading practices, have

arrangements and resources for effective rule enforcement and enforce

compliance with its rules and have the capacity to detect, investigate,

and sanction violations.

A market surveillance program should include monitoring the market

to prevent manipulation, price distortion and disruptions of daily

trading and the physical delivery or cash-settlement process. A market

surveillance program should be conducted in accordance with Core

Principle 4 and the associated regulations in subpart E of this part 38

that would require, among other things, that the DCM demonstrate the

capability of conducting real-time monitoring of trading and

comprehensive and accurate

[[Page 80597]]

trade reconstructions and require that traders in their markets keep

records, including their activity in the underlying commodity and

related derivative markets. Effectively monitoring the market would

require sufficient, well trained market surveillance staff and, where

appropriate, automated tools to assist in the monitoring of the market

for, among other things, potential market disruptions. Such automated

tools should be capable of providing automated trading alerts to detect

many types of potential violations of exchange or Commission rules.

Finally, in order to promote fair and equitable trading, the DCM

must establish and enforce trading rules with adequate specificity to

include, among other things, providing to market participants, on a

fair, equitable and timely basis, information regarding prices, bids

and offers. The DCM should provide a competitive, open and efficient

market and mechanism for executing transactions in accordance with Core

Principle 9 and the associated regulations in subpart J of this part 38

that, among other things, recognizes that trading in the centralized

market provides a price discovery function and would specifically

require that the execution of transactions be in a manner that protects

that price discovery process.

13. Subpart N--Disciplinary Procedures

Section 735 of the Dodd-Frank Act amends the disciplinary procedure

requirements applicable to DCMs in two significant ways. First, Section

735(a) eliminates all DCM designation criteria, including Designation

Criterion 6 (Disciplinary Procedures).\125\ Second, Section 735(b)

creates a new Core Principle 13 (Disciplinary Procedures) that is

devoted exclusively to exchange disciplinary proceedings, and that

captures disciplinary concepts inherent in both Designation Criterion 6

and in current DCM Core Principle 2 (Compliance with Rules).\126\ The

rules proposed under subpart N implement new Core Principle 13.\127\

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\125\ See Sec. 735(a) of the Dodd-Frank Act.

\126\ Compare current CEA Sec. 5(b)(6) and Sec. 5(d)(2) with

CEA Sec. 5(d)(13) as amended by the Dodd-Frank Act.

\127\ Prior to the passage of the Dodd-Frank Act, the standards

for DCMs' disciplinary practices were found in Designation Criterion

6 and the statutory language, guidance, and acceptable practices for

former Core Principle 2. Designation Criterion 6 required that a DCM

establish and enforce disciplinary procedures that authorized it to

discipline, suspend, or expel members or market participants that

violated the rules of the DCM, or similar methods for performing the

same functions, including delegation of the functions to third

parties. Paragraph (a)(2) of the application guidance for former

Core Principle 2 required DCMs to have the ``arrangements,

resources, and authority [necessary] for effective rule

enforcement,'' and the ``authority and ability to discipline and

limit, or suspend the activities of a member or market participant

pursuant to clear and fair standards.'' 17 CFR part 38, App. B,

Application Guidance for Core Principle 2 at (a)(2). In addition,

paragraph (b)(4) of the former core principle's acceptable practices

required any DCM that wished to take advantage of the acceptable

practice's safe harbor to have ``prompt and effective disciplinary

action for any violation * * * found to have been committed.'' 17

CFR part 38, App. B, Acceptable Practices for Core Principle 2 at

(b)(4). Paragraph (b)(4) also referenced part 8 of the Commission's

regulations as an example that DCMs could follow to comply with Core

Principle 2. 17 CFR 8.01 et seq. In its experience, the Commission

has found that many DCMs' disciplinary programs do in fact model the

disciplinary structures and processes in part 8. While the

acceptable practices for former Core Principle 2 offered the

disciplinary procedures in part 8 as an example of appropriate

disciplinary procedures, DCMs were exempt from part 8 pursuant to

Sec. 38.2. The disciplinary procedures proposed herein do not re-

subject DCMs to part 8, but rather propose new disciplinary

procedures for inclusion in part 38.

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The proposed rules in subpart N are consistent with current

disciplinary practices at most DCMs. They reflect disciplinary concepts

formerly found in Designation Criterion 6 and the guidance and

acceptable practices for former Core Principle 2. The proposed rules

also are similar to the text of the disciplinary procedures in part 8

of the Commission's regulations.\128\ In general, the Commission's

proposed rules seek to ensure a fair, prompt, and effective

disciplinary program. They require meaningful sanctions against persons

and entities that violate DCM rules. The proposed rules also provide

numerous procedural safeguards to ensure fairness for all respondents

in disciplinary actions. Finally, they require full customer

restitution in any disciplinary matter where customer harm is

demonstrated.

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\128\ See supra note 47.

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In those cases where the proposed rules place new requirements on

DCMs with respect to their disciplinary procedures, such requirements

are derived from findings and recommendations made by Commission staff

through its RERs. Proposed Sec. 38.701 (Enforcement Staff), for

example, requires a DCM to have sufficient staff and resources to

effectively and promptly prosecute possible violations of exchange

rules. It also requires a DCM to monitor the size and workload of its

enforcement staff annually, and to increase its enforcement resources

and staff as appropriate. The text of proposed rule 38.701 mirrors that

of proposed rule 38.155, which requires DCMs to retain sufficient

compliance staff and resources to comply with new DCM Core Principle

2--Compliance with Rules.\129\

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\129\ See Rule Enforcement Review of the Minneapolis Grain

Exchange (Aug. 27, 2009), Rule Enforcement Review of ICE Futures

U.S. (Feb. 2, 2010), and Rule Enforcement Review of the Chicago

Board of Trade and the Chicago Mercantile Exchange (Sep. 13, 2010)

for findings and recommendations pertaining to the adequate staff

size of DCM compliance departments.

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Other proposed requirements in subpart N that are based on findings

and recommendations in recent RERs include a requirement that

disciplinary panels improve their written documentation in disciplinary

decisions and settlements.\130\ These heightened documentation

requirements appear in proposed Sec. 38.703 (Review of Investigation

Report), proposed Sec. 38.709 (Settlement Offers), and proposed Sec.

38.711 (Decisions), all of which require that the facts and analysis

supporting disciplinary settlements and decisions be explained

carefully and in writing by the relevant disciplinary panel. The

Commission believes that improved written documentation, as required by

the proposed rules, will yield a number of significant benefits.

Disciplinary panels will be required to focus their analysis more

carefully in order to articulate the rationale for their decisions. DCM

enforcement staff will gain a better understanding of the evidentiary

expectations to which different disciplinary panels adhere. DCM

enforcement staff and respondents will both have an improved record to

base any appeals they may wish to file. Finally, improved written

documentation of the facts and analysis supporting settlements and

disciplinary decisions will help facilitate subsequent review of DCMs'

disciplinary programs by the Commission.

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\130\ See Rule Enforcement Review of the New York Mercantile

Exchange (Sep. 16, 2004) and Rule Enforcement Review of the Chicago

Board of Trade and the Chicago Mercantile Exchange (Sep. 13, 2010).

The structure of disciplinary panels is discussed in the context of

proposed Sec. 38.702, below.

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Proposed Sec. 38.714 (Disciplinary Sanctions), further provides

that all disciplinary penalties imposed by a DCM or its disciplinary

panels must be commensurate with the violations committed, and be

sufficient to deter recidivist activity. This proposed rule reflects

DMO staff's concerns with respect to the adequacy of disciplinary

sanctions in cases it has examined through its RER process.\131\

Finally, proposed Sec. 38.715 (Summary Fines for Violations of Rules

Regarding Timely

[[Page 80598]]

Submission of Records, Decorum, or Other Similar Activities) makes

clear that a DCM should issue no more than one warning letter in a

rolling 12-month period before sanctions are imposed, again reflecting

DMO staff's concerns with respect to the adequacy of sanctions imposed.

Proposed subpart N is divided into a total of 16 rules, each of which

is described in detail below.

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\131\ See Rule Enforcement Review of the New York Mercantile

Exchange (Sep. 16, 2004); Rule Enforcement Review of the Kansas City

Board of Trade (June 16, 2006); and Rule Enforcement Review of the

Minneapolis Grain Exchange (Aug. 27, 2009).

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i. Proposed Sec. 38.701--Enforcement Staff

Proposed Sec. 38.701 requires that a DCM establish and maintain

sufficient enforcement staff and resources to effectively and promptly

prosecute possible rule violations within the jurisdiction of the

contract market. A DCM must also monitor the size and workload of its

enforcement staff annually and increase its resources and staff as

appropriate. The Commission recognizes that at some DCMs, compliance

staff also serves as enforcement staff. That is, they both investigate

cases and present them before disciplinary panels. These proposed rules

are not intended to prohibit that practice.

The Commission believes that adequate staff and resources are

essential to the effective performance of a DCM's disciplinary program.

As noted previously, this is reflected in DMO staff's findings and

recommendations in recent RERs, in which DMO staff recommended that

DCMs increase their compliance staff levels and monitor the size of

their staff and increase the number of staff appropriately as trading

volume increases, new responsibilities are assigned to compliance

staff, or internal reviews demonstrate that work is not completed in an

effective or timely manner.

Proposed Sec. 38.701 also provides that a DCM's enforcement staff

may not include members of the exchange or persons whose interests

conflict with their enforcement duties. Moreover, a member of the

enforcement staff may not operate under the direction or control of any

person or persons with trading privileges at the contract market. These

provisions seek to ensure the independence of enforcement staff, and

help promote disciplinary procedures that are free of potential

conflicts of interest.

ii. Proposed Sec. 38.702--Disciplinary Panels

Proposed Sec. 38.702 requires a DCM to establish one or more

Review Panels and one or more Hearing Panels (together, ``disciplinary

panels'') to fulfill its obligations under this section. The

composition of both panels must meet the composition requirements of

proposed Sec. 40.9(c)(3)(ii)\132\ and may not include any members of

the DCM's compliance staff, or any person involved in adjudicating any

other stage of the same proceeding. Paragraph (b) of the proposed rule

provides that a Review Panel must be responsible for determining

whether a reasonable basis exists for finding a violation of contract

market rules, and for authorizing the issuance of a notice of charges

against persons alleged to have violated exchange rules. If a notice of

charges is issued, then Paragraph (c) of the proposed rule helps to

ensure an impartial hearing by requiring a separate Hearing Panel to

adjudicate the matter and issue sanctions. The Commission notes that,

while proposed Sec. 38.702 requires DCMs to empanel distinct bodies to

issue charges and to adjudicate charges in a particular matter, DCMs

may determine for themselves whether their Review and Hearing Panels

are separate standing panels or ad hoc bodies whose members are chosen

from a larger ``disciplinary committee'' to serve in one capacity or

the other for a particular disciplinary matter.

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\132\ Section 40.9(c)(3)(ii), as proposed in the separate

release titled Requirements for Derivatives Clearing Organizations,

Designated Contract Markets, and Swap Execution Facilities Regarding

the Mitigation of Conflicts of Interest, provides that ``Each

Disciplinary Panel shall include at least one person who would not

be disqualified from serving as a Public Director by Sec.

1.3(ccc)(1)(i)-(vi) and (2) of this chapter (a ``Public

Participant''). Such Public Participant shall chair each

Disciplinary Panel. In addition, any registered entity specified in

paragraph (c)(3)(i) of this section shall adopt rules that would, at

a minimum: (A) Further preclude any group or class of participants

from dominating or exercising disproportionate influence on a

Disciplinary Panel and (B) Prohibit any member of a Disciplinary

Panel from participating in deliberations or voting on any matter in

which the member has a financial interest.'' See 75 FR 63732, Oct.

18, 2010.

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iii. Proposed Sec. 38.703--Review of Investigation Report

Proposed Sec. 38.703 requires a Review Panel to promptly review an

investigation report received pursuant to proposed Sec. 38.158(c). In

addition, a Review Panel must take action on any investigation report

received within 30 days of such receipt. The Commission believes that

prompt action by all disciplinary panels is necessary for an effective

disciplinary program. Among other considerations, prompt disciplinary

action provides the best opportunity for witnesses to recall

conversations, facts, and other information relevant to the matter. In

addition, prompt and effective disciplinary action provides a clear

signal to the market and to market participants that violations of

exchange rules will not be tolerated by the DCM.

After receipt of the investigation report, if a Review Panel

determines that additional investigation or evidence is needed, it must

promptly direct the compliance staff to conduct further investigation.

In the alternative, if a Review Panel determines that no reasonable

basis exists for finding a violation, or that prosecution is

unwarranted, it may direct that no further action be taken. This

determination must include a written statement setting forth the facts

and analysis supporting the decision. Finally, if a Review Panel

determines that a reasonable basis exists for finding a violation and

adjudication is warranted, it must direct that the person or entity

alleged to have committed the violation be served with a notice of

charges.

iv. Proposed Sec. 38.704--Notice of Charges

Proposed Sec. 38.704 describes the minimally acceptable contents

of a notice of charges (``notice'') issued by a Review Panel. The

notice must adequately state the acts, conduct, or practices in which

the respondent is alleged to have engaged; state the rule, or rules,

alleged to have been violated; and prescribe the period within which a

hearing on the charges may be requested. Further, the notice must also

advise the respondent charged that he is entitled, upon request, to a

hearing on the charges. Pursuant to paragraphs (a) and (b) of the

proposed rule, the DCM may adopt rules providing that (1) the failure

to request a hearing within the time prescribed in the notice, except

for good cause, may be deemed a waiver of the right to a hearing; and

(2) the failure to answer or deny expressly a charge may be deemed to

be an admission of such charge.

v. Proposed Sec. 38.705--Right to Representation

Proposed Sec. 38.705 requires that, upon being served with a

notice of charges, a respondent must have the right to be represented

by counsel or any other representative of his choosing in all

succeeding stages of the disciplinary process. Together with proposed

Sec. Sec. 38.704 (requiring an adequate notice of charges to the

respondent), 38.708 (conferring the right to hearing), and 38.710

(hearing procedures), 38.705 is one of the primary proposed rules in

subpart N that helps ensure basic fairness for respondents in

disciplinary proceedings.

[[Page 80599]]

vi. Proposed Sec. 38.706--Answer to Charges

Proposed Sec. 38.706 provides that a respondent must be given a

reasonable period of time to file an answer to a charge. In general,

paragraphs (a) through (c) of the proposed rule provide that the rules

of the DCM may require that: (1) The answer must be in writing and

include a statement that the respondent admits, denies or does not have

and is unable to obtain sufficient information to admit or deny each

allegation; (2) failure to file an answer on a timely basis shall be

deemed an admission of all allegations in the notice of charges; and

(3) failure in an answer to deny expressly a charge shall be deemed to

be an admission of such charge.

vii. Proposed Sec. 38.707--Admission or Failure to Deny Charges

Proposed Sec. 38.707 provides that, if a respondent admits or

fails to deny any of the violations alleged in a notice of charges,

then a Hearing Panel may find that the violations admitted or not

denied have in fact been committed. If a DCM adopts a rule concerning

the admission or failure to deny charges, then Sections (a) through (c)

of the proposed rule provide that: (1) The Hearing Panel must impose a

sanction for each violation found to have been committed; (2) the DCM

must promptly notify the respondent in writing of any sanction to be

imposed and advise the respondent that they may request a hearing on

such sanction within the period of time stated in the notice; and (3)

the rules of the DCM may provide that if the respondent fails to

request a hearing within the period of time stated in the notice, then

the respondent will be deemed to have accepted the sanction.

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

Proposed Sec. 38.708 provides that in every instance where a

respondent has requested a hearing on a charge that he or she denies,

or on a sanction set by the Hearing Panel pursuant to proposed Sec.

38.707, the respondent must be given the opportunity for a hearing in

accordance with the requirements of proposed Sec. 38.710. The DCM's

rules may provide that, except for good cause, the hearing must be

concerned only with those charges denied or sanctions set by the

Hearing Panel under proposed Sec. 38.707 for which a hearing has been

requested.

ix. Proposed Sec. 38.709--Settlement Offers

Proposed Sec. 38.709 provides the procedures a DCM must follow if

it permits the use of settlements to resolve disciplinary cases.

Section (a) of the proposed rule states that the rules of a DCM may

permit a respondent to submit a written offer of settlement any time

after an investigation report is completed. The disciplinary panel

presiding over the matter may accept the offer of settlement, but may

not alter the terms of the offer unless the respondent agrees. In

addition, Section (b) of the proposed rule provides that the rules of

the DCM may allow a disciplinary panel to permit the respondent to

accept a sanction without admitting or denying the rule violations upon

which the sanction is based.

Section (c) of proposed Sec. 38.709 states that a disciplinary

panel accepting a settlement offer must issue a written decision

specifying the rule violations it has reason to believe were committed,

and any sanction imposed, including any order of restitution where

customer harm has been demonstrated. Importantly, Section (c) also

provides that if an offer of settlement is accepted without the

agreement of a DCM's enforcement staff, the decision must carefully

explain the disciplinary panel's acceptance of the settlement. Finally,

Section (d) of proposed Sec. 38.709 allows a respondent to withdraw

his or her offer of settlement at any time before final acceptance by a

disciplinary panel. If an offer is withdrawn after submission, or is

rejected by a disciplinary panel, the respondent must not be deemed to

have made any admissions by reason of the offer of settlement and must

not be otherwise prejudiced by having submitted the offer of

settlement.

x. Proposed Sec. 38.710--Hearings

Proposed Sec. 38.710 requires a DCM to adopt rules that provide

certain minimum requirements for any hearing conducted pursuant to a

notice of charges. In general, Sections (a)(1) through (a)(7) of the

proposed rule require the following requirements: (1) A fair hearing;

(2) authority for a respondent to examine evidence relied on by

enforcement staff in presenting the charges contained in the notice of

charges; (3) the DCM's enforcement and compliance staffs must be

parties to the hearing and the enforcement staff must present its case

on those charges and sanctions that are the subject of the hearing; (4)

the respondent must be entitled to appear personally at the hearing,

have the authority to cross-examine persons appearing as witnesses at

the hearing, and call witnesses and present evidence as may be relevant

to the charges; (5) the DCM must require persons within its

jurisdiction who are called as witnesses to participate in the hearing

and produce evidence; (6) a copy of the hearing must be made and become

a record of the proceeding if the respondent has requested a hearing;

and (7) the rules of the DCM may provide that the cost of transcribing

the record must be borne by a respondent who requests a transcript.

Additionally, proposed paragraph (b) specifies that the rules of the

DCM may provide that a sanction be summarily imposed upon any person

within its jurisdiction whose actions impede the progress of a hearing.

xi. Proposed Sec. 38.711--Decisions

Proposed Sec. 38.711 details the procedures that a Hearing Panel

must follow in rendering disciplinary decisions. The proposed rule

requires that all decisions include: (1) A notice of charges or a

summary of the charges; (2) the answer, if any, or a summary of the

answer; (3) a summary of the evidence produced at the hearing or, where

appropriate incorporation by reference in the investigation report; (4)

a statement of findings and conclusions with respect to each charge,

and a careful explanation of the evidentiary and other basis for such

findings and conclusions with respect to each charge; (5) an indication

of each specific rule with which the respondent was found to have

violated; and (6) a declaration of any penalty imposed against the

respondent, including the basis for such sanctions and the effective

date of such sanctions.

xii. Proposed Sec. 38.712--Right to Appeal

Proposed Sec. 38.712 provides the procedures that a DCM must

follow in the event that the DCM's rules authorize an appeal of adverse

decisions in all or in certain classes of cases. Notably, the proposed

rule requires a DCM that permits appeals by disciplinary respondents to

also permit appeals by its enforcement staff. This provision reflects

the Commission's belief that DCM enforcement staff must have the

discretion to appeal disciplinary panel decisions that, for example, do

not adequately sanction a respondent's violative conduct.

For DCMs that permit appeals, the language in paragraphs (a)

through (d) of proposed Sec. 38.712 generally requires the DCM to: (1)

Establish an appellate panel that is authorized to hear appeals; (2)

ensure that the appellate panel composition is consistent with

[[Page 80600]]

Sec. 40.9(c)(iv) of the Commission's regulations and does not include

any members of the DCM's compliance staff, or any person involved in

adjudicating any other stage of the same proceeding; (3) except for

good cause shown, conduct the appeal or review solely on the record

before the Hearing Panel, the written exceptions filed by the parties,

and the oral or written arguments of the parties; and (4) issue a

written decision of the board of appeals and provide a copy to the

respondent promptly following the appeal or review proceeding.

xiii. Proposed Sec. 38.713--Final Decisions

Proposed Sec. 38.713 requires that each DCM establish rules

setting forth when a decision rendered under this subpart N will become

the final decision of the DCM.

xiv. Proposed Sec. 38.714--Disciplinary Sanctions

Proposed Sec. 38.714 requires that every disciplinary sanction

imposed by a DCM must be commensurate with the violations committed and

must be clearly sufficient to deter recidivism or similar violations by

other market participants. Additionally, the proposed rule requires

that, in the event of demonstrated customer harm, any disciplinary

sanction must include full customer restitution. In evaluating

appropriate sanctions, the proposed rule requires the DCM to take into

account a respondent's disciplinary history.\133\

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\133\ Proposed Sec. 38.158(c), which is being proposed as part

of this release with respect to Core Principle 2, requires that a

copy of a member or market participant's disciplinary history be

included in the compliance staff's investigation report.

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xv. Proposed Sec. 38.715--Summary Fines for Violations of Rules

Regarding Timely Submission of Records, Decorum, or Other Similar

Activities

Proposed Sec. 38.715 permits a DCM to adopt a summary fine

schedule for violations of rules relating to timely submission of

accurate records required for clearing or verifying each day's

transactions, decorum, attire, or other similar activities. A DCM may

authorize its compliance staff to summarily impose minor sanctions

against persons within the DCM's jurisdiction for violating such rules.

The proposed rule makes clear that a DCM should issue no more than one

warning letter in a rolling 12-month period for the same violation

before sanctions are imposed. Additionally, the proposed rule specifies

that a summary fine schedule must provide for progressively larger

fines for recurring violations.

xvi. Proposed Sec. 38.716--Emergency Disciplinary Actions

Proposed Sec. 38.716 provides that a DCM may impose a sanction,

including a suspension, or take other summary action against a person

or entity subject to its jurisdiction upon a reasonable belief that

such immediate action is necessary to protect the best interest of the

marketplace. The proposed rule also provides that any emergency action

taken by the DCM must be in accordance with certain procedural

safeguards that protect the respondent, including the right to be

served with notice before the action is taken or otherwise at the

earliest possible opportunity after action has been taken; the right to

be represented by legal counsel in any proceeding subsequent to the

emergency disciplinary action; the right to a hearing as soon as

reasonably practical; and the right to receive a written decision on

the summary action taken by the DCM.

14. Subpart O--Dispute Resolution

Under the Dodd-Frank Act current Core Principle 13 is not

substantively changed but it is renumbered as Core Principle 14. This

core principle governs the obligations of DCMs to implement and enforce

a dispute resolution program for their market participants and market

intermediaries.\134\ Currently, compliance with the core principle is

guided by application guidance and acceptable practices in Appendix B

of part 38. Based upon the Commission's experience over the last 10

years, this guidance has been successful in enabling DCMs to structure

the appropriate dispute resolution program for themselves. Accordingly,

the Commission proposes to maintain the guidance and acceptable

practices, adding only clarifying changes that do not revise the

substantive obligations of DCMs with respect to this core principle.

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\134\ 17 CFR part 38, App. B.

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15. Subpart P--Governance Fitness Standards

The Dodd-Frank Act redesignated former current Core Principle 14 as

Core Principle 15. The language of this core principle remains

unchanged and requires the DCM to establish and enforce appropriate

fitness standards for directors, members of any disciplinary committee,

members of the contract market, and any other persons with direct

access to the facility (including any parties affiliated with any of

the persons described in this core principle). This release proposes to

codify the statutory text of the core principle in proposed Sec.

38.800. The applicable regulations implementing this core principle

will be proposed in a forthcoming rulemaking, expected to be completed

by the statutory deadline of July 15, 2011.\135\

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\135\ See CFTC Web site for additional information on the

``Governance Requirements for Derivatives Clearing Organizations,

Designated Contract Markets, and Swap Execution Facilities,

Additional Requirements Regarding the Mitigation of Conflicts of

Interest,'' at http://www.cftc.gov/LawRegulation/DoddFrankAct/

Rulemakings/DF_9_DCOGovernance/index.htm (last visited Dec. 14,

2010).

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16. Subpart Q--Conflicts of Interest

The Dodd-Frank Act redesignated current Core Principle 15

(Conflicts of Interest) as Core Principle 16. However, in all other

respects, Dodd-Frank did not substantively amend the core principle.

This release proposes to codify the statutory text of the core

principle in proposed Sec. 38.850. The applicable regulations

implementing this core principle were proposed in a separate release

titled ``Requirements for Derivatives Clearing Organizations,

Designated Contract Markets, and Swap Execution Facilities Regarding

the Mitigation of Conflicts of Interest.'' \136\

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\136\ 75 FR 63732, Oct. 18, 2010.

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

The Dodd-Frank Act redesignated the former Core Principle 16

(Composition of Governing Boards of Mutually Owned Contract Markets) as

Core Principle 17. In addition, current Core Principle 16 was amended

by: (i) Changing the title of the core principle to ``Composition of

Governing Boards of Contract Markets''; and (ii) revising the scope of

the core principle such that it now requires the governance

arrangements of all DCMs to be designed to permit the consideration of

the views of market participants.\137\ This release proposes to codify

the statutory text of the core principle in proposed Sec. 38.900. The

applicable regulations implementing this core principle will be

proposed in a forthcoming rulemaking, which is expected to be completed

by the statutory deadline of July 15, 2011.\138\

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\137\ Former Core Principle 16, which applied only to mutually

owned DCMs, required such DCMs to ensure that the composition of

their governing boards included market participants.

\138\ See supra note 131.

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18. Subpart S--Recordkeeping

The Dodd-Frank Act designated current Core Principle 17

(Recordkeeping) as Core Principle 18. In almost all respects, Dodd-

Frank did not substantively amend the Core Principle. Under current

Core Principle 17, DCMs

[[Page 80601]]

are required to maintain records of all activities related to their

business as DCMs, in a form and manner acceptable to the Commission,

``for a period of 5 years.'' \139\ The Commission adopted acceptable

practices for this core principle by stating that DCMs could comply

with the core principle by complying with Sec. 1.31 of the

Commission's regulations (``Sec. 1.31''). Section 1.31 establishes

recordkeeping requirements for all books and records required to be

kept under the CEA, whether by a DCM or otherwise and requires that

books and records be kept ``for a period of 5 years.'' \140\ The

Commission proposes to maintain compliance with Sec. 1.31 as a primary

component of compliance with this core principle, and proposes to

incorporate the requirements in Sec. 1.31 into proposed Sec. 38.951.

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\139\ See 7 U.S.C. 7(d)(17).

\140\ 17 CFR 1.31(a)(1).

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One notable change in the amended core principle is that while

current Core Principle 17 requires that records be retained for 5

years, the amended Core Principle (18) now requires that records be

retained for ``at least 5 years.'' \141\ Accordingly, proposed Sec.

38.951 permits the Commission to extend DCMs' recordkeeping

requirements beyond the five years otherwise required of all entities

by Sec. 1.31, should it elect to do so. Thus, by its terms, the

proposed rule requires DCMs to ``maintain records of all activities

relating to the business of the contract market, in a form and manner

acceptable to the Commission, for a period of at least 5 years.'' In

addition, DCMs must ``maintain such records, including trade records

and investigatory and disciplinary files, in accordance with the

requirements of Sec. 1.31 [of the Commission's regulations].''

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\141\ Compare 7 USC 7(d)(17) with Section 5(d)(18) of the CEA as

amended by the Dodd-Frank Act (emphasis added).

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By incorporating Sec. 1.31, and more specifically, by

incorporating Sec. 1.31(a), proposed Sec. 38.951 effectively requires

that DCMs' books and records be readily accessible for the first two

years of the minimum five-year statutory period and be open to

inspection by any representatives of the Commission or the United

States Department of Justice. The DCM, at its own expense, must

promptly provide either a copy or the original book or record upon

request.

Proposed Sec. 38.951 also effectively incorporates current Sec.

1.31(b)'s description of the permissible methods of storing books and

records. Consequently, a DCM may store its books and records on either

micrographic media, such as microfilm or microfiche or any similar

medium, or electronic storage media as defined by Sec.

1.31(b)(1)(ii).\142\ DCMs must, at all times, have the facilities to

immediately produce the micrographic media or electronic storage media

images and be prepared to present legible hard-copy images of such

records. Additionally, DCM's must keep only Commission-required records

on the media, store a duplicate of the record at a separate location,

and organize and maintain an accurate index of all information

maintained on both the original and duplicate storage media. DCMs that

use electronic storage media are also required to develop and maintain

an audit system to track the initial entry of original or duplicate

records and any subsequent changes made thereafter.

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\142\ Among other criteria, Sec. 1.31(b)(1)(ii) defines

electronic storage media as ``any digital storage medium or system

that preserves the records exclusively in a non-rewritable, non-

erasable format [and] verifies automatically the quality and

accuracy of the storage media recording process * * *.''

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Finally, proposed Sec. 38.951 also incorporates Sec. Sec. 1.31(c)

and 1.31(d). Section 1.31(c) of the Commission's regulations requires

record-keepers who employ an electronic storage system to certify with

the Commission that the system meets the requirements of an electronic

storage media as defined in Sec. 1.31(b)(1)(ii). Section 1.31(d)

states that trading cards, documents on which trade information is

originally recorded in writing, certain written orders, and paper

copies of certain electronically filed forms and reports with original

signatures must be retained in hard-copy for the requisite time period.

The proposed rule also requires a DCM to comply with the requirements

of proposed Sec. 45.1--``Swap Recordkeeping Requirements''--if

applicable to the DCM.

19. Subpart T--Antitrust Considerations

Current Core Principle 18 governs the antitrust obligations of

DCMs.\143\ The Dodd-Frank Act renumbered this core principle as Core

Principle 19, but in all other respects the statutory text of the core

principle is the same. The Commission believes that the existing

guidance to this Core Principle remains appropriate. Accordingly, other

than to codify the statutory text of Core Principle 19 into the

proposed Sec. 38.1000, the Commission at this time is not proposing

any amendments to the relevant guidance under part 38.

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\143\ Part 38 contains guidance governing compliance with Core

Principle 18. 17 CFR part 38, App. B.

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Proposed Sec. 38.1001 refers applicants and DCMs to the guidance

in Appendix B to part 38 for purposes of demonstrating to the

Commission their compliance with the requirements of proposed Sec.

38.1000.20.

20. Subpart U--System Safeguards

Proposed Sec. 38.1051 establishes system safeguards requirements

for all DCMs, pursuant to new Core Principle 20 added under the Dodd-

Frank Act. Core Principle 20, codified in Sec. 38.1050 requires DCMs

to: (1) Establish and maintain a program of risk oversight to identify

and minimize sources of operational risk through the development of

appropriate controls and procedures and the development of automated

systems that are reliable, secure, and have adequate scalable capacity;

(2) establish and maintain emergency procedures, backup facilities, and

a plan for disaster recovery that allow for the timely recovery and

resumption of operations and the fulfillment of the responsibilities

and obligations of the DCM; and (3) periodically conduct tests to

verify that backup resources are sufficient to ensure continued order

processing and trade matching, price reporting, market surveillance,

and maintenance of a comprehensive and accurate audit trail. The rules

proposed under subpart U implement these requirements.

Because automated systems play a central and critical role in

today's electronic financial market environment, oversight of core

principle compliance by DCMs with respect to automated systems is an

essential part of effective oversight of both futures and swaps

markets. Sophisticated computer systems are crucial to a DCM's ability

to meet its obligations and responsibilities. Safeguarding the

reliability, security, and capacity of such systems is also essential

to mitigation of systemic risk for the nation's financial sector as a

whole. This is particularly true in light of the fact that the over-

the-counter swaps market is estimated to have in excess of $600

trillion in outstanding contracts, roughly 40 times the gross domestic

product of the United States.\144\ The ability of DCMs to recover and

resume trading promptly in the event of a disruption of their

operations is highly important to the U.S. economy. Ensuring the

resilience of the automated systems of DCMs is a vitally important

[[Page 80602]]

part of the Commission's mission, and will be crucial to the robust and

transparent systemic risk management framework established by the Dodd-

Frank Act. DCM compliance with generally accepted standards and best

practices with respect to the development, operation, reliability,

security and capacity of automated systems can reduce the frequency and

severity of automated system security breaches or functional failures,

thereby augmenting efforts to mitigate systemic risk. Notice to the

Commission concerning systems malfunctions, systems security incidents,

or any events leading to the activation of a DCM's business continuity-

disaster recovery (``BC-DR'') plan will assist the Commission's

oversight and its ability to assess systemic risk levels. It would

present unacceptable risks to the U.S. financial system if futures and

swaps markets that comprise critical components of the world financial

system were to become unavailable for an extended period of time for

any reason, and adequate system safeguards are crucial to mitigation of

such risks.

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\144\ These figures derived from Bank for International

Settlements, BIS Quarterly Review, June 2010, Page A121, Table 19 at

http://www.bis.org/statistics/otcder/dt1920a.pdf.; see also, Bureau

of Economic Analysis news release, BEA 10-47, issued September 30,

2010 at http://www.bea.gov/newsreleases/national/gdp/

gdpnewsrelease.htm.

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Based on the aforementioned, the rules proposed under Sec. 38.1051

would require a DCM's program of risk analysis and oversight to address

five categories of risk analysis and oversight, including information

security; BC-DR planning and resources, capacity and performance

planning; systems operations; systems development and quality

assurance; and physical security and environmental controls. The

proposed rules specifically would require each DCM to maintain a BC-DR

plan and BC-DR resources sufficient to enable resumption of trading and

of all of the responsibilities and obligations of the DCM during the

next business day following any disruption of its operations, either

through sufficient infrastructure and personnel resources of its own or

through sufficient contractual arrangements with other DCMs or disaster

recovery service providers. The proposed rules also would require each

DCM to notify Commission staff of various system security-related

events; to provide relevant documents to the Commission; and to conduct

regular, periodic, objective testing and review of its automated

systems. Moreover, the proposed rules would require each DCM, to the

extent practicable, to coordinate its BC-DR plan with those of the

members and market participants upon whom it depends to provide

liquidity, to initiate coordinated testing of such plans, and to take

into account in its own BC-DR plan, the BC-DR plans of relevant

telecommunications, power, water, and other essential service

providers.

21. Subpart V--Financial Resources

The Dodd-Frank Act added new Core Principle 21. This core principle

requires that a DCM must have adequate financial resources to discharge

its responsibilities. The new core principle also requires that boards

of trade must maintain financial resources sufficient to cover

operating costs for a period of at least one year, calculated on a

rolling basis.

The Commission notes that a DCM is the first entity in the trading

process to ensure that trading occurs in a liquid, fair, and

financially secure trading facility. For instance, a DCM must have,

among other things, adequate trade practice and market surveillance,

disciplinary, recordkeeping, and alternate dispute resolution programs

in place in order to comply with the relevant core principles. In order

to fulfill these responsibilities, a DCM must have appropriate minimum

financial resources on hand and on an ongoing basis to sustain

operations for a reasonable period of time. Furthermore, DCMs must have

sufficient resources at any given time to allow them, if necessary, to

close out trading in a manner not disruptive to the market.

Proposed Sec. 38.1101 sets out financial resource requirements for

DCMs, to implement new Core Principle 21. Under proposed Sec. 38.1101,

DCMs that also operate as DCOs are also subject to the financial

resource requirements for DCOs in proposed Sec. 39.11.\145\

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\145\ Commission regulation Sec. 39.11 establishes requirements

that a DCO will have to meet in order to comply with DCO Core

Principle B (Financial Resources), as amended by the Dodd-Frank Act.

Amended Core Principle B requires a DCO to possess financial

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

enable the DCO to meet its financial obligations to its clearing

members notwithstanding a default by the clearing member creating

the largest financial exposure for the DCO in extreme but plausible

conditions; and enable the DCO to cover its operating costs for a

period of 1 year, as calculated on a rolling basis. See 75 FR 63113,

Oct. 14, 2010.

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i. Proposed Sec. 38.1101 (a)--General Requirements

Proposed Sec. 38.1100 recites the language of Core Principle 21,

as set forth in Section 5(d)(21) of the CEA, as amended by the Dodd-

Frank Act. Proposed Sec. 38.1101(a)(1) and (3) would require DCMs to

maintain sufficient financial resources to cover operating costs for at

least one year, calculated on a rolling basis--i.e., at all times. The

DCM must have sufficient financial resources to cover operating costs

for at least one year from any particular point in time. The one year

period is required under the amended core principle, and the Commission

considers one year an appropriate timeframe given the potential need to

allow contracts to expire and to allow the DCM's business to wind down

in an orderly fashion. The Commission believes that this requirement

will provide a clear baseline for financial resources, thus enhancing

the financial integrity of the markets.\146\

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\146\ Some foreign regulatory authorities already have similar

requirements for the equivalent entities they regulate. For example,

the UK Financial Services Authority's (``FSA'') recognition

requirements for UK recognized investment exchanges and UK

recognized clearing houses (collectively, ``UK recognized bodies'')

include the maintenance of financial resources sufficient to ensure

that the UK recognized body would be able to complete an orderly

closure or transfer of its business without being prevented from

doing so by insolvency or lack of available funds. Section 2.3.7 of

the FSA Recognition Requirements calls for a UK recognized body to

have at all times liquid financial assets amounting to at least six

months' operating costs and net capital of at least that amount.

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The one-year period also is consistent with established accounting

standards, under which an entity's ability to continue as a going

concern comes into question if there is evidence that the entity may be

unable to continue to meet its obligations in the next 12 months

without substantial disposition of assets outside the ordinary course

of business, restructuring of debt, externally forced revisions of its

operations, or similar actions.\147\

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\147\ See American Institute of Certified Public Accountants

Auditing Standards Board Statement of Auditing Standards No. 59, The

Auditor's Consideration of an Entity's Ability to Continue as a

Going Concern, as amended.

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ii. Proposed Sec. 38. 1101(b)--Types of Financial Resources

Under proposed Sec. 38.1101(b), financial resources available to

DCMs to satisfy the applicable financial requirements would include the

DCM's own capital (assets in excess of liabilities) and any other

financial resource deemed acceptable by the Commission. A DCM would be

able to request an informal interpretation from Commission staff on

whether a particular financial resource would be acceptable to the

Commission. The Commission invites commenters to recommend particular

financial resources for inclusion in the final regulation.

iii. Proposed Sec. 38.1101(c)--Computation of Financial Resource

Requirement

Proposed Sec. 38.1101(c) would require a DCM at the end of each

fiscal quarter to make a reasonable calculation of the financial

resources it needs to meet the

[[Page 80603]]

requirements of proposed Sec. 38.1101(b). In the first instance, the

DCM would have reasonable discretion in determining a methodology it

uses to make the calculation. However, the Commission may review the

methodology and require changes as appropriate.

iv. Proposed Sec. 38.1101(d)--Valuation of Financial Resources

Proposed Sec. 38.1101(d) would require DCMs, no less frequently

than at the end of each fiscal quarter, to calculate the current market

value of each financial resource used to meet their obligations under

these proposed rules. Additionally, the DCMs would be required to

perform the valuation at other times as appropriate. This provision is

designed to address the need to update valuations in circumstances

where there may have been material fluctuations in market value that

could impact a DCM's ability to meet its obligations on a rolling basis

as required by proposed Sec. 38.1101(a). When valuing a financial

resource, a DCM would be required to reduce the value, as appropriate,

to reflect any market or credit risk specific to that particular

resource, i.e., apply a haircut.\148\ The Commission would permit each

DCM to exercise its discretion in determining the applicable haircuts.

However, such haircuts are subject to Commission review and must be

acceptable to the Commission.

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\148\ A ``haircut'' is a deduction taken from the value of an

asset to reserve for potential future adverse price movements in

such asset.

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v. Proposed Sec. 38.1101(e)--Liquidity of Financial Resources

Proposed Sec. 38.1101(e) would require DCMs to maintain

unencumbered liquid financial assets, such as cash or highly liquid

securities, equal to at least six months' operating costs. The

Commission believes that having six months' worth of unencumbered

liquid financial assets would give a DCM time to liquidate the

remaining financial assets it would need to continue operating for the

last six months of the required one-year period. If a DCM does not have

six months' worth of unencumbered liquid financial assets, it would be

allowed to use a committed line of credit or similar facility to

satisfy this requirement.

The Commission notes that a committed line of credit or similar

facility is not listed in proposed Sec. 38.1101(b) as a financial

resource available to a DCM to satisfy the requirements of proposed

Sec. 38.1101(a). A DCM may only use a committed line of credit or

similar facility to meet the liquidity requirements set forth in

proposed Sec. 38.1101(e).

vi. Proposed Sec. 38.1101(f)--Reporting Requirements

Under proposed Sec. 38.1101(f), at the end of each fiscal quarter,

or at any time upon Commission request, DCMs would be required to

report to the Commission: (i) the amount of financial resources

necessary to meet the requirements set forth in the regulation; and

(ii) the value of each financial resource available to meet those

requirements. A DCM would also have to provide the Commission with a

financial statement, including the balance sheet, income statement, and

statement of cash flows, of the DCM or of its parent company (if the

DCM does not have an independent financial statement and the parent

company's financial statement is prepared on a consolidated basis).

Proposed Sec. 38.1101(f) requires a DCM to provide the Commission

with sufficient documentation that explains the methodology it used to

calculate its financial requirements and the basis for its

determinations regarding valuation and liquidity. The DCM also must

provide copies of any agreements establishing or amending a credit

facility, insurance coverage, or any similar arrangement that evidences

or otherwise supports its conclusions. The sufficiency of the

documentation would be determined by the Commission in its sole

discretion. The DCM would have 17 business days \149\ from the end of

the fiscal quarter to file the report, but would also be able to

request an extension of time from the Commission.

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\149\ This filing deadline is consistent with the deadline

imposed on FCMs for the filing of monthly financial reports. See 17

CFR 1.10(b).

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The Commission invites comments on all these proposed rules

relating to requirements for financial resources for DCMs.

22. Subpart W--Diversity of Boards of Directors

The Dodd-Frank Act added new Core Principle 22, requiring that

publicly traded DCMs must endeavor to recruit individuals to serve on

their board of directors from among a broad and culturally diverse pool

of qualified candidates. This release proposes to codify the statutory

text of the core principle in proposed Sec. 38.1150. This core

principle will be addressed in a forthcoming release that is expected

to be completed by the statutory deadline of July 15, 2011.

23. Subpart X--Securities and Exchange Commission

The Dodd-Frank Act added new Core Principle 23, requiring that DCMs

keep any records relating to swaps defined in CEA Section 1a(47)(A)(v),

as amended by the Dodd-Frank Act, open to inspection and examination by

the Securities and Exchange Commission (``SEC'').\150\ Consistent with

the text of this core principle, the Commission proposes guidance under

part 38 that provides that each DCM should have arrangements and

resources for collecting and maintaining accurate records pertaining to

any swap agreements defined in section 1a(47)(A)(v) of the amended CEA.

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\150\ 7 U.S.C. 7; see also Section 5(d)(23) of the CEA, as

amended by the Dodd-Frank Act.

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Proposed Sec. 38.1201 refers applicants and DCMs to the guidance

in Appendix B to part 38 for purposes of demonstrating to the

Commission their compliance with the requirements of Proposed Sec.

38.1200, which codifies the text of the core principle.

III. Related Matters

A. Regulatory Flexibility Act

The Regulatory Flexibility Act (``RFA'') \151\ requires Federal

agencies, in promulgating rules, to consider the impact of those rules

on small entities. The rules adopted herein will affect designated

contract markets. The Commission has previously established certain

definitions of ``small entities'' to be used by the Commission in

evaluating the impact of its rules on small entities in accordance with

the RFA.\152\ The Commission previously determined that designated

contract markets are not small entities for the purpose of the

RFA.\153\ Therefore, the Chairman, on behalf of the Commission,

pursuant to 5 U.S.C. 605(b) certifies that the proposed rules will not

have a significant economic impact on a substantial number of small

entities.

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\151\ 5 U.S.C. 601 et seq.

\152\ 47 FR 18618-21, Apr. 30, 1982.

\153\ Id.

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B. Paperwork Reduction Act

This proposed rulemaking contains information collection

requirements. The Paperwork Reduction Act (PRA) \154\ imposes certain

requirements on Federal agencies in connection with their conducting or

sponsoring any collection of information as defined by the PRA. An

agency may not conduct or sponsor, and a person is not required to

respond to, a collection of information unless it displays a currently

valid control number. The Commission is

[[Page 80604]]

proposing to amend Collection 3038-0052 to allow for an increase in

response hours for the proposed rulemaking amending part 38, which

captures associated proposed amendments to rules 1.52 and 16.01, as

required under the Dodd-Frank Act.\155\ The Commission therefore is

submitting this proposal to the Office of Management and Budget (OMB)

for its review in accordance with 44 U.S.C. 3507(d) and 5 CFR 1320.11.

The title for this collection is ``Part 38--Designated Contract

Markets'' (OMB Control number 3038-0052). Responses to this collection

of information would be mandatory. The Commission will protect

proprietary information according to the Freedom of Information Act

(FOIA) and 17 CFR part 145, ``Commission Records and Information.'' In

addition, section 8(a)(1) of the CEA strictly prohibits the Commission,

unless specifically authorized by the Act, from making public ``data

and information that would separately disclose the business

transactions or market positions of any person and trade secrets or

names of customers.'' \156\ The Commission is also required to protect

certain information contained in a government system of records

according to the Privacy Act of 1974.\157\

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\154\ 44 U.S.C. 3501 et seq.

\155\ Dodd Frank Wall Street Reform and Consumer Protection Act,

Public Law 111-203, 124 Stat. 1376 (2010).

\156\ 7 U.S.C. 12.

\157\ 5 U.S.C. 552a.

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1. Additional Information Provided by Designated Contract Markets

The proposed rules require each respondent to file information with

the Commission. For instance, contract markets must file applications

and supporting documents and information with the Commission for

designation pursuant to Commission rule 38.3. Designated contract

markets must either request approval or certify rules and products with

the Commission pursuant to Commission rule 38.4. Designated contract

markets must disclose information related to prices, volume, open

interest and certain trading information pursuant to Core Principle 8

(Daily Publication of Trading Information).\158\

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\158\ See Section 735(b) of the Dodd-Frank Act.

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Commission staff previously estimated 300 hours average response

time from each respondent for this collection of information for

designation and compliance purposes pursuant to part 38. Based on its

experience with administering registered entities' submission

requirements since implementation of the Commodity Futures

Modernization Act of 2000,\159\ Commission staff believes that the

response time for designation and compliance would generally increase

by 10% with the implementation of swaps trading on designated contract

markets pursuant to Section 723(a)(3) of the Dodd-Frank Act and the

addition of new core principles with which designated contract markets

must comply. Commission staff estimates that it would receive filings

from 17 respondents.\160\ Accordingly, the additional burden in terms

of hours would be 30 additional hours per respondent and 510 additional

hours annually for all respondents for designation and compliance.

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\159\ Public Law 106-554, 114 Stat. 2763 (2000).

\160\ The number of designated contract markets increased from

13 to 17 since the last amendment to Collection 3038-0052.

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In addition to the general increase noted above, pursuant to the

proposed rulemaking, respondents are subject to new Core Principle 21

(Financial Resources) that requires the respondent to have adequate

financial, operational and managerial resources.\161\ In order to

demonstrate compliance with Core Principle 21, each respondent will

need to file specific reports to the Commission on a quarterly basis,

which would result in four quarterly responses per respondent per year.

Commission staff estimates that each respondent would expend 10 hours

to prepare each filing required under the proposed regulations. As

noted above, Commission staff estimates that it would receive filings

from 17 respondents. Accordingly, the additional burden in terms of

hours would be 40 additional hours annually per respondent and 680

additional hours annually for all respondents to comply with Core

Principle 21.

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\161\ See section 735(b) of the Dodd-Frank Act.

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Commission staff estimates that respondents could expend up to an

additional $3,640 annually based on an hourly wage rate of $52 (30

hours + 40 hours x $52) to comply with the proposed rules. This would

result in an aggregated additional cost of $61,880 per annum (17

respondents x $3,640).

OMB Control Number 3038-005.

Estimated Number of Respondents: 17.

Quarterly Responses by Each Respondent: 4.

Total Quarterly Responses by Each Respondent: 68.

Estimated Additional Average Hours per Response: 70.

Aggregate Annual Hourly Reporting Burden: 1190.

2. Information Collection Comments

Copies of the submission from the Commission to OMB are available

by visiting RegInfo.gov. The Commission will consider public comments

on this proposed collection of information in:

(1) Evaluating whether the proposed collection of information is

necessary for the proper performance of the functions of the

Commission, including whether the information will have a practical

use;

(2) Evaluating the accuracy of the estimated burden of the proposed

collection of information, including the degree to which the

methodology and the assumptions that the Commission employed were

valid;

(3) Enhancing the quality, utility, and clarity of the information

proposed to be collected; and

(4) Minimizing the burden of the proposed information collection

requirements on designated clearing organizations, designated contract

markets, and swap execution facilities, including through the use of

appropriate automated, electronic, mechanical, or other technological

information collection techniques, e.g., permitting electronic

submission of responses.

Organizations and individuals desiring to submit comments on the

proposed information collection requirements should contact the Office

of Information and Regulatory Affairs, Office of Management and Budget,

by fax at (202) 395-6566 or by e-mail at [email protected]

Please provide the Commission with a copy of submitted comments so that

they may be summarized and addressed in the final rulemaking. Refer to

the Addresses section of this notice of proposed rulemaking for comment

submission instructions to the Commission.

OMB is required to make a decision concerning the proposed

information collection requirements between 30 and 60 days after

publication of this Release in the Federal Register. Therefore, a

comment to OMB is best assured of receiving full consideration if OMB

receives it within 30 days of publication of this Release. Nothing in

the foregoing affects the deadline enumerated above for public comment

to the Commission on the proposed rules.

C. Cost Benefit Analysis

Section 15(a) of the CEA \162\ requires that the Commission

consider the costs and benefits of its actions before issuing a

regulation under the Act. By its terms, Section 15(a) does not require

the Commission to quantify the costs and

[[Page 80605]]

benefits of a new rule or determine whether the benefits of the

rulemaking outweigh its costs; rather, Section 15(a) requires the

Commission to ``consider'' the costs and benefits of its actions.

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\162\ 7 U.S.C. 19(a).

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Section 15(a) of the CEA further specifies that 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. Accordingly, the Commission

could, in its discretion, give greater weight to any one of the five

considerations and could, in its discretion, determine that,

notwithstanding its costs, a particular rule was necessary or

appropriate to protect the public interest or to effectuate any of the

provisions or to accomplish any of the purposes of the CEA.

Summary of Proposed Requirements

The proposed rulemaking would change the criteria applicants for

designation as a contract market must meet by: (1) Eliminating all of

the existing eight designation criteria and incorporating those

criteria into various DCM core principles; (2) revising, in some

instances, the wording of the 18 pre-existing DCM core principles; and

(3) adding five additional DCM core principles. In addition to revising

the DCM core principles, the Dodd-Frank Act requires that the trading

or processing of clearable swaps must occur only on a registered DCM or

SEF.\163\ This rulemaking will implement, in part 38 of the

Commission's regulations, these amended provisions of the Act relevant

to DCMs. Specific provisions include a proposal to replace guidance and

acceptable practices associated with certain core principles with

regulations. The Commission also is proposing several procedural

changes for new applications for designation as a contract market,

including the elimination of the expedited approval procedures and the

creation of a DCM application form. Under the proposal, the timing of

reviews of designation applications would be governed only by the 180-

day statutory review period.

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\163\ See section 723 of Dodd-Frank Act.

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Costs

As highlighted by recent events in the global credit markets,

transacting of swaps in unregulated, over-the-counter markets does not

contribute to the goal of stability in the broader financial markets.

The public would continue to be at risk to such financial instability

if certain derivatives were allowed to trade over the counter rather

than on regulated exchanges. Designated contract markets that determine

to list swaps for trading will be subject to core principles for

trading of swaps just as they are for futures contracts. If swaps were

allowed to continue to be transacted bilaterally, rather than on the

centralized market of a DCM, price discovery and transparency in the

swaps markets would continue to be inhibited.

Under the proposed rulemaking, designated contract markets will be

required to comply with five additional core principles for trading

futures and option contracts. Moreover, designated contract markets

that determine to list standardized swaps for trading will be required

to comply with the same core principles as for trading futures

contracts. These procedures are mandatory pursuant to the Dodd-Frank

Act and any additional costs associated with these procedures are

required by the implementation of the Dodd-Frank Act. The Commission is

also proposing to replace guidance and acceptable practices associated

with certain core principles with regulations. While these new

regulations generally codify existing industry practice, bringing their

procedures into full compliance with these new regulations may impose

some costs on DCMs.

Regarding new applications for designation as a contract market,

the Commission is proposing several procedural changes, including the

elimination of the expedited approval procedures, such that the timing

of such reviews would be governed only by the 180-day statutory review

period. This may impose costs on DCM applicants that may have to wait

longer for designation than under current procedures. However, in light

of the difficulties in submitting a complete application under the

expedited procedures, few DCMs have been eligible for designation under

the expedited procedures, so these costs should be limited.

Benefits

The Commission believes that the benefits of the rulemaking are

significant. The proposed regulations provide for the transacting of

swaps on DCMs. DCMs will compete with swap execution facilities to list

new standardized swaps contracts, while certain customized swaps will

continue to transact bilaterally. This competition will benefit the

marketplace. Providing market participants with the ability to trade

standardized swaps openly and competitively additionally will provide

market participants with enhanced price transparency resulting in

greater protection of market participants and the public.

The proposed regulations also require DCMs that determine to list

swaps for trading will have to coordinate with DCOs so that the swaps

may be listed swaps for clearing. This will subject the swaps to the

DCO's risk management and margining procedures, which addresses the

consideration of sound risk management practices and will add to the

financial integrity of the swaps markets.

The proposed regulations eliminate all of the existing eight

designation criteria and incorporate those criteria into various

existing DCM core principles. The proposed regulations additionally

implement five new core principles, specifically Core Principle 13

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

Principle 21 (Financial Resources), Core Principle 22 (Diversity of

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

Commission). The proposed rules also modify existing core principles.

For example, newly amended Core Principle 9 (Execution of Transactions)

requires the board of trade to provide a competitive, open and

efficient market and mechanism for executing transactions that protects

the price discovery process of trading in the centralized market. These

changes will benefit the public by further enhancing the transparency

and integrity of futures and options markets as well as swap markets on

DCMs.

Further, the Commission proposes to replace guidance and acceptable

practices associated with certain core principles with regulations.

This will have the benefit to DCMs and the public of providing greater

regulatory certainty. Finally the changes to the procedures for

applying for contract market designation will benefit new applicants by

improving the workability and efficiency of the application process.

Public Comment

The Commission invites public comment on its cost-benefit

considerations. Commenters are also invited to submit any data or other

information that they may have quantifying or qualifying the costs and

benefits of the Proposal with their comment letters.

[[Page 80606]]

IV. Text of Proposed Rules

List of Subjects

17 CFR Part 1

Commodity futures, Designated contract markets, Minimum financial

requirements for intermediaries, Reporting and recordkeeping

requirements.

17 CFR Part 16

Commodity futures, Reporting and Recordkeeping requirements.

17 CFR Part 38

Block transaction, Commodity futures, Designated contract markets,

Reporting and Recordkeeping requirements, Transactions off the

centralized market.

For the reasons stated in the preamble, and under the authority of

7 U.S.C. 1, et seq., the Commodity Futures Trading Commission proposes

to amend 17 CFR parts 1, 16 and 38 as follows:

PART 1--GENERAL REGULATIONS UNDER THE COMMODITY EXCHANGE ACT

1. Revise the authority citation for part 1 to read as follows:

Authority: 7 U.S.C. 1a, 2, 5, 6, 6a, 6b, 6c, 6d, 6e, 6f,, 6g,

6h, 6i, 6j, 6k, 6l, 6m, 6n, 6o, 6p, 7, 7a-2, 7b, 8, 9, 12, 12a, 12c,

13a, 13a-1, 16, 19, 21, 23 and 24, as amended by Pub. L. No. 111-

203, 124 Stat 1376.

Sec. 1.38 [Removed and Reserved]

2. Remove and reserve Sec. 1.38.

3. Revise Sec. 1.52 to read as follows:

Sec. 1.52 Self-regulatory organization adoption and surveillance of

minimum financial requirements.

(a) Each self-regulatory organization must adopt rules prescribing

minimum financial and related reporting requirements for members who

are registered futures commission merchants, registered retail foreign

exchange dealers, or registered introducing brokers. The self-

regulatory minimum financial and related reporting requirements must be

the same as, or more stringent than, the requirements contained in

Sec. Sec. 1.10 and 1.17 of this chapter, for futures commission

merchants and introducing brokers, and Sec. Sec. 5.7 and 5.12 of this

chapter for retail foreign exchange dealers; Provided, however, a self-

regulatory organization may permit its member registrants that are

registered with the Securities and Exchange Commission as securities

brokers or dealers to file (in accordance with Sec. 1.10(h) of this

chapter) a copy of their Financial and Operational Combined Uniform

Single Report under the Securities Exchange Act of 1934, Part II, Part

IIA, or Part II CSE, in lieu of Form 1-FR. The definition of adjusted

net capital must be the same as that prescribed in Sec. 1.17(c) of

this chapter for futures commission merchants and introducing brokers,

and Sec. 5.7(b)(2) of this chapter for futures commission merchants

offering or engaging in retail forex transactions and for retail

foreign exchange dealers.

(b) Each self-regulatory organization must establish and operate a

supervisory program for the purpose of assessing whether each member

registrant is in compliance with the applicable self-regulatory

organization and Commission rules and regulations governing minimum net

capital and related financial requirements, the obligation to segregate

customer funds, financial reporting requirements, recordkeeping

requirements, and sales practice and other compliance requirements. The

supervisory program also must address the following elements:

(1) Adequate levels and independence of audit staff. A self-

regulatory organization must maintain staff of an adequate size,

training, and experience to effectively implement a supervisory

program. Staff of the self-regulatory organization, including officers,

directors and supervising committee members, must maintain independent

judgment and its actions must not impair its independence nor appear to

impair its independence in matters related to the supervisory program.

The self-regulatory organization must provide annual ethics training to

all staff with responsibilities for the supervisory program.

(2) Ongoing surveillance. A self-regulatory organization's ongoing

surveillance of member registrants must include the review and analysis

of financial reports and regulatory notices filed by member registrants

with the designated self-regulatory organization.

(3) High-risk firms. A self-regulatory organization's supervisory

program must include procedures for identifying member registrants that

are determined to pose a high degree of potential financial risk,

including the potential risk of loss of customer funds. High-risk

member registrants must include firms experiencing financial or

operational difficulties, failing to meet segregation or net capital

requirements, failing to maintain current books and records, or

experiencing material inadequacies in internal controls. Enhanced

monitoring for high risk firms should include, as appropriate, daily

review of net capital, segregation, and secured calculations, to assess

compliance with self-regulatory and Commission requirements.

(4) On-site examinations. (i) A self-regulatory organization must

conduct routine periodic on-site examinations of member registrants.

Member futures commission merchants and retail foreign exchange dealers

must be subject to on-site examinations no less frequently than once

every eighteen months. A self-regulatory organization may establish a

risk-based method of establishing the scope of each on-site

examination, provided however, that the scope of each on-site

examination of a futures commission merchant or retail foreign exchange

dealer must include an assessment of whether the registrant is in

compliance with applicable Commission and self-regulatory organization

minimum capital and customer fund protection requirements,

recordkeeping, and reporting requirements.

(ii) A self-regulatory organization must establish the frequency of

on-site examinations of member introducing brokers that do not operate

pursuant to guarantee agreements with futures commission merchants or

retail foreign exchange dealers using a risk-based approach, provided

however, that each introducing broker is subject to an on-site

examination no less frequently than once every three years.

(iii) A self-regulatory organization must conduct on-site

examinations of member registrants in accordance with uniform audit

programs and procedures that have been submitted to the Commission.

(5) Adequate documentation. A self-regulatory organization must

adequately document all aspects of the operation of the supervisory

program, including the conduct of risk-based scope setting and the

risk-based surveillance of high-risk member registrants, and the

imposition of remedial and punitive action(s) for material violations.

(c) Any two or more self-regulatory organizations may file with the

Commission a plan for delegating to a designated self-regulatory

organization, for any registered futures commission merchant, retail

foreign exchange dealer, or introducing broker that is a member of more

than one such self-regulatory organization, the responsibility of:

(1) Monitoring and auditing for compliance with the minimum

financial and related reporting requirements adopted by such self-

regulatory organizations and the Commission in accordance with

paragraphs (a) and (b) of this section; and

[[Page 80607]]

(2) Receiving the financial reports necessitated by such minimum

financial and related reporting requirements.

(d) Any plan filed under this section may contain provisions for

the allocation of expenses reasonably incurred by the designated self-

regulatory organization among the self-regulatory organizations

participating in such a plan.

(e) A plan's designated self-regulatory organization must report

to:

(1) That plan's other self-regulatory organizations any violation

of such other self-regulatory organizations' rules and regulations for

which the responsibility to monitor, audit or examine has been

delegated to such designated self-regulatory organization under this

section; and

(2) The Commission any violation of a self-regulatory

organization's rules and regulations or any violation of the

Commission's regulations for which the responsibility to monitor, audit

or examine has been delegated to such designated self-regulatory

organization under this section.

(f) The self-regulatory organizations may, among themselves,

establish programs to provide access to any necessary financial or

related information.

(g) After appropriate notice and opportunity for comment, the

Commission may, by written notice, approve such a plan, or any part of

the plan, if it finds that the plan, or any part of it:

(1) Is necessary or appropriate to serve the public interest;

(2) Is for the protection and in the interest of customers or

option customers;

(3) Reduces multiple monitoring and multiple auditing for

compliance with the minimum financial rules of the self-regulatory

organizations submitting the plan of any futures commission merchant,

retail foreign exchange dealer, or introducing broker that is a member

of more than one self-regulatory organization;

(4) Reduces multiple reporting of the financial information

necessitated by such minimum financial and related reporting

requirements by any futures commission merchant, retail foreign

exchange dealer, or introducing broker that is a member of more than

one self-regulatory organization;

(5) Fosters cooperation and coordination among the self-regulatory

organizations; and

(6) Does not hinder the development of a registered futures

association under Section 17 of the Act.

(h) After the Commission has approved a plan, or part thereof,

under Sec. 1.52(g), a self-regulatory organization relieved of

responsibility must notify each of its members that are subject to such

a plan:

(1) Of the limited nature of its responsibility for such a member's

compliance with its minimum financial and related reporting

requirements; and

(2) Of the identity of the designated self-regulatory organization

that has been delegated responsibility for such a member.

(i) The Commission may at any time, after appropriate notice and

opportunity for hearing, withdraw its approval of any plan, or part

thereof, established under this section, if such plan, or part thereof,

ceases to adequately effectuate the purposes of Section 4f(b) of the

Act or of this section.

(j) Whenever a registered futures commission merchant, a registered

retail foreign exchange dealer, or a registered introducing broker

holding membership in a self-regulatory organization ceases to be a

member in good standing of that self-regulatory organization, such

self-regulatory organization must, on the same day that event takes

place, give electronic notice of that event to the Commission at its

Washington, DC, headquarters and send a copy of that notification to

such futures commission merchant, retail foreign exchange dealer, or

introducing broker.

(k) Nothing in this section shall preclude the Commission from

examining any futures commission merchant, retail foreign exchange

dealer, or introducing broker for compliance with the minimum financial

and related reporting requirements to which such futures commission

merchant, retail foreign exchange dealer, or introducing broker is

subject.

(l) In the event a plan is not filed and/or approved for each

registered futures commission merchant, retail foreign exchange dealer,

or introducing broker that is a member of more than one self-regulatory

organization, the Commission may design and, after notice and

opportunity for comment, approve a plan for those futures commission

merchants, retail foreign exchange dealers, or introducing brokers that

are not the subject of an approved plan (under paragraph (g) of this

section), delegating to a designated self-regulatory organization the

responsibilities described in paragraph (c) of this section.

PART 16--REPORTS BY CONTRACT MARKETS AND SWAP EXECUTION FACILITIES

4. The authority citation for part 16 is revised to read as

follows:

Authority: 7 U.S.C. 2, 6a, 6c, 6g, 6i, and 7, and 7b-3, as

amended by Pub. L. 111-203, 124 Stat. 1376.

5. The heading for part 16 is revised to read as set forth above.

6. Revise Sec. 16.01 to read as follows:

Sec. 16.01 Publication of market data on futures, swaps and options

thereon: Trading volume, open contracts, prices, and critical dates.

(a) Trading volume and open contracts. (1) Each reporting market,

as defined in part 15 of this chapter, must record for each business

day the following information separately:

(i) For futures, by commodity and by futures expiration date;

(ii) For options by underlying futures contracts for options on

futures contracts or by underlying physical for options on physicals,

and by put, by call, by expiration date and by strike price;

(iii) For swaps or class of swaps, by product type and by term life

of the swap; and

(iv) For swaptions or class of swaptions, by underlying swap

contracts for options on swap contracts or by underlying physical for

swaptions on physicals, and by put, by call, by expiration date and by

strike price.

(2) Volume for swaps and swaptions shall be reported in terms of

contracts for standard-sized contracts (i.e., contracts with a set

contract size for all contracts) or in terms of notional value for non-

standard-sized contracts (i.e., contracts whose contract size is not

set and can vary for each transaction):

(i) The option delta, where a delta system is used;

(ii) The total gross open contracts for futures, excluding those

contracts against which delivery notices have been stopped;

(iii) For futures products that specify delivery, open contracts

against which delivery notices have been issued on that business day;

(iv) The total volume of trading, excluding transfer trades or

office trades;

(v) The total volume of futures/options/swaps/swaptions exchanged

for commodities or for derivatives positions that are included in the

total volume of trading; and

(vi) The total volume of block trades included in the total volume

of trading.

(b) Prices. (1) Each reporting market must record the following

information separately:

(i) For futures, by commodity and by futures expiration,

(ii) For options, by underlying futures contracts for options on

futures contracts or by underlying physical for

[[Page 80608]]

options on physicals, and by put, by call, by expiration date and by

strike price,

(iii) For swaps, by product type and contract month or term life of

the swap, and

(iv) For swaptions or class of swaptions, by underlying swap

contracts for options on swap contracts or by underlying physical for

swaptions on physicals, and by put, by call, by expiration date and by

strike price.

(2) Each reporting market must record for the trading session and

for the opening and closing periods of trading as determined by each

reporting market:

(i) The opening and closing prices of each futures, option, swap or

swaption.

(ii) The price that is used for settlement purposes, if different

from the closing price.

(iii) The lowest price of a sale or offer, whichever is lower, and

the highest price of a sale or bid, whichever is higher, that the

reporting market reasonably determines accurately reflects market

conditions. Bids and offers vacated or withdrawn shall not be used in

making this determination. A bid is vacated if followed by a higher bid

or price and an offer is vacated if followed by a lower offer or price.

(3) If there are no transactions, bids, or offers during the

opening or closing periods, the reporting market may record as

appropriate:

(i) The first price (in lieu of opening price data) or the last

price (in lieu of closing price data) occurring during the trading

session, clearly indicating that such prices are the first and last

prices; or

(ii) Nominal opening or nominal closing prices that the reporting

market reasonably determines to accurately reflect market conditions,

clearly indicating that such prices are nominal.

(4) Additional information. Each reporting market must record the

following information with respect to transactions in commodity

futures, commodity options, swaps or swaptions on that reporting

market:

(i) The method used by the reporting market in determining nominal

prices and settlement prices; and

(ii) If discretion is used by the reporting market in determining

the opening and/or closing ranges or the settlement prices, an

explanation that certain discretion may be employed by the reporting

market and a description of the manner in which that discretion may be

employed. Discretionary authority must be noted explicitly in each case

in which it is applied (for example, by use of an asterisk or

footnote).

(c) Critical dates. Each reporting market must report to the

Commission, for each futures contract, the first notice date and the

last trading date, and for each option contract, the expiration date in

accordance with paragraph (d) of this section.

(d) Form, manner and time of filing reports. Unless otherwise

approved by the Commission or its designee, reporting markets must

submit to the Commission the information specified in paragraphs

(a)(2), (b), and (c) of this section as follows:

(1) Using the format, coding structure and electronic data

transmission procedures approved in writing by the Commission or its

designee; provided however, that the information must be made available

to the Commission or its designee in hard copy upon request;

(2) When each such form of the data is first available, but not

later than 7 a.m. on the business day following the day to which the

information pertains for the delta factor and settlement price and not

later than 12 p.m. for the remainder of the information. Unless

otherwise specified by the Commission or its designee, the stated time

is U.S. eastern standard time for information concerning markets

located in that time zone, and U.S. central time for information

concerning all other markets; and

(3) For information on reports to the Commission for swap or

swaption contracts, refer to part 20 of this chapter.

(e) Publication of recorded information. (1) Reporting markets must

make the information in paragraph (a) of this section readily available

to the news media and the general public without charge, in a format

that readily enables the consideration of such data, no later than the

business day following the day to which the information pertains. The

information in paragraphs (a)(2)(iv) through (vi) of this section shall

be made readily available in a format that presents the information

together.

(2) Reporting markets must make the information in paragraphs

(b)(2) and (3) of this section readily available to the news media and

the general public, and the information in paragraph (b)(4)(ii) of this

section readily available to the general public, in a format that

readily enables the consideration of such data, no later than the

business day following the day to which the information pertains.

Information in paragraph (b)(4)(i) of this section must be made

available in the registered entity's rulebook, which is publicly

accessible on its Web site.

PART 38--DESIGNATED CONTRACT MARKETS

7. Revise the authority citation for part 38 to read as follows:

Authority: 7 U.S.C. 2, 4c,. 6, 6a, 6d, 6e, 6f, 6g, 6i, 6j, 6k,

6l, 6m, 6n, 7, 7a-2, 7b, 7b-1, 7b-3, 8, 9, 15, and 21 as amended by

Pub. L. 111-203, 124 Stat. 1376.

8. Designate existing Sec. Sec. 38.1 through 38.6 as subpart A

under the following subpart heading:

Subpart A--General Provisions

* * * * *

Sec. 38.1 [Amended]

9. Amend Sec. 38.1 by removing the reference ``Parts 36 or 37 of

this chapter'' and adding in its place the reference ``parts 37 or 49

of this chapter''.

10. Revise Sec. 38.2 to read as follows:

Sec. 38.2 Applicable provisions.

A designated contract market, the contract market's operator and

transactions traded on or through a designated contract market under

Section 5 of the Act shall comply with the requirements of this part

38, Sec. Sec. 1.3, 1.12(e), 1.31, 1.37(c)-(d), 1.52, 1.59(d), 1.60,

1.63(c), 1.67, 33.10, part 9, parts 15 through 21, part 40, part 41,

part 43, part 45, part 46, part 49, part 151, and part 190 of this

chapter, including any related definitions and cross-referenced

sections.

11. Revise Sec. 38.3 to read as follows:

Sec. 38.3 Procedures for designation.

(a) Application procedures. (1) A board of trade seeking

designation as a contract market must file electronically Application

Form DCM provided in Appendix A of this part, with the Secretary of the

Commission at its Washington, DC headquarters at [email protected]

and the Division of Market Oversight at [email protected] The

Commission will review the application for designation as a contract

market pursuant to the 180-day timeframe and procedures specified in

Section 6(a) of the Act. The Commission shall approve or deny the

application or, if deemed appropriate, designate the applicant as a

contract market subject to conditions.

(2) The application must include information sufficient to

demonstrate compliance with the core principles specified in Section

5(d) of the Act. Application Form DCM consists of instructions, general

questions and a list of Exhibits (documents, information and evidence)

required by the Commission in order to determine whether an applicant

is able to comply with the core principles. An application will not

[[Page 80609]]

be considered to be materially complete unless the applicant has

submitted, at a minimum, the Exhibits as required in Application Form

DCM. If the application is not materially complete, the Commission

shall notify the applicant that the application will not be deemed to

have been submitted for purposes of the 180-day review period set forth

in paragraph (a)(1) of this section.

(3) The applicant must identify with particularity any information

in the application that will be subject to a request for confidential

treatment pursuant to Sec. 145.9 of this chapter.

(4) Section 40.8 of this chapter sets forth those sections of the

application that will be made publicly available, notwithstanding a

request for confidential treatment pursuant to Sec. 145.9 of this

chapter.

(5) If any information contained in the application or in any

Exhibit is or becomes inaccurate for any reason, an amendment to the

application or a submission filed under part 40 of this chapter must be

filed promptly correcting such information.

(b) Reinstatement of dormant designation. Before listing or

relisting products for trading, a dormant designated contract market as

defined in Sec. 40.1 of this chapter must reinstate its designation

under the procedures of paragraphs (a)(1) and (a)(2) of this section;

provided, however, that an application for reinstatement may rely upon

previously submitted materials that still pertain to, and accurately

describe, current conditions.

(c) Delegation of authority. (1) The Commission hereby delegates,

until it orders otherwise, to the Director of the Division of Market

Oversight or such other employee or employees as the Director may

designate from time to time, upon consultation with the General Counsel

or the General Counsel's delegate, authority to notify the applicant

seeking designation under Section 6(a) of the Act that the application

is materially incomplete and the running of the 180-day period is

stayed.

(2) The Director may submit to the Commission for its consideration

any matter that has been delegated in this paragraph.

(3) Nothing in this paragraph prohibits the Commission, at its

election, from exercising the authority delegated in paragraph (c)(1)

of this section.

(d) Request for transfer of designation. (1) Request for transfer

of designation, listed contracts and open interest. A designated

contract market that wants to request the transfer of its designation

from its current legal entity to a new legal entity, as a result of a

corporate reorganization or otherwise, must file a request with the

Commission for approval to transfer the designation, listed contracts

and positions comprising all associated open interest. Such request

must be filed electronically with the Secretary of the Commission at

its Washington, DC headquarters at [email protected] and the

Division of Market Oversight at [email protected]

(2) Timing of submission. The request must be filed no later than

three months prior to the anticipated corporate change; provided that

the designated contract market may file a request with the Commission

later than three months prior to the anticipated change if the

designated contract market does not know and reasonably could not have

known of the anticipated change three months prior to the anticipated

change. In such event, the designated contract market shall be required

to immediately file the request with the Commission as soon as it knows

of such change with an explanation as to the timing of the request.

(3) Required information. The request shall include the following:

(i) The underlying agreement that governs the corporate change.

(ii) A narrative description of the corporate change, including the

reason for the change and its impact on the designated contract market,

including its governance, and operations, and its impact on the rights

and obligations of market participants holding the open interest

positions.

(iii) A discussion of the transferee's ability to comply with the

Act, including the core principles applicable to designated contract

markets, and the Commission's regulations thereunder.

(iv) The governing documents of the transferee including, but not

limited to, articles of incorporation and bylaws.

(v) The transferee's rules marked to show changes from the current

rules of the designated contract market.

(vi) A list of contracts, agreements, transactions or swaps for

which the designated contract market requests transfer of open

interest.

(vii) A representation by the transferee that it:

(A) Will be the surviving corporation and successor-in-interest to

the transferor designated contract market and will retain and assume,

without limitation, all the assets and liabilities of the transferor;

(B) Will assume responsibility for complying with all applicable

provisions of the Act and the Commission's regulations thereunder,

including part 38 and Appendices thereto;

(C) Will assume, maintain and enforce all rules implementing and

complying with these core principles, including the adoption of the

transferor's rulebook, as amended in the request, and that any such

amendments will be submitted to the Commission pursuant to Section

5c(c) of the Act and part 40 of the Commission's regulations; and

(D) Will comply with all self-regulatory responsibilities except if

otherwise indicated in the request, and will maintain and enforce all

self-regulatory programs.

(viii) A representation by the transferee that upon the transfer:

(A) All open interest in all contracts listed on the transferor

will be transferred to and represent equivalent open interest in all

such contracts listed on the transferee;

(B) It will assume responsibility for and maintain compliance with

product core principles for all contracts previously listed for trading

through the transferor, whether by certification or approval; and

(C) That none of the proposed rule changes will affect the rights

and obligations of any participant with open positions transferred to

it and that the proposed rule changes do not modify the manner in which

such contracts are settled or cleared.

(ix) A representation by the transferee that market participants

will be notified of all changes to the transferor's rulebook prior to

the transfer and will be further notified of the concurrent transfer of

the contract market designation and the related transfer of all listed

contracts and all associated open interest, to the transferee upon

Commission approval and issuance of an order permitting this transfer.

(4) Commission determination. The Commission will review a request

as soon as practicable and such request will be approved or denied

pursuant to a Commission order and based on the Commission's

determination as to the transferee's ability to continue to operate the

designated contract market in compliance with the Act and the

Commission's regulations thereunder.

(e) Request for withdrawal of application for designation. An

applicant for designation may withdraw its application submitted

pursuant to paragraphs (a)(1) and (a)(2) of this section by filing such

a request with the Commission at its Washington, DC headquarters.

Withdrawal of an application for designation shall not affect any

action taken or to be taken by the Commission based upon actions,

activities or events occurring during the

[[Page 80610]]

time that the application for designation was pending with the

Commission.

(f) Request for vacation of designation. A designated contract

market may vacate its designation under Section 7 of the Act by filing

electronically such a request with the Commission at its Washington, DC

headquarters. Vacation of designation shall not affect any action taken

or to be taken by the Commission based upon actions, activities or

events occurring during the time that the facility was designated by

the Commission.

(g) Requirements for existing designated contract markets. A board

of trade that is designated as a contract market as of [EFFECTIVE DATE

OF FINAL RULE], will be considered to be a designated contract market

under this section, provided that such existing designated contract

market certifies to the Commission in writing that it is in compliance

with each of the designated contract market core principles and

associated regulations in this part, within 60 days of [EFFECTIVE DATE

OF FINAL RULE].

12. In Sec. 38.4, revise paragraphs (a) and (b) to read as

follows:

Sec. 38.4 Procedures for listing products and implementing designated

contract market rules.

(a) Request for Commission approval of rules and products. (1) An

applicant for designation, or a designated contract market, may request

that the Commission approve under Section 5c(c) of the Act, any or all

of its rules and contract terms and conditions, and subsequent

amendments thereto, prior to their implementation or, notwithstanding

the provisions of Section 5c(c)(2) of the Act, at anytime thereafter,

under the procedures of Sec. Sec. 40.3 or 40.5 of this chapter, as

applicable. A designated contract market may label a future, swap or

options product in its rules as ``Listed for trading pursuant to

Commission approval,'' if the future, swap or options product and its

terms or conditions have been approved by the Commission, and it may

label as ``Approved by the Commission'' only those rules that have been

so approved.

(2) Notwithstanding the timeline under Sec. Sec. 40.3(c) and

40.5(c) of this chapter, the operating rules and terms and conditions

of futures, swaps and option products that have been submitted for

Commission approval at the same time as an application for contract

market designation or an application under Sec. 38.3(b) of this part

to reinstate the designation of a dormant designated contract market,

as defined in Sec. 40.1 of this chapter, or while one of the foregoing

is pending, will be deemed approved by the Commission no earlier than

when the facility is deemed to be designated or reinstated.

(b) Self-certification of rules and products. Rules of a designated

contract market and subsequent amendments thereto, including both

operational rules and the terms or conditions of futures, swaps and

option products listed for trading on the facility, not voluntarily

submitted for prior Commission approval pursuant to paragraph (a) of

this section must be submitted to the Commission with a certification

that the rule, rule amendment or futures, swap or options product

complies with the Act or rules thereunder pursuant to the procedures of

Sec. 40.6 of this chapter, as applicable. Provided, however, any rule

or rule amendment that would, for a delivery month having open

interest, materially change a term or condition of a swap or a contract

for future delivery in an agricultural commodity enumerated in Section

1a(9) of the Act, or of an option on such contract or commodity, must

be submitted to the Commission prior to its implementation for review

and approval under Sec. 40.4 of this chapter.

* * * * *

13. Revise Sec. 38.5 to read as follows:

Sec. 38.5 Information relating to contract market compliance.

(a) Requests for information. Upon request by the Commission, a

designated contract market must file with the Commission such

information related to its business as a designated contract market,

including information relating to data entry and trade details, in the

form and manner, and within the time specified by the Commission in its

request.

(b) Demonstration of compliance. Upon request by the Commission, a

designated contract market must file with the Commission a written

demonstration, containing such supporting data, information and

documents, in the form and manner and within such time as the

Commission may specify, that the designated contract market is in

compliance with one or more core principles as specified in the

request, or that is requested by the Commission to satisfy its

obligations under the Act.

(c) Equity interest transfers. (1) Equity transfer notification.

Upon entering into any agreement(s) that could result in an equity

interest transfer of ten percent or more in the contract market, the

designated contract market must file a notification of the equity

interest transfer with the Secretary of the Commission at its

Washington, DC headquarters at [email protected] and the Division of

Market Oversight at [email protected], no later than the business

day, as defined in Sec. 40.1 of this chapter, following the date on

which the designated contract market enters into a firm obligation to

transfer the equity interest.

(2) Required information. (i) The notification must include and be

accompanied by:

(A) Any relevant agreement(s), including any preliminary

agreements;

(B) Any associated changes to relevant corporate documents;

(C) A chart outlining any new ownership or corporate or

organizational structure;

(D) A brief description of the purpose and any impact of the equity

interest transfer; and

(E) A representation from the designated contract market that it

meets all of the requirements of Section 5(d) of the Act and Commission

regulations adopted thereunder.

(ii) The designated contract market must keep the Commission

apprised of the projected date that the transaction resulting in the

equity interest transfer will be consummated, and must provide to the

Commission any new agreements or modifications to the original

agreement(s) filed pursuant to this section. The designated contract

market must notify the Commission of the consummation of the

transaction on the day in which it occurs.

(3) Certification. (i) Upon a transfer of an equity interest of ten

percent or more in a designated contract market, the designated

contract market must file with the Secretary of the Commission at its

Washington, DC headquarters, at [email protected], and the Division

of Market Oversight, at [email protected], a certification that

the designated contract market meets all of the requirements of Section

5(d) of the Act and Commission regulations adopted thereunder, no later

than two business days, as defined in Sec. 40.1 of this chapter,

following the date on which the equity interest transfer of ten percent

or more was consummated. Such certification must state whether changes

to any aspects of the designated contract market's operations were made

as a result of such change in ownership, and include a description of

any such change(s).

(ii) The certification required under this paragraph may rely on

and be supported by reference to an application for designation or

prior filings made pursuant to a product or rule submission

requirement, along with any necessary new filings, including new

filings that provide any and all material

[[Page 80611]]

updates of prior submissions. The DCM shall also amend any information

that is no longer accurate on Form DCM consistent with the procedures

set forth in Sec. 38.3 of this part.

(d) Delegation of authority. The Commission hereby delegates, until

it orders otherwise, the authority set forth in paragraph (b) of this

section to the Director of the Division of Market Oversight or such

other employee or employees as the Director may designate from time to

time. The Director may submit to the Commission for its consideration

any matter that has been delegated in this paragraph. Nothing in this

paragraph prohibits the Commission, at its election, from exercising

the authority delegated in this paragraph.

14. Add Sec. 38.7 to subpart A to read as follows:

Sec. 38.7 Prohibited use of data collected for regulatory purposes.

A designated contract market may not use for business or marketing

purposes any proprietary data or personal information it collects or

receives, from or on behalf of any person, for the purpose of

fulfilling its regulatory obligations; provided however, that a

designated contract market, where necessary, may share such information

with one or more designated contract markets, or swap execution

facilities registered with the Commission, for regulatory purposes.

15. Add Sec. 38.8 to subpart A to read as follows:

Sec. 38.8 Listing of swaps on a designated contract market.

(a) A designated contract market that lists for the first time a

swap contract for trading on its contract market must, either prior to

or at the time of such listing, file with the Commission a written

demonstration detailing how the designated contract market is

addressing its self-regulatory obligations and is fulfilling its

statutory and regulatory obligations with respect to swap transactions.

(b) Prior to listing swaps for trading on or through a designated

contract market, each designated contract market must request from the

Commission a unique, extensible, alphanumeric code for the purpose of

identifying the designated contract market pursuant to part 45 of this

chapter.

16. Add Sec. 38.9 to subpart A to read as follows:

Sec. 38.9 Boards of trade operating both a designated contract market

and a swap execution facility.

(a) A board of trade that operates a designated contract market and

that intends to also operate a swap execution facility must separately

register, pursuant to the swap execution facility registration

requirements set forth in part 37 of this chapter, and on an ongoing

basis, comply with the core principles under Section 5h of the Act, and

the swap execution facility rules under part 37 of this chapter.

(b) A board of trade that operates both a designated contract

market and a swap execution facility, and that uses the same electronic

trade execution system for executing and trading swaps that it uses in

its capacity as a designated contract market must clearly identify to

market participants for each swap whether the execution or trading of

such swap is taking place on the designated contract market or on the

swap execution facility.

17. Add Sec. 38.10 to subpart A to read as follows:

Sec. 38.10 Reporting of swaps traded on a designated contract market.

With respect to swaps traded on or through a designated contract

market, each designated contract market must report specified swap data

as provided under parts 43 and 45 of this chapter.

18. Add subparts B through X to read as follows:

Subpart B--Designation as Contract Market

Sec.

38.100 Core Principle 1.

Subpart C--Compliance With Rules

38.150 Core Principle 2.

38.151 Access requirements.

38.152 Abusive trading practices prohibited.

38.153 Capacity to detect and investigate rule violations.

38.154 Regulatory services provided by a third party.

38.155 Compliance staff and resources.

38.156 Automated trade surveillance system.

38.157 Real-time market monitoring.

38.158 Investigations and investigation reports.

38.159 Ability to obtain information.

38.160 Additional rules required.

Subpart D--Contracts Not Readily Susceptible to Manipulation

38.200 Core Principle 3.

38.201 Additional sources for compliance.

Subpart E--Prevention of Market Disruption

38.250 Core Principle 4.

38.251 General requirements.

38.252 Additional requirements for physical delivery markets.

38.253 Additional requirements for cash-settled markets.

38.254 Ability to obtain information.

38.255 Risk controls for trading.

38.256 Trade reconstruction.

38.257 Regulatory service provider.

38.258 Additional rules required.

Subpart F--Position Limitations or Accountability

38.300 Core Principle 5.

38.301 Position limitations and accountability.

Subpart G--Emergency Authority

38.350 Core Principle 6.

38.351 Additional sources for compliance.

Subpart H--Availability of General Information

38.400 Core Principle 7.

38.401 General requirements.

Subpart I--Daily Publication of Trading Information

38.450 Core Principle 8.

38.451 Reporting of trade information.

Subpart J--Execution of Transactions

38.500 Core Principle 9.

38.501 General requirements.

38.502 Minimum centralized trading requirement.

38.503 Blocks trades on futures contracts.

38.504 Block trades on swap contracts.

38.505 Exchange of derivatives for related position.

38.506 Office trades and transfer trades.

Subpart K--Trade Information

38.550 Core Principle 10.

38.551 Audit trail required.

38.552 Elements of an acceptable audit trail program.

38.553 Enforcement of audit trail requirements.

Subpart L--Financial Integrity of Transactions

38.600 Core Principle 11.

38.601 Mandatory clearing.

38.602 General financial integrity.

38.603 Protection of customer funds.

38.604 Financial surveillance.

38.605 Requirements for financial surveillance program.

38.606 Financial regulatory services provided by a third party.

38.607 Direct access.

Subpart M--Protection of Markets and Market Participants

38.650 Core Principle 12.

38.651 Additional sources for compliance.

Subpart N--Disciplinary Procedures

38.700 Core Principle 13.

38.701 Enforcement staff.

38.702 Disciplinary panels.

38.703 Review of investigation report.

38.704 Notice of charges.

38.705 Right to representation.

38.706 Answer to charges.

38.707 Admission or failure to deny charges.

38.708 Denial of charges and right to hearing.

38.709 Settlement offers.

38.710 Hearings.

38.711 Decisions.

38.712 Right to appeal.

38.713 Final decisions.

38.714 Disciplinary sanctions.

38.715 Summary fines for violations of rules regarding timely

submission of

[[Page 80612]]

records, decorum, or other similar activities.

38.716 Emergency disciplinary actions.

Subpart O--Dispute Resolution

38.750 Core Principle 14.

38.751 Additional sources for compliance.

Subpart P--Governance Fitness Standards

38.800 Core Principle 15.

Subpart Q--Conflicts of Interest

38.850 Core Principle 16.

Subpart R--Composition of Governing Boards of Contract Markets

38.900 Core Principle 17.

Subpart S--Recordkeeping

38.950 Core Principle 18.

38.951 Additional sources for compliance.

Subpart T--Antitrust Considerations

38.1000 Core Principle 19.

38.1001 Additional sources for compliance.

Subpart U--System Safeguards

38.1050 Core Principle 20.

38.1051 General requirements.

Subpart V--Financial Resources

38.1100 Core Principle 21.

38.1101 General requirements.

Subpart W--Diversity of Boards of Directors

38.1150 Core Principle 22.

Subpart X--Securities and Exchange Commission

38.1200 Core Principle 23.

38.1201 Additional sources for compliance.

Subpart B--Designation as Contract Market

Sec. 38.100 Core Principle 1.

(a) In general. To be designated, and maintain a designation, as a

contract market, a board of trade shall comply with:

(1) Any core principle described in Section 5(d) of the Act, and

(2) Any requirement that the Commission may impose by rule or

regulation pursuant to Section 8a(5) of the Act.

(b) Reasonable discretion of the contract market. Unless otherwise

determined by the Commission by rule or regulation, a board of trade

described in paragraph (a) of this section shall have reasonable

discretion in establishing the manner in which the board of trade

complies with the core principles described in this subsection.

Subpart C--Compliance With Rules

Sec. 38.150 Core Principle 2.

(a) In general. The board of trade shall establish, monitor, and

enforce compliance with the rules of the contract market, including:

(1) Access requirements;

(2) The terms and conditions of any contracts to be traded on the

contract market; and

(3) Rules prohibiting abusive trade practices on the contract

market.

(b) Capacity of contract market. The board of trade shall have the

capacity to detect, investigate, and apply appropriate sanctions to any

person that violates any rule of the contract market.

(c) Requirement of rules. The rules of the contract market shall

provide the board of trade with the ability and authority to obtain any

necessary information to perform any function described in this

section, including the capacity to carry out such international

information-sharing agreements, as the Commission may require.

Sec. 38.151 Access requirements.

(a) Jurisdiction. Prior to granting any member or market

participant access to its markets, a designated contract market must

require that the member or market participant consent to its

jurisdiction.

(b) Impartial access by members, market participants and

independent software vendors. A designated contract market must provide

its members, market participants and independent software vendors with

impartial access to its markets and services, including:

(1) Access criteria that are impartial, transparent, and applied in

a non-discriminatory manner; and

(2) Comparable fee structures for members, market participants and

independent software vendors receiving equal access to, or services

from, the designated contract market.

(c) Limitations on access. A designated contract market must

establish and impartially enforce rules governing denials, suspensions,

and revocations of a member's and market participant's access

privileges to the designated contract market, including when such

actions are part of a disciplinary or emergency action by the

designated contract market.

Sec. 38.152 Abusive trading practices prohibited.

A designated contract market must prohibit abusive trading

practices on its markets by members and market participants. Designated

contract markets that permit intermediation must prohibit customer-

related abuses including, but not limited to, trading ahead of customer

orders, trading against customer orders, accommodation trading, and

improper cross trading. Specific trading practices that must be

prohibited by all designated contract markets include front-running,

wash trading, pre-arranged trading, fraudulent trading, money passes,

and any other trading practices that a designated contract market deems

to be abusive. In addition, a designated contract market also must

prohibit any other manipulative or disruptive trading practices

prohibited by the Act or by the Commission pursuant to Commission

regulation.

Sec. 38.153 Capacity to detect and investigate rule violations.

A designated contract market must have arrangements and resources

for effective enforcement of its rules. Such arrangements must include

the authority to collect information and documents on both a routine

and non-routine basis, including the authority to examine books and

records kept by the designated contract market's members and by market

participants. A designated contract market's arrangements and resources

must also facilitate the direct supervision of the market and the

analysis of data collected to determine whether a rule violation

occurred.

Sec. 38.154 Regulatory services provided by a third party.

(a) Use of third-party provider permitted. A designated contract

market may choose to contract with a registered futures association or

another registered entity, as such terms are defined under the CEA,

(collectively, ``regulatory service provider''), for the provision of

services to assist in complying with the core principles, as approved

by the Commission. Any designated contract market that chooses to

contract with a regulatory service provider must ensure that its

regulatory service provider has the capacity and resources necessary to

provide timely and effective regulatory services, including adequate

staff and automated surveillance systems. A designated contract market

will at all times remain responsible for the performance of any

regulatory services received, for compliance with the designated

contract market's obligations under the CEA and Commission regulations,

and for the regulatory service provider's performance on its behalf.

(b) Duty to supervise third party. A designated contract market

that elects to utilize a regulatory service provider must retain

sufficient compliance staff to supervise the quality and effectiveness

of the services provided on its behalf. Compliance staff of the

designated contract market must hold regular meetings with the

regulatory service provider to discuss ongoing investigations, trading

patterns, market participants, and any other matters of

[[Page 80613]]

regulatory concern. A designated contract market also must conduct

periodic reviews of the adequacy and effectiveness of services provided

on its behalf. Such reviews must be documented carefully and made

available to the Commission upon request.

(c) Regulatory decisions required from the designated contract

market. A designated contract market that elects to utilize a

regulatory service provider must retain exclusive authority in

decisions involving the cancellation of trades, the issuance of

disciplinary charges against members or market participants, and

denials of access to the trading platform for disciplinary reasons. A

designated contract market may also retain exclusive authority in other

areas of its choosing; provided however, that the decision to open an

investigation into a possible rule violation must always reside

exclusively with the regulatory service provider. A designated contract

market must document any instances where its actions differ from those

recommended by its regulatory service provider, including the reasons

for the course of action recommended by the regulatory service provider

and the reasons why the designated contract market chose a different

course of action.

Sec. 38.155 Compliance staff and resources.

(a) Sufficient compliance staff. A designated contract market must

establish and maintain sufficient compliance department resources and

staff to ensure that it can conduct effective audit trail reviews,

trade practice surveillance, market surveillance, and real-time market

monitoring. The designated contract market's compliance staff must also

be sufficient to address unusual market or trading events as they

arise, and to conduct and complete investigations in a timely manner,

as set forth in Sec. 38.158(b) of this part.

(b) Ongoing monitoring of compliance staff resources. A designated

contract market must monitor the size and workload of its compliance

staff annually, and ensure that its compliance resources and staff are

at appropriate levels. In determining the appropriate level of

compliance resources and staff, the designated contract market should

consider projected trading volume increases, the number of new products

or contracts projected to be listed for trading, any new

responsibilities expected to be assigned to compliance staff, the

results of any internal review demonstrating that work is not completed

in an effective or timely manner, and any other factors suggesting the

need for increased resources and staff.

Sec. 38.156 Automated trade surveillance system.

A designated contract market must maintain an automated trade

surveillance system capable of detecting and investigating potential

trade practice violations. Such system must maintain all data

reflecting the details of each order entered into the trading system,

including all order modifications and cancellations and maintain all

data reflecting transactions executed on the designated contract

market. The automated system must load and process daily orders and

trades no later than 24 hours after the completion of the trading day.

In addition, the automated trade surveillance system must have the

capability to detect and flag specific trade execution patterns and

trade anomalies; compute, retain, and compare trading statistics;

compute trade gains, losses, and futures-equivalent positions;

reconstruct the sequence of market activity; perform market analyses;

and support system users to perform in-depth analyses and ad hoc

queries of trade-related data.

Sec. 38.157 Real-time market monitoring.

A designated contract market must conduct real-time market

monitoring of all trading activity on its electronic trading

platform(s) to ensure orderly trading and identify any market or system

anomalies. A designated contract market must have the authority to

adjust trade prices or cancel trades when necessary to mitigate market

disrupting events caused by malfunctions in its electronic trading

platform(s) or errors in orders submitted by members and market

participants. Any trade price adjustments or trade cancellations must

be transparent to the market and subject to standards that are clear,

fair, and publicly available.

Sec. 38.158 Investigations and investigation reports.

(a) Procedures. A designated contract market must establish and

maintain procedures that require its compliance staff to conduct

investigations of possible rule violations. An investigation must be

commenced upon the receipt of a request from Commission staff or upon

the discovery or receipt of information by the designated contract

market that, in the judgment of its compliance staff, indicates a

possible basis for finding that a violation has occurred or will occur.

(b) Timeliness. Each compliance staff investigation must be

completed in a timely manner. Absent mitigating factors, a timely

manner is no later than 12 months after the date that an investigation

is opened. Mitigating factors that may reasonably justify an

investigation taking longer than 12 months to complete include the

complexity of the investigation, the number of firms or individuals

involved as potential wrongdoers, the number of potential violations to

be investigated, and the volume of documents and data to be examined

and analyzed by compliance staff.

(c) Investigation reports when a reasonable basis exists for

finding a violation. Compliance staff must submit a written

investigation report for disciplinary action in every instance in which

compliance staff determines from surveillance or from an investigation

that a reasonable basis exists for finding a rule violation. The

investigation report must include the reason the investigation was

initiated; a summary of the complaint, if any; the relevant facts;

compliance staff's analysis and conclusions; and a recommendation as to

whether disciplinary action should be pursued. The report must also

include the member or market participant's disciplinary history at the

designated contract market.

(d) Investigation reports when no reasonable basis exists for

finding a violation. If after conducting an investigation, compliance

staff determines that no reasonable basis exists for finding a

violation, it must prepare a written report including the reason the

investigation was initiated; a summary of the complaint, if any; the

relevant facts; compliance staff's analysis and conclusions; and if

applicable, any recommendation that a disciplinary committee issue a

warning letter in accordance with paragraph (e) of this section. If

compliance staff recommends that a warning letter be issued to a member

or market participant pursuant to paragraph (e) of this section, the

investigation report must include a copy of the letter as well as the

member or market participant's disciplinary history at the designated

contract market.

(e) Warning letters. In addition to the action required to be taken

under paragraphs (c) and (d) of this section, the rules of a designated

contract market may authorize compliance staff to issue a warning

letter to a person or entity under investigation or to recommend that a

disciplinary committee take such an action. A warning letter issued in

accordance with this section is not a penalty or an indication that a

finding

[[Page 80614]]

of a violation has been made. A copy of a warning letter issued by

compliance staff must be included in the investigation report required

by paragraphs (c) and (d) of this section. No more than one warning

letter for the same potential violation may be issued to the same

person or entity during a rolling 12-month period.

Sec. 38.159 Ability to obtain information.

A designated contract market must have the ability and authority to

obtain any necessary information to perform any function required under

this subpart C of the Commission's regulations, including the capacity

to carry out international information-sharing agreements as the

Commission may require. Appropriate information-sharing agreements can

be established with other designated contract markets and swap

execution facilities, or the Commission can act in conjunction with the

designated contract market to carry out such information sharing.

Sec. 38.160 Additional rules required.

A designated contract market must adopt and enforce any additional

rules that it believes are necessary to comply with the requirements of

this subpart C.

Subpart D--Contracts Not Readily Subject to Manipulation

Sec. 38.200 Core Principle 3.

The board of trade shall list on the contract market only contracts

that are not readily susceptible to manipulation.

Sec. 38.201 Additional sources for compliance.

Applicants and designated contract markets may refer to the

guidance in appendix C of this part to demonstrate to the Commission

compliance with the requirements of Sec. 38.200 of this part.

Subpart E--Prevention of Market Disruption

Sec. 38.250 Core Principle 4.

The board of trade shall have the capacity and responsibility to

prevent manipulation, price distortion, and disruptions of the delivery

or cash-settlement process through market surveillance, compliance, and

enforcement practices and procedures, including:

(a) Methods for conducting real-time monitoring of trading; and

(b) Comprehensive and accurate trade reconstructions.

Sec. 38.251 General requirements.

A designated contract market must:

(a) Collect and evaluate data on individual traders' market

activity on an ongoing basis in order to detect and prevent

manipulation, price distortions and, where possible, disruptions of the

delivery or cash-settlement process;

(b) Monitor and evaluate general market data in order to detect and

prevent manipulative activity that would result in the failure of the

market price to reflect the normal forces of supply and demand;

(c) Have the capacity to conduct real-time monitoring of trading

and comprehensive and accurate trade reconstructions. The monitoring of

intraday trading must include the capacity to detect abnormal price

movements, unusual trading volumes, impairments to market liquidity,

and position-limit violations; and

(d) Have either manual processes or automated alerts that are

effective in detecting and preventing trading abuses.

Sec. 38.252 Additional requirements for physical delivery contracts.

(a) For physical delivery contracts, the designated contract market

must:

(1) Monitor a contract's terms and conditions as to whether there

is convergence between the contract price and the price of the

underlying commodity;

(2) Monitor that the deliverable supply is adequate so that the

contract will not be susceptible to price manipulation or distortion;

(3) Assess whether the deliverable commodity reasonably can be

expected to be available to short traders and salable by long traders

at its market value in normal cash marketing channels; and

(4) When available, monitor data related to the size and ownership

of deliverable supplies.

(b) The designated contract market must continually monitor the

appropriateness of the contract's terms and conditions, including the

delivery instrument, the delivery locations and location differentials,

and the commodity characteristics and related differentials. The

designated contract market must address conditions that are interfering

with convergence or causing price distortions or market disruptions,

including, when appropriate, changes to contract terms.

Sec. 38.253 Additional requirements for cash-settled contracts.

(a) For cash-settled contracts, the designated contract market must

monitor:

(1) The availability and pricing of the commodity making up the

index to which the contract will be settled; and

(2) The continued appropriateness of the methodology for deriving

the index. Designated contract markets must promptly amend any

methodologies that result, or are likely to result, in manipulation,

price distortions, or market disruptions, or must impose new

methodologies to resolve the threat of disruptions or distortions.

(b) If a contract listed on a designated contract market is settled

by reference to the price of a contract or commodity traded in another

venue, including a price or index derived from prices on another

designated contract market, the designated contract market must have

rules that require traders on the DCM market to provide the DCM with

their positions in the reference markets as the traders' contracts

approach settlement. In the alternative, the DCM may have an

information sharing agreement with the other venue or designated

contract market.

Sec. 38.254 Ability to obtain information.

(a) The designated contract market must have rules that require

traders in its contracts to keep records of their trading, including

records of their activity in the underlying commodity and related

derivatives markets and make such records available, upon request, to

the designated contract market.

(b) A designated contract market with customers trading through

intermediaries must either use a comprehensive large-trader reporting

system (LTRS) or be able to demonstrate that it can obtain position

data from other sources in order to conduct an effective surveillance

program.

Sec. 38.255 Risk controls for trading.

The designated contract market must establish and maintain risk

control mechanisms to reduce the potential risk of market disruptions,

including but not limited to market restrictions that pause or halt

trading in market conditions prescribed by the designated contract

market. If a contract is linked to, or a substitute for, other

contracts on the designated contract market or on other trading venues,

such risk controls must, to the extent practicable, be coordinated with

any similar controls placed on those other contracts. If a contract is

based on the price of an equity security or the level of an equity

index, such risk controls must, to the extent practicable, be

coordinated with any similar controls placed on national security

exchanges.

Sec. 38.256 Trade reconstruction.

The designated contract market must have the ability to

comprehensively and accurately reconstruct all trading on its trading

facility. All audit-trail data and reconstructions must be made

available

[[Page 80615]]

to the Commission in a form, manner, and time as determined by the

Commission.

Sec. 38.257 Regulatory service provider.

A designated contract market must comply with the regulations in

this subpart through a dedicated regulatory department, or by

delegation of that function to a registered futures association or a

registered entity (collectively, ``regulatory service provider''), as

such terms are defined under the Act and over which the designated

contract market has supervisory authority.

Sec. 38.258 Additional rules required.

A designated contract market must adopt and enforce any additional

rules that it believes are necessary to comply with the requirements of

subpart E of this part.

Subpart F--Position Limitations or Accountability

Sec. 38.300 Core Principle 5.

To reduce the potential threat of market manipulation or congestion

(especially during trading in the delivery month), the board of trade

shall adopt for each contract of the board of trade, as is necessary

and appropriate, position limitations or position accountability for

speculators. For any contract that is subject to a position limitation

established by the Commission pursuant to Section 4a(a), the board of

trade shall set the position limitation of the board of trade at a

level not higher than the position limitation established by the

Commission.

Sec. 38.301 Position limitations and accountability.

A designated contract market must meet the requirements of part 151

of this chapter.

Subpart G--Emergency Authority

Sec. 38.350 Core Principle 6.

The board of trade, in consultation or cooperation with the

Commission, shall adopt rules to provide for the exercise of emergency

authority, as is necessary and appropriate, including the authority:

(a) To liquidate or transfer open positions in any contract;

(b) To suspend or curtail trading in any contract; and

(c) To require market participants in any contract to meet special

margin requirements.

Sec. 38.351 Additional sources for compliance.

Applicants and designated contract markets may refer to the

guidance and/or acceptable practices in Appendix B of this part to

demonstrate to the Commission compliance with the requirements of Sec.

38.350.

Subpart H--Availability of General Information

Sec. 38.400 Core Principle 7.

The board of trade shall make available to market authorities,

market participants, and the public accurate information concerning:

(a) The terms and conditions of the contracts of the contract

market; and

(b)(1) The rules, regulations and mechanisms for executing

transactions on or through the facilities of the contract market, and

(2) The rules and specifications describing the operation of the

contract market's:

(i) Electronic matching platform, or

(ii) Trade execution facility.

Sec. 38.401 General requirements.

(a) General. (1) A designated contract market must have procedures,

arrangements and resources for disclosing to the Commission, market

participants and the public accurate information pertaining to:

(i) Contract terms and conditions;

(ii) Rules and regulations pertaining to the trading mechanisms;

and

(iii) Rules and specifications pertaining to operation of the

electronic matching platform or trade execution facility.

(2) Through such procedures, arrangements and resources, the

designated contract market must ensure public dissemination of

information pertaining to new product listings, new rules, rule

amendments or other changes to previously disclosed information, in

accordance with the timeline provided in paragraph (c) of this section.

(3) A designated contract market shall meet the requirements of

this paragraph (a), by placing the information on the designated

contract market's Web site within the time prescribed in paragraph (c)

of this section.

(b) Accuracy Requirement. A designated contract market must provide

accurate and complete information and not omit material information

with respect to any communication with the Commission, and any

information required to be transmitted or made available to market

participants and the public, including on its Web site or otherwise.

(c) Notice of Regulatory Submissions. (1) A designated contract

market, in making available on its Web site information pertaining to

new product listings, new rules, rule amendments or other changes to

previously-disclosed information, must place such information on its

Web site simultaneous with the filing of such information with the

Secretary of the Commission. Satisfaction of the requirements of this

paragraph (c) shall be in addition to the requirements of paragraph (d)

of this section.

(2) To the extent that a designated contract market requests

confidential treatment of any information filed with the Secretary of

the Commission, the designated contract market must post on its Web

site the public version of such filing or submission.

(d) Rulebook. A designated contract market must ensure that the

rulebook posted on its Web site is accurate, complete, current and

readily accessible to the public. A designated contract market must

publish or post in its rulebook all new or amended rules, both

substantive and non-substantive, on the date of implementation of such

new or amended rule, the day a new product is listed, or the day any

changes to previously disclosed information take effect. Satisfaction

of the requirements of this paragraph (d) is in addition to the

requirements of paragraph (c) of this section.

Subpart I--Daily Publication of Trading Information

Sec. 38.450 Core Principle 8.

The board of trade shall make public daily information on

settlement prices, volume, open interest, and opening and closing

ranges for actively traded contracts on the contract market.

Sec. 38.451 Reporting of trade information.

A designated contract market must meet the reporting requirements

set forth in part 16 of this chapter.

Subpart J--Execution of Transactions

Sec. 38.500 Core Principle 9.

The board of trade shall provide a competitive, open, and efficient

market and mechanism for executing transactions that protects the price

discovery process of trading in the centralized market of the board of

trade. The rules of the board of trade may authorize, for bona fide

business purposes:

(a) Transfer trades or office trades;

(b) An exchange of:

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

(2) Futures for cash commodities; or

(3) Futures for swaps; or

(c) A futures commission merchant, acting as principal or agent, to

enter into or confirm the execution of a contract for the purchase or

sale of a commodity

[[Page 80616]]

for future delivery if the contract is reported, recorded, or cleared

in accordance with the rules of the contract market or a derivatives

clearing organization.

Sec. 38.501 General requirements.

(a) Transactions on the centralized market; requirements. All

purchases and sales of any commodity for future delivery, and any

commodity option or swap, on or subject to the rules of a designated

contract market, must be executed openly and competitively by open

outcry, posting of bids and offers, or other equally open and

competitive methods, in a place or through an electronic system

provided by the designated contract market, during the hours prescribed

by the designated contract market for trading in such commodity,

commodity option or swap.

(b) Transactions off the centralized market; requirements.

Notwithstanding paragraph (a) of this section, transactions may be

executed off of a designated contract market's centralized market,

including transfer trades, office trades, block trades, or trades

involving the exchange of derivatives for related positions, if

transacted in accordance with the written rules of the designated

contract market that provide for execution of transactions off the

centralized market and that have been certified to or approved by the

Commission. Every person handling, executing, clearing, or carrying the

trades, transactions or positions described in this paragraph shall

comply with the rules of the appropriate designated contract market,

including to identify and mark by appropriate symbol or designation all

such transactions or contracts and all orders, records and memoranda

pertaining thereto.

Sec. 38.502 Minimum centralized market trading requirement.

(a) Minimum centralized market trading percentage requirement. No

designated contract market may continue to list a contract for trading

unless an average of 85% or greater of the total volume of such

contract is traded on the designated contract market's centralized

market, as calculated over a 12 month period as specified in paragraph

(b) of this section.

(b) Centralized market trading percentage calculation. (1)

Contracts listed after the effective date of this section. For each new

contract listed after the effective date of Sec. 38.502, the

designated contract market must determine the percentage of the total

volume, in all contract months combined, that is attributable to

centralized market trading for a 12 month period commencing one year

following the date of the contract's initial listing on the designated

contract market, and on each 12 month anniversary of the contract's

listing thereafter. The designated contract market must calculate the

centralized market trading percentage for each listed contract within

thirty days following the conclusion of the 12 month anniversary of

each contract's listing.

(2) Contracts listed as of the effective date of this section. For

contracts and contract months listed as of the effective date of Sec.

38.502, the designated contract market initially must complete the

centralized market trading percentage calculation in each such contract

within thirty days of the effective date of this Sec. 38.502

(``Initial Calculation'').

(3) Initial Calculation. The Initial Calculation for each such

existing contract must be based on:

(i) The trading volume in such contract during the 12 month period

immediately preceding the effective date of this section; or

(ii) If contract has been listed less than 12 months, the trading

volume in such contract during the time period in which the contract

was initially listed on the designated contract market.

(4) Anniversary Calculation. Thereafter, the designated contract

market must calculate and file with the Commission the centralized

market trading percentage in each such contract within thirty days of

the 12 month anniversary of the Initial Calculation.

(c) Mandatory delisting. Except as otherwise provided in paragraph

(d) of this section, as to any contract that does not meet the minimum

centralized market trading percentage requirement of paragraph (a) of

this section, within ninety days of the centralized market trading

percentage calculation, the designated contract market must:

(1) Delist the contract from the designated contract market and

transfer open positions in the contract to a SEF that it operates;

(2) Delist the contract from the designated contract market and

transfer all open positions in the contract to another SEF that will

accept the contract; or

(3) Liquidate the contract.

(d) Treatment of contracts listed as of the effective date of this

section. Contracts and contract months that are listed on a designated

contract market as of the effective date of Sec. 38.502 and that do

not meet the requirements of paragraph (a) of this section, as

calculated in accordance with paragraph (b) of this section, may

continue to be listed on the designated contract market until all open

positions in such contracts and contract months are liquidated. Trading

in such contracts is allowed for liquidation purposes only.

(e) Exemptions upon petition. (1) A designated contract market may

petition the Commission to exempt a contract from the requirements of

paragraphs (c) or (d) of this section, for a maximum period of 12

months, or such other time as determined by the Commission.

(2) The designated contract market must demonstrate in its petition

that:

(i) (A) Such contract achieved an average of at least 50% trading

volume on the centralized market over the preceding 12 month period,

and

(B) The contract is likely to attain the minimum centralized market

trading percentage requirement within the following 12 month period; or

(ii) As of the effective date of this section, such contract has

been listed for less than 12 months.

(3) Petitions seeking an exemption from the mandatory delisting

requirement must be submitted to the Commission within thirty-five days

of the 12 month anniversary of the listing of such contract, or for

contracts listed less than 12 months, thirty-five days after the

effective date of this section, as applicable.

(4) The filing of a petition for a mandatory delisting exemption

shall toll the mandatory delisting requirement set forth in paragraph

(c) of this section until such time that a decision is made on the

petition.

Sec. 38.503 Block trades on futures contracts.

(a) Block trade rules. A designated contract market that permits

block trade transactions on futures contracts must have rules that

limit such block trades to large transactions, and impose minimum size

requirements on such transactions that are appropriate for each listed

contract subject to a block trading provision. The block trade size for

each listed contract must be certified to or approved by the

Commission.

(b) Block size review. A designated contract market must review the

minimum size thresholds for all block trades on futures contracts on an

annual basis to ensure that the minimum size remains appropriate for

each contract, and in accordance with the provisions of this section

38.503.

(c) Eligible block trade participants. Block trading must be

limited to Eligible Contract Participants, as that term is defined in

Section 1a(18) of the Act, except that the designated contract market

may allow a commodity trading advisor acting in an asset managerial

[[Page 80617]]

capacity and registered pursuant to Section 4n of the Act, or a

principal thereof, including any investment advisor who satisfies the

criteria of Sec. 4.7(a)(2)(v) of this chapter, or a foreign person

performing a similar role or function and subject as such to foreign

regulation, to transact block trades for customers who are not Eligible

Contract Participants, if such commodity trading advisor, investment

advisor or foreign person has more than $25,000,000 in total assets

under management. A person may transact a block trade on behalf of a

customer only when such person has received an instruction or prior

consent to do so from the customer.

(d) Affiliated parties. (1) Block trades between affiliated parties

are permitted under the circumstances provided in paragraph (d)(3) of

this section.

(2) For purposes of block trades, an affiliated party is a party

that directly or indirectly through one or more persons, controls, is

controlled by, or is under common control with another party.

(3) Block trades between affiliated parties are permitted if:

(i) Priced on a competitive market price, either by falling within

the contemporaneous bid-ask spread on the centralized market or

calculated based on a contemporaneous market price in a related cash

market;

(ii) Each party has a separate and independent legal bona fide

business purpose for engaging in the trades; and

(iii) Each party's decision to enter into the block trade is made

by a separate and independent decision-maker.

(e) Aggregation. Except as otherwise stated in this paragraph (e),

the aggregation of orders for different accounts in order to satisfy

the minimum block size requirement is prohibited. Aggregation is

permissible if done by a commodity trading advisor acting in an asset

managerial capacity and registered pursuant to Section 4n of the Act,

or a principal thereof, including any investment advisor who satisfies

the criteria of Sec. 4.7(a)(2)(v) of this chapter, or a foreign person

performing a similar role or function and subject as such to foreign

regulation, if such commodity trading advisor, investment advisor or

foreign person has more than $25,000,000 in total assets under

management.

(f) Recordkeeping. Parties to, and members facilitating, a block

trade must keep accurate block trade records that comply with Sections

5(d)(10) and 5(d)(18) of the Act and the associated Commission

regulations in subparts K and S of this part. Block trade orders must

be recorded by the member and time-stamped with both the time the order

was received and the time the order was reported to the designated

contract market, and must indicate if the block trades are between

affiliated parties. When requested by the designated contract market,

the Commission or the Department of Justice, parties to, and members

facilitating, a block trade must provide records to document that the

block trade is executed in conformance with the board of trade's rules.

(g) Reporting. (1) Each block trade must be reported to the

designated contract market within five minutes after its execution.

(2) The designated contract market must publicize the details of

each block trade immediately upon receipt of the transaction report,

and must publicize daily the total quantity of block trades that are

included in the total volume of trading under the procedures set forth

in Sec. 16.01 of this chapter.

(h) Block size determinations; pricing of block trades. Applicants

and designated contract markets may refer to the guidance and

acceptable practices in appendix B of this part to demonstrate to the

Commission compliance with the requirements for block size

determinations and pricing of block trades.

Sec. 38.504 Block trades on swap contracts.

A designated contract market must have rules requiring that block

trades involving swaps comply with the requirements set forth in part

43 of this chapter.

Sec. 38.505 Exchange of derivatives for related position.

(a) (1) A designated contract market may permit bona fide exchange

of derivatives for related positions transactions.

(2) (i) A bona fide exchange of derivatives for related positions

transaction must include:

(A) Separate but integrally related transactions involving the same

or a related commodity;

(B) Price correlation and quantitative equivalence of the

derivative and related position legs; and

(C) A buyer of a derivative who is the seller of the corresponding

related position, and a seller of a derivative who is the buyer of the

corresponding related position.

(ii) The transaction must result in an actual transfer of ownership

of the related position and occur between parties with different

beneficial owners or under separate control.

(iii) The price differential between the futures leg and the

commodities leg or derivatives position should reflect commercial

realities, and at least one leg of the transaction should be priced at

the prevailing market price.

(b) A designated contract market may permit parties to an exchange

of derivatives for related position transaction to engage in a separate

transaction that offsets a leg of the exchange of derivatives for a

related position if:

(1) The offsetting transaction results in an actual transfer of

ownership and demonstrates other indicia of being a bona fide

transaction as set forth in paragraph (a) of this section; and

(2) The offsetting transaction must be able to stand on its own as

a commercially appropriate transaction, with no obligation on either

party that the offsetting transaction be dependent upon the execution

of the exchange of derivatives for related position transaction, or

that the exchange of derivatives for a related position transaction be

dependent upon the execution of the offsetting transaction.

(c) An exchange of derivatives for a related position transaction

must be bona fide such that the exchange of derivatives for the related

position is not contingent upon an offsetting transaction.

(d) An exchange of derivatives for a related position transaction

must be reported to the designated contract market within five minutes

after its execution.

(e) A designated contract market must make public, on a daily

basis, the total quantity of exchanges of derivatives for a related

position transactions that are included in the total volume of trading

under the procedures set forth in Sec. 16.01 of this chapter.

Sec. 38.506 Office trades and transfer trades.

A designated contract market must keep records of office trades and

transfer trades under the procedures set forth in Sec. 1.31 of this

chapter.

Subpart K--Trade Information

Sec. 38.550 Core Principle 10.

The board of trade shall maintain rules and procedures to provide

for the recording and safe storage of all identifying trade information

in a manner that enables the contract market to use the information:

(a) To assist in the prevention of customer and market abuses; and

(b) To provide evidence of any violations of the rules of the

contract market.

Sec. 38.551 Audit trail required.

A designated contract market must capture and retain all audit

trail data

[[Page 80618]]

necessary to detect, investigate, and prevent customer and market

abuses. Such data must be sufficient to reconstruct all transactions

within a reasonable period of time and to provide evidence of any

violations of the rules of the designated contract market. An

acceptable audit trail must also permit the designated contract market

to track a customer order from the time of receipt through fill,

allocation, or other disposition, and must include both order and trade

data.

Sec. 38.552 Elements of an acceptable audit trail program.

(a) Original source documents. A designated contract market's audit

trail must include original source documents. Original source documents

include unalterable, sequentially identified records on which trade

execution information is originally recorded, whether recorded manually

or electronically. Records for customer orders (whether filled,

unfilled or cancelled, each of which shall be retained or

electronically captured) must reflect the terms of the order, an

account identifier that relates back to the account(s) owner(s), and

the time of order entry. For open-outcry trades, the time of report of

execution of the order shall also be captured.

(b) Transaction history database. A designated contract market's

audit trail program must include an electronic transaction history

database. An adequate transaction history database includes a history

of all orders and trades, and also includes:

(1) All data that are input into the trade entry or matching system

for the transaction to match and clear;

(2) The categories of participants for which such trades are

executed, including whether the person executing a trade was executing

it for his/her own account or an account for which he/she has

discretion, his/her clearing member's house account, the account of

another member, including market participants present on the floor, or

the account of any other customer;

(3) Timing and sequencing data adequate to reconstruct trading; and

(4) Identification of each account to which fills are allocated.

(c) Electronic analysis capability. A designated contract market's

audit trail program must include electronic analysis capability with

respect to all audit trail data in the transaction history database. An

adequate electronic analysis capability must permit the sorting and

presentation of data in the transaction history database so as to

reconstruct trading and identify possible trading violations with

respect to both customer and market abuse.

(d) Safe storage capability. A designated contract market's audit

trail program must include the capability to safely store all audit

trail data retained in its transaction history database. Such safe

storage capability must include the capability to store all data in the

database in a manner that protects it from unauthorized alteration, as

well as from accidental erasure or other loss. Data must be retained in

accordance with the recordkeeping requirements of Core Principle 18 and

the associated regulations in subpart S of this part.

Sec. 38.553 Enforcement of audit trail requirements.

(a) Annual audit trail and recordkeeping reviews. A designated

contract market must enforce its audit trail and recordkeeping

requirements through at least annual reviews of all members and market

participants to verify their compliance with the contract market's

audit trail and recordkeeping requirements. Such reviews must include,

but are not limited to, the following:

(1) For electronic trading, audit trail and recordkeeping reviews

must include reviews of randomly selected samples of front-end audit

trail data for order routing systems; a review of the process by which

user identifications are assigned and user identification records are

maintained; a review of usage patterns associated with user

identifications to monitor for violations of user identification rules;

and reviews of account numbers and customer type indicator codes in

trade records to test for accuracy and improper use.

(2) For open outcry trading, audit trail and recordkeeping reviews

must include reviews of members' and market participants' compliance

with the designated contract market's trade timing, order ticket, and

trading card requirements.

(b) Enforcement program required. A designated contract market must

establish a program for effective enforcement of its audit trail and

recordkeeping requirements for both electronic and open-outcry trading,

as applicable. An effective program must identify members and market

participants that have failed to maintain high levels of compliance

with such requirements, and levy meaningful sanctions when deficiencies

are found. Sanctions must be sufficient to deter recidivist behavior,

and may not include more than one warning letter for the same violation

within a rolling twelve month period.

Subpart L--Financial Integrity of Transactions

Sec. 38.600 Core Principle 11.

The board of trade shall establish and enforce:

(a) Rules and procedures for ensuring the financial integrity of

transactions entered into on or through the facilities of the contract

market (including the clearance and settlement of the transactions with

a derivatives clearing organization); and

(b) Rules to ensure:

(1) The financial integrity of any:

(i) Futures commission merchant, and

(ii) Introducing broker; and

(2) The protection of customer funds.

Sec. 38.601 Mandatory clearing.

Transactions executed on or through the designated contract market,

other than transactions in security futures products, must be cleared

through a Commission-registered derivatives clearing organization, in

accordance with the provisions of part 39 of this chapter.

Sec. 38.602 General financial integrity.

A designated contract market must provide for the financial

integrity of its transactions by establishing and maintaining

appropriate minimum financial standards for its members and non-

intermediated market participants.

Sec. 38.603 Protection of customer funds.

A designated contract market must have rules concerning the

protection of customer funds. These rules shall address appropriate

minimum financial standards for intermediaries, the segregation of

customer and proprietary funds, the custody of customer funds, the

investment standards for customer funds, intermediary default

procedures and related recordkeeping. A designated contract market must

review the default rules and procedures of the derivatives clearing

organization that clears for such designated contract market to wind

down operations, transfer customers, or otherwise protect customers in

the event of a default of a clearing member or the derivatives clearing

organization.

Sec. 38.604 Financial surveillance.

A designated contract market must monitor members' compliance with

the designated contract market's minimum financial standards and,

therefore, must routinely receive and promptly review financial and

related information from its members, as well as continuously monitor

the positions of members and their customers. A designated contract

market must have rules that prescribe minimum capital requirements for

member futures commission merchants

[[Page 80619]]

and introducing brokers. A designated contract market must:

(a) Continually survey the obligations of each futures commission

merchant created by the positions of its customers;

(b) As appropriate, compare those obligations to the financial

resources of the futures commission merchant; and

(c) Take appropriate steps to use this information to protect

customer funds.

Sec. 38.605 Requirements for financial surveillance program.

A designated contract market's financial surveillance program for

futures commission merchants, retail foreign exchange dealers, and

introducing brokers must comply with the requirements of Sec. 1.52 of

this chapter to assess the compliance of such entities with applicable

contract market rules and Commission regulations.

Sec. 38.606 Financial regulatory services provided by a third party.

A designated contract market may comply with the requirements of

Sec. 38.604 (Financial Surveillance) and Sec. 38.605 (Requirements

for Financial Surveillance Program) of this part through the regulatory

services of a registered futures association or a registered entity

(collectively, ``regulatory service provider''), as such terms are

defined under the Act. A designated contract market must ensure that

its regulatory service provider has the capacity and resources

necessary to provide timely and effective regulatory services,

including adequate staff and appropriate surveillance systems. A

designated contract market will at all times remain responsible for

compliance with its obligations under the Act and Commission

regulations, and for the regulatory service provider's performance on

its behalf. Regulatory services must be provided under a written

agreement with a regulatory services provider that shall specifically

document the services to be performed as well as the capacity and

resources of the regulatory service provider with respect to the

services to be performed.

Sec. 38.607 Direct access.

A designated contract market that permits direct electronic access

by customers (i.e., allowing customers of futures commission merchants

to enter orders directly into a designated contract market's trade

matching system for execution) must have in place effective systems and

controls reasonably designed to enable the FCM's management of

financial risk, such as automated pre-trade controls that enable member

futures commission merchants to implement appropriate financial risk

limits. A designated contract market must implement and enforce rules

requiring the member futures commission merchants to use the provided

systems and controls.

Subpart M--Protection of Markets and Market Participants

Sec. 38.650 Core Principle 12.

The board of trade shall establish and enforce rules:

(a) To protect markets and market participants from abusive

practices committed by any party, including abusive practices committed

by a party acting as an agent for a participant; and

(b) To promote fair and equitable trading on the contract market.

Sec. 38.651 Additional sources for compliance.

A designated contract market must have and enforce rules that are

designed to promote fair and equitable trading and to protect the

market and market participants from abusive practices including

fraudulent, noncompetitive or unfair actions, committed by any party.

The designated contract market must have methods and resources

appropriate to the nature of the trading system and the structure of

the market to detect trade practice and market abuses and to discipline

such behavior, in accordance with Core Principles 2 and 4, and the

associated regulations in subparts C and E of this part, respectively.

The designated contract market also must provide a competitive, open

and efficient market and mechanism for executing transactions in

accordance with Core Principle 9 and the associated regulations under

subpart J of this part.

Subpart N--Disciplinary Procedures

Sec. 38.700 Core Principle 13.

The board of trade shall establish and enforce disciplinary

procedures that authorize the board of trade to discipline, suspend, or

expel members or market participants that violate the rules of the

board of trade, or similar methods for performing the same functions,

including delegation of the functions to third parties.

Sec. 38.701 Enforcement staff.

A designated contract market must establish and maintain sufficient

enforcement staff and resources to effectively and promptly prosecute

possible rule violations within the disciplinary jurisdiction of the

contract market. A designated contract market must also monitor the

size and workload of its enforcement staff annually, and ensure that

its enforcement resources and staff are at appropriate levels. The

enforcement staff may not include either members of the designated

contract market or persons whose interests conflict with their

enforcement duties. A member of the enforcement staff may not operate

under the direction or control of any person or persons with trading

privileges at the contract market. A designated contract market's

enforcement staff may operate as part of the designated contract

market's compliance department.

Sec. 38.702 Disciplinary panels.

(a) Disciplinary panels required. A designated contract market must

establish one or more Review Panels and one or more Hearing Panels

(collectively, ``disciplinary panels'') that are authorized to fulfill

their obligations under the rules of this subpart. Disciplinary panels

must meet the composition requirements of Sec. 40.9(c)(3)(ii) of this

chapter, and must not include any members of the designated contract

market's compliance staff, or any person involved in adjudicating any

other stage of the same proceeding.

(b) Review panels. A designated contract market's Review Panel(s)

must be responsible for determining whether a reasonable basis exists

for finding a violation of contract market rules, and for authorizing

the issuance of notices of charges against persons alleged to have

committed violations if the Review Panel believes that the matter

should be adjudicated.

(c) Hearing Panels. A designated contract market's Hearing Panel(s)

must be responsible for adjudicating disciplinary cases pursuant to a

notice of charges authorized by a Review Panel, and must also be

responsible for such other duties as are specified in this subpart.

Sec. 38.703 Review of investigation report.

Promptly after receiving a completed investigation report pursuant

to Sec. 38.158(c) of this part, a Review Panel must promptly review

the report and, within 30 days of such receipt, must take one of the

following actions:

(a) If the Review Panel determines that additional investigation or

evidence is needed, it must promptly direct the compliance staff to

conduct further investigation.

(b) If the Review Panel determines that no reasonable basis exists

for finding a violation or that prosecution is otherwise unwarranted,

it may direct that no further action be taken. Such determination must

be in writing, and must include a written statement setting

[[Page 80620]]

forth the facts and analysis supporting the decision.

(c) If the Review Panel determines that a reasonable basis exists

for finding a violation and adjudication is warranted, it must direct

that the person or entity alleged to have committed the violation be

served with a notice of charges and must proceed in accordance with the

rules of this section.

Sec. 38.704 Notice of charges.

A notice of charges must adequately state the acts, conduct, or

practices in which the respondent is alleged to have engaged; state the

rule, or rules, alleged to have been violated (or about to be

violated); and prescribe the period within which a hearing on the

charges may be requested. The notice must also advise the respondent

charged that he is entitled, upon request, to a hearing on the charges;

and if the rules of the designated contract market so provide:

(a) That failure to request a hearing within the period prescribed

in the notice, except for good cause, may be deemed a waiver of the

right to a hearing; and

(b) That failure to answer or to deny expressly a charge may be

deemed to be an admission of such charge.

Sec. 38.705 Right to representation.

Upon being served with a notice of charges, a respondent must have

the right to be represented by legal counsel or any other

representative of its choosing in all succeeding stages of the

disciplinary process.

Sec. 38.706 Answer to charges.

A respondent must be given a reasonable period of time to file an

answer to a notice of charges. The rules of a designated contract

market may require that:

(a) The answer must be in writing and include a statement that the

respondent admits, denies, or does not have and is unable to obtain

sufficient information to admit or deny each allegation. A statement of

a lack of sufficient information shall have the effect of a denial of

an allegation;

(b) Failure to file an answer on a timely basis shall be deemed an

admission of all allegations contained in the notice of charges; and

(c) Failure in an answer to deny expressly a charge shall be deemed

to be an admission of such charge.

Sec. 38.707 Admission or failure to deny charges.

The rules of a designated contract market may provide that if a

respondent admits or fails to deny any of the charges a Hearing Panel

may find that the violations alleged in the notice of charges for which

the respondent admitted or failed to deny any of the charges have been

committed. If the designated contract market's rules so provide, then:

(a) The Hearing Panel must impose a sanction for each violation

found to have been committed;

(b) The Hearing Panel must promptly notify the respondent in

writing of any sanction to be imposed pursuant to paragraph (a) of this

section and shall advise the respondent that it may request a hearing

on such sanction within the period of time, which shall be stated in

the notice;

(c) The rules of a designated contract market may provide that if a

respondent fails to request a hearing within the period of time stated

in the notice, the respondent will be deemed to have accepted the

sanction.

Sec. 38.708 Denial of charges and right to hearing.

In every instance where a respondent has requested a hearing on a

charge that is denied, or on a sanction set by the Hearing Panel

pursuant to Sec. 38.707 of this part, the respondent must be given an

opportunity for a hearing in accordance with the requirements of Sec.

38.710 of this part. The designated contract market's rules may provide

that, except for good cause, the hearing must be concerned only with

those charges denied and/or sanctions set by the Hearing Panel under

Sec. 38.707 of this part for which a hearing has been requested.

Sec. 38.709 Settlement offers.

(a) The rules of a designated contract market may permit a

respondent to submit a written offer of settlement at any time after

the investigation report is completed. The disciplinary panel presiding

over the matter may accept the offer of settlement, but may not alter

the terms of a settlement offer unless the respondent agrees.

(b) The rules of a designated contract market may provide that, in

its discretion, a disciplinary panel may permit the respondent to

accept a sanction without either admitting or denying the rule

violations upon which the sanction is based.

(c) If an offer of settlement is accepted, the panel accepting the

offer must issue a written decision specifying the rule violations it

has reason to believe were committed, including the basis or reasons

for the panel's conclusions, and any sanction to be imposed, which must

include full customer restitution where customer harm is demonstrated.

If an offer of settlement is accepted without the agreement of the

enforcement staff, the decision must adequately support the Hearing

Panel's acceptance of the settlement. Where applicable, the decision

must also include a statement that the respondent has accepted the

sanctions imposed without either admitting or denying the rule

violations.

(d) The respondent may withdraw his or her offer of settlement at

any time before final acceptance by a panel. If an offer is withdrawn

after submission, or is rejected by a disciplinary panel, the

respondent must not be deemed to have made any admissions by reason of

the offer of settlement and must not be otherwise prejudiced by having

submitted the offer of settlement.

Sec. 38.710 Hearings.

(a) A designated contract market must adopt rules that provide for

the following minimum requirements for any hearing conducted pursuant

to a notice of charges:

(1) The hearing must be fair, must be conducted before members of

the Hearing Panel, and must be promptly convened after reasonable

notice to the respondent. The formal rules of evidence need not apply;

nevertheless, the procedures for the hearing may not be so informal as

to deny a fair hearing. No member of the Hearing Panel for the matter

may have a financial, personal, or other direct interest in the matter

under consideration.

(2) In advance of the hearing, the respondent must be entitled to

examine all books, documents, or other evidence in the possession or

under the control of the designated contract market that are to be

relied upon by the enforcement staff in presenting the charges

contained in the notice of charges or which are relevant to those

charges.

(3) The designated contract market's enforcement and compliance

staffs must be parties to the hearing, and the enforcement staff must

present their case on those charges and sanctions that are the subject

of the hearing.

(4) The respondent must be entitled to appear personally at the

hearing, must be entitled to cross-examine any persons appearing as

witnesses at the hearing, and must be entitled to call witnesses and to

present such evidence as may be relevant to the charges.

(5) The designated contract market must require persons within its

jurisdiction who are called as witnesses to participate in the hearing

and to produce evidence. It must make reasonable efforts to secure the

presence of all other persons called as witnesses whose testimony would

be relevant.

(6) If the respondent has requested a hearing, a copy of the

hearing must be

[[Page 80621]]

made and must become a part of the record of the proceeding. The record

must be one that is capable of being accurately transcribed; however,

it need not be transcribed unless the transcript is requested by

Commission staff or the respondent, the decision is appealed pursuant

to Sec. 38.712 of this part, or is reviewed by the Commission pursuant

to Section 8c of the Act or part 9 of this chapter. In all other

instances a summary record of a hearing is permitted.

(7) The rules of a designated contract market may provide that the

cost of transcribing the record of the hearing must be borne by a

respondent who requests the transcript, appeals the decision pursuant

to Sec. 38.712 of this part, or whose application for Commission

review of the disciplinary action has been granted. In all other

instances, the cost of transcribing the record must be borne by the

designated contract market.

(b) The rules of a designated contract market may provide that a

sanction may be summarily imposed upon any person within its

jurisdiction whose actions impede the progress of a hearing.

Sec. 38.711 Decisions.

Promptly following a hearing conducted in accordance with Sec.

38.710 of this part, the Hearing Panel must render a written decision

based upon the weight of the evidence contained in the record of the

proceeding and must provide a copy to the respondent.

The decision must include:

(a) The notice of charges or a summary of the charges;

(b) The answer, if any, or a summary of the answer;

(c) A summary of the evidence produced at the hearing or, where

appropriate, incorporation by reference of the investigation report;

(d) A statement of findings and conclusions with respect to each

charge, and a complete explanation of the evidentiary and other basis

for such findings and conclusions with respect to each charge;

(e) An indication of each specific rule that the respondent was

found to have violated; and

(f) A declaration of all sanctions imposed against the respondent,

including the basis for such sanctions and the effective date of such

sanctions.

Sec. 38.712 Right to appeal.

The rules of a designated contract market may permit the parties to

a proceeding to appeal promptly an adverse decision of the Hearing

Panel in all or in certain classes of cases. Such rules may require a

party's notice of appeal to be in writing and to specify the findings,

conclusions, or sanctions to which objection are taken. If the rules of

a designated contract market permit appeals, then both the respondent

and the enforcement staff must have the opportunity to appeal and the

designated contract must provide for the following:

(a) The designated contract market must establish an appellate

panel that must be authorized to hear appeals of respondents. In

addition, the rules of a designated contract market may provide that

the appellate panel may, on its own initiative, order review of a

decision by the Hearing Panel within a reasonable period of time after

the decision has been rendered.

(b) The composition of the appellate panel must be consistent with

Sec. 40.9(c)(iv) of this chapter, and must not include any members of

the designated contract market's compliance staff, or any person

involved in adjudicating any other stage of the same proceeding. The

rules of a designated contract market must provide for the appeal

proceeding to be conducted before all of the members of the board of

appeals or a panel thereof.

(c) Except for good cause shown, the appeal or review must be

conducted solely on the record before the Hearing Panel, the written

exceptions filed by the parties, and the oral or written arguments of

the parties.

(d) Promptly following the appeal or review proceeding, the board

of appeals must issue a written decision and must provide a copy to the

respondent. The decision issued by the board of appeal must adhere to

all the requirements of Sec. 38.711 of this part, to the extent that a

different conclusion is reached from that issued by the Hearing Panel.

Sec. 38.713 Final decisions.

Each designated contract market must establish rules setting forth

when a decision rendered pursuant to this section will become the final

decision of such designated contract market.

Sec. 38.714 Disciplinary sanctions.

All disciplinary sanctions imposed by a designated contract market

or its disciplinary panels must be commensurate with the violations

committed and must be clearly sufficient to deter recidivism or similar

violations by other market participants. All disciplinary sanctions

must take into account the respondent's disciplinary history. In the

event of demonstrated customer harm, any disciplinary sanction must

also include full customer restitution.

Sec. 38.715 Summary fines for violations of rules regarding timely

submission of records, decorum, or other similar activities.

A designated contract market may adopt a summary fine schedule for

violations of rules relating to the timely submission of accurate

records required for clearing or verifying each day's transactions,

decorum, attire, or other similar activities. A designated contract

market may permit its compliance staff, or a designated panel of

contract market officials, to summarily impose minor sanctions against

persons within the designated contract market's jurisdiction for

violating such rules. A designated contract market's summary fine

schedule may allow for warning letters to be issued for first-time

violations or violators, provided that no more than one warning letter

may be issued per rolling 12-month period for the same violation. If

adopted, a summary fine schedule must provide for progressively larger

fines for recurring violations.

Sec. 38.716 Emergency disciplinary actions.

(a) A designated contract market may impose a sanction, including

suspension, or take other summary action against a person or entity

subject to its jurisdiction upon a reasonable belief that such

immediate action is necessary to protect the best interest of the

marketplace.

(b) Any emergency disciplinary action must be taken in accordance

with a designated contract market's procedures that provide for the

following:

(1) If practicable, a respondent must be served with a notice

before the action is taken, or otherwise at the earliest possible

opportunity. The notice must state the action, briefly state the

reasons for the action, and state the effective time and date, and the

duration of the action.

(2) The respondent must have the right to be represented by legal

counsel or any other representative of its choosing in all proceedings

subsequent to the emergency action taken. The respondent must be given

the opportunity for a hearing as soon as reasonably practicable and the

hearing must be conducted before the Hearing Panel pursuant to the

requirements of Sec. 38.710 of this part.

(3) Promptly following the hearing provided for in this rule, the

designated contract market must render a written decision based upon

the weight of the evidence contained in the record of the proceeding

and must provide a copy to the respondent. The decision must include a

description of the summary action taken; the reasons for the

[[Page 80622]]

summary action; a summary of the evidence produced at the hearing; a

statement of findings and conclusions; a determination that the summary

action should be affirmed, modified, or reversed; and a declaration of

any action to be taken pursuant to the determination, and the effective

date and duration of such action.

Subpart O--Dispute Resolution

Sec. 38.750 Core Principle 14.

The board of trade shall establish and enforce rules regarding, and

provide facilities for alternative dispute resolution as appropriate

for, market participants and any market intermediaries.

Sec. 38.751 Additional sources for compliance.

Applicants and designated contract markets may refer to the

guidance and acceptable practices in Appendix B of this part to

demonstrate to the Commission compliance with the requirements of Sec.

38.750 of this part.

Subpart P--Governance Fitness Standards

Sec. 38.800 Core Principle 15.

The board of trade shall establish and enforce appropriate fitness

standards for directors, members of any disciplinary committee, members

of the contract market, and any other person with direct access to the

facility (including any party affiliated with any person described in

this paragraph).

Subpart Q--Conflicts of Interest

Sec. 38.850 Core Principle 16.

The board of trade shall establish and enforce rules:

(a) To minimize conflicts of interest in the decision-making

process of the contract market; and

(b) To establish a process for resolving conflicts of interest

described in paragraph (a) of this section.

Subpart R--Composition of Governing Boards of Contract Markets

Sec. 38.900 Core Principle 17.

The governance arrangements of the board of trade shall be designed

to permit consideration of the views of market participants.

Subpart S--Recordkeeping

Sec. 38.950 Core Principle 18.

The board of trade shall maintain records of all activities

relating to the business of the contract market:

(a) In a form and manner that is acceptable to the Commission; and

(b) For a period of at least 5 years.

Sec. 38.951 Additional sources for compliance.

A designated contract market must maintain such records, including

trade records and investigatory and disciplinary files, in accordance

with the requirements of Sec. 1.31 of this chapter, and in accordance

with Sec. 45.1 of this chapter, if applicable.

Subpart T--Antitrust Considerations

Sec. 38.1000 Core Principle 19.

Unless necessary or appropriate to achieve the purposes of this

Act, the board of trade shall not:

(a) Adopt any rule or taking any action that results in any

unreasonable restraint of trade; or

(b) Impose any material anticompetitive burden on trading on the

contract market.

Sec. 38.1001 Additional sources for compliance.

Applicants and designated contract markets may refer to the

guidance and acceptable practices in appendix B of this part to

demonstrate to the Commission compliance with the requirements of Sec.

38.1000 of this part.

Subpart U--System Safeguards

Sec. 38.1050 Core Principle 20.

Each designated contract market shall:

(a) Establish and maintain a program of risk analysis and oversight

to identify and minimize sources of operational risk, through the

development of appropriate controls and procedures, and the development

of automated systems, that are reliable, secure, and have adequate

scalable capacity;

(b) Establish and maintain emergency procedures, backup facilities,

and a plan for disaster recovery that allow for the timely recovery and

resumption of operations and the fulfillment of the responsibilities

and obligations of the board of trade; and

(c) Periodically conduct tests to verify that backup resources are

sufficient to ensure continued order processing and trade matching,

transmission of matched orders to a designated clearing organization

for clearing, price reporting, market surveillance, and maintenance of

a comprehensive and accurate audit trail.

Sec. 38.1051 General requirements.

(a) A designated contract market's program of risk analysis and

oversight with respect to its operations and automated systems must

address each of the following categories of risk analysis and

oversight:

(1) Information security;

(2) Business continuity-disaster recovery planning and resources;

(3) Capacity and performance planning;

(4) Systems operations;

(5) Systems development and quality assurance; and

(6) Physical security and environmental controls.

(b) In addressing the categories of risk analysis and oversight

required under paragraph (a) of this section, a designated contract

market should follow generally accepted standards and best practices

with respect to the development, operation, reliability, security, and

capacity of automated systems.

(c) A designated contract market must maintain a business

continuity-disaster recovery plan and business continuity-disaster

recovery resources, emergency procedures, and backup facilities

sufficient to enable timely recovery and resumption of its operations

and resumption of its ongoing fulfillment of its responsibilities and

obligations as a designated contract market following any disruption of

its operations. Such responsibilities and obligations include, without

limitation, order processing and trade matching; transmission of

matched orders to a designated clearing organization for clearing;

price reporting; market surveillance; and maintenance of a

comprehensive audit trail. The designated contract market's business

continuity-disaster recovery plan and resources generally should enable

resumption of trading and clearing of the designated contract market's

products during the next business day following the disruption.

Designated contract markets determined by the Commission to be critical

financial markets are subject to more stringent requirements in this

regard, set forth in Sec. 40.9 of this chapter. Electronic trading is

an acceptable backup for open outcry trading in the event of a

disruption.

(d) A designated contract market that is not determined by the

Commission to be a critical financial market satisfies the requirement

to be able to resume trading and clearing during the next business day

following a disruption by maintaining either:

(1) Infrastructure and personnel resources of its own that are

sufficient to ensure timely recovery and resumption of its operations

and resumption of its ongoing fulfillment of its responsibilities and

obligations as a designated contract market following any disruption of

its operations; or

(2) Contractual arrangements with other designated contract markets

or

[[Page 80623]]

disaster recovery service providers, as appropriate, that are

sufficient to ensure continued trading and clearing of the designated

contract market's products, and ongoing fulfillment of all of the

designated contract market's responsibilities and obligations with

respect to those products, in the event that a disruption renders the

designated contract market temporarily or permanently unable to satisfy

this requirement on its own behalf.

(e) A designated contract market must notify Commission staff

promptly of all:

(1) Electronic trading halts and systems malfunctions;

(2) Cyber security incidents or targeted threats that actually or

potentially jeopardize automated system operation, reliability,

security, or capacity; and

(3) Any activation of the designated contract market's business

continuity-disaster recovery plan.

(f) A designated contract market must give Commission staff timely

advance notice of all:

(1) Planned changes to automated systems that may impact the

reliability, security, or adequate scalable capacity of such systems;

and

(2) Planned changes to the designated contract market's program of

risk analysis and oversight.

(g) A designated contract market must provide to the Commission

upon request current copies of its business continuity-disaster

recovery plan and other emergency procedures, its assessments of its

operational risks, and other documents requested by Commission staff

for the purpose of maintaining a current profile of the designated

contract market's automated systems.

(h) A designated contract market must conduct regular, periodic,

objective testing and review of its automated systems to ensure that

they are reliable, secure, and have adequate scalable capacity. It must

also conduct regular, periodic testing and review of its business

continuity-disaster recovery capabilities. Both types of testing should

be conducted by qualified, independent professionals. Such qualified

independent professionals may be independent contractors or employees

of the designated contract market, but should not be persons

responsible for development or operation of the systems or capabilities

being tested. Pursuant to Core Principle 18 (Recordkeeping) and

Sec. Sec. 38.950 and 38.951 of this part, the designated contract

market must keep records of all such tests, and make all test results

available to the Commission upon request.

(i) To the extent practicable, a designated contract market should:

(1) Coordinate its business continuity-disaster recovery plan with

those of the members and other market participants upon whom it depends

to provide liquidity, in a manner adequate to enable effective

resumption of activity in its markets following a disruption causing

activation of the designated contract market's business continuity-

disaster recovery plan;

(2) Initiate and coordinate periodic, synchronized testing of its

business continuity-disaster recovery plan and the business continuity-

disaster recovery plans of the members and other market participants

upon whom it depends to provide liquidity; and

(3) Ensure that its business continuity-disaster recovery plan

takes into account the business continuity-disaster recovery plans of

its telecommunications, power, water, and other essential service

providers.

(j) Part 46 of this chapter governs the obligations of those

registered entities that the Commission has determined to be critical

financial markets, with respect to maintenance and geographic dispersal

of disaster recovery resources sufficient to meet a same-day recovery

time objective in the event of a wide-scale disruption. Section 40.9 of

this chapter establishes the requirements for core principle compliance

in that respect.

Subpart V--Financial Resources

Sec. 38.1100 Core Principle 21.

(a) In General. The board of trade shall have adequate financial,

operational, and managerial resources to discharge each responsibility

of the board of trade.

(b) Determination of Adequacy. The financial resources of the board

of trade shall be considered to be adequate if the value of the

financial resources exceeds the total amount that would enable the

contract market to cover the operating costs of the contract market for

a 1-year period, as calculated on a rolling basis.

Sec. 38.1101 General requirements.

(a) General rule. (1) A designated contract market must maintain

financial resources sufficient to enable it to perform its functions in

compliance with the core principles set forth in Section 5 of the Act

and regulations thereunder.

(2) An entity that operates as both a designated contract market

and a derivatives clearing organization also shall comply with the

financial resource requirements of Sec. 39.11 of this chapter.

(3) Financial resources shall be considered sufficient if their

value is at least equal to a total amount that would enable the

designated contract market, or applicant for designation as such, to

cover its operating costs for a period of at least one year, calculated

on a rolling basis.

(b) Types of financial resources. Financial resources available to

satisfy the requirements of paragraph (a) of this section may include:

(1) The designated contract market's own capital; and

(2) Any other financial resource deemed acceptable by the

Commission.

(c) Computation of financial resource requirement. A designated

contract market must, on a quarterly basis, based upon its fiscal year,

make a reasonable calculation of its projected operating costs over a

12-month period in order to determine the amount needed to meet the

requirements of paragraph (a) of this section. The designated contract

market shall have reasonable discretion in determining the methodology

used to compute such projected operating costs. The Commission may

review the methodology and require changes as appropriate.

(d) Valuation of financial resources. At appropriate intervals, but

not less than quarterly, a designated contract market must compute the

current market value of each financial resource used to meet its

obligations under paragraph (a) of this section. Reductions in value to

reflect market and credit risk (``haircuts'') must be applied as

appropriate.

(e) Liquidity of financial resources. The financial resources

allocated by the designated contract market to meet the requirements of

paragraph (a) of this section must include unencumbered, liquid

financial assets (i.e., cash and/or highly liquid securities) equal to

at least six months' operating costs. If any portion of such financial

resources is not sufficiently liquid, the designated contract market

may take into account a committed line of credit or similar facility

for the purpose of meeting this requirement.

(f) Reporting requirements. (1) Each fiscal quarter, or at any time

upon Commission request, a designated contract market must:

(i) Report to the Commission:

(A) The amount of financial resources necessary to meet the

requirements of paragraph (a) of this section; and

(B) The value of each financial resource available, computed in

accordance with the requirements of paragraph (d) of this section; and

(ii) Provide the Commission with a financial statement, including

the balance sheet, income statement, and statement of cash flows of the

[[Page 80624]]

designated contract market or of its parent company.

(2) The calculations required by this paragraph shall be made as of

the last business day of the designated contract market's fiscal

quarter.

(3) The designated contract market must provide the Commission

with:

(i) Sufficient documentation explaining the methodology used to

compute its financial requirements under paragraph (a) of this section,

(ii) Sufficient documentation explaining the basis for its

determinations regarding the valuation and liquidity requirements set

forth in paragraphs (d) and (e) of this section, and

(iii) Copies of any agreements establishing or amending a credit

facility, insurance coverage, or other arrangement evidencing or

otherwise supporting the designated contract market's conclusions.

(4) The report shall be filed not later than 17 business days after

the end of the designated contract market's fiscal quarter, or at such

later time as the Commission may permit, in its discretion, upon

request by the designated contract market.

Subpart W--Diversity of Board of Directors

Sec. 38.1150 Core Principle 22.

The board of trade, if a publicly traded company, shall endeavor to

recruit individuals to serve on the board of directors and the other

decision-making bodies (as determined by the Commission) of the board

of trade from among, and to have the composition of the bodies reflect,

a broad and culturally diverse pool of qualified candidates.

Subpart X--Securities and Exchange Commission

Sec. 38.1200 Core Principle 23.

The board of trade shall keep any such records relating to swaps

defined in Section 1a(47)(A)(v) of the Act open to inspection and

examination by the Securities and Exchange Commission.

Sec. 38.1201 Additional sources for compliance.

Applicants and designated contract markets may refer to the

guidance and/or acceptable practices in Appendix B of this part to

demonstrate to the Commission compliance with the requirements of Sec.

38.1200 of this part.

19. Revise appendix A to part 38 to read as follows:

Appendix A--Form DCM[GPO: Follow lit]

COMMODITY FUTURES TRADING COMMISSION

FORM DCM

CONTRACT MARKET

APPLICATION OR AMENDMENT TO APPLICATION FOR DESIGNATION

DESIGNATION INSTRUCTIONS

Intentional misstatements or material omissions of fact may

constitute Federal criminal violations (7 U.S.C. 13 and 18 U.S.C.

1001) or grounds for disqualification from designation.

DEFINITIONS

Unless the context requires otherwise, all terms used in the

Form DCM have the same meaning as in the Commodity Exchange Act, as

amended (``CEA'' or ``Act''), and in the General Rules and

Regulations of the Commodity Futures Trading Commission

(``Commission'') thereunder.

GENERAL INSTRUCTIONS

1. Application Form DCM and Exhibits thereto are to be filed

with the Commission by applicants for designation as a contract

market, or by a designated contract market amending such

designation, pursuant to Section 5 of the CEA and the Commission's

regulations thereunder. Applicants may prepare their own Form DCM

but must follow the format prescribed herein. Upon the filing of an

application for designation in accordance with the instructions

provided herein, the Commission will publish notice of the filing

and afford interested persons an opportunity to submit written data,

views and arguments concerning such application. No application for

designation shall be effective unless the Commission, by order,

grants such designation.

2. Individuals' names, except the executing signature in Item

10, shall be given in full (Last Name, First Name, and Middle Name).

3. Signatures on all copies of the Form DCM filed with the

Commission can be executed electronically. If the Form DCM is filed

by a limited liability company, it must be signed in the name of the

limited liability company by a member duly authorized to sign on the

limited liability company's behalf; if filed by a partnership, it

shall be signed in the name of the partnership by a general partner

duly authorized; if filed by an unincorporated organization or

association which is not a partnership, it shall be signed in the

name of such organization or association by the managing agent--

i.e., a duly authorized person who directs or manages or who

participates in the directing or managing of its affairs; if filed

by a corporation, it shall be signed in the name of the corporation

by a principal officer duly authorized.

4. If Form DCM is being filed as an application for designation,

all applicable items must be answered in full. If any item is not

applicable, indicate by ``none,'' ``not applicable,'' or ``N/A'' as

appropriate.

5. For the purposes of this Form DCM, the term ``Applicant''

shall include any applicant for designation as a contract market or

any designated contract market that is amending Form DCM.

6. Under Section 5 of the CEA and the Commission's regulations

thereunder, the Commission is authorized to solicit the information

required to be supplied by this Form DCM from Applicants seeking

designation as a contract market and from a designated contract

market. Disclosure of the information specified on this Form DCM is

mandatory prior to the start of processing of an application for

designation as a contract market. The information provided with this

Form DCM will be used for the principal purpose of determining

whether the Commission should grant or deny designation to an

Applicant. The Commission further may determine that other and

additional information is required from the Applicant in order to

process its application. Except in cases where confidential

treatment is requested by the Applicant and granted by the

Commission, pursuant to the Freedom of Information Act and the rules

of the Commission thereunder, information supplied on this Form DCM

will be included routinely in the public files of the Commission and

will be available for inspection by any interested person. A Form

DCM which is not prepared and executed in compliance with applicable

requirements and instructions may be returned as not acceptable for

filing. Acceptance of this Form DCM, however, shall not constitute a

finding that the Form DCM has been filed as required or that the

information submitted is true, current or complete.

UPDATING INFORMATION ON THE FORM DCM

1. Part 38 of the Commission's regulations requires that if any

information contained in this application, or any supplement or

amendment thereto, is or becomes inaccurate for any reason, an

amendment to Form DCM, or a submission under part 40 of the

Commission's regulations, in either case correcting such information

must be filed promptly with the Commission.

2. Designated Contract Markets filing Form DCM as an amendment

need file only the facing page, the signature page (Item 10), and

any pages on which an answer is being amended, together with any

exhibits that are being amended. The submission of an amendment

represents that the remaining items and exhibits remain true,

current and complete as previously filed.

WHERE TO FILE

The Application Form DCM and appropriate exhibits must be filed

electronically with the Secretary of the Commission at its

Washington DC headquarters at [email protected] and the Division

of Market Oversight at [email protected]

BILLING CODE 6351-01-P

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BILLING CODE 6351-01-C

EXHIBITS INSTRUCTIONS

The following exhibits must be filed with the Commission by

Applicants seeking designation as a contract market, or by a

designated contract market amending its designation, pursuant to

Section 5 of the CEA and the Commission's regulations thereunder.

The exhibits should be labeled according to the items specified in

this Form DCM. If any exhibit is not applicable, please specify the

exhibit letter and indicate by ``none,'' ``not applicable,'' or ``N/

A'' as appropriate.

EXHIBITS--BUSINESS ORGANIZATION

1. Attach as Exhibit A, the name of any person(s) who owns ten

percent (10%) or more of the Applicant's stock or who, either

directly or indirectly, through agreement or otherwise, in any other

manner, may control or direct the management or policies of

Applicant.

Provide as part of Exhibit A the full name and address of each

such person and attach a copy of the agreement or, if there is none

written, describe the agreement or basis upon which such person

exercises or may exercise such control or direction.

2. Attach as Exhibit B, a list of the present officers,

directors, governors (and, in the case of an Applicant that is not a

corporation, the members of all standing committees grouped by

committee), or persons performing functions similar to any of the

foregoing, of the designated contract market or of any entity that

performs the regulatory activities of the Applicant, indicating for

each:

a. Name

b. Title

c. Dates of commencement and termination of present term of

office or position

d. Length of time each present officer, director, or governor

has held the same office or position

e. Brief account of the business experience of each officer and

director over the last five (5) years

f. Any other business affiliations in the derivatives and

securities industry

g. For directors, list any committees on which they serve and

any compensation received by virtue of their directorship

h. A description of:

(1) Any order of the Commission with respect to such person

pursuant to Section 5e of the CEA;

(2) Any conviction or injunction against such person within the

past ten (10) years;

(3) Any disciplinary actions with respect to such person within

the last five (5) years;

(4) Any disqualification under Sections 8b and 8d of the CEA;

(5) Any disciplinary action under Section 8c of the CEA; and

(6) Any violation pursuant to Section 9 of the CEA.

3. Attach as Exhibit C, a narrative that sets forth the fitness

standards for the Board of Directors and its composition including

the number and percentage of public directors.

4. Attach as Exhibit D, a narrative or graphic description of

the organizational structure of the Applicant. Include a list of all

affiliates of the Applicant and indicate the general nature of the

affiliation. Note: If the designated contract market activities of

the Applicant are or will be conducted primarily by a division,

subdivision, or other separate entity within the Applicant,

corporation or organization, describe the relationship of such

entity within the overall organizational structure and attach as

Exhibit D a description only as it applies to the division,

subdivision or separate entity, as applicable. Additionally, provide

any relevant jurisdictional information, including any and all

jurisdictions in which you or any affiliated entity are doing

business, and registration status, including pending applications

(e.g., country, regulator, registration category, date of

registration). Provide the address for legal service of process for

each jurisdiction, which cannot be a post office box.

5. Attach as Exhibit E, a description of the personnel

qualifications for each category of professional employees employed

by the Applicant or the division, subdivision, or other separate

entity within the Applicant as described in Item 4.

6. Attach as Exhibit F, an analysis of staffing requirements

necessary to carry out operations of the Applicant as a designated

contract market and the name and qualifications of each key staff

person.

7. Attach as Exhibit G, a copy of the constitution, articles of

incorporation, formation or association with all amendments thereto,

partnership or limited liability agreements, and existing by-laws,

operating agreement, rules or instruments corresponding thereto, of

the Applicant. Include any additional governance fitness information

not included in Exhibit C. Provide a certificate of good standing

dated

[[Page 80628]]

within one week of the date of the Form DCM.

8. Attach as Exhibit H, a brief description of any pending legal

proceeding(s), other than ordinary and routine litigation incidental

to the business, to which the Applicant or any of its affiliates is

a party or to which any of its or their property is the subject.

Include the name of the court or agency where the proceeding(s) are

pending, the date(s) instituted, the principal parties involved, a

description of the factual basis alleged to underlie the

proceeding(s), and the relief sought. Include similar information as

to any proceeding(s) known to be contemplated by the governmental

agencies.

EXHIBITS--FINANCIAL INFORMATION

9. Attach as Exhibit I:

a. (i) Balance sheet, (ii) Statement of income and expenses,

(iii) Statement of cash flows, and (iv) Statement of sources and

application of revenues and all notes or schedules thereto, as of

the most recent fiscal year of the Applicant, or of its parent

company, if applicable. If a balance sheet and any statements

certified by an independent public accountant are available, such

balance sheet and statement(s) should be submitted as Exhibit I.

b. Provide a narrative of how the value of the financial

resources of the Applicant is at least equal to a total amount that

would enable the Applicant to cover its operating costs for a period

of at least one year, calculated on a rolling basis, and whether

such financial resources include unencumbered, liquid financial

assets (i.e. cash and/or highly liquid securities) equal to at least

six months' operating costs.

c. Attach copies of any agreements establishing or amending a

credit facility, insurance coverage, or other arrangement evidencing

or otherwise supporting the Applicant's conclusions regarding the

liquidity of its financial assets.

d. Representations regarding sources and estimates for future

ongoing operational resources.

10. Attach as Exhibit J, a balance sheet and an income and

expense statement for each affiliate of the designated contract

market that also engages in designated contract market activities as

of the end of the most recent fiscal year of each such affiliate,

and each affiliate of the designated contract market that engages in

swap execution facility activities.

11. Attach as Exhibit K, the following:

a. A complete list of all dues, fees and other charges imposed,

or to be imposed, by or on behalf of Applicant for its designated

contract market services that are provided on an exclusive basis and

identify the service or services provided for each such due, fee, or

other charge.

b. A description of the basis and methods used in determining

the level and structure of the dues, fees and other charges listed

in paragraph (a.) of this item.

c. If the Applicant differentiates, or proposes to

differentiate, among its customers, or classes of customers in the

amount of any dues, fees, or other charges imposed for the same or

similar exclusive services, so state and indicate the amount of each

differential. In addition, identify and describe any differences in

the cost of providing such services, and any other factors, that

account for such differentiations.

EXHIBITS--COMPLIANCE

12. Attach as Exhibit L, a narrative and supporting documents

that may be provided under other Exhibits herein, that describe the

manner in which the Applicant is able to comply with each core

principle. The Applicant should include an explanation, and any

other forms of documentation the Applicant thinks will be helpful to

its explanation, demonstrating how the designated contract market

will be able to comply with each core principle. To the extent that

the application raises issues that are novel, or for which

compliance with a core principle is not self-evident, include an

explanation of how that item and the application satisfy the core

principles.

13. Attach as Exhibit M, a copy of the Applicant's rules (as

defined in Sec. 40.1 of the Commission's regulations) and any

technical manuals, other guides or instructions for users of, or

participants in, the market, including minimum financial standards

for members or market participants. Include rules citing applicable

Federal position limits and aggregation standards in part 151 of the

Commission's regulations and any exchange set position limit rules.

Include rules on publication of daily trading information with

regards to the requirements of part 16 of the Commission's

regulations. The Applicant should include an explanation, and other

forms of documentation the Applicant thinks will be helpful to its

explanation, demonstrating how the designated contract market will

be able to comply with each core principle and how its rules,

technical manuals, other guides or instructions for users of, or

participants in, the market, or minimum financial standards for

members of market participants as provided in this Exhibit M help

support the designated contract market's compliance with the core

principles.

14. Attach as Exhibit N, executed or executable copies of any

agreements or contracts entered into or to be entered into by the

Applicant, including third party regulatory service provider or

member or user agreements that enable or empower the Applicant to

comply with applicable core principles. Identify: (1) The services

that will be provided; and (2) The core principles addressed by such

agreement.

15. Attach as Exhibit O, a copy of any compliance manual and any

other documents that describe with specificity, the manner in which

the Applicant will conduct trade practice, market and financial

surveillance.

16. Attach as Exhibit P, a description of the Applicant's

disciplinary and enforcement protocols, tools, and procedures and

the arrangements for alternative dispute resolution.

17. Attach as Exhibit Q, a description of the Applicant's trade

matching algorithm and examples of how that algorithm works in

various trading scenarios involving various types of orders.

18. Attach as Exhibit R, a list of rules prohibiting specific

trade practice violations.

19. Attach as Exhibit S, a discussion of how trading data will

be maintained by the designated contract market.

20. Attach as Exhibit T, a list of the name of the clearing

organization(s) that will be clearing the Applicant's trades, and a

representation that clearing members of that organization will be

guaranteeing such trades.

21. Attach as Exhibit U, any information (described with

particularity) included in the application that will be subject to a

request for confidential treatment pursuant to Sec. 145.9 of the

Commission's regulations.

EXHIBITS--OPERATIONAL CAPABILITY

22. Attach as Exhibit V, information responsive to the

Technology Questionnaire (hyperlink to Web site). This questionnaire

focuses on information pertaining to the Applicant's program of risk

analysis and oversight. Main topic areas include: information

security; business continuity-disaster recovery (``BC-DR'') planning

and resources; capacity and performance planning; systems

operations; systems development and quality assurance; and physical

security and environmental controls.

20. Revise Appendix B to part 38 to read as follows:

Appendix B to Part 38--Guidance on, and Acceptable Practices in,

Compliance With Core Principles

1. This appendix provides guidance on complying with core

principles, both initially and on an ongoing basis, to obtain and

maintain designation under Section 5(d) of the Act and this part 38.

Where provided, guidance is set forth in paragraph (a) following the

relevant heading and can be used to demonstrate to the Commission

compliance with the selected requirements of a core principle, under

Sec. Sec. 38.3 and 38.5 of this part. The guidance for the core

principle is illustrative only of the types of matters a designated

contract market may address, as applicable, and is not intended to

be used as a mandatory checklist. Addressing the issues set forth in

this appendix would help the Commission in its consideration of

whether the designated contract market is in compliance with the

selected requirements of a core principle; provided however, that

the guidance is not intended to diminish or replace, in any event,

the obligations and requirements of applicants and designated

contract markets to comply with the regulations provided under this

part.

2. Where provided, acceptable practices meeting selected

requirements of core principles are set forth in paragraph (b)

following guidance. Designated contract markets that follow specific

practices outlined in the acceptable practices for a core principle

in this appendix will meet the selected requirements of the

applicable core principle; provided however, that the acceptable

practice is not intended to diminish or replace, in any event, the

obligations and requirements of applicants and designated contract

markets to comply with the regulations provided under this part 38.

The acceptable practices are for

[[Page 80629]]

illustrative purposes only and do not state the exclusive means for

satisfying a core principle.

Core Principle 1 of section 5(d) of the Act: DESIGNATION AS

CONTRACT MARKET.--(A) IN GENERAL--To be designated, and maintain a

designation, as a contract market, a board of trade shall comply

with--

(i) any core principle described in this subsection; and

(ii) any requirement that the Commission may impose by rule or

regulation pursuant to section 8a(5).

(B) REASONABLE DISCRETION OF CONTRACT MARKET--Unless otherwise

determined by the Commission by rule or regulation, a board of trade

described in subparagraph (A) shall have reasonable discretion in

establishing the manner in which the board of trade complies with

the core principles described in this subsection.

(a) Guidance. [Reserved.]

(b) Acceptable Practices. [Reserved.]

Core Principle 2 of section 5(d) of the Act: COMPLIANCE WITH

RULES--(A) IN GENERAL.--The board of trade shall establish, monitor,

and enforce compliance with the rules of the contract market,

including--

(i) access requirements;

(ii) the terms and conditions of any contracts to be traded on

the contract market; and

(iii) rules prohibiting abusive trade practices on the contract

market.

(B) CAPACITY OF CONTRACT MARKET.--The board of trade shall have

the capacity to detect, investigate, and apply appropriate sanctions

to any person that violates any rule of the contract market.

(C) REQUIREMENT OF RULES.--The rules of the contract market

shall provide the board of trade with the ability and authority to

obtain any necessary information to perform any function described

in this subsection, including the capacity to carry out such

international information-sharing agreements as the Commission may

require.

(a) Guidance. [Reserved.]

(b) Acceptable Practices. [Reserved.]

Core Principle 3 of section 5(d) of the Act: CONTRACTS NOT

READILY SUBJECT TO MANIPULATION--The board of trade shall list on

the contract market only contracts that are not readily susceptible

to manipulation.

(a) Guidance. (1) Designated contract markets may list new

products for trading by self-certification under Sec. 40.2 of this

chapter or may submit products for Commission approval under Sec.

40.3 of this chapter.

(2) Guidance in appendix C to this part may be used as guidance

in meeting this core principle for both new products listings and

existing listed contracts.

(b) Acceptable Practices. [Reserved.]

Core Principle 4 of section 5(d) of the Act: PREVENTION OF

MARKET DISRUPTION.--The board of trade shall have the capacity and

responsibility to prevent manipulation, price distortion, and

disruptions of the delivery or cash-settlement process through

market surveillance, compliance, and enforcement practices and

procedures, including--

(A) methods for conducting real-time monitoring of trading; and

(B) comprehensive and accurate trade reconstructions.

(a) Guidance. [Reserved.]

(b) Acceptable Practices. [Reserved.]

Core Principle 5 of section 5(d) of the Act: POSITION

LIMITATIONS OR ACCOUNTABILITY--(A) IN GENERAL.--To reduce the

potential threat of market manipulation or congestion (especially

during trading in the delivery month), the board of trade shall

adopt for each contract of the board of trade, as is necessary and

appropriate, position limitations or position accountability for

speculators.

(B) MAXIMUM ALLOWABLE POSITION LIMITATION.--For any contract

that is subject to a position limitation established by the

Commission pursuant to section 4a(a), the board of trade shall set

the position limitation of the board of trade at a level not higher

than the position limitation established by the Commission.

(a) Guidance. [Reserved.]

(b) Acceptable Practices. [Reserved.]

Core Principle 6 of section 5(d) of the Act: EMERGENCY

AUTHORITY--The board of trade, in consultation or cooperation with

the Commission, shall adopt rules to provide for the exercise of

emergency authority, as is necessary and appropriate, including the

authority--

(A) to liquidate or transfer open positions in any contract;

(B) to suspend or curtail trading in any contract; and

(C) to require market participants in any contract to meet

special margin requirements.

(a) Guidance. In consultation and cooperation with the

Commission, a designated contract market should have the authority

to intervene as necessary to maintain markets with fair and orderly

trading and to prevent or address manipulation or disruptive trading

practices, whether the need for intervention arises exclusively from

the DCM's market or as part of a coordinated, cross-market

intervention. DCM rules should include procedures and guidelines to

avoid conflicts of interest in accordance with the provisions of

Sec. 40.9 of this chapter, and include alternate lines of

communication and approval procedures to address emergencies

associated with real time events. To address perceived market

threats, the designated contract market should have rules that allow

it to take certain actions in the event of an emergency, as defined

in Sec. 40.1(h) of this chapter, including: imposing or modifying

position limits, price limits, and intraday market restrictions;

imposing special margin requirements; ordering the liquidation or

transfer of open positions in any contract; ordering the fixing of a

settlement price; extending or shortening the expiration date or the

trading hours; suspending or curtailing trading in any contract;

transferring customer contracts and the margin or altering any

contract's settlement terms or conditions; and, where applicable,

providing for the carrying out of such actions through its

agreements with its third-party provider of clearing or regulatory

services. In situations where a swap is traded on more than one

platform, emergency action to liquidate or transfer open interest

must be as directed, or agreed to, by the Commission or the

Commission's staff. The Commission should be notified promptly of

the DCM's exercise of emergency action, explaining how conflicts of

interest were minimized, including the extent to which the DCM

considered the effect of its emergency action on the underlying

markets and on markets that are linked or referenced to the contract

market and similar markets on other trading venues. Information on

all regulatory actions carried out pursuant to a DCM's emergency

authority should be included in a timely submission of a certified

rule pursuant to part 40 of this chapter.

(b) Acceptable Practices. A designated contract market must have

procedures and guidelines for decision-making and implementation of

emergency intervention in the market. At a minimum, the DCM must

have the authority to liquidate or transfer open positions in the

market, suspend or curtail trading in any contract, and require

market participants in any contract to meet special margin

requirements. In situations where a swap is traded on more than one

platform, emergency action to liquidate or transfer open interest

must be directed, or agreed to, by the Commission or the

Commission's staff. The DCM must promptly notify the Commission of

the exercise of its emergency authority, documenting its decision-

making process, including how conflicts of interest were minimized,

and the reasons for using its emergency authority. The DCM must also

have rules that allow it to take such market actions as may be

directed by the Commission.

Core Principle 7 of section 5(d) of the Act: AVAILABILITY OF

GENERAL INFORMATION.--The board of trade shall make available to

market authorities, market participants, and the public accurate

information concerning--

(A) the terms and conditions of the contracts of the contract

market; and

(B)(i) the rules, regulations, and mechanisms for executing

transactions on or through the facilities of the contract market;

and

(ii) the rules and specifications describing the operation of

the contract market's--

(I) electronic matching platform; or

(II) trade execution facility.

(a) Guidance. [Reserved.]

(b) Acceptable Practices. [Reserved.]

Core Principle 8 of section 5(d) of the Act: DAILY PUBLICATION

OF TRADING INFORMATION.--The board of trade shall make public daily

information on settlement prices, volume, open interest, and opening

and closing ranges for actively traded contracts on the contract

market.

(a) Guidance. [Reserved.]

(b) Acceptable Practices. [Reserved.]

Core Principle 9 of section 5(d) of the Act: EXECUTION OF

TRANSACTIONS.--``(A) IN GENERAL.--The board of trade shall provide a

competitive, open, and efficient market and mechanism for executing

transactions that protects the price discovery process of trading in

the centralized market of the board of trade.

(B) RULES.--The rules of the board of trade may authorize, for

bona fide business purposes--

[[Page 80630]]

(i) transfer trades or office trades;

(ii) an exchange of--

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

(II) futures for cash commodities; or

(III) futures for swaps; or

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

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

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

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

the contract market or a derivatives clearing organization.

(a) Guidance. [Reserved.]

(b) Acceptable Practices. (1) Block size determination for

existing contracts. For any futures contract that has been trading

for one calendar quarter or longer, the acceptable minimum block

trade size should be a number larger than the size at which a single

buy or sell order is customarily able to be filled in its entirety

in that product's centralized market without incurring a substantial

price concession. In specifying the minimum block, the designated

contract market should consider, and the Commission will review,

data related to factors including: the trading volume, open

interest, liquidity and depth of the order book, typical trade and

order sizes in the market, any input the designated contract market

receives from brokers, floor traders and/or market users related to

these factors, and the block sizes on comparable swap products.

(2) Block size determination for new contracts. For any futures

contract that has been listed for trading for less than one calendar

quarter, an acceptable minimum block trade size should be a number

equal to the size of a trade that the exchange reasonably

anticipates will not be able to be filled in its entirety in that

product's centralized market without incurring a substantial price

concession. In reviewing the block size for these products, the

designated contract market should consider, and the Commission will

review: centralized market data in a related futures contract, the

same contract traded on another exchange, trading activity in the

underlying cash market, and the block sizes on comparable swap

products. For both existing and new contracts, the designated

contract market may consider other relevant factors, but must

present those factors to the Commission when it certifies or seeks

approval of the block trade size.

(3) Pricing of block trades. (i) Block trades must be at a price

that is fair and reasonable. In determining whether a block trade

price is fair and reasonable, the DCM should consider: (A) the size

of the block; (B) the price and size of other block trades in any

relevant markets at the applicable time; and/or (C) the circumstance

of the market or the parties to the block trade. Relevant markets

include the designated contract market itself, the underlying cash

markets, and/or related futures or options markets. (ii) Block

trades between affiliated parties are subject to the pricing

requirements set forth in Sec. 38.503(d) of this part.

(4) Recordkeeping for block trades. Records kept in accordance

with the requirements of FASB Statement No. 133 (``Accounting for

Derivative Instruments and Hedging Activities''), as amended by FASB

Statement No. 161 (``Disclosures about Derivative Instruments and

Hedging Activities--an amendment of FASB Statement No. 133'') are

acceptable records.

Core Principle 10 of section 5(d) of the Act: TRADE

INFORMATION.--The board of trade shall maintain rules and procedures

to provide for the recording and safe storage of all identifying

trade information in a manner that enables the contract market to

use the information--

(A) to assist in the prevention of customer and market abuses;

and

(B) to provide evidence of any violations of the rules of the

contract market.

(a) Guidance. [Reserved.]

(b) Acceptable Practices. [Reserved.]

Core Principle 11 of section 5(d) of the Act: FINANCIAL

INTEGRITY OF TRANSACTIONS.--The board of trade shall establish and

enforce--

(A) rules and procedures for ensuring the financial integrity of

transactions entered into on or through the facilities of the

contract market (including the clearance and settlement of the

transactions with a derivatives clearing organization); and

(B) rules to ensure--

(i) the financial integrity of any--

(I) futures commission merchant; and

(II) introducing broker; and

(ii) the protection of customer funds.

(a) Guidance. [Reserved.]

(b) Acceptable Practices. [Reserved.]

Core Principle 12 of section 5(d) of the Act: PROTECTION OF

MARKETS AND MARKET PARTICIPANTS-- The board of trade shall establish

and enforce rules--

(A) to protect markets and market participants from abusive

practices committed by any party, including abusive practices

committed by a party acting as an agent for a participant; and

(B) to promote fair and equitable trading on the contract

market.

(a) Guidance. [Reserved.]

(b) Acceptable Practices. [Reserved.]

Core Principle 13 of section 5(d) of the Act: DISCIPLINARY

PROCEDURES.--The board of trade shall establish and enforce

disciplinary procedures that authorize the board of trade to

discipline, suspend, or expel members or market participants that

violate the rules of the board of trade, or similar methods for

performing the same functions, including delegation of the functions

to third parties.

(a) Guidance. [Reserved.]

(b) Acceptable Practices. [Reserved.]

Core Principle 14 of section 5(d) of the Act: DISPUTE

RESOLUTION.--The board of trade shall establish and enforce rules

regarding, and provide facilities for alternative dispute resolution

as appropriate for, market participants and any market

intermediaries.

(a) Guidance. A designated contract market should provide

customer dispute resolution procedures that are: appropriate to the

nature of the market; fair and equitable; and available on a

voluntary basis, either directly or through another self-regulatory

organization, to customers that are non-eligible contract

participants.

(b) Acceptable Practices.

(1) Fair and equitable procedure. Every contract market shall

provide customer dispute resolution procedures that are fair and

equitable. An acceptable customer dispute resolution mechanism

would:

(i) Provide the customer with an opportunity to have his or her

claim decided by an objective and impartial decision-maker;

(ii) Provide each party with the right to be represented by

counsel at the commencement of the procedure, at the party's own

expense;

(iii) Provide each party with adequate notice of the claims

presented against such party, an opportunity to be heard on all

claims, defenses and permitted counterclaims, and an opportunity for

a prompt hearing;

(iv) Authorize prompt, written, final settlement awards that are

not subject to appeal within the designated contract market; and

(v) Notify the parties of the fees and costs that may be

assessed.

(2) Voluntary Procedures. The use of dispute settlement

procedures shall be voluntary for customers other than eligible

contract participants as defined in section 1a(18) of the Act, and

may permit counterclaims as provided in Sec. 166.5 of this chapter.

(3) Member-to-Member Procedures. If the designated contract

market also provides procedures for the resolution of disputes that

do not involve customers (i.e., member-to-member disputes), the

procedures for resolving such disputes must be independent of and

shall not interfere with or delay the resolution of customers'

claims or grievances.

(4) Delegation. A designated contract market may delegate to

another self-regulatory organization or to a registered futures

association its responsibility to provide for customer dispute

resolution mechanisms, provided, however, that in the event of such

delegation, the designated contract market shall in all respects

treat any decision issued by such other organization or association

with respect to such dispute as if the decision were its own,

including providing for the appropriate enforcement of any award

issued against a delinquent member.

Core Principle 15 of section 5(d) of the Act: GOVERNANCE FITNESS

STANDARDS.--The board of trade shall establish and enforce

appropriate fitness standards for directors, members of any

disciplinary committee, members of the contract market, and any

other person with direct access to the facility (including any party

affiliated with any person described in this paragraph).

(a) Guidance. [Reserved.]

(b) Applicable Practices. [Reserved.]

Core Principle 16 of section 5(d) of the Act: CONFLICTS OF

INTEREST.--The board of trade shall establish and enforce rules--

(A) to minimize conflicts of interest in the decision making

process of the contract market; and

(B) to establish a process for resolving conflicts of interest

described in subparagraph (A).

(a) Guidance. [Reserved.]

(b) Acceptable Practices. [Reserved.]

Core Principle 17 of section 5(d) of the Act: COMPOSITION OF

GOVERNING BOARDS OF CONTRACT MARKETS.--The governance arrangements

of the board of

[[Page 80631]]

trade shall be designed to permit consideration of the views of

market participants.

(a) Guidance. [Reserved.]

(b) Acceptable Practices. [Reserved.]

Core Principle 18 of section 5(d) of the Act: RECORDKEEPING.--

The board of trade shall maintain records of all activities relating

to the business of the contract market--

(A) in a form and manner that is acceptable to the Commission;

and

(B) for a period of at least 5 years.

(a) Guidance. [Reserved.]

(b) Acceptable Practices. [Reserved.]

Core Principle 19 of section 5(d) of the Act: ANTITRUST

CONSIDERATIONS.--Unless necessary or appropriate to achieve the

purposes of this Act, the board of trade shall not--

(A) adopt any rule or taking any action that results in any

unreasonable restraint of trade; or

(B) impose any material anticompetitive burden on trading on the

contract market.

(a) Guidance. An entity seeking designation as a contract market

may request that the Commission consider under the provisions of

section 15(b) of the Act, any of the entity's rules, including

trading protocols or policies, and including both operational rules

and the terms or conditions of products listed for trading, at the

time of designation or thereafter. The Commission intends to apply

section 15(b) of the Act to its consideration of issues under this

core principle in a manner consistent with that previously applied

to contract markets.

(b) Acceptable Practices. [Reserved.]

Core Principle 20 of section 5(d) of the Act: SYSTEM

SAFEGUARDS.--The board of trade shall--

(A) establish and maintain a program of risk analysis and

oversight to identify and minimize sources of operational risk,

through the development of appropriate controls and procedures, and

the development of automated systems, that are reliable, secure, and

have adequate scalable capacity;

(B) establish and maintain emergency procedures, backup

facilities, and a plan for disaster recovery that allow for the

timely recovery and resumption of operations and the fulfillment of

the responsibilities and obligations of the board of trade; and

(C) periodically conduct tests to verify that backup resources

are sufficient to ensure continued order processing and trade

matching, price reporting, market surveillance, and maintenance of a

comprehensive and accurate audit trail.

(a) Guidance. [Reserved.]

(b) Acceptable Practices. [Reserved.]

Core Principle 21 of section 5(d) of the Act: FINANCIAL

RESOURCES.--

(A) IN GENERAL.--The board of trade shall have adequate

financial, operational, and managerial resources to discharge each

responsibility of the board of trade.

(B) DETERMINATION OF ADEQUACY.--The financial resources of the

board of trade shall be considered to be adequate if the value of

the financial resources exceeds the total amount that would enable

the contract market to cover the operating costs of the contract

market for a 1-year period, as calculated on a rolling basis.

(a) Guidance. [Reserved.]

(b) Acceptable Practices. [Reserved.]

Core Principle 22 of section 5(d) of the Act: DIVERSITY OF BOARD

OF DIRECTORS.--The board of trade, if a publicly traded company,

shall endeavor to recruit individuals to serve on the board of

directors and the other decision-making bodies (as determined by the

Commission) of the board of trade from among, and to have the

composition of the bodies reflect, a broad and culturally diverse

pool of qualified candidates.

(a) Guidance. [Reserved.]

(b) Acceptable Practices. [Reserved.]

Core Principle 23 of section 5(d) of the Act: SECURITIES AND

EXCHANGE COMMISSION.--The board of trade shall keep any such records

relating to swaps defined in section 1a(47)(A)(v) open to inspection

and examination by the Securities and Exchange Commission.

(a) Guidance. A designated contract market should have

arrangements and resources for collecting and maintaining accurate

records pertaining to any swaps agreements defined in section

1a(47)(A)(v) of the Act.

(b) Acceptable Practices. [Reserved.]

21. Add appendix C to part 38 to read as follows:

Appendix C--Demonstration of Compliance That a Contract is not Readily

Susceptible to Manipulation

(a) Futures Contracts--General Information. When a designated

contract market certifies or submits for approval contract terms and

conditions for a new futures contract, that submission must include

the following information:

(1) A narrative describing the contract, including data and

information to support the contract's terms and conditions, as set

by the designated contract market. When designing a futures

contract, the designated contract market should conduct market

research so that the contract design meets the risk management needs

of prospective users and promotes price discovery of the underlying

commodity. The designated contract market should consult with market

users to obtain their views and opinions during the contract design

process to ensure the contract's term and conditions reflect the

underlying cash market and that the futures contract will perform

the intended risk management and/or price discovery functions. A

designated contract market should provide a statement indicating

that it took such steps to ensure the usefulness of the submitted

contract.

(2) A detailed cash market description for physical and cash-

settled contracts should be included. Such descriptions must be

based on government and/or other publically-available data whenever

possible and be formulated for both the national and regional/local

market relevant to the underlying commodity. For tangible

commodities, the cash market descriptions for the relevant market

(i.e., national and regional/local) must incorporate at least five

full years of data that may include, among other factors,

production, consumption, stocks, imports, exports, and prices. Each

of those cash market variables must be fully defined and the data

sources must be fully specified and documented to permit Commission

staff to replicate the estimates of deliverable supply (defined in

paragraph (b)(1)(A) of this appendix C). Whenever possible, the

Commission requests that monthly or daily prices (depending on the

contract) underlying the cash settlement index be submitted for the

most recent five full calendar years and for as many of the current

year's months for which data are available. For contracts that are

cash settled to an index, the index's methodology must be provided

along with supporting information showing how the index is

reflective of the underlying cash market, is not readily subject to

manipulation or distortion, and is based on a cash price series that

is reliable, acceptable, publicly available and timely (defined in

paragraphs (c)(2) and (c)(3) of this appendix C). The Commission

recognizes that the data necessary for accurate and cogent cash

market analyses for an underlying commodity vary with the nature of

the underlying commodity. The Commission may require that the

designated contract market submit a detailed report on commodity

definitions and uses.

(b) Futures Contracts Settled by Physical Delivery. (1) For

listed contracts that are settled by physical delivery, the terms

and conditions of the contract should conform to the most common

commercial practices and conditions in the cash market for the

commodity underlying the futures contract. The terms and conditions

should be designed to avoid any impediments to the delivery of the

commodity so as to promote convergence between the price of the

futures contract and the cash market value of the commodity at the

expiration of a futures contract.

(i) Estimating Deliverable Supplies.

(A) General definition. The specified terms and conditions,

considered as a whole, must result in a ``deliverable supply'' that

is sufficient to ensure that the contract is not susceptible to

price manipulation or distortion. In general, the term ``deliverable

supply'' means the quantity of the commodity meeting the contract's

delivery specifications that reasonably can be expected to be

readily available to short traders and salable by long traders at

its market value in normal cash marketing channels at the contract's

delivery points during the specified delivery period, barring

abnormal movement in interstate commerce. Typically, deliverable

supply reflects the quantity of the commodity that potentially could

be made available for sale on a spot basis at current prices at the

contract's delivery points. For a non-financial physical-delivery

commodity contract, this estimate might represent product which is

in storage at the delivery point(s) specified in the futures

contract or can be moved economically into or through such points

consistent with the delivery procedures set forth in the contract

and which is available for sale on a spot basis within the marketing

channels that normally are tributary to the delivery point(s).

Furthermore, an appropriate estimate of deliverable supply excludes

commodity supplies that are committed to some commercial use. The

size of commodity supplies that are committed to

[[Page 80632]]

some commercial use may be estimated by consulting with market

participants. An adequate measure of deliverable supply would be an

amount of the commodity that would meet the normal or expected range

of delivery demand without causing futures prices to become

distorted relative to cash market prices. Given the availability of

acceptable data, deliverable supply should be estimated on a monthly

basis for at least the most recent five years for which data are

available. To the extent possible and that data resources permit,

deliverable supply estimates should be constructed such that the

data reflect, as close as possible, the market defined by the

contract's terms and conditions, and should be formulated, whenever

possible, with government or publically available data. All

deliverable supply estimates must be fully defined, have all

underlying assumptions explicitly stated, and have documentation of

all data/information sources in order to permit estimate replication

by Commission staff.

(B) Accounting for variations in deliverable supplies. To assure

the availability of adequate deliverable supplies and acceptable

levels of commercial risk management utility, contract terms and

conditions should account for variations in the patterns of

production, consumption and supply over a period of years of

sufficient length to assess adequately the potential range of

deliverable supplies. This assessment also should consider

seasonality, growth, and market concentration in the production/

consumption of the underlying cash commodity. Deliverable supply

implications of seasonal effects are more straightforwardly

delineated when deliverable supply estimates are calculated on a

monthly basis and when such monthly estimates are provided for at

least the most recent five years for which data resources permit. In

addition, consideration should be given to the relative roles of

producers, merchants, and consumers in the production, distribution,

and consumption of the cash commodity and whether the underlying

commodity exhibits a domestic or international export focus. Careful

consideration also should be given to the quality of the cash

commodity and to the movement or flow of the cash commodity in

normal commercial channels and whether there exist external factors

or regulatory controls that could affect the price or supply of the

cash commodity.

(C) Calculation of deliverable supplies. Designated contract

markets should derive a quantitative estimate of the deliverable

supplies for the delivery period specified in the proposed contract.

For commodities with seasonal supply or demand characteristics, the

deliverable supply analysis should include that period when

potential supplies typically are at their lowest levels. The

estimate should be based on statistical data, when reasonably

available, covering a period of time that is representative of the

underlying commodity's actual patterns of production, patterns of

consumption, and patterns of seasonal effects (if relevant). Often,

such a relevant time period should include at least five years of

monthly deliverable supply estimates permitted by available data

resources. Deliverable supply estimates should also exclude the

amount of the commodity that would not be otherwise deliverable on

the futures contract. For example, deliverable supplies should

exclude quantities that at current price levels are not economically

obtainable or deliverable or were previously dedicated under

contract for commercial use.

(2) Contract Terms and Conditions Requirements for Futures

Contracts Settled by Physical Delivery.

(i) For physical delivery contracts, an acceptable specification

of terms and conditions would include, but may not be limited to,

rules that address, as appropriate, the following criteria and

comply with the associated standards:

(A) Quality Standards: The terms and conditions of a commodity

contract should describe or define all of the economically

significant characteristics or attributes of the commodity

underlying the contract. In particular, the quality standards should

be described or defined so that such standards reflect those used in

transactions in the commodity in normal cash marketing channels.

Documentation establishing that the quality standards of the

contract's underlying commodity comply with those accepted/

established by the industry, by Government regulations, and/or by

relevant laws should also be submitted. For any particular commodity

contract, the specific attributes that must be enumerated depend

upon the individual characteristics of the underlying commodity.

These may include, for example, the following items: grade, quality,

purity, weight, class, origin, growth, issuer, originator, maturity

window, coupon rate, source, hours of trading, etc. If the terms of

the contract provide for the delivery of multiple qualities of a

specific attribute of the commodity having different cash market

values, then a ``par'' quality should be specified with price

differentials applicable to the ``non-par'' qualities that reflect

discounts or premiums commonly observed or expected to occur in the

cash market for that commodity.

(B) Delivery Points and Facilities: Delivery point/area

specifications should provide for futures delivery at a single

location or at multiple locations where the underlying cash

commodity is normally transacted or stored and where there exists a

viable cash market(s). If multiple delivery points are specified and

the value of the commodity differs between these locations, contract

terms should include price differentials that reflect usual

differences in value between the different delivery locations. If

the price relationships among the delivery points are unstable and a

designated contract market chooses to adopt fixed locational price

differentials, such differentials should fall within the range of

commonly observed or expected commercial price differences. In this

regard, any price differentials must be supported with cash price

data for the delivery location(s). The terms and conditions of the

contracts also should specify, as appropriate, any conditions the

delivery facilities and/or delivery facility operators must meet in

order to be eligible for delivery. Specification of any requirements

for delivery facilities also should consider the extent to which

ownership of such facilities is concentrated and whether the level

of concentration would be susceptible to manipulation of the futures

contract's prices. Commodity contracts also should specify

appropriately detailed delivery procedures that describe the

responsibilities of deliverers, receivers and any required third

parties in carrying out the delivery process. Such responsibilities

could include allocation between buyer and seller of all associated

costs such as load-out, document preparation, sampling, grading,

weighing, storage, taxes, duties, fees, drayage, stevedoring,

demurrage, dispatch, etc. Required accreditation for third-parties

also should be detailed. These procedures should seek to minimize or

eliminate any impediments to making or taking delivery by both

deliverers and takers of delivery to help ensure convergence of cash

and futures at the expiration of a futures delivery month.

(C) Delivery Period and Last Trading Day: An acceptable

specification of the delivery period would allow for sufficient time

for deliverers to acquire the deliverable commodity and make it

available for delivery, considering any restrictions or requirements

imposed by the designated contract market. Specification of the last

trading day for expiring contracts should consider whether adequate

time remains after the last trading day to allow for delivery on the

contract.

(D) Contract Size and Trading Unit: An acceptable specification

of the delivery unit and/or trading unit would be a contract size

that is consistent with customary transactions, transportation or

storage amounts in the cash market (e.g., the contract size may be

reflective of the amount of the commodity that represents a

pipeline, truckload or railcar shipment). For purposes of increasing

market liquidity, a designated contract market may elect to specify

a contract size that is smaller than the typical commercial

transaction size, storage unit or transportation size. In such

cases, the commodity contract should include procedures that allow

futures traders to easily take or make delivery on such a contract

with a smaller size, or, alternatively, the designated contract

market may adopt special provisions requiring that delivery be made

only in multiple contracts to accommodate reselling the commodity in

the cash market. If the latter provision is adopted, contract terms

should be adopted to minimize the potential for default in the

delivery process by ensuring that all contracts remaining open at

the close of trading in expiring delivery months can be combined to

meet the required delivery unit size. Generally, contract sizes and

trading units must be determined after a careful analysis of

relevant cash market trading practices, conditions and deliverable

supply estimates, so as to ensure that the underlying market

commodity market and available supply sources are able to support

the contract sizes and trading units at all times.

(E) Delivery Pack: The term ``delivery pack'' refers to the

packaging standards (e.g., product may be delivered in burlap or

polyethylene bags stacked on wooden

[[Page 80633]]

pallets) or non-quality related standards regarding the composition

of commodity within a delivery unit (e.g., product must all be

imported from the same country or origin). An acceptable

specification of the delivery pack or composition of a contract's

delivery unit should reflect, to the extent possible, specifications

commonly applied to the commodity traded or transacted in the cash

market.

(F) Delivery Instrument: An acceptable specification of the

delivery instrument (e.g., warehouse receipt, depository certificate

or receipt, shipping certificate, bill of lading, in-line transfer,

book transfer of securities, etc.) would provide for its conversion

into the cash commodity at a commercially-reasonable cost.

Transportation terms (e.g., FOB, CIF, freight prepaid to

destination) as well as any limits on storage or certificate daily

premium fees should be specified. These terms should reflect cash

market practices and the customary provision for allocating delivery

costs between buyer and seller.

(G) Inspection Provisions: Any inspection/certification

procedures for verifying compliance with quality requirements or any

other related delivery requirements (e.g., discounts relating to the

age of the commodity, etc.) should be specified in the contract

rules. An acceptable specification of inspection procedures would

include the establishment of formal procedures that are consistent

with procedures used in the cash market. To the extent that formal

inspection procedures are not used in the cash market, an acceptable

specification would contain provisions that assure accuracy in

assessing the commodity, that are available at a low cost, that do

not pose an obstacle to delivery on the contract and that are

performed by a reputable, disinterested third party or by qualified

designated contract market employees. Inspection terms also should

detail which party pays for the service, particularly in light of

the possibility of varying inspection results.

(H) Delivery (Trading) Months: Delivery months should be

established based on the risk management needs of commercial

entities as well as the availability of deliverable supplies in the

specified months.

(I) Minimum Price Fluctuation (Minimum Tick): The minimum price

increment (tick) should be set at a level that is equal to, or less

than, the minimum price increment commonly observed in cash market

transactions for the underlying commodity. Specifying a futures'

minimum tick that is greater than the minimum price increment in the

cash market can undermine the risk management utility of the futures

contract by preventing hedgers from efficiently establishing and

liquidating futures positions that are used to hedge anticipated

cash market transactions or cash market positions.

(J) Maximum Price Fluctuation Limits: Designated contract

markets may adopt price limits to: (1) Reduce or constrain price

movements in a trading day that may not be reflective of true market

conditions but might be caused by traders overreacting to news; (2)

Allow additional time for the collection of margins in times of

large price movements; and (3) Provide a ``cooling-off'' period for

futures market participants to respond to bona fide changes in

market supply and demand fundamentals that would lead to large cash

and futures price changes. If price limit provisions are adopted,

the limits should be set at levels that are not overly restrictive

in relation to price movements in the cash market for the commodity

underlying the futures contract.

(K) Speculative Limits: Specific information regarding the

establishment of speculative position limits are set forth in part

151 of the Commission's regulations.

(L) Reportable Levels: Refer to Sec. 15.03 of the Commission's

regulations.

(M) Trading Hours: Should be set by the designated contract

market to delineate each trading day.

(c) Futures Contracts Settled by Cash Settlement. (1) Cash

settlement is a method of settling certain futures or option

contracts whereby, at contract expiration, the contract is settled

by cash payment in lieu of physical delivery of the commodity or

instrument underlying the contract. An acceptable specification of

the cash settlement price for commodity futures and option contracts

would include rules that fully describe the essential economic

characteristics of the underlying commodity (e.g., grade, quality,

weight, class, growth, issuer, maturity, source, rating, description

of the underlying index and index's calculation methodology, etc.),

as well as how the final settlement price is calculated. In

addition, the rules should clearly specify the trading months and

hours of trading, the last trading day, contract size, minimum price

change (tick size) and any limitations on price movements (e.g.,

price limits or trading halts).

(2) Cash settled contracts may be susceptible to manipulation or

price distortion. In evaluating the susceptibility of a cash-settled

contract to manipulation, a designated contract market must consider

the size and liquidity of the cash market that underlies the listed

contract. In particular, situations susceptible to manipulation

include those in which the volume of cash market transactions and/or

the number of participants contacted in determining the cash-

settlement price are very low. Cash-settled contracts may create an

incentive to manipulate or artificially influence the data from

which the cash-settlement price is derived or to exert undue

influence on the cash-settlement price's computation in order to

profit on a futures position in that commodity. The utility of a

cash-settled contract for risk management and price discovery would

be significantly impaired if the cash settlement price is not a

reliable or robust indicator of the value of the underlying

commodity or instrument. Accordingly, careful consideration should

be given to the potential for manipulation or distortion of the cash

settlement price, as well as the reliability of that price as an

indicator of cash market values. Appropriate consideration also

should be given to the commercial acceptability, public

availability, and timeliness of the price series that is used to

calculate the cash settlement price. Documentation demonstrating

that the settlement price index is a reliable indicator of market

values and conditions and is commonly used as a reference index by

industry/market agents should be provided. Such documentation may

take on various forms, including carefully documented interview

results with knowledgeable agents.

(3) Where an independent, private-sector third party calculates

the cash settlement price series, a designated contract market must

consider the need for a licensing agreement that will ensure the

designated contract market's rights to the use of the price series

to settle the listed contract.

(i) Where an independent, private-sector third party calculates

the cash settlement price series, the designated contract market

should verify that the third party utilizes business practices that

minimize the opportunity or incentive to manipulate the cash-

settlement price series. Such safeguards may include lock-downs,

prohibitions against derivatives trading by employees, or public

dissemination of the names of sources and the price quotes they

provide. Because a cash-settled contract may create an incentive to

manipulate or artificially influence the underlying market from

which the cash-settlement price is derived or to exert undue

influence on the cash-settlement computation in order to profit on a

futures position in that commodity, a designated contract market

should, whenever practicable, enter into an information-sharing

agreement with the third-party provider which would enable the

designated contract market to better detect and prevent manipulative

behavior.

(ii) Where a designated contract market itself generates the

cash settlement price series, the designated contract market should

establish calculation procedures that safeguard against potential

attempts to artificially influence the price. For example, if the

cash settlement price is derived by the designated contract market

based on a survey of cash market sources, the designated contract

market should maintain a list of such entities which all should be

reputable sources with knowledge of the cash market. In addition,

the sample of sources polled should be representative of the cash

market, and the poll should be conducted at a time when trading in

the cash market is active. The cash-settlement survey should include

a minimum of four independent entities if such sources do not take

positions in the commodity (e.g., if the survey list is comprised

exclusively of brokers) or at least eight independent entities if

such sources trade for their own accounts (e.g., if the survey list

is comprised of dealers or merchants).

(iii) The cash-settlement calculation should involve

computational procedures that eliminate or reduce the impact of

potentially unrepresentative data.

(iv) The cash settlement price should be an accurate and

reliable indicator of prices in the underlying cash market. The cash

settlement price also should be acceptable to commercial users of

the commodity contract. The registered entity should fully document

that the settlement price is accurate, reliable, highly regarded by

industry/market agents, and fully reflects the economic and

commercial conditions of the relevant designated contract market.

[[Page 80634]]

(v) To the extent possible, the cash settlement price should be

based on cash price series that are publicly available and available

on a timely basis for purposes of calculating the cash settlement

price at the expiration of a commodity contract. A designated

contract market should make the final cash settlement price and any

other supporting information that is appropriate for release to the

public, available to the public when cash settlement is accomplished

by the derivatives clearing organization. If the cash settlement

price is based on cash prices that are obtained from non-public

sources (e.g., cash market surveys conducted by the designated

contract market or by third parties on behalf of the designated

contract market), a designated contract market should make available

to the public as soon as possible after a contract month's

expiration the final cash settlement price as well as any other

supporting information that is appropriate or feasible to make

available to the public.

(4) Contract Terms and Conditions Requirements for Futures

Contracts Settled by Cash Settlement

(i) An acceptable specification of the terms and conditions of a

cash-settled commodity contract will also set forth the trading

months, last trading day, contract size, minimum price change (tick

size) and daily price limits, if any.

(A) Commodity Characteristics: The terms and conditions of a

commodity contract should describe the commodity underlying the

contract.

(B) Contract Size and Trading Unit: An acceptable specification

of the trading unit would be a contract size that is consistent with

customary transactions in the cash market. A designated contract

market may opt to set the contract size smaller than that of

standard cash market transactions.

(C) Cash Settlement Procedure: The cash settlement price should

be reliable, acceptable, publicly available, and reported in a

timely manner as described in paragraphs (c)(3)(iv) and (c)(3)(v) of

this appendix C.

(D) Pricing Basis and Minimum Price Fluctuation (Minimum Tick):

The minimum price increment (tick) should be set a level that is

equal to, or less than, the minimum price increment commonly

observed in cash market transactions for the underlying commodity.

Specifying a futures' minimum tick that is greater than the minimum

price increment in the cash market can undermine the risk management

utility of the futures contract by preventing hedgers from

efficiently establishing and liquidating futures positions that are

used to hedge anticipated cash market transactions or cash market

positions.

(E) Maximum Price Fluctuation Limits: Designated contract

markets may adopt price limits to: (1) Reduce or constrain price

movements in a trading day that may not be reflective of true market

conditions but might be caused by traders overreacting to news; (2)

Allow additional time for the collection of margins in times of

large price movements; and (3) Provide a ``cooling-off'' period for

futures market participants to respond to bona fide changes in

market supply and demand fundamentals that would lead to large cash

and futures price changes. If price-limit provisions are adopted,

the limits should be set at levels that are not overly restrictive

in relation to price movements in the cash market for the commodity

underlying the futures contract. For broad-based stock index futures

contracts, rules should be adopted that coordinate with New York

Stock Exchange (``NYSE'') declared Circuit Breaker Trading Halts and

would recommence trading in the futures contract only after trading

in the majority of the stocks underlying the index has recommenced.

(F) Last Trading Day: Specification of the last trading day for

expiring contracts should be established such that it occurs before

publication of the underlying third-party price index or

determination of the final settlement price. If the designated

contract market chooses to allow trading to occur through the

determination of the final settlement price, then the designated

contract market should show that futures trading would not distort

the final settlement price calculation.

(G) Trading Months: Trading months should be established based

on the risk management needs of commercial entities as well as the

availability of price and other data needed to calculate the cash

settlement price in the specified months. Specification of the last

trading day should take into consideration whether the volume of

transactions underlying the cash settlement price would be unduly

limited by occurrence of holidays or traditional holiday periods in

the cash market. Moreover, a contract should not be listed past the

date for which the designated contract market has access to use a

proprietary price index for cash settlement.

(H) Speculative Limits: Specific rules and policies for

speculative position limits are set forth in the part 151 of the

Commission's regulations.

(I) Reportable Levels: Refer to Sec. 15.03 of the Commission's

regulations.

(J) Trading Hours: Should be set by the designated contract

market to delineate each trading day.

(d) Options on a Futures Contract. (1) The Commission's

experience with the oversight of trading in futures option contracts

indicates that most of the terms and conditions associated with such

trading do not raise any regulatory concerns or issues. The

Commission has found that the following terms do not affect an

option contract's susceptible to manipulation or its utility for

risk management. Thus, the Commission believes that, in most cases,

any specification of the following terms would be acceptable; the

only requirement is that such terms be specified in an automatic and

objective manner in the option contract's rules:

[cir] Exercise method;

[cir] Exercise procedure (if positions in the underlying futures

contract are established via book entry);

[cir] Strike price listing provisions, including provisions for

listing strike prices on a discretionary basis;

[cir] Strike price intervals;

[cir] Automatic exercise provisions;

[cir] Contract size (unless not set equal to the size of the

underlying futures contract); and

[cir] Option minimum tick should be equal to or smaller than

that of the underlying futures contract.

(2) Option Expiration & Last Trading Day. For options on futures

contracts, specification of expiration dates should consider the

relationship of the option expiration date to the delivery period

for the underlying futures contract. In particular, an assessment

should be made of liquidity in the underlying futures market to

assure that any futures contracts acquired through exercise can be

liquidated without adversely affecting the orderly liquidation of

futures positions or increasing the underlying futures contract's

susceptibility to manipulation. When the underlying futures contract

exhibits a very low trading activity during an expiring delivery

month's final trading days or has a greater risk of price

manipulation than other contracts, the last trading day and

expiration day of the option should occur prior to the delivery

period or the settlement date of the underlying future. For example,

the last trading day and option expiration day might appropriately

be established prior to first delivery notice day for option

contracts with underlying futures contracts that have very limited

deliverable supplies. Similarly, if the futures contract underlying

an option contract is cash settled using cash prices from a very

limited number of underlying cash market transactions, the last

trading and option expiration days for the option contract might

appropriately be established prior to the last trading day for the

futures contract.

(3) Speculative Limits. In cases where the terms of an

underlying futures contract specify a spot-month speculative

position limit and the option contract expires during, or at the

close of, the futures contract's delivery period, the option

contract should include a spot-month speculative position limit

provision that requires traders to combine their futures and option

position and be subject to the limit established for the futures

contract. Specific rules and policies for speculative position

limits are set forth in part 151 of the Commission's regulations.

(4) Options on Physicals Contracts.

(i) Under the Commission's regulations, the term ``option on

physicals'' refers to option contracts that do not provide for

exercise into an underlying futures contract. Upon exercise, options

on physicals can be settled via physical delivery of the underlying

commodity or by a cash payment. Thus, options on physicals raise

many of the same issues associated with trading in futures contracts

regarding adequacy of deliverable supplies or acceptability of the

cash settlement price series. In this regard, an option that is cash

settled based on the settlement price of a futures contract would be

considered an ``option on physicals'' and the futures settlement

price would be considered the cash price series.

(ii) In view of the above, acceptable practices for the terms

and conditions of options on physicals contracts include, as

appropriate, those practices set forth above for physical-delivery

or cash-settled futures contracts plus the practices set forth for

options on futures contracts.

(e) Security Futures Products. (1) The listing of security

futures products are

[[Page 80635]]

governed by the special requirements of part 41 of the Commission's

regulations. A designated contract market should follow the

appropriate guidance regarding physically delivered security futures

products that are settled through physical delivery or cash

settlement.

(f) Non-Price Based Futures Contracts. (1) Non-price based

contracts are typically construed as binary options, but also may be

designed to function similar to traditional futures or option

contracts.

(2) Where the contract is settled to a third party cash-

settlement series, the designated contract market should consider

the nature and sources of the data comprising the cash-settlement

calculation, the computational procedures, and the mechanisms in

place to ensure the accuracy and reliability of the index value. The

evaluation also considers the extent to which the third party has,

or will adopt, safeguards against unauthorized or premature release

of the index value itself or any key data used in deriving the index

value.

(3) The designated contract market should follow the guidance in

paragraph (c)(4) (Contract Terms and Conditions Requirements for

Futures Contracts Settled by Cash Settlement) of this appendix C to

meet compliance.

(g) Swap Contracts. (1) In general, swap contracts are an

agreement to exchange a series of cash flows over a period of time

based on reference price indices. When listing a swap for trading, a

swap execution facility or designated contract market must determine

that the reference price indices used for its contracts are not

readily susceptible to manipulation. Accordingly, careful

consideration should be given to the potential for manipulation or

distortion of the cash settlement price, as well as the reliability

of that price as an indicator of cash market values. Appropriate

consideration also should be given to the commercial acceptability,

public availability, and timeliness of the price series that is used

to calculate the cash settlement price. Documentation demonstrating

that the settlement price index is a reliable indicator of market

values and conditions and is highly regarded by industry/market

agents should be provided. Such documentation may take on various

forms, including carefully documented interviews with principal

market trading agents, pricing experts, marketing agents, etc.

Appropriate consideration also should be given to the commercial

acceptability, public availability, and timeliness of the price

series that is used to calculate the cash flows of the swap.

(i) Where an independent, private-sector third party calculates

the referenced price index, the designated contract market should

verify that the third party utilizes business practices that

minimize the opportunity or incentive to manipulate the cash-

settlement price series. Such safeguards may include lock-downs,

prohibitions against derivatives trading by employees, or public

dissemination of the names of sources and the price quotes they

provide. Because a cash-settled contract may create an incentive to

manipulate or artificially influence the underlying market from

which the cash-settlement price is derived or to exert undue

influence on the cash-settlement computation in order to profit on a

futures position in that commodity, a designated contract market

should, whenever practicable, enter into an information-sharing

agreement with the third-party provider which would enable the

designated contract market to better detect and prevent manipulative

behavior.

(ii) Where a designated contract market itself generates the

cash settlement price series, the designated contract market should

establish calculation procedures that safeguard against potential

attempts to artificially influence the price. For example, if the

cash settlement price is derived by the designated contract market

based on a survey of cash market sources, the designated contract

market should maintain a list of such entities which all should be

reputable sources with knowledge of the cash market. In addition,

the sample of sources polled should be representative of the cash

market, and the poll should be conducted at a time when trading in

the cash market is active. The cash-settlement survey should include

a minimum of four independent entities if such sources do not take

positions in the commodity (e.g., if the survey list is comprised

exclusively of brokers) or eight independent entities if such

sources trade for their own accounts (e.g., if the survey list is

comprised of dealers or merchants).

(iii) The cash-settlement calculation should involve appropriate

computational procedures that eliminate or reduce the impact of

potentially unrepresentative data.

(2) Speculative Limits: Specific rules and policies for

speculative position limits are set forth in part 151 of the

Commission's regulations.

(3) Intraday Market Restrictions: Designated contract markets or

swap execution facilities must have in place intraday market

restrictions that pause or halt trading in the event of

extraordinary price moves that may result in distorted prices. Such

restrictions need to be coordinated with other markets that may be a

proxy or a substitute for the contracts traded on their facility.

For example, coordination with NYSE rule 80.B Circuit Breaker

Trading Halts. The designated contract market or swap execution

facility must adopt rules to specifically address who is authorized

to declare an emergency; how the designated contract market or swap

execution facility will notify the Commission of its decision that

an emergency exists; how it will address conflicts of interest in

the exercise of emergency authority; and how it will coordinate

trading halts with markets that trade the underlying price reference

index or product.

(4) Settlement Method. The designated contract market or swap

execution facility should follow the guidance in paragraph (c)(4)

(Contract Terms and Conditions Requirements for Futures Contracts

Settled by Cash Settlement) of this appendix C to meet compliance,

or paragraph (b)(2) (Contract Terms and Conditions Requirements for

Futures Contracts Settled by Physical Delivery) of this appendix C,

as appropriate.

By the Commission.

Dated: December 1, 2010.

David A. Stawick,

Secretary.

Appendices to Core Principles and Other Requirements for Designated

Contract Markets--Commission Voting Summary and Statements of

Commissioners

Note: The following appendices will not appear in the Code of

Federal Regulations

Appendix 1--Commission Voting Summary

On this matter, Chairman Gensler and Commissioners Dunn and

Chilton voted in the affirmative; Commissioners Sommers and O'Malia

voted in the negative.

Appendix 2--Statements of Commissioners

Statement of Chairman Gary Gensler

I support the proposed rulemaking to update our rules and

guidance with regard to designated contract markets (DCMs). The

Dodd-Frank Act updated the statutory language for core principles

for contract markets, increasing the number to 23 and modifying

existing core principles. Thus, it is important to update our rules

and guidance to reflect those changes. Further, the Dodd-Frank Act

allows DCMs to--for the first time--offer swaps in addition to

futures and commodity options, and this proposal addresses that

broader scope. I believe it is also important to update the rules

and guidance for DCMs in light of the fact that we will be

promulgating rules and guidance for swap execution facilities, and

many of the core principles are similar. This rule will help to

promote transparency and market integrity.

Dissent of Commissioner Jill E. Sommers and Commissioner Scott D.

O'Malia

We respectfully dissent from the action taken today by the

Commission to issue proposed regulations relating to ``Core

Principle and Other Requirements for Designated Contract Markets''

(DCMs). While we each dissent for a number of reasons, we join in

writing to express our disagreement with the Commission's narrow

interpretation of Core Principle 9--Execution of Transactions, and

request comment on the implications of such a narrow interpretation

of Core Principle 9 for markets and market participants.

In relevant part, Core Principle 9 states: ``The board of trade

shall provide a competitive, open, and efficient market and

mechanism for executing transactions that protects the price

discovery process of trading in the centralized market of the board

of trade.'' Core Principle 9 does not say that every contract listed

for trading on the board of trade must trade in the centralized

market. Nor does it require that every contract listed for trading

serve a price discovery function. Rather, it requires a mechanism

for protecting the price discovery function for those contracts that

do trade in the centralized market. With these proposed regulations,

the Commission is interpreting

[[Page 80636]]

Core Principle 9 in a way that does not comport with the plain

language of the statute.

Over the past decade, a long list of non-standardized, illiquid

contracts in the energy sphere have been executed off-exchange and

cleared on-exchange through the exchange of futures for swaps (EFS)

mechanism. The availability of clearing for these contracts added a

level of safety, soundness and transparency to the marketplace that

did not exist before. If the Commission had not permitted these

contracts to be listed for clearing through the EFS process it is

highly doubtful that the level of clearing that exists today for

these contracts would have been achieved, and highly likely that

this activity would have remained opaque to market participants and

regulators. Congress was aware of this specialized marketplace when

it amended Core Principle 9. If Congress had intended to outlaw this

activity it could have done so by explicitly requiring all DCM

contracts to trade in the centralized market. It did not do so. In

fact, Core Principle 9 explicitly allows boards of trade to

authorize certain types of contracts that have traditionally been

traded off the centralized market, including EFS.

Finally, the full ramifications of the Commission's overly-

restrictive reading of Core Principle 9 are not yet known, but are

likely to be of great consequence to many market participants.

Clearing helps mitigate risk, and the movement of illiquid contracts

into a cleared environment was a positive development for our

markets and market participants. Clearing contracts listed on a DCM

also permits market participants to take advantage of certain

efficiencies, like portfolio margining. Now, hundreds of contracts

that are listed for trading on DCMs and cleared likely will no

longer enjoy that status. The assumption appears to be that these

contracts will simply be listed for trading on a swap execution

facility (SEF) and cleared, without any disruption to markets or

market participants. We are not willing to make such a bold

assumption, especially when the Commission has not yet proposed

regulations relating to listing and trading requirements for SEFs.

We would have preferred that the proposed regulations preserve

the functioning of this specialized marketplace; a marketplace that

has not adversely affected price discovery for any contract

currently traded in the centralized market.

[FR Doc. 2010-31458 Filed 12-21-10; 8:45 am]

BILLING CODE 6351-01-P

Last Updated: December 22, 2010