2011-19365

Federal Register, Volume 76 Issue 147 (Monday, August 1, 2011)[Federal Register Volume 76, Number 147 (Monday, August 1, 2011)]

[Proposed Rules]

[Pages 45730-45738]

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

[FR Doc No: 2011-19365]

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COMMODITY FUTURES TRADING COMMISSION

17 CFR Parts 1, 23, and 39

RIN 3038-AD51

Customer Clearing Documentation and Timing of Acceptance for

Clearing

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 rules to implement new statutory provisions enacted by

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

Act. These proposed rules address: The documentation between a customer

and a futures commission merchant that clears on behalf of the

customer, and the timing of acceptance or rejection of trades for

clearing by derivatives clearing organizations and clearing members.

DATES: Submit comments on or before September 30, 2011.

ADDRESSES: You may submit comments, identified by RIN number 3038-AD51,

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.

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

Follow the instructions for submitting comments.

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

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

Street, NW., Washington, DC 20581.

Courier: Same as mail above.

Please submit your comments using only one method. RIN number,

3038-AD51, must be in the subject field of responses submitted via e-

mail, and clearly indicated on written submissions. 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 CFTC 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 CFTC's regulations.\1\

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\1\ 17 CFR 145.9.

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

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

submission from http://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 this action 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: John C. Lawton, Deputy Director and

Chief Counsel, 202-418-5480, [email protected], or Christopher A. Hower,

Attorney-Advisor, 202-418-6703, [email protected], Division of Clearing

and Intermediary Oversight, Commodity Futures Trading Commission, Three

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

SUPPLEMENTARY INFORMATION:

I. Background

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

Reform and Consumer Protection Act (Dodd-Frank Act).\2\ Title VII of

the Dodd-Frank Act amended the Commodity Exchange Act (CEA or Act) \3\

to establish a comprehensive new regulatory framework for 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 rigorous recordkeeping and real-time reporting

[[Page 45731]]

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. Title VII also

includes amendments to the federal securities laws to establish a

similar regulatory framework for security-based swaps under the

authority of the Securities and Exchange Commission (SEC).

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\2\ See Dodd-Frank Wall Street Reform and Consumer Protection

Act, Public Law 111-203, 124 Stat. 1376 (2010).

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

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II. Proposed Regulations

A. Introduction

A fundamental premise of the Dodd-Frank Act is that the use of

properly regulated central clearing can reduce systemic risk. Another

tenet of the Dodd-Frank Act is that open access to clearing by market

participants will increase market transparency and promote market

efficiency by enabling market participants to reduce counterparty risk

and by facilitating offset of open positions. The Commission has

proposed extensive regulations addressing open access at the

derivatives clearing organization (DCO) level.\4\

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\4\ See, e.g., 76 FR 3698 (Jan. 20, 2011) (Risk Management

Requirements for Derivatives Clearing Organizations).

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Clearing members provide the portals through which market

participants gain access to DCOs as well as the first line of risk

management. Accordingly, the Commission is proposing regulations to

facilitate customer access to clearing and to bolster risk management

through timely processing. The proposals address: (i) The documentation

between a customer and a futures commission merchant (FCM) that clears

on behalf of the customer; and (ii) the timing of acceptance or

rejection of trades for clearing by DCOs and clearing members.

B. Customer Clearing Documentation

Section 4d(c) of the CEA, as amended by the Dodd-Frank Act, directs

the Commission to require FCMs to implement conflict of interest

procedures that address such issues the Commission determines to be

appropriate. Similarly, section 4s(j)(5), as added by the Dodd-Frank

Act, requires SDs and MSPs to implement conflict of interest procedures

that address such issues the Commission determines to be appropriate.

Section 4s(j)(5) also requires SDs and MSPs to ensure that any persons

providing clearing activities or making determinations as to accepting

clearing customers are separated by appropriate informational

partitions from persons whose involvement in pricing, trading, or

clearing activities might bias their judgment or contravene the core

principle of open access.

Pursuant to these provisions, the Commission has proposed Sec.

1.71(d)(1) relating to FCMs and Sec. 23.605(d)(1) relating to SDs and

MSPs.\5\ These regulations would prohibit SDs and MSPs from interfering

or attempting to influence the decisions of affiliated FCMs with regard

to the provision of clearing services and activities and would prohibit

FCMs from permitting them to do so.

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\5\ 75 FR 70152 (Nov. 17, 2010) (Implementation of Conflicts of

Interest Policies and Procedures by Futures Commission Merchants and

Introducing Brokers); 75 FR 71391 (Nov. 23, 2010) (Implementation of

Conflicts of Interest Policies and Procedures by Swap Dealers and

Major Swap Participants).

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Section 4s(j)(6) of the CEA prohibits an SD or MSP from adopting

any process or taking any action that results in any unreasonable

restraint on trade or imposes any material anticompetitive burden on

trading or clearing, unless necessary or appropriate to achieve the

purposes of the Act. The Commission has proposed Sec. 23.607 to

implement this provision.\6\

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\6\ 75 FR 91397 (Nov. 23, 2010) (Regulations Establishing Duties

of Swap Dealers and Major Swap Participants).

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Section 2(h)(1)(B)(ii) of the CEA requires that DCO rules provide

for the non-discriminatory clearing of swaps executed bilaterally or

through an unaffiliated designated contract market (DCM) or swap

execution facility (SEF). The Commission has proposed Sec. 39.12(b)(2)

to implement this provision.\7\

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\7\ 76 FR 3698 (Jan. 20, 2011) (Risk Management Requirements for

Derivatives Clearing Organizations); 76 FR 13101 (March 10, 2011)

(Requirements for Processing, Clearing, and Transfer of Customer

Positions).

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On June 16, 2011, the Futures Industry Association (FIA) and the

International Swap and Derivatives Association (ISDA), published an

FIA-ISDA Cleared Derivatives Execution Agreement (Agreement) as a

template for use by swap market participants in negotiating execution-

related agreements with counterparties to swaps that are intended to be

cleared.\8\ The Agreement was developed with the assistance of a

committee comprised of representatives of certain FIA and ISDA member

firms which included both swap dealers and buy-side firms. More than 60

organizations provided input during the development of the document.\9\

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\8\ See press release, ``FIA and ISDA Publish Documentation for

Cleared Swaps'' (June 16, 2011) at http://www.futuresindustry.org.

\9\ Id.

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FIA and ISDA emphasized that the use of the agreement is voluntary

and may not be necessary and appropriate under all circumstances.\10\

FIA and ISDA recognized that many of the provisions in the Agreement

will be superseded by new regulatory requirements and the rules of swap

execution venues and clearing organizations.\11\

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\10\ Id.

\11\ Id.

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The Agreement includes optional annexes that make the clearing

member to one or both of the executing parties a party to the Agreement

(the Tri-party annexes). Some of the participants in the process, as

well as some market participants that were not included, have expressed

concern to the Commission that aspects of the Tri-party annexes may be

inconsistent with certain principles of the Dodd-Frank Act.\12\

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\12\ See, e.g., letter dated April 11, 2011 from Stuart J.

Kaswell, Executive Vice President, Managing Director, and General

Counsel, Managed Funds Association; letter dated April 19, 2011 from

James Cawley, Swaps & Derivatives Market Association. These letters

can be found in the Commission's comment file for 76 FR 13101.

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Specifically, concerns arise in connection with certain provisions

that would permit a customer's FCM, in consultation with the SD, to

establish specific credit limits for the customer's swap transactions

with the SD, and to declare that with regard to trades with that SD,

the FCM will only accept for clearing those transactions that fall

within these specific limits.\13\ The limits set for trades with the SD

might be less than the overall limits set for the customer for all

trades cleared through the FCM. The result would be to create a

``sublimit'' for the customer for trades with that SD. Some market

participants have stated that the setting of such ``sublimits'' would

result in restrictions of customer counterparties because, without such

``sublimits,'' the customer may enter into transactions with whomever

it chooses, up to its overall limit with the FCM.\14\

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\13\ See Kaswell letter at 9.

\14\ Id. at 10.

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Generally, in cleared markets, an FCM does not know the identity of

its customer's executing counterparty. Another effect of such sublimits

would be to disclose the identity of the customer's counterparty to the

FCM. In many instances, the FCM and the customer's counterparty--the

SD--might be affiliated entities. Some market participants have stated

that such disclosure may lead to ``greater information exchange''

between the FCM and the affiliated SD, which would

[[Page 45732]]

``force the customer to execute with the clearing member's trading desk

affiliate.'' \15\ A third effect of such sublimits could be to delay

acceptance of the trades into clearing while the FCM verifies

compliance with the sublimits.

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\15\ Id.

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Arrangements with these effects potentially conflict with the

concepts of open access to clearing and execution of customer

transactions on a DCM or SEF on terms that have a reasonable

relationship to the best terms available. More specifically, they

potentially conflict with proposed Sec. Sec. 1.71(d)(1), 23.605(d)(1),

23.608, and 39.12. As certain market participants have stated, tri-

party agreements of the type described above could lead to undue

influence by FCMs on a customer's choice of counterparties (or,

conversely, undue influence by SDs on a customer's choice of clearing

member). Therefore, they could constrain a customer's opportunity to

obtain execution of the trade on the terms that have a reasonable

relationship to the best terms available by limiting the number of

potential counterparties.\16\

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\16\ The Commission previously proposed Sec. 155.7, an

execution standard that would apply to swaps available for trading

on a DCM or SEF to ensure fair dealing and protect against fraud and

other abusive practices. 75 FR 80638, 80648 (Dec. 22, 2010). The

proposed rule would require Commission registrants to execute swaps

available for trading on a DCM or SEF on terms that have a

reasonable relationship to the best terms available.

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To address these concerns and to provide further clarity in this

area, the Commission is now proposing Sec. 1.72 relating to FCMs,

Sec. 23.608 relating to SDs and MSPs, and Sec. 39.12(a)(1)(vi)

relating to DCOs. These new regulations would prohibit arrangements

involving FCMs, SDs, MSPs, or DCOs that would (a) disclose to an FCM,

SD, or MSP the identity of a customer's original executing

counterparty; (b) limit the number of counterparties with whom a

customer may enter into a trade; (c) restrict the size of the position

a customer may take with any individual counterparty, apart from an

overall credit limit for all positions held by the customer at the FCM;

(d) impair a customer's access to execution of a trade on terms that

have a reasonable relationship to the best terms available; or (e)

prevent compliance with specified time frames for acceptance of trades

into clearing.

The Commission believes that implementation of the proposal would

reduce risk and foster open access to clearing, as well as execution of

customer trades on terms that have a reasonable relationship to the

best terms available. Restrictions of the sort prohibited by the

proposed rules could increase risk by delaying or blocking access to

clearing. They could increase costs and reduce market efficiency by

limiting the number of counterparties available for trading. They could

restrict access to clearing by limiting the potential clearing members

with which a customer could deal.

The Commission is not proposing to dictate here what happens to a

trade that is rejected for clearing by an FCM or a DCO. Three outcomes

are possible: (i) The parties could try to clear the trade through

another DCO or FCM; (ii) the trade could revert to a bilateral

transaction; or (iii) the parties could break the trade. The parties

should agree in advance, subject to applicable law, which alternative

will apply and how to measure and apportion any resulting losses. The

Commission believes that the proposals herein will decrease the

likelihood that trades will be rejected and diminish the potential for

loss in cases where rejection does occur.

The Commission requests comment on whether the proposals will

achieve the intended goals and on the costs and benefits of the

proposed means of achieving those goals. In particular, the Commission

requests comment on:

Whether the proposal would increase open access to

clearing and execution of customer transactions on a DCM or SEF on

terms that have a reasonable relationship to the best terms available;

Whether the proposal could decrease open access to

clearing in any way; and

Whether the proposals would increase risk to DCOs, FCMs,

SDs, or MSPs in any way.

C. Time Frames for Acceptance Into Clearing

As noted above, a goal of the Dodd-Frank Act is to reduce risk by

increasing the use of central clearing. Minimizing the time between

trade execution and acceptance into clearing is an important risk

mitigant. The Commission recently proposed Sec. 39.12(b)(7) regarding

time frames for clearing.\17\ Upon review of the comments received, the

Commission is now proposing a revised version of that provision.\18\

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\17\ 76 FR 13101 (March 10, 2011) (Requirements for Processing,

Clearing, and Transfer of Customer Positions).

\18\ The Commission continues to review comments on other

aspects of the March 10 proposal and they will be addressed

separately.

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As previously proposed, Sec. 39.12(b)(7)(i) required DCOs to

coordinate with designated contract markets (DCMs) and swap execution

facilities (SEFs) to facilitate prompt and efficient processing of

trades. In response to a comment, the Commission now proposes to

require prompt, efficient, and accurate processing of trades.\19\

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\19\ See letter from Robert Pickel, Executive Vice Chairman,

International Swaps and Derivatives Association, dated April 8,

2011.

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Recognizing the key role clearing members play in trade processing

and submission of trades to central clearing, the Commission is also

now proposing parallel provisions for coordination among DCOs and

clearing members. Proposed Sec. 39.12(b)(7)(i)(B) would require DCOs

to coordinate with clearing members to establish systems for prompt

processing of trades. Proposed Sec. Sec. 1.74(a) and 23.610(a) would

require reciprocal coordination with DCOs by FCMs, SDs, and MSPs that

are clearing members.

As previously proposed, Sec. 39.12(b)(7)(ii) required DCOs to

accept immediately upon execution all transactions executed on a DCM or

SEF. A number of DCOs and other commenters expressed concern that this

requirement could expose DCOs to unwarranted risk because DCOs need to

be able to screen trades for compliance with applicable clearinghouse

rules related to product and credit filters.\20\ The Commission

recognizes that while immediate acceptance for clearing upon execution

currently occurs in some futures markets, it might not be feasible for

all cleared markets at this time. For example, where the same cleared

product is traded on multiple execution venues, a DCO needs to be able

to aggregate the risk of trades coming in to ensure that a clearing

member or customer has not exceeded its credit limits. Accordingly, the

Commission is proposing to modify Sec. 39.12(b)(7)(ii) to permit DCOs

to screen trades against applicable product and credit criteria before

accepting or rejecting them. Consistent with principles of open access,

the proposal would require that such criteria be non-discriminatory

with respect to trading venues and clearing participants.

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\20\ See letter from Craig S. Donohue, Chief Executive Officer,

CME Group, dated April 11, 2011; letter from R. Trabue Bland, Vice

President and Assistant General Counsel, ICE, dated April 11, 2011;

letter from Iona J. Levine, Group General Counsel and Managing

Director, LCH.Clearnet, dated April 11, 2011; letter from William H.

Navin, Executive Vice President and General Counsel, Options

Clearing Corporation, dated April 11, 2011; letter from John M.

Damgard, President, Futures Industry Association, dated April 14,

2011.

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The Commission continues to believe that acceptance or rejection

for clearing in close to real time is crucial both for effective risk

management and for the

[[Page 45733]]

efficient operation of trading venues.\21\ Rather than prescribe a

specific length of time, the Commission is proposing as a standard that

action be taken ``as quickly as would be technologically practicable if

fully automated systems were used.'' The Commission anticipates that

this standard would require action in a matter of milliseconds or

seconds or, at most, a few minutes, not hours or days.\22\

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\21\ See letter from James Cawley, Swaps and Derivatives Market

Association, dated April 19, 2011.

\22\ The Commission notes that processing times may vary by

market or product.

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This is intended to be a performance standard, not the prescription

of a particular method of trade processing. The Commission expects that

fully automated systems will be in place at some DCOs, FCMs, SDs, and

MSPs. Others might have systems with some manual steps. This would be

permitted so long as the process could operate within the same time

frame as the automated systems.

The Commission recognizes that some trades on a DCM or SEF are

executed non-competitively. Examples include block trades and exchanges

of futures for physicals (EFPs). A DCO may not be notified immediately

upon execution of these trades. Accordingly, as discussed below, they

will be treated in the same manner as trades that are not executed on a

DCM or SEF.

As previously proposed, Sec. Sec. 39.12(b)(7)(iii) and

39.12(b)(7)(iv) distinguished between swaps subject to mandatory

clearing and swaps not subject to mandatory clearing. Upon review of

the comments, the Commission believes that this distinction is

unnecessary with regard to processing time frames. If a DCO lists a

product for clearing, it should be able to process it regardless of

whether clearing is mandatory or voluntary. Therefore, newly proposed

Sec. 39.12(b)(7)(iii) would cover all trades not executed on a DCM or

SEF. It would require acceptance or rejection by the DCO as quickly

after submission as would be technologically practicable if fully

automated systems were used.

Proposed Sec. 1.74(b) would set up a parallel requirement for

clearing FCMs; proposed Sec. 23.610(b) would set up a parallel

requirement for SDs and MSPs that are clearing members. These rules,

again, would apply a performance standard, not a prescribed method for

achieving it.

The Commission notes that from both a timing perspective and a risk

perspective, the most efficient method would be to screen all orders

using predetermined criteria established by the rules of the DCO and

the provisions of the clearing documentation between the customer and

its clearing member. In such a case all trades would be accepted for

clearing upon execution because the clearing member and DCO would have

already applied their credit and product filters.

A less efficient means would be for the clearing member to

authorize the DCO to screen trades on its behalf and to accept or

reject according to criteria set by the clearing member. The least

efficient would be for the DCO to send a message to the clearing member

for each trade requesting acceptance or rejection.

The Commission requests comment on the costs and benefits of the

proposal. In particular, the Commission requests comment on whether the

performance standard is appropriate and workable.

III. Related Matters

A. Regulatory Flexibility Act

The Regulatory Flexibility Act (RFA) requires that agencies

consider whether the regulations they propose will have a significant

economic impact on a substantial number of small entities.\23\ The

Commission previously has established certain definitions of ``small

entities'' to be used in evaluating the impact of its regulations on

small entities in accordance with the RFA.\24\ The proposed regulations

would affect FCMs, DCOs, SDs, and MSPs.

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\23\ 5 U.S.C. 601 et seq.

\24\ 47 FR 18618, Apr. 30, 1982.

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The Commission previously has determined, however, that FCMs should

not be considered to be small entities for purposes of the RFA.\25\ The

Commission's determination was based, in part, upon the obligation of

FCMs to meet the minimum financial requirements established by the

Commission to enhance the protection of customers' segregated funds and

protect the financial condition of FCMs generally.\26\ The Commission

also has previously determined that DCOs are not small entities for the

purpose of the RFA.\27\

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\25\ Id. at 18619.

\26\ Id.

\27\ See 66 FR 45605, 45609, Aug. 29, 2001.

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SDs and MSPs are new categories of registrants. Accordingly, the

Commission has not previously addressed the question of whether such

persons are, in fact, small entities for purposes of the RFA. Like

FCMs, SDs will be subject to minimum capital and margin requirements

and are expected to comprise the largest global financial firms. The

Commission is required to exempt from SD registration any entities that

engage in a de minimis level of swap dealing in connection with

transactions with or on behalf of customers. The Commission anticipates

that this exemption would tend to exclude small entities from

registration. Accordingly, for purposes of the RFA for this rulemaking,

the Commission is hereby proposing that SDs not be considered ``small

entities'' for essentially the same reasons that FCMs have previously

been determined not to be small entities and in light of the exemption

from the definition of SD for those engaging in a de minimis level of

swap dealing.

The Commission also has previously determined that large traders

are not ``small entities'' for RFA purposes.\28\ In that determination,

the Commission considered that a large trading position was indicative

of the size of the business. MSPs, by statutory definition, maintain

substantial positions in swaps or maintain outstanding swap positions

that create substantial counterparty exposure that could have serious

adverse effects on the financial stability of the United States banking

system or financial markets. Accordingly, for purposes of the RFA for

this rulemaking, the Commission is hereby proposing that MSPs not be

considered ``small entities'' for essentially the same reasons that

large traders have previously been determined not to be small entities.

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\28\ Id. at 18620.

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Accordingly, the Chairman, on behalf of the Commission, hereby

certifies pursuant to 5 U.S.C. 605(b) that the proposed regulations

will not have a significant economic impact on a substantial number of

small entities. The Commission invites the public to comment on whether

SDs and MSPs should be considered small entities for purposes of the

RFA.

B. Paperwork Reduction Act

The Paperwork Reduction Act (PRA) \29\ imposes certain requirements

on Federal agencies (including the Commission) in connection with their

conducting or sponsoring any collection of information as defined by

the PRA. This proposed rulemaking would result in new collection of

information requirements within the meaning of the PRA. The Commission

therefore is submitting this proposal to the Office of Management and

Budget (OMB) for review in accordance with 44 U.S.C. 3507(d) and 5 CFR

1320.11. The title for this collection of information is

[[Page 45734]]

``Customer Clearing Documentation and Timing of Acceptance for

Clearing.'' 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 OMB has not yet assigned this

collection a control number.

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\29\ 44 U.S.C. 3501 et seq.

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The collection of information under these proposed regulations is

necessary to implement certain provisions of the CEA, as amended by the

Dodd-Frank Act. Specifically, it is essential to reducing risk and

fostering open access to clearing and execution of customer

transactions on a DCM or SEF on terms that have a reasonable

relationship to the best terms available by prohibiting restrictions in

customer clearing documentation of SDs, MSPs, FCMs, or DCOs that could

delay or block access to clearing, increase costs, and reduce market

efficiency by limiting the number of counterparties available for

trading. The proposed regulations are also crucial both for effective

risk management and for the efficient operation of trading venues among

SDs, MSPs, FCMs, and DCOs.

If the proposed regulations are adopted, responses to this

collection of information would be mandatory. The Commission will

protect proprietary information according to the Freedom of Information

Act and 17 CFR part 145, ``Commission Records and Information.'' In

addition, section 8(a)(1) of the CEA strictly prohibits the Commission,

unless specifically authorized by the CEA, from making public ``data

and information that would separately disclose the business

transactions or market positions of any person and trade secrets or

names of customers.'' The Commission is also required to protect

certain information contained in a government system of records

according to the Privacy Act of 1974, 5 U.S.C. 552a.

1. Information Provided by Reporting Entities/Persons

SDs, MSPs, FCMs, and DCOs would be required to develop and maintain

written customer clearing documentation in compliance with proposed

regulations 1.72, 23.608, and 39.12. Proposed regulation

39.12(b)(7)(i)(B) would require DCOs to coordinate with clearing

members to establish systems for prompt processing of trades. Proposed

regulations 1.74(a) and 23.610(a) require reciprocal coordination with

DCOs by FCMs, SDs, and MSPs that are clearing members.

The annual burden associated with these proposed regulations is

estimated to be 16 hours, at an annual cost of $1,600 for each FCM, SD,

and MSP. Burden means the total time, effort, or financial resources

expended by persons to generate, maintain, retain, disclose, or provide

information to or for a federal agency. The Commission has

characterized the annual costs as initial costs because the Commission

anticipates that the cost burdens will be reduced dramatically over

time as the documentation and procedures required by the proposed

regulations become increasingly standardized within the industry.

Proposed Sec. Sec. 1.72 and 23.608 would require each FCM, SD, and

MSP to ensure compliance with the proposed regulations. Maintenance of

contracts is prudent business practice and the Commission anticipates

that SDs and MSPs already maintain some form of this documentation.

Additionally, the Commission believes that much of the existing

customer clearing documentation already complies with the proposed

rules, and therefore that compliance will require a minimal burden.

In addition to the above, the Commission anticipates that FCMs,

SDs, and MSPs will spend an average of 16 hours per year drafting and,

as needed, updating customer clearing documentation to ensure

compliance required by proposed Sec. Sec. 1.72 and 23.608.

For each DCO, the annual burden associated with these proposed

regulations is estimated to be 40 hours, at an annual cost of $4,000.

Burden means the total time, effort, or financial resources expended by

persons to generate, maintain, retain, disclose, or provide information

to or for a federal agency. The Commission has characterized the annual

costs as initial costs as the Commission anticipates that the cost

burdens will be reduced dramatically over time as once the

documentation and procedures required by the proposed regulations are

implemented, any additional expenditure related to Sec. 39.12 likely

would be limited to the time required to review and, as needed, amend,

existing documentation and procedures.

Proposed 39.12(b)(7) would require each DCO to coordinate with

clearing members to establish systems for prompt processing of trades.

The Commission believes that this is currently a practice of DCOs.

Accordingly, any additional expenditure related to Sec. 39.12(b)(7)

likely would be limited to the time initially required to review and,

as needed, amend, existing trade processing procedures to ensure that

they conform to all of the required elements and to coordinate with

FCMs, SDs, and MSPs to establish reciprocal procedures.

The Commission anticipates that DCOs will spend an average of 20

hours per year drafting and, as needed, updating the written policies

and procedures to ensure compliance required by proposed Sec. 39.12,

and 20 hours per year coordinating with FCMs, SDs, and MSPs on

reciprocal procedures.

The hour burden calculations below are based upon a number of

variables such as the number of FCMs, SDs, MSPs, and DCOs in the

marketplace and the average hourly wage of the employees of these

registrants that would be responsible for satisfying the obligations

established by the proposed regulation.

There are currently 134 FCMs and 14 DCOs based on industry data.

SDs and MSPs are new categories of registrants. Accordingly, it is not

currently known how many SD and MSPs will become subject to these

rules, and this will not be known to the Commission until the

registration requirements for these entities become effective after

July 16, 2011, the date on which the Dodd-Frank Act becomes effective.

While the Commission believes there will be approximately 200 SD and 50

MSPs, it has taken a conservative approach, for PRA purposes, in

estimating that there will be a combined number of 300 SDs and MSPs who

will be required to comply with the recordkeeping requirements of the

proposed rules. The Commission estimated the number of affected

entities based on industry data.

According to recent Bureau of Labor Statistics, the mean hourly

wage of an employee under occupation code 11-3031, ``Financial

Managers,'' (which includes operations managers) that is employed by

the ``Securities and Commodity Contracts Intermediation and Brokerage''

industry is $74.41.\30\ Because SDs, MSPs, FCMs, and DCOs include large

financial institutions whose operations management employees' salaries

may exceed the mean wage, the Commission has estimated the cost burden

of these proposed regulations based upon an average salary of $100 per

hour.

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Accordingly, the estimated hour burden was calculated as follows:

Developing Written Procedures for Compliance, and Maintaining

Records Documenting Compliance for SDs and MSPs. This hourly burden

arises from the proposed requirement that SDs and MSPs make and

maintain records documenting compliance related to client clearing

documentation.

[[Page 45735]]

Number of registrants: 300.

Frequency of collection: as needed.

Estimated number of annual responses per registrant: 1.

Estimated aggregate number of annual responses: 300.

Estimated annual hour burden per registrant: 16 hours.

Estimated aggregate annual hour burden: 4,800 burden hours [300

registrants x 16 hours per registrant].

Developing Written Procedures for Compliance, and Maintaining

Records Documenting Compliance for FCMs. This hourly burden arises from

the proposed requirement that FCMs make and maintain records

documenting compliance related to client clearing documentation.

Number of registrants: 134.

Frequency of collection: as needed.

Estimated number of annual responses per registrant: 1.

Estimated aggregate number of annual responses: 134.

Estimated annual hour burden per registrant: 16 hours.

Estimated aggregate annual hour burden: 2,144 burden hours [134

registrants x 16 hours per registrant].

Drafting and Updating Trade Processing Procedures for DCOs. This

hour burden arises from the time necessary to develop and periodically

update the trade processing procedures required by the proposed

regulations.

Number of registrants: 14.

Frequency of collection: Initial drafting, updating as needed.

Estimated number of annual responses per registrant: 1.

Estimated aggregate number of annual responses: 14.

Estimated annual hour burden per registrant: 40 hours.

Estimated aggregate annual hour burden: 560 burden hours [14

registrants x 40 hours per registrant].

Based upon the above, the aggregate hour burden cost for all

registrants is 7,504 burden hours and $750,400 [7,504 x $100 per hour].

2. Information Collection Comments

The Commission invites the public and other federal agencies to

comment on any aspect of the recordkeeping burdens discussed above.

Pursuant to 44 U.S.C. 3506(c)(2)(B), the Commission solicits comments

in order to: (i) Evaluate whether the proposed collection of

information is necessary for the proper performance of the functions of

the Commission, including whether the information will have practical

utility; (ii) evaluate the accuracy of the Commission's estimate of the

burden of the proposed collection of information; (iii) determine

whether there are ways to enhance the quality, utility, and clarity of

the information to be collected; and (iv) minimize the burden of the

collection of information on those who are to respond, including

through the use of automated collection techniques or other forms of

information technology.

Comments may be submitted directly to the Office of Information and

Regulatory Affairs, 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 all comments can be summarized and

addressed in the final rule preamble. Refer to the Addresses section of

this notice of proposed rulemaking for comment submission instructions

to the Commission. A copy of the supporting statements for the

collections of information discussed above may be obtained by visiting

RegInfo.gov. OMB is required to make a decision concerning the

collection of information between 30 and 60 days after publication of

this document in the Federal Register. Therefore, a comment is best

assured of having its full effect if OMB receives it within 30 days of

publication.

C. Consideration of Costs and Benefits Under Section 15(a) of the CEA

Section 15(a) of the CEA requires the Commission to consider the

costs and benefits of its action before promulgating a regulation under

the CEA. Section 15(a) of the CEA 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. The Commission may in its

discretion give greater weight to any one of the five enumerated areas

and could in its discretion determine that, notwithstanding its costs,

a particular order is 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.

The proposed rules have two major components: (i) The documentation

between a customer and a futures commission merchant that clears on

behalf of the customer; and (ii) the timing of acceptance or rejection

of trades for clearing by derivatives clearing organizations and

clearing members. The discussion below will consider each component in

light of the section 15(a) concerns.

A. Documentation Between a Customer and Futures Commission Merchant

That Clears on Behalf of the Customer

The Commission is proposing regulations that would prohibit

arrangements involving FCMs, SDs, MSPs, or DCOs that would (a) disclose

to an FCM, SD, or MSP the identity of a customer's counterparty; (b)

limit the number of counterparties with whom a customer may enter into

swaps; (c) restrict the size of the position a customer may take with

any individual counterparty, apart from an overall limit for all

positions held by the customer at the FCM; (d) impair a customer's

access to execution of trades on a DCM or SEF on terms that have a

reasonable relationship to the best terms available; or (e) prevent

compliance with specified time frames for acceptance of trades into

clearing.

1. Protection of Market Participants and the Public

This measure protects the customer from any discriminatory behavior

by potential clearing members or counterparties and helps ensure that

customers have open access to the markets and an opportunity to obtain

execution on competitive terms. The proposal would also promote

financial integrity by removing potential obstacles such as more

documentation requirements imposed by dealers or unnecessary

restrictions on trading by a third-party, and by accelerating the

timeframe for acceptance or rejection of a trade for clearing thereby

reducing risk of delay or uncertainty as to whether a swap will be

accepted or rejected for clearing. For example, by contrast, under a

tri-party agreement, an FCM might have to evaluate each customer

transaction not only against the customer's overall credit limit but

also against a sub-limit for each counterparty which can delay

acceptance.

As far as costs are concerned, the possibility of ``breakage''

remains for SDs and other counterparties. However, this concern is

mitigated by the timelines required in the second section of this rule,

which reduce the likelihood that a SD would have time to enter into

other transactions before the one in view is accepted or rejected for

clearing. Similarly, if a SD has to enter into a replacement trade, the

costs will be mitigated by the tight timeline, because the SD would

know quickly whether the trade was accepted or rejected for clearing.

As noted above, the process of evaluating individual transactions

against counterparty sub-limits could

[[Page 45736]]

delay notification of acceptance or rejection for clearing. In the

absence of this rule, the cost to trade will have to account for these

factors and additional market risk during that time.

2. Efficiency, Competitiveness, and Financial Integrity of Futures

Markets

This rule helps prevent the disclosure, to the FCM, of the identity

of the counterparty of its customer. Such lack of disclosure promotes

integrity in the market by ensuring that all participants who meet

certain qualifying criteria for trading have open access to all

available counterparties because intermediaries will be unable to set

sub-limits by counterparty. Moreover, in the absence of this rule, tri-

party agreements or other similar arrangements among FCMs, SDs or MSPs

and customers could result in matching processes that have the

potential to be time intensive. Preventing these agreements will

promote faster matching which may increase liquidity through lower

transaction costs.

This rule also prevents customers from being penalized (or having

distorted commercial incentives) in their choice of FCM due to previous

transactions with a given FCM or SD. As a consequence, this rule also

has the potential to promote competition among FCMs to deliver services

efficiently. Lastly, this rule would reduce duplicative risk management

because DCOs and their members already have access to information

necessary to perform credit analysis on individual customers and

counterparties. SDs would be unnecessarily duplicating work that has

already been done.

3. Price Discovery

By not forcing a customer to transact with counterparties who may

be offering less attractive terms, this rule may improve pricing. In

addition, adhering to time frames specified for acceptance of trades

into clearing helps to prevent stale prices.

4. Sound Risk Management Practices

The rule does not affect the risk management structure of FCMs.

Moreover, by preventing customers from learning their counterparty's

identity, the responsibility for risk management remains clear. The FCM

must be responsible for evaluating each customer's credit risk. It

cannot rely on a counterparty to conduct due diligence. Moreover,

preserving anonymity in the market increases the number of available

counterparties, which leads to a more liquid market, thereby reducing

risk.

As mentioned before, to the extent that the SD experiences

``breakage,'' it exposes a SD to counterparty risk which is a potential

cost. However, by facilitating quicker acceptance or rejection into

clearing, the proposal would mitigate such costs by compressing the

time within which the counterparty exposure would exist.

B. Timing of Acceptance or Rejection of Trades for Clearing by

Derivatives Clearing Organizations and Clearing Members

The Commission is proposing regulations that would require prompt,

efficient, and accurate processing of trades, and require DCOs to

coordinate with clearing members to establish systems for prompt

processing of trades.

1. Protection of Market Participants

Rapid processing protects market participants from acting on bad

information by making additional trades under the presumption that an

initial trade has gone through if that trade may, in fact, not clear.

As mentioned, compressing the time for acceptance or rejection for

clearing also reduces the time within exposures can accumulate if a

trade is rejected.

As far as costs are concerned, coordination among the DCOs, FCMs,

SDs and MSPs in order to design and implement a system to clear

transactions ``as quickly as would be technologically practicable if

fully automated systems were used'' will likely require capital

investment and personnel hours in some instances. The Commission

believes, however, that DCOs and clearing members may already be using

procedures that comply with the standard. To the extent that

participants do not currently have automated systems, they made need to

install or upgrade existing systems to comply.

2. Efficiency, Competitiveness, and Financial Integrity of Futures

Markets

Rapid clearing helps ensure that eligible counterparties will not

be tied up in transactions that do not clear. They will be available to

other eligible customers. This increases both competitiveness and

efficiency of the market. In addition, extensive coordination among the

DCOs, FCMs, SDs, and MSPs has the potential to standardize processes

and technologies to support this rule. That reduces switching costs for

customers and increases competitiveness.

Costs will be incurred in developing systems and procedures for

those products and participants where the proposed standards are not

currently being met. The Commission anticipates, however, that

eventually such costs would be compensated for by increased efficiency

and market integrity. The Commission does not know at this time, and

requests comment on, how many parties will need to upgrade their

systems, if any. Additionally, the Commission requests comment from the

public as to what the costs might be to upgrade existing systems or

install new systems to comply with the proposed regulation.

3. Price Discovery

Requiring rapid clearing encourages screening for credit worthiness

of customers. That helps ensure that only bids and offers of qualified

parties are contained in the limit order book which helps protect its

informational value. Moreover, pricing feedback from cleared

transactions will reach the market more quickly.

4. Sound Risk Management Practices

Timely clearing allows each party to the transaction to act more

quickly if they need to implement a hedge or other transactions related

to the swap. This reduces the risk associated with potential adverse

movements of the market while waiting for clearing to occur. However,

if some of the processes are manual, the mandate for greater speed

increases the possibility of errors.

5. Other Public Interest Considerations

Rapid clearing makes U.S. based DCOs, FCMs, SDs, and MSPs more

attractive as service providers for global swap business. Furthermore,

the proposal would facilitate achievement of the overarching Dodd-Frank

Act mandate to promote clearing.

List of Subjects

17 CFR Part 1

Conflicts of interest, Futures commission merchants, Major swap

participants, Swap dealers.

17 CFR Part 23

Conflicts of interests, Futures commission merchants, Major swap

participants, Swap dealers.

17 CFR Part 39

Derivatives clearing organizations, Risk management, Swaps.

In light of the foregoing, the Commission hereby proposes to amend

part 1; part 23, as proposed to be added at 75 FR 71390, November 23,

2010, and further amended at 75 FR 81530, December 28, 2010; and part

39, as proposed to be amended at 76 FR 13101, March 10, 2011, of Title

17 of the Code of Federal Regulations as follows:

[[Page 45737]]

PART 1--GENERAL REGULATIONS UNDER THE COMMODITY EXCHANGE ACT

1. The authority citation for part 1 is revised to read as follows:

Authority: 7 U.S.C. 1a, 2, 2a, 5, 6, 6a, 6b, 6c, 6d, 6e, 6f,

6g, 6h, 6i, 6k, 6l, 6m, 6n, 6o, 6p, 6r, 6s, 7, 7a-1, 7a-2, 7b, 7b-3,

8, 9, 10a, 12, 12a, 12c, 13a, 13a-1, 16, 16a, 19, 21, 23, and 24, as

amended by Title VII of the Dodd-Frank Wall Street Reform and

Consumer Protection Act, Pub. L. 111-203, 124 Stat. 1376 (2010).

2. Add Sec. 1.72 to part 1 to read as follows:

Sec. 1.72 Restrictions on customer clearing arrangements.

No futures commission merchant providing clearing services to

customers shall enter into an arrangement that:

(a) Discloses to the futures commission merchant or any swap dealer

or major swap participant the identity of a customer's original

executing counterparty;

(b) Limits the number of counterparties with whom a customer may

enter into a trade;

(c) Restricts the size of the position a customer may take with any

individual counterparty, apart from an overall limit for all positions

held by the customer at the futures commission merchant;

(d) Impairs a customer's access to execution of a trade on terms

that have a reasonable relationship to the best terms available; or

(e) Prevents compliance with the time frames set forth in Sec.

1.73(a)(9)(ii), Sec. 23.609(a)(9)(ii), or Sec. 39.12(b)(7) of this

chapter.

3. Add Sec. 1.74 to part 1 to read as follows:

Sec. 1.74 Futures commission merchant acceptance for clearing.

(a) Each futures commission merchant that is a clearing member of a

derivatives clearing organization shall coordinate with each

derivatives clearing organization on which it clears to establish

systems that enable the futures commission merchant, or the derivatives

clearing organization acting on its behalf, to accept or reject each

trade submitted to the derivatives clearing organization for clearing

by or for the futures commission merchant or a customer of the futures

commission merchant as quickly as would be technologically practicable

if fully automated systems were used; and

(b) Each futures commission merchant that is a clearing member of a

derivatives clearing organization shall accept or reject each trade

submitted by or for it or its customers as quickly as would be

technologically practicable if fully automated systems were used; a

clearing futures commission merchant may meet this requirement by:

(1) Establishing systems to pre-screen orders for compliance with

criteria specified by the clearing futures commission merchant;

(2) Establishing systems that authorize a derivatives clearing

organization to accept or reject on its behalf trades that meet, or

fail to meet, criteria specified by the clearing futures commission

merchant; or

(3) Establishing systems that enable the clearing futures

commission merchant to communicate to the derivatives clearing

organization acceptance or rejection of each trade as quickly as would

be technologically practicable if fully automated systems were used.

PART 23--SWAP DEALERS AND MAJOR SWAP PARTICIPANTS

4. The authority citation for part 23 is revised to read as

follows:

Authority: 7 U.S.C. 1a, 2, 6, 6a, 6b, 6b-1, 6c, 6p, 6r, 6s, 6t,

9, 9a, 12, 12a, 13b, 13c, 16a, 18, 19, 21.

5. Add Sec. 23.608 to part 23, subpart J, to read as follows:

Sec. 23.608 Restrictions on counterparty clearing relationships.

No swap dealer or major swap participant entering into a cleared

swap with a counterparty that is a customer of a futures commission

merchant shall enter into an arrangement that:

(a) Discloses to the futures commission merchant or any swap dealer

or major swap participant the identity of a customer's original

executing counterparty;

(b) Limits the number of counterparties with whom a customer may

enter into a trade;

(c) Restricts the size of the position a customer may take with any

individual counterparty, apart from an overall limit for all positions

held by the customer at the futures commission merchant;

(d) Impairs a customer's access to execution of a trade on terms

that have a reasonable relationship to the best terms available; or

(e) Prevents compliance with the time frames set forth in Sec.

1.73(a)(9)(ii), Sec. 23.609(a)(9)(ii), or Sec. 39.12(b)(7) of this

chapter.

6. Add Sec. 23.610 to part 23, subpart J, to read as follows:

Sec. 23.610 Clearing member acceptance for clearing.

(a) Each swap dealer or major swap participant that is a clearing

member of a derivatives clearing organization shall coordinate with

each derivatives clearing organization on which it clears to establish

systems that enable the clearing member, or the derivatives clearing

organization acting on its behalf, to accept or reject each trade

submitted to the derivatives clearing organization for clearing by or

for the clearing member as quickly as would be technologically

practicable if fully automated systems were used; and

(b) Each swap dealer or major swap participant that is a clearing

member of a derivatives clearing organization shall accept or reject

each trade submitted by or for it as quickly as would be

technologically practicable if fully automated systems were used; a

clearing member may meet this requirement by:

(1) Establishing systems to pre-screen orders for compliance with

criteria specified by the clearing member;

(2) Establishing systems that authorize a derivatives clearing

organization to accept or reject on its behalf trades that meet, or

fail to meet, criteria specified by the clearing member; or

(3) Establishing systems that enable the clearing member to

communicate to the derivatives clearing organization acceptance or

rejection of each trade as quickly as would be technologically

practicable if fully automated systems were used.

PART 39--DERIVATIVES CLEARING ORGANIZATIONS

7. Revise the authority citation for part 39 to read as follows:

Authority: 7 U.S.C. 1a, 2, 5, 6, 6d, 7a-1, 7a-2, and 7b as

amended by the Dodd-Frank Wall Street Reform and Consumer Protection

Act, Pub. L. 111-203, 124 Stat. 1376.

Subpart B--Compliance With Core Principles

8. In Sec. 39.12, add paragraph (a)(1)(vi) to read as follows:

(a) * * *

(1) * * *

(vi) No derivatives clearing organization shall require as a

condition of accepting a swap for clearing that a futures commission

merchant enter into an arrangement with a customer that:

(A) Discloses to the futures commission merchant or any swap dealer

or major swap participant the identity of a customer's original

executing counterparty;

(B) Limits the number of counterparties with whom a customer may

enter into trades;

(C) Restricts the size of the position a customer may take with any

individual counterparty, apart from an overall limit for all positions

held by the customer at the futures commission merchant;

[[Page 45738]]

(D) Impairs a customer's access to execution of a trade on terms

that have a reasonable relationship to the best terms available; or

(E) Prevents compliance with the time frames set forth in Sec.

1.73(a)(9)(ii), Sec. 23.609(a)(9)(ii), or Sec. 39.12(b)(7) of this

chapter.

9. Amend Sec. 39.12 by:

a. Redesignating paragraph (b)(7)(v) as paragraph (b)(8); and

b. Revising Sec. 39.12(b)(7) to read as follows:

(i) Coordination with markets and clearing members

(A) Each derivatives clearing organization shall coordinate with

each designated contract market and swap execution facility that lists

for trading a product that is cleared by the derivatives clearing

organization in developing rules and procedures to facilitate prompt,

efficient, and accurate processing of all transactions submitted to the

derivatives clearing organization for clearing.

(B) Each derivatives clearing organization shall coordinate with

each clearing member that is a futures commission merchant, swap

dealer, or major swap participant to establish systems that enable the

clearing member, or the derivatives clearing organization acting on its

behalf, to accept or reject each trade submitted to the derivatives

clearing organization for clearing by or for the clearing member or a

customer of the clearing member as quickly as would be technologically

practicable if fully automated systems were used.

(ii) Transactions executed competitively on or subject to the rules

of a designated contract market or swap execution facility. A

derivatives clearing organization shall have rules that provide that

the derivatives clearing organization will accept or reject for

clearing as quickly after execution as would be technologically

practicable if fully automated systems were used, all contracts that

are listed for clearing by the derivatives clearing organization and

are executed competitively on a designated contract market or a swap

execution facility. The derivatives clearing organization shall accept

all trades:

(A) For which the executing parties have clearing arrangements in

place with clearing members of the derivatives clearing organization;

(B) For which the executing parties identify the derivatives

clearing organization as the intended clearinghouse; and

(C) That satisfy the criteria of the derivatives clearing

organization, including but not limited to applicable risk filters;

provided that such criteria are non-discriminatory across trading

venues and are applied as quickly as would be technologically

practicable if fully automated systems were used.

(iii) Swaps not executed on or subject to the rules of a designated

contract market or a swap execution facility or executed non-

competitively on or subject to the rules of a designated contract

market or a swap execution facility. A derivatives clearing

organization shall have rules that provide that the derivatives

clearing organization will accept or reject for clearing as quickly

after submission to the derivatives clearing organization as would be

technologically practicable if fully automated systems were used, all

swaps that are listed for clearing by the derivatives clearing

organization and are not executed on a designated contract market or a

swap execution facility. The derivatives clearing organization shall

accept all trades:

(A) That are submitted by the parties to the derivatives clearing

organization, in accordance with Sec. 23.506 of this chapter;

(B) For which the executing parties have clearing arrangements in

place with clearing members of the derivatives clearing organization;

(C) For which the executing parties identify the derivatives

clearing organization as the intended clearinghouse; and

(D) That satisfy the criteria of the derivatives clearing

organization, including but not limited to applicable risk filters;

provided that such criteria are non-discriminatory across trading

venues and are applied as quickly as would be technologically

practicable if fully automated systems were used.

Issued in Washington, DC, on July 19, 2011, by the Commission.

David A. Stawick,

Secretary of the Commission.

Appendices to Customer Clearing Documentation and Timing of Acceptance

for Clearing--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 O'Malia and Sommers

voted in the negative.

Appendix 2--Statement of Chairman Gary Gensler

I support the proposed rulemaking for customer clearing

documentation and timing of acceptance for clearing. The proposed

rule promotes market participants' access to central clearing,

increases market transparency and supports market efficiency. This

proposal will foster bilateral clearing arrangements between

customers and their futures commission merchants. This proposal also

re-proposes certain time-frame provisions of the Commission's

proposed rule in February related to straight-through processing.

[FR Doc. 2011-19365 Filed 7-29-11; 8:45 am]

BILLING CODE P

Last Updated: August 1, 2011