2018-24642
Federal Register, Volume 83 Issue 231 (Friday, November 30, 2018)
[Federal Register Volume 83, Number 231 (Friday, November 30, 2018)]
[Proposed Rules]
[Pages 61946-62149]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2018-24642]
[[Page 61945]]
Vol. 83
Friday,
No. 231
November 30, 2018
Part III
Commodity Futures Trading Commission
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17 CFR Parts 9, 36, et al.
Swap Execution Facilities and Trade Execution Requirement; Proposed
Rule
Federal Register / Vol. 83, No. 231 / Friday, November 30, 2018 /
Proposed Rules
[[Page 61946]]
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COMMODITY FUTURES TRADING COMMISSION
17 CFR Parts 9, 36, 37, 38, 39, and 43
RIN 3038-AE25
Swap Execution Facilities and Trade Execution Requirement
AGENCY: Commodity Futures Trading Commission.
ACTION: Proposed rule.
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SUMMARY: The Commodity Futures Trading Commission (``Commission'' or
``CFTC'') is proposing amendments to regulations relating to the trade
execution requirement under the Commodity Exchange Act (``CEA'' or
``Act'') and amendments to existing regulations relating to swap
execution facilities (``SEFs'') and designated contract markets
(``DCMs''). Among other amendments, the proposed rules apply the SEF
registration requirement to certain swaps broking entities and
aggregators of single-dealer platforms; broaden the scope of the trade
execution requirement to include all swaps subject to the clearing
requirement under the Act that a SEF or a DCM lists for trading; allow
SEFs to offer flexible execution methods for all swaps that they list
for trading; amend straight-through processing requirements; and amend
the block trade definition. The proposed rules, which also include non-
substantive amendments and various conforming changes to other
Commission regulations, reflect the Commission's enhanced knowledge and
experience with swaps trading characteristics and would further the
Dodd-Frank Act's statutory goals for SEFs, i.e., promote more SEF
trading and pre-trade price transparency in the swaps market. Further,
the proposed rules are intended to strengthen the existing swaps
regulatory framework by reducing unnecessary complexity, costs, and
other burdens that impede SEF development, innovation, and growth.
DATES: Comments must be received on or before February 13, 2019.
ADDRESSES: You may submit comments, identified by ``Swap Execution
Facilities and Trade Execution Requirement'' and RIN 3038-AE25, by any
of the following methods:
CFTC Comments Portal: https://comments.cftc.gov. Select
the ``Submit Comments'' link for this rulemaking and follow the
instructions on the Public Comment Form.
Mail: Send to Christopher Kirkpatrick, Secretary of the
Commission, Commodity Futures Trading Commission, Three Lafayette
Centre, 1155 21st Street NW, Washington, DC 20581.
Hand Delivery/Courier: Follow the same instructions as for
Mail, above.
Please submit your comments using only one of these methods. To
avoid possible delays with mail or in-person deliveries, submissions
through the CFTC Comments Portal are encouraged.
All comments must be submitted in English, or if not, be
accompanied by an English translation. Comments will be posted as
received to https://comments.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 (``FOIA''), a petition
for confidential treatment of the exempt information may be submitted
according to the procedures established under Sec. 145.9 of the
Commission's regulations.\1\
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\1\ 17 CFR 145.9.
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The Commission reserves the right, but shall have no obligation, to
review, pre-screen, filter, redact, refuse or remove any or all
submissions from https://comments.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 FOIA.
FOR FURTHER INFORMATION CONTACT: Nhan Nguyen, Special Counsel, (202)
418-5932, [email protected]; Roger Smith, Special Counsel, (202) 418-
5344, [email protected]; or David Van Wagner, Chief Counsel, (202) 418-
5481, [email protected], Division of Market Oversight; Michael
Penick, Senior Economist, (202) 418-5279, [email protected], Office of
the Chief Economist, Commodity Futures Trading Commission, Three
Lafayette Centre, 1155 21st Street NW, Washington, DC 20581.
SUPPLEMENTARY INFORMATION:
Table of Contents
I. Background and Introduction
A. Statutory Background: The Dodd-Frank Act
B. Regulatory History: The Part 37 Rules
1. Challenges of Existing Regulatory Approach
a. Lack of MAT Determinations
b. Swaps Market Characteristics
c. Operational Complexities and Costs
C. Proposed Approach
D. Summary of Proposed Revisions
E. Consultation With Other U.S. Financial Regulators
II. Part 9--Rules Relating To Review of Exchange Disciplinary,
Access Denial or Other Adverse Actions
III. Part 36--Trade Execution Requirement
IV. Part 37--Subpart A: General Provisions
A. Sec. 37.1--Scope
B. Sec. 37.2--Applicable Provisions and Definitions
1. Sec. 37.2(a)--Applicable Provisions
2. Sec. 37.2(b)--Definition of ``Market Participant''
a. Applicability of Sec. 37.404(b) to Market Participants
b. SEF Jurisdiction Over Clients of Market Participants
C. Sec. 37.3--Requirements and Procedures for Registration
1. Sec. 37.3(a)--Requirements for Registration
a. Footnote 88
b. Single-Dealer Aggregator Platforms
c. Swaps Broking Entities, Including Interdealer Brokers
(1) Structure and Operations of Swaps Broking Entities,
Including Interdealer Brokers
(2) SEF Registration Requirement for Swaps Broking Entities,
Including Interdealer Brokers
d. Foreign Swaps Broking Entities and Other Foreign Multilateral
Swaps Trading Facilities
(1) Proposed Delay of SEF Registration Requirement
(2) Proposed Conditions for Delay of SEF Registration
Requirement
2. Sec. 37.3(a)(2) Through (3)--Minimum Trading Functionality
and Order Book Definition
3. Sec. 37.3(b)--Procedures for Registration
a. Elimination of Temporary Registration
b. Sec. 37.3(b)(1)--Application for Registration
(1) Form SEF Exhibits--Business Organization
(2) Form SEF Exhibits--Financial Information
(3) Form SEF Exhibits--Compliance
(4) Form SEF Exhibits--Operational Capability
(5) Other Form SEF Amendments
(6) Request for Legal Entity Identifier
c. Sec. 37.2(b)(2)--Request for Confidential Treatment
d. Sec. 37.3(b)(3)--Amendment of Application for Registration
e. Sec. 37.3(b)(4)--Effect of Incomplete Application
f. Sec. 37.3(b)(5)--Commission Review Period
g. Sec. 37.3(b)(6)--Commission Determination
4. Sec. 37.3(c)--Amendment to an Order of Registration
5. Sec. 37.3(d)--Reinstatement of Dormant Registration
6. Sec. 37.3(e)--Request for Transfer of Registration
7. Sec. 37.3(f)--Request for Withdrawal of Application for
Registration
8. Sec. 37.3(g)--Request for Vacation of Registration
9. Sec. 37.3(h)--Delegation of Authority
D. Sec. 37.4--Procedures for Implementing Rules
E. Sec. 37.5--Provision of Information Relating to a Swap
Execution Facility
[[Page 61947]]
1. Sec. 37.5(a)--Request for Information
2. Sec. 37.5(b)--Demonstration of Compliance
3. Sec. 37.5(c)--Equity Interest Transfer
4. Sec. 37.5(d)--Delegation of Authority
F. Sec. 37.6--Enforceability
1. Sec. 37.6(a)--Enforceability of Transactions
2. Sec. 37.6(b)--Swap Documentation
a. Sec. 37.6(b)(1)--Legally Binding Documentation
b. Sec. 37.6(b)(2)--Requirements for Swap Documentation
G. Sec. 37.7--Prohibited Use of Data Collected for Regulatory
Purposes
H. Sec. 37.8--Boards of Trade Operating Both a Designated
Contract Market and a Swap Execution Facility
I. Sec. 37.9--Methods of Execution for Required and Permitted
Transactions; Sec. 37.10--Process for a Swap Execution Facility To
Make a Swap Available to Trade; Sec. 37.12--Trade Execution
Compliance Schedule; Sec. 38.11--Trade Execution Compliance
Schedule; Sec. 38.12--Process for a Designated Contract Market To
Make a Swap Available to Trade
1. Trade Execution Requirement and MAT Process
2. Execution Method Requirements
3. Implementation of Existing Requirements
4. Proposed Approach
a. Sec. 36.1(a)--Trade Execution Requirement
b. Elimination of Required Execution Methods
V. Part 37--Subpart B: Core Principle 1 (Compliance With Core
Principles)
VI. Part 37 Regulations Related to SEF Execution Methods--Subpart C:
Core Principle 2 (Compliance With Rules)
A. Sec. 37.201--Requirements for Swap Execution Facility
Execution Methods
1. Sec. 37.201(a)--Required Swap Execution Facility Rules
a. Sec. 37.201(a)(1)--Trading and Execution Protocols and
Procedures
b. Sec. 37.201(a)(2)--Discretion
c. Sec. 37.201(a)(3)--Market Pricing Information
2. Sec. 37.203(a)--Pre-Arranged Trading Prohibition; Sec.
37.9(b)--Time Delay Requirement
a. Sec. 37.201(b)--Pre-Execution Communications
(1) Exception for Swaps Not Subject to the Trade Execution
Requirement
(2) Sec. 37.201(b)(1)--Exception for Package Transactions
3. Sec. 37.201(c)--SEF Trading Specialists
a. Sec. 37.201(c)(1)--Definition of ``SEF Trading Specialist''
b. Sec. 37.201(c)(2)--Fitness
c. Sec. 37.201(c)(3)--Proficiency Requirements
d. Sec. 37.201(c)(4)--Ethics Training
(1) Guidance to Core Principle 2 in Appendix B--Ethics Training
e. Sec. 37.201(c)(5)--Standards of Conduct
f. Sec. 37.201(c)(6)--Duty To Supervise
g. Sec. 37.201(c)(7)--Additional Sources for Compliance
VII. Additional Part 37 Regulations--Subpart C: Core Principle 2
(Compliance With Rules)
A. Sec. 37.202--Access Requirements
1. Sec. 37.202(a)--Impartial Access to Markets, Market
Services, and Execution Methods
a. Sec. 37.202(a)(1)--Impartial Access Criteria
(1) Application of Impartial Access Requirement
(i) Eligibility and Onboarding Criteria
(ii) Access to Execution Methods
(iii) Use of Discretion
b. Sec. 37.202(a)(2)--Fees
2. Sec. 37.202(b)--Limitations on Access
3. Sec. 37.202(c)--Eligibility
4. Sec. 37.202(d)--Jurisdiction
B. Sec. 37.203--Rule Enforcement Program
1. Sec. 37.203(a)--Abusive Trading Practices Prohibited
2. Sec. 37.203(b)--Authority To Collect Information
3. Sec. 37.203(c)--Compliance Staff and Resources
4. Sec. 37.203(d)--Automated Trade Surveillance System
5. Sec. 37.203(e)--Error Trade Policy
a. Error Trades--Swaps Submitted for Clearing
b. Current SEF Error Trade Policies
c. Sec. 37.203(e)--Error Trade Policy
6. Sec. 37.203(f)--Investigations
7. Sec. 37.203(g)--Additional Sources for Compliance
C. Sec. 37.204--Regulatory Services Provided by a Third Party
1. Sec. 37.204(a)--Use of Regulatory Service Provider Permitted
2. Sec. 37.204(b)--Duty To Supervise Regulatory Service
Provider
3. Sec. 37.204(c)--Delegation of Authority
D. Sec. 37.205--Audit Trail
1. Sec. 37.205(a)--Audit Trail Required
2. Sec. 37.205(b)--Elements of an Acceptable Audit Trail
Program
a. Sec. 37.205(b)(1)--Original Source Documents; Sec.
37.205(b)(2)--Transaction History Database; Sec. 37.205(b)(3)--
Electronic Analysis Capability
3. Sec. 37.205(c)--Audit Trail Reconstruction
E. Sec. 37.206--Disciplinary Procedures and Sanctions
1. Sec. 37.206(a)--Enforcement Staff
2. Sec. 37.206(b)--Disciplinary Program
3. Sec. 37.206(c)--Hearings
4. Sec. 37.206(d)--Decisions
5. Sec. 37.206(e)--Disciplinary Sanctions
6. Sec. 37.206(f)--Warning Letters
7. Sec. 37.206(g)--Additional Sources for Compliance
F. Part 9--Rules Relating To Review of Exchange Disciplinary,
Access Denial or Other Adverse Actions
VIII. Part 37--Subpart D: Core Principle 3 (Swaps Not Readily
Susceptible to Manipulation)
A. Sec. 37.301--General Requirements
1. Appendix C--Demonstration of Compliance That a Swap Contract
Is Not Readily Susceptible to Manipulation
IX. Part 37--Subpart E: Core Principle 4 (Monitoring of Trading and
Trade Processing)
A. Sec. 37.401--General Requirements
B. Sec. 37.402--Additional Requirements for Physical-Delivery
Swaps
C. Sec. 37.403--Additional Requirements for Cash-Settled Swaps
D. Sec. 37.404--Ability To Obtain Information
E. Sec. 37.405--Risk Controls for Trading
F. Sec. 37.406--Trade Reconstruction
G. Sec. 37.407--Regulatory Service Provider; Sec. 37.408--
Additional Sources for Compliance
X. Part 37--Subpart F: Core Principle 5 (Ability To Obtain
Information)
A. Sec. 37.501--Establish and Enforce Rules
B. Sec. 37.502--Provide Information to the Commission
C. Sec. 37.503--Information-Sharing
D. Sec. 37.504--Prohibited Use of Data Collected for Regulatory
Purposes
XI. Part 37--Subpart G: Core Principle 6 (Position Limits or
Accountability)
A. Sec. 37.601--Additional Sources for Compliance; Guidance to
Core Principle 6 in Appendix B
XII. Part 37--Subpart H: Core Principle 7 (Financial Integrity of
Transactions); Sec. 39.12--Participant and Product Eligibility
A. Sec. 37.701--Required Clearing
B. Sec. 37.702--General Financial Integrity
1. Sec. 37.702(a)--Minimum Financial Standards
2. Sec. 37.702(b) and Sec. 39.12(b)(7)--Time Frame for
Clearing
a. ``Prompt and Efficient'' Standard and AQATP Standard
b. Proposed Approach to Straight-Through Processing
(1) Sec. 37.702(b)(1) and Sec. 39.12(b)(7)(i)(A)--``Prompt,
Efficient, and Accurate'' Standard
(2) Sec. 39.12(b)(7)(ii)--AQATP Standard for Registered DCOs
(3) Sec. 37.702(b)(2) Through (3)--Pre-Execution Credit
Screening
3. Applicability of Sec. 37.702(b) to SEFs That Do Not
Facilitate Clearing
C. Sec. 37.703--Monitoring for Financial Soundness
XIII. Part 37--Subpart I: Core Principle 8 (Emergency Authority)
A. Sec. 37.801--Additional Sources for Compliance
XIV. Part 37--Subpart J: Core Principle 9 (Timely Publication of
Trading Information)
XV. Part 37--Subpart K: Core Principle 10 (Recordkeeping and
Reporting)
XVI. Part 37--Subpart L: Core Principle 11 (Antitrust
Considerations)
XVII. Part 37--Subpart M: Core Principle 12 (Conflicts of Interest)
XVIII. Part 37--Subpart N: Core Principle 13 (Financial Resources)
A. Sec. 37.1301--General Requirements
1. Sec. 37.1301(a)
2. Sec. 37.1301(b)
3. Sec. 37.1301(c)
B. Sec. 37.1302--Types of Financial Resources
C. Sec. 37.1303--Liquidity of Financial Resources
D. Sec. 37.1304--Computation of Costs To Meet Financial
Resources Requirement
1. Acceptable Practices to Core Principle 13 in Appendix B
E. Sec. 37.1305--Valuation of Financial Resources
F. Sec. 37.1306--Reporting to the Commission
1. Sec. 37.1306(a)
2. Sec. 37.1306(b)
3. Sec. 37.1306(c)
4. Sec. 37.1306(d)
5. Sec. 37.1306(e)
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G. Sec. 37.1307--Delegation of Authority
XIX. Part 37--Subpart O: Core Principle 14 (System Safeguards)
A. Sec. 37.1401(c)
B. Sec. 37.1401(g)--Program of Risk Analysis and Oversight
Technology Questionnaire
C. Sec. 37.1401(j)
XX. Part 37--Subpart P: Core Principle 15 (Designation of Chief
Compliance Officer)
A. Sec. 37.1501--Chief Compliance Officer
1. Sec. 37.1501(a)--Definitions
2. Sec. 37.1501(b)--Chief Compliance Officer
a. Acceptable Practices to Core Principle 15 in Appendix B
3. Sec. 37.1501(c)--Duties of Chief Compliance Officer
4. Sec. 37.1501(d)--Preparation of Annual Compliance Report
5. Sec. 37.1501(e)--Submission of Annual Compliance Report and
Related Matters
6. Sec. 37.1501(f)--Recordkeeping
7. Sec. 37.1501(g)--Delegation of Authority
XXI. Part 36--Trade Execution Requirement
A. Sec. 36.1--Trade Execution Requirement
1. Sec. 36.1(a)--Trade Execution Requirement
2. Sec. 36.1(b)--Exemption for Certain Swaps Listed Only by
Exempt SEFs
a. Discussion of CEA Section 4(c) Enumerated Factors
3. Sec. 36.1(c)--Exemption for Swap Transactions Excepted or
Exempted From the Clearing Requirement Under Part 50
a. Discussion of CEA Section 4(c) Enumerated Factors
4. Sec. 36.1(d)--Exemption for Swaps Executed With Bond
Issuance
a. Discussion of CEA Section 4(c) Enumerated Factors
5. Sec. 36.1(e)--Exemption for Swaps Executed Between
Affiliates That Elect To Clear
a. Discussion of CEA Section 4(c) Enumerated Factors
B. Sec. 36.2--Registry of Registered Entities Listing Swaps
Subject to the Trade Execution Requirement; Appendix A to Part 36--
Form TER
C. Sec. 36.3--Trade Execution Requirement Compliance Schedule
1. Sec. 36.3(c)(1)--Category 1 Entities
2. Sec. 36.3(c)(2)--Category 2 Entities
3. Sec. 36.3(c)(3)--Other Counterparties
4. Sec. 36.3(e)--Future Compliance Schedules
XXII. Part 43--Sec. 43.2--Definition of ``Block Trade''
A. Sec. 43.2--Definition--Block Trade; Sec. 37.203(a)--
Elimination of Block Trade Exception to Pre-Arranged Trading
XXIII. Related Matters
A. Regulatory Flexibility Act
B. Paperwork Reduction Act
1. Information Provided by Reporting Entities/Persons
a. Sec. 37.3(a)--Requirements for Registration
b. Sec. 37.3(b)--Procedures for Registration
c. Sec. 37.3(c)--Amendment to an Order of Registration
d. Sec. 37.5(c)--Provision of Information Relating to a Swap
Execution Facility
e. Sec. 37.6(b)(1)--Legally Binding Documentation
f. Sec. 37.203(d)--Automated Trade Surveillance System
g. Sec. 37.203(e)--Error Trade Policy
h. Sec. 37.205(a)--Audit Trail Required
i. Sec. 37.205(b)--Elements of an Acceptable Audit Trail
Program
j. Sec. 37.205(c)--Audit Trail Reconstruction
k. Sec. Sec. 37.206(b)-(d)--Disciplinary Program
l. Sec. 37.401--General Requirements for Monitoring of Trading
and Trade Processing
m. Sec. 37.1301(b)--General Requirements for Financial
Resources
n. Sec. 37.1306--Financial Reporting to the Commission
o. Sec. 37.1401(g)--Program of Risk Analysis and Oversight
Technology Questionnaire
p. Sec. 37.1501(d)--Preparation of Annual Compliance Report
q. Part 36--Trade Execution Requirement
2. Information Collection Comments
C. Cost-Benefit Considerations
1. Introduction
2. Baseline
3. SEF Registration
a. Overview
(1) Application of SEF Registration Requirement
(2) SEF Registration Process and Related Forms
b. Benefits
(1) Application of SEF Registration Requirement
(2) SEF Registration Process and Related Forms
c. Costs
(1) Application of SEF Registration Requirement
(2) SEF Registration Process and Related Forms
d. Section 15(a) Factors
(1) Protection of Market Participants and the Public
(2) Efficiency, Competitiveness, and Financial Integrity of
Markets
(3) Price Discovery
(4) Sound Risk Management Practices
(5) Other Public Interest Considerations
4. Market Structure and Trade Execution
a. Overview
(1) Elimination of Minimum Trading Functionality and Execution
Method Requirements
(2) Trade Execution Requirement and Elimination of MAT Process
(3) Pre-Execution Communications and Block Trades
(4) Impartial Access
b. Benefits
(1) Elimination of Minimum Trading Functionality and Execution
Method Requirements
(2) Trade Execution Requirement and Elimination of MAT Process
(3) Pre-Execution Communications and Block Trades
(4) Impartial Access
c. Costs
(1) Elimination of Minimum Trading Functionality and Execution
Method Requirements
(2) Trade Execution Requirement and Elimination of MAT Process
(3) Pre-Execution Communications and Block Trades
(4) Impartial Access
d. Section 15(a) Factors
(1) Protection of Market Participants and the Public
(2) Efficiency, Competitiveness, and Financial Integrity of
Markets
(3) Price Discovery
(4) Sound Risk Management Practices
(5) Other Public Interest Considerations
5. Compliance and SRO Responsibilities
a. Overview
(1) SEF Trading Specialists
(2) Rule Compliance and Enforcement
(i) Definition of ``Market Participant''
(ii) Audit Trail and Surveillance Program
(iii) Compliance and Disciplinary Programs
(iv) Regulatory Service Provider
(3) Error Trade Policy
(4) Chief Compliance Officer
(5) Recordkeeping, Reporting, and Information-Sharing
(i) Equity Interest Transfer
(ii) Confirmation and Trade Evidence Record
(iii) Information-Sharing
(6) System Safeguards
b. Benefits
(1) SEF Trading Specialists
(2) Rule Compliance and Enforcement
(i) Definition of ``Market Participant''
(ii) Audit Trail and Surveillance Program
(iii) Compliance and Disciplinary Programs
(iv) Regulatory Service Provider
(3) Error Trade Policy
(4) Chief Compliance Officer
(5) Recordkeeping, Reporting, and Information-Sharing
(i) Equity Interest Transfer
(ii) Confirmation and Trade Evidence Record
(iii) Information-Sharing
(6) System Safeguards
c. Costs
(1) SEF Trading Specialists
(2) Rule Compliance and Enforcement
(i) Definition of ``Market Participant''
(ii) Audit Trail and Surveillance Program
(iii) Compliance and Disciplinary Programs
(iv) Regulatory Service Provider
(3) Error Trade Policy
(4) Chief Compliance Officer
(5) Recordkeeping, Reporting, and Information-Sharing
(i) Equity Interest Transfer
(ii) Confirmation and Trade Evidence Record
(iii) Information-Sharing
(6) System Safeguards
d. Section 15(a) Factors
(1) Protection of Market Participants and the Public
(2) Efficiency, Competitiveness, and Financial Integrity of
Markets
(3) Price Discovery
(4) Sound Risk Management Practices
(5) Other Public Interest Considerations
6. Design and Monitoring of Swaps
a. Overview
(1) Swaps Not Readily Susceptible to Manipulation
(2) Monitoring of Trading and Trade Processing
b. Benefits
(1) Swaps Not Readily Susceptible to Manipulation
(2) Monitoring of Trading and Trade Processing
c. Costs
(1) Swaps Not Readily Susceptible to Manipulation
[[Page 61949]]
(2) Monitoring of Trading and Trade Processing
d. Section 15(a) Factors
(1) Protection of Market Participants and the Public
(2) Efficiency, Competitiveness, and Financial Integrity of
Markets
(3) Price Discovery
(4) Sound Risk Management Practices
(5) Other Public Interest Considerations
7. Financial Integrity of Transactions
a. Overview
b. Benefits
c. Costs
d. Section 15(a) Factors
(1) Protection of Market Participants and the Public
(2) Efficiency, Competitiveness, and Financial Integrity of
Markets
(3) Price Discovery
(4) Sound Risk Management Practices
(5) Other Public Interest Considerations
8. Financial Resources
a. Overview
b. Benefits
c. Costs
d. Section 15(a) Factors
(1) Protection of Market Participants and the Public
(2) Efficiency, Competitiveness, and Financial Integrity of
Markets
(3) Price Discovery
(4) Sound Risk Management Practices
(5) Other Public Interest Considerations
D. Antitrust Considerations
I. Background and Introduction
A. Statutory Background: The Dodd-Frank Act
Title VII of the Dodd-Frank Wall Street Reform and Consumer
Protection Act (``Dodd-Frank Act'') \2\ amended the Commodity Exchange
Act (``CEA'' or ``Act'') \3\ to establish a comprehensive new swaps
regulatory framework that includes the registration and the oversight
of swap execution facilities (``SEFs'').\4\ As amended, CEA section
1a(50) defines a SEF as a trading system or platform that allows
multiple participants to execute or trade swaps with multiple
participants through any means of interstate commerce.\5\ CEA section
5h(a)(1) establishes the SEF registration requirement, which requires
an entity to register as a SEF prior to operating a facility for the
trading or processing of swaps.\6\ CEA section 5h(f) requires
registered SEFs to comply with fifteen core principles.\7\ Further, the
trade execution requirement in CEA section 2(h)(8) provides that swap
transactions that are subject to the clearing requirement in CEA
section 2(h)(1)(A) \8\ must be executed on a DCM, SEF, or a SEF that is
exempt from registration pursuant to CEA section 5h(g) (``Exempt
SEF''),\9\ unless no DCM or SEF \10\ ``makes the swap available to
trade'' or the related transaction is subject to a clearing requirement
exception pursuant to CEA section 2(h)(7).
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\2\ See Dodd-Frank Wall Street Reform and Consumer Protection
Act, Public Law 111-203, tit. VII, 124 Stat. 1376 (2010) (codified
as amended in various sections of 7 U.S.C.), available at https://www.cftc.gov/sites/default/files/idc/groups/public/@lrfederalregister/documents/file/2013-12242a.pdf.
\3\ 7 U.S.C. 1 et seq.
\4\ 7 U.S.C. 7b-3 (adding a new CEA section 5h to establish a
registration requirement and regulatory regime for SEFs).
\5\ As amended by the Dodd-Frank Act, CEA section 1a(50)
specifically defines a ``swap execution facility'' as a trading
system or platform in which multiple participants have the ability
to execute or trade swaps by accepting bids and offers made by
multiple participants in the facility or system, through any means
of interstate commerce, including any trading facility, that
facilitates the execution of swaps between persons; and is not a
designated contract market. 7 U.S.C. 1a(50).
\6\ CEA section 5h(a)(1) states 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 under section 5h. 7 U.S.C. 7b-
3(a)(1).
\7\ 7 U.S.C. 7b-3(f).
\8\ Section 723(a)(3) of the Dodd-Frank Act added a new CEA
section 2(h) to establish the clearing requirement for swaps. 7
U.S.C. 2(h). CEA section 2(h)(1)(A) provides that it is unlawful for
any person to engage in a swap unless that person submits such swap
for clearing to a derivatives clearing organization that is
registered under the Act or a derivatives clearing organization that
is exempt from registration under this Act if the swap is required
to be cleared. 7 U.S.C. 2(h)(1)(A). CEA section 2(h)(2) specifies
the process for the Commission to review and determine whether a
swap, group, category, type or class of swap should be subject to
the clearing requirement. 7 U.S.C. 2(h)(2). The Commission further
implemented the clearing determination process under part 50, which
also specifies the swaps that are currently subject to the
requirement. 17 CFR part 50.
\9\ The Commission notes that CEA section 2(h)(8)(A)(ii)
contains a typographical error that specifies CEA section 5h(f),
rather than CEA section 5h(g), as the provision that allows the
Commission to exempt a SEF from registration. Where appropriate, the
Commission corrects this reference in the discussion herein.
\10\ CEA sections 2(h)(8)(A)(i)-(ii) provide that with respect
to transactions involving swaps subject to the clearing requirement,
counterparties shall execute the transaction on a board of trade
designated as a contract market under section 5; or execute the
transaction on a swap execution facility registered under 5h or a
swap execution facility that is exempt from registration under
section 5h(g) of the Act. Given this reference in CEA section
2(h)(8)(A)(ii), the Commission accordingly interprets ``swap
execution facility'' in CEA section 2(h)(8)(B) to include a swap
execution facility that is exempt from registration pursuant to CEA
section 5h(g).
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B. Regulatory History: The Part 37 Rules
Pursuant to its discretionary rulemaking authority in CEA sections
5h(f)(1) and 8a(5), the Commission identified the relevant areas in
which the statutory SEF framework would benefit from additional rules
or regulations.\11\ Accordingly, the Commission adopted the part 37
rules to implement a regulatory framework for SEFs and for the trading
and execution of swaps \12\ on such facilities.\13\ Among other
provisions, subpart A to part 37 applies the SEF registration
requirement to facilities that meet the statutory SEF definition;
specifies a minimum trading functionality that a SEF must offer to
participants for all listed swaps, i.e., an ``Order Book''; \14\ and
specifies the process for a SEF to make a swap ``available to trade''
(``MAT''), i.e., required to be executed on a SEF or DCM pursuant to
the trade execution requirement.\15\ Subpart A also defines swaps
subject to the trade execution requirement as ``Required Transactions''
and requires a SEF to offer either (i) an Order Book or (ii) a request-
for-quote system that sends a request-for-quote to no less than three
unaffiliated market participants and operates in conjunction with an
Order Book (``RFQ System'') for the execution of these
transactions.\16\ Swaps that are not subject to the trade execution
requirement are defined as ``Permitted Transactions,'' for which a SEF
may offer any execution method and for which market participants may
voluntarily trade on a SEF.\17\ The Commission's regulations specify
additional requirements that correspond to the use of an Order Book or
RFQ System to execute Required Transactions.\18\ Subparts B through O
[[Page 61950]]
set forth regulations that further implement each of the fifteen SEF
core principles in CEA section 5h(f). Appendix B provides further
guidance and acceptable practices associated with the SEF core
principles.\19\
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\11\ To implement the SEF core principles, Core Principle 1
provides that the Commission may, in its discretion, determine by
rule or regulation the manner in which SEFs comply with the core
principles. 7 U.S.C. 7b-3(f)(1)(B).
\12\ The Commission notes that, unless otherwise stated, the
terms ``trades,'' ``transactions,'' and ``swaps'' are used
interchangeably in the discussion herein.
\13\ Core Principles and Other Requirements for Swap Execution
Facilities, 78 FR 33476 (Jun. 4, 2013) (``SEF Core Principles Final
Rule''); Process for a Designated Contract Market or Swap Execution
Facility To Make a Swap Available to Trade, Swap Transaction
Compliance and Implementation Schedule, and Trade Execution
Requirement Under the Commodity Exchange Act, 78 FR 33606 (Jun. 4,
2013) (``MAT Final Rule'').
\14\ 17 CFR 37.3(a)(2). An Order Book is defined as (i) an
``electronic trading facility,'' as that term is defined in CEA
section 1a(16); (ii) a ``trading facility,'' as that term is defined
in CEA section 1a(51); or (iii) a trading system or platform in
which all market participants have the ability to enter multiple
bids and offers, observe or receive bids and offers entered by other
market participants, and transact on such bids and offers. 17 CFR
37.3(a)(3).
\15\ 17 CFR 37.10. Given that swaps subject to the trade
execution requirement may also be executed on a DCM, the Commission
adopted the same process for a registered DCM to make a swap
``available to trade'' in part 38. 17 CFR 38.12. Accordingly,
discussion in this notice with respect to the application of the
trade execution requirement or the MAT process to SEFs should be
interpreted to also apply to DCMs.
\16\ 17 CFR 37.9(a). With the exception of block trades, as
defined under Sec. 43.2, Required Transactions must be executed on
a SEF's Order Book or RFQ System. 17 CFR 37.9(a)(2)(i).
\17\ 17 CFR 37.9(c).
\18\ See infra notes 85 (15-second time delay for the entry of
pre-arranged or pre-negotiated transactions to an Order Book) and
242 (additional requirements for RFQ Systems) and accompanying
discussion.
\19\ 17 CFR part 37 app. B.
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These rules reflect a more limited and prescriptive regulatory
approach to implementing the statutory provisions and promoting the
statutory goals of section 5h of the Act, i.e., promoting the trading
of swaps on SEFs and promoting pre-trade price transparency in the
swaps market.\20\ In particular, the Commission focused on achieving
pre-trade price transparency by mandating a minimum trading
functionality requirement for all swaps listed on a SEF and two
specific, limited execution methods for Required Transactions. The
Commission adopted the Order Book requirement both as a minimum trading
functionality for SEF registration and as an execution method for
Required Transactions.\21\ To provide some execution flexibility for
Required Transactions,\22\ the Commission also allowed SEFs to offer an
RFQ System, as described above.\23\ To further the goal of pre-trade
price transparency with respect to trading via an RFQ System, however,
the Commission required that an RFQ must be submitted to three
unaffiliated market participants and that a requester receive
applicable firm bids and offers from the Order Book in addition to any
RFQ responses.\24\ Recognizing that only certain swaps are well-suited
to be traded and executed through an Order Book or RFQ System, the
Commission interpreted the trade execution requirement in CEA section
2(h)(8), in particular the phrase ``makes the swap available to
trade,'' to have a scope of application that is consistent with the use
of these methods. Accordingly, the Commission interpreted the phrase,
which the Act does not otherwise define, to implement a voluntary MAT
process for determining the swaps that must be executed on a SEF; this
process primarily focuses on whether a swap has ``sufficient trading
liquidity'' to be executed via an Order Book or RFQ System.\25\
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\20\ 7 U.S.C. 7b-3(e) (specifying the rule of construction for
CEA section 5h).
\21\ 17 CFR 37.3(a)(2) (minimum trading functionality
requirement); 17 CFR 37.9(a)(2)(i)(A) (Required Transactions
requirement).
\22\ SEF Core Principles Final Rule at 33564-65.
\23\ 17 CFR 37.9(a)(3).
\24\ SEF Core Principles Final Rule at 33497, 33499.
\25\ MAT Final Rule at 33609 (noting that a MAT determination
may focus on whether a swap is sufficiently liquid to be subject to
the trade execution requirement).
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The Commission noted that the prescribed trading methods, such as
the Order Book, are consistent with the SEF definition in CEA section
1a(50) of the Act as they allow multiple market participants to post
bids or offers and accept bids and offers that are transparent to
multiple market participants.\26\ The Commission stated that the RFQ
System is consistent with the SEF definition because it requires market
participants to be able to access multiple market participants, but not
necessarily the entire market.\27\ Further, in response to commenters'
feedback that the Commission's approach is inconsistent with the Act,
the Commission stated that the limited execution methods for Required
Transactions are consistent with the phrase ``through any means of
interstate commerce'' in the SEF definition because a SEF ``may for
purposes of execution and communication use `any means of interstate
commerce,' including, but not limited to, the mail, internet, email,
and telephone, provided that the chosen execution method satisfies the
requirements . . . for Order Books or . . . for [RFQ Systems].'' \28\
The Commission also noted that a SEF may provide any method of
execution for Permitted Transactions as further justification for its
approach under the Act.\29\
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\26\ SEF Core Principles Final Rule at 33501.
\27\ Id. at 33496.
\28\ Id. at 33501.
\29\ Id. at 33484.
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In adopting a regulatory framework that would effectuate the
statutory SEF provisions and goals, the Commission relied in part upon
its experience with the futures market, including DCM oversight and DCM
core principles implementation.\30\ While the Commission did provide
flexibility for certain swap requirements relative to the DCM
rules,\31\ the Commission sought, where possible, to harmonize SEF
regulations with DCM regulations based on the similarities in the
statutory core principles between SEFs and DCMs, and the ability of
both types of entities to offer swaps for trading and execution.\32\
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\30\ Id. at 33477.
\31\ For example, the RFQ System requirement for Required
Transactions on SEFs is less restrictive than the RFQ-to-all
approach that is used by some DCMs. The Commission decided that the
former approach was more appropriate for SEFs due to the less
standardized nature of the swaps market. SEF Core Principles Final
Rule at 33497 n.270.
\32\ Id. at 33478, 33553 (noting the similarities between the
statutory requirements for SEFs and DCMs).
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1. Challenges of Existing Regulatory Approach
The Commission's existing regulatory approach has transitioned some
degree of swaps trading and market participants to SEFs, but has also
created several challenges for swaps trading on SEFs, as described
below.
a. Lack of MAT Determinations
The voluntary, SEF-driven MAT determination process has resulted in
a limited set of products that are required to be executed on SEFs.
Since 2014, SEFs have submitted a limited number of swaps, relative to
the scope of swaps subject to the clearing requirement, as ``available
to trade'' to the Commission.\33\ The swaps that SEFs have submitted--
``on-the-run'' index credit default swaps (``CDS'') and fixed-to-
floating interest rate swaps (``IRS'') in benchmark tenors--are
generally the most standardized and liquid swaps contracts.\34\ Beyond
this initial set of MAT determinations, the Commission has not received
any filings for additional swaps despite the subsequent expansion of
the clearing requirement.\35\
[[Page 61951]]
The lack of additional determinations is partly attributable to market
participants' concerns over the Commission's required methods of
execution for Required Transactions.\36\ Based on those concerns, SEFs
have not pursued making additional swaps subject to the trade execution
requirement. This lack of additional submissions has effectively
limited the number of swaps that must be executed on SEFs which has
limited the amount of trading and liquidity formation occurring on
SEFs.
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\33\ For a list of MAT determinations that have been submitted
to the Commission, see CFTC, Industry Oversight, Industry Filings,
Swaps Made Available to Trade Determination, https://sirt.cftc.gov/sirt/sirt.aspx?Topic=%20SwapsMadeAvailableToTradeDetermination. For
a current list of swaps that have been made ``available to trade''
and are subject to the trade execution requirement, see CFTC,
Industry Oversight, Industry Filings, Swaps Made Available to Trade,
https://www.cftc.gov/sites/default/files/idc/groups/public/@otherif/documents/file/swapsmadeavailablechart.pdf. For a list of swaps
subject to the clearing requirement, see 17 CFR 50.4; see also CFTC,
Industry Oversight, Industry Filings, Swaps Subject to Clearing
Requirement, https://www.cftc.gov/sites/default/files/idc/groups/public/@otherif/documents/ifdocs/clearingrequirementcharts9-16.pdf.
\34\ See, e.g., Bloomberg SEF, Submission No. 2013-R-9,
Bloomberg SEF LLC--Made Available to Trade (``MAT'') Submission of
Certain Credit Default Swaps (``CDS'') and Interest Rate Swaps
(``IRS'') pursuant to [CFTC] Regulation 40.6 at 3 (Dec. 5, 2013)
(stating that its MAT determination consists of only the most
standardized and liquid swaps, which represent a majority of market
traded volume), https://www.cftc.gov/sites/default/files/stellent/groups/public/@otherif/documents/ifdocs/bsefmatdetermltr120513.pdf;
``TW SEF,TW SEF LLC--Clarification and Amendment to Self-
Certification for Swaps to be Made Available to Trade'' at 8 (Nov.
29, 2013) (stating that its MAT determinations with respect to IRS
represent the ``standard benchmarks, which are the most standard,
liquid, and transparent of the IRS market, and trade with market-
accepted, standard, plain vanilla dates), https://www.cftc.gov/sites/default/files/stellent/groups/public/@otherif/documents/ifdocs/twsefamendmatltr112913.pdf.
\35\ In 2016, the Commission expanded the clearing requirement
for IRS in the four classes (fixed-to-floating swaps, basis swaps,
forward rate agreements, overnight index swaps) to additional
currencies. CFTC, Press Releases, Release No. 7457-16, CFTC Expands
Interest Rate Swap Clearing Requirement, https://www.cftc.gov/PressRoom/PressReleases/pr7457-16 (Sept. 28, 2016). See also
Clearing Requirement Determination Under Section 2(h) of the
Commodity Exchange Act for Interest Rate Swaps, 81 FR 71202 (Oct.
14, 2016) (``Second Clearing Determination Final Rule'').
\36\ See CFTC Public Roundtable: The Made Available to Trade
Process, 151-152, 192-193 (July 15, 2015), https://www.cftc.gov/idc/groups/public/%40newsroom/documents/file/transcript071515.pdf
(``2015 MAT Roundtable'') (discussing the prescriptive nature of the
required methods of execution and noting the relationship to the MAT
determination process).
---------------------------------------------------------------------------
b. Swaps Market Characteristics
Over the course of the part 37 implementation process, the
Commission has gained greater familiarity with the swaps markets, in
particular the nature of the products and how market participants trade
and execute those products. Based on what it has learned, the
Commission believes that the existing regulatory framework has
contributed to the limited amount of swaps that are subject to the
trade execution requirement, and therefore, the limited scope of swaps
trading that occurs on SEFs.
Swaps consist of many highly variable terms and conditions beyond
price and size that can be negotiated and tailored to suit a market
participant's specific and unique needs. While some swaps are
relatively standardized, others are customized and consist of
innumerable permutations, making them generally less standardized and
more bespoke than futures contracts. Given the ability to customize
swaps to address specific and often large risks that cannot be offset
through more standardized instruments, the swaps market is generally
comprised of a relatively concentrated number of sophisticated market
participants in contrast to the futures market. In this regard, the
Commission notes that CEA section 2(e) limits swaps trading on SEFs to
``eligible contract participants'' (``ECPs''), as defined by CEA
section 1a(18).\37\ These swaps market characteristics contribute to
varying liquidity profiles for swaps that range from relatively
illiquid to episodic to relatively liquid.
---------------------------------------------------------------------------
\37\ 7 U.S.C. 2(e); 7 U.S.C. 1a(18).
---------------------------------------------------------------------------
Historically, these particular characteristics have contributed to
the use of a variety of execution methods--electronic, voice-based, or
a hybrid of both (``voice-assisted'')--by market participants.
Utilizing one execution method or another depends on considerations
such as the type of swap, transaction size, complexity, the swap's
liquidity at a given time, the number of potential liquidity providers,
and the associated desire to minimize potential information leakage and
front-running risks. For swaps with standard tenors that are relatively
liquid, market participants may utilize a method of trading and
execution, such as an electronic order book platform, that disseminates
trading interests to all other market participants on the platform.
Trading and execution in less standardized products, however, generally
occur on systems or platforms that are more discreet in disseminating
trading interests, such as auction platforms. The Commission's existing
approach to required execution methods, as described above, creates a
tension with swaps market characteristics that necessitate flexible
execution methods. This tension has otherwise hindered the expansion of
the trade execution requirement.
c. Operational Complexities and Costs
The Commission has learned that its approach to other part 37 rules
may have imposed certain burdens on SEFs, including operating
complexities and costs that have impeded development, innovation, and
growth in the swaps market. SEFs have indicated that they are unable to
comply with some of these requirements because they are impractical or
unachievable due to technology limitations or incompatible with
existing market practices. For example, as discussed further below,
SEFs have informed the Commission that the confirmation requirement for
uncleared swaps under Sec. 37.6(b) and the electronic analysis
capability requirements with respect to audit trail data for voice
orders under Sec. 37.205 have been operationally difficult and
impractical to implement.\38\ Even where SEFs have been able to comply
with some of the requirements, they have asserted that the compliance
costs are high and compliance is unnecessary in helping them satisfy
their self-regulatory obligations and the SEF core principles. For
example, SEFs have noted the high costs of the financial resources
requirements imposed by the Core Principle 13 regulations.\39\ SEFs and
market participants have attributed the limited development,
innovation, and growth of SEFs to these ongoing burdens.
---------------------------------------------------------------------------
\38\ See infra Section IV.F.--Sec. 37.6--Enforceability
(discussion of SEF confirmation requirements); Section VII.D.--Sec.
37.205--Audit Trail (discussion of SEF audit trail requirements).
\39\ See Letter from Wholesale Markets Brokers' Association,
Americas (``WMBAA''), Swap Execution Facility Regulations, Made
Available to Trade Determinations, and Swap Trading Requirements at
5 (Mar. 11, 2016) (``2016 WMBAA Letter''); see also CFTC Letter No.
17-25, Division of Market Oversight Guidance on Calculating
Projected Operating Costs By Designated Contract Markets and Swap
Execution Facilities (Apr. 28, 2017) (``CFTC Letter No. 17-25'').
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As a result of these burdens, the Commission believes that a
significant amount of swaps liquidity formation activity occurs away
from registered SEFs in a manner similar to the pre-Dodd-Frank Act
swaps trading environment. These examples include (i) entities that
aggregate single-dealer platforms to allow market participants to
obtain indicative or firm pricing and execute swaps with multiple
single-dealer liquidity providers away from SEFs; and (ii) swaps
broking entities, including interdealer brokers \40\ that facilitate
swaps trading between multiple market participants through non-
registered voice or electronic platforms. While some of these
interdealer brokers are affiliated with registered SEFs, the Commission
understands that they have nevertheless maintained a bifurcated
operating structure under which a SEF primarily executes and processes
orders that have already been negotiated or arranged on an affiliated
broker platform, in effect limiting a SEF's role to a swaps transaction
booking and processing engine.\41\ By operating in this manner, the
Commission believes that many entities have been able to avoid the
burdens arising from SEF registration and compliance under part 37.
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\40\ The Commission believes that most of these swaps broking
entities are currently registered with the Commission as introducing
brokers (``IBs''). See infra note 340 and accompanying discussion.
\41\ The Commission notes that these swaps broking entities and
their affiliated SEFs primarily operate as part the ``dealer-to-
dealer'' segment of the swaps market, which primarily facilitates
swaps trading between swap dealers. See infra Section
VII.A.1.a.(1)(i).--Eligibility and Onboarding Criteria (discussion
of impartial access requirements).
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When necessary or appropriate to mitigate these burdens in the
course of implementing part 37, Commission staff has issued various
guidance and time-limited no-action relief to SEFs and market
participants. The no-action relief has afforded additional time for
compliance with certain part 37 regulations and related procedures or
has provided an opportunity to
[[Page 61952]]
determine whether a longer-term regulatory solution--such as those
proposed in this notice--is warranted.\42\ Where compliance could not
be achieved or impractical compliance burdens arose from the existing
part 37 rules, SEFs may have been impeded from pursuing beneficial
market initiatives, such as developing new trading systems and
protocols to attract greater swaps liquidity. The Commission believes
that it is appropriate to address these issues as part of the changes
to the existing regulations proposed in this notice.
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\42\ See infra notes 223 (no-action relief from existing Sec.
37.6(b) confirmation requirements for uncleared swap transactions
executed on a SEF), 433 (no-action relief from existing Sec. 37.9
and Sec. 37.203(a) with respect to the correction of error trades
on SEFs), 474 (no-action relief from existing Sec. 37.205(a) with
respect to capturing of trade allocation information in a SEF
transaction history database), 822 (no-action relief from existing
Sec. 37.1501(f) with respect to SEF annual compliance report filing
requirements), 898 (no-action relief from certain ``block trade''
definitional requirements under existing Sec. 43.2) and
accompanying discussion.
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C. Proposed Approach
Given the challenges described above and the Commission's enhanced
knowledge and experience from implementing part 37, the Commission is
proposing to strengthen its swaps trading regulatory framework, while
still effectuating the statutory SEF provisions and better promoting
the statutory SEF goals. The Commission's proposed approach also more
appropriately accounts for swaps market characteristics and should
reduce certain complexities and costs that have contributed to a
significant amount of swaps liquidity formation occurring away from
SEFs; limited the scope of swaps that are subject to the trade
execution requirement; and impeded SEF development, innovation, and
growth. In this regard, the Commission proposes a simple but
comprehensive approach that provides SEFs with flexibility, where
appropriate, to calibrate their trading and compliance functions based
on their respective trading operations and markets. The Commission
believes that this proposed approach will attract greater liquidity
formation on SEFs.
First, the Commission aims to effectuate the SEF registration
requirement to ensure that multiple-to-multiple trading of swaps occurs
on a SEF by requiring that swaps broking entities and certain single-
dealer aggregator platforms register as SEFs (emphasis added). In
particular, consistent with the statutory SEF provisions and goals,
this proposed rulemaking would apply the SEF registration requirement
in CEA section 5h(a)(1) and Sec. 37.3(a) to swaps broking entities,
including interdealer brokers, that are currently registered with the
Commission as IBs, and their personnel currently facilitating swaps
trading away from SEFs. Based on its experience and observation of
market developments since the adoption of part 37, the Commission has
witnessed the various ways in which swaps broking entities, including
interdealer brokers, have structured themselves to facilitate swaps
trading, and therefore liquidity formation, outside of the existing SEF
regulatory framework.
Second, the Commission aims to facilitate increased trading and
liquidity on SEFs by proposing a revised interpretation of the trade
execution requirement that is consistent with CEA section 2(h)(8). The
Commission's proposed interpretation would apply the trade execution
requirement to all swaps that are both subject to the clearing
requirement under section 2(h)(1) of the Act and listed for trading on
a SEF. As a result of this approach, the Commission would also withdraw
the existing voluntary MAT process.
The proposed expansion of the trade execution requirement is
expected to capture a greater number of swaps with different liquidity
profiles, thereby reinforcing the need to establish a more flexible
regulatory approach to swaps trading and execution that would help
foster customer choice, promote competition between and innovation by
SEFs, and better account for fundamental swaps market characteristics.
Accordingly, the Commission also proposes to allow a SEF to offer any
method of execution for all swaps trading and execution, rather than
only an Order Book or RFQ System.
Rather than dictating certain execution methods for Required
Transactions, the Commission's proposed flexible approach would enable
SEFs to provide, and ultimately allow market participants to choose,
execution methods that are appropriate for the liquidity and other
characteristics of particular swaps. The Commission's approach should
also promote pre-trade price transparency in the swaps market by
allowing execution methods that maximize participation and concentrate
liquidity during times of episodic liquidity. The Commission believes
that providing flexibility in execution methods will allow the swaps
market to continue to naturally evolve and allow SEFs to innovate and
provide more efficient, transparent, and cost-effective means of
trading and execution. The Commission also proposes to eliminate the
minimum trading functionality requirement, which should reduce the
costs incurred by SEFs to operate and maintain order books that have
not attracted significant volumes. In lieu of specific execution method
requirements, the Commission is proposing general disclosure-based
trading and execution rules that would apply to any execution method
offered by a SEF.
In conjunction with allowing SEFs to offer more flexible execution
methods, the Commission is proposing new rules for certain SEF
personnel--``SEF trading specialists''--that constitute part of a SEF's
trading system or platform. The proposed rules require SEFs to adopt
minimum proficiency testing and ethics training requirements to ensure
that their trading specialists possess and maintain an adequate level
of technical knowledge and understand their ethical responsibilities in
customer trading or execution and fostering liquidity formation. The
proposed rules would also require SEFs to adopt trading conduct
standards and a duty of supervision. With the ability to offer more
flexible execution methods for all swaps, in particular those that
involve discretion by trading specialists in handling trading or
execution, the Commission believes that these proposed requirements are
necessary to enhance professionalism in the swaps market and to promote
market integrity and fairness. Further, the proposed requirements would
mandate requisite levels of knowledge and competence that are
commensurate to other similar requirements established for personnel in
major trading markets, such as futures and equities.\43\
---------------------------------------------------------------------------
\43\ See infra note 355.
---------------------------------------------------------------------------
The Commission is also proposing a series of amendments to
additional part 37 regulations that implement the SEF core principles.
These proposed amendments would allow a SEF to better tailor its
compliance and regulatory oversight programs to its trading operations
and markets. The Commission believes that these proposed revisions are
critical to the ability of SEFs to offer the diverse types of execution
methods that would be available to them under this proposal. Further,
the proposed rules would streamline and refine some of the existing
prescriptive requirements applicable to SEFs to better reflect
technological capabilities and existing market practices in the swaps
market. The proposed rules would also seek to reduce unnecessary
compliance costs while still maintaining robust
[[Page 61953]]
compliance programs and consistency with the SEF core principles. The
ability to tailor compliance and oversight programs is consistent with
the ``reasonable discretion'' that Core Principle 1 provides SEFs to
comply with the core principles and mitigates compliance challenges
that SEFs have encountered in implementing part 37.\44\
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\44\ Core Principle 1 states that, unless otherwise determined
by the Commission by rule or regulation, a SEF shall have reasonable
discretion in establishing the manner in which it complies with the
SEF core principles.'' 7 U.S.C. 7b-3(f)(1)(B).
---------------------------------------------------------------------------
With respect to existing staff guidance and staff no-action relief,
the Commission would adopt or codify such guidance or relief where
appropriate. Providing a simple, but more comprehensive regulatory
approach would help mitigate barriers for market participants to trade
and execute further on SEFs, which would in turn better promote the
statutory SEF goals.
Finally, the proposed rules include non-substantive amendments and
various conforming changes to relevant provisions in the Commission's
regulations.
The Commission believes that the proposed revisions to the part 37
framework are consistent with the statutory SEF provisions and should
serve to advance swaps trading on SEFs. The proposed rules are designed
to more appropriately account for swaps market characteristics,
especially with respect to the use of a wider array of different
execution methods to trade and execute a broad scope of swaps with
varying liquidity characteristics. Accordingly, the proposed rules are
expected to better promote the development, innovation, and growth of
the swaps market, with the intent of attracting liquidity formation
onto SEFs.
D. Summary of Proposed Revisions
As a general overview of the major changes described in this
notice, the Commission is proposing:
Registration: A proposed interpretation to apply the
statutory SEF registration requirement and the definition of ``swap
execution facility'' in CEA sections 5h(a)(1) and 1a(50),
respectively, to certain swaps broking entities, including
interdealer brokers, as well as aggregators of single-dealer
platforms. The proposed rules also include revisions to simplify the
registration process by streamlining Form SEF.
Trade Execution Requirement: A revised interpretation
of the trade execution requirement in CEA section 2(h)(8) and new
rules based upon that interpretation that (i) broaden the scope of
the trade execution requirement; (ii) create a compliance schedule
for the expanded requirement; and (iii) provide exemptions from the
requirement for certain types of swap transactions pursuant to CEA
section 4(c). Further, the Commission is proposing to require each
SEF to submit a Form TER that specifies those swaps that it lists
for trading that are subject to the clearing requirement.
Execution Methods: New general, disclosure-based
trading and execution rules under Core Principle 2 that apply to any
execution method offered by a SEF. These proposed rules would
replace the Sec. 37.3(a)(2) minimum trading functionality
requirement and the execution methods prescribed under Sec. 37.9
for Required Transactions, thereby allowing a SEF to offer flexible
methods of execution for swaps subject to the trade execution
requirement. Further, the Commission is also proposing to limit the
scope of trading-related communications that SEF participants may
conduct away from a SEF's trading system or platform.
Proficiency: In conjunction with allowing SEFs to offer
more flexible methods of execution for swaps subject to the trade
execution requirement, the Commission is also proposing new rules
under Core Principle 2 for SEF trading specialists. The proposed
rules would benefit SEF participants by strengthening market
integrity and fairness through requirements for SEFs to establish
proficiency testing and ethics training, trading conduct standards,
and a duty of supervision.
Swap Documentation: Amendments to the existing Sec.
37.6(b) confirmation requirement that would allow a SEF to provide a
``trade evidence'' record for an uncleared swap that serves as
evidence of a legally binding swap transaction, but may be
supplemented by counterparties with additional terms based on
previously negotiated underlying agreements.
Impartial Access: Modifications to the existing
impartial access rules under Sec. 37.202 that would allow a SEF to
structure participation criteria and trading practices in a manner
that aligns with the current swaps market structure.
Self-Regulatory Oversight: Amendments to Sec. Sec.
37.203-206 under Core Principle 2 that provide a SEF with the
ability to, among other things, (i) tailor its rule enforcement
program and disciplinary procedures and sanctions to the
characteristics of its trading operations and market; (ii) develop
an audit trail surveillance system that is appropriate to the types
of available execution methods it offers; and (iii) choose other
additional types of regulatory service providers to assist with
fulfilling its oversight duties.
Product Guidance: Additional guidance, pursuant to Core
Principle 3, for a SEF to demonstrate that the swaps that it lists
for trading are not readily susceptible to manipulation.
Straight-Through Processing: Amendments and
clarifications to the SEF straight-through processing requirements
that better reflect existing swaps market practices.
Financial Resources: Amendments to apply the existing
Core Principle 13 financial resource requirements in a more
practical manner to SEF operations. The proposed rule changes
include amendments to the existing six-month liquidity requirement
and the addition of new acceptable practices that provide further
guidelines to SEFs for making a reasonable calculation of their
projected operating costs.
Chief Compliance Officer: Amendments to Core Principle
15 regulations that streamline existing requirements for the chief
compliance officer (``CCO'') position; allow SEF management to
exercise discretion in CCO oversight; and simplify the preparation
and submission of the required annual compliance report.
E. Consultation With Other U.S. Financial Regulators
In developing these rules, the Commission has consulted with the
Securities and Exchange Commission, pursuant to section 712(a)(1) of
the Dodd-Frank Act.\45\
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\45\ Dodd-Frank Act, Public Law 111-203, tit. VII, Sec.
712(a)(1), 124 Stat. 1376 (2010).
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II. Part 9--Rules Relating To Review of Exchange Disciplinary, Access
Denial or Other Adverse Actions
The Commission is proposing non-substantive amendments to part 9 of
the Commission's regulations that conform to proposed amendments to
Sec. 37.206--Disciplinary procedures and sanctions. Accordingly, the
Commission discusses those proposed amendments to part 9 in Section
VII.F. of this notice in conjunction with its discussion of the
proposed amendments to Sec. 37.206.
III. Part 36--Trade Execution Requirement
The Commission is proposing new rules under part 36 of the
Commission's regulations to implement a proposed revised interpretation
of the trade execution requirement in CEA section 2(h)(8), which would
broaden the scope of the requirement to include additional swaps. The
Commission discusses the proposed implementing rules in Section
IV.I.4.a. of this notice in conjunction with its discussion of (i) the
proposed adoption of flexible means of execution and elimination of the
minimum trading functionality under Sec. 37.3(a)(2); (ii) the
prescribed execution methods under Sec. 37.9; and (iii) the MAT
process (and corresponding trade execution compliance schedule) under
Sec. 37.10, Sec. 37.12, and Sec. Sec. 38.11-12.\46\ Further, the
Commission discusses the proposed Form TER submission, the proposed
compliance schedule for the expanded requirement, and proposed
exemptions from the requirement in Section XXI. of this notice.
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\46\ See infra Section IV.I.4.a.--Sec. 36.1(a)--Trade Execution
Requirement.
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[[Page 61954]]
IV. Part 37--Subpart A: General Provisions
A. Sec. 37.1--Scope
Section 37.1 currently clarifies that part 37 applies to every SEF
that is registered or is applying to become registered as a SEF with
the Commission. Section 37.1 also clarifies that part 37's
applicability does not affect the eligibility of a registered SEF or a
SEF applicant to operate as either a DCM under part 38 of the
Commission regulations or a swap data repository (``SDR'') under part
49 of the Commission's regulations.
The Commission proposes a non-substantive amendment to Sec. 37.1.
The Commission has not identified any provisions in part 37 that would
preclude a registered SEF from being eligible to operate as a DCM or an
SDR; accordingly, the clarifying language may create unnecessary
ambiguity. Therefore, the Commission proposes a non-substantive
amendment to eliminate the existing language to avoid any potential
confusion.
B. Sec. 37.2--Applicable Provisions and Definitions \47\
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\47\ The Commission proposes to retitle Sec. 37.2 to
``Applicable provisions and definitions'' from ``Applicable
provisions'' based on the proposed addition of Sec. 37.2(b)
described below.
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1. Sec. 37.2(a)--Applicable Provisions
Section 37.2 states that a SEF must comply with part 37 and all
other applicable Commission regulations, including any related
definitions and cross-referenced sections. Section 37.2 also identifies
certain specific pre-Dodd-Frank Act provisions whose applicability to
SEFs may otherwise not be apparent--in particular, Sec. 1.60 and part
9 of the Commission's regulations.\48\ The Commission proposes to adopt
a non-substantive amendment to eliminate the reference to part 9; the
Commission notes that it has since adopted amendments to part 9 to
conform to the relevant part 37 regulations.\49\
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\48\ Section 1.60 sets forth requirements for futures commission
merchants (``FCMs'') and DCMs to submit documents requested by the
Commission that have been filed in any material legal proceeding in
which the FCM or DCM is a party. 17 CFR 1.60. For a description of
the Commission's part 9 regulations, see infra Section VII.F.--Part
9--Rules Relating to Review of Exchange Disciplinary, Access Denial
or Other Adverse Actions.
\49\ Technical Amendments to Rules on Registration and Review of
Exchange Disciplinary, Access Denial, or Other Adverse Actions, 83
FR 1538 (Jan. 12, 2018). The Commission notes that it is also
proposing additional amendments to part 9 in this notice that
conform to the proposed amendments to the Core Principle 2
regulations discussed herein. The Commission also proposes to
renumber this provision to subsection (a) based on the proposed
addition of Sec. 37.2(b) described below.
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2. Sec. 37.2(b)--Definition of ``Market Participant''
The Commission proposes a new provision under Sec. 37.2(b) to
define ``market participant,'' as the term is currently used in part
37, to clarify a SEF's jurisdiction over the various participants that
may be involved in trading or executing swaps on its facility. In the
preamble to the SEF Core Principles Final Rule, the Commission
specified that a ``market participant'' includes any ``person that
directly or indirectly effects transactions on the SEF. [The
definition] includes persons with trading privileges on the SEF and
persons whose trades are intermediated.'' \50\ This term applies to
several part 37 rules and triggers certain obligations under the Core
Principle 2 regulations, which set forth a SEF's self-regulatory
responsibilities. For example, Sec. 37.206 requires a SEF to establish
participation rules that broadly impose a SEF's disciplinary authority
across different categories of participants, including market
participants.\51\
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\50\ SEF Core Principles Final Rule at 33506. See also Division
of Market Oversight Guidance on Swap Execution Facility Jurisdiction
(Feb. 10, 2014) (``2014 Staff Jurisdiction Guidance'').
\51\ 17 CFR 37.206.
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In practice, SEFs have created various participation categories,
including ``direct access,'' ``direct market access,'' and ``sponsored
access'' to describe how persons connect to their trading systems or
platforms. For example, the Commission understands that ``direct
access'' generally refers to participants who have been granted trading
privileges by a SEF and utilize their own proprietary means, e.g.,
trading credentials and/or front-end interface, to participate directly
on the SEF.\52\ In contrast, ``direct market access'' or ``sponsored
access'' generally describe arrangements in which a person uses a SEF
participant's means, including trading credentials and/or front-end
systems, to participate directly on the SEF. For example, many SEFs
allow persons to access their systems or platforms by using the
credentials and/or front-end functionality provided by a SEF
participant, such as a futures commission merchant (``FCM'') serving as
a clearing member on the SEF or an IB.\53\ Finally, some persons may
participate on a SEF via an agency execution model by directing an
intermediary, e.g., an FCM or an IB, to submit orders or request quotes
on their behalf.
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\52\ The Commission notes that ``direct access'' also refers to
participants who may onboard and utilize a SEF's own front-end
application to trade swaps on the SEF's systems or platforms.
\53\ The Commission notes that some SEFs refer to such persons
as ``customers'' of a SEF trading participant.
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Notwithstanding these categories, SEFs have generally relied on the
existing description of ``market participant'' in the SEF Core
Principles Final Rule preamble to establish jurisdiction over all of
these participants that access the SEF and trade swaps on a direct or
indirect basis. Given this established reliance and the continued use
of this term under the proposed rules, the Commission seeks to codify
the definition of ``market participant'' in part 37. The Commission
proposes to define ``market participant'' as any person who accesses a
SEF (i) through direct access provided by a SEF; (ii) through access or
functionality provided by a third-party; or (iii) through directing an
intermediary that accesses a SEF on behalf of such person to trade on
its behalf. As a threshold matter, the Commission notes that since
these persons are currently considered ``market participants,'' they
are already subject to a SEF's jurisdiction. The Commission believes
that persons accessing a SEF through the various means described above
interact with other market participants on the SEF and have the ability
to engage in abusive trading practices. Therefore, they should continue
to be subject to a SEF's jurisdiction, including disciplinary
procedures and recordkeeping obligations.\54\
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\54\ Although a person who directs an intermediary to trade on
its behalf does not interact with other market participants in the
same manner, the Commission believes that such a person could engage
in abusive trading activity by using more than one intermediary to
place orders that result in an abusive trading practice. For
example, a person seeking to achieve a wash result could structure a
transaction or a series of transactions through separate
intermediaries, which may give the appearance of bona fide purchases
and sales, but where the trades have been entered into without the
intent to take a bona fide market position. While persons do not
typically access a SEF in this manner, the Commission is mindful
that the part 37 rules do not preclude this access method and notes
that some SEFs currently facilitate agency-based trading.
Accordingly, the Commission believes that a SEF must continue to
have jurisdiction and disciplinary authority over these persons in
order to effectively investigate misconduct and prosecute rule
violations that occur on the SEF.
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a. Applicability of Sec. 37.404(b) to Market Participants
The Commission notes in particular that this proposed definition of
``market participant'' would apply to the recordkeeping requirements
under Sec. 37.404(b). Section 37.404(b) requires a SEF to adopt rules
that require its market participants to keep records of their trading,
including records of their activity in any index or instrument used as
a reference price, the underlying
[[Page 61955]]
commodity, and related derivatives markets.\55\ Participants who trade
on a SEF via direct access and participants who use the access or
functionality of another participant to trade on a SEF have primary
access to these types of records of their own trading. Further, the
Commission believes persons who direct an intermediary to trade on
their behalf are best situated to maintain the records required by
Sec. 37.404(b). The Commission understands that such intermediaries
would likely only have access to records of swaps activity occurring on
the SEF, not necessarily activity by their customers in the index or
instruments used as a reference price, the underlying commodity, and
related derivatives markets. Consequently, the Commission believes that
as ``market participants'' under the proposed definition, they should
be subject to the recordkeeping requirements under Sec. 37.404(b).\56\
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\55\ 17 CFR 37.404(b).
\56\ The Commission notes that the proposed ``market
participant'' definition, or the discussion herein, does not alter
any person's obligations under Sec. 1.35. 17 CFR 1.35.
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b. SEF Jurisdiction Over Clients of Market Participants
The proposed ``market participant'' definition would not capture
clients of asset managers who, as market participants of a SEF, trade
on a SEF on their clients' behalf.\57\ The Commission recognizes that
based on general industry practice, these clients have given their
respective asset managers broad discretion to execute transactions in
various financial products in different markets, including swaps. When
asset managers trade on a client's behalf based on that discretion,
such trading typically occurs without specific knowledge by the client
as to whether such transactions are occurring on a SEF or the identity
of the SEFs involved. While the clients themselves ultimately are the
named counterparties to any transactions executed on their behalf, the
asset managers are the participants accessing the SEF, and as such, are
subject to the ``market participant'' definition and the obligations
thereunder, including the SEF's jurisdiction. The Commission notes that
asset managers--not their clients--access the SEF and sign onboarding
documentation subjecting them to the SEF's jurisdiction. Since clients
of asset managers would not be captured under the proposed market
participant definition, a SEF would not be required to subject these
clients to jurisdiction under proposed Sec. 37.202(d).
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\57\ The Commission notes that in the SEF Core Principles Final
Rule, one commenter expressed concern that the vague use of the term
``market participant'' could potentially subject dealers' customers,
and thus asset managers and their clients, to onerous requirements.
SEF Core Principles Final Rule at 33506.
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Given that these clients give broad trading discretion to their
asset managers, the Commission believes that requiring an asset manager
who accesses and conducts actual trading on a SEF to submit to the
SEF's jurisdiction is sufficient. This approach ensures that SEFs have
the ability to take disciplinary action against the individual or
entity--the asset manager--that could actually engage in potentially
abusive trading practices on the SEF. The Commission notes that this
logic would apply in other circumstances where a client gives broad
trading discretion to another person to trade and execute swap
transactions on the client's behalf. Therefore, these situations would
not fall within the third prong of the ``market participant''
definition as described above because the client is not ``directing''
the intermediary to trade on its behalf.
With respect to recordkeeping, the Commission understands that
asset managers typically maintain records of swap transactions on SEFs
to which their clients are named counterparties. Although asset
managers would likely not have complete records of their clients'
trading activity in the index or instruments used as a reference price,
the underlying commodity, and related derivatives markets under Sec.
37.404(b), the Commission does not believe that SEFs would need these
client records for regulatory purposes to the extent that the client is
not directing the asset manager to trade on its behalf, but rather
allowing the asset manager to exercise discretion in trading swaps.
Therefore, the potential risks of manipulation, price distortion, and
disruptions of the delivery or cash settlement process, which a SEF is
required to prevent through trade monitoring under Core Principle 4,
may be less attributable to such clients. To the extent that such risks
may exist, however, the Commission believes it is sufficient for SEFs
to have access to records that relate to the asset manager, who is
conducting the actual swaps trading activity.
Request for Comment
The Commission requests comment on all aspects of proposed Sec.
37.2(b). The Commission is particularly interested in the impact of the
scope of the proposed ``market participant'' definition on various
constituencies and, therefore, requests comment on the following
questions:
(1) Is the Commission's proposed definition of ``market
participant'' clear and complete? Please comment on any aspect of the
definition that you believe is not clear or adequately addressed.
(2) Should the proposed definition of ``market participant''
distinguish between clients that give up complete trading discretion to
an asset manager or another SEF participant and clients that do not so
give up discretion or only give up partial discretion? If so, on what
basis should the definition establish such a distinction?
(3) Do customers currently access a SEF through an intermediary,
e.g., an FCM or IB, and direct that intermediary to trade on their
behalf through an agency-based approach? If this is not common, could
this method of accessing a SEF become more common in the future? If so,
under what circumstances would this occur? Is the third prong of the
proposed ``market participant'' definition appropriate, which would
include a person who directs an intermediary that accesses a SEF to
trade on its behalf? If not, then why?
(4) Are there any other methods that are either currently being
used or could be used to access a SEF? Are there any other examples of
how a person could access a SEF through access or functionality
provided by a third party? What type of abusive trading practices, if
any, could a customer attempt to conduct if the customer directs its
trading through an intermediary such as an FCM or an IB? Please provide
examples.
(5) What type of abusive trading practices, if any, could a client
of an asset manager conduct if the client gives up complete trading
discretion to the asset manager? Please provide examples. If the client
allows an asset manager to exercise discretion in trading swaps, what
are the risks of manipulation, price distortion, and disruptions of the
delivery or cash settlement process that may be attributable to the
client?
(6) Does a SEF's ability to monitor trading to prevent such risks
require it to have access to client trading records that include
activity in the index or instrument used as a reference price, the
underlying commodity, and related derivatives markets? Are there any
trading records that are currently created and maintained by clients of
asset managers that would not also be retained by the asset managers?
If so, please describe such records. Should SEFs receive such records
for regulatory purposes?
[[Page 61956]]
C. Sec. 37.3--Requirements and Procedures for Registration
1. Sec. 37.3(a)--Requirements for Registration \58\
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\58\ The Commission proposes to renumber paragraph (a)(1) to
subsection (a) based on the proposed elimination of the minimum
trading functionality requirement under Sec. 37.3(a)(2) and the
Order Book definition under Sec. 37.3(a)(3) described below.
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CEA section 5h(a)(1) establishes the SEF registration requirement
and specifies 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.\59\ In adopting the SEF Core Principles Final Rule, the Commission
affirmed its view under existing Sec. 37.3(a)(1) that the broad
registration requirement in CEA section 5h(a)(1) applies only to
facilities that meet the SEF definition in CEA section 1a(50).\60\ In
furtherance of CEA section 5h(a)(1), existing Sec. 37.3(a)(1) states
that any person operating a facility that offers a trading system or
platform in which more than one market participant has the ability to
execute or trade swaps with more than one other market participant on
the system or platform shall register the facility as a SEF or as a
DCM.\61\ The Commission believed that this interpretation of the
statutory SEF registration requirement would help further the statutory
SEF goals of promoting swaps trading on SEFs and promoting pre-trade
price transparency in the swaps market.\62\
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\59\ CEA section 5h(a)(1) states that no person may operate a
facility for the trading or processing of swaps unless the facility
is registered as a swap execution facility or as a designated
contract market. 7 U.S.C. 7b-3(a)(1).
\60\ SEF Core Principles Final Rule at 33481. The statutory SEF
definition in CEA section 1a(50) provides that a SEF is a trading
system or platform in which multiple participants have the ability
to execute or trade swaps by accepting bids and offers made by
multiple participants in the facility or system, through any means
of interstate commerce, including any trading facility, that
facilitates the execution of swaps between persons; and is not a
designated contract market. 7 U.S.C. 1a(50).
\61\ 17 CFR 37.3(a)(1). In addition to SEFs, existing Sec.
37.3(a)(1) also references registration as a DCM. While the trading
of swaps may occur through either a SEF or a DCM, CEA section 2(e)
limits the trading of swaps on SEFs to ECPs. Both ECPs and non-ECPs
may trade swaps through a DCM. 7 U.S.C. 2(e).
\62\ SEF Core Principles Final Rule at 33481.
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As discussed further below, the Commission is proposing to apply
the SEF registration requirement to several types of entities. The
Commission does not intend for the discussion in this notice to
exhaustively address which entities must register as a SEF. Rather, a
determination of whether an entity must register as a SEF pursuant to
CEA section 5h(a)(1) would depend on an evaluation of the operations of
the entity, in particular whether it meets the SEF definition under CEA
section 1a(50).\63\
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\63\ The Commission notes that the preamble to the SEF Core
Principles Final Rule addresses the applicability of the SEF
registration requirement in CEA section 5h(a)(1) to several types of
entities that facilitate swaps activity. SEF Core Principles Final
Rule at 33479-84. The Commission maintains its approach to these
types of entities with respect to the registration requirement,
except as discussed herein. See infra Section IV.C.1.b.--Single-
Dealer Aggregator Platforms (addressing the SEF registration
requirement with respect to single-dealer aggregator platforms).
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a. Footnote 88
As noted above, the Commission has stated that the SEF registration
requirement in CEA section 5h(a)(1) \64\ only applies to facilities
that meet the statutory SEF definition in CEA section 1a(50).\65\ In
footnote 88 of the preamble to the SEF Core Principles Final Rule, the
Commission specifically stated that the SEF registration requirement is
not limited by the trade execution requirement in CEA section 2(h)(8),
``such that only facilities trading swaps subject to the trade
execution requirement would be required to register as a SEF.\66\
Therefore, a facility is required to register as a SEF if it operates
in a manner that meets the statutory SEF definition even though it only
executes or trades swaps that are not subject to the trade execution
[requirement].'' \67\ The Commission adopted this approach despite
several comments to the proposed part 37 regulations, stating that
registration as a SEF should only be required if an entity both met the
SEF definition and offered swaps subject to the trade execution
requirement.\68\ The Commission stated that its approach to this issue
is consistent with the statutory SEF registration requirement, the
statutory SEF definition, and the trade execution requirement; the
Commission also held that its approach promotes the statutory SEF
goals.\69\
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\64\ 7 U.S.C. 5h(a)(1).
\65\ 7 U.S.C. 1a(50).
\66\ SEF Core Principles Final Rule at 33481 n.88.
\67\ Id.
\68\ Id. at 33479-80.
\69\ Id. at 33481-82.
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The Commission proposes to codify this existing approach to the SEF
registration requirement by amending Sec. 37.3(a)(1) to state that a
person operating a facility that meets the statutory SEF definition
must register as a SEF without regard to whether the swaps that it
lists for trading are subject to the trade execution requirement. This
proposed amendment is intended to clarify that the trade execution
requirement is not a determinant of whether an entity must register as
a SEF by codifying the requirement that an entity must register as a
SEF if it permits trading or execution of any swap, including swaps
that are not subject to the trade execution requirement, in a manner
consistent with the statutory SEF definition, i.e., trading or
execution on a ``multiple-to-multiple'' basis among market
participants.
Request for Comment
The Commission requests comment on all aspects of the proposed
amendment to Sec. 37.3(a).
b. Single-Dealer Aggregator Platforms
In the preamble to the SEF Core Principles Final Rule, the
Commission evaluated the application of the statutory SEF registration
requirement to various swaps market entities, including ``aggregation
services or portals'' (``SEF Aggregator Portals'') and ``one-to-many
systems or platforms'' (``Single-Dealer Platforms'').\70\ The
Commission generally determined that SEF Aggregator Portals and Single-
Dealer Platforms do not meet the statutory SEF definition and therefore
are not required to register as SEFs.\71\
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\70\ SEF Core Principles Final Rule at 33481-83.
\71\ See id.
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As the Commission has gained greater knowledge and experience with
the swaps market, however, it has become aware of a different type of a
trading system or platform that implicates the SEF registration
requirement--trading systems or platforms that aggregate Single-Dealer
Platforms (``Single-Dealer Aggregator Platforms''). Specifically, a
Single-Dealer Aggregator Platform typically operates a trading system
or platform that aggregates multiple Single-Dealer Platforms and, thus,
enables multiple dealer participants to provide executable bids and
offers, often via two-way quotes, to multiple non-dealer participants
on the system or platform. Those non-dealer participants are thus able
to view, execute, or trade swaps posted to the Single-Dealer Aggregator
Platform's system or platform from multiple dealer participants. These
types of systems or platforms, however, have not registered their
operations as SEFs.
The Commission believes that the type of trading system or platform
provided by Single-Dealer Aggregator Platforms should be subject to the
SEF registration requirement because it meets the SEF definition in CEA
section 1a(50) by allowing multiple participants to trade swaps by
accepting bids and offers made by multiple participants in the facility
or system.\72\
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\72\ 7 U.S.C. 1a(50).
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[[Page 61957]]
While a Single-Dealer Aggregator Platform has elements that
resemble a Single-Dealer Platform, which is a type of entity that does
not trigger the SEF registration requirement,\73\ the Commission
believes that both types of platforms are distinguishable from one
another. In the preamble to the SEF Core Principles Final Rule, the
Commission characterized Single-Dealer Platforms as systems or
platforms in which a single dealer serves as a single liquidity
provider by exclusively providing all bids and offers against which its
customers, i.e., participants, trade or execute swaps.\74\ Accordingly,
the dealer serves as the counterparty to all swaps executed on its
trading system or platform.\75\ Unlike the ``one-to-many'' nature of a
Single-Dealer Platform, however, a Single-Dealer Aggregator Platform
comports with the SEF definition in CEA section 1a(50) by providing a
trading system or platform where multiple dealers send or stream bids
and offers to multiple participants, thereby subjecting them to SEF
registration.
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\73\ SEF Core Principles Final Rule at 33482.
\74\ Id.
\75\ See id.
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The Commission also believes that Single-Dealer Aggregator
Platforms are distinguishable from SEF Aggregator Portals. SEF
Aggregator Portals are services or portals that enable market
participants to access multiple SEFs, each of which provides a trading
system or platform that facilitates the trading or execution of swaps
between multiple participants. In the preamble to the SEF Core
Principles Final Rule, the Commission stated that a SEF Aggregator
Portal does not meet the statutory SEF definition because it merely
provides a portal through which its users may access multiple SEFs,
rather than providing a venue for the trading or execution of
swaps.\76\ A SEF Aggregator Portal does not provide a trading system or
platform where multiple participants have the ability to execute or
trade swaps with multiple participants within its facility; rather, the
multiple-to-multiple participant execution or trading occurs on the SEF
and not the SEF Aggregator Portal. A Single-Dealer Aggregator Platform,
in contrast, acts as more than a mere portal because it provides a
system or platform for multiple-to-multiple participant swaps trading
or execution, thereby subjecting it to the SEF registration
requirement.
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\76\ Although the Commission maintains that a SEF Aggregator
Portal is generally not required to register as a SEF, such a system
or platform may be subject to the Act and Commission regulations as
an IB, as defined in CEA section 1a(31), given that its activity may
constitute soliciting or accepting orders to be routed to SEFs. 7
U.S.C. 1a(31).
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Request for Comment
The Commission requests comment on all aspects of the proposed
application of the SEF registration requirement to Single-Dealer
Aggregator Platforms. The Commission may consider alternatives to the
proposed application of the registration requirement to Single-Dealer
Aggregator Platforms and requests comment on the following questions:
(7) Is the Commission's position that Single-Dealer Aggregator
Platforms meet the SEF definition appropriate? Please explain.
(8) Should the Commission apply the SEF registration requirement to
any other type of entity or activity? If so, please describe the type
of entity and/or activity at issue.
(9) What factors, if any, would prevent a Single-Dealer Aggregator
Platform from complying with the SEF registration requirement?
(10) Is the Commission's existing position that SEF Aggregator
Portals and Single-Dealer Platforms do not satisfy the statutory SEF
definition appropriate? Please explain.
c. Swaps Broking Entities, Including Interdealer Brokers
In the preamble to SEF Core Principles Final Rule, the Commission
specified whether the SEF registration requirement would apply to
several specific types of entities,\77\ but did not address whether the
requirement would apply to swaps broking entities, i.e., interdealer
brokers, most of whom are registered with the Commission as IBs and
traditionally facilitate swaps trading in the over-the-counter
(``OTC'') markets.\78\ As discussed below, the Commission believes that
the activities of these entities--firms operating trading systems or
platforms that facilitate swaps trading primarily between swap
dealers--trigger the SEF registration requirement because they allow
multiple participants to trade swaps with multiple participants in a
manner consistent with the language of CEA sections 5h(a)(1) and 1a(50)
(emphasis added). In light of existing market practices, the Commission
believes that it is necessary to apply the SEF registration requirement
to ensure that the multiple-to-multiple ``trading'' that occurs on such
trading systems or platforms is subject to the Act and Commission's
regulations as regulated SEFs. This application is consistent with
Congressional intent, as evidenced by the statutory SEF registration
requirement and SEF definition, and is further consistent with the
statutory SEF goals.
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\77\ As noted in the preamble to the SEF Core Principles Final
Rule, the Commission received comments characterizing the SEF
registration requirement as ambiguous and requesting that the
Commission provide clarification with respect to certain entities.
SEF Core Principles Final Rule at 33479-81. In response, the
Commission provided examples of how the SEF registration requirement
would or would not apply to ``certain categories of better
understood facilities.'' Id. at 33482-84. These categories included
(i) one-to-many systems or platforms; (ii) blind auction systems or
platforms; (iii) aggregation services or portals; (iv) services
facilitating portfolio compression and risk mitigation transactions;
and (v) swap processing services. The Commission, however,
emphasized that these examples do not ``comprehensively'' address
all entities that are subject to SEF registration and urged
participants to seek clarification from the Commission as to how the
registration requirement applied to their particular operations. Id.
at 33482.
\78\ ``Interdealer broker,'' as used in this notice, refers to
an interdealer broker entity or operation in the aggregate and not
to a particular individual, i.e., an associated person, who works as
a broker within the entity or operation. The Commission, however,
considers such individuals to constitute part of the interdealer
broker's trading system or platform. See infra Section VI.A.1.--
Sec. 37.201(a)--Required Swap Execution Facility Rules (specifying
proposed rules for SEF execution methods that apply to activities of
SEF trading specialists who facilitate swaps trading or execution
by, among other things, conducting broking-like functions).
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The Commission understands that the proposed interpretation may
require certain non-domestic operations--in particular, foreign swaps
broking entities, such as foreign interdealer broker operations--to
seek SEF registration or an exemption from SEF registration pursuant to
CEA section 5h(g), provided that they fall within the Commission's
jurisdiction.\79\ Given the potentially complex issues that may arise
for these entities from the Commission's proposed application of the
SEF registration requirement, the Commission proposes below to delay
the compliance date of the requirement with respect to such entities
and their operations. This proposed delay would allow the Commission to
further develop its cross-border regulatory regime, including the
achievement of additional comparability determinations with foreign
regulators regarding their respective regulatory frameworks for swap
trading venues located within their respective jurisdictions, i.e.,
foreign multilateral swaps trading
[[Page 61958]]
facilities, which would include foreign swaps broking entities as
described below. Such a determination would allow such operations to
seek an exemption from SEF registration. A delay would also provide
time to foreign swaps broking entities to determine an appropriate
course of action for their respective operations.\80\
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\79\ Pursuant to CEA section 5h(g), the Commission may exempt a
facility from SEF registration upon a finding that it is subject to
``comparable, comprehensive supervision and regulation'' under the
rules and regulations of the facility's home country. 7 U.S.C. 7b-
3(g). See infra Section IV.C.1.d.--Foreign Swaps Broking Entities
and Other Foreign Multilateral Swaps Trading Facilities.
\80\ The Commission notes that potential courses of action for
such entities may include seeking SEF or DCM registration;
reorganizing into an existing affiliated SEF; working with the
appropriate regulator within their home country to seek an exemption
from registration pursuant to CEA section 5h(g); or adjusting their
activity to avoid the Commission's jurisdiction.
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(1) Structure and Operations of Swaps Broking Entities, Including
Interdealer Brokers
Since adopting part 37, the Commission has developed a deeper
understanding of the swaps market and has observed how swaps broking
entities, including interdealer brokers, have structured themselves in
relation to the current SEF regulatory framework. Interdealer broker
trading systems or platforms facilitate swaps trading between multiple
customers by negotiating or arranging swaps through voice-based or
voice-assisted systems that combine voice functionalities with
electronic systems such as order books. Swap dealers currently use
these trading systems or platforms for several purposes, including
obtaining market color or maintaining pre-trade anonymity in the course
of trading. Specifically, an interdealer broker typically ``works''
customer orders by issuing RFQs-to-all among other customers and
negotiating or arranging any resultant bids or offers. Once the
interdealer broker arranges a reciprocating bid and reciprocating
offer, it sets a price for a specific swap transaction for a particular
product, which in many cases enables a subsequent ``trade work-up''
session.\81\ Finally, the interdealer broker will either facilitate the
execution of the transaction(s) if the broker is part of a SEF's
trading system or platform \82\ or will otherwise route the pre-
arranged transaction(s) to a SEF for execution if the broker is not a
part of the registered SEF.
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\81\ For a description of a ``trade work-up'' session, see infra
note 269.
\82\ As discussed below, persons operating within these SEFs
that facilitate swaps trading are commonly referred to as ``trading
specialists'' or ``execution specialists.'' See infra Section
VI.A.3.--Sec. 37.201(c)--SEF Trading Specialists.
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The Commission notes that interdealer brokers have adopted varying
approaches to structuring themselves in relation to the SEF regulatory
framework. Some interdealer brokers have registered components of their
trading systems or platforms as SEFs. Other interdealer brokers have
operated very similar trading systems or platforms outside of the
structure of a SEF, often through registered IB entities, and have
interacted with a SEF solely as participants of the SEF.\83\ As SEF
participants, they submit transactions, which have already been
arranged on those trading systems or platforms, to the SEF for
execution. Notably, many interdealer brokers have maintained the latter
approach by operating both a SEF platform and a non-SEF trading system
or platform simultaneously, using the latter to facilitate the
interaction of bids and offers and bringing the resulting arranged
swaps to the SEF for execution.
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\83\ In becoming participants on a SEF, interdealer brokers
typically meet the SEF's access criteria prior to onboarding, which
provides them with trading privileges on the SEF. As SEF
participants, they are subject to the SEF's jurisdiction, including
all applicable disciplinary rules, similar to any other SEF
participant. Where the SEF offers its participants the ability to
submit pre-arranged or pre-negotiated transactions for execution, an
interdealer broker SEF participant will route transactions it has
arranged between its customers or clients, who are also SEF
participants, for execution on the SEF.
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This bifurcated approach has existed despite the close similarities
among interdealer broker trading systems or platforms, whether they are
registered or not as SEFs--they offer trading systems or platforms that
facilitate the trading of swaps between multiple participants. This
approach, however, has been justified by the execution of the swap on a
SEF; as noted, the interdealer brokers that conduct activity on non-SEF
platforms ultimately route the pre-arranged transactions to a SEF where
they are executed. This approach seems premised on the view that
because the execution occurs on a registered SEF, the facilitating
interdealer broker does not need to register as a SEF, notwithstanding
its role in negotiating or arranging the transaction(s).
To facilitate trading in Required Transactions outside the SEF,
these interdealer broker trading systems or platforms typically operate
outside of SEFs pursuant to the time delay requirement for Required
Transactions under Sec. 37.9(b).\84\ Under Sec. 37.9(b), the
Commission implemented a fifteen-second time-delay requirement for
Required Transactions that are pre-arranged or pre-negotiated by a
broker and submitted as cross trades for execution through the SEF's
Order Book. This requirement allows a broker or dealer to execute a
Required Transaction by trading against a customer's order or executing
two customers' orders against each other through pre-negotiation or
pre-arrangement, provided that one side of the transaction is exposed
to the Order Book for fifteen seconds before the other side of the
transaction is submitted for execution. The time delay is intended to
provide other market participants with an opportunity to execute
against the first order.\85\ In practice, however, the time delay
requirement has enabled interdealer brokers to facilitate ``trading''
of swaps i.e., the negotiating or arranging of swaps transactions
outside the SEF, through the interdealer brokers' multiple-to-multiple
trading systems or platforms. Negotiating or arranging consists of
facilitating the interaction of bids and offers.\86\ Once the
transaction is pre-negotiated or pre-arranged through the interdealer
broker's multiple-to-multiple trading system or platform, the
interdealer broker routes the pre-arranged transaction to the SEF,
where one side of the transaction is exposed for fifteen seconds on the
Order Book prior to the entry of the other side for execution.
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\84\ 17 CFR 37.9(b).
\85\ SEF Core Principles Final Rule at 33503. See infra note 322
and accompanying discussion (describing the policy reason for the
Sec. 37.9(b) time delay requirement).
\86\ See infra Section VI.A.2.a.--Sec. 37.201(b)--Pre-Execution
Communications (discussion of how pre-execution communications
between market participants constitute ``trading'').
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For swaps that are not subject to the trade execution requirement,
i.e., Permitted Transactions, SEFs have allowed their market
participants to conduct trading via pre-execution communications away
from their respective facilities and then submit the resulting
transaction, with the price, terms, and conditions already agreed upon
between the participants, to the SEF's trade capture functionality for
execution.\87\ The Commission notes that several SEFs affiliated with
interdealer brokers offer this type of functionality based in part on
the execution flexibility allowed under Sec. 37.9(c)(2) for Permitted
Transactions, i.e., a SEF may offer any method of execution for such
swaps. Accordingly, interdealer brokers submit Permitted Transactions
that have been negotiated or arranged through their trading systems or
platforms to an affiliated SEF without being subject to any
corresponding order exposure (e.g., a fifteen-second time-delay).\88\
Coupled
[[Page 61959]]
with the ability to submit Required Transactions in accordance with the
time delay requirement, these arrangements essentially enable the
operation of multiple-to-multiple trading systems or platforms for a
broad range of swaps outside of the SEF regulatory framework.
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\87\ For further discussion of this execution method, see infra
Section VI.A.2.--Sec. 37.203(a)--Pre-Arranged Trading Prohibition;
Sec. 37.9--Time Delay Requirement.
\88\ The Commission has also observed that other swaps broking
entities that are not affiliated with a SEF similarly negotiate or
arrange transactions away from a registered SEF and subsequently
submit those transactions to a registered SEF for execution. These
types of transactions, however, are less common and constitute a
smaller portion of the overall volume of relevant transactions
discussed herein.
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(2) SEF Registration Requirement for Swaps Broking Entities, Including
Interdealer Brokers
Based on the statutory SEF registration requirement and SEF
definition, the associated SEF goals, the Commission's experience and
knowledge from implementing part 37, and its evaluation of trading
practices that have developed under the current SEF regulatory
framework with respect to swaps broking entities that include
interdealer brokers, the Commission proposes that a trading system or
platform operated by such an entity must register as a SEF pursuant to
CEA section 5h(a)(1) and Sec. 37.3(a).\89\ The Commission believes
that such trading systems or platforms conform to the statutory SEF
definition because they allow multiple participants to trade swaps by
accepting bids and offers made by multiple participants in that
facility or system (emphasis added). As described above, these trading
systems or platforms facilitate the negotiation or arrangement of swap
transactions through the interaction of bids and offers. The Commission
believes that this ``trading'' activity should occur within a SEF,
regardless of whether the product is subject to the trade execution
requirement.\90\ Accordingly, entities operating these types of trading
systems or platforms should be subject to the SEF registration
requirement.\91\
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\89\ Although the Commission's description of swaps broking
entities above focuses on the dealer-to-dealer market, the
Commission clarifies that any person operating a system or platform
for multiple-to-multiple participant swaps trading as described
herein must register as a SEF consistent with CEA section 5h(a)(1)
and Sec. 37.3(a) (emphasis added).
\90\ The Commission notes that this view is consistent with the
proposed amendment to Sec. 37.3(a) to clarify that a person
operating a facility that meets the statutory SEF definition must
register as a SEF without regard to whether the swaps that it lists
for trading are subject to the trade execution requirement. See
supra Section IV.C.1.a.--Footnote 88. As part of the proposed
elimination of the prescriptive execution methods under Sec. 37.9
for Required Transactions, the Commission is proposing to eliminate
the time delay requirement under Sec. 37.9(b). See infra Section
VI.A.2.--Sec. 37.203(a)--Pre-Arranged Trading Prohibition; Sec.
37.9(b)--Time Delay Requirement. Based on this proposed elimination
and the adoption of a flexible approach to SEF execution methods,
the Commission notes that rules permitting the pre-arrangement or
pre-negotiation of a swap transaction subject to a time delay
requirement would no longer be needed or allowed.
\91\ In addition to negotiation or arrangement that occurs
through a swaps broking entity, the Commission believes that
negotiation or arrangement that occurs directly between participants
should also occur within a SEF. The Commission is proposing to
require SEFs to have rules that prohibit market participants from
engaging in pre-execution communications, i.e., negotiation or
arrangement of swaps, away from a SEF's trading system or platform,
subject to certain exceptions. See infra Section VI.A.2.a.--Sec.
37.201(b)--Pre-Execution Communications.
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In addition to the statutory basis for this application, the
Commission's proposed approach would advance the Dodd-Frank goals of
promoting swaps trading on SEFs and pre-trade price transparency.\92\
The Commission believes that the operation of multiple-to-multiple
swaps trading systems or platforms by swaps broking entities, including
interdealer brokers outside of SEFs has frustrated these statutory
goals and moved liquidity formation away from SEFs. To promote both
trading on SEFs and pre-trade price transparency, the Commission
believes that the activities associated with swaps trading should occur
on SEFs consistent with the SEF registration requirement. Allowing such
activities to occur away from a SEF and submitting any resulting
transactions to a SEF for execution effectively makes the SEF a trade-
booking or post-trade processing engine, which is inconsistent with the
statutory language and goals of the CEA related to SEFs.
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\92\ 7 U.S.C. 7b-3(e).
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The Commission also believes that requiring these types of swaps
broking entities to register as SEFs would help to consistently apply
the SEF regulatory framework over a segment of swaps trading activity
that is very similar to registered SEF activity. Interdealer brokers
currently operate trading systems or platforms outside of the SEF
regulatory framework, yet act as participants on SEFs, resulting in
multiple-to-multiple trading that is opaque not only to the SEF where
the negotiated or arranged trade is eventually routed to for execution,
but also to the Commission and the general marketplace. Although many
interdealer brokers are registered as IBs pursuant to CEA section 4f
and are subject to the Commission's rules and regulations,\93\ the
Commission believes that these requirements are neither intended nor
sufficient for the regulation and oversight of such interdealer
brokers' multiple-to-multiple trading activity. The Commission believes
that Congress would not have created SEFs and added the word
``trading'' in the statutory SEF registration requirement and SEF
definition if it intended that an IB framework would be sufficient for
swaps ``trading.'' Given that these interdealer brokers operate trading
systems or platforms outside of the SEF regulatory framework that are
very similar to the activity that occurs on trading systems or
platforms that are located within interdealer brokers' registered
affiliated SEFs,\94\ the Commission believes such activity would be
more appropriately subject to a SEF-specific regulatory framework. This
approach would achieve the policy goal of applying more consistent
regulatory treatment to very similar swaps market activity.
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\93\ 7 U.S.C. 6f(a). Part 3 sets forth the registration and
regulatory requirements for IBs, among other registered entities. 17
CFR part 3. Among those requirements, IBs are required to register
with the National Futures Association (``NFA'') and therefore are
also subject to the NFA rules and regulations. 17 CFR 3.2. The
Commission further notes that Sec. 155.4 sets forth trading
standards for IBs. 17 CFR 155.4. For a description of additional IB-
related Commission requirements, see infra note 341.
\94\ The Commission emphasizes that an interdealer broker that
solely solicits or accepts individual or single bids or offers and
introduces them to an exchange, such as a SEF, would not be required
to register as a SEF because it would not be facilitating the
``trading,'' i.e., negotiating or arranging of swaps between
multiple market participants consistent with the SEF registration
requirement. Such brokers would be able to continue to engage in
such solicitation or acceptance in conformance with the IB
definition. 7 U.S.C. 1a(31).
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Requiring interdealer brokers to either register as SEFs or carry
out their multiple-to-multiple trading activities within a SEF would
also enhance market integrity and monitoring because such activities
would become subject to the SEF core principles and regulations, as
well as direct regulatory oversight of a SEF in its capacity as a self-
regulatory organization (``SRO'').\95\ For example, Core Principle 2
requires SEFs to establish and enforce trading, trade processing, and
participation rules that will deter abuses and have the capacity to
detect, investigate, and enforce those rules, including means to
capture information that may be used in establishing whether rule
violations have occurred.\96\ These requirements enable SEFs to more
comprehensively monitor for, among other things, potential abusive
trading practices such as fraud and manipulation.\97\ The
[[Page 61960]]
Commission notes that establishing SEF monitoring and surveillance
requirements over activity in the interdealer broker market is
especially beneficial based on the role of interdealer brokers in the
manipulation of ISDAFIX, a benchmark for swap rates and spreads for
IRS; and the London Interbank Offered Rate (``LIBOR''), an average
benchmark for short-term interest rates used to determine floating
rates for IRS.\98\
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\95\ 17 CFR 1.3 (definition of ``self-regulatory
organization'').
\96\ 7 U.S.C. 7b-3(f)(2)(B).
\97\ Given that the interdealer brokers are participants of the
SEFs to which they submit negotiated or arranged transactions for
execution, the Commission notes that SEFs still have jurisdiction
over that activity and could investigate suspected prohibited
activity and issue sanctions where appropriate, pursuant to the
SEF's self-regulatory obligations.
\98\ See, e.g., Enforcement Order re: Soci[eacute]t[eacute]
G[eacute]n[eacute]rale S.A. Attempted Manipulation and False
Reporting of LIBOR and Euribor, CFTC Docket No. 18-14 (June 4,
2018); see also Enforcement Order re: JP Morgan Chase Bank, N.A.
Attempted Manipulation of U.S. Dollar ISDAFIX Benchmark, CFTC Docket
No. 18-15 (June 18, 2018).
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Accordingly, the Commission proposes that swaps broking entities,
including interdealer brokers, that offer a trading system or platform
in which more than one market participant has the ability to trade any
swap with more than one other market participant on the system or
platform, shall register as a SEF or seek an exemption from
registration pursuant to CEA section 5h(g) (emphasis added). Where an
entity operates both a registered SEF and an affiliated swaps broking
entity--such as an interdealer broker--that negotiates or arranges
trades via a non-SEF trading system or platform and participates on the
affiliated SEF as a market participant, the swaps broking entity could
also comply with the SEF registration requirement by integrating its
non-SEF trading system or platform into its affiliated SEF. The
Commission believes that this proposed application of the SEF
registration provision in CEA section 5h(a)(1), which the Commission
continues to interpret in conjunction with the SEF definition in CEA
section 1a(50), is consistent with the statute and helps further the
statutory SEF goals provided in CEA section 5h.
The Commission proposes to delay the application of the SEF
registration requirement with respect to swaps broking entities,
including interdealer brokers, for a period of six months, subject to
certain conditions and starting from the compliance date of any final
rule adopted from this proposed rulemaking. Swaps broking entities,
including interdealer brokers, that meet the conditions set forth below
would be able to continue to maintain their current practice of
facilitating the negotiating or arranging of swaps transactions between
multiple participants and routing those swaps transactions to SEFs for
execution.\99\ Without the six-month delay period, the Commission
believes that applying the SEF registration requirement to these
entities would disrupt their operations and further fragment swaps
liquidity.
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\99\ As discussed below, the Commission is proposing Sec.
37.201(b) to prohibit the use of pre-execution communications by
market participants away from a SEF's trading system or platform.
See infra Section VI.A.2.a.--Sec. 37.201(b)--Pre-Execution
Communications. The Commission notes that to the extent swaps
broking entities, including interdealer brokers, engage in such
communications in the course of negotiating or arranging
transactions and submitting them to a SEF for execution, the
prohibition--if adopted via a final rule--would not apply during the
six-month period.
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As applied to swaps broking entities, including interdealer
brokers--most of whom are registered with the Commission as IBs--the
Commission proposes that the six-month delay from the SEF registration
requirement would be subject to the following conditions:
(i) All swap transactions that are traded on a swaps broking
entity, including an interdealer broker, must be routed for execution
to a SEF; and
(ii) The swaps broking entity, including an interdealer broker,
must provide electronically the following information with respect to
itself to the Secretary of the Commission at [email protected] and
the Commission's Division of Market Oversight (``Division'' or ``DMO'')
at [email protected]: (i) Entity name as it appears in the
entity's charter; (ii) name and address of the entity's ultimate parent
company; (iii) any names under which the entity does business; (iv)
address of principal executive office; (v) a contact person's name,
address, phone number, and email address; (vi) asset classes and swap
products for which the entity facilitates trading; and (vii) any
registrations, authorizations, or licenses held.\100\
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\100\ The Commission anticipates that the effective date of any
final rule would be established ninety days from the publication of
the rule in the Federal Register. The Commission believes that the
proposed ninety-day period would provide swaps broking entities,
including interdealer brokers seeking to avail themselves of the
six-month compliance date delay with a sufficient opportunity to
compile and submit this information to the Commission.
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Upon a DMO determination that a swaps broking entity's notice is
complete, the Commission proposes to post these notices on the
Commission's website under the ``Industry Filings'' page. This proposed
approach would effectively maintain the status quo for these swaps
broking entities for the proposed six-month delay period.
The Commission notes that the proposed six-month delay for swaps
broking entities, including interdealer brokers, does not affect any
other requirements under the CEA or the Commission's regulations. In
particular, this delayed compliance date would not affect the
application of CEA section 2(e) and its requirement that only ECPs be
permitted to trade swaps on SEFs.\101\
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\101\ 7 U.S.C. 2(e). See supra note 61.
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As part of this proposed transition period, swaps broking entities,
including interdealer brokers, would be able to route their
transactions to a SEF for execution. Furthermore, during this period,
counterparties subject to the trade execution requirement would be able
to satisfy that requirement by trading via a swaps broking entity,
including an interdealer broker, that routes the transactions to a SEF
for execution.
Request for Comment
The Commission requests comment on all aspects of the proposed
application of the SEF registration requirement to swaps broking
entities. The Commission may consider alternatives to the proposed
application of the requirement and requests comment on the following
questions:
(11) Is the Commission's view that swap broking entities, including
interdealer brokers, meet the SEF definition appropriate? Please
explain why or why not. Is it clear what activity falls within the SEF
registration requirement and SEF definition, including the meaning of
``trading''? If not, please explain.
(12) Should the Commission apply the SEF registration requirement
to any other type of entity or activity?
(13) What factors, if any, would prevent a swaps broking entity,
including an interdealer broker, from complying with the SEF
registration requirement or from seeking an exemption from registration
pursuant to CEA section 5h(g)?
(14) Is the proposed six-month delay period sufficient to allow
swaps broking entities, including interdealer brokers, time to seek
registration or alter their operations in compliance with the SEF
registration requirements? Why or why not?
(15) Should the Commission allow swaps broking entities, including
interdealer brokers, to route swap transactions to exempt SEFs during
this six-month delay period? Why or why not?
d. Foreign Swaps Broking Entities and Other Foreign Multilateral Swaps
Trading Facilities
As discussed above, the Commission has observed that swaps broking
[[Page 61961]]
entities, including interdealer brokers, have utilized various business
structures to operate in a bifurcated manner, i.e., a SEF and a non-SEF
trading system or platform. One common structure consists of an entity
that serves as a parent to a registered SEF entity and several
affiliated broker entities that negotiate or arrange trades and
participate exclusively on the affiliated SEF as market participants.
While many of those broker entities are domestically domiciled, a
significant number of them are also located in numerous foreign
jurisdictions.\102\ Similar to domestic swaps broking entities, these
foreign swaps broking entities are not currently registered as SEFs,
but are typically registered with the Commission as IBs.\103\ These
entities often serve as hubs for liquidity within their particular
jurisdiction during non-U.S. trading hours--operating trading systems
or platforms that facilitate the negotiating or arranging of
transactions for multiple U.S. persons with local customers and the
routing of those transactions to an affiliated SEF for execution.\104\
These foreign swaps broking entities' trading systems or platforms are
very similar to those operated by swaps broking entities within in the
U.S., such that they provide more than one market participant with the
ability to trade swaps with more than one other market participant
(emphasis added). Therefore, the Commission proposes that these foreign
swaps broking entities are ``foreign multilateral swaps trading
facilities,'' which are foreign facilities that operate a trading
system or platform where multiple participants have the ability to
execute or trade swaps with multiple market participants.
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\102\ Based on discussions with market participants, the
Commission is aware of foreign swaps broking entities that are
interdealer brokers located in numerous foreign jurisdictions,
including Australia, Brazil, Canada, Chile, Colombia, Hong Kong,
Japan, Mexico, Singapore, and South Korea, that participate on SEFs.
The Commission is also aware that interdealer brokers domiciled in
the European Union (``EU'') operate as investment firms that operate
Multilateral Trading Facilities (``MTFs'') and Organized Trading
Facilities (``OTFs''). The Commission notes that it has exempted
certain MTFs and OTFs located in the EU from registration as SEFs
pursuant to CEA section 5h(g). See infra note 109 (describing
December 2017 exemptive order issued by the Commission to certain
MTFs and OTFs based on comparability determination).
\103\ See supra note 93 (general description of Commission
requirements with respect to IBs).
\104\ For purposes of this discussion, the term ``U.S. person''
identifies those persons who, under the Commission's interpretation,
could be expected to satisfy the jurisdictional nexus set forth in
CEA section 2(i) based on their swap activities, either on an
individual or aggregate basis. See Interpretive Guidance and Policy
Statement Regarding Compliance With Certain Swap Regulations; Rule,
78 FR 45292, 45301 (Jul. 26, 2013) (``2013 Cross-Border Guidance'').
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Consistent with the proposal regarding the SEF registration
requirement above, such foreign multilateral swaps trading facilities,
including foreign swaps broking entities, would be required to register
as a SEF or seek an exemption from SEF registration if their activity
falls within the jurisdictional reach of the Commission pursuant to CEA
section 2(i). Pursuant to CEA section 2(i), activities outside of the
U.S. are not subject to the swap provisions of the CEA, including any
rules prescribed or regulations promulgated thereof, unless those
activities either have a ``direct and significant connection'' with
activities in, or effect on, commerce of the United States; or
contravene any rule or regulation established to prevent evasion of a
Dodd-Frank Act-enacted provision of the CEA.\105\ The Commission
expects that it will clarify the cross-border jurisdictional reach of
the SEF registration requirement in the future for foreign multilateral
swaps trading facilities, including foreign swaps broking entities,
pursuant to CEA section 2(i).\106\ To the extent that a foreign
multilateral swaps trading facility's activities are determined to fall
within the Commission's jurisdictional reach, the facility would be
required to register as a SEF or seek an exemption from SEF
registration.\107\
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\105\ 7 U.S.C. 2(i).
\106\ In November 2013, DMO issued guidance regarding the
application of the SEF registration requirement to foreign
multilateral swaps trading facilities. Division of Market Oversight
Guidance on Application of Certain Commission Regulations to Swap
Execution Facilities (Nov. 15, 2013). The guidance specified that a
foreign multilateral swaps trading platform that provides U.S.
persons or persons located in the United States (including personnel
and agents of non-U.S. persons located in the United States)
(``U.S.-located persons'') with the ability to trade or execute
swaps on or pursuant to the rules of the platform, either directly
or indirectly through an intermediary, would be expected to register
as a SEF or DCM. Id. at 2. The guidance listed two non-exhaustive
factors to determine whether a foreign platform met this
registration requirement: (i) Whether a foreign multilateral swaps
trading facility directly solicits or markets its services to U.S.
persons or U.S.-located persons; or (ii) whether a significant
portion of the market participants who a foreign multilateral swaps
trading facility permits to effect transactions are U.S. persons or
U.S.-located persons. Id. at 2 n.8. The guidance further specified
DMO's belief that U.S. persons and U.S.-located persons generally
comprise those persons whose activities have the requisite ``direct
and significant'' connection with activities in, or effect on,
commerce of the United States within the meaning of CEA section
2(i). Id. at 2. The guidance also stated DMO's view that a
multilateral swaps trading facility's provision of the ability to
trade or execute swaps on or through the platform to U.S. persons or
U.S.-located persons may create the requisite connection under CEA
section 2(i) for purposes of the SEF/DCM registration requirement.
Id. Subsequently, the Commission learned that many foreign
multilateral swaps trading facilities prohibited U.S. persons and
U.S-located persons from accessing their facilities due to the
uncertainty that the guidance created with respect to SEF
registration. The Commission understands that these prohibitions
reflect concerns that U.S. persons and U.S.-located persons
accessing their facilities would trigger the SEF registration
requirement. As noted above, the Commission expects to address the
application of CEA section 2(i) to foreign multilateral swaps
trading facilities, including foreign swaps broking entities, in the
future.
\107\ The Commission discusses further below the potential
implications for foreign multilateral swaps trading facilities
offering swaps that are subject to the trade execution requirement
to applicable counterparties.
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Such facilities that do not wish to register as a SEF and prefer to
comply with the regulatory requirements of their home country may seek
an exemption from SEF registration pursuant to CEA section 5h(g) either
directly or via the auspices of their home country regulator. Pursuant
to CEA section 5h(g), the Commission may exempt facilities from SEF
registration if the facility is subject to comparable, comprehensive
supervision and regulation on a consolidated basis by the appropriate
governmental authorities in the home country of the facility.\108\
Based on this provision, the Commission issued an order in December
2017 that exempts certain MTFs and OTFs authorized within the EU from
the SEF registration requirement based on a finding that their
respective regulatory frameworks satisfy the standard for granting an
exemption from the SEF registration requirement pursuant to CEA section
5h(g).\109\ At this time, the Commission has neither adopted a formal
regulatory framework for granting an exemption pursuant to this
provision nor has it granted exemptive relief to facilities in other
jurisdictions beyond the 2017 order to EU-based MTFs and OTFs.
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\108\ 7 U.S.C. 7b-3(g).
\109\ Order Exempting MTFs and OTFs Authorized Within the EU
from SEF Registration Requirement (Dec. 8, 2017) (``2017 MTF and OTF
Exemptive Order''). The order established this finding with respect
to EU-wide legal requirements--including, in particular,
requirements under the EU's new Markets in Financial Instruments
Regulation (``MiFIR''), the EU's amended Markets in Financial
Instruments Directive (``MiFID II''), and the EU's Market Abuse
Regulation--that establish regulatory frameworks for MTFs and OTFs.
Pursuant to this finding, the Commission provided specific
exemptions to several MTFs and OTFs. Id. at app. A.
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(1) Proposed Delay of SEF Registration Requirement
Given that the Commission intends to address the cross-border
jurisdictional reach of the Commission's SEF registration requirement
in the future, the Commission proposes to delay the compliance date of
the registration
[[Page 61962]]
requirement only with respect to foreign swaps broking entities,
including foreign interdealer brokers, that currently facilitate
trading, i.e., negotiation or arrangement, of swaps transactions for
U.S. persons (``Eligible Foreign Swaps Broking Entities'') for a period
of two years, subject to certain conditions and starting from the
effective date of any final rule adopted from this notice.
The proposed delay period would not apply to foreign swaps broking
entities that do not currently facilitate trading, i.e., negotiation or
arrangement, of swaps transactions for U.S. persons, given that their
operations would not be materially affected by the proposed application
of the SEF registration requirement to swaps broking entities. Further,
the proposed delay period would not apply to foreign multilateral swaps
trading facilities, as described above, that are not foreign swaps
broking entities. Such facilities are not subject to the Commission's
proposed application of the SEF registration requirement, and
therefore, are already required to register as a SEF pursuant to the
SEF registration requirement or seek an exemption pursuant to CEA
section 5h(g). Similarly, the Commission notes that MTFs and OTFs
located in the EU may not rely on this delay and instead must seek an
exemption from SEF registration pursuant to the terms of the
Commission's 2017 exemptive order.\110\
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\110\ 2017 MTF and OTF Exemptive Order.
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Eligible Foreign Swaps Broking Entities that meet the conditions
set forth below would be able to continue to maintain the current
practice of facilitating the negotiation or arrangement of swaps
transactions between multiple participants and routing those swaps
transactions to SEFs or Exempt SEFs for execution.\111\ Without the
two-year period, the Commission believes that applying the SEF
registration requirement to these entities would disrupt their
operations and fragment swaps liquidity.
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\111\ As discussed below, the Commission is proposing Sec.
37.201(b) to prohibit the use of pre-execution communications by
market participants away from a SEF's trading system or platform.
See infra Section VI.A.2.a.--Sec. 37.201(b)--Pre-Execution
Communications. The Commission notes that to the extent Eligible
Foreign Swaps Broking Entities engage in such communications in the
course of negotiating or arranging transactions and submitting them
to a SEF for execution, the prohibition--if adopted via a final
rule--would not apply during the two-year period.
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During this period, the Commission anticipates that it will address
what constitutes a ``direct and significant connection with activities
in, or effect on, commerce of the United States'' for foreign
multilateral swaps trading facilities, including foreign swaps broking
entities, under CEA section 2(i).\112\ The proposed delay would also
provide the Commission with time to develop any threshold standards for
the application of CEA section 2(i) to the SEF registration requirement
in CEA section 5h(a)(1). While the Commission has yet to determine
standards in this area, the Commission notes that any such standard
could include a de minimis component, whereby the activity of U.S.
persons below some defined quantitative threshold on a particular
foreign multilateral swaps trading facility would not trigger a need
for SEF registration.
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\112\ 7 U.S.C. 2(i).
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The Commission notes that counterparties that are required to
comply with the trade execution requirement may only satisfy the
requirement by executing a swap on a SEF, a DCM, or an Exempt SEF.\113\
Accordingly, any foreign multilateral swaps trading facility that seeks
to offer such swaps to such counterparties for trading must be
registered as a SEF or DCM or obtain an exemption from SEF registration
pursuant to CEA section 5h(g), regardless of whether that trading
system or platform meets the standards (or any future standards the
Commission may develop) for CEA section 2(i), i.e., a ``direct and
significant connection,'' to trigger SEF registration. As noted above,
the proposed delay would not apply to these foreign multilateral swaps
trading facilities. Similarly, upon the expiration of the proposed two-
year delay, any Eligible Foreign Swaps Broking Entity that seeks to
offer such swaps to such counterparties for trading on its trading
system or platform must be registered as a SEF or DCM or obtain an
exemption from SEF registration pursuant to CEA section 5h(g).
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\113\ For a discussion of which counterparties must comply with
the Category A Transaction-Level Requirements, including the trade
execution requirement, see 2013 Cross-Border Guidance at 45350-59
app. D.
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During this time, the Commission could formalize a regulatory
framework for providing exemptions from the SEF registration
requirement for foreign multilateral swaps trading facilities,
including foreign swaps broking entities, that meet that CEA section
2(i) standard. The proposed two-year delay not only could provide the
Commission with sufficient time to formalize this framework, which
would require standards and processes for evaluating exemption
requests, but also give Eligible Foreign Swaps Broking Entities more
time to determine their best course of action, i.e., seek SEF
registration with the Commission or obtain a CEA section 5h(g)
exemption from registration. Accordingly, the proposed delay would
further provide the Commission and regulators in foreign jurisdictions
with additional time to evaluate such registration applications or
requests for exemption received from Eligible Foreign Swaps Broking
Entities.
With respect to exemptions, the Commission anticipates that most
foreign swaps broking entities and other foreign multilateral swaps
trading facilities would seek to comply with the rules and regulations
of their home countries, and thus, seek an exemption from SEF
registration. The Commission further anticipates that the issuance of
such exemptions may take some time based upon the large number of
jurisdictions in which these operations are currently located.\114\
Thus, the Commission believes that it would be beneficial to provide
more time for evaluation of exemption requests because exempting such
comparably-regulated foreign entities from SEF registration, similar to
other deference initiatives, should generally reduce market
fragmentation, regulatory arbitrage, and duplicative or conflicting
regulatory requirements, while increasing the potential for harmonized
regulatory standards on a global level. Further, the Commission
anticipates that any future determination process for granting
exemptions from SEF registration would ensure that foreign and domestic
multilateral swaps trading facilities, which operate in a similar
fashion to one another, are all held to comparable regulatory
standards.
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\114\ See supra note 102 (listing the foreign jurisdictions
where swaps broking entities operate).
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The Commission further believes that this proposal should create
strong incentives for foreign jurisdictions to establish or bolster
their own robust regulatory regimes for swaps trading. Such measures
would also be consistent with the commitment made among the G-20
countries in 2009 ``to take action at the national and international
level to raise standards together so that our national authorities
implement global standards consistently in a way that ensures a level
playing field and avoids fragmentation of markets, protectionism, and
regulatory arbitrage.'' \115\ To the extent that foreign swaps broking
entities and other foreign multilateral swaps trading facilities
operate in foreign jurisdictions that currently do not have or are not
expected to have
[[Page 61963]]
comparable and comprehensive supervision and regulation, such
facilities would be subject to the proposed SEF registration
requirement if their operations create a ``direct and significant''
connection to activities in, or effect on, commerce of the United
States under CEA section 2(i).
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\115\ Group of Twenty, ``G-20 Leaders' Statement: The Pittsburgh
Summit 7 (Sept. 24-25, 2009), https://www.treasury.gov/resource-center/international/g7-g20/Documents/pittsburgh_summit_leaders_statement_250909.pdf.
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(2) Proposed Conditions for Delay of SEF Registration Requirement
As applied to Eligible Foreign Swaps Broking Entities--most of whom
are registered with the Commission as IBs--the Commission proposes that
the two-year delay from the SEF registration requirement be subject to
the following conditions:
(i) All swap transactions involving U.S. persons that are traded on
an Eligible Foreign Swaps Broking Entity must be routed for execution
to a SEF or an Exempt SEF; \116\ and
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\116\ For a current list of Exempt SEFs, see 2017 MTF and OTF
Exemptive Order at app. A.
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(ii) The Eligible Foreign Swaps Broking Entities must provide the
following information electronically to the Secretary of the Commission
at [email protected] and DMO at [email protected]: (i) Entity
name as it appears in the entity's charter; (ii) name and address of
the entity's ultimate parent company; (iii) any names under which the
entity does business; (iv) address of principal executive office; (v) a
contact person's name, address, phone number, and email address; (vi)
asset classes and swap products for which the entity facilitates
trading; (vii) certification that the entity currently arranges or
negotiates swap transactions for U.S. persons; (viii) the entity's home
country regulator or regulators; and (ix) any registrations,
authorizations, or licenses held by the entity in its home
country.\117\
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\117\ The Commission anticipates that the effective date of any
final rule would be established ninety days from the publication of
the rule in the Federal Register. The Commission believes that a
ninety-day effective date would provide Eligible Foreign Swaps
Broking Entities seeking a two-year compliance date delay with
sufficient opportunity to compile and submit the requisite
information to the Commission.
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Upon a DMO determination that an Eligible Foreign Swaps Broking
Entity's notice is complete, the Commission would post these notices on
the Commission's website under the ``Industry Filings'' page. This
proposed approach would effectively maintain the status quo for these
Eligible Foreign Swaps Broking Entities during the two-year compliance
date delay period. The Commission notes that the proposed two-year
delay for Eligible Foreign Swaps Broking Entities does not affect any
other requirements under the CEA or the Commission's regulations. In
particular, this delayed compliance date would not affect the
application of CEA section 2(e) and its limitation of SEF and Exempt
SEF trading to ECPs.\118\
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\118\ 7 U.S.C. 2(e). See supra note 61.
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As part of this proposed transition period, Eligible Foreign Swaps
Broking Entities would be able to route their transactions to either a
SEF or an Exempt SEF for execution. Furthermore, during this two-year
delay, counterparties subject to the trade execution requirement would
be able to satisfy that requirement by trading via an Eligible Foreign
Swaps Broking Entity that routes the transactions to either a SEF or an
Exempt SEF for execution.
In light of these considerations, the Commission notes that the
issue of whether an Eligible Foreign Swaps Broking Entity routes a
transaction to a SEF or an Exempt SEF during the proposed two-year time
delay period would have practical implications for the counterparties
involved in the transaction with respect to complying with Commission
reporting and clearing requirements. For swap transactions that are
routed to a SEF for execution, the SEF would be responsible for
compliance with (i) the real-time reporting requirements under part 43
of the Commission's regulations and (ii) the regulatory reporting
requirements under part 45 of the Commission's regulations.\119\
Counterparties to a swap transaction that is routed to an Exempt SEF
for execution would be responsible for the reporting requirements set
forth in both part 43 and part 45, unless there is a substituted
compliance determination by the Commission with respect to those
requirements.\120\
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\119\ In connection with swap transactions executed on a SEF,
the Commission notes that the part 45 regulations continue to apply
to counterparties that are subject to such reporting requirements.
17 CFR part 45.
\120\ Exempt SEFs may report transactions on behalf of
counterparties as a service provider; the counterparties, however,
retain ultimate responsibility for reporting.
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Further, for swap transactions routed to a SEF that are intended to
be cleared or subject to the clearing requirement, the SEF would be
responsible for routing the swap transaction to a Commission-registered
derivatives clearing organization (``DCO'') or a clearing organization
that has been exempted from DCO registration by the Commission pursuant
to CEA section 5b(h), i.e., Exempt DCO, for clearing.\121\ For swap
transactions routed to an Exempt SEF for execution that are intended to
be cleared or are subject to the clearing requirement, the Commission
notes that the following clearing-related requirements would to apply
to such swap transactions:
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\121\ See 17 CFR 37.700-702.
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(i) When a swap transaction executed by a U.S. person on such an
Exempt SEF is a ``customer'' position subject to CEA section 4d, the
transaction, if intended to be cleared, must be cleared through a
Commission-registered FCM at a Commission-registered DCO;
(ii) When a swap transaction executed by a U.S. person on such an
Exempt SEF is a ``proprietary'' position under Commission regulation
1.3(y), the transaction, if intended to be cleared, must be cleared
either through a Commission-registered DCO or an Exempt DCO; and
(iii) When a swap transaction is subject to the Commission's
clearing requirement, the transaction must be cleared either through a
Commission-registered DCO or an Exempt DCO, provided that consistent
with (i) above, the transaction must be cleared through a Commission-
registered FCM at a Commission-registered DCO and cannot be cleared
through an Exempt DCO if the transaction is a ``customer'' position
subject to CEA section 4d.
Request for Comment
The Commission requests comment on all aspects of its proposed
approach to SEF registration for Eligible Foreign Swaps Broking
Entities, in particular the proposed two-year delay in the compliance
date of any final rule. The Commission may consider alternatives to the
proposed two-year delay and requests comment on the following
questions:
(16) Is the delay of two years for Eligible Foreign Swaps Broking
Entities an adequate delay? If not, then how long of a delay should the
Commission consider and why?
(17) Are there additional considerations that the Commission should
take into account in establishing this delay?
(18) Are there additional conditions that the Commission should
consider imposing on Eligible Foreign Swaps Broking Entities during
this delay period?
2. Sec. Sec. 37.3(a)(2)-(3)--Minimum Trading Functionality and Order
Book Definition
In developing the regulatory framework for SEFs, the Commission
adopted a ``minimum trading functionality'' requirement under Sec.
37.3(a)(2) that requires a SEF to maintain and offer an Order Book for
all
[[Page 61964]]
of the swaps that it lists for trading.\122\ An Order Book is defined
under Sec. 37.3(a)(3) as (i) an electronic trading facility; \123\
(ii) a trading facility; \124\ or (iii) a trading system or platform in
which all market participants in the trading system or platform have
the ability to enter multiple bids and offers, observe or receive bids
and offers entered by other market participants, and transact on such
bids and offers.\125\ In the preamble to the SEF Core Principles Final
Rule, the Commission acknowledged that the Order Book functionality
does not have the requisite flexibility to serve as the ideal method of
execution for a variety of swaps, in particular those that feature
lower levels of liquidity.\126\ The Commission nevertheless believed
that an Order Book could establish a base level of pre-trade price
transparency to all market participants and, therefore, required that
each SEF offer an Order Book for all swaps that it lists for trading,
including both swaps subject to the trade execution requirement and
swaps not subject to the trade execution requirement.\127\
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\122\ 17 CFR 37.3(a)(2).
\123\ CEA section 1a(16) defines ``electronic trading facility''
as a trading facility that (i) operates by means of an electronic or
telecommunications network; and (ii) maintains an automated audit
trail of bids, offers, and the matching of orders or the execution
of transactions on the facility. 7 U.S.C. 1a(16).
\124\ CEA section 1a(51) defines ``trading facility'' as a
person or group of persons that constitutes, maintains, or provides
a physical or electronic facility or system in which multiple
participants have the ability to execute or trade agreements,
contracts, or transactions by accepting bids or offers made by other
participants that are open to multiple participants in the facility
or system; or through the interaction of multiple bids or multiple
offers within a system with a pre-determined non-discretionary
automated trade matching and execution algorithm. 7 U.S.C.
1a(51)(A).
\125\ 17 CFR 37.3(a)(3).
\126\ SEF Core Principles Final Rule at 33564-65. In the
preamble to the SEF Core Principles Final Rule, the Commission
stated its anticipation that an Order Book would typically work well
for liquid Required Transactions, i.e., transactions involving swaps
that are subject to the trade execution requirement. For less liquid
Required Transactions, however, it anticipated that RFQ systems
would help facilitate trading.'' Id.
\127\ SEF Core Principles Final Rule at 33564.
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The Commission has observed that market participants have rarely
used Order Books to trade swaps on SEFs despite their availability for
all swaps listed by SEFs. Depending on the product involved, for
example, order book trading typically ranges between ``less than [one
percent] to less than [three percent] of total CDS transactions'' on
SEFs, while order book trading constitutes between ``less than [one
percent] to approximately [twenty percent] of total IRS transactions. .
. .'' \128\ The Commission believes that this low level of swaps
trading on Order Books is attributable \129\ to an Order Book's
inability to support the broad and diverse range of products traded in
the swaps market that trade episodically, rather than on a continuous
basis.\130\ Given the broad array of liquid and illiquid swaps listed
on SEFs, mandating that a SEF offer an Order Book for all of these
products has imposed significant operational and financial costs and
burdens, particularly from a technological standpoint, with little
benefit to most market participants who choose not to utilize
them.\131\
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\128\ J. Christopher Giancarlo and Bruce Tuckman, Swaps
Regulation Version 2.0: An Assessment of the Current Implementation
of Reform and Proposals for Next Steps 49-50 (Apr. 26, 2018),
available at https://www.cftc.gov/sites/default/files/2018-05/oce_chairman_swapregversion2whitepaper_042618.pdf.
\129\ In addition to reasons stated above, the Commission
acknowledges that the lack of swaps trading on SEF Order Books may
also be attributed to other factors, such as concerns over ``name
give-up'' practices and the current lack of certain trading
features, such as the ability to calculate volume-weighted average
pricing.
\130\ In their study of the index CDS market, Pierre Collin-
Dufresne, Benjamin Junge, and Anders B. Trolle state that
``[p]roponents of bringing all market participants onto one limit
order book typically argue that it would (i) increase quote
competition among dealers and (ii) allow clients to occasionally
supply liquidity via limit orders thereby lowering overall
transaction costs (although at the cost of execution risk). However,
a limit order book arguably works best when trading is continuous
and it is not necessarily optimal when trading is more episodic as
is the case for index CDSs. For instance, Barclay, Hendershott, and
Kotz (2006) document a precipitous drop in electronic trading (via
limit order books) when Treasuries go off-the-run and trading
volumes decline.'' Pierre Collin-Dufresne, Benjamin Junge, & Anders
B. Trolle, Market Structure and Transaction Costs of Index CDSs 6
n.10 (Swiss Fin. Inst. Res. Paper No. 18-40, 2017) (``2017 Collin-
Dufresne Research Paper''), citing Michael J. Barclay, Terrence
Hendershott, & Kenneth Kotz, Automation Versus Intermediation:
Evidence from Treasuries Going Off the Run, 61 J. Fin. 2395, 2395-
2414 (2006).
\131\ The Commission understands that these costs include
regularly occurring software updates to electronic order book
systems and other ongoing technology-related maintenance.
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Therefore, based in part on its experience, the Commission proposes
to eliminate the minimum trading functionality requirement and the
regulatory Order Book definition. The Commission believes that
eliminating the minimum trading functionality would help reduce
operating costs for SEFs, as they would no longer be required to
operate and maintain order book systems that are poorly suited for
trading in less liquid swaps, and therefore, do not attract significant
trading activity. Instead of employing resources to build and support a
seldom-utilized trading system or platform, the proposed elimination
provides a SEF with the flexibility to determine how to allocate its
resources, particularly as it relates to developing methods of
execution that are better suited to trading the products that it lists.
As discussed below, other execution methods may be better suited to
maximizing participation and concentrating liquidity formation on SEFs
in episodically liquid swaps markets.\132\ Therefore, removing this
requirement may spur development and innovation in execution methods.
The Commission also believes that eliminating this requirement may
encourage SEFs to list new and different types of swaps, given that
they would no longer have to incur the costs of operating and
supporting Order Books. The Commission notes, however, that a SEF would
be free to continue to offer an order book if it so chooses.
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\132\ See infra Section IV.I.4.b.--Elimination of Required
Execution Methods.
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The Commission adopted the minimum trading functionality
requirement based in part on the goal of promoting pre-trade price
transparency,\133\ but acknowledges that the CEA does not explicitly
prescribe the Order Book as a SEF minimum trading functionality.
Accordingly, with the elimination of this requirement under Sec.
37.3(a)(2), the only trading functionality obligation that a SEF must
comply with on an ongoing basis is based upon the CEA section 1a(50)
definition of SEF.\134\ Therefore, the SEF must operate a trading
system or platform in which multiple participants have the ability to
execute or trade swaps by accepting bids and offers made by multiple
participants in the facility or system, through any means of interstate
commerce.\135\ To meet the SEF definition, a trading system or platform
must provide multiple participants with the ability to accept bids and
offers from other multiple participants within the facility or system.
As long as multiple participants have the ability to accept bids and
offers from other multiple participants within the facility or system,
the facility or system will meet the SEF definition, regardless of how
the multiple participants choose to interact with one another. Based on
this more straightforward approach, the Commission expects that
determining whether a particular system or platform
[[Page 61965]]
meets the SEF definition would generally be self-evident. Nevertheless,
the Commission will continue to work with entities that seek
interpretive guidance on the parameters of that definition.\136\
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\133\ 7 U.S.C. 7b-3(e).
\134\ The Commission emphasizes that while the SEF definition in
CEA section 1a(50) would serve as the baseline requirement for the
type of trading systems or platforms that a SEF must maintain, it
also provides the basic criterion to determine which types of
trading systems or platforms are subject to the SEF registration
requirement.
\135\ 7 U.S.C. 1a(50).
\136\ Based on the Commission's proposed elimination of the
Order Book as a minimum trading functionality requirement, the
Commission clarifies one particular issue regarding the scope of the
CEA section 1a(50) SEF definition. In the preamble to the SEF Core
Principles Final Rule, the Commission expressed doubt as to whether
an RFQ-to-one system met the multiple participant aspect of the SEF
definition. SEF Core Principles Final Rule at 33498, 33561, and
33563. This view, articulated in the context of the Commission's
discussion of RFQ Systems as a required method of execution, would
suggest that an ``RFQ-to-one'' trading system or platform may, on
its face, not meet the SEF definition. The Commission notes,
however, that this view does not appropriately give meaning to the
`ability' factor of the SEF definition. Therefore, the Commission
seeks to clarify the application of the `ability' factor as it
applies to RFQ-to-one transactions. The Commission believes that an
entity that permits its market participants to use its RFQ-to-one
functionality to issue concurrent or serial RFQs to multiple,
different recipients would fit within the SEF definition, as it
provides participants the ``ability'' to accept bids and offers from
multiple participants within the trading system or platform.
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3. Sec. 37.3(b)--Procedures for Registration \137\
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\137\ Based on the elimination of the temporary registration
requirements, the Commission proposes to retitle Sec. 37.3(b) to
``Procedures for registration'' from ``Procedures for full
registration.'' The Commission also proposes to add a title to Sec.
37.3(b)(1)--``Application for registration.''
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a. Elimination of Temporary Registration
To implement the SEF regulatory framework, the Commission
established a temporary SEF registration regime to help minimize
disruptions to incumbent platforms that had been operating prior to the
adoption of part 37 and to allow new entities to compete with those
incumbent platforms.\138\ Section 37.3(c) sets forth the process for
SEF applicants to apply for temporary SEF registration prior to the
Commission's review of an application for full SEF registration. The
temporary registration process, however, has expired pursuant to a two-
year sunset provision established under Sec. 37.3(c)(5).\139\ Since
the expiration of this process, the Commission has reviewed SEF
applications pursuant to a 180-day Commission review period.\140\
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\138\ SEF Core Principles Final Rule at 33487.
\139\ The Commission notes that the part 37 regulations became
effective on August 5, 2013. Accordingly, the temporary registration
provisions expired on August 5, 2015, subject to certain exceptions.
\140\ 17 CFR 37.3(b)(5).
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Based on the expiration of the temporary registration regime, the
Commission proposes to eliminate the provisions under existing Sec.
37.3(c) and adopt various conforming changes to other provisions in
proposed Sec. 37.3(b) and proposed Sec. 37.3(h), as discussed below.
b. Sec. 37.3(b)(1)--Application for Registration
To request registration as a SEF, Sec. 37.3(b)(1)(i) requires an
applicant to electronically file a complete Form SEF, as set forth in
Appendix A to part 37, with the Commission.\141\ The Commission uses
Form SEF, which is comprised of a series of different exhibits that
require an applicant to provide details of its operations, to determine
whether the applicant demonstrates compliance with the Act and
applicable Commission's regulations.\142\ Applicants must also use Form
SEF to amend a pending application or to seek an amended registration
order.\143\ As part of the SEF registration process, an applicant must
also request from the Commission a unique, extensible, alphanumeric
identifier code for the purpose of identifying the SEF in connection
with swap reporting requirements pursuant to part 45 of the
Commission's regulations.\144\
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\141\ 17 CFR 37.3(b)(1)(i).
\142\ The exhibits that comprise Form SEF concern the
applicant's business organization (Exhibits A-H); financial
information (Exhibits I-K); compliance (Exhibits L-U); and
operational capability (Exhibit V). 17 CFR part 37 app. A.
\143\ 17 CFR 37.3(b)(3); 17 CFR part 37 app. A.
\144\ 17 CFR 37.3(b)(1)(iii).
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Based on its experience with the SEF registration process, the
Commission believes that some of the information requested under Form
SEF has proven to be unnecessary to determine an applicant's compliance
with the Act and applicable Commission regulations. The Commission also
recognizes that some of the exhibit requirements are unclear in the
amount of information required to be provided, thereby causing
inconsistency across applications in the information received to
evaluate compliance. The proposed changes to the part 37 framework, as
discussed further herein, would also necessitate certain Form SEF
revisions. Therefore, the Commission is proposing several amendments to
Form SEF that would consolidate or eliminate several of the existing
exhibits and also request some additional information. Further, the
Commission is proposing several amendments to the Form SEF
instructions. The Commission intends for these proposed changes to
establish a clearer and more streamlined application process that would
still provide the Commission with sufficient and appropriate
information to determine compliance with the Act and Commission
regulations.
(1) Form SEF Exhibits--Business Organization
The Commission proposes several amendments to the ``Business
Organization'' exhibits--existing Exhibits A through H--of Form
SEF.\145\
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\145\ The Commission is not proposing any substantive changes to
Exhibit A, which requires an applicant to specify persons who own
ten percent or more of the applicant's stock or otherwise may
control or direct the applicant's management or policies; and
Exhibit B, which requires an applicant to provide a list of present
officers, directors and governors, or their equivalents. The
Commission is proposing non-substantive amendments to Exhibit A to
reorganize the existing requirements to paragraphs (a)-(b) and to
revise the existing language accordingly.
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First, the Commission proposes to consolidate certain existing
exhibits, in particular (i) existing Exhibit G, which requires an
applicant to submit various governance documents, into existing Exhibit
C, which requires information regarding the applicant's board of
directors; \146\ and (ii) existing Exhibit F, which requires an
analysis of the applicant's staffing, into existing Exhibit E, which
requires a description of the personnel qualifications for each
category of the applicant's professional employees.\147\ Under the
consolidated new Exhibit E, the Commission proposes to require more
specific detail about the applicant's personnel structure, including
personnel seconded to the applicant. As proposed, Exhibit E would
require information about the reporting lines among the applicant's
personnel; estimates of the number of non-management and non-
supervisory employees; and a description of the duties, background,
skills, and other qualifications for each officer, manager/supervisor,
and any other category of non-management and non-supervisory employees.
The Commission believes that amending Exhibit E to provide
[[Page 61966]]
greater specificity would promote consistency among applications and
further assist in evaluating the applicant's compliance with the Act
and the Commission's regulations, particularly with respect to self-
regulatory requirements.\148\
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\146\ Existing Exhibit C requires a narrative that describes the
composition and fitness standards for the applicant's board of
directors. Existing Exhibit G requires a copy of the applicant's
constitution, articles of incorporation, articles of formation, or
articles of association with all amendments thereto; partnership or
limited liability agreements; existing by-laws, operating agreement,
rules or instruments corresponding thereto; any governance fitness
information not included in existing Exhibit C; and a certificate of
good standing. As proposed, the existing Exhibit G requirements
would be re-designated as paragraphs (a) and (c) of a consolidated
new Exhibit C; existing Exhibit C would be re-designated as
paragraph (b) within new Exhibit C.
\147\ Existing Exhibit E requires a description of such
employees employed by the applicant or a division, subdivision, or
other separate entity within the applicant. Existing Exhibit F
requires the analysis of staffing requirements that are necessary to
operate the applicant as a SEF, including the staff names and
qualifications.
\148\ Based on the proposed consolidation of existing Exhibit F
and existing Exhibit G, existing Exhibit H would be re-designated as
a new Exhibit F with no additional substantive changes. This exhibit
requires a brief description of any material 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.
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The Commission also proposes to narrow the scope of information
required by existing Exhibit D, which requires a description of the
applicant's organizational structure that includes a list and
description of affiliates and relevant divisions, subdivisions, or
other separate entities related to the applicant. As proposed, Exhibit
D would require an applicant to describe the nature of the business of
any affiliated entities which engage in financial services or market
activities, including but not limited to, the trading, clearing, or
reporting of swaps. The Commission believes that this amendment would
more appropriately focus the required information on entities related
to the applicant's swaps-trading business and minimize the submission
of information that is not related. Further, the Commission proposes
non-substantive amendments to the existing exhibit.
(2) Form SEF Exhibits--Financial Information
The Commission proposes several amendments to the ``Financial
Information'' exhibits--existing Exhibits I through K--of Form SEF.
The Commission proposes to adopt several changes to existing
Exhibit I.\149\ This exhibit requires applicants to submit financial
information to demonstrate compliance with the financial resources
requirements under Core Principle 13. Among other required information,
paragraph (a) requires applicants to submit their most recent fiscal-
year financial statements \150\ and paragraph (b) requires a narrative
of how the value of the applicant's financial resources is sufficient
to cover operating costs of at least one year, on a rolling basis, of
which six months' value of those resources are unencumbered and liquid.
Paragraph (c) requires an applicant to submit copies of any agreements
(i) establishing or amending a credit facility, (ii) insurance
coverage, or (iii) other arrangement that demonstrate compliance with
the liquidity requirement. Paragraph (d) requires an applicant to
submit representations regarding sources and estimates for future
ongoing operational resources.
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\149\ The Commission also proposes to re-designate existing
Exhibit I as a new Exhibit G based on the proposed changes described
above.
\150\ The financial information currently required under
paragraph (a) includes an applicant's balance sheet; income and
expense statement; cash flow statement; and statement of sources and
application revenues and all notes or schedules thereto.
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The Commission proposes to amend the requirements of paragraphs (a)
through (c) to conform to the proposed amendments to the SEF financial
resources requirements under Core Principle 13. In particular, the
proposed required documentation would demonstrate an applicant's
ability to maintain resources that exceed one year of operating costs
and the existence of resources to meet the liquidity requirement.\151\
The Commission also proposes to eliminate paragraph (d) because the
representation of an applicant's future ongoing operational resources
is not necessary to determine compliance with Core Principle 13.
Additionally, the Commission proposes to amend paragraph (a) to
incorporate the existing Form SEF instruction for newly-formed
applicants who cannot submit the requisite financial statements, but
who alternatively seek to provide pro forma financial statements for a
six-month period.
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\151\ See infra Section XVIII.--Part 37--Subpart N: Core
Principle 13 (Financial Resources) for a description of the
Commission's proposed changes to the Core Principle 13 regulations
upon which new Exhibit G is based.
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The Commission also proposes to adopt several changes to Exhibit
K.\152\ This exhibit requires an applicant to provide disclosures
related to fees that it would impose upon participants. Paragraph (a)
requires a complete list of all of the facility's dues, fees, and other
charges for its services; paragraph (b) requires a description of the
basis or methods used to determine those amounts; and paragraph (c)
requires a description of any differences in charges between different
customers or groups of customers for similar services. The Commission
proposes to amend paragraph (a) to require applicants to identify any
market maker programs, other incentive programs, or other discounts on
dues, fees, or other charges to be imposed. Based on the Commission's
experience, this information is beneficial in evaluating compliance
with access requirements pursuant to Core Principle 2.\153\ Given the
Commission's proposed revisions to the existing impartial access
requirements--in particular, the elimination of the ``comparable fees''
requirement under existing Sec. 37.202(a)(3)--the Commission further
proposes to eliminate the requirement for a description of fee
differentials under paragraph (c). The Commission also proposes several
streamlining changes to the existing language.
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\152\ The Commission also proposes to re-designate existing
Exhibit K as a new Exhibit H based on the proposed changes described
above.
\153\ The Commission notes that proposed Sec. 37.202(a)(2)
would require a SEF to establish and apply fee structures and fee
practices to its market participants in a fair and non-
discriminatory manner. See infra Section VII.A.1.b.--Sec.
37.202(a)(2)--Fees.
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In addition to the amendments to new Exhibit G (existing Exhibit I)
and new Exhibit H (existing Exhibit K), the Commission proposes to
eliminate existing Exhibit J, which requires an applicant to disclose
the financial resources information for any SEF, DCM, or other swap
trading platform affiliates. Based on its experience with Exhibit J,
the Commission recognizes that this information related to an
applicant's affiliates is not particularly useful in demonstrating an
applicant's compliance with Core Principle 13 or the conflicts of
interest requirements under Core Principle 12.
(3) Form SEF Exhibits--Compliance
The Commission proposes several amendments to the ``Compliance''
exhibits--existing Exhibits L through U--of Form SEF.
First, the Commission proposes to eliminate several exhibits
including (i) existing Exhibit P, which requires the applicant to
provide information on disciplinary and enforcement protocols, tools,
and procedures that is generally duplicative to the details contained
in an applicant's rulebook and compliance manual; \154\ (ii) existing
Exhibit R, which requires a list of the applicant's prohibited trade
practice violations that is duplicative to the rules that an applicant
must include in its rulebook pursuant to Core Principle 2 requirements;
\155\ and (iii) existing Exhibit U, which requires a list of items
subject to a request for confidential
[[Page 61967]]
treatment under Sec. 145.9 of the Commission's regulations--as
described further below, the Commission proposes to instead require
SEFs to identify these documents within the Table of Contents to Form
SEF.
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\154\ An applicant is currently required to submit a copy of its
rules under existing Exhibit M and a copy of its compliance manual
under existing Exhibit O, as currently designated. The Commission is
maintaining those requirements under the proposed revisions to Form
SEF as a new Exhibit J and a new Exhibit K, respectively. The
Commission notes that it proposes to move ``arrangements for
alternative dispute resolution'' under existing Exhibit P to a new
Exhibit L described below. See infra note 159.
\155\ Section 37.203 requires a SEF to establish and enforce
trading rules that will deter abuses, including prohibitions on
abusive trading practices in its markets. 17 CFR 37.203.
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Second, the Commission proposes to streamline the requirements of
existing Exhibit L.\156\ This exhibit currently requires a narrative
and documentation that describe the manner in which the applicant
complies with each SEF core principle. This documentation includes a
regulatory compliance chart that sets forth each core principle and
cites the relevant rules, policies, and procedures that describe the
manner in which the applicant is able to comply with each core
principle. For issues that are novel or for which compliance with a
core principle is not evident, this exhibit also requires an applicant
to explain how that item and the application satisfy the SEF core
principles. The Commission proposes to streamline this exhibit to
require that the applicant only submit the regulatory compliance chart
and an explanation of novel issues, as is currently required. Based on
its experience, the Commission believes that the regulatory compliance
chart with citations to relevant rules, policies, and procedures is
sufficient to determine an applicant's compliance with the Act and the
Commission's regulations. The Commission has found that the additional
narrative and documentation that describe the manner in which the
applicant complies with each SEF core principle creates unnecessary
paperwork and does not further the Commission's review of an
application in this regard. The Commission further proposes certain
non-substantive amendments to the existing language of Exhibit L.
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\156\ The Commission also proposes to re-designate existing
Exhibit L as a new Exhibit I based on the proposed changes described
above.
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Third, the Commission proposes to simplify the requirements of
existing Exhibit M.\157\ This exhibit currently requires a copy of the
applicant's rules, and any technical manuals, other guides, or
instruction for SEF users, including minimum financial standards for
members or market participants. The Commission proposes to eliminate
the existing requirement to cite position limits and aggregation
standards in part 151 of the Commission's regulations and any position
limit rules set by the facility. As discussed below with respect to
Core Principle 6, the Commission intends to address the position limit
issue in a separate rulemaking; \158\ the Commission also notes that
this requirement is redundant to the applicant's requirement to submit
a copy of its rules. Further, the Commission proposes several non-
substantive amendments to streamline Exhibit M's existing language.
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\157\ The Commission also proposes to re-designate existing
Exhibit M as a new Exhibit J based on the proposed changes described
above.
\158\ See infra Section XI.--Part 37--Subpart G: Core Principle
6 (Position Limits or Accountability).
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Fourth, the Commission proposes to eliminate the requirements under
existing Exhibit N. The exhibit currently requires an applicant to
provide executed or executable copies of any agreements or contracts
that facilitate the applicant's compliance with the SEF core
principles, including third-party regulatory service provider or member
or user agreements. To streamline Form SEF, the Commission would
require instead that applicants submit these documents pursuant to
other relevant exhibits, as described below.
Fifth, the Commission proposes a new Exhibit L, which would
continue to require an applicant to submit user agreements. As
proposed, the new exhibit would specify that the required agreements
would include, but not be limited to, on-boarding documentation,
regulatory data use consent agreements, intermediary documentation, and
arrangements for alternative dispute resolution.\159\ The new Exhibit L
would also require a narrative of the legal, operational, and technical
requirements for users to directly or indirectly access the SEF. This
requirement reflects some documents that applicants have previously
submitted under existing Exhibit N. The additional specificity,
however, reflects the Commission's experience with different
participant-related agreements that implicate (i) a SEF participant's
ability to access the facility's trading system or platform pursuant to
Core Principle 2; and (ii) the facility's use of a SEF participant's
proprietary data or personal information under existing Sec.
37.7.\160\
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\159\ The Commission notes that ``arrangements for alternative
dispute resolution'' are included based on the requirements of
existing Exhibit P, which the Commission proposes to eliminate from
Form SEF. See supra note 154.
\160\ The Commission notes that it proposes to move the language
of existing Sec. 37.7, which generally prohibits a SEF from using a
participant's proprietary data or personal information that it
collects or receives for regulatory purposes for business or
marketing purposes, to a new Sec. 37.504. See infra Section X.D.--
Sec. 37.504--Prohibited Use of Data Collected for Regulatory
Purposes.
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Sixth, the Commission proposes a new Exhibit M to establish
requirements related to an applicant's swaps reporting capabilities.
The new Exhibit M would require the applicant to submit (i) a list of
the SDRs to which the applicant will report swaps data, including the
respective asset classes; \161\ (ii) an executed copy of all agreements
between the applicant and those SDRs; and (iii) a representation from
each of those SDRs stating that the applicant has satisfactorily
completed all requirements, including all necessary testing, that
enables the SDR to reliably accept data from the applicant. These
requirements reflect some of the documents that the Commission has
required applicants to submit under existing Exhibit N and would enable
the Commission to determine the applicant's ability to comply with
Sec. 37.901, which requires a SEF to report swap data pursuant to
parts 43 and 45 of the Commission's regulations.\162\
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\161\ The Commission notes that the reference to a Commission-
registered SDR in Exhibit M also includes a provisionally-registered
SDR.
\162\ 17 CFR 37.901.
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Seventh, the Commission proposes a new Exhibit N to incorporate the
requirements in existing Exhibit T related to an applicant's ability to
submit swaps to a DCO for clearing. New Exhibit N would require the
applicant to submit (i) a list of DCOs and exempt DCOs to which the
applicant will submit swaps for clearing, including the respective
asset classes; (ii) a representation that the clearing members of those
DCOs and exempt DCOs will guarantee all trades submitted by the swap
execution facility for clearing; (iii) an executed copy of the clearing
agreement and any related documentation for each of those DCOs or
exempt DCOs; and (iv) a representation from each of those DCOs or
exempt DCOs stating that the applicant has satisfactorily completed all
requirements, including all necessary testing, that enable its
acceptance of swap transactions submitted by the applicant for
clearing. These requirements reflect some of the documents that the
Commission has required applicants to submit under existing Exhibit N
and would enable the Commission to determine an applicant's ability to
comply with proposed Sec. 37.702(b)(1) under Core Principle 7, which
requires a SEF to coordinate with each DCO to facilitate ``prompt,
efficient, and accurate'' processing and routing of transactions to the
DCO for clearing.\163\
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\163\ For a discussion of the relevant proposed amendments to
the Core Principle 7 regulations, see infra Section XII.B.--Sec.
37.702--General Financial Integrity.
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Eighth, the Commission proposes a new Exhibit O to require an
applicant to submit all other agreements or contracts that enable the
applicant to comply with the applicable SEF core principles and are not
already required to be submitted
[[Page 61968]]
under new Exhibits L, M, N, or Q.\164\ In conjunction with these other
exhibits, new Exhibit O matches the scope of documents that an
applicant is currently required to submit under existing Exhibit
N.\165\
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\164\ Exhibit Q requires an applicant to complete and submit the
Program of Risk Analysis and Oversight Technology Questionnaire.
Among other things, the questionnaire requires an applicant to
provide any agreements with third-party IT providers. See infra
Section XIX.B.--Sec. 37.1401(g)--Program of Risk Analysis and
Oversight Technology Questionnaire.
\165\ Given this new proposed exhibit, the Commission proposes
to re-designate existing Exhibit O as a new Exhibit K. The content
of the exhibit would remain the same and require an applicant to
submit a copy of a compliance manual and documents that describe how
the applicant will conduct trade practice, market, and financial
surveillance.
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Ninth, the Commission proposes to adopt several changes to existing
Exhibit Q.\166\ This exhibit currently requires an applicant to provide
an explanation of how its trading system(s) or platform(s) satisfy the
Commission's rules, interpretations, and guidelines concerning SEF
execution methods. Where applicable, paragraphs (a) and (b) of Exhibit
Q specify that the explanation should include various details related
to the minimum trade functionality requirement under Sec. 37.3(a)(2),
i.e., an Order Book, and the prescribed execution methods for Required
Transactions under Sec. 37.9, i.e., an Order Book or an RFQ System. As
discussed below, the Commission is proposing to eliminate these
requirements and to allow SEFs to offer flexible means of
execution,\167\ subject to certain trading-related rules under proposed
Sec. 37.201(a).\168\ Accordingly, the Commission proposes conforming
changes to Exhibit Q. In addition to the explanation of the applicant's
trading system(s) or platform(s), the Commission also proposes to
require an applicant to provide screenshots of any of its trading
system(s) or platform(s). Based on the Commission's experience, these
screenshots provide a useful supplement to evaluate any explanation
provided under this exhibit.
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\166\ The Commission also proposes to re-designate existing
Exhibit Q as a new Exhibit P based on the proposed changes described
above.
\167\ See infra Section IV.I.--Sec. 37.9--Methods of Execution
for Required and Permitted Transactions; Sec. 37.10--Process for a
Swap Execution Facility to Make a Swap Available to Trade; Sec.
37.12--Trade Execution Compliance Schedule; Sec. 38.11--Trade
Execution Compliance Schedule; Sec. 38.12--Process for a Designated
Contract Market to Make a Swap Available to Trade.
\168\ Proposed Sec. 37.201(a) would require a SEF to establish
rules that govern the operation of the SEF, including rules that
specify (i) the protocols and procedures for trading and execution;
(ii) the use of discretion in facilitating trading and execution;
and (iii) the sources and methodology for generating any market
pricing information. See infra Section VI.A.1.--Sec. 37.201(a)--
Required Swap Execution Facility Rules.
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Finally, the Commission proposes to consolidate existing Exhibit S,
which currently requires a discussion of how the applicant will
maintain trading data, into new Exhibit K (re-designated from existing
Exhibit O). Exhibit K would require an applicant to submit a copy of
its compliance manual and documents that describe how the applicant
will conduct trade practice, market, and financial surveillance.
(4) Form SEF Exhibits--Operational Capability
The Commission proposes to re-designate existing Exhibit V, which
requires the applicant to provide information pertaining to its program
of risk analysis and oversight via the Technology Questionnaire, as a
new Exhibit Q and to adopt non-substantive amendments to the exhibit's
existing language.\169\ Additionally, the Commission is making certain
amendments to update the questionnaire, as described below.\170\
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\169\ As discussed below, the Commission is proposing Sec.
37.1401(g) to require a SEF to annually prepare and submit an up-to-
date Technology Questionnaire to Commission staff. See infra Section
XIX.B.--Sec. 37.1401(g)--Program of Risk Analysis and Oversight
Technology Questionnaire.
\170\ See infra Section XIX.B.--Sec. 37.1401(g)--Program of
Risk Analysis and Oversight Technology Questionnaire.
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(5) Other Form SEF Amendments
In addition to the proposed amendments to the existing exhibits,
the Commission is proposing several changes to the Form SEF
instructions. Form SEF currently requires applicants to include a Table
of Contents that lists each exhibit submitted as part of the
application. In lieu of a separate list provided via existing Exhibit
U, the Commission proposes to require that applicants designate, in the
Table of Contents, the exhibits that are subject to a request for
confidential treatment. The Commission also proposes to require that
any such confidential treatment be reflected by some type of
identifying number and code on the appropriate exhibit(s), similar to
the approach followed for DCO applications and Form DCO.\171\ Further,
the Commission proposes to eliminate the existing instruction for
newly-formed applicants regarding pro forma financial statements, which
the Commission proposes to incorporate in paragraph (a) of new Exhibit
G.
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\171\ The Commission also proposes to specify in the Form SEF
instructions that an applicant must file a confidentiality request
in accordance with Sec. 145.9 of the Commission's regulations.
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The Commission also proposes two minor amendments related to the
Form SEF cover sheet. First, to enable the Commission to evaluate a
SEF's compliance with ongoing filing requirements more readily, the
Commission proposes to require an applicant to specify its fiscal year-
end date.\172\ Second, the Commission proposes to eliminate the
reference to the use of Form SEF to amend an existing order or
registration, in conformance with the proposed amendment to Sec.
37.3(b)(3) discussed further below.\173\
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\172\ The Commission notes that these ongoing filing
requirements include (i) a fiscal year-end financial report that a
SEF would be required to file within ninety days after the end of
its fourth fiscal quarter under proposed Sec. 37.1306(d), see infra
Section XVIII.F.4.--Sec. 37.1306(d); (ii) proposed Exhibit Q of
Form SEF, i.e., the Program of Risk Analysis and Oversight
Technology Questionnaire that a SEF would be required to file within
ninety days after the end of its fiscal year under proposed Sec.
37.1401(g), see infra Section XIX.B.--Sec. 37.1401(g)--Program of
Risk Analysis and Oversight Technology Questionnaire; and (iii) an
annual compliance report that a SEF would be required to file within
ninety days after the end of its fiscal year under proposed Sec.
37.1501(e)(2), see infra Section XX.A.5.--Sec. 37.1501(e)--
Submission of Annual Compliance Report and Related Matters.
\173\ See infra Section IV.C.3.d.--Sec. 37.3(b)(3)--Amendment
of Application for Registration.
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(6) Request for Legal Entity Identifier
The Commission proposes to eliminate the requirement that an
applicant request a ``unique, extensible, alphanumeric code'' from the
Commission under Sec. 37.3(b)(1)(iii) and to require instead that the
applicant obtain a legal entity identifier (``LEI''). The Commission
adopted part 37 prior to the establishment of the technical
specification and governance mechanism for a global entity identifier.
Since that adoption, a 20-digit alphanumeric LEI has been developed and
adopted by many regulatory authorities in other jurisdictions, as well
as the Commission, for use in identifying counterparties and other
entities pursuant to various regulatory reporting requirements,
including part 45 of the Commission's regulations.\174\
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\174\ The Commission notes that applicants may obtain an LEI
from an LEI-issuing organization that has been accredited by the
Global Legal Entity Identifier Foundation (``GLEIF''). GLEIF, About
LEI--Get an LEI: Find LEI Issuing Organizations, https://www.gleif.org/en/about-lei/get-an-lei-find-lei-issuing-organizations.
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Request for Comment
The Commission requests comments on all aspects of the proposed
amendments to Sec. 37.3(b)(1) and Appendix A to part 37.
[[Page 61969]]
c. Sec. 37.3(b)(2)--Request for Confidential Treatment
The Commission is not proposing any amendments to Sec. 37.3(b)(2).
d. Sec. 37.3(b)(3)--Amendment of Application for Registration \175\
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\175\ The Commission proposes to retitle Sec. 37.3(b)(3) to
``Amendment of application for registration'' from ``Amendment of
application prior or subsequent to full registration'' based on the
proposed changes described below.
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Section 37.3(b)(3) specifies that an applicant amending a pending
application or requesting an amendment to a registration order must
file an amended application with the Secretary of the Commission in the
manner specified by the Commission. The Form SEF instructions
correspond to this requirement and currently specify that requests for
amending a registration order and any associated exhibits must be
submitted via Form SEF. Section 37.3(b)(3) otherwise specifies that a
SEF must file any amendment to its application subsequent to
registration as a submission under part 40 of the Commission's
regulations, or as specified by the Commission.\176\ In the preamble to
SEF Core Principles Final Rule, the Commission also stated that if any
information provided in a Form SEF is or becomes inaccurate for any
reason, even after registration, the SEF ``must promptly make the
appropriate corrections with the Commission.'' \177\
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\176\ 17 CFR 37.3(b)(3). Part 40 governs the submission of new
products, rules and rule amendments for registered entities,
including a process for the voluntary submission of rules for
Commission review and approval under Sec. 40.5 and a process for
the self-certification of rules under Sec. 40.6. 17 CFR 40.5-6.
\177\ SEF Core Principles Final Rule at 33485.
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The Commission proposes to clarify and amend the requirements
regarding post-registration amendments to both Form SEF exhibits and
registration orders. First, the Commission proposes to amend Sec.
37.3(b)(3) and Form SEF to eliminate the required use of Form SEF to
request an amended order of registration from the Commission.\178\
Under current practice, SEFs file a request for an amended order with
the Commission rather than submitting Form SEF. Commission staff
typically will review the request, obtain additional information from
the SEF where necessary, and subsequently recommend to the Commission
whether to grant or deny the amended order. Given current practice, the
Commission believes that an updated Form SEF is not needed to request
an amended order of registration.
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\178\ See infra Section IV.C.4.--Sec. 37.3(c)--Amendment to an
Order of Registration.
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Second, the Commission proposes to eliminate the existing language
that specifies the use of part 40 to file application amendments
subsequent to registration. The Commission emphasizes that not all of
the information from the Form SEF exhibits need to be updated pursuant
to part 40 subsequent to registration; certain part 37 provisions
already require SEFs to update their information on an ongoing basis.
For example, under Sec. 37.1306, a SEF is required to file updated
financial reports, including fiscal year-end reports, which precludes
the need to amend and file new Exhibit G (existing Exhibit I) through
part 40. The Commission clarifies that part 40 only applies to
information from application exhibits that constitute a ``rule,'' as
defined under Sec. 40.1(i).\179\ Therefore, registered SEFs have
already been submitting changes to these types of documentation
pursuant to the part 40 rule filing procedures. Given that part 40
defines ``rule,'' the existing language is not required to be included
under proposed Sec. 37.3(b)(3). If certain information from the Form
SEF exhibits are not required to be updated through other part 37
provisions or part 40, then a SEF does not have to file those
amendments subsequent to registration. The Commission notes, however,
that it may otherwise request information related to a SEF's business
pursuant to Sec. 37.5(a).\180\
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\179\ ``Rule'' is defined under Sec. 40.1(i) as any
constitutional provision, article of incorporation, bylaw, rule,
regulation, resolution, interpretation, stated policy, advisory,
terms and conditions, trading protocol, agreement or instrument
corresponding thereto, including those that authorize a response or
establish standards for responding to a specific emergency, and any
amendment or addition thereto or repeal thereof, made or issued by a
registered entity or by the governing board thereof or any committee
thereof, in whatever form adopted. 17 CFR 40.1(i). The Commission
generally interprets the Sec. 40.1(i) rule definition broadly to
encompass governance documentation (proposed Exhibit C); fees
(proposed Exhibit H); rulebooks (proposed Exhibit J); compliance
manuals (proposed Exhibit K); participant agreements (proposed
Exhibit L); SDR-related agreements (proposed Exhibit M); clearing-
related agreements (proposed Exhibit N); other third-party
agreements (proposed Exhibit O); and information related to
execution methods (proposed Exhibit P).
\180\ 17 CFR 37.5(a).
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Request for Comment
The Commission requests comments on all aspects of the proposed
amendments to Sec. 37.3(b)(3).
e. Sec. 37.3(b)(4)--Effect of Incomplete Application
The Commission is not proposing any amendments to Sec. 37.3(b)(4).
f. Sec. 37.3(b)(5)--Commission Review Period
Based on the elimination of the temporary registration regime under
existing Sec. 37.3(c), the Commission proposes to amend the existing
provision to eliminate related language and specify that the Commission
reviews a SEF registration application pursuant to a 180-day timeframe
and the procedures specified in CEA section 6(a).
g. Sec. 37.3(b)(6)--Commission Determination
The Commission is not proposing any amendments to Sec. 37.3(b)(6).
4. Sec. 37.3(c)--Amendment to an Order of Registration
Consistent with existing Commission practice and the proposal to
eliminate the use of Form SEF to request an amended registration order,
the Commission proposes a new Sec. 37.3(c)--``Amendment to an order of
registration''--to establish a separate process for such requests.\181\
A SEF would be required to submit its request electronically in the
form and manner specified by the Commission.\182\ Similar to the
procedures set forth for the registration application process, a SEF
would be required to provide the Commission with any additional
information and documentation necessary to review a request. The
Commission would issue an amended order if the SEF would continue to
maintain compliance with the Act and the Commission's regulations after
such amendment. Further, the Commission may also issue an amended order
subject to conditions. The Commission also proposes to specify that it
may decline to issue an amended order based upon a determination that
the SEF would not continue to maintain compliance with the Act and the
Commission's regulations upon such amendment.
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\181\ See supra Section IV.C.3.d.--Sec. 37.3(b)(3)--Amendment
of Application for Registration.
\182\ The Commission proposes to eliminate existing Sec.
37.3(c), which establishes the temporary SEF registration process
that is no longer available to applicants, as described above. See
supra Section IV.C.3.a.--Elimination of Temporary Registration.
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Request for Comment
The Commission requests comments on all aspects of proposed Sec.
37.3(c).
5. Sec. 37.3(d)--Reinstatement of Dormant Registration
The Commission is not proposing any amendments to Sec. 37.3(d).
[[Page 61970]]
6. Sec. 37.3(e)--Request for Transfer of Registration
Section 37.3(e) establishes requirements that a SEF must follow
when seeking to transfer its registration from its current legal entity
to a new legal entity as a result of a corporate change.\183\ Among
these requirements, Sec. 37.3(e)(2) requires a SEF to file a transfer
request no later than three months prior to the anticipated corporate
change, or if not possible, as soon as it knows of the change.\184\
Section 37.3(e)(3) requires a transfer request to include certain
information, such as the transferee's governing documents under Sec.
37.3(e)(3)(iv).\185\ Under Sec. 37.3(e)(3)(vi), the request must also
include certain representations from a transferee, including
representations that it will (i) retain and assume, without limitation,
all of the assets and liabilities of the transferor; (ii) assume
responsibility for complying with the Act and the Commission's
regulations; (iii) assume, maintain, and enforce all of the
transferor's rules that are applicable to SEFs, including the
transferor's rulebook and any amendments; (iv) comply with all self-
regulatory responsibilities, including maintaining and enforcing all
self-regulatory programs; and (v) notify market participants of all
changes to the rulebook prior to the transfer, as well as the transfer
and issuance of a corresponding order by the Commission.\186\ Under
Sec. 37.3(e)(3)(vii), the transfer request must also include a
representation from the transferee that upon the transfer, it will
assume responsibility for and maintain compliance with the SEF core
principles for all swaps previously made available for trading through
the transferor; and that none of the proposed rule changes will affect
the rights and obligations of any market participant.\187\
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\183\ 17 CFR 37.3(e).
\184\ 17 CFR 37.3(e)(2).
\185\ 17 CFR 37.3(e)(3).
\186\ 17 CFR 37.3(e)(3)(vi).
\187\ 17 CFR 37.3(e)(3)(vii).
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The Commission proposes several non-substantive amendments to
streamline the existing requirements under Sec. 37.3(e) for filing a
transfer request. First, the Commission proposes to simplify the
timeline for filing a request by requiring that a SEF file the request
``as soon as practicable,'' rather than no later than three months
prior to the anticipated corporate change or as soon as it knows of
such a change, if less than three months prior to the change.\188\
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\188\ The Commission proposes to adopt this amendment under
Sec. 37.3(e)(2).
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Second, with respect to the required information in a transfer
request, the Commission also proposes to specifically reference other
types of governing documents that would be adopted by transferees, such
as a limited liability agreement or an operating agreement.\189\ This
proposed change acknowledges that a transferee of a SEF's registration
may be a non-corporate entity, such as a limited liability company or
partnership.
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\189\ The Commission proposes to adopt this amendment under
Sec. 37.3(e)(3)(iv). The Commission recognizes that different types
of entities are established and governed by different types of
documentation. For example, a corporation is formed based on
articles of incorporation and operates pursuant to bylaws; a limited
liability company is generally established pursuant to articles of
organization and operates pursuant to an operating agreement; and a
limited partnership is generally formed based on a limited
partnership agreement. Based on the proposed amendments to Sec.
37.3(e)(iv), the Commission also proposes to amend Sec.
37.3(e)(3)(i) by changing the word ``agreement'' to
``documentation.''
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Third, the Commission proposes to simplify a transferee's
compliance-related representations under Sec. 37.3(e)(3)(vi). The
Commission proposes to consolidate and eliminate unnecessary language;
\190\ and eliminate the existing requirement that the transferee attest
that it will assume, maintain, and enforce compliance with the SEF core
principles, as well as maintain and enforce self-regulatory
programs.\191\ The Commission notes that the language that it proposes
to delete is otherwise duplicative to Sec. 37.3(e)(3)(vi)(B), which
generally requires the transferee to represent that it will assume
responsibility for compliance with all applicable provisions of the Act
and the Commission's regulations. Further, the Commission proposes to
eliminate the existing requirement under Sec. 37.3(e)(3)(vii)(A) that
a transferee represent that it will continue to comply with the SEF
core principles for all swaps made available for trading through the
transferor. The Commission notes that all SEFs, whether or not a
transferee, must comply with the Act and Commission regulations,
including all requirements applicable to a SEF's listed swaps.
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\190\ The Commission proposes to consolidate existing clauses
(B) and (D) into a new proposed clause (B).
\191\ The Commission proposes to eliminate this requirement
under existing clause (C) and renumber existing clause (E) as clause
(C).
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Fourth, the Commission proposes to amend Sec. 37.3(e) to better
reflect the practical realities of the transfer process. Rather than
require a transferee to represent that it will retain and assume all
the assets and liabilities of the transferor without limitation, the
Commission proposes to instead require that the transferee state in the
request when it would not do so.\192\ In addition, rather than require
a transferee to represent that none of a transferee's proposed rule
changes will affect the rights and obligations of any market
participant, the Commission proposes instead to require that the
transferee represent that it will notify market participants of changes
that may affect their rights and obligations.\193\ These amendments
would eliminate certain pre-emptive restrictions upon business-related
changes associated with the transfer, but also allow the Commission to
continue reviewing whether such changes may be inconsistent with the
Act or the Commission's regulations.
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\192\ The Commission proposes to adopt this amendment under
subparagraph (3)(vi)(A).
\193\ The Commission proposes to amend the language of existing
subparagraph (3)(vii)(B) and renumber the provision to subparagraph
(3)(vii)(C) based on the proposed changes described above. The
Commission notes that the transferee's notification obligations
would not be limited to those that may affect a market participant's
rights and obligations; the proposed rule would maintain the
existing requirement that a transferee represent that it will notify
market participants of all changes to the transferor's rulebook
prior to the transfer.
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7. Sec. 37.3(f)--Request for Withdrawal of Application for
Registration
The Commission is not proposing any amendments to Sec. 37.3(f).
8. Sec. 37.3(g)--Request for Vacation of Registration
The Commission is not proposing any amendments to Sec. 37.3(g).
9. Sec. 37.3(h)--Delegation of Authority
Given the deletion of the phrase relating to temporary registration
in the existing paragraph, the Commission proposes a conforming non-
substantive amendment.
D. Sec. 37.4--Procedures for Implementing Rules 194
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\194\ The Commission proposes to retitle Sec. 37.4 to
``Procedures for implementing rules'' from ``Procedures for listing
products and implementing rules'' based on the proposed changes
described below.
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Section 37.4 currently sets forth rules related to the listing of
swap products and the submission of rules on a pre- and post-
registration basis. Section 37.4(a) specifies that a SEF applicant may
submit the terms and conditions of swaps that it intends to list for
trading as part of its registration application.\195\ Section 37.4(b)
specifies that any swap
[[Page 61971]]
terms and conditions or rules submitted as part of the SEF's
application shall be considered for approval by the Commission at the
time it issues the SEF's registration order.\196\ Section 37.4(c)
specifies that after the Commission issues a registration order, the
SEF shall submit any proposed swap terms and conditions, including
amendments to such terms and conditions, proposed new rules, or
proposed rule amendments, pursuant to part 40 of the Commission's
regulations.\197\ Section 37.4(d) specifies that any swap terms and
conditions or rules submitted as part of an application to reinstate a
dormant SEF shall be considered for approval at the time that the
Commission approves the dormant SEF's reinstatement of
registration.\198\
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\195\ 17 CFR 37.4(a).
\196\ 17 CFR 37.4(b).
\197\ 17 CFR 37.4(c).
\198\ 17 CFR 37.4(d).
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The Commission proposes to eliminate Sec. 37.4(a) and to adopt
conforming amendments to Sec. 37.4(b) to establish that the
Commission's process of reviewing the terms and conditions of a swap
product that the applicant intends to list for trading upon
registration is separate from the review process of a SEF's application
for registration.\199\ As amended, Sec. 37.4(b) would specify that
rules, except swap product terms and conditions, submitted by the SEF
applicant as part of a registration application would be considered for
approval at the time the Commission issues an order of registration.
Upon obtaining an order of registration, a registered SEF may formally
submit product terms and conditions under Sec. 40.2 or Sec. 40.3,
which controls the submission of new product terms and conditions by
registered entities.\200\ Given that the submission procedures for
rules, including product terms and conditions, are established under
part 40, the Commission also proposes to eliminate unnecessary language
by deleting Sec. 37.4(c). The Commission believes that separating
these two processes would promote efficiency for both Commission staff
and SEF applicants. For example, a SEF applicant's registration order
could otherwise be unnecessarily delayed or stayed if the SEF applicant
submits for Commission approval, along with its application for
registration, a novel or complex product that would require additional
consideration or analysis by Commission staff.
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\199\ The Commission proposes to renumber subsection (b) to
subsection (a) based on the proposed amendment as described above.
\200\ 17 CFR part 40. Although an applicant may not submit swap
product terms and conditions for approval as part of the
registration process, the Commission notes that SEF applicants may
informally discuss any proposed products with Commission staff for
informal feedback as part of the registration process.
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To conform to the proposed approach for reviewing swap product
terms and conditions from SEF applicants described above, the
Commission also proposes to amend Sec. 37.4(d) to delete the reference
to any ``swap terms and conditions'' submitted by a dormant SEF that is
applying for reinstatement of registration.\201\ Accordingly, dormant
SEFs would not be able to provide proposed swap product terms and
conditions for approval as part of the dormant SEF registration
reinstatement process. Upon obtaining a reinstatement of registration,
a SEF may formally submit product terms and conditions under Sec. 40.2
or Sec. 40.3, which controls the submission of new product terms and
conditions by registered entities.
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\201\ The Commission proposes to renumber subsection (d) to
subsection (b) based on the proposed amendments as described above.
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Request for Comment
The Commission requests comments on all aspects of the proposed
amendments to Sec. 37.4.
E. Sec. 37.5--Provision of Information Relating to a Swap Execution
Facility 202
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\202\ The Commission proposes to retitle Sec. 37.5 to
``Provision of information relating to a swap execution facility''
from ``Information relating to swap execution facility compliance''
based on the proposed changes described below.
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1. Sec. 37.5(a)--Request for Information
The Commission is not proposing any amendments to Sec. 37.5(a).
2. Sec. 37.5(b)--Demonstration of Compliance
The Commission is proposing certain non-substantive amendments to
Sec. 37.5(b).
3. Sec. 37.5(c)--Equity Interest Transfer
Section 37.5(c) sets forth notification requirements related to
transfers of equity interest in a SEF. Section 37.5(c)(1) requires a
SEF to notify the Commission if the SEF enters into a transaction
involving the transfer of fifty percent or more of the equity interest
in the SEF.\203\ Section 37.5(c)(2) requires the SEF to file the notice
at the earliest possible time, but no later than the open of business
ten business days following the date upon which the SEF enters into a
firm obligation to transfer the equity interest.\204\ Upon such a
notification, the Commission may request supporting documentation of
the transaction.\205\ Where any aspect of the transfer constitutes a
rule as defined under part 40, Sec. 37.5(c)(3) requires a SEF to
comply with the requirements of CEA section 5c(c) and part 40.\206\
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\203\ 17 CFR 37.5(c)(1).
\204\ 17 CFR 37.5(c)(2).
\205\ 17 CFR 37.5(c)(1). In the SEF Core Principles Final Rule,
the Commission specified the types of documentation to include, but
not be limited to, (i) relevant agreement(s); (ii) associated
changes to relevant corporate documents; (iii) a chart outlining any
new ownership or corporate or organization structure, if available;
and (iv) a brief description of the purpose and any impact of the
equity interest transfer. SEF Core Principles Final Rule at 33490.
The final rule also stated that a SEF must file a certification
regarding its compliance with CEA section 5h and the Commission's
regulations thereunder, as set forth in existing Sec. 37.5(c)(4).
Id.
\206\ 17 CFR 37.5(c)(3).
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The Commission has previously stated that in situations where such
an equity transfer occurs, the Commission has an interest in reviewing
and considering the implications of the changes in ownership.\207\ In
particular, the Commission seeks to determine whether the change in
ownership will adversely impact the operations of the SEF or the SEF's
ability to comply with the core principles and the Commission's
regulations thereunder.\208\ Further, the Commission intended for Sec.
37.5(c) to enable Commission staff to consider whether any term or
condition contained in an equity transfer agreement(s) is inconsistent
with the self-regulatory responsibilities of a SEF or with any of the
core principles.\209\
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\207\ Core Principles and Other Requirements for Swap Execution
Facilities, 76 FR 1214, 1217 (Jan. 7, 2011) (``SEF Core Principles
Proposed Rule'').
\208\ Id.
\209\ Id. In the SEF Core Principles Final Rule, the Commission
raised the provision to 50 percent from 10 percent and maintained a
similar policy rationale, SEF Core Principles Final Rule at 33490,
i.e., to ``ensure that SEFs remain mindful of their self-regulatory
responsibilities when negotiating the terms of significant equity
interest transfers.'' SEF Core Principles Proposed Rule at 1217.
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The Commission proposes to amend Sec. 37.5(c)(1) to require a SEF
to file a notice with the Commission in the event of any transaction
that results in the transfer of direct or indirect ownership of fifty
percent or more of the equity interest in the SEF. The Commission notes
that indirect ownership may transpire, for example, through a
transaction involving a direct or indirect parent company of the SEF.
Section 37.5(c), however, only requires a SEF to file a notice where
the SEF is a party to a transaction involving a transfer of direct
ownership of fifty percent or more of the equity interest in the SEF,
but not where the SEF is not a party to the transaction, or where the
transaction results in a transfer of indirect ownership of the SEF. The
Commission believes that such transfers implicate the same regulatory
policies underlying the existing rule and therefore proposes
[[Page 61972]]
amendments to broaden the requirement. Based on the proposed changes
described above, the Commission further proposes conforming non-
substantive amendments to Sec. 37.5(c)(2)--``Timing of
notification''--and Sec. 37.5(c)(4)--``Certification.'' \210\
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\210\ The Commission also proposes to renumber paragraph (c)(4)
to paragraph (c)(3) based on the proposed elimination of the
existing language in paragraph (c)(3) described below.
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The Commission further proposes to streamline Sec. 37.5(c) by
deleting Sec. 37.5(c)(3)--the Commission notes that part 40 already
applies to SEFs with respect to rule filings, and therefore, a separate
provision is not necessary to apply part 40 to SEFs.
Request for Comment
The Commission requests comments on all aspects of the proposed
amendments to Sec. 37.5(c).
4. Sec. 37.5(d)--Delegation of Authority
The Commission is not proposing any amendments to Sec. 37.5(d).
F. Sec. 37.6--Enforceability
1. Sec. 37.6(a)--Enforceability of Transactions
Section 37.6(a) is intended to provide market participants with
legal certainty with respect to swap transactions on a SEF and
generally clarifies that a swap transaction entered into on or pursuant
to the rules of a SEF cannot be void, voidable, subject to recession,
otherwise invalidated, or rendered unenforceable due to a violation by
the SEF of the Act or applicable Commission regulations or any
proceeding that alters or supplements a rule, term or condition that
governs such swap or swap transaction.\211\
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\211\ 17 CFR 37.6(a).
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The Commission proposes non-substantive amendments to Sec.
37.6(a).\212\ These amendments include (i) amending the phrase
``entered into'' to ``executed'' to provide greater clarity; and (ii)
eliminating the reference to swaps executed ``pursuant to the rules
of'' a SEF, which conforms to the proposed amendment to the ``block
trade'' definition under Sec. 43.2, discussed further below.\213\
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\212\ The Commission also proposes to add a new title to Sec.
37.6(a)--``Enforceability of transactions.''
\213\ See infra Section XXII.--Part 43--Sec. 43.2--Definition
of ``Block Trade.''
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2. Sec. 37.6(b)--Swap Documentation
Section 37.6(b) requires a SEF to provide each counterparty to a
transaction with a written ``confirmation'' that contains all of the
terms of a swap transaction at the time of the swap's execution for
both cleared and uncleared swap transactions, including (i) ``economic
terms'' that are specific to a transaction, e.g., swap product, price,
and notional amount; and (ii) non-specific ``relationship terms'' that
generally govern all transactions between two counterparties, e.g.,
default provisions, margin requirements, and governing law.\214\
``Confirmation'' is defined under parts 43 and 45 of the Commission's
regulations as the consummation (electronically or otherwise) of
legally binding documentation that memorializes the agreement of the
counterparties to all terms of the swap (emphasis added).\215\ The
definition also states that a confirmation shall be in writing
(electronic or otherwise) and legally supersede any previous agreement
(electronic or otherwise) relating to the swap.\216\ The Commission
adopted Sec. 37.6(b), in part, to facilitate this process for swaps
transactions--both cleared and uncleared--executed on or pursuant to
the rules of a SEF.\217\
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\214\ 17 CFR 37.6(b).
\215\ 17 CFR 43.2; 17 CFR 45.1. See also 17 CFR 23.500 (similar
definition of ``confirmation'' that applies to swap dealers
(``SDs'') and major swap participants (``MSPs'')).
\216\ 17 CFR 43.2; 17 CFR 45.1.
\217\ SEF Core Principles Final Rule at 33491.
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For uncleared swap transactions, the Commission is aware that many
relationship terms that may govern certain aspects of an uncleared swap
transaction are often negotiated and executed between potential
counterparties prior to execution.\218\ The Commission previously
provided that SEFs may satisfy Sec. 37.6(b) for uncleared swap
transactions by incorporating by reference the relevant terms set forth
in such agreements, as long as those agreements have been submitted to
the SEF prior to execution.\219\ As applied, Sec. 37.6(b) requires
that the SEF obtain and incorporate this documentation into the issued
confirmation, which is intended in part to provide SEF participants
with legal certainty with respect to uncleared swap transactions.\220\
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\218\ SEF Core Principles Final Rule at 33491 n.195. Swap
counterparties have typically relied on the use of industry-standard
legal documentation, including master netting agreements,
definitions, schedules, and confirmations, to document their swap
trading relationships. This documentation, such as the ISDA Master
Agreement and related Schedule and Credit Support Annex (``ISDA
Agreements''), as well as related documentation specific to
particular asset classes, offers a framework for documenting
uncleared swap transactions between counterparties. See
Confirmation, Portfolio Reconciliation, Portfolio Compression, and
Swap Trading Relationship Documentation Requirements for Swap
Dealers and Major Swap Participants, 77 FR 55904, 55906 (Sept. 11,
2012). For uncleared swap transactions, Sec. 23.504(b) requires
written documentation of all the terms governing the trading
relationship between an SD or MSP and its counterparty. 17 CFR
23.504(b).
\219\ SEF Core Principles Final Rule at 33491 n.195.
\220\ To ensure that the SEF confirmation provides legal
certainty, the Commission stated that counterparties choosing to
execute a swap transaction on or pursuant to the rules of a SEF must
have all terms, including possible long-term credit support
arrangements, agreed to no later than execution, such that the SEF
can provide a written confirmation inclusive of those terms at the
time of execution. SEF Core Principles Final Rule at 33491.
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This requirement, however, has created impractical burdens for
SEFs. Based upon feedback from SEFs, the Commission understands that
SEFs have encountered many issues in trying to comply with the
requirement for uncleared swaps, including high financial,
administrative, and logistical burdens to collect and maintain
bilateral transaction agreements from many individual counterparties.
SEFs have stated that they are unable to develop a cost-effective
method to request, accept, and maintain a library of every previous
agreement between counterparties.\221\ SEFs have also noted that the
potential number of previous agreements is considerable, given that SEF
counterparties enter into agreements with many other parties and have
multiple agreements for different asset classes.\222\
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\221\ Many of these agreements are maintained in paper form or
scanned PDF files that are difficult to quickly digitize in a cost-
effective manner. See WMBAA, Request for Extended Relief from
Certain Requirements under Parts 37 and 45 Related to Confirmations
and Recordkeeping for Swaps Not Required or Intended to be Cleared
at 3 (Mar. 1, 2016). Further, some SEFs have cited the considerable
resource cost of obtaining the number of different agreements that
exist to accommodate the different parties and different asset
classes. Id.
\222\ Id.
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Commission staff has acknowledged these technological and
operational challenges and has accordingly granted time-limited no-
action relief.\223\ Based on this relief, SEFs have incorporated
[[Page 61973]]
applicable relationship terms from previous agreements by reference in
the confirmation without obtaining copies of these agreements prior to
the execution of a swap.\224\ SEFs, however, still must memorialize the
relationship terms contained in separate, previously-negotiated
agreements that the SEF has not reviewed at the time of incorporation,
and would likely not review post-execution. One industry participant,
however, noted that a SEF would not be familiar with the terms of the
agreements that it is required to incorporate by reference into a
confirmation.\225\
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\223\ Commission staff provided initial no-action relief in
2014. CFTC Letter No. 14-108, Re: Staff No-Action Position Regarding
SEF Confirmations and Recordkeeping Requirements under Certain
Provisions Included in Regulations 37.6(b) and 45.2 (Aug. 18, 2014).
Commission staff has since extended this no-action relief on several
occasions. See CFTC Letter No. 17-17, Re: Extension of No-Action
Relief for Swap Execution Facility Confirmation and Recordkeeping
Requirements under Commodity Futures Trading Commission Regulations
37.6(b), 37.1000, 37.1001, 45.2, and 45.3(a) (Mar. 24, 2017); CFTC
Letter No. 16-25, Re: Extension of No-Action Relief for Swap
Execution Facility Confirmation and Recordkeeping Requirements under
Commodity Futures Trading Commission Regulations 37.6(b), 37.1000,
37.1001, 45.2, and 45.3(a) (Mar. 14, 2016); CFTC Letter 15-25, Re:
Extension of No-Action Relief for SEF Confirmation and Recordkeeping
Requirements under Commission Regulations 37.6(b), 37.1000, 37.1001,
and 45.2, and Additional Relief for Confirmation Data Reporting
Requirements under Commission Regulation 45.3(a) (Apr. 22, 2015).
\224\ Id.
\225\ See SIFMA Asset Management Group, Re: Straight-Through
Processing, Swap Execution Facility Implementation and Relief
Relating to the Aggregation Provision in Final Block Trade Rule at 6
n.14 (Oct. 25, 2013) (stating that ``it is highly impractical for a
SEF to familiarize itself with the often complex, bespoke master
agreement and trade terms (and the various documents that may be
incorporated by reference) in order to produce a customized,
potentially complex confirmation on a trade by trade basis.'').
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Based on its experience with the part 37 implementation, the
Commission acknowledges that cleared and uncleared swaps raise
different issues with respect to confirmation requirements and the
current SEF requirements create difficulties for the latter type of
swap transaction. Therefore, the Commission is proposing a revised
approach to Sec. 37.6(b) as described below.
a. Sec. 37.6(b)(1)--Legally Binding Documentation
The Commission proposes Sec. Sec. 37.6(b)(1)(i)-(ii) to establish
separate swap transaction documentation requirements for cleared and
uncleared swaps. Proposed Sec. 37.6(b)(1)(i)(A) would apply the
existing confirmation requirement--that a SEF must issue a written
confirmation that includes all of the terms of the transaction--to
cleared swap transactions. The Commission further proposes to define
``confirmation document'' under Sec. 37.6(b)(1)(i)(B) as a legally
binding written documentation that memorializes the agreement to all
terms of a swap transaction and legally supersedes any previous
agreement that relates to the swap transaction between the
counterparties.
With respect to uncleared swap transactions the Commission proposes
a revised approach under Sec. 37.6(b)(1)(ii) that would require a SEF
to provide the counterparties to an uncleared swap transaction with a
``trade evidence record'' that memorializes the terms of the swap
transaction agreed upon between the counterparties on the SEF. In
contrast to a cleared swap confirmation, the trade evidence record
would not be required to include all of the terms of the swap
transaction, including relationship terms contained in underlying
documentation between the counterparties. As defined under proposed
Sec. 37.6(b)(1)(ii)(B), a trade evidence record means a legally
binding written documentation that memorializes the terms of a swap
transaction agreed upon by the counterparties and legally supersedes
any conflicting term in any previous agreement that relates to the swap
transaction between the counterparties. The Commission anticipates that
these terms would include, at a minimum, the ``economic terms'' that
are agreed upon between the counterparties to a specific SEF
transaction, e.g., trade date, notional amount, settlement date, and
price.
The Commission believes that the proposed rule would provide SEFs
with a simplified approach to comply with the legal documentation
requirement, but also continue to promote the policy objective of Sec.
37.6(b) by providing SEF participants with legal certainty with respect
to both cleared and uncleared swap transactions. Further, the proposed
approach accommodates existing counterparty trading practices for
uncleared swaps, particularly the use of separate, previously-
negotiated underlying agreements to establish relationship terms that
generally govern the trading relationship, as opposed to a specific
transaction, between two counterparties. To the extent that such terms
either are agreed upon between the counterparties in underlying
documentation established away from the SEF and continue to govern the
transaction post-execution or are not required to establish legal
certainty for a specific transaction, a SEF would not be required to
incorporate those terms into a trade evidence record. The proposed
approach should address the challenges that have prevented SEFs from
fully complying with Sec. 37.6(b) by reducing the administrative
burdens for SEFs, who would not be required to obtain, incorporate, or
reference those previous agreements, and for counterparties, who would
not be required to submit all of their relevant documentation with
other potential counterparties to the SEF.\226\
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\226\ The Commission acknowledges that the issuance of a trade
evidence record would not alter the other obligations of a SEF or
the counterparties under the CEA and the Commission's regulations.
For example, a SEF would still be required to report all required
swap creation data under Sec. 45.3(a), as applicable. 17 CFR
45.3(a). Further, a counterparty that is a swap dealer or major swap
participant would also still be required to transmit a confirmation
pursuant to Sec. 23.501, as applicable. 17 CFR 23.501.
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Request for Comment
The Commission requests comments on all aspects of proposed Sec.
37.6(b)(1). In particular, the Commission is particularly interested in
the prescribed contents and legal import of a trade evidence record and
requests comment on the following questions:
(19) Should the Commission allow a SEF to issue a trade evidence
record that does not include all the terms of a swap transaction agreed
to on the SEF?
(20) Should the Commission require a SEF to include a minimum set
of terms in a trade evidence record, e.g., material economic terms?
Should the Commission specify those terms in the proposed regulation?
(21) Should the Commission require a SEF to include any of the
``primary economic terms,'' as defined under Sec. 45.1, in a trade
evidence record? If so, which terms should be included?
(22) Should the Commission specify that a trade evidence record (i)
serves as evidence of a legally binding agreement upon the
counterparties; and (ii) legally supersedes any previous agreement,
rather than any conflicting term in any previous agreement, as
proposed? With respect to (i), are there terms that are generally
contained within previously-negotiated, underlying agreements between
the counterparties that are necessary to make a transaction legally
binding, and therefore must be submitted to the SEF?
(23) Should the Commission specify in its regulations that
notwithstanding the trade evidence record requirement, a SEF is allowed
to incorporate by reference underlying, previous agreements containing
terms governing a swap transaction into any trade evidence record
associated with the transaction?
(24) Do proposed Sec. Sec. 37.6(b)(1)(i)-(ii) provide sufficient
legal certainty with respect to any contradictory terms that may be
contained within the previous agreements?
b. Sec. 37.6(b)(2)--Requirements for Swap Documentation
Section 37.6(b) requires that the confirmation take place at the
same time as execution, except for a limited exception for certain
information for bunched orders.\227\ The Commission proposes Sec.
37.6(b)(2)(i) to amend this requirement and instead require a SEF to
provide a confirmation document or trade evidence record to the
counterparties to a transaction ``as soon as technologically
practicable'' after the
[[Page 61974]]
execution of the swap transaction on the SEF.\228\
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\227\ 17 CFR 37.6(b).
\228\ The Commission notes that in the context of real-time
public reporting, it has defined ``as soon as technologically
practicable'' to mean as soon as possible, taking into consideration
the prevalence, implementation and use of technology by comparable
market participants. 17 CFR 43.2. The meaning of this term, as
proposed in Sec. 37.6(b)(2)(i) herein, would be consistent with
this definition.
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The Commission recognizes that a strict implementation of the
existing requirement is not practical from a temporal standpoint, given
that a SEF's issuance of a written confirmation document or trade
evidence record would only occur upon execution by counterparties.\229\
Further, the required issuance of a written confirmation document or
trade evidence record simultaneous with execution may become further
impracticable for some SEFs from an operational and technological
standpoint based on the different trading systems or platforms that
SEFs may offer under a more flexible approach to execution methods
proposed by the Commission.\230\ Therefore, proposed Sec.
37.6(b)(2)(i) is intended to establish a more practical approach that
accommodates different types of SEF operations. The Commission believes
that the proposed standard--``as soon as technologically
practicable''--would also continue to promote the Commission's goals of
providing the swap counterparties with legal certainty in a prompt
manner. Based on this proposed amendment to the existing language of
Sec. 37.6(b), the Commission also proposes to renumber the existing
requirement regarding bunched orders to proposed Sec. 37.6(b)(2)(ii)
and adopt non-substantive amendments.
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\229\ The Commission notes that a public commenter previously
cited execution and confirmation as two separate processes in the
swap transaction process. SEF Core Principles Final Rule at 33491
(comment from the Energy Working Group that execution and
confirmation are ``distinct steps'' in the swap transaction
process).
\230\ See infra Section IV.I.--Sec. 37.9--Methods of Execution
for Required and Permitted Transactions; Sec. 37.10--Process for a
Swap Execution Facility to Make a Swap Available to Trade; Sec.
37.12--Trade Execution Compliance Schedule; Sec. 38.11--Trade
Execution Compliance Schedule; Sec. 38.12--Process for a Designated
Contract Market to Make a Swap Available to Trade.
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As noted, Sec. 37.6(b) requires a SEF to provide the written
confirmation of a transaction executed on or pursuant to the SEF's
rules to ``each counterparty to [the] transaction.'' The Commission
proposes to add Sec. 37.6(b)(2)(iii) to provide that a SEF may issue a
confirmation document or trade evidence record to the intermediary
trading on behalf of a counterparty, provided that the SEF establish
and enforce rules to require any intermediary to transmit any such
document or record to the counterparty as soon as technologically
practicable. Based on industry practice, the Commission notes that to
the extent that intermediaries, acting on behalf of swap participants,
facilitate swap execution on a SEF, the SEF transmits the written
confirmation to the intermediary and then requires the intermediary to
forward the confirmation to its customer. The Commission understands
that participants using intermediaries to trade on a SEF may not
establish the appropriate connectivity necessary to receive written
confirmations directly from the SEF. Requiring the intermediary to
transmit the document or record as soon as technologically practicable
would further accommodate current market practices, as discussed above.
Request for Comment
The Commission requests comments on all aspects of proposed Sec.
37.6(b)(2). In particular, the Commission requests comment on the
following questions:
(25) Is the Commission's proposal, to require a SEF to transmit
confirmation documents or trade evidence records to counterparties ``as
soon as technologically practicable'' after the execution of the swap
transaction on the SEF an appropriate time frame? Should the Commission
require that the SEF issue the confirmation document or trade evidence
record within a specified time limit?
(26) Is the Commission's proposal to require a SEF to establish and
enforce rules that require an intermediary acting on behalf of a
counterparty to transmit a confirmation document or trade evidence
record to such counterparty ``as soon as technologically practicable''
an appropriate time frame? Should the Commission require that the SEF
issue the confirmation document or trade evidence record within a
specified time limit?
(27) Should the Commission define ``as soon as technologically
practicable'' in a similar manner to the definition in part 43?
G. Sec. 37.7--Prohibited Use of Data Collected for Regulatory Purposes
The Commission proposes to move and amend Sec. 37.7, which
prohibits a SEF from using proprietary or personal information that it
collects or receives to fulfill regulatory obligations for business or
marketing purposes, as a new Sec. 37.504 under the Core Principle 5
(Ability to Obtain Information) regulations. The Commission discusses
the proposed amendments to the existing requirements further
below.\231\
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\231\ See infra Section X.D.--Sec. 37.504--Prohibited Use of
Data Collected for Regulatory Purposes.
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H. Sec. 37.8--Boards of Trade Operating Both a Designated Contract
Market and a Swap Execution Facility 232
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\232\ The Commission proposes to renumber Sec. 37.8 to Sec.
37.7 based on the proposed changes described above.
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Section 37.8(a) requires an entity that operates as both a DCM and
a SEF to separately register with the Commission in accordance with the
procedures set forth under part 38 and part 37 of the Commission's
regulations, respectively. Section 37.8(a) further requires that a
dually-registered entity comply with the respective DCM and SEF core
principles and regulations on an ongoing basis.
The Commission notes that the language is superfluous to the
similar requirements that already exist under Sec. 38.2 and Sec. 37.2
for DCMs and SEFs, respectively, and therefore proposes to delete this
latter requirement. The Commission notes, however, that this is not a
substantive change and DCMs and SEFs must otherwise comply with the Act
and applicable regulations.
I. Sec. 37.9--Methods of Execution for Required and Permitted
Transactions; Sec. 37.10--Process for a Swap Execution Facility To
Make a Swap Available to Trade; Sec. 37.12--Trade Execution Compliance
Schedule; Sec. 38.11--Trade Execution Compliance Schedule; Sec.
38.12--Process for a Designated Contract Market To Make a Swap
Available To Trade
The CEA, as amended by the Dodd-Frank Act, requires the Commission
to develop and implement a regulatory framework for trading swaps on
registered SEFs and establishes a corresponding trade execution
requirement that requires certain swaps to be executed on DCMs, SEFs,
or Exempt SEFs.\233\ The regulatory framework that the Commission
developed to implement these provisions prescribes, among other things,
(i) a process that allows SEFs and DCMs to initiate determinations of
which swaps should be subject to the CEA section 2(h)(8) trade
execution requirement, i.e., the MAT process; and (ii) the methods of
execution that must be used for swaps that are subject to the trade
execution requirement. In addition, the framework permits SEFs to offer
any method of execution for swaps
[[Page 61975]]
that are not subject to the trade execution requirement.
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\233\ 7 U.S.C. 2(h)(8). Although the trade execution requirement
may be satisfied through DCMs, the Commission's discussion of the
trade execution requirement in this proposed rulemaking will
generally pertain to SEFs, unless otherwise noted.
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The Commission adopted this framework in part to achieve the SEF
statutory goals in CEA section 5h(e) of promoting trading on SEFs and
promoting pre-trade transparency in the swaps market. The Commission
acknowledges that the existing framework has transitioned some swaps
trading and market participants to SEFs. Since 2013, however, the
Commission has gained considerable knowledge and experience with swaps
trading dynamics through implementing part 37, particularly with
respect to the required use of certain execution methods. Based on that
knowledge and experience, the Commission believes that certain aspects
of the current SEF regulatory framework should be enhanced to further
promote the statutory SEF goals and better maximize the role of SEFs as
vibrant and liquid marketplaces for swaps trading.
Accordingly, the Commission is proposing two revisions to the
current framework. First, the Commission proposes to adopt a revised
interpretation of CEA section 2(h)(8) to set the applicability of the
trade execution requirement, i.e., swaps subject to the clearing
requirement and listed for trading by a SEF or DCM would be subject to
the requirement. Instead of maintaining the current MAT determination
process, the Commission believes that this proposed approach would be
better aligned with the intent of CEA section 2(h)(8) and further the
statutory goal of promoting swaps trading on SEFs. As applied to the
current scope of swaps that are subject to the clearing requirement and
listed for trading by SEFs and DCMs, the Commission anticipates that
this approach would significantly expand the scope of swaps that are
subject to the trade execution requirement. Second, based on its
understanding of swaps trading dynamics and the increased scope of
swaps that would become subject to the trade execution requirement, the
Commission also proposes to allow greater flexibility in the trading of
such swaps by eliminating the prescribed execution methods for swaps
subject to the requirement.
1. Trade Execution Requirement and MAT Process
The trade execution requirement mandates counterparties to execute
swap transactions subject to the clearing requirement on a SEF or DCM,
unless no SEF or DCM ``makes the swap available to trade.'' \234\ The
Commission adopted Sec. 37.10 and Sec. 38.12 to establish a ``MAT
determination'' process that allows SEFs and DCMs, respectively, to
make swaps ``available to trade,'' and therefore, subject to the trade
execution requirement.\235\ These processes enable a SEF or DCM to make
a swap ``available to trade'' by submitting a determination to the
Commission pursuant to the part 40 rule filing procedures.\236\ A SEF
or DCM that submits a MAT determination must include an assessment of
whether the subject swap has ``sufficient trading liquidity'' and must
address at least one of six factors that serve as indicia of the swap's
trading liquidity.\237\ Swaps that become subject to the trade
execution requirement pursuant to the approval or certification of a
MAT determination must, with the limited exception of block
transactions, be executed by counterparties on a SEF or DCM.\238\
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\234\ 7 U.S.C. 2(h)(8). CEA section 2(h)(8) also specifies that
swaps that are subject to a clearing exception under section 2(h)(7)
are not subject to the trade execution requirement. See infra
Section XXI.A.3.--Sec. 36.1(c)--Exemption for Swap Transactions
Excepted or Exempted from the Clearing Requirement under Part 50.
The Commission interprets ``swap execution facility'' in CEA section
2(h)(8)(B) to include a swap execution facility that is exempt from
registration pursuant to CEA section 5h(g). See supra note 10.
\235\ 17 CFR 37.10; 17 CFR 38.12.
\236\ The Commission notes that a SEF or DCM may submit a MAT
determination pursuant to the rule approval process under Sec. 40.5
or through the rule certification process under Sec. 40.6. 17 CFR
37.10(a)(1) and 38.12(a)(1).
\237\ 17 CFR 37.10(b), 38.12(b). Parts 37 and 38 respectively
specify the same six factors: (i) Whether there are ready and
willing buyers and sellers for the swap; (ii) the frequency or size
of transactions in the swap; (iii) the swap's trading volume; (iv)
the number and types of market participants trading the swap; (v)
the swap's bid/ask spread; and (vi) the usual number of resting firm
or indicative bids and offers in the swap. 17 CFR 37.10(b),
38.12(b). The Commission explained in the preamble to the MAT Final
Rule that with respect to factors (ii)-(iii), the submitting DCM or
SEF could look to DCM, SEF, or bilateral transactions. MAT Final
Rule at 3360.
\238\ Based on part 40, a MAT determination filing applies the
trade execution requirement to a particular swap either upon
Commission approval (in the case of a filing submitted for approval
under Sec. 40.5) or upon the lack of Commission objection (in the
case of a filing submitted on a self-certified basis under Sec.
40.6).
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2. Execution Method Requirements
Section 37.9 defines swaps that are subject to the trade execution
requirement, i.e., those swaps that must be executed on a SEF or DCM,
as ``Required Transactions'' \239\ and specifies that a SEF may only
offer two methods for executing such swaps. Specifically, Required
Transactions must be executed on (i) an Order Book, as defined under
Sec. 37.3(a)(3) and discussed above; \240\ or (ii) an RFQ System, as
defined under Sec. 37.9(a)(3).\241\ An RFQ System is defined, among
other requirements, as a trading system or platform where a market
participant transmits a request for a bid or offer to no less than
three market participants who are not affiliates of, or controlled by,
the requester or each other (``RFQ-to-3 requirement'').\242\ To the
extent that a SEF offers an RFQ System for Required Transactions, that
system must operate in conjunction with an Order Book, which a SEF is
currently required to establish and maintain as a minimum trading
functionality.\243\ Pursuant to the statutory SEF definition, SEFs have
been able to offer these methods through ``any means of interstate
commerce,'' \244\ which the Commission has interpreted to mean ``a
variety of means of execution or communication, including, but not
limited to, telephones, internet communications, and electronic
transmissions.'' \245\ Accordingly, SEFs have been able to develop and
offer an Order Book or RFQ System through various forms, including
voice-based systems.
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\239\ 17 CFR 37.9(a)(1).
\240\ See supra notes 123-125 and accompanying discussion
(definition of ``Order Book'' under Sec. 37.3(a)(3)).
\241\ 17 CFR 37.9(a)(2).
\242\ 17 CFR 37.9(a)(3). The RFQ System definition additionally
specifies that the three requesters may not be affiliates or
controlled by one another; and the system must provide each of its
market participants with equal priority in receiving RFQs and
transmitting and displaying for execution responsive orders. 17 CFR
37.9(a)(3); 17 CFR 37.9(a)(3)(iii).
\243\ 17 CFR 37.9(a)(2)(i)(B). In operating an RFQ System in
conjunction with an Order Book, a SEF must communicate to a
requester any firm bid or offer pertaining to the same instrument
resting on any of the SEF's Order Books; and provide the requester
with the ability to execute against such firm resting bids or offers
along with any responsive RFQ orders. 17 CFR 37.9(a)(3)(i)-(ii). As
discussed above, the Commission is proposing to eliminate the
minimum trading functionality under Sec. 37.3(a)(2) and the Order
Book definition under Sec. 37.3(a)(3). See supra Section IV.C.2.--
Sec. Sec. 37.3(a)(2)-(3)--Minimum Trading Functionality and Order
Book Definition.
\244\ 7 U.S.C. 1a(50).
\245\ SEF Core Principles Final Rule at 33501 n.328.
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In establishing the Order Book and RFQ System requirements, the
Commission sought in part to transition swaps trading onto SEFs and
achieve the statutory SEF goal of promoting pre-trade price
transparency in the swaps market. In addition to establishing the Order
Book as a minimum trading functionality for all swaps listed for
trading by a SEF, the Commission intended for the Order Book
requirement to promote such transparency for swaps subject to the trade
execution requirement. The Commission did acknowledge, however, that an
Order Book lacks the appropriate
[[Page 61976]]
flexibility to be suitable for trading many types of swaps, in
particular those lacking liquidity.\246\ The lack of liquidity is a
characteristic of broad segments of the swaps market, which trade
episodically among a limited number of market participants in large
average notional amounts.
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\246\ SEF Core Principles Final Rule at 33564-65. In the
preamble to the SEF Core Principles Final Rule, the Commission
expressed its anticipation that ``the order book method will
typically work well for liquid Required Transactions (i.e.,
transactions involving swaps that are subject to the trade execution
requirement in CEA section 2(h)(8)), but for less liquid Required
Transactions, RFQ systems are expected to help facilitate trading.''
Id.
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To address this lack of suitability even within the scope of
Required Transactions, the Commission prescribed the RFQ System as an
alternative execution method for these transactions.\247\ At the time,
the Commission observed that RFQ systems provide market participants
with a certain level of trading flexibility, in particular by allowing
them to balance the risks of information leakage and front-running
associated with disclosing trading interests against the price
competition benefits derived by disseminating a request to a larger
number of participants.\248\ The Commission recognizes that most SEFs
currently offer an RFQ System for most of the respective products that
they list for trading; when trading swaps subject to the trade
execution requirement, market participants have mostly utilized an RFQ
System, transmitting RFQs to more than three unaffiliated market
participants in many instances.\249\
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\247\ 17 CFR 37.9(a)(2). The Commission adopted the RFQ System
requirement based upon its prevalence in the OTC swaps market. Id.
at 33564. The Commission stated that ``RFQ systems are currently
used by market participants in the OTC swap market, many in
conjunction with order book functionality.'' In adopting the
requirement, the Commission also stated it was ``leveraging best
practices from current swaps trading platforms.'' Id. at 33565.
\248\ SEF Core Principles Final Rule at 33476.
\249\ In discussing trading of CDX and iTraxx indices, Lynn
Riggs, Esen Onur, David Reiffen, and Haoxiang Zhu found that
``[c]ustomers most frequently request quotes from three dealers,
which happens in about 45% of the RFQ sessions, followed by five
dealers, which happens in just below 30% of the RFQ sessions. In
about 18% of the sessions the customer selects four dealers.'' Lynn
Riggs, Esen Onur, David Reiffen, & Haoxiang Zhu, Mechanism Selection
and Trade Formation on Swap Execution Facilities: Evidence from
Index CDS 10 (2017), https://www.cftc.gov/idc/groups/public/@economicanalysis/documents/file/oce_mechanism_selection.pdf (``2017
Riggs Study'').
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3. Implementation of Existing Requirements
While the Commission acknowledges that the existing approach has
transitioned some swaps trading to SEFs, this transition has stagnated
and will not likely increase further without changes to the existing
regulatory framework. This stagnation, as discussed further below, is
reflected by the limited set of swaps that have become subject to the
trade execution requirement, and therefore subject to mandatory trading
on SEFs, through the Commission's MAT process. The lack of additional
swaps becoming subject to the requirement over the last several years
has been attributable to market participants' concerns over the
Commission's Order Book and RFQ System requirements for Required
Transactions under Sec. 37.9; this concern, in turn, has dissuaded
SEFs from submitting additional MAT determinations.
Since the Commission's adoption of the MAT determination process, a
small number of swaps that are subject to the clearing requirement have
become subject to the trade execution requirement. In the fall of 2013,
four SEFs and one DCM submitted a limited number of swaps to the
Commission as ``available to trade'' via the Commission's Sec. 40.6
self-certification process.\250\ The swaps submitted consist of the
current ``on-the-run'' and most recent ``off-the-run'' index CDS with a
five-year tenor and fixed-to-floating IRS with benchmark tenors
denominated in U.S. dollars, euros, and pound sterling.\251\ The IRS
and CDS that are currently subject to the trade execution requirement
represent the most standardized and highly liquid swaps contracts
offered by SEFs,\252\ but also represent a very limited segment of the
potential universe of swaps eligible to become subject to the trade
execution requirement, i.e., those swaps that are both subject to the
clearing requirement and currently listed for trading on a SEF.\253\
Based on data evaluated by the International Swaps and Derivatives
Association (``ISDA''), approximately 85 percent of total reported IRS
traded notional volume (``traded notional'') in 2017 consisted of swaps
subject to the clearing requirement.\254\ This represents an increase
from the approximately 73 to 77 percent of total reported IRS traded
notional during 2015 to 2016 that was subject to the clearing
requirement.\255\ Data analysis conducted by Commission staff found
that the percentage of trading volume in IRS subject to the trade
execution requirement is far lower than the percentage subject to the
clearing requirement and has actually declined, from approximately 10
to 12 percent of total reported IRS traded notional in 2015 to
approximately 7 to 9 percent of the total reported IRS traded notional
in 2017 and the first half of 2018.\256\
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\250\ TW SEF LLC--Amendment to Self-Certification for Swaps to
be Made Available to Trade (Jan. 26, 2014) (third amended filing
from initial submission on October 28, 2013); Javelin SEF, LLC, No.
13-06R(3), Javelin Determination of Made Available to Trade of
Certain Interest Rate Swaps made Pursuant to Parts 37 of the Rules
of the Commodity Futures Trading Commission (Jan. 8, 2014) (third
amended filing from initial submission on October 18, 2013)
(``Javelin SEF MAT Determination''); Bloomberg SEF LLC, No. 2013-R-
9, Bloomberg SEF LLC--Made Available to Trade (``MAT'') Submission
of Certain Credit Default Swaps (``CDS'') and Interest Rate Swaps
(``IRS'') pursuant to Commodity Futures Trading Commission (the
``Commission'') Regulation 40.6 (submission #2013-R-9) (Dec. 5,
2013) (``Bloomberg SEF MAT Determination''); MarketAxess SEF
Corporation, Made Available to Trade (``MAT'') Submission of Certain
Credit Default Swaps (Oct. 30, 2013) (``MarketAxess SEF MAT
Determination''); trueEX, LLC, Submission 2013-14, Made Available to
Trade (``MAT'') Submission of Certain Interest Rate Swaps (``IRS'')
pursuant to CFTC Regulation 40.6 (Oct. 21, 2013) (``trueEX MAT
Determination'').
\251\ CFTC, Industry Filings--Swaps Made Available to Trade,
https://www.cftc.gov/idc/groups/public/@otherif/documents/file/swapsmadeavailablechart.pdf.
\252\ See, e.g., TW SEF LLC--Self-Certification for Swaps to be
Made Available to Trade at 8 (Oct. 28, 2013) (describing the IRS
submitted as benchmark swaps with the most liquidity and the CDS
submitted as the most actively traded); Javelin SEF MAT
Determination at 11 (noting that the bid-offer spreads for the IRS
submitted is tight and characteristic of considerable liquidity);
Bloomberg SEF MAT Determination at 3 (stating that the scope of the
MAT determination represents IRS and CDS that are the most
standardized and liquid); MarketAxess SEF MAT Determination at 1
(stating that the MAT determination consists of the most liquid CDS
listed); trueEX MAT Determination at 4 (specifying that the trade
frequency of IRS with whole-year tenors is sufficient to support a
MAT determination).
\253\ The clearing requirement currently applies to various
categories of IRS, including fixed-to-floating swaps denominated in
U.S. dollars, pound sterling, and euros with whole- and partial-year
tenors that range from 28 days to 50 years; fixed-to-floating swaps
in additional currency denominations with whole and partial tenors
that range from 28 days up to 30 years; basis swaps, overnight index
swaps, and forward rate agreements in varying denominations and
tenors; and various CDX and iTraxx index CDS in the current on-the-
run series and a broad range of older series (prior to the most
recent off-the-run series) with whole-year benchmark tenors. 17 CFR
50.4.
\254\ ISDA, ISDA Research Note: Actual Cleared Volumes vs.
Mandated Cleared Volumes: Analyzing the US Derivatives Market 3
(July 2018), https://www.isda.org/a/6yYEE/Actual-Cleared-Volumes-vs-Mandated-Cleared-Volumes.pdf (``2018 ISDA Research Note'').
\255\ Id.
\256\ Commission staff conducted data analysis based on publicly
available data accessed via Clarus Financial Technology
(``Clarus''). In a separate analysis, ISDA found that only 5 percent
of trading volume in IRS during 2015 and the first three quarters of
2016 consisted of IRS subject to the trade execution requirement.
ISDA, ISDA Research Note: Trends in IRD Clearing and SEF Trading 1,
3, 11 (December 2016), https://www.isda.org/a/xVDDE/trends-in-ird-clearing-and-sef-trading1.pdf (``2016 ISDA Research Note'').
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Beyond this limited initial set of self-certified MAT
determinations, however,
[[Page 61977]]
the Commission has not received any additional MAT determinations for
the significantly large number of IRS and CDS that are subject to the
clearing requirement. This discrepancy has grown even larger as a
result of a subsequent expansion of the clearing requirement.\257\ The
Commission believes that the lack of further MAT determinations from
SEFs or DCMs is largely attributed to the influence of market
participants who believe that applying the trade execution requirement,
and therefore the required use of an Order Book or RFQ System, would
adversely impact their ability to utilize execution methods that are
best suited for the swap they are trading and their individual trading
needs.\258\
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\257\ The Commission expanded the list of swaps subject to the
clearing requirement in 2016 by adding several new classes of IRS
denominated in nine different currencies. See supra note 35. The
Commission believes that the expansion likely contributed to the
increase noted above in the percentage of total reported IRS traded
notional subject to the clearing requirement in 2017 relative to
prior years.
\258\ SIFMA AMG noted that these limited methods of execution
meant that a MAT determination ``could force the entire swap market
to change its practice, disrupting trading and upending the natural
evolution of market dynamics.'' See Letter from the Asset Management
Group of the Securities Industry and Financial Markets Association
(``SIFMA AMG''), In re Concerns Regarding the SEF Framework 3 (May
11, 2015) (``2015 SIFMA AMG Letter''). Further, SIFMA AMG argued
that the ``artificial limitation'' on execution methods for required
transactions ``has resulted in reduced liquidity and fewer options
for asset managers working to reduce portfolio risk in a cost-
effective manner. . . .'' Id. At a Commission roundtable discussion
on the MAT process, one participant noted that market participant
aversion to a broad MAT determination by Javelin SEF discouraged
other SEFs from submitting determinations, based on the fear that
market participants would cease trading or avoid their respective
platforms altogether. 2015 MAT Roundtable at 65-67. See also Joe
Rennison, Experts split on MAT determinations, Risk.net (Nov. 8,
2013), https://www.risk.net/infrastructure/trading-platforms/2305790/experts-split-mat-determinations (noting market participant
resistance to Javelin SEF's initial MAT submission).
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To establish which swaps would be sufficiently liquid to be traded
via an Order Book or RFQ System, the Commission relied upon the
expertise and experience of SEFs and DCMs in the MAT determination
process.\259\ The limited number of MAT determinations that has
resulted reflects these execution methods' lack of suitability in
facilitating a broad range of swaps trading. Market participants have
stated that the prescriptive requirements under Sec. 37.9 limit their
ability to otherwise utilize other execution methods that they believe
may be better suited to address their business needs, adapt to quickly-
changing market conditions, or achieve some combination thereof.\260\
Given that many of the swaps that are subject to the clearing
requirement are highly customizable and less liquid, continuing to
mandate the use of an Order Book and RFQ System is inconsistent with
transitioning a broader segment of the swaps market to the SEF
regulatory framework. Therefore, the Commission recognizes the need for
greater flexibility in execution methods to broaden the scope of the
trade execution requirement over additional swaps trading.\261\
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\259\ MAT Final Rule at 33609.
\260\ See 2015 SIFMA AMG Letter at 8 (In re the current approach
to required methods of execution: ``this prescriptive approach has
negatively impacted market conditions and has caused fragmentation
of the U.S. swap market. The unnecessary restriction on modes of
execution . . . limits a SEF's ability to foster liquidity and
diminishes the venues that asset managers may access for liquid,
competitive pricing.'').
\261\ The Commission notes that the current SEF regulatory
framework allows a SEF to offer flexible methods of execution for
swaps that are not subject to the trade execution requirement, i.e.,
Permitted Transactions; this approach would facilitate trading in
bespoke or less liquid swaps on a SEF. 17 CFR 37.9(c). As noted
above, only 7 to 9 percent of total reported IRS traded notional has
consisted of swaps subject to the trade execution requirement in
recent months; however, approximately 57 percent of total reported
IRS traded notional has occurred on SEFs in 2018. ISDA, ISDA
SwapsInfo Weekly Analysis: Week Ending October 19, 2018, http://analysis.swapsinfo.org/2018/10/interest-rate-and-credit-derivatives-weekly-trading-volume-week-ending-october-19-2018/ (``2018 ISDA
SwapsInfo Weekly Analysis''). Accordingly, the Commission believes
that adopting a more flexible approach to execution methods in the
SEF regulatory framework would better reflect the current swaps
market environment.
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The Commission acknowledges that the Order Book and RFQ System
requirements are too prescriptive and limiting to be applied over a
broader segment of the swaps market. Specifically, these methods do not
account for the swaps products that are highly customized and
episodically liquid by nature. The Commission previously acknowledged
that market participants take into account factors such as swap product
complexity, trade size, and liquidity in deciding how to trade swaps,
including the number of market participants to whom a request for quote
will be sent.\262\ Thus, even the RFQ-to-3 requirement, which the
Commission adopted to provide more execution flexibility, may hinder
market participants from determining the appropriate number of market
participants to disseminate an RFQ for the additional swaps that would
be subject to the trade execution requirement. Mandating the use of
limited methods of execution for swaps subject to the requirement
imposes the Commission's judgment regarding how best to execute
different swaps and ultimately inhibits market participants from
tailoring their own trading strategies and decisions based on the swaps
involved, their individual business needs, the desired transaction
size, and existing market conditions, among other factors.
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\262\ SEF Core Principles Final Rule at 33562.
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The required methods of execution has also limited SEFs from
developing more efficient, transparent, and cost-effective methods of
trading, as well as impeded their ability to compete with one another
using innovative and different methods of execution.\263\ For example,
a SEF may develop a new trading functionality that does not qualify as
an Order Book or RFQ System, but is effective and efficient in trading
both IRS that are and are not subject to the trade execution
requirement. Under the current regulatory framework, participants could
not use that new method for IRS that are subject to the trade execution
requirement or IRS that would become subject to the requirement in the
future. This scenario deprives market participants of a useful
execution method and deprives the SEF that developed the method of
benefitting from its innovative efforts.
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\263\ At the Commission's 2015 MAT Roundtable, one participant
expressed concern that a MAT determination would ``cut[ ]off
potential modes of execution,'' rather than promoting new innovative
execution methods. See 2015 MAT Roundtable at 165.
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The Commission notes that this scenario could occur with respect to
forward rate agreements (``FRAs''), many of which are economically
similar to IRS that are currently subject to the trade execution
requirement. In spite of this economic similarity, FRAs in several
different types of currency denominations and tenor ranges that are
currently subject to the clearing requirement, but have not been
submitted to the Commission as ``available to trade.'' \264\ Based on
an ISDA analysis, over 97 percent of total reported FRA traded notional
during the third quarter of 2016 was cleared and approximately 81
percent of which was traded on SEF and accounted for slightly less than
54 percent of total reported IRS traded notional occurring on
SEFs.\265\ The Commission has
[[Page 61978]]
observed that FRA trading on SEFs occurs through ``permitted''
execution methods, such as risk mitigation services,\266\ that assist
market participants with managing their exposures to market, credit,
and other sources of risk.\267\ Despite their utility, risk mitigation
services do not constitute an Order Book or RFQ System, and therefore,
are not available as an execution method for swaps subject to the trade
execution requirement under the current regulatory framework. Given
that many FRAs would become subject to the trade execution requirement
under the Commission's proposed regulatory framework, as discussed
further below, allowing SEF participants to continue executing these
types of swaps would require more flexible execution methods that are
appropriate for conducting risk mitigation exercises.
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\264\ 17 CFR 50.4 (specifying the FRAs that are subject to
mandatory clearing).
\265\ 2016 ISDA Research Note at 5. The Commission notes that
these statistics include both swaps subject to the clearing
requirement and swaps that are voluntarily cleared. In a subsequent
analysis, however, ISDA determined that 92 to 98 percent of total
reported FRA traded notional from 2014 to 2017 consisted of FRAs
subject to the clearing requirement. 2018 ISDA Research Note at 9.
Commission staff replicated ISDA's results and also found that in
2018, the share of total reported FRA traded notional that is
cleared has increased to 99 percent, with approximately 81 percent
of cleared FRAs continuing to trade on SEF. Commission staff also
found that during the first half of 2018, cleared FRAs accounted for
approximately 48 percent of IRS volume on SEFs, a somewhat smaller
share than the amount that ISDA found during its own review period.
\266\ The Commission notes that market participants have
contended that the required methods of execution are unsuitable for
allowing SEFs to conduct risk mitigation services for swaps that are
subject to the trade execution requirement. See CFTC Letter No. 13-
81, Time-Limited No-Action Relief from Required Transaction
Execution Methods for Transactions that Result from Basis Risk
Mitigation Services (Dec. 23, 2013). See also 2016 WMBAA Letter at
app. A (stating that ``[a]dditional methods of execution for
Required Transactions should include risk mitigation [platforms]'').
\267\ The Commission previously determined that risk mitigation
services that facilitate swap execution are subject to the SEF
registration requirement. SEF Core Principles Final Rule at 33482-
83.
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Further, the Commission believes that the current approach to
required methods of execution may have imposed barriers to entry for
entities that seek to offer swaps trading. As noted above, limiting the
execution methods that a SEF can provide limits their ability to offer
new and innovative trading solutions. As a result, new entrant SEFs
have been unable to differentiate themselves from incumbent SEFs on the
basis of innovation and development, given that both incumbent
platforms and newly-registered entities are otherwise limited to
offering an Order Book and an RFQ System. Accordingly, SEFs have been
forced to compete with one another on a more ancillary basis, rather
than on fundamental operating aspects that provide value to market
participants, in particular the available trading system and platform.
The Commission's current approach to required methods of execution
has also compelled SEFs to make unintended adjustments and alterations
to their execution methods, including auction platforms \268\ and work-
up trading protocols.\269\ Given the prescriptive requirements that a
SEF execution method must comply with to qualify as an Order Book under
Sec. 37.3(a)(3) or as an RFQ System under Sec. 37.9(a)(3), some SEFs
have expended time and effort to amend certain aspects of their trading
systems or platforms, including trading protocols, prior to allowing
participants to use those methods to execute swaps subject to the trade
execution requirement. The Commission acknowledges that SEFs have not
been able to employ and operate execution methods that are fully
developed to facilitate price discovery and more robust participation
on the SEF in periods of episodic liquidity. Rather, requiring SEFs to
adjust various aspects of their respective systems or platforms to
comply with the required methods of execution has likely introduced
operating inefficiencies that have not provided corresponding benefits
to SEF participants. Therefore, the Commission believes that the
prescriptive execution methods have inhibited the effectiveness of
execution methods designed and developed by SEFs to promote trading.
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\268\ For a description of auction-based platforms, see infra
note 313 and accompanying discussion.
\269\ In a trade work-up session associated with a SEF's trading
system or platform, two participants that execute a particular swap
transaction at a particular price have the opportunity to execute
additional volume of that swap at that price within a given time
period established by the SEF. When that period has lapsed, multiple
other buyers and sellers may then seek to execute that particular
swap at the established price set by the initial transaction.
Interested participants may continue to seek to execute that swap at
the established price until the buying and selling interest is
exhausted or the work-up session has expired, as set forth by the
SEF. The Commission has observed that SEFs offer these sessions
within a particular execution method, e.g., an electronic order
book, to encourage participants to provide liquidity to the market.
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4. Proposed Approach
To further promote the SEF statutory goals, the Commission proposes
a SEF regulatory framework that would facilitate a more robust
application of the trade execution requirement and allow more
flexibility in the execution methods that may be offered and used for
trading swaps that are subject to the requirement. The Commission
believes that this approach would better establish SEFs as vibrant and
liquid marketplaces for swaps trading that foster price discovery and
liquidity formation. The Commission believes that its proposed approach
is consistent with the statutory SEF provisions and would also further
the statutory SEF goals, while helping to alleviate the challenges of
the existing approach described above.
The Commission proposes to adopt a new interpretation of the trade
execution requirement that would greatly expand the scope of swaps that
are subject to the requirement. Considering the market characteristics
and episodic liquidity profiles of these additional swaps, the
Commission's proposed approach would provide needed flexibility to SEFs
and market participants to support more trading through SEF trading
systems or platforms. In conjunction with an expansion of the trade
execution requirement, the Commission also proposes to eliminate the
prescriptive execution methods for swaps subject to the requirement.
Rather than impose execution method requirements that are limited to an
Order Book or RFQ System, the Commission's proposed approach would
allow SEFs to develop and offer--and therefore enable--market
participants to choose execution methods that are appropriate to their
trading. Providing market participants with greater choice in execution
methods allows them to utilize trading systems or platforms that are
not constrained by prescriptive regulatory requirements and suit their
trading circumstances and the market conditions for those swaps at a
given time. This flexibility is necessary to facilitate trading in the
broad scope of swaps that would become subject to the trade execution
requirement. This flexibility should also allow the swaps market and
SEFs to continue to naturally evolve and innovate to more efficient,
transparent, and cost effective means of trading, even for swaps
currently subject to the trade execution requirement. The Commission
believes that this flexibility, in concert with the concentration of
trading activity in episodically liquid swaps on SEFs, should help
foster price discovery and allow market participants to pursue more
appropriate, counterparty and swap-specific levels of pre-trade price
transparency through additional methods of execution.\270\ Accordingly,
[[Page 61979]]
the Commission believes that more execution flexibility also reduces
certain complexity, costs, and burdens that have impeded SEF
development and innovation, particularly with more swaps that would be
subject to mandatory trading on SEFs. Ultimately, this approach is
intended to attract greater liquidity that would promote more trading
on SEFs.
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\270\ As discussed above, the Commission acknowledges that
market participants take into account factors such as swap product
complexity, trade size, liquidity, and the associated desire to
minimize potential information leakage and front-running risks in
deciding how to trade swaps, including the number of market
participants to whom a request for quote will be sent. In selecting
that number of market participants to whom a request for quote will
be sent, the market participant is determining the appropriate level
of pre-trade transparency necessary to efficiently and effectively
execute that swap transaction based on the above factors and its
individual trading needs. See supra Section I.B.1.b.--Swaps Market
Characteristics.
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a. Sec. 36.1(a)--Trade Execution Requirement
The Commission has interpreted the trade execution requirement in
CEA Section 2(h)(8)--in particular, the phrase ``makes the swap
available to trade''--in a manner that has limited the scope of swaps
that must be traded on a SEF.\271\ Initially designed to ensure that
the Order Book and RFQ System requirements could support swaps that are
sufficiently liquid for trading, the MAT determination process has
resulted in a small number of swaps that are currently subject to the
trade execution requirement. As noted above, Commission staff has
determined that only a small and declining percentage of total reported
IRS traded notional over a recent time period is subject to the trade
execution requirement, with only part of overall IRS trading volume
occurring on SEFs.\272\
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\271\ MAT Final Rule at 33606.
\272\ See supra notes 256 and 261 and accompanying discussion.
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Given the current regulatory framework's limited ability in
promoting swaps trading on SEFs, which limits the statutory SEF goals,
the Commission is proposing to adopt a revised interpretation of CEA
section 2(h)(8). The Commission believes that the phrase ``makes the
swap available to trade'' should be interpreted to mean that once the
clearing requirement applies to a swap, then the trade execution
requirement applies to that swap upon any single SEF or DCM listing the
swap for trading.\273\ As previously noted by some commenters to the
proposed MAT rule, CEA section 2(h)(8) does not mandate the MAT process
adopted by the Commission to implement the trade execution
requirement.\274\ The Commission believes that the most straightforward
reading of CEA section 2(h)(8) would specify that once the clearing
requirement applies to a swap, then the trade execution requirement
also applies to that swap unless no SEF or DCM ``makes the swap
available to trade.'' Accordingly, once any single DCM or SEF ``makes
available,'' i.e., lists, a swap that is subject to the clearing
requirement for trading on its facility, then the trade execution
requirement would apply to that swap, such that market participants may
only execute the swap on a SEF, a DCM, or an Exempt SEF.
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\273\ In addition to DCMs and SEFs, CEA section 2(h)(8)
contemplates the ability of Exempt SEFs to list swaps subject to the
clearing requirement. As discussed below, the Commission proposes to
use its exemptive authority pursuant to CEA section 4(c) to exclude
swaps that are exclusively listed by Exempt SEFs from being subject
to the trade execution requirement. Accordingly, only a CFTC-
registered DCM or SEF would be able to trigger the CEA section
2(h)(8) trade execution requirement by listing a clearing
requirement swap. See infra Section XXI.A.2.--Sec. 36.1(b)--
Exemption For Certain Swaps Listed Only By Exempt SEFs.
\274\ MAT Final Rule at 33607. These commenters believed that
use of the clearing determination process in CEA section 2(h)(2)
``as the exclusive basis for finding that a swap is available to
trade would subject more swaps to the trade execution requirement
and further the objectives of the Dodd-Frank Act.'' SEF Core
Principles Final Rule at 33607-08. Some commenters pointed out that
the procedure for determining whether a swap was made available to
trade was ``duplicative of the mandatory clearing determination
process [in CEA section 2(h)(2)] and accordingly stated that the
Commission should rely on the clearing determination process to also
determine whether a swap is available to trade.'' MAT Final Rule at
33607.
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The Commission notes that Congress had the ability to delineate a
comprehensive statutory process for determining when a swap should be
subject to the trade execution requirement, but did not do so when
amending the CEA via the Dodd-Frank Act.\275\ In contrast, the clearing
requirement, established by Congress concurrently with the trade
execution requirement under the Dodd-Frank Act, sets forth a formal
statutory process for the Commission to follow in determining which
swaps must be submitted to a DCO for clearing.\276\ The Commission
notes that the statutory process in CEA section 2(h)(2) establishes
that submissions from a DCO for each swap, or any group, category,
type, or class of swap that it plans to accept for clearing is
automatically subject to a clearing determination by the
Commission.\277\ As part of a clearing requirement determination, the
CEA requires the Commission to evaluate submitted swaps based on a
prescribed set of factors that includes trading liquidity.\278\ Given
the absence of analogous CEA provisions governing the trade execution
requirement and based on its experience since implementing the swaps
trading framework, the Commission believes that the proposed
interpretation of CEA section 2(h)(8) is consistent both with that
statutory provision and with the statutory goal of promoting the
trading of swaps on SEFs.
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\275\ The Commission also observes that Congress specifically
placed the trade execution requirement within the CEA section 2(h)
heading of ``clearing requirement.'' The Commission believes that
this placement of the trade execution requirement within the
clearing requirement further supports the view that no additional
framework was intended by Congress beyond the processes already
enumerated within this section. 7 U.S.C. 2(h).
\276\ Specifically, CEA section 2(h)(2) delineates a structured
process that outlines a specific set of factors that the Commission
must consider in its clearing requirement determination and includes
a provision for public comment. Among other things, the Commission
must consider outstanding notional exposures; trading liquidity;
adequate pricing data; adequate clearing infrastructure; mitigation
of systematic risk; effects on competition; and legal certainty
surrounding solvency concerns. 7 U.S.C. 2(h)(2).
\277\ CEA section 2(h)(2)(B)(iii)(II).
\278\ As adopted under part 50 of the Commission's regulations,
the Commission has noted that this required analysis of a swap's
trading liquidity is intended for risk management purposes, i.e.,
pricing and margining of cleared swaps. In this connection, the
Commission has noted that higher trading liquidity in swaps would
assist DCOs in end-of-day settlement procedures, as well as in
managing the risk of CDS portfolios, particularly in mitigating the
liquidity risk associated with unwinding a portfolio of a defaulting
clearing member. 77 FR 47176.
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As support for its view that the proposed interpretation of CEA
section 2(h)(8) would promote the trading of swaps on SEFs, the
Commission notes that more than 85 percent of IRS and index CDS trading
volume is currently subject to the clearing requirement; \279\ many,
but not all, of those swaps are currently listed for trading by SEFs.
Therefore, the proposed reading would both promote the statutory SEF
goal of swaps trading on SEFs and help to further swaps liquidity on
SEFs by requiring all counterparties to trade these swaps on a SEF,
which may promote increased pre-trade price transparency.\280\ A more
robust trade
[[Page 61980]]
execution requirement would help migrate and concentrate additional
trading interests to available trading systems or platforms on
SEFs.\281\ The Commission believes that all of these factors can
increase activity on SEFs, as well as help improve their efficiency and
effectiveness.
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\279\ 2018 ISDA Research Note at 3, 15-16.
\280\ The Commission believes that further achieving both SEF
statutory goals--promoting trading on SEFs and promoting pre-trade
price transparency--requires both (i) increasing the number of swaps
that are subject to the trade execution requirement, thereby
increasing the amount of trading that must occur on SEF; and (ii)
concurrently providing flexible execution methods. The Commission
believes that requiring market participants to conduct a larger
portion of their swaps trading on SEFs would centralize liquidity,
foster additional competition among a more concentrated number of
market participants, and reduce information asymmetries that would
increase market efficiency and decrease transaction costs. While
offering flexible methods of execution alone could transition
additional swaps trading to SEFs, the Commission believes that
maximizing the potential benefits of the proposed approach
necessitates an approach that would also lessen fragmentation in
trading of swaps on SEFs versus the OTC environment.
Accordingly, the Commission's proposed approach would have a
profound impact on the amount of swaps trading that occurs on SEFs.
As noted above, Commission staff found that a small and declining
percentage of the reported IRS volume in recent months has consisted
of swaps subject to the trade execution requirement (currently less
than 10 percent). ISDA determined, however, that more than 55
percent of total reported IRS traded notional has been occurring on
SEFs since 2015. See supra note 261 (noting that SEFs have
facilitated trading of Permitted Transactions). Based on these
determinations, the Commission's proposed interpretation of the
trade execution requirement may result in a significantly larger
amount of additional IRS trading volume on SEFs, given that the
Commission believes that many, but not all, of that 85 percent of
IRS that is subject to clearing requirement is currently listed on
SEFs. Moreover, it is plausible that adopting this proposed
interpretation would induce SEFs to list additional swaps subject to
the clearing requirement, which would expand the amount of swaps
trading that is subject to the trade execution requirement.
\281\ As noted above, the Commission expects that the proposal
would greatly expand the scope of the trade execution requirement.
In particular, the Commission expects that the following swaps would
become subject to the trade execution requirement based on the fact
they are currently subject to the clearing requirement and also
listed by at least one SEF or DCM: (i) Various swaps in the interest
rate asset class including fixed-to floating swaps denominated in
U.S. dollars, pound sterling, and euros with non-benchmark tenors
(whole and partial) that range from 28 days to 50 years; fixed-to-
floating swaps in additional denominations with whole and partial
tenors ranging from 28 days up to 30 years; basis swaps, overnight
index swaps (``OIS''), and FRAs with different denominations and
tenors; and (ii) various CDX and iTraxx index CDSs in older series
(prior to the most recent off-the-run series) and additional tenors,
as well as new CDS indices.
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Given the Commission's proposed approach to the trade execution
requirement, as described above, the Commission proposes to eliminate
(i) the MAT process for SEFs under Sec. 37.10; (ii) the associated
trade execution compliance schedule under Sec. 37.12; (iii) the MAT
process for DCMs under Sec. 38.12; and (iv) the associated trade
execution compliance schedule under Sec. 38.11.
The Commission further proposes to codify under Sec. 36.1(a) the
statutory language of the trade execution requirement in CEA section
2(h)(8), which requires counterparties to execute a swap that is
subject to the clearing requirement on a DCM, a SEF, or an exempt SEF
unless no such entity ``makes the swap available to trade'' or the swap
is subject to a clearing exception in CEA section 2(h)(7).\282\ As
proposed, Sec. 36.1(a) would specify that counterparties must execute
a transaction subject to the clearing requirement on a DCM, a SEF, or
an Exempt SEF that lists the swap for trading. As discussed above, the
Commission believes that the statutory phrase ``makes the swap
available to trade'' specifies the listing of a swap by a DCM, a SEF,
or an exempt SEF on its facility for trading. Accordingly, the trade
execution requirement would apply to a swap that is subject to the
clearing requirement upon the listing of that swap by any DCM or
SEF.\283\
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\282\ 7 U.S.C. 2(h)(8)(B). The Commission interprets ``swap
execution facility'' in CEA section 2(h)(8)(B) to include a swap
execution facility that is exempt from registration pursuant to CEA
section 5h(g). See supra note 10.
\283\ As discussed below, the Commission is proposing an
exemption from the requirement for swap transactions involving swaps
that are listed for trading only by an Exempt SEF. See infra Section
XXI.A.2.--Sec. 36.1(b)--Exemption For Certain Swaps Listed Only By
Exempt SEFs.
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As discussed further below, the Commission is also proposing (i)
exemptions of various transactions from the trade execution requirement
under Sec. 36.1 pursuant to its exemptive authority in CEA section
4(c); (ii) a compliance schedule for market participants with respect
to the expanded application of the trade execution requirement to
additional swaps; (iii) a public registry with information as to which
swaps are subject to the trade execution requirement and the SEFs or
DCMs that list them for trading; and (iv) a standardized form to assist
the Commission in populating the public registry with relevant
information regarding the trade execution requirement.\284\
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\284\ See infra Section XXI.A.--Sec. 36.1--Trade Execution
Requirement.
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Request for Comment
The Commission requests comment on all aspects of its proposed
approach to the trade execution requirement, including Sec. 36.1(a) as
well as any alternative approaches to implementation of the trade
execution requirement.
b. Elimination of Required Execution Methods
To better foster trading on SEFs--particularly with respect to the
many episodically liquid swaps that will become subject to the trade
execution requirement--the Commission proposes to eliminate the
existing execution method requirements under Sec. 37.9. These
requirements include the (i) definition of and associated requirements
for Required Transactions under Sec. 37.9(a), including the RFQ System
definition under Sec. 37.9(a)(3); \285\ and (ii) the definition and
associated provision for Permitted Transactions under Sec. 37.9(c).
Therefore, a SEF would be permitted to offer any method of execution
that meets the SEF definition for any swap that it lists for trading,
irrespective of whether the particular swap is or is not subject to the
trade execution requirement. The Commission believes that this approach
is consistent with the statutory SEF definition in CEA section 1a(50),
which establishes that a SEF operates a trading system or platform
whereby multiple participants have the ability to execute or trade
swaps by accepting bids and offers made by multiple participants also
using the trading system or platform.\286\
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\285\ As discussed above, the Commission is also proposing to
eliminate the Order Book definition set forth under Sec.
37.3(a)(3). See supra Section IV.C.2.--Sec. Sec. 37.3(a)(2)-(3)--
Minimum Trading Functionality and Order Book Definition. As
discussed below, the Commission is also proposing to eliminate the
time delay requirement under Sec. 37.9(b), which applies to
Required Transactions executed on an Order Book. See infra Section
VI.A.2.--Sec. 37.203(a)--Pre-Arranged Trading Prohibition; Sec.
37.9(b)--Time Delay Requirement.
\286\ 7 U.S.C. 1a(50).
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The Commission's proposed elimination of Sec. 37.9(a) also
includes the elimination of subparagraph (a)(2)(ii), which currently
specifies that with respect to offering an Order Book or RFQ System for
Required Transactions, a SEF may utilize ``any means of interstate
commerce'' for purposes of execution and communication, including, but
not limited to, the mail, internet, email and telephone.\287\ Given the
elimination of the Order Book and RFQ System requirements, the
Commission notes that this provision is no longer necessary.
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\287\ 17 CFR 37.9(a)(2)(ii).
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As noted above, implementing the proposed interpretation of the
trade execution requirement would increase the number of swaps that are
required to trade on a SEF. Many of these swaps, which are all
currently subject to the clearing requirement would have terms and
conditions, e.g., partial-year tenors and varying payment terms, that
counterparties customize to address idiosyncratic risks, such as larger
and longer duration risk exposures.\288\ Given
[[Page 61981]]
their variable and complex nature, trading in these types of swaps can
be punctuated by alternating periods of liquidity and illiquidity.\289\
The markets for many of these swaps may consist of only a few trades
per day or, in some cases, a few trades per month.\290\ Historically,
market participants have had discretion to utilize execution methods
tailored to their particular trading motives and needs, the liquidity
profile and characteristics of the swap being traded, and current
market conditions, among other considerations.\291\
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\288\ Additionally, market participants may execute such swaps
as part of different transaction structures, including package
transactions composed of multiple risk-assuming or risk-hedging swap
and non-swap components that are priced together. In their review of
three months of OTC IRS trading, Federal Reserve Bank of New York
(``FRBNY'') staff found that the swaps traded were ``broad in scope
with a wide range of products, currencies, and maturities traded . .
. [including] transactions in eight different product types, 28
currencies and maturities ranging from less than one month to 55
years.'' Michael Fleming, John Jackson, Ada Li, Asani Sarkar, &
Patricia Zobel, Federal Reserve Bank of New York Staff Report No.
557, An Analysis of OTC Interest Rate Derivatives Transactions:
Implications for Public Reporting 2 (2012) (``2012 FRBNY
Analysis''). The analysis further identified ``a meaningful degree
of customization in contract terms, particularly in payment
frequencies and floating rate tenors.'' Id. at 3. The Commission
acknowledges that while some of the swaps that were included in the
FRBNY's analysis would not be subject to the clearing requirement,
e.g., any IRS with a 55-year tenor, the Commission nevertheless
believes that this analysis captures many of the swaps that are
subject to the clearing requirement.
\289\ In a 2011 Senate hearing related to SEFs, one participant
testified that ``[t]rading in [swaps] markets is characterized by
variable or non[-]continuous liquidity. Such liquidity can be
episodic, with liquidity peaks and troughs that can be seasonal . .
. or more volatile and tied to external market and economic
conditions (e.g., many credit, energy and interest rate products).''
Emergence of Swap Execution Facilities: A Progress Report: Hearing
Before the S. Subcomm. on Sec., Ins., and Investment of the S. Comm.
on Banking, Hous., and Urban Affairs, 112th Cong. 15 (2011)
(statement of Stephen Merkel, Executive Vice President and General
Counsel, BGC Partners, Inc.).
\290\ In their review of three months of OTC IRS swaps, FRBNY
staff also ``found over 10,500 combinations of product, currency,
tenor and forward tenor traded during [their] three-month sample,
with roughly 4,300 combinations traded only once.'' 2012 FRBNY
Analysis at 3. Further, their analysis found that within the data
set, even the most commonly traded instruments were not frequently
traded. No single instrument in the data set traded more than 150
times per day, on average, and the most frequently traded
instruments in OIS and FRA only traded an average of 25 and 4 times
per day, respectively. Id. Collin-Dufresne, Junge, and Trolle also
made similar observations with respect to index CDS trading on SEFs,
noting that the market is generally characterized by relatively few
trades in very large sizes. Based on their analysis, the CDX.IG
swaps market consists of 114 dealer-to-client trades and 24 dealer-
to-dealer trades per day, on average, with a median trade size of
USD $50 million in both segments. The average number of trades in
the CDX.HY market are greater--164 dealer-to-client trades and 27
dealer-to-dealer trades per day, on average--but the median trade
size is smaller--USD $10 million in both segments--which they
attributed to the significantly higher volatility of high-yield
contracts. 2017 Collin-Dufresne Research Paper at 16.
\291\ Those means include, for example, voice-based trading
systems or platforms that utilize human trading specialists who
exercise discretion and judgment in managing the degree to which
trading interests are exposed and how orders are filled. Where pre-
trade market information from bids and offers may be limited due to
market participants' caution in displaying trading interests, SEFs
often offer session-based execution methods, such as auctions, to
generate trading interest.
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The existing execution methods for Required Transactions under the
current framework, however, has precluded the full use of such
discretion and forces participants to trade certain swaps in accordance
with an Order Book or an RFQ System. As noted above, the Commission
believes that these limited execution methods would not be suitable for
the broad swath of the swaps market that would become newly subject to
the trade execution requirement. Instead, prescribing those execution
methods for this expanded group of swaps would likely impose greater
trading risks on market participants, including execution and liquidity
risks that negate any benefits associated with the centralized exchange
trading of such swaps.\292\ The Commission also notes that the current
execution methods could exacerbate the current information leakage and
front running risks as described above.\293\
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\292\ See supra note 130 (explaining that requiring all market
participants to use a central limit order book will not necessarily
promote price competition among dealers in markets that lack
continuous trading or have episodic liquidity).
\293\ SEF Core Principles Final Rule at 33562. See generally
2017 Riggs Study (discussing the ``winner's curse,'' which is
similar to information leakage in context, in the dealer-to-client
CDS market).
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The existing framework was designed to promote the SEF statutory
goals, in particular to promote pre-trade price transparency, but based
on its implementation experience, the Commission believes that a SEF
regulatory framework that requires a greater number of swaps to be
traded through flexible execution methods on a SEF will better promote
both SEF statutory goals. The Commission believes that requiring more
swaps to be traded on SEFs would help foster vibrant and liquid SEF
markets as liquidity formation and price discovery is centralized on
these markets. With more swaps trading activity occurring in a
concentrated SEF environment, the Commission anticipates that a greater
number of observable transactions--for example, IRS of varying tenors
along a single price curve--would allow for a richer price curve that
provides participants with more accurate pricing for economically
similar swaps along other points of the curve.
For example, auction platforms and work-up sessions--both of which
SEFs currently offer under the existing framework--help to maximize
participation and trading on the SEF at specific points of time and
serve as effective tools for price discovery for market participants in
periods of episodic liquidity. By allowing SEFs the flexibility to
develop and tailor these types of functionalities to facilitate trading
across a wide range of market liquidity conditions, a SEF can
effectively promote appropriate counterparty and swap-specific levels
of pre-trade price transparency \294\ across a broader range of swaps.
Further, as discussed above, affording SEFs with greater flexibility
with execution methods would avoid forcing them to alter these types of
functionalities in a sub-optimal manner simply to conform to certain
limited execution methods that are not suitable for trading a broad
range of swaps with varying liquidity profiles.
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\294\ See supra note 270 (discussing appropriate counterparty
and swap-specific levels of pre-trade price transparency).
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By eliminating the existing approach to required methods of
execution, the Commission's proposed regulatory framework is also
expected to foster customer choice in a manner that would benefit the
swaps markets. The Commission believes that its proposed approach
appropriately allows market participants, each of whom is a
sophisticated entity trading in a professional market, to determine the
execution method that best suits the swap being traded and their
trading needs and strategies.\295\ As noted above, the Commission
believes that market participants in a professional market, in part
because of sophistication and self-interest, will seek the most
efficient and cost-effective method of execution to achieve their
business and trading objectives. The Commission believes that providing
for customer choice, while also concentrating liquidity and price
discovery onto SEFs, may help create an environment for swaps trading
that is better able to promote appropriate counterparty and swap-
specific levels of pre-trade price transparency than the existing
framework and will also do so for a significantly broader segment of
the swaps markets than the existing framework. As noted above,
execution methods such as auction platforms and work-up sessions may do
a better job of maximizing participation and concentrating liquidity
than Order Books or RFQ Systems in episodically liquid markets.
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\295\ The Commission notes that other markets--such as bonds,
U.S. treasuries, and FX--do not prescribe methods of execution, but
rather permit their market participants to determine the best method
of execution for the transaction. Swaps markets have historically
followed this model. In this respect, the Commission believes that
its proposal realigns the swaps market trading characteristics with
other fixed income markets.
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The proposed approach would allow SEFs to offer varied and
innovative execution methods that are best suited to the products they
list, as well as the
[[Page 61982]]
trading needs of their market participants. Rather than being confined
to limited execution methods, SEFs would be able to develop more
efficient, transparent, and cost-effective means for participants to
trade swaps. In turn, the Commission believes that this innovation may
serve to promote more competition between SEFs to attract participation
through novel trading systems or platforms. The Commission further
believes greater execution flexibility may also potentially incentivize
new entrant trading venues to enter the SEF marketplace, as they would
be able to utilize new and different execution methods than are
currently employed by incumbent platforms.
Request for Comment
The Commission requests comment on all aspects of its proposed
approach to execution methods as well as any alternative approaches.
V. Part 37--Subpart B: Core Principle 1 (Compliance With Core
Principles)
The Commission is not proposing any amendments to Sec. 37.100,
which codifies the language of Core Principle 1.\296\
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\296\ Core Principle 1 requires a SEF to comply with the core
principles set forth in CEA section 5h(f) and any requirement that
the Commission may impose by rule or regulation pursuant to CEA
section 8a(5) as a condition of obtaining and maintain registration
as a SEF. 7 U.S.C. 7b-3(f)(1). Core Principle 1 also provides a SEF
with reasonable discretion in establishing the manner in which it
complies with the core principles, unless the Commission determines
otherwise by rule or regulation. 7 U.S.C. 7b-3(f)(1)(B).
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VI. Part 37--Regulations Related to SEF Execution Methods--Subpart C:
Core Principle 2 (Compliance With Rules)
Core Principle 2 requires a SEF to establish and enforce rules that
govern its facility, including trading procedures to be followed when
entering and executing orders, among other requirements.\297\
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\297\ Core Principle 2 also requires a SEF to (i) establish and
enforce compliance with rules, including terms and conditions of
swaps traded or processed on or through the SEF and any limitation
on access to the SEF; (ii) establish and enforce trading, trade
processing, and participation rules that will deter abuses and have
the capacity to detect, investigate, and enforce those rules,
including means to provide market participants with impartial access
to the market and to capture information that may be used in
establishing whether rule violations have occurred; and (iii)
provide by its rules that when a SD or MSP enters into or
facilitates a swap that is subject to the clearing requirement, the
SD or MSP will be responsible for compliance with the trade
execution requirement. 7 U.S.C. 7b-3(f)(2). The Commission codified
Core Principle 2 under Sec. 37.200. 17 CFR 37.200.
---------------------------------------------------------------------------
To support the proposed approach of allowing more flexible
execution methods on SEFs, which is intended to foster more liquidity
formation through trading activity on SEF trading systems and
platforms, the Commission is proposing to amend certain rules and adopt
new rules under Core Principle 2, as described below. These proposed
rules would, among other things, help foster open and transparent
markets as well as promote market efficiency and integrity. In
particular, the Commission proposes to establish general rules that
would apply to any execution method that a SEF offers on its facility.
The Commission also proposes to limit the ability of market
participants to conduct pre-execution communications and submit
resulting pre-negotiated or pre-arranged trades to a SEF for execution;
and eliminate exceptions to the pre-arranged trading prohibition under
Sec. 37.203(a), including the time delay requirement under Sec.
37.9(b).
Additionally, the Commission proposes to amend certain existing
rules and adopt new rules under Core Principle 2, as described below,
that correspond to the Commission's application of the SEF registration
requirement to swap broking entities, including interdealer brokers.
Among other goals, these proposed rules would enhance professionalism
requirements for certain SEF personnel--``SEF trading specialists''--
that operate as part of a SEF's trading system or platform, e.g.,
voice-based trading functionalities, by facilitating trading and
execution on the facility. Specifically, the Commission proposes rules
under Sec. 37.201(c) that would require SEFs to ensure minimum
proficiency and conduct standards for SEF trading specialists.
A. Sec. 37.201--Requirements for Swap Execution Facility Execution
Methods 298
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\298\ The Commission proposes to retitle Sec. 37.201 to
``Requirements for swap execution facility execution methods'' from
``Operation of swap execution facility and compliance with rules''
based on the proposed changes described below.
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Section 37.201 implements the Core Principle 2 requirement that a
SEF establish and enforce rules that govern its facility. Section
37.201(a) specifies that these requirements include trading procedures
to be followed when entering and executing orders traded or posted on
the SEF.\299\ Section 37.201(b) additionally requires a SEF to
establish and impartially enforce rules related to (i) the terms and
conditions of swaps traded or processed on the SEF; (ii) access to the
SEF; (iii) trade practice requirements; (iv) audit trail requirements;
(v) disciplinary requirements; and (vi) mandatory trading
requirements.\300\ The Commission proposes to eliminate these rules,
which are largely duplicative of the Core Principle 2 requirements, and
adopt the new rules described below.
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\299\ 17 CFR 37.201(a).
\300\ 17 CFR 37.201(b).
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1. Sec. 37.201(a)--Required Swap Execution Facility Rules
Proposed Sec. 37.201(a) would require a SEF to establish rules
that govern the operation of the SEF, including rules that specify (i)
the protocols and procedures for trading and execution; (ii) the
permissible uses of ``discretion'' in facilitating trading and
execution; and (iii) the sources and methodology for generating any
market pricing information.
Pursuant to a SEF regulatory framework that would allow SEFs to
offer flexible execution methods, the Commission believes that such
rules would benefit market participants by providing a baseline level
of transparency in SEF trading. As the Commission previously noted, one
of the central goals of the Dodd-Frank Act is to bring transparency to
the opaque OTC swaps market.\301\ The Commission has further observed
that when markets are open and transparent, prices are more competitive
and markets are more efficient.\302\ In this regard, the Commission
notes that rather than imposing detailed, prescriptive SEF execution
method requirements that do not comport with swaps market
characteristics, this proposed rule represents a more balanced
approach--a SEF would have the flexibility to develop and offer
execution methods designed to foster trading based on the dynamics of
the applicable swaps market (e.g., liquidity and product
characteristics) and on its market participants' needs, but also would
be required to disclose how these execution methods operate. This
disclosure would help to foster open and transparent markets, and
promote market efficiency and integrity by establishing a consistent
level of disclosure and information across all SEFs, which would allow
market participants to make informed decisions regarding whether to
onboard to a particular SEF and whether to use a particular execution
method offered by a SEF.\303\ In making such decisions,
[[Page 61983]]
market participants would be able to understand more fully any
differences among those flexible methods across SEFs.
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\301\ SEF Core Principles Final Rule at 33553.
\302\ Id.
\303\ The Commission notes that this view is analogous to the
principles set forth in the FX Global Code. The FX Global Code was
developed by a partnership between central banks and participants
from 16 jurisdictions. The code does not impose legal or regulatory
obligations on participants nor does it act as a substitute for
regulation, but rather serves as a supplement to local laws by
setting forth guidelines for good practices in the FX markets. The
code specifies, among other recommendations, that ``Market
Participants,'' which include operators of trading systems or
platforms, should provide all relevant disclosures and information
to participants to help them make informed decisions about whether
to transact or not. See FX Global Code at 13-14 (updated Aug. 2018)
(``FX Global Code''), available at https://www.globalfxc.org/docs/fx_global.pdf.
---------------------------------------------------------------------------
Based on the definition of ``rule'' under Sec. 40.1(a), which
encompasses any SEF ``trading protocol,'' the proposed rule clarifies
those features of a SEF's execution methods that constitute SEF
``rules'' and must be submitted to the Commission pursuant to part 40
and disclosed to SEF market participants.\304\ Accordingly, SEFs would
be required to disclose such information in their rulebooks. After
reviewing SEF rulebooks, the Commission believes that this proposed
disclosure requirement is consistent with current market practice and
the general level of information already disclosed by many SEFs.
Accordingly, the Commission does not anticipate that this proposed rule
would require material changes to most SEF rulebooks; rather, the
proposed rule would ensure that currently-registered and new SEFs
provide a consistent, minimum level of transparency and disclosure to
the marketplace. The Commission further notes that SEFs are free to
provide additional levels of disclosure beyond that required under
proposed Sec. 37.201(a).
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\304\ See supra note 179 (definition of ``rule'' in the
Commission's regulations).
---------------------------------------------------------------------------
a. Sec. 37.201(a)(1)--Trading and Execution Protocols and Procedures
Proposed Sec. 37.201(a)(1) would require a SEF to establish rules
governing the protocols and procedures for trading and execution,
including entering, amending, cancelling, or executing orders for each
execution method offered by the SEF. The Commission believes that
requiring SEFs to provide this level of detail and transparency for
each of their execution methods is particularly important given the
Commission's proposal to permit SEFs to offer flexible execution
methods for all of their listed swaps.
The Commission believes that proposed Sec. 37.201(a)(1) clarifies
a SEF's existing obligations and is consistent with current market
practice, in particular the general level of disclosure and information
that many SEFs already provide in their rulebooks. This proposed rule
is also better aligned with other proposed Core Principle 2 regulations
that relate to SEF trading protocols and procedures, such as proposed
Sec. 37.203(e), which would require SEFs to promulgate rules and
procedures to resolve error trades, including trade amendments or
cancellations, as discussed below.\305\
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\305\ See infra Section VII.B.5.--Sec. 37.203(e)--Error Trade
Policy.
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To comply with this rule, for example, a SEF that offers an RFQ
protocol could specify various operational aspects of that protocol in
its rulebook. Those aspects could include, among other things, how a
requestor could initiate an RFQ; whether the RFQ requestor's identity
is disclosed or anonymous; whether an RFQ request could be made visible
to the entire market; whether a responder could offer either indicative
or firm bids or offers; the length of time that an RFQ response with a
firm bid or firm offer would have to remain executable by the RFQ
requestor; or whether RFQ responses are disclosed to the whole market
or just the requestor. By specifically requiring a SEF to disclose
information regarding how each offered execution method operates, a
market participant would have the ability to (i) make an informed
decision about whether to trade and execute on that SEF; (ii) determine
the type of trading system or platform that best suits its needs; and
(iii) conform its trading and execution practices to the SEF's
protocols and procedures.\306\
---------------------------------------------------------------------------
\306\ See FX Global Code at 13-14 (recommending that trading
systems or platforms have rules that are transparent, including how
orders are handled and transacted).
---------------------------------------------------------------------------
b. Sec. 37.201(a)(2)--Discretion
Proposed Sec. 37.201(a)(2) would require a SEF, where applicable,
to establish rules specifying the manner or circumstances in which the
SEF may exercise ``discretion'' in facilitating trading and execution
for each of its execution methods. Many SEFs, in particular those that
resemble or are based upon operations of swaps broking entities,
including interdealer brokers, feature execution methods that involve
the use of discretion.\307\ SEF trading specialists,\308\ who have
traditionally served as interdealer brokers in the wholesale swaps
market, exercise discretion on behalf of market participants in a
variety of ways. This discretion includes determining how, when, and
with whom to disseminate, arrange, and execute bids and offers; and
determining whether and when to amend or cancel those bids and offers
in response to market developments. Exercising this type of trading and
execution judgment involves taking different factors into account, such
as the characteristics and needs of the client, size and nature of the
order, likelihood and speed of execution, price and costs of execution,
and current market conditions. The use of discretion in trading
reflects the market characteristics of the wholesale swaps market,
where the wide range of different swaps and transaction sizes results,
in some instances, in low liquidity markets with episodic, non-
continuous trading activity.
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\307\ As noted above, upon the adoption of part 37, some
interdealer brokers have registered their operations or components
of their operations, i.e., trading systems or platforms, as SEFs.
See supra Section IV.C.1.c.(1)--Structure and Operations of Swaps
Broking Entities, Including Interdealer Brokers.
\308\ ``SEF trading specialist'' refers to a natural person
employed by a SEF (or acting in a similar capacity as a SEF
employee) to perform various core functions that facilitate trading
and execution, including discussing market color with market
participants, negotiating trade terms, issuing RFQs, and arranging
bids and offers. For the Commission's proposed definition of ``SEF
trading specialist,'' see infra Section VI.A.3.--Sec. 37.201(c)--
SEF Trading Specialists.
---------------------------------------------------------------------------
Given the established role of swaps broking entities, including
interdealer brokers, in fostering market liquidity through identifying
and arranging multiple trading interests--both liquid and illiquid--
amidst changing market conditions, the Commission recognizes that the
use of discretion is an important element in fostering an efficient
market. Therefore, the Commission's proposed regulatory framework would
further accommodate the use of discretion by SEFs. As described above,
SEFs would be allowed to offer flexible execution methods, thereby
allowing methods that involve the exercise of discretion by SEF trading
specialists.\309\ Further, the proposed expansion of the trade
execution requirement would lead to a greater number of swaps being
traded on SEFs.
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\309\ The Commission's clarification of the SEF registration
requirement, as discussed above, would require swaps broking
entities, including interdealer brokers, to register as SEFs. Id.
The Commission notes that as a result, a significant number of
personnel at these entities would likely meet the definition of
``SEF trading specialist.''
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The Commission believes that the proposed broadening of both the
SEF registration requirement and the trade execution requirement would
increase the level of discretion that SEFs (and their trading
specialists) exercise in connection with swaps trading. To address this
situation, proposed Sec. 37.201(a)(2) would require SEFs to disclose
the manner or circumstances in which they may exercise discretion. The
Commission believes that such a disclosure requirement is important to
[[Page 61984]]
inform market participants, facilitate an orderly SEF trading
environment, foster open and transparent markets, and promote market
integrity while remaining consistent with Core Principle 2.\310\ Such
information would help a market participant have important awareness of
how a trading system or platform is designed, thereby allowing them to
make informed decisions with respect to swaps trading on a particular
SEF. For example, such information would help market participants
determine appropriate parameters or instructions in submitting their
bids and offers to a particular SEF, as well as inform their
expectations about possible trading outcomes or objectives on that SEF.
The Commission believes that more informed market participants would
promote fairer and more efficient trading on SEFs and, ultimately, make
SEFs more robust price discovery mechanisms.
---------------------------------------------------------------------------
\310\ See FX Global Code at 13-14 (recommending that trading
systems or platforms should make participants aware of where
discretion may exist or may be expected, and how it may be
exercised, as a way to promote fairness and transparency in
trading).
---------------------------------------------------------------------------
Pursuant to proposed Sec. 37.201(a)(2), the Commission intends to
require each SEF to generally disclose the possible areas in which it
may use discretion for each execution method, rather than establish
exact, pre-determined trading protocols and procedures. In identifying
those general areas, a SEF's rules should disclose sufficient
information that a reasonable market participant would consider
important in deciding whether to onboard onto the SEF and, once
participating on the SEF, in understanding how discretion may affect
trading. The proposed rule, however, does not necessarily require a SEF
to disclose any proprietary or confidential information in its public
rulebook.\311\ Based on its experience with reviewing SEF rulebooks,
the Commission believes that proposed Sec. 37.201(a)(2) is consistent
with current market practice and the general level of information that
many SEFs already provide in their rulebooks.\312\ Accordingly, the
Commission does not anticipate that existing SEFs will be required to
adopt material changes to their rulebooks; rather, the proposed rule
would ensure that both currently-registered and new SEFs continue to
provide sufficient transparency and disclosure.
---------------------------------------------------------------------------
\311\ The Commission notes, however, that if a SEF believes that
any such information should be kept confidential, such that it
should be provided to market participants but not in a public
filing, the SEF may submit a request for confidential treatment with
its respective rule submission. 17 CFR 40.8. The Commission's
treatment of such information would be governed by Sec. 145.9, 17
CFR 145.9, and the Freedom of Information Act. 5 U.S.C. 552.
\312\ The Commission notes, for example, that SEF rules have
generally specified several areas where discretion may be exercised
in facilitating trading, such as determining when to enter orders on
behalf of participants; determining when and with which participants
to gauge possible trading interest; and determining how to calculate
mid-market prices for use in a session-based execution method, i.e.,
determining the number of factors to consider in the calculation of
a mid-market price or the weight of each factor.
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c. Sec. 37.201(a)(3)--Market Pricing Information
Proposed Sec. 37.201(a)(3) would require each SEF to adopt rules
that disclose the general sources and methodology for generating any
market pricing information that the SEF provides to market participants
to facilitate trading and execution. The term ``sources'' would include
any general inputs that the SEF may consider when forming a price, such
as swaps pricing data, e.g., the last traded price; historical,
executable, or indicative bids and offers on the SEF or other trading
platforms; or the views of market participants, who the SEF may contact
to ascertain interest. The term ``methodology'' means that a SEF should
generally identify the extent to which it may formulate a price on its
trading systems or platforms, whether prices generated by SEFs are
based on discretion or some type of pre-set approach, and how the
information or data sources are generally applied or weighted within
the SEF's methodology.
The Commission recognizes that some SEFs provide participants
either an indicative or executable ``market price'' to encourage price
discovery and liquidity or otherwise inform trading interest. The use
of market prices is particularly prevalent in connection with certain
execution methods, such as auctions and similar matching sessions.\313\
SEFs often generate these prices by considering various sources of
data, including prices from executed transactions, prices from
executable or indicative bids and offers, publicly reported swaps data,
active market participant views, or prices from related instruments in
other markets. Based on the availability of this information at a given
time, a SEF may take one or more of these factors into account
differently in formulating a single price. These pricing mechanisms
help to initiate the price discovery process and allow market
participants to formulate views about the current state of the market.
By relying upon an established price, a market participant may make
trading decisions without being exposed to information leakage that
might otherwise cause widened bid-offer spreads and impose higher
transaction costs.\314\ Given this unique feature of the swaps market
due to its episodic liquidity, the Commission recognizes that SEF
pricing practices are an important element in fostering liquidity on
SEFs and, therefore, in promoting the Act's statutory goals of
encouraging SEF trading and pre-trade price transparency.
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\313\ In a typical SEF auction or matching session-based trading
functionality, a SEF establishes a price for a listed swap that is
determined through a variety of different factors. Participants may
submit their trading interest in the swap at the established price,
either within an established time session or on a continuous basis,
and subsequently execute that swap at the established price, often
on a time-priority basis.
\314\ The Commission understands that participants often avoid
acting as a ``first-mover'' for relatively less liquid swaps by
exercising caution in displaying their trading interests, i.e.,
price and size; accordingly, SEFs--similar to historical OTC trading
environments--utilize these types of methods to promote trading for
particular swaps and pre-trade price transparency.
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Where pricing generated by a SEF in lieu of pricing based on market
participant bids and offers help to foster liquidity and price
discovery, the Commission believes that requiring SEFs to inform market
participants as to their price formation sources and methodology would
foster open and transparent markets and promote market integrity and
efficiency. Requiring a SEF to disclose the sources of information used
to generate a price and the methodology for calculating that price, for
example, would allow market participants to be aware of prevailing
liquidity and market conditions, thereby helping them to form views as
to whether that price is an appropriate indicator of a particular
market. Accordingly, market participants would be able to make informed
trading decisions, such as whether to participate in an available
trading session, and if so, the level of participation, e.g., whether
they would contribute their own information to help establish a trading
price in a particular execution method.\315\ The Commission believes
that this information should build confidence among participants in the
integrity, fairness, and effectiveness of the SEF as a regulated
trading venue. In turn, a greater level of confidence in SEFs should
lead to increased swaps trading volume and, ultimately, an increased
potential for higher levels of pre-trade price transparency through
increased participation.
---------------------------------------------------------------------------
\315\ See supra note 313 (describing mechanics of a SEF auction
or matching session-based trading functionality).
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Similar to proposed Sec. 37.201(a)(2), the Commission emphasizes
that proposed Sec. 37.201(a)(3) would establish a general
[[Page 61985]]
approach as to the scope of information that a SEF must disclose and
does not require the SEF to specify detailed calculations or algorithms
used to generate pricing information. The Commission also notes that
the proposed rule would not require SEFs to disclose the identities of
market participants who provide data used to formulate prices or to
disclose proprietary aspects of their pricing methodology.\316\ Rather,
a SEF's rules should disclose sufficient information that a reasonable
market participant would consider important to determine whether to
join the SEF and to generally understand the nature of the market
pricing information provided by the SEF. In addition, proposed Sec.
37.201(a)(3) would not require a SEF to provide any proprietary or
confidential information in its public rulebook. Based on its
experience with reviewing SEF rulebooks submitted via the part 40 rule
filing process, the Commission believes that proposed Sec.
37.201(a)(3) is consistent with current market practice and the general
level of information that many SEFs already include in their
rulebooks.\317\
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\316\ The Commission further notes, however, that regardless of
whether market participants participate in the price-formation
process or whether their identities remain anonymous, all market
participants remain subject to section 9(a)(2) of the Act. That
provision prohibits any attempt to provide false, misleading, or
knowingly inaccurate reports concerning market information or
conditions that affect or tend to affect the price of any swap. 7
U.S.C. 13(a)(2).
\317\ In disclosing the general sources and methodologies for
generating market pricing information, the Commission notes that
such SEF rules have generally specified (i) the SEF's ability to
consider either a single or multiple number of established factors
in determining a price; (ii) the various types of factors that it
may take into account to determine a price; or (iii) other
additional analytical methods that may be used to supplement a price
calculated from existing bids and offers on the platform.
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Request for Comment
The Commission requests comment on all aspects of proposed Sec.
37.201(a). In particular, the Commission requests comment on the
following question:
(28) Do the requirements under proposed Sec. Sec. 37.201(a)(1)-(3)
set an appropriate level of disclosure by SEFs to market participants?
Are the requirements too broad? Should the Commission require
additional disclosures that would be material for market participants
to make an informed decision to participate on the SEF? If so, what
additional disclosures should be required? Please provide specific
examples in your responses.
2. Sec. 37.203(a)--Pre-Arranged Trading Prohibition; Sec. 37.9(b)
Time Delay Requirement
Part 37 has permitted market participants to communicate with one
another away from a SEF in connection with the eventual execution of
swap transactions via the SEF's trading systems or platforms.\318\ The
Commission has observed that such communications, which commonly occur
on a direct basis between swap dealers and their clients in the dealer-
to-client market, vary in nature and scope. Such communication may, for
example, include communications to discern trading interest prior to
trading on the SEF, e.g., obtaining market color, identifying potential
trades, and locating interested counterparties. Such communications,
however, may also consist of the actual negotiation or arrangement of a
swap transaction's terms and conditions prior to execution on a SEF.
Such communications are permitted through several provisions in the
current regulatory framework, as described below, based in part on
whether the transaction qualifies for an exception to the prohibition
on pre-arranged trading under Sec. 37.203(a); or whether the swap is
otherwise not subject to the trade execution requirement.
---------------------------------------------------------------------------
\318\ SEF Core Principles Final Rule at 33503.
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The Commission notes that ``pre-arranged trading'' is prohibited as
an abusive trading practice under Sec. 37.203(a). This prohibition
generally applies to market participants who communicate with one
another to pre-negotiate the terms of a trade away from a SEF's trading
system or platform, but then execute the trade on such system or
platform in a manner that appears competitive and subject to market
risk. The Commission has intended for this prohibition to maintain the
integrity of price competition and market risk that is incident to
trading in the market.\319\ Notwithstanding this prohibition, SEFs have
permitted pre-arranged trading on their facilities in certain
instances.
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\319\ The Commission generally considers pre-arranged trading to
be a form of ``fictitious'' trading that is prohibited pursuant to
CEA section 4c(a)(1), which makes it unlawful for any person to
offer to enter into, or confirm the execution of a fictitious sale.
7 U.S.C. 6c(a)(1), 6c(a)(2)(A)(ii). Specifically, pre-arranged
trading involves ``the use of trading techniques that give the
appearance of submitting trades to the open market while negating
the risk of price competition incident to such a market.'' Harold
Collins, [1986-1987 Transfer Binder] Comm. Fut. L. Rep. (CCH) 22982,
31902 (CFTC Apr. 4, 1986). Generally, pre-arranged trading creates a
false impression to the market that an executed transaction is
indicative of a competitive trading environment. Id. at 31903 (``By
determining trade information such as price and quantity outside the
pit, then using the market mechanism to shield the private nature of
the bargain from public scrutiny, both price competition and market
risk are eliminated.'').
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For Required Transactions executed via an Order Book, a SEF may
permit market participants to communicate with one another and pre-
arrange or pre-negotiate a swap transaction away from its trading
system or platform, subject to a time delay requirement and facility
rules on pre-execution communications. Section 37.9(b)(1) currently
permits a broker or dealer to engage in pre-execution communications to
pre-arrange or pre-negotiate a swap, as long as one side of the
resulting transaction is entered into the Order Book for a 15-second
delay before the second side is entered for execution against the first
side (the ``time delay requirement''). The Commission defined ``pre-
execution communications'' as communications between market
participants to discern interest in the execution of a transaction
prior to the exposure of the market participants' orders (e.g., price,
size, and other terms) to the market; such communications include
discussion of the size, side of market, or price of an order, or a
potentially forthcoming order.\320\ To the extent that SEFs would allow
their market participants to engage in such pre-execution
communications, the Commission required SEFs to adopt associated
rules.\321\
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\320\ SEF Core Principles Final Rule at 33503. In light of the
Commission's general prohibition on pre-arranged trading under Sec.
37.203(a), the Commission defined this term to clarify the
permissible types of communications in which market participants can
pre-arrange or pre-negotiate a transaction consistent with Sec.
37.9(b)(1). The Commission currently requires that SEFs that choose
to allow their market participants to engage in pre-execution
communications prior to executing such transactions must do so
pursuant to their rules. 17 CFR 37.203(a). Such communications may
constitute an element of pre-arranged trading, which is an abusive
trading practice prohibited under existing Sec. 37.203(a).
\321\ SEF Core Principles Final Rule at 33509.
---------------------------------------------------------------------------
The Commission implemented Sec. 37.9(b) to ensure a minimum level
of pre-trade price transparency for orders based on pre-execution
communications that occur away from the SEF, and to incentivize price
competition between market participants for orders entered into an
Order Book.\322\ The Commission
[[Page 61986]]
anticipated that disclosing one side of a pre-arranged transaction in
the Order Book first would provide other market participants with an
opportunity to execute against that side prior to entry of the second
side in the Order Book.\323\ A similar requirement, however, was not
applied to Required Transactions executed through a SEF's RFQ System.
The Commission noted that the requirement to send an RFQ to three other
market participants already provides pre-trade price transparency,
thereby obviating the need for a corresponding time delay.\324\
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\322\ Id. at 33503. The Commission modeled the time delay
requirement after similar DCM rules that have imposed time delays on
cross trades involving futures and options on futures. Pursuant to
these rules, market participants are permitted to conduct pre-
execution communications with respect to orders that are later
exposed to the market for a certain period of time prior to
execution on the DCM's trading system or platform. As DCM Core
Principle 9 requires DCMs 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 of the DCM, 7 U.S.C. 7(d)(9)(A), DCMs have implemented
certain time delay procedures that establish a ``safe harbor'' for
orders resulting from pre-execution communications that would
otherwise be considered pre-arranged trading. To protect price
discovery, such orders must be exposed to the market for a minimum
amount of time prior to allowing such orders to match against one
another on a DCM. This time delay generally provides other
participants with an opportunity to execute against the initial
order. See, e.g., CME Group, Rule 539.C (rules on pre-execution
communications regarding Globex trades).
\323\ 17 CFR 37.9(b)(1).
\324\ SEF Core Principles Final Rule at 33504. The SEF Core
Principles Final Rule did not explicitly require a SEF to adopt pre-
execution communication rules for swaps executed using its RFQ
System. Nevertheless, the Commission has observed that some SEFs
have self-certified rules under Sec. 40.6 to allow their market
participants to engage in pre-execution communication prior to
transmitting an RFQ through the facility's RFQ System.
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In addition to the time delay requirement, Sec. 37.203(a) also
specifies that a SEF may choose to permit pre-arranged trading in other
instances. First, a SEF may permit a swap that it lists to be executed
as a block trade away from a SEF pursuant to part 43. This exception
allows such large-sized transactions to be privately negotiated to
avoid potentially significant and adverse price impacts that would
occur if traded on trading systems or platforms with pre-trade price
transparency.\325\ Second, a SEF may permit pre-arranged trading for
``other types of transactions'' through rules that are filed with the
Commission pursuant to part 40. These rules permit pre-arranged trading
with respect to Required Transactions that are intended to resolve
error trades \326\ or are executed as a component of certain categories
of package transactions.\327\
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\325\ As defined under Sec. 43.2, a ``block trade'' involves a
SEF-listed swap transaction with a notional amount that meets the
corresponding appropriate minimum block size and is executed away
from the SEF's trading system or platform, but pursuant to the SEF's
rules and procedures. 17 CFR 43.2. The Commission is proposing to
amend that definition to specify that block trades must be executed
on a SEF. See infra Section XXII.--Part 43--Sec. 43.2--Definition
of ``Block Trade.''
\326\ Based on time-limited no-action relief issued by DMO, a
SEF may submit pre-arranged Required Transactions for execution on
the SEF that resolve error trades, i.e., correct transactions to
offset an initial transaction executed on the SEF containing a
clerical or operational error, and where necessary, a new
transaction that reflects the terms to which the counterparties had
originally assented. See infra note 433 and accompanying discussion.
\327\ Based on time-limited no-action relief issued by DMO, a
SEF may submit pre-arranged Required Transactions for execution on
SEFs that are components of certain categories of package
transactions. See infra note 334.
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In the preamble to the SEF Core Principles Final Rule, the
Commission did not discuss the issue of pre-execution communications
regarding swaps that are not subject to the trade execution
requirement, i.e., Permitted Transactions, but the Commission has
permitted SEFs to adopt a more flexible approach to the use of
communications away from the SEF. This approach corresponds to the
Commission's approach to Permitted Transactions, which are not required
to be executed on a SEF and otherwise may be executed on a SEF through
flexible execution methods.\328\ Under a more flexible approach, the
Commission has observed that SEFs--both those that facilitate trading
in the dealer-to-client market and those that facilitate trading in the
dealer-to-dealer market--have consequently adopted rules to allow their
market participants to engage in a variety of pre-execution
communications away from their respective trading systems or platforms
prior to executing Permitted Transactions on SEFs. The Commission notes
in particular that some methods allow counterparties to submit pre-
negotiated terms and conditions of a transaction to a SEF ``order
entry'' system for execution and related post-trade processing.\329\
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\328\ SEF Core Principles Final Rule at 33504.
\329\ As noted above, several SEFs affiliated with interdealer
brokers offer this type of functionality. As participants affiliated
with a SEF, interdealer brokers have arranged Permitted Transactions
on behalf of dealer clients through ``communications'' on their
trading systems or platforms and submitted those transactions to a
SEF for execution without being subject to any corresponding order
exposure. See supra note 88 and accompanying discussion.
---------------------------------------------------------------------------
a. Sec. 37.201(b)--Pre-Execution Communications
The Commission proposes several amendments under the proposed
framework that would broadly apply to pre-execution communications that
occur away from a SEF. For swaps subject to the trade execution
requirement, proposed Sec. 37.201(b) would require a SEF to prohibit
its participants from engaging in pre-execution communications away
from its facility, including negotiating or arranging the terms and
conditions of a swap prior to its execution on the SEF, i.e., via the
SEF's methods of execution. This prohibition would be subject to
certain proposed exceptions discussed further below. Given this general
prohibition, the Commission also proposes to eliminate the existing
exceptions to the pre-arranged trading prohibition, including (i) the
time delay requirement under Sec. 37.9(b); (ii) the exception for
block trades under Sec. 37.203(a) as part of the Commission's proposed
amendments to the ``block trade'' definition under Sec. 43.2; \330\
and (iii) the exception for ``other types of transactions'' under Sec.
37.203(a). Proposed Sec. 37.203(a), as discussed below, would continue
to require a SEF to prohibit abusive trading practices, including pre-
arranged trading, as appropriate to its trading systems or platforms.
Therefore, a SEF would not be allowed to provide rules that allow
market participants to pre-negotiate or pre-arrange a transaction and
submit the sides of the transaction to an order book pursuant to a time
delay.
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\330\ See infra Section XXII.--Part 43--Sec. 43.2--Definition
of ``Block Trade.''
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In eliminating the prescriptive execution methods and allowing more
flexible execution for swaps subject to the trade execution
requirement, the Commission believes that pre-execution communications,
including the negotiation or arrangement of those swaps, would be able
to occur entirely within a SEF's trading system or platform. Such
negotiation or arrangement, regardless of the method through which they
may occur, i.e., among participants themselves or through a swaps
broking entity, constitutes ``trading'' that should occur on a SEF. The
Commission notes that ``trading,'' as discussed above, includes the
negotiation or arrangement of transactions through the interaction of
bids and offers.\331\ Based on its experience with implementing part
37, the Commission believes that the broad scope of pre-execution
communications that have been allowed to occur away from the SEF under
the existing framework has undermined a meaningful role of the SEF in
facilitating trading activity and liquidity formation.
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\331\ With respect interdealer brokers, the Commission believes
that their trading systems or platforms facilitate ``trading''
between multiple participants in conformance with the statutory SEF
definition and, therefore, are subject to the SEF registration
requirement. See supra Section IV.C.1.c.(2)--SEF Registration
Requirement for Swaps Broking Entities, Including Interdealer
Brokers.
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Accordingly, the Commission believes that these proposed changes
are an important element of the proposed SEF regulatory framework and
are intended
[[Page 61987]]
to enhance this framework, such that a broader range of swaps trading
activity would be occurring on SEFs and creating a vibrant and liquid
marketplace for swaps trading. For example, the Commission notes the
likely increase in the number of swaps that would become subject to the
trade execution requirement under this proposal. Currently, many of
those swaps are Permitted Transactions submitted to a SEF for execution
after negotiation or arrangement away from the facility, or are
negotiated and executed on an OTC basis. With an expanded scope of
swaps subject to the trade execution requirement, the Commission is
concerned that allowing a disproportionate amount of SEF transactions
to be pre-arranged or pre-negotiated away from the facility under the
pretense of trading flexibility would undercut the import of the
expansion of the requirement. Without a limitation on pre-execution
communications that occur away from the SEF, the SEF's role in
facilitating swaps trading is also diminished and would undermine the
statutory goals of promoting greater swaps trading on SEFs and
promoting pre-trade price transparency.
The Commission also notes that its proposed approach to pre-
execution communications, as applied to SEFs in the dealer-to-dealer
market, is consistent with the application of the SEF registration
requirement to swaps broking entities, e.g., interdealer brokers that
facilitate swaps trading activity between market participants. As
discussed above, the Commission believes that brokers, who facilitate
trading communications between market participants away from a SEF and
subsequently submit pre-negotiated or pre-arranged trades to the SEF
for execution, relegate the SEF to a de facto post-trade processing
venue. Requiring these entities to register as SEFs would ensure that
this type of liquidity formation occurs on a SEF.\332\ Similarly, the
submission of trade terms negotiated or arranged via direct
communications between participants, e.g., a swap dealer and a client,
away from a SEF allows liquidity formation to occur outside of the SEF
regulatory framework, which undermines the statutory SEF goals.
Limiting the scope of these communications would also help ensure that
this activity occurs on a registered SEF via flexible means of
execution, which promotes the statutory goals of promoting trading on
SEFs and promoting pre-trade price transparency.
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\332\ As noted above, the Commission recognizes that domestic
swaps broking entities and foreign swaps broking entities would be
subject to a six-month and two-year delayed application of the SEF
registration requirement, respectively. These delays would allow
them to continue to negotiate or arrange swaps transactions between
multiple participants and route them to SEFs or Exempt SEFs for
execution. Accordingly, the compliance date of any final rule with
respect to the prohibition on pre-execution communication under
proposed Sec. 37.201(b) and the pre-arranged trading prohibition
under Sec. 37.203(a) for these entities would also be subject to a
delay of six months or two years, depending on the entity's domicile
and starting from the effective date of the final rule. See supra
Section IV.C.1.c.--Swaps Broking Entities, Including Interdealer
Brokers and Section IV.C.1.d.--Foreign Swaps Broking Entities and
Other Foreign Multilateral Swaps Trading Facilities.
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(1) Exception for Swaps Not Subject to the Trade Execution Requirement
The Commission proposes an exception to the proposed prohibition on
pre-execution communications under Sec. 37.201(b) for swaps that are
not subject to the trade execution requirement. The Commission's
proposed exception recognizes that market participants do not have to
execute such swaps on SEFs. The Commission also acknowledges that two
counterparties may initially discuss or negotiate a potential swap
transaction on a bilateral basis away from a SEF with the intent to
execute the transaction away from the SEF, but subsequently determine
to submit the resulting arranged transaction to be executed on a SEF.
The Commission believes that applying the proposed Sec. 37.201(b)
prohibition to swaps not subject to the trade execution requirement
would not be practical, given that counterparties do not have to
execute these swaps on a SEF. The Commission emphasizes, however, that
this proposed exception does not affect the SEF registration
requirement under proposed Sec. 37.3(a), which would specify that a
person operating a facility that meets the statutory SEF definition
must register as a SEF without regard to whether the swaps that it
lists for trading are subject to the trade execution requirement.\333\
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\333\ See supra Section IV.C.1.a.--Footnote 88. For example, the
exception would inherently not apply to a swaps broking entity that
conducts pre-execution communications to facilitate trading activity
on behalf of multiple participants in swaps that are not subject to
the trade execution requirement. As noted above, such an entity
would be subject to the SEF registration requirement and personnel
facilitating those communications would likely be designated as SEF
trading specialists that constitute part of a SEF's trading system
or platform. See supra notes 308-309.
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(2) Sec. 37.201(b)(1)--Exception for Package Transactions
The Commission also proposes an exception under Sec. 37.201(b)(1)
to the proposed prohibition on pre-execution communications for swaps
subject to the trade execution requirement that are components of
``package transactions'' that also include components that are not
subject to the trade execution requirement.\334\ For purposes of this
[[Page 61988]]
exception, a ``package transaction'' involves two or more
counterparties and consist of two or more component transactions whose
executions are (i) contingent upon one another, (ii) priced or quoted
together as one economic transaction, and (iii) executed simultaneous
or near simultaneous to each other.\335\
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\334\ The Commission notes that the swap components of different
categories of package transactions have been subject to time-limited
no-action relief provided by Commission staff from the trade
execution requirement and required methods of execution. These
categories of package transactions include those where (i) each of
the components is a swap subject to the trade execution requirement
(``MAT/MAT''); (ii) at least one of the components is subject to the
trade execution requirement and each of the other components is
subject to the clearing requirement (``MAT/Non-MAT (Cleared)'');
(iii) each of the swap components is subject to the trade execution
requirement and all other components are U.S. Treasury securities
(``U.S. Dollar Swap Spreads''); (iv) each of the swap components is
subject to the trade execution requirement and all other components
are agency mortgage-backed securities (``MAT/Agency MBS''); (v) at
least one individual swap component is subject to the trade
execution requirement and at least one individual component is a
bond issued and sold in the primary market (``MAT/New Issuance
Bond''); (vi) at least one individual swap component is subject to
the trade execution requirement and all other components are futures
contracts (``MAT/Futures''); (vii) at least one of the swap
components is subject to the trade execution requirement and at
least one of the components is a CFTC swap that is not subject to
the clearing requirement (``MAT/Non-MAT (Uncleared)''); (viii) at
least one of the swap components is subject to the trade execution
requirement and at least one of the components is not a swap
(excluding aforementioned categories) (``MAT/Non-Swap
Instruments''); and (ix) at least one of the swap components is
subject to the trade execution requirement and at least one of the
components is a swap over which the CFTC does not have exclusive
jurisdiction, e.g., a mixed swap (``MAT/Non-CFTC Swap''). See CFTC
Letter No. 14-12, No-Action Relief from the Commodity Exchange Act
Sections 2(h)(8) and 5(d)(9) and from Commission Regulation Sec.
37.9 for Swaps Executed as Part of a Package Transaction (Feb. 10,
2014) (``NAL No. 14-12''); CFTC Letter No. 14-62, No-Action Relief
from the Commodity Exchange Act Sections 2(h)(8) and 5(d)(9) and
from Commission Regulation Sec. 37.9 for Swaps Executed as Part of
Certain Package Transactions and No-Action Relief for Swap Execution
Facilities from Compliance with Certain Requirements of Commission
Regulations Sec. 37.9(a)(2), Sec. 37.203(a) and Sec. 38.152 for
Package Transactions (May 1, 2014) (``NAL No. 14-62''); CFTC Letter
No. 14-121, Extension of No-Action Relief for Swap Execution
Facilities and Designated Contract Markets from Compliance with
Certain Requirements of Commission Regulations Sec. 37.9(a)(2),
Sec. 37.203(a) and Sec. 38.152 for Package Transactions (Sept. 30,
2014) (``NAL No. 14-121''); CFTC Letter No. 14-137, Extension of No-
Action Relief from the Commodity Exchange Act Sections 2(h)(8) and
5(d)(9) and from Commission Regulation Sec. 37.9 and Additional No-
Action Relief for Swap Execution Facilities from Commission
Regulation Sec. 37.3(a)(2) for Swaps Executed as Part of Certain
Package Transactions (Nov. 10, 2014) (``NAL No. 14-137''); CFTC
Letter No. 15-55, Extension of No-Action Relief from the Commodity
Exchange Act Sections 2(h)(8) and 5(d)(9) and from Commission
Regulation Sec. 37.9 and No-Action Relief for Swap Execution
Facilities from Commission Regulation Sec. 37.3(a)(2) for Swaps
Executed as Part of Certain Package Transactions (Oct. 15, 2014)
(``NAL No. 15-55''); CFTC Letter No. 16-76, Re: Extension of No-
Action Relief from the Commodity Exchange Act Sections 2(h)(8) and
5(d)(9) and from Commission Regulation Sec. 37.9 and No-Action
Relief for Swap Execution Facilities from Commission Regulation
Sec. 37.3(a)(2) for Swaps Executed as Part of Certain Package
Transactions (Nov. 1, 2016) (``NAL No. 16-76''); CFTC Letter No. 17-
55, Re: Extension of No-Action Relief from Sections 2(h)(8) and
5(d)(9) of the Commodity Exchange Act and from Commission
Regulations 37.3(a)(2) and 37.9 for Swaps Executed as Part of
Certain Package Transactions (Oct. 31, 2017) (``NAL No. 17-55''). To
the extent that counterparties may be facilitating package
transactions that involve a ``security,'' as defined in section
2(a)(1) of the Securities Act of 1933 or section 3(a)(10) of the
Securities Exchange Act of 1934, or any component agreement,
contract, or transaction over which the Commission does not have
exclusive jurisdiction, the Commission does not opine on whether
such activity complies with other applicable law and regulations.
\335\ The Commission notes that it similarly defines ``package
transaction'' under proposed Sec. 36.1(d)(1) for purposes of
providing an exemption to the trade execution requirement for swaps
that are executed as part of package that includes a bond issued in
a primary market. See infra Section XXI.A.4.--Sec. 36.1(d)--
Exemption for Swaps Executed with Bond Issuance.
---------------------------------------------------------------------------
The Commission recognizes that some package transactions contain
both a swap that is subject to the trade execution requirement and
other swap or non-swap components that are not subject to the
requirement. Components not subject to the requirement include, for
example, swaps not subject to the clearing requirement, e.g.,
swaptions, and various types of securities.\336\ The negotiation or
arrangement of each of these components generally occurs concurrently
or on a singular basis; in particular, negotiations for the pricing of
such package transactions may be primarily based on the components that
are not subject to the requirement. Further, the swap components in
those types of transactions that are subject to the requirement often
serve as hedging tools to other components. For those components not
subject to the requirement, market participants may negotiate the terms
away from a SEF.
---------------------------------------------------------------------------
\336\ Based on time-limited no-action relief issued by DMO, the
categories of package transactions that consist of components not
subject to the requirement include (i) U.S. Dollar Swap Spreads;
(ii) MAT/Agency MBS; (iii) MAT/New Issuance Bond; (iv) MAT/Futures;
(v) MAT/Non-MAT (Uncleared); (vi) MAT/Non-Swap Instruments; and
(vii) MAT/Non-CFTC Swaps. See supra note 334.
---------------------------------------------------------------------------
The Commission believes that imposing a prohibition on swaps
subject to the trade execution requirement that are part of a package
transaction that includes components not subject to the requirement
would inhibit the ability of counterparties to negotiate or arrange the
latter components away from the SEF.\337\ Given that components of
package transactions are each priced or quoted together as part of one
economic transaction, the Commission recognizes the impracticality of
requiring communications related to the negotiation or the arrangement
of the swap component that is subject to the trade execution
requirement to occur on the SEF. Accordingly, an exception from the
prohibition on pre-execution communications away from the SEF for swap
components subject to the requirement would be appropriate in such
circumstances.\338\ Consistent with its intent to incorporate existing
staff no-action relief into the Commission's regulations, the
Commission notes that the proposed exception would codify some of the
relief that currently applies to certain types of package
transactions.\339\
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\337\ Package transactions composed entirely of swaps that are
subject to the trade execution requirement would be subject to the
prohibition of pre-execution communications under proposed Sec.
37.201(b) and are not eligible for this proposed exception.
\338\ The Commission notes that a swaps broking entity that
facilitates trading in any swap component on behalf of multiple
participants, regardless of whether the swap is subject to the trade
execution requirement, would be subject to the SEF registration
requirement. See supra note 333.
\339\ Swap components in the following categories of package
transactions are currently subject to relief from the required
methods of execution under existing Sec. 37.9: (i) MAT/Non-MAT
(Uncleared); (ii) MAT/Non-Swap Instruments; and (iii) MAT/Non-CFTC
Swap. NAL No. 17-55 at app. A. Pursuant to this relief, the
Commission notes that SEFs have allowed market participants to
negotiate or arrange the swap components away from the SEF and
submit them for execution.
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Request for Comment
The Commission requests comment on all aspects of proposed Sec.
37.201(b). In particular, the Commission seeks insights regarding
market participants' use of pre-execution communications and requests
comment on the following questions:
(29) What are market participants' current pre-execution
communication practices? How often do market participants currently
engage in pre-execution communication? What level of trade detail is
discussed during such pre-execution communications? What role, if any,
should pre-execution communications continue to have in the SEF market
structure?
(30) Is the Commission's proposal to require a SEF to prohibit
market participants from conducting pre-execution communications away
from a SEF with respect to swaps that are subject to the trade
execution requirement appropriate? In light of the Commission's
proposal to allow SEFs to offer flexible execution methods, are there
any impediments for market participants to execute those swaps, in
particular those that would become subject to the Commission's proposed
approach to the trade execution requirement?
(31) With respect to swaps that are not subject to the trade
execution requirement, is the Commission's proposal to allow SEFs to
permit market participants to conduct pre-execution communications away
from a SEF appropriate?
(32) Are there any technical limitations that a SEF would face to
accommodate pre-execution communications that would otherwise impede
the ability of market participants to trade and execute swaps on a SEF?
(33) Should the Commission allow an exception to the proposed
prohibition against pre-execution communications for communications
involving ``market color''? If so, how should the Commission define
``market color''? For example, should such a definition consist of
views shared by market participants on the general state of the market
or trading information provided on an anonymized and aggregated basis?
Should such a definition exclude (i) an express or implied arrangement
to execute a specified trade; (ii) non-public information regarding an
order; and (iii) information about an individual trading position? Are
these elements appropriate and should the Commission consider
additional elements?
(34) Should the Commission allow an exception to the proposed
prohibition against pre-execution communications for communications
intended to discern the type of transaction--which may or may not be a
swap--that a market participant may ultimately execute on a SEF? The
Commission understands that these types of communications are common in
the dealer-to-client market and allow a dealer to assist a client with
determining which financial instruments may be best suited to manage
the client's risks or to establish certain market positions. If so,
please describe the nature and scope of these communications that would
support an exception to the proposed prohibition.
(35) Should the Commission allow an exception to the proposed
prohibition against pre-execution communications for all corrective
trades intended to resolve error trades pursuant to the proposed error
trade policy rules under Sec. 37.203(e), as discussed further below?
Please explain why or why not.
[[Page 61989]]
(36) The Commission is proposing to allow market participants to
engage in pre-execution communications away from a SEF for package
transactions in which at least one component is not subject to the
trade execution requirement. For the swap components of some of these
package transactions that are currently traded and executed on SEFs--
for example, those where all other components are U.S. Treasury
securities--should they not be subject to this exception? Are there
other types of package transactions for which the Commission should
provide an exception to the proposed prohibition on pre-execution
communications?
3. Sec. 37.201(c)--SEF Trading Specialists
The Commission notes that a number of registered SEFs--in
particular, those that operate in the dealer-to-dealer market--offer
voice-based or voice-assisted execution platforms that utilize natural
persons to facilitate trading in varying degrees. These persons,
commonly referred to as ``trading specialists'' or ``execution
specialists,'' perform core functions that facilitate swaps trading and
execution in a multiple-to-multiple participant environment, including
disseminating trading interests to the market, e.g., transmitting RFQs
provided by participants; matching bids and offers; and negotiating or
arranging transaction terms and conditions on behalf of participants.
Many individuals currently carry out the same functions away from a
SEF as part of a swaps broking entity, such as an interdealer broker,
prior to execution of the transaction on the SEF.\340\ These swaps
broking entities are often registered with the Commission as IBs \341\
and these individuals are registered as associated persons of IBs.\342\
As associated persons of IBs, these persons are subject to various
regulatory requirements for intermediaries aimed at protecting
customers.\343\ As noted above, the Commission has proposed that these
swaps broking entities be registered as a SEF, given that they
facilitate trading.\344\
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\340\ See supra Section IV.C.1.c.(1)--Structure and Operations
of Swaps Broking Entities, Including Interdealer Brokers.
\341\ The Commission notes above that IBs are registered with
the Commission pursuant to CEA section 4f. See supra note 93 and
accompanying discussion. IBs and their associated persons are
required to register pursuant to registration procedures set forth
by the NFA. 17 CFR 3.10, 3.12. Section 170.17 requires that each IB
becomes and remains a member of at least one registered futures
association, e.g., the NFA. 17 CFR 170.17. Pursuant to CEA sections
4p and 17(p), such entities are subject to, among other requirements
administered by the registered futures association, training
standards and proficiency testing. 7 U.S.C. 6p, 21(p). Depending on
the category of intermediary, registrants may be subject to various
financial and reporting requirements, e.g., 17 CFR 1.10 (financial
reports of FCMs and IBs), 1.17 (minimum financial requirements for
FCMs and IBs), as well as trading standards, e.g., 17 CFR part 155
(trading standards for floor brokers, FCMs, and IBs). Pursuant to
CEA section 6c and part 180, all registrants are subject to
prohibitions against fraud and manipulation. 7 U.S.C. 9; 17 CFR part
180. Applicants for registration are subject to statutory
disqualifications from registration pursuant to CEA section 8a(2)
based on related past convictions that involve fraud or other acts
of malfeasance. 7 U.S.C. 12a(2).
\342\ Section 1.3 defines an ``associated person'' of an IB as
any natural person who is associated with an introducing broker as a
partner, officer, employee, or agent (or any natural person
occupying a similar status or performing similar functions), in any
capacity which involves the solicitation or acceptance of customers'
orders (other than in a clerical capacity) or the supervision of any
person or persons so engaged. 17 CFR 1.3.
\343\ See supra note 341. See also NFA Registration Rules part
400 (proficiency requirements established by the NFA for various
registered entities and associated person).
\344\ Upon adoption of the SEF Core Principles Final Rule, some
swaps broking entities, in particular interdealer brokers,
registered their operations or components of their operations, i.e.,
trading systems or platforms, as SEFs. See supra Section
IV.C.1.c.(1)--Structure and Operations of Swaps Broking Entities,
Including Interdealer Brokers. As part of this process, the
Commission understands that some specialists have transitioned to
the SEF from affiliated broker entities, in either a permanent
capacity or pursuant to a secondment arrangement.
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The Commission recognizes, however, that the current regulatory
requirements for swaps broking entities do not necessarily fully
address the unique functions of trading specialists on a SEF, which are
broader in scope than the traditional IB functions of solicitation or
acceptance of orders. SEF trading specialists serve an intermediary-
type role for each market participant that accesses their SEF by
facilitating fair, orderly, and efficient trading and overall market
integrity. From a regulatory perspective, the Commission believes that
SEF trading specialists--whether operating as part of a fully voice-
based system or as a voice-assisted system with electronic-based
features--are an integral part of their respective SEF's trading system
or platform.
A voice-based or voice-assisted SEF trading system or platform is
unique among SEF execution methods. Unlike a trading system or platform
that executes orders and facilitates trading through generally
automated means, trading specialists that comprise part of the voice-
based or voice-assisted systems usually exercise a level of discretion
and judgment in facilitating interaction between bids and offers from
multiple market participants. That discretion and judgment is informed
by their knowledge and understanding of market conditions, which are
based upon information obtained from observing historical activity and
gauging potential or actual trading interest from communications with
participants.
By allowing SEFs to offer flexible methods of execution and
broadening the trade execution requirement to swaps with more episodic
liquidity, the Commission believes that the proposed rulemaking would
lead to greater volumes of trading on voice-based trading systems or
platforms that utilize discretion and judgment. The use of these
methods should increase and enhance the utility of SEFs in a manner
consistent with the SEF statutory intent and goals, but the Commission
also believes that the expected increased role of discretion in SEF
trading operations should be accompanied with a regulatory approach
that aims to enhance professionalism among trading specialists and
enhance market integrity. The Commission believes in particular that
such a regulatory approach should address in particular the integral
role that trading specialists play in exercising that discretion in a
SEF's multiple-to-multiple trading environment.
Therefore, the Commission proposes to adopt a definition under
Sec. 37.201(c) that would categorize certain persons employed by a SEF
as a ``SEF trading specialist'' and require a SEF to ensure that any
such person (i) is not subject to a statutory disqualification under
CEA sections 8a(2) or 8a(3); (ii) has met certain proficiency
requirements; and (iii) undergoes ethics training on a periodic basis.
The proposed regulations would further require a SEF to establish and
enforce a code of conduct for its SEF trading specialists, as well as
diligently supervise their activities. These proposed rules are
intended to enhance professionalism in the swaps market and promote
market integrity.
a. Sec. 37.201(c)(1)--Definition of ``SEF Trading Specialist''
The Commission proposes to define a ``SEF trading specialist''
under Sec. 37.201(c)(1) as any natural person who, acting as an
employee (or in a similar capacity) of a SEF, facilitates the trading
or execution of swap transactions (other than in a ministerial or
clerical capacity), or who is responsible for direct supervision of
such persons. This proposed definition would include both persons
directly employed by the SEF and persons who are not directly employed,
such as independent contractors and persons who are serving as SEF
personnel pursuant to an arrangement with an affiliated broker
employer, i.e.,
[[Page 61990]]
``seconded'' persons. Based on the Commission's proposed application of
the SEF registration requirement, as described above, the Commission
notes that this definition would also apply to those persons who
facilitate swaps trading through swaps broking entities, including
interdealer brokers, who would be subject to SEF registration.\345\ As
noted above, facilitating the ``trading'' of swaps means the
negotiating or arranging swaps transactions; \346\ negotiating or
arranging consists of facilitating the interaction of bids and
offers.\347\ The proposed definition, however, would exclude SEF
personnel who facilitate trading solely in a ministerial or clerical
capacity because the activities of such employees do not involve the
level of discretion and judgement as the activities of SEF trading
specialists and, thus, do not implicate the same regulatory
concerns.\348\
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\345\ See supra Section IV.C.1.c.(2)--SEF Registration
Requirement for Swaps Broking Entities, Including Interdealer
Brokers and Section IV.C.1.d.--Foreign Swaps Broking Entities and
Other Foreign Multilateral Swaps Trading Facilities.
\346\ See supra Section IV.C.1.c.(2)--SEF Registration
Requirement for Swaps Broking Entities, Including Interdealer
Brokers.
\347\ Id.
\348\ The Commission notes that persons acting in a ministerial
or clerical capacity are subject to exceptions from other Commission
requirements. For example, the definition of ``associated person''
under Sec. 1.3 excludes a person who solicits or accepts customer
orders in a clerical capacity on behalf of an FCM or IB, or who
solicits or accepts swaps in a clerical or ministerial capacity on
behalf of an SD or MSP. 17 CFR 1.3.
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b. Sec. 37.201(c)(2)--Fitness
In light of the activities of SEF trading specialists and the
regulatory considerations discussed above, the Commission proposes
Sec. 37.201(c)(2)(i) to prohibit a SEF from permitting any person who
is subject to a statutory disqualification under CEA sections 8a(2) or
8a(3) to serve as a SEF trading specialist if the SEF knows, or in the
exercise of reasonable care should know, of the person's statutory
disqualification.\349\ CEA sections 8a(2) and 8a(3) set forth numerous
bases upon which the Commission may refuse to register a person,
including, without limitation, felony convictions, commodities or
securities law violations, and bars or other adverse actions taken by
financial regulators.\350\ While SEF trading specialists would not be
required to register with the Commission, the Commission believes that
given the nature of their interaction with market participants in
facilitating swaps trading and execution, as well as the central role
they play in maintaining market integrity and orderly trading, a SEF
should not be permitted to employ those who are subject to such a
statutory disqualification.
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\349\ The Commission notes that CEA section 4s(b)(6) makes it
unlawful for an SD or MSP to permit any person associated with the
SD or MSP who is subject to a statutory disqualification to effect
or be involved in effecting swaps on behalf of the SD or MSP, if the
SD or MSP knew, or in the exercise of reasonable care should have
known, of the statutory disqualification. 7 U.S.C. 6s(b)(6). This
prohibition applies with respect to an AP of an SD or MSP, but does
not include an individual employed in a clerical or ministerial
capacity. 17 CFR 23.22(a) (definition of ``person'' applicable to
the prohibition).
\350\ 7 U.S.C. 12a(2)-(3).
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The Commission, however, also proposes two exceptions to the
proposed prohibition. Under proposed Sec. 37.201(c)(2)(ii)(A), the
prohibition would not apply where a person is listed as a principal
\351\ or is registered with the Commission as an AP of a Commission
registrant or as a floor trader or floor broker, notwithstanding that
the person is subject to a disqualification from registration under
sections 8a(2) or 8a(3) of the Act. Pursuant to authority delegated to
it by the Commission,\352\ the NFA has permitted a person to be listed
as a principal or registered with the Commission where, in its
discretion, the NFA has determined that the incident giving rise to a
statutory disqualification is insufficiently serious, recent, or
otherwise relevant to evaluating the person's fitness. Under proposed
Sec. 37.201(c)(2)(ii)(B), the prohibition also would not apply where a
person subject to a statutory disqualification is not registered with
the Commission, but provides a written notice from a registered futures
association (``RFA'') stating that if the person were to apply for
registration as an AP, then the RFA would not deny the application on
the basis of the statutory disqualification. The Commission believes
that a statutory disqualification that has not or would not prevent a
person from being listed as a principal or from registering with the
Commission because it is insufficiently serious, recent, or otherwise
relevant to evaluating the person's fitness for registration with the
Commission, as determined by an RFA, should not be a basis for
prohibiting a SEF from employing the person as a SEF trading
specialist.
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\351\ Section 3.10(a)(2) requires each natural person who is a
principal of an applicant for registration to execute a Form 8-R to,
among other things, be listed as a principal of a registrant. 17 CFR
3.10(a)(2).
\352\ CEA section 8a(10) enables the Commission to authorize any
person to perform any portion of the registration functions under
the Act. 7 U.S.C. 12(a)(10). The Commission has delegated to the NFA
the authority to perform the full range of registration functions,
including vetting of applicants for statutory disqualifications.
See, e.g., 50 FR 34885 (Aug. 28, 1985); 57 FR 23136 (Jun. 2, 1992).
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c. Sec. 37.201(c)(3)--Proficiency Requirements
The Commission proposes to require a SEF to maintain proficiency
standards for SEF trading specialists. Proposed Sec. 37.201(c)(3)(i)
would require a SEF to establish and enforce standards and procedures
to ensure that its SEF trading specialists have the proficiency and
knowledge necessary to fulfill their responsibilities to the SEF and to
comply with the Act, applicable Commission regulations, and the SEF's
rules. Further, the Commission proposes under proposed Sec.
37.201(c)(3)(ii) to mandate that a SEF require any person employed as a
SEF trading specialist to have taken and passed a swaps proficiency
examination as administered by an RFA.\353\ Accordingly, SEFs would not
have to comply with the examination requirement until an RFA, such as
the NFA, completes development of the exam and establishes an
administration process. Pursuant to proposed Sec. 37.201(c)(3)(iii), a
SEF's compliance with the proficiency examination requirement would
constitute compliance with the general proficiency requirements upon
establishment of an exam and administration process by the RFA.\354\
Additionally, a SEF would satisfy the examination requirement if a SEF
trading specialist took and passed the examination once without any
further testing, unless the person has
[[Page 61991]]
not served in such a capacity for a continuous two-year period. In that
case, the SEF trading specialist would have to retake and pass the
examination.
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\353\ As proposed, the swaps proficiency examination would have
to be developed and administered by an RFA. The NFA currently
requires persons seeking to become members or associate members of
the NFA, or persons seeking to register with the Commission as an AP
to take and pass the National Commodity Futures Examination
(``Series 3 Exam''), which is administered by FINRA, subject to
certain exceptions. The Series 3 Exam does not test for swaps
proficiency. As a result, NFA Registration Rule 401(e) currently
provides an exception to the NFA's qualification testing requirement
for a person applying for registration with the Commission as an AP,
if the applicant's sole activities subject to regulation by the
Commission are swaps-related. NFA Registration Rule 401(e). The
Commission is aware that the NFA recently announced that it would
develop a swaps proficiency requirements program for all APs
engaging in swaps activities, including those of FCMs, IBs,
commodity pool operators (``CPOs''), commodity trading advisors
(``CTAs''), and individuals who act as APs at SDs. NFA, NFA to
Develop Swaps Proficiency Requirements Program,'' https://www.nfa.futures.org/news/newsRel.asp?ArticleID=5014 (Jun. 5, 2018).
\354\ The Commission clarifies, however, that in the absence of
an available examination that meets the Commission's requirements,
SEFs would still be required to ensure that their SEF trading
specialists meet the general proficiency requirements set forth
under proposed Sec. 37.201(c)(3)(i).
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Given the level of discretion and judgement that SEF trading
specialists exercise in facilitating swaps trading and execution, as
well as the size and complexity of the transactions often executed on a
SEF, the Commission believes that it is essential that a SEF ensure
that its SEF trading specialists possess appropriate skills and
knowledge. Accordingly, the Commission believes that demonstrating such
skills and knowledge would be best achieved through a swaps proficiency
examination regime. The Commission notes that persons who intermediate
transactions in the futures markets and securities markets are already
subject to proficiency requirements that include examinations.\355\ The
Commission believes that requiring SEFs to ensure that their SEF
trading specialists have the necessary skills and proficiency to
perform the key functions of a SEF would similarly enhance the level of
professionalism and market integrity in the swaps market.\356\
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\355\ In addition to the Series 3 Exam, which applies to persons
seeking membership with the NFA as an AP of a registered entity with
respect to futures and options on futures, see supra note 353,
persons who seek registration as a securities professional must also
pass various qualification exams to demonstrate competency in
particular securities-related areas. See generally FINRA,
Registrations and Qualifications, www.finra.org/industry/registration-qualification.
\356\ The Commission notes that this proposed requirement is
analogous to the principles set forth in the FX Global Code
regarding ethics. The code specifies, among other recommendations,
that operators of trading systems or platforms and their personnel,
have sufficient knowledge of, and comply with, applicable law and
have sufficient relevant experience, technical knowledge, and
qualifications. FX Global Code at 6-7.
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d. Sec. 37.201(c)(4)--Ethics Training
The Commission proposes Sec. 37.201(c)(4) to require a SEF to
establish and enforce policies and procedures to ensure that its SEF
trading specialists receive ethics training on a periodic basis. Given
each trading specialist's obligation to promote a fair and orderly
market in facilitating trading and execution while also using
discretion in handling orders on behalf of individual market
participants, a SEF must maintain a training program to ensure that its
trading specialists are aware of and understand the relevant
professional and ethical standards established by the SEF.\357\
Proposed Sec. 37.201(c)(4) is consistent with and would further a
SEF's existing obligation under Core Principle 12 to establish and
enforce rules that minimize conflicts of interest.\358\ Additionally,
the proposed rule corresponds to the existing requirement under Sec.
37.1501 that a SEF CCO establish and administer a written code of
ethics for the SEF that is designed to prevent ethical violations and
promote honesty and ethical conduct by the SEF's personnel.\359\ The
Commission also views ethics training as a necessary element of a SEF's
adequate supervision of its trading specialists and, accordingly,
proposes to require such supervision under Sec. 37.201(c)(6), as
described below.\360\ The Commission believes that the proposed
requirement would enhance professionalism in the overall swaps market
and promote swaps market integrity.
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\357\ As discussed above, this proposed requirement is similar
to one of the leading principles set forth in the Global FX Code
regarding ethical standards. The Global FX Code states, in part,
that firms should promote ethical values and behavior, support
efforts to promote such ethical standards in the wider FX market,
and encourage involvement by personnel in such efforts. FX Global
Code at 6-7.
\358\ 7 U.S.C. 7b-3(f)(12).
\359\ See infra Section XX.A.3.--Sec. 37.1501(c)--Duties of
Chief Compliance Officer (requirement under proposed Sec.
37.1501(c)(6)).
\360\ See infra Section VI.A.3.f.--Sec. 37.201(c)(6)--Duty to
Supervise.
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(1) Guidance to Core Principle 2 in Appendix B--Ethics Training
The Commission also proposes new guidance to Core Principle 2 in
Appendix B that would provide the general objectives for an ethics
training program and examples of topics that should be addressed.\361\
The guidance provides SEFs with the latitude to determine the
appropriate frequency, duration, and format of ethics training for its
trading specialists, including the use of qualified third-party
providers and various forms of technology and media. The proposed
guidance, however, specifies that an ethics training program is
essential to enable SEF trading specialists to remain current with
respect to the ethical and regulatory implications of evolving
technology, trading practices, products, and other relevant changes.
For example, if a SEF's trading protocols or operations continue to
develop, e.g., the SEF adopts a new discretionary approach to
prioritizing or managing competing bids on its voice-based or voice-
assisted trading system, then the SEF's ethics training should address
how its trading specialists should appropriately conduct themselves
under such new protocols. This approach is generally consistent with
the Commission's implementation of the training requirements applicable
to Commission registrants under CEA section 4p(b), as set forth in
acceptable practices established by the Commission for ethics training
for registered persons under part 3 of the Commission's
regulations.\362\
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\361\ The Commission proposes to add this guidance as a new
paragraph (a)(1) and eliminate existing paragraph (a)(1), which
states that a SEF's rules may authorize its compliance staff to
issue warning letters or recommend that a disciplinary panel take
such action. See infra note 456 (discussing proposed changes to the
existing SEF warning letter requirements).
\362\ 17 CFR part 3 app. B (Statement of Acceptable Practices
With Respect to Ethics Training).
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e. Sec. 37.201(c)(5)--Standards of Conduct
The Commission proposes to require a SEF to establish and enforce a
code of conduct for its SEF trading specialists. Like the proposed
ethics training requirement under Sec. 37.201(c)(4), the proposed code
of conduct requirement aims to ensure that SEFs foster and maintain a
high level of professionalism, integrity, and ethical conduct among
their trading specialists when dealing with market participants and
facilitating trading and execution. A SEF's code of conduct may provide
that, among other things, a SEF trading specialist should (i) act in an
honest and ethical manner and observe high standards of
professionalism; (ii) handle orders with fairness and transparency; and
(iii) not engage in fraudulent, manipulative, or disruptive conduct.
The Commission includes these items for SEF consideration, but a SEF
may include different or additional standards as well. These proposed
standards of conduct are intended to be general and principles-based,
given the many unique aspects of a SEF trading specialist's role in
facilitating trading and execution as part of the SEF's particular
trading system or platform.
f. Sec. 37.201(c)(6)--Duty To Supervise
To help promote compliance with a SEF's professionalism
requirements, including ethics requirements and standards of conduct,
the Commission also proposes Sec. 37.201(c)(6) to require a SEF to
diligently supervise the activities of its trading specialists in
facilitating trading and execution on the SEF. While a SEF is generally
responsible for the actions of its agents pursuant to CEA section
2(a)(1)(B) and Sec. 1.2,\363\ proposed Sec. 37.201(c)(6) would impose
an affirmative duty of supervision on each SEF. Given the dynamic
manner in
[[Page 61992]]
which SEF trading specialists may use discretion to facilitate swaps
trading and execution on behalf of market participants, a SEF should
have an affirmative obligation to supervise its trading specialists.
The Commission notes that a similar customer protection rule currently
applies to registered entities, including IBs--Sec. 166.3 requires
each Commission registrant to diligently supervise all the activities
of its partners, officers, employees and agents (or persons occupying a
similar status or performing a similar function) relating to its
business as a Commission registrant.\364\ Therefore, to the extent that
some of these SEFs were previously registered with the Commission and
operated as IBs, the Commission believes that proposed Sec.
37.201(c)(6) would impose certain analogous requirements.
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\363\ CEA section 2(a)(1)(B) and Sec. 1.2 establish that the
act, omission, or failure of any official, agent, or other person
acting for a principal within the scope of his employment or office
is imputed to the principal. 7 U.S.C. 2(a)(1)(B); 17 CFR 1.2.
\364\ 17 CFR 166.3.
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g. Sec. 37.201(c)(7)--Additional Sources for Compliance
The Commission is proposing Sec. 37.201(c)(7) to refer SEFs to the
new guidance to Core Principle 2 in Appendix B as discussed above.
Request for Comment
The Commission requests comment on all aspects of proposed Sec.
37.201(c). In particular, the Commission requests comment on the
following questions:
(37) Is the proposed definition of the term ``SEF trading
specialist'' overly broad or too narrow? Are there additional
activities that SEF trading specialists engage in that should be
reflected in the definition? Are there additional natural persons who
should be captured by the proposed definition?
(38) Are the exceptions to the fitness requirement for SEF trading
specialists under proposed Sec. 37.201(c)(2)(ii) appropriate? Should
the Commission prohibit a SEF from employing persons other than those
subject to a statutory disqualification under CEA sections 8a(2) or
8a(3)? If so, what additional disqualification factors should the
Commission use? In this connection, should the Commission not rely on
any of the disqualification factors in CEA sections 8a(2) or 8a(3)?
(39) Should the qualification testing requirement under proposed
Sec. 37.201(c)(3)(ii) be broadened to allow a SEF to employ persons
who have taken and passed a swaps proficiency examination developed and
administered by parties other than an RFA? If so, should the Commission
then adopt standards to ensure that such testing adequately ensures
proficiency? How could the Commission ensure that the examination meets
appropriate standards and consistency, such that it could be recognized
by all SEFs? Should the Commission approve each examination to ensure
appropriate standards are met and consistency is achieved across
different examinations?
(40) Are the ethics training and standards of conduct requirements
under proposed Sec. Sec. 37.201(c)(4)-(5), respectively, overly
prescriptive or too flexible? Should the Commission provide greater
specificity regarding the standards of conduct that a SEF must enforce?
Are there particular subjects that should be specifically required as
part of ethics training?
VII. Additional Part 37 Regulations--Subpart C: Core Principle 2
(Compliance With Rules)
In addition to requiring a SEF to establish and enforce rules that
govern its facility, Core Principle 2 requires a SEF to adopt trading,
trade processing, and participation rules that provide participants
with impartial access to the market and deter abuses; and establish and
enforce compliance with any limitation on access.\365\ Further, Core
Principle 2 requires a SEF to have the capacity to detect, investigate,
and enforce those rules, including the means to capture information
that may be used in identifying rule violations.\366\ The Commission
adopted many detailed regulations in part 37 to further implement these
requirements, including impartial access requirements under Sec.
37.202; rule enforcement program requirements under Sec. 37.203;
third-party service provider requirements under Sec. 37.204; audit
trail requirements under Sec. 37.205; and disciplinary procedures and
sanctions requirements under Sec. 37.206.
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\365\ 7 U.S.C. 7b-3(f)(2)(B)(i).
\366\ 7 U.S.C. 7b-3(f)(2)(B)(ii).
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The Commission is proposing several new rules and rule amendments
under Core Principle 2, including clarifications of existing rules
where appropriate, to implement its proposed swaps regulatory
framework. These proposed amendments would streamline the SEF rules and
allow SEFs to account for technological developments, existing market
practices, and costs in their trading and market operations. Further,
the amendments would codify no-action relief that has been provided
under several existing Commission staff no-action letters. Among these
changes, the Commission is proposing a modification to the impartial
access requirements under Sec. 37.202 and several corresponding
amendments, which would provide a SEF with the ability to devise its
participation criteria based on its own trading operations and market
focus. Further, the Commission is proposing several amendments to
Sec. Sec. 37.203-206 that would allow a SEF to better tailor its own
compliance and regulatory oversight rules to its trading operations and
markets, while still maintaining a robust compliance program.
A. Sec. 37.202 Access Requirements
The Commission implemented the statutory impartial access
requirement by adopting Sec. 37.202. Existing Sec. 37.202(a)(1)
requires a SEF to provide any ECP and any independent software vendor
(``ISV'') with impartial access to its market(s) and market services,
including indicative quote screens or any similar pricing data
displays, provided that the facility has, among other things, criteria
governing such access that are ``impartial, transparent, and applied in
a fair and non-discriminatory manner.'' \367\ In the preamble to the
SEF Core Principles Final Rule, the Commission stated that
``impartial'' means ``fair, unbiased, and unprejudiced.'' \368\ The
Commission further stated that the impartial access requirement allows
ECPs to ``compete on a level playing field'' \369\ and does not allow a
SEF to ``limit access . . . to certain types of ECPs or ISVs.'' \370\
The Commission also noted that each similarly situated group of ECPs
and ISVs must be treated similarly.\371\ The Commission believed that
this approach would increase the number of market participants on SEFs,
which in turn would increase SEF trading, thereby improving liquidity
and price discovery in the swaps market.\372\
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\367\ 17 CFR 37.202(a)(1).
\368\ SEF Core Principles Final Rule at 33508.
\369\ Id.
\370\ Id.
\371\ Id.
\372\ Id.
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Core Principle 2, however, also allows a SEF to establish and
enforce compliance with any rule of the SEF, including any limitation
on access to the SEF.\373\ Accordingly, existing Sec. 37.202(c)
requires a SEF to establish and impartially enforce rules that govern
the SEF's decision to allow, deny, suspend, or permanently bar ECPs'
access to the SEF, including when such decisions are made as part of a
disciplinary or emergency action by the SEF.\374\ The Commission
further stated that a SEF may establish different access criteria for
each of its markets, provided that the criteria are impartial and are
not
[[Page 61993]]
used as a competitive tool against certain ECPs and ISVs.\375\ Subject
to these requirements, the Commission stated that a SEF may ``use its
own reasonable discretion to determine its access criteria, provided
that the criteria are impartial, transparent and applied in a fair and
non-discriminatory manner, and are not anti-competitive.'' \376\
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\373\ 7 U.S.C. 7b-3(f)(2)(A)(ii).
\374\ 17 CFR 37.202(c).
\375\ SEF Core Principles Final Rule at 33508.
\376\ Id.
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Existing Sec. 37.202(a)(3) requires a SEF to have a comparable fee
structure for ECPs and ISVs receiving comparable access to, or services
from, the SEF.\377\ The Commission clarified that this requirement
neither sets nor limits fees that a SEF may charge.\378\ The Commission
further clarified that a SEF may establish different categories of ECPs
and ISVs seeking access to, or services from, the SEF, but may not
discriminate with respect to fees within a particular category.\379\
The Commission stated that existing Sec. 37.202(a)(3) is not intended
to be a ``rigid requirement that fails to take into account legitimate
business justifications for offering different fees to different
categories of entities seeking access to the SEF.'' \380\
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\377\ 17 CFR 37.202(a)(3).
\378\ SEF Core Principles Final Rule at 33509.
\379\ Id.
\380\ Id.
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Finally, existing Sec. 37.202(a)(2) requires SEFs to have
procedures for ECPs to provide written or electronic confirmation of
their ECP status with the SEF prior to obtaining access.\381\ Under
existing Sec. 37.202(b), an ECP must consent to a SEF's jurisdiction
prior to obtaining access to the SEF.\382\
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\381\ 17 CFR 37.202(a)(2).
\382\ 17 CFR 37.202(b).
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1. Sec. 37.202(a)--Impartial Access to Markets, Market Services, and
Execution Methods \383\
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\383\ The Commission proposes to retitle Sec. 37.202(a) to
``Impartial access to markets, market services, and execution
methods'' from ``Impartial access to markets and market services''
based on the proposed changes described below.
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The Commission has applied the impartial access requirements to
various areas of a SEF's operations that concern participant access to
the market. These features include (i) eligibility or onboarding
criteria; (ii) a participant's ability to access the SEF's
functionalities, i.e., trade and execute on a SEF's execution methods;
(iii) the manner in which a SEF's execution methods treat market
participants' bids and offers, in particular the use of discretion; and
(iv) participation fee structures. The Commission's current approach to
impartial access in these areas, however, has raised two issues that
have led to certain inconsistencies in implementation of the
requirement.
First, the existing approach has created uncertainty for SEFs
seeking to establish and apply access criteria in a consistent manner.
The Commission recognizes that SEF Core Principle 2 requires a SEF to
provide impartial access, but also allows a SEF to establish
limitations on access. Accordingly, the Commission has allowed SEFs to
establish different access criteria for different markets, but has also
required each ``similarly situated'' group of ECPs and ISVs to be
treated in the same manner.\384\ The preamble to the SEF Core
Principles Final Rule also states that SEFs can use their own
reasonable discretion to determine their access criteria, provided that
they are impartial. In practice, implementation of the rule has led to
some uncertainty by SEFs as to whether different access criteria for
their markets, market services, and execution methods would be allowed
or not allowed under Sec. 37.202.
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\384\ SEF Core Principles Final Rule at 33508.
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Second, the manner in which the Commission has implemented the
existing approach has often favored the promotion of an ``all-to-all''
trading environment and has, thus, limited the ability of SEFs to adapt
their operations to the characteristics and dynamics of the swaps
market.\385\ All-to-all trading environments, such as futures markets,
are generally marked by smaller-sized products with standardized terms
and conditions that appeal to a broad range of market participants,
including retail customers. These same characteristics are also more
conducive to continuous and liquid trading. By contrast, swaps trading
often occurs between a limited number of ECPs in a broad array of
unique, larger-sized products with more variable terms that are
customized to address specific and unique hedging risks. These
characteristics result in episodic market liquidity in many swaps
markets, in contrast to the continuous liquidity found in all-to-all
trading environments. The Commission believes that the imposition of
features found in an ``all-to-all'' trading environment upon swaps
markets is at odds with general market characteristics and dynamics of
swaps trading.
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\385\ Id.
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a. Sec. 37.202(a)(1)--Impartial Access Criteria
Based on its experience with implementing part 37, the Commission
proposes to modify its approach to applying the impartial access
requirement. In doing so, the Commission proposes to streamline and
consolidate the existing language and relevant preamble discussion from
the SEF Core Principles Final Rule, including the Commission's view of
``impartial'' and the concept of ``similarly situated,'' to establish a
revised impartial access requirement. Under proposed Sec.
37.202(a)(1), a SEF would be required to establish rules that set forth
impartial access criteria for accessing its markets, market services,
and execution methods, including any indicative quote screens or any
similar pricing data displays. Such impartial access criteria must be
transparent, fair and non-discriminatory and applied to all or
similarly situated market participants.
In proposing this approach, the Commission believes that criteria
that are ``fair and non-discriminatory'' would inherently be ``fair,
unbiased, and unprejudiced,'' which the Commission previously defined
as ``impartial.'' The Commission also believes that the proposed rule
clarifies that this criteria must be applied to market participants in
a fair and non-discriminatory manner, as currently required under the
existing requirements of Sec. 37.202(a)(1). Finally, proposed Sec.
37.202(a)(1) would continue to allow each SEF to determine which market
participants are ``similarly situated'' in its market and configure
appropriate access criteria, provided that such criteria are
transparent, fair, and non-discriminatory to participants. Applying
access criteria in a ``fair and non-discriminatory'' manner means that
a SEF should permit or deny access to a market participant on a non-
arbitrary basis, based on objective, pre-established requirements or
limitations. The Commission emphasizes, however, that this streamlined
approach does not mean that a SEF must create an ``all-to-all'' trading
environment.
The Commission acknowledges that it has often applied the impartial
access requirement to promote an ``all-to-all'' trading environment,
which is neither required under Core Principle 2 nor is consistent with
swaps market structure. Under the proposed approach, the Commission
would not seek to apply the requirement to mandate that all
participants have access to all SEFs, which may have circumscribed a
SEF's ability under Core Principle 2 to set access limitations. Rather,
to allow SEFs to serve different types of market participants or have
different access criteria for different execution methods, the
Commission would allow SEFs to apply access limitations, as long as
they
[[Page 61994]]
are applied in a fair and non-discriminatory manner.
This approach would also align with swaps market characteristics--
in particular, the episodic nature of swaps liquidity--that have led to
the overall swaps market being made up of both dealer-to-client and
dealer-to-dealer markets, as described below. The Commission believes
that the structure of the swaps market is a natural outgrowth of
certain fundamental features of swaps trading. The Commission further
believes that all-to-all markets are inimical to these fundamental
swaps trading features; therefore, imposing all-to-all, market-derived
requirements on swaps markets ultimately detracts from achieving the
statutory SEF goals of promoting swaps trading on SEFs and pre-trade
price transparency in the swaps market. Accordingly, the Commission
believes that each SEF should be able to use access criteria to develop
its business in a manner that is both consistent with the
characteristics of swaps markets and accommodating of the types of
participants that comprise the SEF's intended market.
The Commission still believes that any access criteria intended to
prevent or reduce competition among similarly situated market
participants would be unfair and discriminatory and, therefore,
inconsistent with proposed Sec. 37.202(a)(1). If a market participant
is willing or able to meet the objective, pre-established, and
transparent criteria for eligibility to onboard to a SEF or gain
additional access to a SEF's trading mechanisms, then the SEF should
not preclude that market participant from onboarding to the SEF or
using its functionalities. Accordingly, such a market participant
should not be subject to access criteria that are unfair and
discriminatory and are intended to prevent or dis-incentivize that
market participant's participation on the SEF.\386\
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\386\ The Commission also notes that such criteria may be
inconsistent with Core Principle 11. Core Principle 11 prohibits a
SEF from adopting measures that result in any unreasonable restraint
of trade or impose any material anticompetitive burdens on trading
or clearing, unless they are necessary or appropriate to achieve the
purposes of the CEA and are otherwise consistent with the CEA and
the Commission's regulations. 17 CFR 37.1100.
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The Commission emphasizes that under proposed Sec. 37.202(a)(1),
any access criteria--whether it concerns eligibility or onboarding
criteria, prerequisites for using certain trading functionalities, or
fee schedules--constitutes a ``rule,'' as that term is defined under
Sec. 40.1(i), that would be subject to rule approval or self-
certification procedures under part 40.\387\ Through the part 40 rule
review process, the Commission would continue to evaluate a SEF's
compliance with the impartial access requirements as proposed.
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\387\ 17 CFR 40.5-6.
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The Commission also proposes to eliminate the reference to
``ISVs,'' which the Commission notes is not required under Core
Principle 2. Given that a SEF should be able to set its access criteria
to develop its business based on its desired market and participant
needs, the Commission also believes that a SEF should be able to
determine an ISV's level of access to the SEF. The Commission
previously applied the impartial access requirement to ISVs on the
basis that such types of vendors would provide various benefits to the
swaps market and market participants, such as enhanced transparency and
trading efficiency through the consolidation of trading data from
multiple venues, analytics, and best displayed prices.\388\ Based on
the Commission's experience and notwithstanding the existing impartial
access requirement, ISVs have not established a significant level of
participation on SEFs, nor have they achieved a broad level of adoption
among market participants. Rather, the Commission has observed that
most participants access SEFs through means other than ISV
services.\389\ Therefore, the Commission believes that the impartial
access requirement should apply to market participants who are
accessing SEF trading systems or platforms to trade swaps, rather than
establish requirements for a separate set of entities that are merely
providing ancillary market services.
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\388\ The Commission previously cited examples of ISVs that
included smart order routers, trading software companies that
develop front-end trading applications, and aggregator platforms.
SEF Core Principles Final Rule at 33508 n.423.
\389\ See supra notes 52-54 (describing the various modes of
participation on SEFs by market participants).
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(1) Application of Impartial Access Requirement
Based on the areas in which the Commission has applied the existing
impartial access requirement to various aspects of a SEF's operation
during the part 37 implementation, the Commission discusses below how
the proposed impartial access approach would apply to these areas to
provide further clarity, including (i) eligibility and onboarding; (ii)
execution methods; and (iii) SEF use of discretion.
(i) Eligibility and Onboarding Criteria
The Commission has applied the impartial access requirement to
assess a SEF's eligibility and onboarding criteria. In the preamble to
the SEF Core Principles Final Rule, the Commission prospectively
identified whether or not certain hypothetical arrangements would
comply with the rulemaking's approach to impartial access. Certain
criteria were deemed non-compliant, such as platforms whose
participants were limited to wholesale liquidity providers; \390\
platforms that imposed participation limits based on maintaining
financial integrity and operational safety; \391\ platforms that
established objective minimum capital or credit requirements; \392\ and
platforms that limited participation to sophisticated market
participants.\393\ The Commission generally characterized these types
of criteria as inconsistent with Core Principle 2 because they would
inherently limit access to certain types of ECPs and ISVs.\394\
Subsequent Commission staff guidance further identified other
eligibility criteria that Commission staff viewed as inconsistent with
impartial access, based on the view that limiting access to a SEF's
trading systems or platforms to certain types of ECPs or ISVs is
inconsistent with Core Principle 2.\395\
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\390\ SEF Core Principles Final Rule at 33507-08.
\391\ Id.
\392\ Id. at 33507.
\393\ Id.
\394\ Id. at 33508.
\395\ These criteria included (i) not providing access to an ECP
that is both a liquidity provider and taker; (ii) prohibiting
individuals from obtaining access despite their meeting the
requirements to be an ECP; (iii) limiting access to ECPs that
satisfy minimum transaction volume level requirements; and (iv)
requiring an ECP to be a clearing member or to have an agreement
with a clearing member to access the SEF, even if only for the
purpose of trading swaps that are not intended to be cleared.
Commission staff also expressed concern that SEFs allowing only
either intermediated access or direct access may impede impartial
access in certain instances. Division of Clearing and Risk, Division
of Market Oversight and Division of Swap Dealer and Intermediary
Oversight Guidance on Application of Certain Commission Regulations
to Swap Execution Facilities (Nov. 14, 2013) (``2013 Staff Impartial
Access Guidance'').
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The Commission has realized from experience that certain criteria
developed by SEFs reflect fundamental swap market segments. In
particular, the swaps market consists of both a dealer-to-client market
segment and a dealer-to-dealer market segment that are related, but
also differ in important respects. In the dealer-to-client segment,
corporate end-users and other buy-side participants access and utilize
the swaps market to manage risk positions
[[Page 61995]]
that are unique to their particular circumstances. Swap dealers provide
liquidity to the participants within this market segment for a fee,
which participants are willing to pay, that reflects the risks incurred
by dealers from the episodic or relative lack of liquidity in the swaps
market for many specific swaps. The swap dealers subsequently offset
positions established through the dealer-to-client market segment by
hedging their swaps inventories on a portfolio basis in the dealer-to-
dealer market, which is wholesale in nature. Those dealer-to-dealer
markets consist of other primary dealers and sophisticated market-
making participants seeking to fulfill similar objectives through
competitive execution of large-sized transactions. In pricing a
customer trade, dealers base their prices on the cost of hedging those
trades in the dealer-to-dealer markets.
The dealer-to-dealer market may provide benefits to the swaps
markets, in particular to non-dealer clients, by allowing dealers who
provide liquidity to offload risk from clients. Without this market,
liquidity in the dealer-to-client market may suffer because the
inherent risks of holding swaps inventory could arguably dis-
incentivize participation by dealers in the dealer-to-client market or
otherwise require dealers to charge their customers higher prices for
taking on this risk. Absent the supply of liquidity providers, non-
dealers who are liquidity takers would have difficulty executing swaps
at competitive pricing. SEFs that serve the wholesale, dealer-to-dealer
market have stated that using eligibility or participation criteria to
maintain a dealer-to-dealer market is beneficial, given that it allows
participants who share similar profiles and trading interests to
interact with each another, thereby helping to promote liquid markets
with tight pricing.
For the reasons stated above, the Commission believes that SEF
eligibility and onboarding criteria that would serve to maintain this
market structure would be appropriate and consistent with existing
market dynamics and may provide the benefits discussed above.
Accordingly, a SEF could premise these criteria in different ways, such
as limiting access upon the type of the market participant or the swap
product itself. For example, a SEF would be able to calibrate access to
serve market participants within a particular market segment, such as
dealers trading in a wholesale swaps market, who may be categorized as
``similarly situated.''
(ii) Access to Execution Methods
In addition to assessing SEF onboarding and eligibility, the
Commission has also applied the current impartial access standard to
evaluate various SEF-established prerequisites for trading on certain
platforms or interacting with certain participants. Some of those
prerequisites reflect the nature of the swap involved, e.g., whether
the swap is submitted for clearing or is uncleared, which determines
whether certain market participants are eligible to trade with one
another.\396\ When a SEF lists a swap that is traded as a component of
a transaction with other non-swap legs, the SEF might also establish
trading eligibility criteria that take account of a participant's
ability to trade the non-swap leg components of such swaps.\397\ Other
prerequisites may be based upon the prior or ongoing level of trading
activity generated by a particular participant, e.g., whether the
participant has been actively submitting bids and offers. During the
implementation of part 37, the Commission has deemed appropriate
certain criteria based on business or operational justifications, but
also deemed other criteria as inconsistent with impartial access. For
example, platform access criteria that require a market participant to
contribute a certain amount of liquidity, e.g., provide a minimum
number of bids and offers, have been prohibited, despite the business
or operational justifications offered by SEFs.
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\396\ Such a situation might result in a SEF limiting trading
access to uncleared swaps to only those market participants who have
existing underlying documentation to execute such swaps with other
potential counterparties.
\397\ For example, a SEF could require market participants (or
their clearing members) to have membership in a particular clearing
organization, e.g., membership with the Fixed Income Clearing
Corporation (``FICC''), in order to access a method of execution in
which counterparties execute a package transaction with a non-swap
leg that FICC must clear.
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SEFs have also argued that requiring market participants to meet
trading prerequisites or participation criteria to access certain
platforms or trade certain products can be beneficial to promoting
effective trading markets on SEFs. In implementing part 37, the
Commission has acknowledged that such criteria may be beneficial toward
maintaining and promoting orderly trading for uncleared swaps on SEFs--
for example, where participants must have certain trading enablements
in place prior to trading uncleared swaps with other participants on
the platform.\398\ Specifically, the Commission has allowed such types
of enablements, e.g., trading relationship documentation with a minimum
percentage of trading participants prior to posting bids and offers or
trading in certain established minimum sizes, to promote a more dynamic
and liquid trading environment for uncleared swaps with active
participation.\399\
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\398\ The Commission notes that Commission staff previously used
the term ``enablement mechanism'' in guidance to refer to ``any
mechanism, scheme, functionality, counterparty filter, or other
arrangement that prevents a market participant from interacting or
trading with, or viewing the bids and offers (firm or indicative)
displayed by any other market participant on that SEF, whether by
means of any condition or restriction on its ability or authority to
display a quote to any other market participant or to respond to any
quote issued by any other market participant on that SEF, or
otherwise.'' 2013 Staff Impartial Access Guidance at 1.
\399\ The Commission notes that Commission staff previously
viewed a SEF's application or support otherwise for enablement
mechanisms with respect to swaps that were intended to be cleared as
``prohibited discriminatory treatment,'' that is inconsistent with
the existing impartial access requirement under Sec. 37.202. Id. at
1-2.
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The Commission's current approach to impartial access, however, has
led to confusion as to whether these types of criteria are
inappropriate because they do not ensure equal participation by all
market participants; or as to whether they are appropriate because they
reflect a SEF's ability to impose limitations on access and are
consistent with the view that SEFs should have the discretion to
determine the most suitable way to promote trading on their platforms.
Specifically, the Commission recognizes that requiring impartial access
for ``similarly situated'' groups of market participants has currently
been interpreted to require that a SEF allow all participants in that
group to be able to interact with one another in the same manner and
degree.
The Commission clarifies that a SEF must have impartial access
criteria, i.e., transparent, fair, and non-discriminatory, for trading
prerequisites or participation criteria prior to accessing certain
platforms or trading certain products. As long as these access criteria
are impartial, such that any market participant who meets the criteria
is able to utilize a certain execution method or trade a certain
product, then they would be allowed to do so under the proposed
approach. For example, if a SEF established a minimum trade size for
its order book that applied to a market participant's orders, then such
criteria would be allowed if any of its market participants who met
these criteria could trade on the order book. As noted above, Core
Principle 2 does not require a SEF to create an ``all-to-all''
marketplace, and the Commission believes that SEFs should be allowed to
establish criteria that would facilitate trading based on its products
and the intended trading environment. As long as a SEF also
[[Page 61996]]
applies its impartial access criteria in a fair and non-discriminatory
manner, as described above, the Commission believes that such criteria
would comply with Sec. 37.202(a)(1).
(iii) Use of Discretion
The Commission has also previously determined whether a SEF
complies with the impartial access requirement based on how the SEF's
trading systems or platforms handle participant orders. For example, a
SEF's voice-based or voice-assisted execution methods involve the
exercise of ``discretion'' by a SEF trading specialist in managing the
interaction of multiple bids and offers from multiple participants. As
described above, SEF trading specialists solicit orders on behalf of
the SEF and seek to arrange transactions by matching those orders with
reciprocal trading interests.\400\ Given the variability in how
participant orders may be handled through the use of discretion, the
Commission has sought to ensure that market participants are receiving
``impartial access'' in the manner in which their orders are handled
while also acknowledging that discretion is inherent to these types of
systems or platforms.
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\400\ For the Commission's previous description of the role of
SEF trading specialists, who function as part of a SEF's voice-based
or voice-assisted trading system or platform, and their use of
discretion, see supra Section VI.A.1.b.--Sec. 37.201(a)(2)--
Discretion and Section VI.A.3.--Sec. 37.201(c)--SEF Trading
Specialists.
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The Commission also recognizes that its current approach to
impartial access may be in tension with its proposal to allow more
flexible execution methods on SEFs, particularly those that involve
discretion and are prevalent in the dealer-to-dealer market. While some
SEF execution methods facilitate trading and execution on a non-
discretionary basis, e.g., electronic trading systems, including Order
Books and RFQ Systems, some execution methods rely upon the ability of
a SEF trading specialist to ascertain liquidity for particular products
and manage multiple competing bids and offers, e.g., voice-based
platforms. To facilitate trading and execution in such a trading
environment, SEF trading specialists must account for a host of
changing market conditions, such as available pricing, product
complexity, prevailing trade sizes, and market participant needs. The
Commission recognizes that SEF trading specialists may apply these
factors differently among different participants during different
periods of trading. In contrast to prevailing practices among swaps
broking entities, such as interdealer brokers that have operated
outside of the SEF regulatory framework,\401\ the Commission has
scrutinized similar practices on SEF voice-based platforms against the
impartial access requirements. The Commission acknowledges that its
application of impartial access at times has constrained the ability of
SEFs to establish trading systems or platforms that serve particular
segments of the swaps marketplace.
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\401\ As discussed above, the Commission is clarifying the
application of the SEF registration requirement in this notice to
specify that these types of entities are subject to SEF registration
based on their activity in facilitating trading and execution in
swaps on a multiple-to-multiple basis between market participants.
See supra Section IV.C.1.c.(2)--SEF Registration Requirement for
Swaps Broking Entities, Including Interdealer Brokers.
---------------------------------------------------------------------------
The Commission also believes that the trading discretion exercised
by SEF trading specialists may affect the manner in which market
participants are treated on a facility, but would not necessarily be
inconsistent with the Commission's proposed approach to impartial
access. The Commission believes that to the extent that the exercise of
discretion furthers a SEF's ability to facilitate trading and execution
on its system or platform--including identifying trading interest in a
discrete manner or managing bids and offers to maintain accurate market
pricing--it should be viewed as being consistent with impartial access.
The Commission also notes that proposed Sec. 37.201(a)(2) would
support the use of discretion in a manner consistent with impartial
access; as discussed above, the proposed rule would provide
transparency into the use of discretion by requiring each SEF to
disclose the general manner and circumstances behind its use within
each execution method.\402\ Notwithstanding proposed Sec.
37.201(a)(2), however, the Commission emphasizes that a SEF would still
be required to ensure that any use of trading discretion occurs in a
fair and non-discriminatory manner.
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\402\ See supra Section VI.A.1.b.--Sec. 37.201(a)(2)--
Discretion and Section VI.A.3.--Sec. 37.201(c)--SEF Trading
Specialists.
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b. Sec. 37.202(a)(2)--Fees
Based on its experience in reviewing fee structures for SEFs, the
Commission proposes to eliminate the requirement under Sec.
37.202(a)(3) that a SEF must establish ``comparable fee structures''
for ECPs and ISVs receiving ``comparable access'' to the SEF or
services from the SEF. In practice, this requirement has not fully
accounted for the market practices described above. Instead, the
Commission proposes Sec. 37.202(a)(2) to require a SEF to establish
and apply fee structures and fee practices in a fair and non-
discriminatory manner to its market participants.\403\
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\403\ To further streamline the other existing impartial access
requirements, the Commission proposes to renumber existing paragraph
(a)(2), which requires confirmation of a participant's ECP status,
to subsection (c); and to renumber existing paragraph (a)(3), which
addresses SEF fee requirements, to paragraph (a)(2). The Commission
also proposes to renumber subsection (c)--``Limitations on
access''--to subsection (b) and to amend that existing language, as
described below. Accordingly, the Commission also proposes to
renumber existing subsection (b)--``Jurisdiction''--to subsection
(d).
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Currently, SEFs have established different fee levels for different
categories of market participants or different types of trading
activity, whether imposed directly through a trading fee schedule or
indirectly through the use of trading incentive or discount
programs.\404\ The Commission has observed that SEFs have generally
based their fees or discounts on a host of different considerations,
such as technological costs attributable to facilitating a particular
method of accessing the platform or a listed product's complexity. In
particular, fee-setting arrangements for swaps trading in the dealer-
to-dealer segment, which includes interdealer broker operations that
would become subject to the proposed SEF registration requirement,\405\
may differ, even in instances where market participants are receiving
comparable access or services from the SEF. Rather, fee arrangements in
the dealer-to-dealer market are often subject to individualized
negotiations between a particular market participant and its broker,
often involving a combination of different factors and business
considerations that can lead to different fees for market participants
who could otherwise be characterized as similarly situated.\406\ The
Commission has observed that these factors or considerations may
include discounts based on past or current trading volume attributable
to the market participant, market maker participation, or pricing
arrangements related to services
[[Page 61997]]
provided by a SEF-affiliated entity involving other non-swap products.
The confluence of such factors, and the varying degrees to which they
help inform swap trading fee determinations, have been difficult to
distill into fee structures applicable to categories of market
participants.
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\404\ With respect to trading incentive or discount programs,
the Commission has observed various types of arrangements, such as
discounts from trading fees that vary in size and scope based on the
method of execution utilized and the relative rank of a SEF
participant vis a vis other participants in terms of quoting
frequency and number of products quoted.
\405\ See supra Section IV.C.1.c.(2)--SEF Registration
Requirement for Swaps Broking Entities, Including Interdealer
Brokers.
\406\ In some instances, swap trading fees comprise part of a
larger overall negotiated fee that is agreed upon between a market
participant and a broker for broking services in a broad range of
other products, including other fixed income instruments and
equities.
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Based on this practical difficulty, the Commission is proposing to
allow SEFs and market participants the flexibility to determine fees
based on legitimate business negotiations. In this proposal, the
Commission does not intend to limit the scope of business-related
factors that a SEF may continue to consider in establishing
participation fee arrangements. Proposed Sec. 37.202(a)(2) is intended
to provide market participants and SEFs with the flexibility to
negotiate fee arrangements on an individualized basis based on
legitimate business justifications. The Commission emphasizes, however,
that consistent with the impartial access requirement under proposed
Sec. 37.202(a)(1), a SEF should not use fees to discriminate against
certain market participants.
2. Sec. 37.202(b)--Limitations on Access
The Commission proposes to require a SEF to maintain documentation
of any decision to deny, suspend, permanently bar, or otherwise limit a
market participant's access to the SEF.\407\ The Commission believes
that such documentation is important to assisting a SEF's CCO in
reviewing the SEF's adherence to its access criteria rules and
determining whether the SEF is applying its access criteria in a manner
that meets Sec. 37.202. This documentation can further assist the
Commission in reviewing any limitation on access determinations for a
market participant during rule enforcement reviews or in the event that
a market participant or the Commission challenges a SEF's access
decision.
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\407\ The Commission proposes to renumber existing subsection
(c)--``Limitations on access''--to subsection (b) and amend the
requirement as described above.
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The Commission also proposes non-substantive amendments to the
existing provision, including amending the existing reference to
``eligible contract participant'' to ``market participant'' to provide
greater clarity.
3. Sec. 37.202(c)--Eligibility
The Commission proposes under Sec. 37.202(c) to maintain the
existing requirement that a SEF must require its market participants to
provide a written confirmation (electronic or otherwise) of their ECP
status prior to obtaining access to the SEF. The Commission also
proposes to make minor non-substantive revisions to the current
language.\408\
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\408\ The Commission proposes to renumber existing paragraph
(a)(2) to subsection (c) and adopt a new title--``Eligibility.''
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4. Sec. 37.202(d)--Jurisdiction
The Commission proposes under Sec. 37.202(d) to maintain the
existing requirement that a SEF must require that a market participant
consent to its jurisdiction prior to granting any market participant
access to its facilities. The Commission also proposes to make minor
non-substantive revisions to the current language.\409\ In addition,
the Commission confirms that consistent with prior Commission staff
guidance, a SEF does not need to obtain consent to its jurisdiction
through an affirmative writing, and a SEF may obtain consent through a
notification in its rulebook.\410\
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\409\ The Commission proposes to renumber existing subsection
(b)--``Jurisdiction'' to subsection (d).
\410\ 2014 Staff Jurisdiction Guidance at 2.
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Request for Comment
The Commission requests comment on all aspects of proposed Sec.
37.202. In particular, the Commission requests comment on the following
questions:
(41) Should the Commission specify a basis for how it would
determine that a SEF's access criteria are unfair and discriminatory?
Should a SEF be limited in the type of justifications that it may
provide for its access criteria to demonstrate that they are impartial,
e.g., such criteria are intended to promote participation and/or
liquidity? If so, what would those justifications be?
(42) What should be the bases or factors for determining whether
market participants are ``similarly situated''?
(43) Should enablements be allowed as a type of access criteria for
cleared swaps, in addition to their usage for uncleared swaps? Is this
consistent with the Commission's proposed approach to impartial access?
Why or why not? If so, please provide examples of enablements for
cleared swaps that are consistent with the Commission's proposed
approach to impartial access.
B. Sec. 37.203--Rule Enforcement Program
Section 37.203 implements certain aspects of Core Principle 2,
which requires a SEF to (i) establish and enforce trading, trade
processing, and participation rules to deter abuses; and (ii) have the
capacity to detect, investigate, and enforce those rules, including the
ability to capture information to identify rule violations.\411\ The
regulation sets forth the requirements of an acceptable SEF rule
enforcement program, including requirements related to prohibiting
abusive trading practices; detecting and investigating rule violations;
maintaining sufficient staffing and resources; maintaining an automated
trade surveillance system; conducting real-time market monitoring; and
conducting investigations.
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\411\ 7 U.S.C. 7b-3(f)(2).
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During the part 37 implementation process, the Commission has
acquired greater experience with the swaps markets, in particular
related to SEF compliance and regulatory oversight requirements. The
Commission acknowledges that the existing swaps regulatory framework
was developed based in part on the futures regulatory framework. As a
result, the current part 37 regulations do not sufficiently account for
differences between futures and swaps markets, in particular the
differences in the complexity and size of transactions, the number and
sophistication of market participants,\412\ and the variations in the
methods of execution offered. Within the swaps market, the Commission
also recognizes that product offerings, execution methods, types of
market participants, and liquidity may even vary among SEFs.
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\412\ The Commission notes that CEA section 2(e) limits swaps
trading to ECPs, as defined by section 1a(18) of the Act. 7 U.S.C.
2(e).
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Accordingly, the Commission believes that instead of prescribing a
limited approach to compliance and regulatory oversight requirements, a
SEF should be enabled to tailor its compliance and oversight program to
fit its respective operations and market.\413\ Further, the Commission
seeks to ensure that SEF rule enforcement requirements are consistent
with the ability of a SEF to offer flexible execution methods for any
of its listed swaps. Therefore, as described below, the Commission
proposes to amend Sec. 37.203 to enable a SEF to establish a rule
enforcement program that is best suited to its trading systems and
platforms, as well as its market participants, while still ensuring the
ability to fulfill its self-regulatory obligations. The Commission
believes that these proposed amendments would also reduce certain
complexities, costs, and burdens, while still continuing to implement
the Core Principle 2 requirements and require a robust compliance
program.
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\413\ The Commission proposes to eliminate the introductory
sentence under Sec. 37.203, which states that a SEF shall establish
and enforce trading, trade processing, and participation rules that
will deter abuses and it shall have the capacity to detect,
investigate, and enforce those rules. This language is duplicative
of the existing requirements under Core Principle 2.
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[[Page 61998]]
1. Sec. 37.203(a)--Abusive Trading Practices Prohibited
Section 37.203(a) requires a SEF to generally prohibit abusive
trading practices on its markets by members and market participants,
but also enumerates specific practices that a SEF must specifically
prohibit, including front-running, wash trading, pre-arranged trading
(except for block trades or other types of transactions certified or
approved by the Commission under part 40), fraudulent trading, money
passes, and any other trading practice that the SEF deems to be
abusive.\414\ Section 37.203(a) further requires a SEF to prohibit any
other manipulative or disruptive trading practices prohibited by the
Act or Commission regulations. SEFs permitting intermediation must also
prohibit customer-related abuses, such as trading ahead of customer
orders, trading against customer orders, accommodation trading, and
improper cross trading.
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\414\ 17 CFR 37.203(a).
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The Commission proposes a non-substantive amendment to Sec.
37.203(a) to eliminate the term ``members.'' The Commission notes that
its proposed definition of ``market participant'' under Sec. 37.2(b)
would capture the universe of persons and entities that could engage in
abusive trading practices, including a SEF's members.\415\
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\415\ See supra Section IV.B.2.--Sec. 37.2(b)--Definition of
``Market Participant.''
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As discussed above in conjunction with the proposed prohibition on
pre-execution communications under Sec. 37.201(b), the Commission is
also proposing to eliminate exceptions to the pre-arranged trading
prohibition under Sec. 37.203(a).\416\
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\416\ See supra Section VI.A.2.a.--Sec. 37.201(b)--Pre-
Execution Communications.
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Request for Comment
The Commission requests comment on all aspects of proposed Sec.
37.203(a). In particular, the Commission requests comment on the
following questions:
(44) Are there any abusive trading practices enumerated under
proposed Sec. 37.203(a) that are not applicable to swaps trading on a
SEF, on certain SEF markets, or through certain methods of execution?
(45) Are there other abusive trading practices that could
potentially occur in the swaps markets that the Commission should
enumerate as a required prohibition under Sec. 37.203(a), e.g.,
intradesk and intracompany trading; order flashing; a failure to honor
firm prices; attempting to change the general conditions of a swap
transaction after price has been agreed upon; or potential abuses at
those points in the day when options are settled against swaps levels?
2. Sec. 37.203(b)--Authority To Collect Information \417\
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\417\ The Commission proposes to retitle Sec. 37.203(b) to
``Authority to collect information'' from ``Capacity to detect and
investigate rule violations'' based on the proposed changes
described below.
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Section 37.203(b) currently requires a SEF to have arrangements and
resources for effective enforcement of its rules, which includes the
authority to collect information and examine books and records of SEF
members and persons under investigation. A SEF must also facilitate
direct supervision of the market and analysis of data collected to
determine whether a rule violation has occurred.\418\
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\418\ 17 CFR 37.203(b).
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The Commission proposes several amendments to the existing
requirements. First, the Commission proposes to eliminate the
requirement that a SEF's arrangements and resources must facilitate the
direct supervision of the market and the analysis of data collected to
determine whether a rule violation has occurred. The Commission views
the language of this requirement as superfluous because other
regulations already set forth these requirements in greater
specificity, such as Sec. 37.203(d), which requires a SEF to maintain
an automated trade surveillance system that is capable of detecting and
reconstructing potential trade practice violations.\419\
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\419\ 17 CFR 37.203(d). The Commission also notes that other
part 37 regulations require a SEF to supervise the market and
analyze data, including regulations that implement Core Principle 4.
As amended, Sec. 37.401(a) would require a SEF to conduct real-time
market monitoring of all trading activity on the SEF to identify
disorderly trading, any market or system anomalies, and instances or
threats of manipulation, price distortion, and disruption. See infra
Section IX.A.--Sec. 37.401--General Requirements.
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Second, the Commission proposes to eliminate the requirements that
SEFs have the authority to collect documents on a routine and non-
routine basis and examine books and records kept by members and persons
under investigation. Instead, the Commission proposes to require that
each SEF have the authority to collect information required to be kept
by persons subject to the SEF's recordkeeping rules.\420\ The
Commission recognizes that the existing requirement does not provide
clarity as to the meaning of collecting of documents on a ``routine and
non-routine'' basis and how a SEF can collect information from
``persons under investigation.'' \421\ Based on the Commission's
experience in implementing part 37, the Commission believes that SEFs
are better suited to determine what recordkeeping rules are appropriate
based on the products that it offers for trading and the types of
participants on its market, among other considerations.
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\420\ A SEF's recordkeeping rules are established by, among
other provisions, Sec. 37.404(b), which requires a SEF to have
rules that require its market participants to keep records of their
trading. 17 CFR 37.404(b).
\421\ The Commission notes that this lack of clarity existed
during the adoption of part 37. For example, one commenter
previously requested clarity regarding the scope of the rule. SEF
Core Principles Final Rule at 33511.
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Request for Comment
The Commission requests comment on all aspects of proposed Sec.
37.203(b).
3. Sec. 37.203(c)--Compliance Staff and Resources
Section 37.203(c) currently requires a SEF to establish and
maintain sufficient compliance staff and resources to conduct a number
of enumerated tasks, such as audit trail reviews, trade practice
surveillance, market surveillance, and real-time monitoring. The rule
further requires that such staff must be sufficient to address unusual
market or trading events and to conduct investigations in a timely
manner.\422\
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\422\ 17 CFR 37.203(c).
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The Commission proposes to eliminate the enumerated tasks and
replace them with the phrase ``self-regulatory obligations under the
Act and Commission regulations.'' The proposed amendment is intended to
apply the requirement to all of the SEF's applicable self-regulatory
functions and clarify that the existing requirement is not limited to
the enumerated tasks. Similarly, the Commission also proposes to
eliminate the language that requires staffing to be sufficient to
address unusual market or trading events and to complete investigations
in a timely manner, given that these enumerated requirements are an
inherent part of a SEF's existing self-regulation obligations. As the
Commission noted in the SEF Core Principles Final Rule, a SEF may also
take into account the staff and resources of any third-party entities
it uses under Sec. 37.204 to provide regulatory services when
evaluating the sufficiency of its compliance staff.\423\ Further, the
Commission reiterates that as stated in the preamble to the SEF Core
Principles
[[Page 61999]]
Final Rule, some SEF compliance staff can be shared among affiliated
entities as appropriate.\424\
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\423\ The Commission notes that a SEF must, at all times,
maintain sufficient internal compliance staff to oversee the quality
and effectiveness of the regulatory services provided, as required
by Sec. 37.204. As discussed below, the Commission proposes to
expand Sec. 37.204(a) to allow a SEF to use a non-registered entity
approved by the Commission for the provision of regulatory services.
\424\ SEF Core Principles Final Rule at 33511.
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Request for Comment
The Commission requests comment on all aspects of proposed Sec.
37.203(c).
4. Sec. 37.203(d)--Automated Trade Surveillance System
Section 37.203(d) requires a SEF to maintain an automated trade
surveillance system capable of detecting potential trade practice
violations.\425\ The rule also requires that the system load and
process daily orders and trades no later than twenty-four hours after
the completion of the trading day. Given that this requirement applies
to all orders and trades regardless of the type of execution method,
Sec. 37.203(d) requires orders that are not submitted to an electronic
trading system, e.g., orders submitted by voice or certain other
electronic communications, such as instant messaging and email, also be
loaded and processed into an automated trade surveillance system. Such
a system, among other requirements, must have the capability to detect
and flag specific trade execution patterns and trade anomalies;
compute, retain, and compare trading statistics; compute trading gains
and losses and swap-equivalent positions; and reconstruct the sequence
of trading activity.
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\425\ 17 CFR 37.203(d).
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The Commission proposes to eliminate the specific automated trade
surveillance system capabilities enumerated under Sec. 37.203(d),
except for the ability of a SEF to reconstruct the sequence of market
activity. Specifically, the Commission proposes to retain this concept
by amending the remaining rule language to require that a SEF's
automated trade surveillance system be capable of detecting potential
trade practice violations and reconstructing the sequence of market
activity and trading. The Commission believes that an automated trade
surveillance system must be able to reconstruct both the sequence of
market activity and trading in order to detect such violations.
The Commission recognizes based on its experience with implementing
the existing requirement that a SEF's automated trade surveillance
system cannot perform all of the enumerated capabilities under the
existing rule, such as computing trade gains, losses, and swap
equivalent positions. The Commission also acknowledges that it has not
clarified the enumerated capabilities, which has led to some
confusion.\426\ As amended, the rule would provide each SEF with the
ability to tailor its automated trade surveillance system requirements
as needed to fulfill its compliance responsibilities, thereby allowing
the SEF to account for the nature of its trading systems or platforms.
The Commission believes that this proposed approach is consistent with
the reasonable discretion given to a SEF under Core Principle 1 to
establish the manner in which it complies with the SEF core principles.
---------------------------------------------------------------------------
\426\ The Commission notes that some commenters previously
expressed concern about the clarity of the enumerated capabilities.
SEF Core Principles Final Rule at 33512.
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The Commission also proposes to amend Sec. 37.203(d) to clarify
that all trades executed by voice or by entry into a SEF's electronic
trading system or platform, as well as orders that are ``entered into
an electronic trading system or platform,'' must be loaded and
processed into the automated trade surveillance system. This proposed
amendment reflects the Commission's recognition that no cost-effective
and efficient means currently exists that would provide a SEF with the
capability to load and process orders that are not initially entered
into an electronic trading system or platform, e.g., orders entered by
voice or certain other electronic communications, such as instant
messaging and email, given that those orders are in different formats.
The Commission notes that this proposed change is consistent with the
proposed amendments to Sec. Sec. 37.205(b)(2)-(3), as discussed below,
that would similarly limit a SEF's electronic transaction history
database and electronic analysis capability requirements.\427\ The
Commission, however, emphasizes that a SEF must continue to have the
capability to load and process all executed trades, including those
resulting from orders entered by voice or certain other electronic
communications, such as instant messaging and email. The Commission
also emphasizes that under proposed Sec. 37.205(a), a SEF must
continue to capture all orders entered by voice (i.e., oral
communications) or certain other electronic communications, such as
instant messaging and email.
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\427\ See infra Section VII.D.2.a.--Sec. 37.205(b)(1)--Original
Source Documents; Sec. 37.205(b)(2)--Transaction History Database;
Sec. 37.205(b)(3)--Electronic Analysis Capability.
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Finally, the Commission proposes to clarify that the term ``trading
day''--on which such data must be loaded into the automated trade
surveillance system--means the day ``on which such trade was executed
or such order was entered.''
Request for Comment
The Commission requests comment on all aspects of proposed Sec.
37.203(d).
5. Sec. 37.203(e)--Error Trade Policy \428\
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\428\ The Commission also proposes to retitle Sec. 37.203(e) to
``Error trade policy'' from ``Real-time market monitoring'' based on
the proposed changes described below.
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Section 37.203(e) currently requires a SEF to conduct real-time
market monitoring of all trading activity on its system(s) or
platform(s) to identify disorderly trading and any market or system
anomalies.\429\ The regulation further requires a SEF to have the
authority to adjust prices and cancel trades when needed to mitigate
``market disrupting events'' caused by SEF trading system or platform
malfunctions or errors in orders submitted by market participants.
Further, any trade price adjustments or trade cancellations must be
transparent to the market and subject to standards that are clear,
fair, and publicly available.
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\429\ 17 CFR 37.203(e).
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a. Error Trades--Swaps Submitted for Clearing
In 2013, the Division of Clearing and Risk (``DCR'') and DMO
(together, the ``Divisions'') issued guidance (the ``2013 Staff STP
Guidance'') to address ``straight-through processing'' requirements
that, among other things, expressed the view that SEFs should have
rules stating that trades that are rejected from clearing are ``void ab
initio.'' \430\ According to the Divisions, swap transactions that are
executed and subsequently rejected by the DCO from clearing would be
considered void, even where the rejection is attributable to an
operational or clerical error from the SEF or market participants.\431\
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\430\ Staff Guidance on Swaps Straight-Through Processing at 5
(Sept. 26, 2013) (``2013 Staff STP Guidance''). In addition to
discussing the void ab initio concept, as discussed below, the 2013
Staff STP Guidance also discussed ``straight-through processing''
for swap transactions. See infra Section XII.B.2.--Sec. 37.702(b)
and Sec. 39.12(b)(7)--Time Frame for Clearing. The Commission notes
that to the extent that error trades leading to a rejection from
clearing could be corrected without the execution of a new trade,
such methods would depart from the void ab initio concept
articulated by the Divisions.
\431\ As previously stated by Commission staff for purposes of
granting time-limited no-action relief, an operational or clerical
error is any type of error other than a rejection from clearing due
to credit reasons. CFTC Letter No. 17-27, Re: No-Action Relief for
Swap Execution Facilities and Designated Contract Markets in
Connection with Swaps with Operational or Clerical Errors Executed
on a Swap Execution Facility or Designated Contract Market (May 30,
2017) at 1 n.2 (``NAL No. 17-27'').
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[[Page 62000]]
SEFs and market participants raised concerns that considering such
transactions to be void ab initio under the guidance would impede their
ability to correct trades that were rejected from clearing at the DCO
on the basis of such errors. For example, some transactions submitted
for clearing may fail to match a specified term due to a clerical
error, e.g., counterparty names; as a result, the trades would be
rejected from clearing and deemed void ab initio, even though the error
would be readily correctable.\432\ The Divisions' view on void ab
initio would compel counterparties to execute a new trade with the
corrected terms, rather than allow a SEF to identify and correct the
error through other established protocols and procedures.
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\432\ The Commission understands that when a swap trade that is
intended to be cleared has an operational or clerical error, a DCO
will reject that trade, even if it otherwise complies with the risk-
based limits established for the respective counterparties. As DCOs
do not distinguish clearing rejections for credit reasons from
clearing rejections due to clerical or operational errors, error
trades are treated as void ab initio.
---------------------------------------------------------------------------
For those SEFs that apply the concept of void ab initio, however,
the Commission's current execution method requirements have inhibited
the ability to correct errors through subsequent trades, where a swap
has been rejected from clearing due to the error or where a swap
containing an error has been accepted for clearing by a DCO. For swaps
that are Required Transactions, market participants have been otherwise
prohibited from determining how to resolve the error between themselves
by entering into an offsetting trade or a new trade with the correct
terms due to (i) the execution method requirements under Sec.
37.9(a)(2), which requires that all Required Transactions be traded via
either an Order Book or RFQ System; and (ii) the corresponding
prohibition on pre-arranged trading under Sec. 37.203(a). In response
to these concerns related to void ab initio, Commission staff has
provided time-limited no-action relief.\433\
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\433\ CFTC Letter No. 13-66, Time-Limited No-Action Relief for
Swap Execution Facilities from Compliance With Certain Requirements
of Commission Regulation 37.9(a)(2) and 37.203(a) (Oct. 25, 2013)
(``NAL No. 13-66''). In April 2015, staff issued additional no-
action relief, which reinstated the previous time-limited no-action
relief from NAL No. 13-66 for SEFs from Sec. 37.9(a)(2) and Sec.
37.203(a) for swaps rejected from clearing due to an operational or
clerical error. Under the expanded no-action relief, SEF market
participants have resolved error trades accepted for clearing at the
DCO, among other types of transaction. CFTC Letter No. 15-24, Re:
No-Action Relief for Swap Execution Facilities and Designated
Contract Markets in Connection with Swaps with Operational or
Clerical Errors Executed on a Swap Execution Facility or Designated
Contract Market (Apr. 22, 2015) (``NAL No. 15-24''). Commission
staff subsequently extended the relief provided in NAL No. 15-24 in
June 2016. CFTC Letter No. 16-58, Re: No-Action Relief for Swap
Execution Facilities and Designated Contract Markets in Connection
with Swaps with Operational or Clerical Errors Executed on a Swap
Execution Facility or Designated Contract Market (June 12, 2016).
This relief has been most recently extended by NAL No. 17-27 in May
2017.
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Based on this no-action relief, SEFs have allowed market
participants to pre-arrange corrective trades for execution and
submission to a DCO for clearing through means not prescribed under
Sec. 37.9 for Required Transactions. Such trades include a new trade
with the corrected terms, where an error trade has been rejected from
clearing. Such trades also include a new trade to offset an error trade
accepted for clearing and a second subsequent trade with the corrected
terms, as originally intended between the counterparties. This relief
has enabled counterparties to address error trades, but has required
SEFs to adopt mechanisms to identify these corrective trades and
additional related rules and procedures for their respective market
participants.
In light of the challenges described above, the Commission proposes
clarifications and amendments to address the role of void ab initio
with respect to error trades for SEFs as described below.\434\ The
Commission notes that void ab initio is a determination made by a SEF,
and not by a DCO, which merely accepts or rejects a trade from
clearing. Additionally, consistent with the 2013 Staff STP
Guidance,\435\ the Commission notes that void ab initio does not apply
to back-loaded trades, i.e., trades originally executed without an
intent to clear, which the parties subsequently decided to clear.
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\434\ The Commission notes that it is also proposing certain
clarifications and amendments related to the 2013 Staff STP Guidance
with respect to straight-through processing of swaps. See infra
Section XII.B.2.b.--Proposed Approach to Straight-Through
Processing.
\435\ 2013 Staff STP Guidance at 5.
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b. Current SEF Error Trade Policies
SEFs have adopted rules and protocols to address other general
aspects of correcting an error trade. These factors, among the many
specified across all SEFs, include a definition of ``error trade''; the
circumstances to which the SEF's error trade rules would apply; the
process for a market participant to report an alleged error trade; the
process through which a SEF may review and determine that an error
trade has occurred; notification procedures; and the possible courses
of action that a SEF may take (or allow its market participants to
take) to correct the error trade. The Commission believes that the
adoption of such error trade policies by SEFs reflects their
understanding that such policies are a beneficial practice that
promotes a fair and orderly trading market for their market
participants.\436\
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\436\ The Commission notes that the guidance to Core Principle 4
in Appendix B cites ``clear error-trade and order-cancellation''
policies as a type of trading risk control that could be part of an
acceptable program for preventing market disruptions. 17 CFR part 37
app. B (guidance to Core Principle 4--paragraph (a)(5)--``Risk
controls for trading'').
---------------------------------------------------------------------------
Notwithstanding the existence of error trade rules and protocols
across different SEFs, market participants have stated that those rules
and protocols, and the manner in which they are applied, have been
inconsistent in some respects. Participants have cited a number of such
examples, including inconsistent approaches to notifying SEFs of
alleged error trades; the varying factors that SEFs consider in
evaluating alleged error trades; and the level of notification provided
to other market participants regarding alleged errors. Therefore, some
market participants--particularly those that are participants of
multiple SEFs--have recommended that the Commission adopt some general
error trade policy requirements to promote a more consistent approach.
Based on the feedback received and its own observations during the part
37 implementation, the Commission proposes to refine its approach to
SEF error trade policies in a manner that would benefit market
participants.
c. Sec. 37.203(e)--Error Trade Policy \437\
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\437\ The Commission proposes to retitle Sec. 37.203(e) to
``Error trade policy'' from ``Real-time market monitoring.''
---------------------------------------------------------------------------
The Commission proposes to eliminate the real-time market
monitoring requirement, which is duplicative of Core Principle 4, and
adopt a refined approach to SEF error trade policies under proposed
Sec. 37.203(e) that would allow a SEF to implement its own protocols
and processes to correct error trades with respect to swaps (i)
rejected by a DCO due to an operational or clerical error or (ii)
accepted for clearing by a DCO that contains an operational or clerical
error.\438\ Therefore, the Commission's
[[Page 62001]]
proposal would explicitly permit a SEF to establish its own rules
regarding error trades rejected from clearing, which the Commission
believes would facilitate a SEF's ability to establish its own error
trade procedures that it believes is best suited to its particular
market, including whether to maintain an approach based on the void ab
initio concept for trades rejected from clearing due to non-credit
related errors.
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\438\ The Commission notes that the real-time market monitoring
requirement is duplicative of Core Principle 4, which requires a SEF
to conduct real-time monitoring of trading and comprehensive and
accurate trade reconstructions. To account for the minor difference
between the real-time monitoring requirements under Sec. 37.203(e),
which requires a SEF's monitoring to ``identify disorderly
trading,'' and Sec. 37.401, which currently does not specify that
requirement, the Commission is proposing to amend Sec. 37.401 to
incorporate this requirement. See infra Section IX.A.--Sec.
37.401--General Requirements.
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Consistent with proposed Sec. 37.702(b)(1),\439\ however, the
Commission notes that SEFs would now be required to deem any swap
submitted for clearing as void ab initio if a DCO rejects the trade
from clearing due to credit reasons. Under this scenario, clearing
members for the executing counterparties to the rejected trade must
resolve the outstanding credit issue that prevented a DCO from
accepting the trade for clearing. The ability for a clearing member to
resolve credit issues, a process which is outside of a SEF's purview,
is inconsistent with the SEF's ability to provide for the financial
integrity of swaps entered into on the SEF in contravention of Core
Principle 7 and proposed Sec. 37.702(b)(1), which would require a SEF
to coordinate with a DCO to facilitate prompt, efficient, and accurate
processing and routing of transactions to the DCO.\440\ In contrast, a
SEF's role in this context is limited to controlling the process of
correcting an operational or clerical error within the terms of a swap
using the SEF's error trade-related rules and procedures. Therefore, a
SEF should not rely upon a clearing member to resolve such credit
issues, but instead must declare a swap that is rejected from clearing
for credit reasons as void ab initio.
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\439\ The Commission proposes to renumber Sec. 37.702(b)(2) to
Sec. 37.702(b)(1). See infra Section XII.B.2.b.(1)--Sec.
37.702(b)(1) and Sec. 39.12(b)(7)(i)(A)--``Prompt, Efficient, and
Accurate'' Standard.
\440\ In some cases, clearing members and the DCO may not be
able to resolve an outstanding credit issue, but the swap
nevertheless remains void ab initio.
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In addition to allowing a SEF to configure an approach to
correcting non-credit related error trade swaps submitted to a DCO for
clearing, however, the Commission emphasizes that proposed Sec.
37.203(e) would generally require a SEF to establish baseline
procedural requirements for an error trade policy for all swaps
executed on its facility. The proposed approach would permit a SEF to
develop and adopt a more efficient approach based on the nature of the
transaction and error, as well as the SEF's own operational and
technological capabilities.\441\ Given that market participants often
execute subsequent swaps to hedge the risk of an initial transaction,
this approach would help mitigate the potential exposure to market and
execution risk that arises if such hedge positions are established
against a swap that has been deemed void ab initio. Accordingly, a SEF
may reduce that risk by facilitating a more targeted and timely
correction of errors in the initial transaction that would not
necessitate the resubmission of an entire transaction that has been
voided.\442\
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\441\ See 17 CFR part 37 app. B (guidance to Core Principle 4--
paragraph (a)(5)--``Risk controls for trading'') (noting that risk
controls such as error trade policies should be adapted to the
unique characteristics of the trading platform and of the markets to
which they apply). The Commission notes that based on its proposal
to adopt separate error trade policy rules under Sec. 37.205(e), it
also proposes to eliminate the guidance to Core Principle 4 in
Appendix B that specifies error trade policies as a type of risk
control that a SEF may adopt. See infra Section IX.E.--Sec.
37.405--Risk Controls for Trading.
\442\ The Commission notes, however, that to the extent that a
DCO has its own protocols and policies for resolving error trades--
both for error trades that are rejected for clearing due to non-
credit related errors and for error trades that have been accepted
for clearing--a SEF should coordinate its own approach with the DCO,
pursuant to the requirements of proposed Sec. 37.702(b)(1)
(existing Sec. 37.702(b)(2)), which requires a SEF to coordinate
with a DCO, to which it submits transactions for clearing, to
develop rules and procedures to facilitate prompt and efficient
transaction processing in accordance with Sec. 39.12(b)(7).
---------------------------------------------------------------------------
The proposed approach, in conjunction with the proposed adoption of
more flexible methods of execution, would also render the current no-
action relief unnecessary for those SEFs that choose to deem error
trades as void ab initio.\443\ For example, if a SEF maintains an
approach similar to the current no-action relief, then the elimination
of the prescriptive execution methods under Sec. 37.9 would allow
counterparties to execute a corrective trade via flexible methods of
execution offered by the SEF.\444\ Under the proposed approach,
however, a SEF also may not choose to follow the void ab initio
approach for non-credit related errors and instead adopt operational
protocols or procedures to resolve an error trade that do not require
the execution or resubmission of a corrective trade. Relief from the
pre-arranged trading prohibition under Sec. 37.203(a) would also be
unnecessary; under the proposed approach, a SEF could allow
counterparties to use flexible means of execution to execute a
corrective trade.\445\
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\443\ NAL No. 17-27.
\444\ To the extent that a SEF currently maintains a similar
approach as set forth in the no-action relief, however, the
Commission clarifies that a SEF could maintain those protocols and
procedures, notwithstanding the adoption of the proposed version of
Sec. 37.203(e).
\445\ See infra note 319 and accompanying discussion (noting
that the pre-arranged trading prohibition is intended to maintain
the integrity of price competition and market risk that is incident
to trading in the market).
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In conjunction with the proposed flexibility to correcting error
trades, Sec. 37.203 would also set forth general requirements that are
intended to create a baseline consistency among SEF error trade
policies. Proposed Sec. 37.203(e)(1) defines an ``error trade'' as any
swap transaction executed on a SEF that contains an error in any term,
including price, size, or direction.\446\ Proposed Sec. 37.203(e)(2)
would require a SEF to establish and maintain rules and procedures to
help resolve error trades in a ``fair, transparent, consistent, and
timely manner.'' At a minimum, such rules would be required to provide
the SEF with the authority to adjust trade terms and cancel trades; and
specify the rules and procedures for market participants to notify the
SEF of an error trade, including any time limits for notification.
While the Commission is providing SEFs with flexibility in designing
their error trade policies, the Commission believes that fairness,
transparency, consistency, and timeliness should be key principles in a
SEF's error trade policy.
---------------------------------------------------------------------------
\446\ This definition, however, would not include a swap trade
that is rejected from clearing for credit reasons, as discussed
above. Therefore, the Commission notes that proposed Sec. 37.203(e)
would not apply to such trades.
---------------------------------------------------------------------------
Further, proposed Sec. 37.203(e)(3) would establish a minimum set
of notification requirements for a SEF. A SEF would be required to
notify all of its market participants, as soon as practicable, of (i)
any swap transaction that is under review pursuant to the SEF's error
trade rules and procedures; (ii) a determination that the trade under
review is or is not an error trade; and (iii) the resolution of any
error trade, including any trade term adjustment or cancellation. The
Commission proposes an ``as soon as practicable'' standard based on
competing considerations, such as the need to maintain orderly trading
versus the need for timely transparency. Under this proposed approach,
a SEF may determine that making error trade information available at a
particular point in time is not practicable, given the countervailing
concerns of potential market disruptions caused by the announcement of
a potentially erroneous trade that has been disseminated to the SEF's
participants.
Proposed Sec. 37.203(e)(4) would allow a SEF to establish non-
reviewable ranges.
[[Page 62002]]
The Commission has observed that in the interests of minimizing market
disruption and maintaining orderly trading, many SEFs have established
non-reviewable ranges during the course of trading. Therefore, the
Commission believes that to allow SEFs to maintain existing beneficial
market practices, a SEF should continue to be able to establish such
ranges, which may be adjusted based on market conditions. Pursuant to
proposed Sec. 37.203(e)(2), however, the Commission emphasizes that
such ranges must be established and administered in a fair,
transparent, consistent, and timely manner.
The Commission recognizes that identifying and resolving error
trades in a timely manner is important to promote market integrity and
efficiency and ensure that trade data, which market participants rely
upon to inform their swaps trading decisions, accurately reflects
prevailing market pricing at any given time. The Commission believes
that proposed Sec. 37.203(e) would accomplish these goals for market
participants and the market as a whole.
Request for Comment
The Commission requests comments on all aspects of proposed Sec.
37.203(e). The Commission may consider alternatives to its proposed
error trade policy requirements and requests comment on the following
questions:
(46) Does the lack of a void ab initio requirement for non-credit
related errors create concerns about market risk with respect to error
trades that have been executed, but have not been voided despite the
rejection from clearing? If so, should a SEF be limited in the types of
errors that may be corrected without void ab initio, e.g., errors that
do not create market risk? Should the Commission adopt a mandatory void
ab initio requirement that certain types of errors, e.g., those that do
cause market risk, must be resolved via a corrective trade approach? Or
should counterparties otherwise have the ability to maintain breakage
agreements to address such risks?
(47) Is the Commission's proposed definition of ``error trade''
overly broad or narrow? Should the definition or requirement
specifically address certain types of errors, such as the wrong
affiliate counterparty or the wrong product identified?
(48) Is the Commission's proposed definition of ``error trade''
sufficient to include those trades where an incorrect term (e.g.,
incorrect notional amount) results in a rejection by a DCO ostensibly
due to credit reasons, but where the DCO otherwise would have accepted
the trade had the trade included the correct terms? If not, then how
should the term ``error trade'' be defined to better discern this
situation from a situation where a true rejection for credit reasons
has occurred? Similarly, is the Commission's proposed definition of
``error trade'' sufficiently clear so that the SEF knows which errors
are required to be treated as error trades and which errors are
required to be treated as void ab initio? If not, please explain.
Should the Commission's definition of ``error trade'' specifically
state that it does not include rejections from clearing for credit
reasons?
(49) Should trades that are rejected by a DCO for insufficient
credit be required to be deemed to be void ab initio by SEFs? If so,
should the Commission codify such a requirement under proposed Sec.
37.203(e) or elsewhere in the Commission's regulations?
(50) Are SEFs and DCOs able to distinguish between trades that are
rejected from clearing due to insufficient credit from those trades
that are rejected because they are error trades? Why or why not?
(51) The proposed regulations require that error trades be resolved
in a timely manner, recognizing that a SEF may not be in a position to
resolve every error trade within a specific time frame. Would requiring
resolution of an error trade ``as soon as practicable'' or within a
specific time frame lead to quicker resolutions and reduce risk for
market participants? If so, what time frame would be appropriate and
should it vary based on other factors, such as the nature of the
product or transaction type, whether the error was a participant error
or system error, or whether the error was discovered before or after
the trade was cleared?
(52) Should a SEF be permitted to adjust or cancel an error trade
without consulting with the parties to the trade in some or all
circumstances, or should the Commission require a SEF to consult with
or obtain the consent of the parties to an error trade in some or all
circumstances?
(53) Should market participants be required to report all errors to
a SEF or are there certain errors that are immaterial and do not
otherwise require correction?
(54) What type of error trade policy should a SEF be required to
adopt for swap transactions that are subject to an exception to the
prohibition on pre-execution communications under proposed Sec.
37.201(b), given that such swaps may be negotiated or arranged away
from the SEF's trading system or platform?
(55) Should a SEF be required to specify who may request a review
of a trade as a potential error trade? Should the ability to request a
review be limited to the parties to a trade or should market
participants affected by the trade also have the ability to request a
review?
(56) Are there alternative requirements that would enhance
efficiency and transparency in the error trade resolution process?
(57) Should the Commission require SEFs to notify all market
participants of an error trade and the resolution of such trade or only
a smaller subset of participants? Should the Commission provide any
time frame for such notice?
(58) Should a DCO be required to notify a SEF of the reason why a
trade was rejected from clearing? If so, what type of information
should the Commission require the DCO to provide to the SEF in such a
circumstance?
6. Sec. 37.203(f)--Investigations \447\
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\447\ The Commission proposes to retitle Sec. 37.203(f) to
``Investigations'' from ``Investigations and investigation reports''
based on the proposed changes described below.
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Existing Sec. 37.203(f) currently sets forth requirements for SEFs
with respect to conducting investigations of their market participants
for potential rule violations.\448\ Existing Sec. 37.203(f)(1)
requires a SEF to have procedures that require its compliance staff to
conduct investigations of possible rule violations.\449\ The rule
further requires that an investigation be commenced upon Commission
staff's request or upon discovery of information by a SEF that
indicates a reasonable basis for finding that a violation has occurred
or will occur. Existing Sec. 37.203(f)(2) requires that investigations
be completed in a timely manner, defined as twelve months after an
investigation is opened, absent enumerated mitigating
circumstances.\450\ Existing Sec. 37.203(f)(3) requires a SEF's
compliance staff to submit an investigation report for disciplinary
action any time staff determines that a reasonable basis exists for
finding a rule violation,\451\ while existing Sec. 37.203(f)(4)
requires compliance staff to prepare an investigation report upon
concluding an investigation and determining that no reasonable basis
exists for finding a rule violation.\452\ Existing Sec. Sec.
37.203(f)(3)-(4) enumerate the items that must be included in the
investigation report. Finally, existing Sec. 37.203(f)(5) prohibits a
SEF from issuing more than one
[[Page 62003]]
warning letter to the same person or entity for the same rule violation
during a rolling twelve-month period.\453\
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\448\ 17 CFR 37.203(f).
\449\ 17 CFR 37.203(f)(1).
\450\ 17 CFR 37.203(f)(2).
\451\ 17 CFR 37.203(f)(2).
\452\ 17 CFR 37.203(f)(4).
\453\ 17 CFR 37.203(f)(5).
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The Commission proposes to amend existing Sec. 37.203(f) to
simplify and streamline the procedures for SEFs to conduct
investigations and prepare investigation reports. First, the Commission
proposes to amend Sec. 37.203(f)(1) to state that each SEF must
establish and maintain procedures requiring compliance staff to conduct
investigations, including the commencement of an investigation upon the
receipt of a request from Commission staff or upon the discovery or
receipt of information by the SEF that indicates the existence of a
reasonable basis for finding that a violation may have occurred or will
occur (emphasis added). This proposed amendment reflects the
Commission's view that SEFs may, and should have the right to, choose
to initiate investigations under broader circumstances than the two
instances identified in the existing provision.
Second, the Commission proposes to amend Sec. 37.203(f)(2) to
eliminate the twelve-month requirement for completing investigations
and instead provide SEFs with the ability to complete investigations in
a timely manner taking into account the facts and circumstances of the
investigation. Based on its experience, the Commission recognizes that
each investigation raises unique issues, facts, and circumstances that
affect the time that it takes to complete the investigation. A SEF may
complete some investigations in less than twelve months and complete
some investigations in more than twelve months. The Commission also
recognizes that the list of mitigating factors in the existing rule is
not comprehensive, and other factors may affect the time of an
investigation. Rather than prescribe a singular requirement, the
Commission believes that it is more appropriate to establish general
parameters for completing investigations. In conjunction with this
amendment, the Commission also proposes guidance to Core Principle 2 in
Appendix B to provide SEFs with reasonable discretion to determine that
time frame.\454\
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\454\ The Commission proposes to add this guidance as paragraph
(a)(2) to Core Principle 2 in Appendix B and eliminate the existing
guidance, which currently states that a SEF should adopt and enforce
any additional rules it believes are necessary to comply with Sec.
37.203. The Commission views this guidance as unnecessary based on
the proposed changes to Sec. 37.203(f).
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Third, the Commission proposes to streamline the requirements that
apply to all SEF investigation reports, regardless of whether a
reasonable basis exists for finding a violation, by consolidating the
provisions under existing Sec. 37.203(f)(4) into a new proposed Sec.
37.203(f)(3). Accordingly, proposed Sec. 37.203(f)(3) would require a
SEF's compliance staff to prepare a written investigation report to
document the conclusion of each investigation. The proposed rule would
maintain the existing requirement that each investigation report
contain the following information: (i) The reason the investigation was
initiated; (ii) a summary of the complaint, if any; (iii) the relevant
facts; (iv) the compliance staff's analysis and conclusions; and (v) a
recommendation as to whether disciplinary action should be pursued. To
provide further clarity regarding the actions that a SEF may take once
the investigation report is completed, the Commission proposes adding
guidance to Core Principle 2 in Appendix B to provide that compliance
staff should submit all investigation reports to the CCO or other
compliance department staff responsible for reviewing such reports and
determining next steps in the process; and the CCO or other responsible
staff should have reasonable discretion to decide whether to take any
action, such as presenting the investigation report to a disciplinary
panel for disciplinary action.\455\
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\455\ The Commission proposes to add this guidance as paragraph
(a)(3) to Core Principle 2 in Appendix B. The Commission notes that
it provided similar clarification in the preamble to the SEF Core
Principles Final Rule. SEF Core Principles Final Rule at 33515. As
discussed below, the Commission proposes to renumber the existing
language in paragraph (a)(3) to paragraph (a)(6), see infra Section
VII.E.1.--Sec. 37.206(a)--Enforcement Staff; and eliminate the
existing language in paragraph (a)(6), see infra Section VII.E.2.--
Sec. 37.206(b)--Disciplinary Program.
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As part of the Commission's proposal to consolidate multiple
existing warning letter requirements into a single provision under
proposed Sec. 37.206(c)(2), the Commission also proposes to eliminate
the warning letter requirement under existing Sec. 37.203(f)(5).\456\
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\456\ The Commission proposes to streamline and consolidate
multiple existing provisions that address the SEF's use of warning
letters--under existing Sec. 37.203(f)(5), existing Sec.
37.205(c)(2) with respect to audit trail violations, and existing
Sec. 36.206(f) with respect to rule violations--into a single
provision under proposed Sec. 37.206(c)(2), as discussed below. See
infra Section VII.E.3.--Sec. 37.206(c)--Hearings. Further, the
Commission proposes to eliminate the existing language under
paragraph (a)(1) of the guidance to Core Principle 2 in Appendix B,
which states that a SEF's rules may authorize its compliance staff
to issues warning letters or recommend that a disciplinary panel
take such action. The Commission views this guidance as unnecessary
based on the proposed changes to Sec. 37.203(f).
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Request for Comment
The Commission requests comment on all aspects of proposed Sec.
37.203(f) and the associated guidance to Core Principle 2 in Appendix
B.
7. Sec. 37.203(g)--Additional Sources for Compliance
The Commission is not proposing any amendments to Sec. 37.203(g).
C. Sec. 37.204--Regulatory Services Provided by a Third Party
Section 37.204, among other things, permits a SEF to contract with
an RFA, another registered entity, or the Financial Industry Regulatory
Authority (``FINRA'') for the provision of regulatory services, subject
to the requirement that the SEF supervises its regulatory service
provider and retains exclusive authority over substantive decisions. As
described below, the Commission proposes a series of amendments that
would provide a SEF with further options in choosing and utilizing a
regulatory service provider to assist with fulfilling its regulatory
obligations, while still maintaining regulatory protections that relate
to the use of an external services provider.
1. Sec. 37.204(a)--Use of Regulatory Service Provider Permitted
Section 37.204(a) permits a SEF to contract with an RFA, another
registered entity, or FINRA to assist the SEF in complying with the Act
and Commission regulations, as approved by the Commission.\457\ A SEF
that elects to use the services of a regulatory service provider must
ensure that the provider has the capacity and resources to provide
timely and effective regulatory services.\458\ A SEF remains
responsible at all times for the performance of any regulatory services
received, compliance with its obligations under the Act and Commission
regulations, and the regulatory service provider's performance on its
behalf.\459\
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\457\ 17 CFR 37.204(a).
\458\ Id.
\459\ Id.
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Based upon its experience with implementing part 37, the Commission
is proposing to expand the scope of entities that may provide
regulatory services under Sec. 37.204(a) to include any non-registered
entity approved by the Commission.\460\ The Commission believes that
this proposed expansion would be appropriate and notes that the Act
does not address or proscribe the
[[Page 62004]]
types of entities that SEFs may use for the provision of regulatory
services; for example, the Commission used this basis originally to
include FINRA among the list of entities that could provide regulatory
services. Therefore, consistent with the statute, SEFs would be allowed
to choose from a greater number of potential third-party providers. The
Commission believes that this change would potentially increase
competition among existing and potential regulatory service providers
and, thus, reduce operating costs for SEFs, encourage innovation and
technological developments, and mitigate barriers to entry for new
SEFs.
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\460\ The Commission proposes to amend ``Financial Industry
Regulatory Authority'' in the text of Sec. 37.204(a) to ``any non-
registered entity.''
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Section 37.204(a), however, would also continue to be subject to
important protections to ensure that a regulatory service provider
provides effective regulatory services. To ensure each SEF's compliance
with Sec. Sec. 37.203(c)-(d), among other provisions, the Commission
would continue to evaluate the sufficiency of a provider's compliance
staff and resources and the capabilities of its automated trade
surveillance system, and other capabilities.\461\ Section 37.204(a)
would still require each SEF to be responsible at all times for the
performance of the regulatory services received, for compliance with
the SEF's obligations under the Act and Commission regulations, and for
the provider's performance on its behalf. Further, as discussed below,
Sec. 37.204(b) would still impose a duty to supervise the provider.
Accordingly, the Commission believes that these protections, combined
with the Commission's prior evaluation of any provider, support the
ability of a SEF to consider an entity outside of an RFA, a registered
entity, or FINRA.
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\461\ The Commission would evaluate a provider with respect to
these requirements prior to approving any arrangement between a SEF
and the provider, or during the course of conducting routine
oversight of a SEFs self-regulatory program.
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Request for Comment
The Commission requests comment on all aspects of proposed Sec.
37.204(a).
2. Sec. 37.204(b)--Duty To Supervise Regulatory Service Provider
Existing Sec. Sec. 37.204(b)-(c) generally set forth a SEF's
oversight responsibilities with respect to a regulatory service
provider. Existing Sec. 37.204(b) requires a SEF to retain sufficient
compliance staff to supervise the quality and effectiveness of the
services performed by a regulatory service provider; hold regular
meetings with the regulatory service provider to discuss ongoing
investigations, trading patterns, market participants, and any other
matters of regulatory concern; and conduct and document periodic
reviews of the adequacy and effectiveness of services provided on its
behalf.\462\ Existing Sec. 37.204(c), however, requires a SEF to
retain exclusive authority over all substantive decisions made by its
regulatory service provider, such as decisions involving trade
cancellations, issuance of disciplinary charges, and access
denials.\463\ A SEF is also required to document any instance 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 SEF chose a
different course of action.\464\
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\462\ 17 CFR 37.204(b).
\463\ 17 CFR 37.204(c).
\464\ Id.
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The Commission proposes to combine and streamline the requirements
of existing Sec. Sec. 37.204(b)-(c) into a new proposed Sec.
37.204(b). The Commission further proposes to maintain a SEF's duty to
supervise its regulatory service provider, but to eliminate the
requirement that the SEF hold regular meetings and conduct periodic
reviews of the provider. Instead, the Commission proposes that a SEF be
able to determine the necessary processes for supervising their
regulatory service providers. Consistent with this proposed change, the
Commission also proposes to provide each SEF with the option to allow
its regulatory service provider to make substantive decisions, provided
that, at a minimum, the SEF is involved in such decisions. Therefore, a
SEF would have the discretion to determine how they are involved in
such decisions. The proposed rule would keep the existing examples of
substantive decisions, including the adjustment or cancellation of
trades, the issuance of disciplinary charges, and denials of access to
the SEF for disciplinary reasons. Finally, the Commission proposes to
eliminate the requirement that a SEF document where its actions differ
from the regulatory service provider's recommendations, deferring
instead to the SEF and its regulatory service provider to mutually
agree on the method that they will use to document substantive
decisions.
Based on its experience implementing the SEF regulatory framework,
the Commission believes that some of the specific requirements
currently prescribed under existing Sec. Sec. 37.204(b)-(c) are
unnecessary and overly prescriptive because SEFs, consistent with their
position as self-regulatory organizations, remain ultimately
responsible for the performance of any regulatory services received,
for compliance with their obligations under the Act and Commission
regulations, and for the regulatory service providers' performance on
their behalf. Given a SEF's ultimate responsibility, the Commission
believes that the SEF should be allowed to determine how best to
supervise its regulatory service provider based on the services it
receives and the nature of the SEF's operations and markets. The
Commission also notes that this proposed approach is consistent with a
SEF's discretion under Core Principle 1.\465\ The Commission further
believes that the discretion that SEFs and their regulatory service
providers would have under Sec. 37.204(b) to determine a mutually
acceptable process may enable more timely decision making regarding
substantive matters.\466\
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\465\ 7 U.S.C. 7b-3(f)(1)(B).
\466\ The Commission notes that a commenter to the SEF Core
Principles Final Rule stated that entrusting greater discretion to a
regulatory service provider would provide for prompt decision-
making. SEF Core Principles Final Rule at 33517.
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Request for Comment
The Commission requests comment on all aspects of proposed Sec.
37.204(b).
3. Sec. 37.204(c)--Delegation of Authority
The Commission proposes a new Sec. 37.204(c) to delegate to DMO
the authority to approve any regulatory service provider chosen by a
SEF. This does not, however, prohibit the Commission from exercising
authority to approve any third party regulatory service provider. The
Commission anticipates that expanding the scope of entities that may
provide regulatory services under proposed Sec. 37.204(a) may lead to
a greater number of approval requests for such entities. Therefore, the
Commission proposes to delegate this authority to ensure that such a
review is conducted in an efficient manner. Such approval would
require, at a minimum, that each regulatory service provider
demonstrate that it has the capabilities and resources necessary to
provide timely and effective regulatory services on behalf of the SEF,
including adequate staff and automated surveillance systems, as
required under proposed Sec. 37.204(a).
Request for Comment
The Commission requests comment on all aspects of proposed Sec.
37.204(c).
D. Sec. 37.205--Audit Trail
Section 37.205 sets forth a SEF's audit trail requirements and
generally requires a SEF to establish procedures to
[[Page 62005]]
capture and retain information that may be used in establishing whether
rule violations have occurred. Specifically, Sec. 37.205(a) requires a
SEF to have an audit trail; Sec. 37.205(b) prescribes the elements of
an acceptable audit trail program; and Sec. 37.205(c) requires a SEF
to enforce its audit trail requirements.\467\
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\467\ 17 CFR 37.205(a)-(c).
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Based on the Commission's experience with implementing part 37,
including the SEF registration process, the Commission has observed
that technology limitations have impacted SEFs' ability to comply with
all of the audit trail requirements, particularly for orders submitted
by voice and certain electronic communications that include instant
messages and emails. Based on these observations, as well as the
proposed ability for a SEF to offer flexible execution methods, the
Commission proposes amendments to the audit trail requirements that
seek to strike the appropriate balance between offering SEFs the
ability to adopt such requirements that are best suited to their
respective trading systems or platforms, while also ensuring that such
programs enable SEFs to fulfill their self-regulatory obligations. The
Commission believes that the proposed changes are consistent with Core
Principle 2, which generally requires a SEF to capture information that
may be used in establishing whether rule violations have occurred.\468\
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\468\ 7 U.S.C. 7b-3(f)(2).
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1. Sec. 37.205(a)--Audit Trail Required
Section 37.205(a) requires a SEF to capture and retain all audit
trail data necessary to detect, investigate, and prevent customer and
market abuses.\469\ Such audit trail data must be sufficient to
reconstruct all indications of interest, requests for quotes, orders,
and trades.\470\ The audit trail must also permit a SEF to track a
customer order from the time of receipt through fill, allocation, or
other disposition.\471\
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\469\ 17 CFR 37.205(a).
\470\ Id.
\471\ Id.
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The Commission proposes several amendments to streamline the
existing requirements, account for different execution methods and
swaps market practices, and eliminate redundancies with other part 37
requirements. Notwithstanding the proposed changes described above, the
Commission emphasizes that the type of execution method offered by a
SEF does not alter the obligation to capture all audit trail data
necessary to detect, investigate, and enforce its rules pursuant to
Core Principle 2.
First, the Commission proposes to clarify the existing language to
specify that a SEF must capture and retain all audit trail data
necessary to reconstruct all trading on its facility, detect and
investigate customer and market abuses, and take appropriate
disciplinary action (emphasis added).\472\ By replacing the requirement
to ``prevent'' customer and market abuses with the requirement to
``take appropriate disciplinary action'' and specifying that the data
must enable the SEF to reconstruct all trading on its facility, the
Commission believes that Sec. 37.205(a) would more accurately reflect
the capabilities for which a SEF may use its audit trail data. The
Commission notes that an audit trail cannot ``prevent'' customer and
market abuses and the ability to ``reconstruct'' trading is already
required under existing Sec. 37.205(a), as described below.
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\472\ The Commission proposes to eliminate the introductory
sentence under Sec. 37.205, which states that a SEF shall establish
procedures to capture and retain information that may be used in
establishing whether rule violations have occurred, given that this
language is duplicative of the audit trail requirements under Sec.
37.205(a).
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Second, the Commission proposes to move the requirement that audit
trail data shall be sufficient to reconstruct all indications of
interest, requests for quotes, orders, and trades to the guidance to
Core Principle 2 in Appendix B.\473\ Given the proposal to allow each
SEF to offer flexible methods of execution, as well as continuing
advances in technology, the Commission believes that enumerating
specific audit trail data in the regulatory language may unnecessarily
limit the universe of data relevant to a SEF's audit trail. The
Commission emphasizes that a SEF must capture all audit trail data
related to each offered execution method that is necessary to
reconstruct all trading on its facility, detect and investigate
customer and market abuses, and take disciplinary action as noted
above. The Commission also believes that SEFs must capture such a data
set to be able to detect, investigate and enforce its rules under Core
Principle 2, to reconstruct all trading under Core Principle 4, and to
comply with the audit trail reconstruction program under proposed
37.205(c), as described below.
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\473\ The Commission proposes to add this guidance to paragraph
(a)(4) to Core Principle 2 in Appendix B. As discussed below, the
Commission proposes to eliminate the existing language in paragraph
(a)(4), see infra Section VII.E.2.--Sec. 37.206(b)--Disciplinary
Program.
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Third, the Commission proposes to eliminate the requirement that a
SEF capture post-execution allocation information in its audit trail
data. During the SEF registration process, numerous SEFs indicated that
post-execution allocations normally occur between the clearing firm or
the customer and the DCO, or at the middleware provider.\474\
Therefore, these SEFs represented that they typically do not have
access to post-execution allocation information, and are unable to
obtain such data from third parties, such as DCOs and SDRs, due to
confidentiality concerns. Based on these representations, Commission
staff has issued continuing no-action relief to SEFs from this
requirement.\475\ Based on its experience, the Commission understands
that SEFs are still routinely unable to obtain this information
pursuant to the requirements of Sec. Sec. 37.205(a) and (b)(2).\476\
Accordingly, in lieu of requiring that the audit trail track a customer
order through ``fill, allocation, or other disposition,'' the
Commission proposes to require SEFs to capture the audit trail data
only through execution on the SEF. The Commission understands that this
proposed change is consistent with current swap market practices.
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\474\ CFTC Letter No. 17-54, Re: No-Action Relief for Swap
Execution Facilities from Certain Audit Trail Requirements in
Commission Regulation 37.205 Related to Post-Execution Allocation
Information at 2 (Oct. 31, 2017).
\475\ Id.
\476\ The Commission notes that Sec. 37.205(b)(2) also requires
a SEF's audit trail to include an electronic transaction history
database that captures, among other elements, the identity of each
account to which fills are allocated. 17 CFR 37.205(b)(2). As
discussed below, the Commission proposes to eliminate this
requirement. See infra note 484 and accompanying discussion.
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Request for Comment
The Commission requests comment on all aspects of proposed Sec.
37.205(a). In particular, the Commission requests comment on the
following questions:
(59) Is the scope of the proposed audit trail requirements
sufficiently clear? If not, then please explain. Is the scope overly
broad or narrow to enable a SEF to comply with its obligations under
the Act? If so, please explain. Would a SEF's audit trail obligations
be impacted by the Commission's proposed approach to pre-execution
communications? If so, then how?
(60) What challenges, if any, do SEFs encounter in capturing or
retaining audit trail data?
(61) Are there any specific audit trail data points that are too
costly or burdensome for a SEF to capture or maintain?
(62) Is the proposed guidance to this section appropriate? Are SEFs
currently capturing all indications of interest, requests for quotes,
orders, and trades? Is the meaning of ``indications of
[[Page 62006]]
interest'' sufficiently clear? If not, please provide suggestions on
how to clarify this term. Should a SEF be required to capture all
indications of interest and requests for quotes to enable it to comply
with its obligations under the Act? Are there other data points that
should be added to the guidance?
2. Sec. 37.205(b)--Elements of an Acceptable Audit Trail Program
Section 37.205(b) requires, among other things, that SEFs retain
all original source documents; maintain a transaction history database;
conduct electronic analysis; and safely store all audit trail
data.\477\ Section 37.205(b)(1) requires that a SEF's audit trail
include original source documents and specifies the nature and content
of such documents.\478\ Section 37.205(b)(2) requires a SEF's audit
trail program to include an electronic transaction history database and
specifies the required elements of an adequate database.\479\ Section
37.205(b)(3) requires a SEF's audit trail program to include electronic
analysis capability with respect to all audit trail data in the
transaction history database.\480\ Section 37.205(b)(4) requires a
SEF's audit trail program to safely store all audit trail data retained
in the transaction history database.\481\
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\477\ 17 CFR 37.205(b).
\478\ 17 CFR 37.205(b)(1).
\479\ 17 CFR 37.205(b)(2).
\480\ 17 CFR 37.205(b)(3).
\481\ 17 CFR 37.205(b)(4).
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a. Sec. 37.205(b)(1)--Original Source Documents; Sec. 37.205(b)(2)--
Transaction History Database; Sec. 37.205(b)(3)--Electronic Analysis
Capability
The Commission proposes to eliminate certain elements of the
original source documents requirement under Sec. 37.205(b)(1) that
specify the nature and content of the original source documents,\482\
as such requirements may not capture the appropriate universe of
content. The Commission also believes that the detailed requirements
are not necessary; as discussed above, the general requirement that a
SEF must capture all audit trail data necessary to reconstruct all
trading on its facility, detect and investigate customer and market
abuses, and take disciplinary action is sufficient to guide a SEF as to
the content of its original source documents, which would be based on
the SEF's execution methods, trading operations, and markets. Section
37.205(b)(1), however, would maintain that the SEF's audit trail must
include original source documents, including unalterable, sequentially-
identified records on which trade execution information is originally
recorded, whether recorded manually or electronically.
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\482\ Section 37.205(b)(1) requires, among other things, that
records for customer orders (whether filled, unfilled, or cancelled,
each of which shall be retained or electronically captured) shall
reflect the terms of the order, an account identifier that relates
back to the account(s) owner(s), the time of order entry, and the
time of trade execution. A SEF must also require that all orders,
indications of interest, and requests for quotes be immediately
captured in the audit trail. 17 CFR 37.205(b)(1).
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The Commission further proposes to amend Sec. 37.205(b)(2) to
revise the scope of audit trail data that must be captured in a SEF's
electronic transaction history database. Specifically, the Commission
proposes to eliminate the requirement that the database include all
indications of interest, requests for quotes, orders, and trades
entered into a SEF's trading system or platform. Instead, the SEFs
would be required to include (i) trades executed by voice or by entry
into a SEF's electronic trading system or platform; and (ii) orders
that are entered into its electronic trading system or platform.
Similar to proposed Sec. 37.203(d), this proposed amendment recognizes
that a SEF may not have a cost-effective and efficient method for
inputting orders submitted by voice or certain other electronic
communications, such as instant messaging and email, into an electronic
transaction history database, given that they are not in the same
format as orders and trades that are entered into a SEF's electronic
trading system or platform.\483\ As noted above, the Commission
emphasizes that a SEF must continue to keep a record of all orders
entered by voice (i.e., oral communications) or certain other
electronic communications, such as instant messaging and email. Such a
record, however, would not need to be included in the SEF's electronic
transaction history database given the formatting challenges.
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\483\ See supra Section VII.B.4.--Sec. 37.203(d)--Automated
Trade Surveillance System.
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The Commission additionally proposes to eliminate the remaining
requirements of Sec. 37.205(b)(2) that detail the information that
must be included in transaction history database, given that these
requirements are already captured in other audit trail requirements or
do not comport with existing swaps market practices.\484\ Consistent
with the proposed amendments to Sec. 37.205(b)(2), the Commission
further proposes to amend Sec. 37.205(b)(3) to clarify that a SEF's
electronic analysis capability must enable the SEF to reconstruct ``any
trade executed by voice or by entry into a swap execution facility's
electronic trading system or platform and any order entered into its
electronic trading system or platform'' rather than ``indications of
interest, requests for quotes, orders, and trades.''
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\484\ For example, customer type indicator code (``CTI'') is
used in futures trading to designate the capacity in which the
person was executing a trade--for the person's own account; for a
proprietary account; on behalf of another member; or for a customer.
Many DCM-based automated trade surveillance systems are programmed
to detect aberrations in CTI code usage that may indicate potential
rule violations. The Commission understands, however, that a SEF's
automated trade surveillance system does not use CTI codes to detect
potential rule violations. Therefore, the Commission proposes to
eliminate this requirement. Further, as discussed above, since SEFs
cannot routinely obtain post-execution allocation information, it is
not possible to identify ``each account to which fills are
allocated.'' See supra note 476 and accompanying discussion.
Therefore, the proposed amendment to Sec. 37.205(b)(2) would also
eliminate the requirement to include post-execution allocation
information in a SEF's transaction history database.
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These proposed amendments are consistent with feedback received
regarding the audit trail requirements during the SEF registration
process. Some SEFs that offer voice-based trading systems or platforms
stated that they do not have the requisite technology to conduct an
electronic analysis of audit trail data that is not entered into a
SEF's electronic trading system or platform, such as oral
communications, electronic instant messages, and emails. The Commission
understands that during that time, such technology, if available, would
have been costly for SEFs to adopt and would not have been fully
capable of digitizing oral communications in a sufficiently accurate
manner to conduct effective surveillance.
While the Commission is aware that promising technologies are
developing in this area, it does not believe that a viable, cost-
effective automated technology solution currently exists. Currently,
SEFs that offer any form of voice-based trading system or platform are
required, as a condition to their registration, to establish voice
audit trail surveillance programs to ensure that they can reconstruct a
sample of voice trades and review such trades for possible trading
violations. The proposed amendments to Sec. Sec. 37.205(b)(2)-(3)
would relieve a SEF from establishing or maintaining such a program,
but the proposed audit trail reconstruction requirement under Sec.
37.205(c), as discussed below, would apply instead. Nonetheless, a SEF
must continue to conduct electronic analysis, using an automated trade
surveillance system that meets the requirements of proposed Sec.
37.203(d).
[[Page 62007]]
The Commission further proposes to eliminate the safe storage
requirement under Sec. 37.205(b)(4), given that it is generally
duplicative of the requirements under Core Principle 14 and related
regulations.\485\ As discussed below, however, the Commission proposes
a non-substantive amendment to move the requirement that a SEF must
protect audit trail data from unauthorized alteration, accidental
erasure, or other loss to Sec. 37.1401(c), which addresses system
safeguard requirements.\486\
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\485\ 7 U.S.C. 7b-3(f)(14); 17 CFR 37.1401.
\486\ See infra Section XIX.A.--Sec. 37.1401(c).
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Request for Comment
The Commission requests comment on all aspects of proposed
Sec. Sec. 37.205(b)(1)-(3).
3. Sec. 37.205(c)--Audit Trail Reconstruction \487\
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\487\ The Commission proposes to retitle Sec. 37.205(c) to
``Audit trail reconstruction'' from ``Enforcement of audit trail
requirements'' based on the proposed changes described below.
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Section 37.205(c) generally requires a SEF to enforce its audit
trail and recordkeeping requirements.\488\ Section 37.205(c)(1)
requires enforcement through annual reviews and prescribes the minimum
components that must be included in such reviews.\489\ Section
37.205(c)(2) requires that a SEF establish an enforcement program and
to impose meaningful sanctions against persons and firms where
deficiencies are found.\490\
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\488\ 17 CFR 37.205(c).
\489\ 17 CFR 37.205(c)(1).
\490\ 17 CFR 37.205(c)(2). The Commission notes that Sec.
37.205(c)(2) also imposes a warning letter requirement for audit
trail violations. As discussed below, the Commission proposes to
streamline and consolidate this provision into proposed Sec.
37.206(c)(2). See infra Section VII.E.6.--Sec. 37.206(f)--Warning
Letters.
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The Commission proposes to eliminate the existing audit trail
enforcement requirements under Sec. 37.205(c) and adopt an audit trail
reconstruction requirement instead.\491\ The Commission believes that
the primary goal of audit trail enforcement is to ensure that a SEF's
audit trail enables it to reconstruct trading and conduct effective
surveillance to fulfill its Core Principle 2 obligations. To that end,
audit trail enforcement focuses on reviewing certain components of the
audit trail data to ensure that a SEF's audit trail data is complete
and accurate. Existing audit trail reviews include a (1) review of
randomly selected samples of front-end audit trail data; (2) review of
the process by which user identifications are assigned and records
relating to user identifications are maintained; (3) review of the
usage patterns of user identifications to identify violations of user
identification rules; and (4) review of account numbers and CTI codes
for accuracy and proper use. The Commission understands that these
reviews focus on components of the audit trail that are generally not
relevant to SEFs. For example, SEFs have represented that there is
little, if any, ``front-end audit trail data'' that is not already
captured by the SEF, and that many of the data points for review, such
as user identifications, account numbers, and CTI codes, are not used
in the same manner as they are for DCMs. Therefore, the Commission
believes that requiring SEFs to conduct an audit trail enforcement
program based on the requirements of existing Sec. 37.205(c) serves a
limited purpose.
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\491\ Notwithstanding these proposed changes, the Commission
notes that to comply with the general audit trail requirement under
proposed Sec. 37.205(a), which requires a SEF to capture all audit
trail data related to each offered execution method that is
necessary to reconstruct all trading on its facility, detect and
investigate customer and market abuses, and take disciplinary
action, the SEF must ensure that market participants are submitting
accurate and complete audit trail data.
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The Commission believes that ensuring a SEF's audit trail is
accurate and sufficient to conduct effective surveillance--the primary
goals of audit trail enforcement--would be better served through an
audit trail reconstruction program that focuses on verifying the
accuracy of audit trail data and a SEF's ability to comprehensively and
accurately reconstruct all trading on its facility in a timely manner.
As discussed above, the Commission is aware that SEFs that offer any
form of a voice-based trading system or platform do not currently have
cost-effective solutions for consolidating certain types of data, such
as oral communications, electronic instant messages, and emails,
inputting them into an electronic transaction history database, and
loading and processing them into an automated system to reconstruct
trading. Given that the ability to reconstruct all trading is an
essential component to conducting effective surveillance and is
currently not being conducted in a routine, automated manner for
certain key data, the Commission proposes to require that a SEF
establish a program to verify its ability to comprehensively and
accurately reconstruct all trading on its facility in a timely manner.
The Commission also proposes to adopt guidance to Core Principle 2 in
Appendix B specifying that an effective audit trail reconstruction
program should annually review an adequate sample of executed and
unexecuted orders and trades from each execution method offered to
verify compliance with Sec. 37.205(c).\492\
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\492\ The Commission proposes to add this guidance to paragraph
(a)(5) to Core Principle 2 in Appendix B. 17 CFR part 37 app. B. As
discussed below, the Commission proposes to eliminate the existing
language in paragraph (a)(5). See infra Section VII.E.2.---Sec.
37.206(b)--Disciplinary Program.
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Since SEFs that offer only electronic trading systems or platforms
can use their automated trade surveillance systems to reconstruct
trading, the reconstructions under proposed Sec. 37.205(c) would serve
to verify the accuracy of their audit trail data. A SEF that offers any
form of voice-based trading could comply with proposed Sec. 37.205(c)
by conducting manual reconstructions, including orders entered by oral
communications, instant messages, and email, and trades executed by
voice that are captured by the SEF's electronic transaction history
database. In addition to verifying the accuracy of the audit trail data
for SEFs that offer electronic trading systems or platforms, these
reconstructions would help ensure that in the absence of such an
automated solution, a SEF that offers voice-based trading is able to
reconstruct trading as necessary, including when they are investigating
problematic trading activity.
Request for Comment
The Commission requests comment on all aspects of proposed Sec.
37.205(c) and the associated guidance to Core Principle 2 in Appendix
B. In particular, the Commission requests comment on the following
questions:
(63) What factors should a SEF consider in selecting an adequate
sample of orders and trades for reconstruction?
(64) Should SEFs be required to annually reconstruct a minimum
number or orders and trades? If so, what is the minimum number?
(65) Should SEFs be required to conduct annual audit trail reviews
of their members and firms that are subject to recordkeeping
requirements? If so, what should these reviews include?
E. Sec. 37.206--Disciplinary Procedures and Sanctions
Section 37.206 generally requires a SEF to establish rules that
deter abuses and have the capacity to enforce those rules though prompt
and effective disciplinary action. The disciplinary rules that
implement this requirement require a SEF to maintain sufficient
enforcement staff, establish disciplinary panels, follow certain
disciplinary
[[Page 62008]]
procedures that afford respondents procedural safeguards, and impose
sanctions that are commensurate to the violations committed.\493\ The
rules prescribe the use of various sanctions, including suspension or
expulsion of members or market participants; customer restitution; and
issuance of warning letters.\494\
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\493\ 17 CFR 37.206(a)-(f).
\494\ 17 CFR 37.206(e)-(f).
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Since the adoption of Sec. 37.206, the Commission has considered
whether alternative cost-effective methods exist for complying with
Core Principle 2's requirement to establish and enforce trading, trade
processing, and participation rules that deter abuses, and have the
capacity to investigate and enforce such abuses.\495\ Based on its
experience with the part 37 implementation, the Commission believes
that alternative disciplinary methods exist that would ensure that SEFs
maintain robust disciplinary structures necessary to enforce compliance
with their rules and deter abusive trading to promote market integrity.
The Commission acknowledges that Sec. 37.206 is a limited approach
that is based in many respects on its experience with oversight of DCM
disciplinary programs.\496\ While the Commission believes that all SEFs
should be subject to certain threshold requirements, it also believes
that SEFs should be able to use their experience and knowledge to
establish disciplinary procedures that are appropriate for their own
markets and market participants. The Commission notes that this
approach is consistent with the reasonable discretion afforded to SEFs
under Core Principle 1.\497\ Therefore, the Commission proposes to
streamline the SEF disciplinary program rules, discussed further
below.\498\
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\495\ 7 U.S.C. 7b-3(f)(2)(B).
\496\ See SEF Core Principles Final Rule at 33520-21 (noting
that the disciplinary procedures in the part 37 proposed rules
paralleled the procedures for DCMs).
\497\ 7 U.S.C. 7b-3(f)(1)(B).
\498\ The Commission proposes to eliminate the introductory
sentence under Sec. 37.206, which states that a SEF shall establish
trading, trade processing, and participation rules that will deter
abuses and have the capacity to enforce such rules through prompt
and effective disciplinary action, including suspension or expulsion
of members or market participants who violate the rules of the swap
execution facility, given that this language is duplicative of
requirements elsewhere in this part, including Core Principle 2 and
various provisions under Sec. 37.206.
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1. Sec. 37.206(a)--Enforcement Staff
Section 37.206(a) requires a SEF to establish and maintain
sufficient enforcement staff and resources to effectively and promptly
prosecute possible rule violations within the disciplinary jurisdiction
of the SEF.\499\
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\499\ 17 CFR 37.206(a).
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The Commission proposes to change the word ``prosecute'' to
``enforce'' to more accurately describe the requirements under Sec.
37.206(a), given that every rule violation may not lead to a
prosecution.
The Commission also proposes to amend the guidance to Core
Principle 2 in Appendix B that addresses a SEF's enforcement
staff.\500\ The Commission proposes eliminating the language stating
that a SEF's enforcement staff may operate as part of the SEF's
compliance staff. The Commission no longer believes this language is
necessary, given that SEFs should have the option to determine the
appropriate structure for their disciplinary programs, including their
enforcement staff, discussed further below with respect to Sec.
37.206(b).
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\500\ The Commission proposes to renumber paragraph (a)(3) to
paragraph (a)(6) of the guidance to Core Principle 2 in Appendix B
and adopt the amendments described above. 17 CFR part 37 app. B.
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Request for Comment
The Commission requests comment on all aspects of proposed Sec.
37.206(a) and the associated guidance to Core Principle 2 in Appendix
B.
2. Sec. 37.206(b)--Disciplinary Program \501\
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\501\ The Commission proposes to retitle Sec. 37.206(b) to
``Disciplinary program'' from ``Disciplinary panels'' based on the
proposed changes described below.
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Section 37.206(b) currently requires SEFs to establish one or more
disciplinary panels that meet the composition requirements of part 40
and do not include a SEF's compliance staff or any person involved in
adjudicating any other stage of the same proceeding.\502\
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\502\ 17 CFR 37.206(b). The Commission proposed composition
requirements for disciplinary panels, but has not adopted those
requirements in a final rule. Requirements for Derivatives Clearing
Organizations, Designated Contract Markets, and Swap Execution
Facilities Regarding the Mitigation of Conflicts of Interest, 75 FR
63732, 63752 (Oct. 18, 2010).
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The Commission proposes to amend Sec. 37.206(b) to permit a SEF to
administer its disciplinary program through not only one or more
disciplinary panels, as currently allowed, but also through its
compliance staff. As discussed above, this amendment provides SEFs with
the ability to adopt a cost-effective disciplinary structure that best
suits their markets and market participants, while still effectuating
the requirements and protections of Core Principle 2 through compliance
staff, disciplinary panels, or some combination of both.\503\
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\503\ While the participation of SEF compliance staff could
present a possible conflict of interest, the Commission believes
that this concern is adequately addressed through the SEF's CCO.
Under proposed Sec. 37.1501(c)(2), a CCO would be required to take
reasonable steps to resolve any material conflicts of interest. See
infra Section XX.A.3.--Sec. 37.1501(c)--Duties of Chief Compliance
Officer. Further, a CCO would be required to conduct an annual
assessment of the SEF's policies on the handling of conflicts of
interest. See infra Section XX.A.4.--Sec. 37.1501(d)--Preparation
of Annual Compliance Report. The Commission also notes that the
SEF's disciplinary practices are within the scope of the
Commission's examinations.
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The Commission also proposes other amendments to Sec. 37.206(b),
including non-substantive revisions, to streamline certain existing
composition requirements for disciplinary panels.\504\ For SEFs that
elect to administer their disciplinary program though compliance staff,
the Commission proposes to amend Sec. 37.206(b) to exclude compliance
staff from the requirements under Sec. 1.64(c)(4). Section 1.64, among
other things, prescribes rules that govern the composition of an SRO's
major disciplinary committee.\505\ The Commission recognizes that a
SEF's compliance staff could qualify as a ``[m]ajor disciplinary
committee'' \506\ under Sec. 1.64(a)(2) when imposing sanctions under
the proposed rule; therefore, the staff would otherwise be subject to
the composition requirement of Sec. 1.64(c)(4), which requires
``sufficient different membership
[[Page 62009]]
interests.'' \507\ Accordingly, the Commission believes these
amendments are necessary to effectuate the proposed rule of allowing
compliance staff to administer a SEF's disciplinary program.
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\504\ The Commission proposes to amend the panel composition
language by replacing the reference to part 40 with ``applicable
Commission regulations.'' Additionally, paragraph (a)(11)(ii) of the
guidance to Core Principle 2 in Appendix B currently specifies that
the composition of the appellate panels should be consistent with
part 40 and should not include any members of the SEF's compliance
staff or any person involved in adjudicating any other stage of the
same proceeding. 17 CFR part 37 app. B. To avoid duplicative
language, the Commission proposes to consolidate these provisions
under Sec. 37.206(b) to require that any disciplinary panel or
appellate panel established by a SEF must meet the composition
requirements of applicable Commission regulations, and shall not
include any member of the SEF's compliance staff or any person
involved in adjudicating any other stage of the same proceeding
(emphasis added). The Commission also proposes to eliminate
paragraph (a)(11) of the guidance to Core Principle 2 in Appendix B
as noted below. 17 CFR part 37 app. B.
\505\ 17 CFR 1.64.
\506\ Section 1.64(a)(2) defines ``major disciplinary
committee'' as a committee of persons authorized by a self-
regulatory organization to conduct disciplinary hearings, settle
disciplinary charges, or impose disciplinary sanctions. Such a
committee may also hear appeals of cases involving any violation of
a SRO's rules, except for rules related to decorum or attire;
financial requirements; reporting or recordkeeping; and violations
that do not involve fraud, deceit or conversion. 17 CFR 1.64(a)(2).
Under Sec. 37.2, SEFs are subject to all applicable Commission
regulations, including Sec. 1.64.
\507\ Section 1.64(c)(4) requires that each major disciplinary
committee, or hearing panel thereof, include sufficient different
membership interests so as to ensure fairness and prevent special
treatment or preference for any person in the conduct of a
committee's or panel's responsibilities. 17 CFR 1.64(c)(4).
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Consistent with the Commission's intention to streamline
requirements while still effectuating the Core Principle 2
requirements, the Commission proposes to eliminate the guidance to Core
Principle 2 in Appendix B that specifies protocols for the SEF to
handle charges and settlement offers.\508\ Given that proposed Sec.
37.206(b) would permit SEFs to administer their disciplinary program
through compliance staff, the Commission does not believe that this
detailed guidance is necessary. Instead, the Commission proposes new
guidance to specify that a SEF's rules governing the adjudication of a
matter by the SEF's disciplinary panel should be fair, equitable, and
publicly available.\509\
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\508\ The Commission proposes to eliminate paragraphs (a)(4)-(9)
of the guidance to Core Principle 2 in Appendix B. 17 CFR part 37
app. B.
\509\ The Commission proposes to add this guidance as paragraph
(a)(7) to Core Principle 2 in Appendix B. 17 CFR part 37 app. B.
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Request for Comment
The Commission requests comment on all aspects of proposed Sec.
37.206(b) and the associated guidance to Core Principle 2 in Appendix
B.
3. Sec. 37.206(c)--Hearings
Section 37.206(c) requires a SEF to adopt rules that provide
certain minimum procedural safeguards for any hearing. In general, the
rule requires a fair hearing, promptly convened after reasonable notice
to the respondent; and a copy of the hearing to be made and be a part
of the record of the proceeding if the respondent requested the
hearing.\510\
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\510\ 17 CFR 37.206(c).
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The Commission proposes to eliminate Sec. 37.206(c). First, the
detailed hearing procedures under existing Sec. 37.206(c) are not
necessary, as SEFs that choose to establish a disciplinary panel have
reasonable discretion to do so pursuant to Core Principle 1.\511\
Second, the Commission notes that requirements for hearings under Sec.
37.206(c) would not apply to SEFs that choose to administer their
disciplinary program through compliance staff. Third, as noted above,
the Commission proposes to add guidance to Core Principle 2 in Appendix
B that a SEF's rules relating to disciplinary panel procedures should
be fair, equitable, and publicly available.\512\ The Commission
believes this guidance adequately captures the principal procedural
objectives when SEFs are conducting disciplinary hearings and obviates
the need for the otherwise prescriptive regulatory requirements.
Consistent with the Commission's elimination of Sec. 37.206(c), the
Commission also proposes to eliminate the guidance to Core Principle 2
in Appendix B that specifies detailed guidelines for disciplinary
hearing protocols.\513\
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\511\ 7 U.S.C. 7b-3(f)(1)(B).
\512\ See supra note 509.
\513\ The Commission proposes to eliminate paragraph (a)(10) of
the guidance to Core Principle 2 in Appendix B. 17 CFR part 37 app.
B.
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Request for Comment
The Commission requests comment on all aspects of the proposed
elimination of Sec. 37.206(c) and the associated guidance to Core
Principle 2 in Appendix B.
4. Sec. 37.206(d)--Decisions
Section 37.206(d) requires a disciplinary panel to render a written
decision promptly following a hearing.\514\ The rule also provides
detailed items to be included in the decision, such as a notice or
summary of charges, the answer, and a statement of finding and
conclusions with respect to each charge.\515\
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\514\ 17 CFR 37.206(d).
\515\ Id.
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The Commission proposes to eliminate the prescriptive requirements
under Sec. 37.206(d). This proposed elimination is consistent with
other proposed amendments to Sec. 37.206 that would allow a SEF to
exercise discretion in establishing its disciplinary procedures
pursuant to Core Principle 2. The Commission, however, also proposes to
add guidance to Core Principle 2 in Appendix B to specify that a SEF's
rules should require the disciplinary panel to promptly issue a written
decision following a hearing or the acceptance of a settlement
offer.\516\ Consistent with the Commission's elimination of the
requirements under Sec. 37.206(d), the Commission also proposes to
eliminate the guidance to Core Principle 2 in Appendix B that specifies
guidelines for a SEF's ability to provide rights of appeal to
respondents and issue a final decision.\517\
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\516\ The Commission proposes to add this guidance as part of
paragraph (a)(7) to Core Principle 2 in Appendix B. 17 CFR part 37
app. B.
\517\ The Commission proposes to eliminate paragraphs (a)(11)-
(12) of the guidance to Core Principle 2 in Appendix B. 17 CFR part
37 app. B.
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Request for Comment
The Commission requests comment on all aspects of the proposed
elimination of Sec. 37.206(d) and the associated guidance to Core
Principle 2 in Appendix B.
5. Sec. 37.206(e)--Disciplinary Sanctions
Existing Sec. 37.206(e) requires that all disciplinary sanctions
imposed by a SEF must be commensurate with the violations committed and
must be clearly sufficient to deter recidivism or similar violations by
other market participants.\518\ A SEF is also required to consider a
respondent's disciplinary history when evaluating appropriate
sanctions.\519\ In the event of demonstrated customer harm, any
disciplinary sanction must include full customer restitution, except
where the amount of restitution, or to whom it should be provided,
cannot be reasonably determined.\520\
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\518\ 17 CFR 37.206(e).
\519\ Id.
\520\ Id.
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The Commission proposes to consolidate the requirements that apply
to disciplinary sanctions and warning letters, under existing Sec.
37.206(e) and existing Sec. 37.206(f),\521\ respectively, into a new
proposed Sec. 37.206(c).\522\ Consistent with the Commission's goal to
provide SEFs with a greater ability to develop cost-effective
approaches to administer their disciplinary programs based on their
markets and market participants, the Commission believes that a SEF
should have greater discretion to choose between taking disciplinary
action or issuing a warning letter. Accordingly, as discussed below,
the Commission proposes under Sec. 37.206(c)(2) to expand the current
use of warning letters by allowing a SEF to issue more than one warning
letter over a rolling twelve-month period for violations that involve
minor recordkeeping or reporting infractions. To balance the expanded
authority to issue warning letters and ensure their proper use by SEFs,
the Commission also proposes under Sec. 37.206(c)(1) to extend the
existing criteria for issuing disciplinary sanctions to warning
letters. Specifically, proposed
[[Page 62010]]
Sec. 37.206(c)(1) would require that all warning letters and sanctions
imposed by a SEF must be commensurate with the violations committed and
shall be clearly sufficient to deter recidivism or similar violations
by other market participants. Further, all warning letters and
sanctions, including summary fines and sanctions imposed pursuant to an
accepted settlement offer, must take into account the respondent's
disciplinary history.\523\
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\521\ Existing Sec. 37.206(f) states that where a rule
violation is found to have occurred, no more than one warning letter
may be issued per rolling twelve-month period for the same
violation.
\522\ The Commission proposes to retitle Sec. 37.206(c) to
``Warning letters and sanctions'' from ``Hearings'' based on the
proposed changes described below.
\523\ The Commission proposes to add the term ``summary fine''
to clarify that summary fines are among the types of disciplinary
sanctions that may be issued and would be subject to the
requirements of the proposed rule.
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The Commission also proposes several amendments to related guidance
to Core Principle 2 in Appendix B that are consistent with the proposed
changes and are intended to allow a SEF to determine how to issue
warning letters and sanctions. First, the Commission proposes to adopt
guidance to Core Principle 2 in Appendix B to state that SEFs should
have reasonable discretion in determining when to issue warning letters
and apply sanctions.\524\ Second, the Commission also proposes to
eliminate detailed guidance regarding the procedures for taking
emergency disciplinary action. The guidance, however, would maintain
that a SEF may impose a sanction or take summary action as necessary to
protect the best interest of the marketplace.\525\
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\524\ The Commission proposes to add this guidance as paragraph
(a)(9) to Core Principle 2 in Appendix B. 17 CFR part 37 app. B.
\525\ The Commission proposes to renumber paragraph (a)(14) to
paragraph (a)(8) to Core Principle 2 in Appendix B. 17 CFR part 37
app. B.
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Request for Comment
The Commission requests comment on all aspects of proposed Sec.
37.206(c)(1) and the associated guidance to Core Principle 2 in
Appendix B. In particular, the Commission requests comment on the
following question:
(66) Should the Commission provide further explanation regarding
the meaning of ``minor'' recordkeeping or reporting infractions?
6. Sec. 37.206(f)--Warning Letters
Existing Sec. 37.206(f) states that where a rule violation is
found to have occurred, no more than one warning letter may be issued
per rolling twelve-month period for the same violation.\526\
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\526\ 17 CFR 37.206(f).
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As part of a new proposed Sec. 37.206(c)(2) noted above, the
Commission proposes to amend this provision to establish a more
practical approach to the use of warning letters. Under the proposed
approach, a SEF would be allowed to issue more than one warning letter
over a rolling twelve-month period for violations that involve minor
recordkeeping or reporting infractions. Given the de minimis nature of
such infractions, the Commission believes that a SEF should have the
ability to determine whether they merit the issuance of a warning
letter or sanction. The Commission also proposes to clarify that the
twelve-month limitation on warning letters applies to the same
individual who is found to have committed the same rule violation,
rather than an entity. The Commission acknowledges that applying the
limitation to subject entities is not practical because many of them
have hundreds of employees trading on behalf of the entity.\527\
Further, the Commission notes that the rolling twelve-month period
begins tolling once the SEF finds that a violation occurred, rather
than the date that the subject activity occurred.
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\527\ The Commission notes, however, that this provision would
be evaluated in conjunction proposed Sec. 37.206(c)(1).
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The Commission also proposes to eliminate guidance to Core
Principle 2 in Appendix B that currently specifies that a SEF may adopt
summary fines for violations of rules related to the failure to timely
submit accurate records required for clearing or verifying each day's
transactions.\528\ The Commission notes that Sec. 37.206(c)(1) as
proposed would already specify that a SEF may issue summary fines as a
sanction.
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\528\ The Commission proposes to eliminate paragraph (a)(13) of
the guidance to Core Principle 2 in Appendix B. 17 CFR part 37 app.
B.
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Request for Comment
The Commission requests comment on all aspects of proposed Sec.
37.206(c)(2) and the associated guidance to Core Principle 2 in
Appendix B. In particular, the Commission requests comment on the
following question:
(67) Is the Commission's approach to warning letters appropriate?
Should the Commission allow SEFs to issue more than one warning letter
to the same individual within a rolling twelve-month period for other
rule violations in addition to minor recordkeeping or reporting
infractions? If so, should the Commission specify which rule
violations? If so, identify those rule violations and explain why.
7. Sec. 37.206(g)--Additional Sources for Compliance
The Commission is not proposing any amendments to Sec.
37.206(g).\529\
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\529\ The Commission proposes to renumber Sec. 37.206(g) to
Sec. 37.206(d) based on the proposed changes described above.
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F. Part 9--Rules Relating to Review of Exchange Disciplinary, Access
Denial or Other Adverse Actions
Part 9 of the Commission's regulations details the process and
procedures for the Commission's review of exchange disciplinary, access
denial, or other adverse actions.\530\ The rules also address the
procedures and standards governing filing and service, motions, and
settlement; the process that exchanges must follow in providing notice
of a final disciplinary action to the subject of the action and to the
Commission; and the publication of such notice.\531\
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\530\ 17 CFR part 9. For these purposes, the Commission
interprets references to ``exchange'' to part 9 to mean DCMs and
SEFs.
\531\ Id.
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The Commission is proposing several non-substantive amendments to
part 9 that correspond to certain proposed amendments to the Core
Principle 2 regulations under part 37.\532\ As discussed above, the
Commission proposes to eliminate various disciplinary procedures under
proposed Sec. 37.206 and the applicable guidance to Core Principle 2
in Appendix B to part 37 to streamline existing Core Principle 2
requirements and provide SEFs with discretion in administering their
disciplinary programs.\533\ These proposed changes include eliminating
requirements concerning disciplinary decisions under Sec. 37.206(d)
and eliminating various procedures detailed in guidance to Core
Principle 2 concerning settlement offers; \534\ sanctions upon persons
who impede the progress of disciplinary hearings; \535\ the right to
appeal adverse actions; \536\ and summary fines for violations of rules
regarding the timely submission of records.\537\ To the extent that the
part 9 regulations contain cross-references to these part 37
provisions, the Commission proposes to eliminate those references.\538\
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\532\ The Commission also proposes to renumber Sec. 9.1(b)(4)
to Sec. 9.1(c) and Sec. 9.1(c) to Sec. 9.1(d).
\533\ See supra Section VII.E.--Sec. 37.206--Disciplinary
Procedures and Sanctions.
\534\ See supra note 508 (elimination of paragraph (a)(9)).
\535\ See supra note 513 (elimination of paragraph (a)(10)(vi)).
\536\ See supra note 517 (elimination of in paragraph
(a)(11)(iv)).
\537\ See supra note 528 (elimination of paragraph (a)(13)).
\538\ The Commission also proposes to renumber the cross-
references under Sec. 9.2(k), Sec. 9.12(a)(1), and Sec.
9.24(a)(2) from paragraph (a)(14) to paragraph (a)(8) of the
guidance to Core Principle 2 in Appendix B. See supra note 525.
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Specifically, the Commission proposes to eliminate those references
under Sec. 9.11(b)(2), which govern the content requirements for SEF
[[Page 62011]]
disciplinary and access denial notices that must be filed with the
person subject to the action. Currently, the notice of such actions
must be provided as a copy of a written decision, which accords with
Sec. 37.206(d) and guidance to Core Principle 2 in Appendix B relating
to the use of written decisions where a disciplinary panel accepts a
settlement offer; \539\ and paragraph (a)(11)(iv), where an appellate
panel responds to appeals of adverse decisions by a disciplinary
panel.\540\ Alternatively, Sec. 9.11(b)(2) provides that SEFs may file
a written notice that includes the items listed under Sec. Sec.
9.11(b)(3)(i)-(vi).\541\ Given the proposed elimination of Sec.
37.206(d) and associated guidance to Core Principle 2, the Commission
proposes that the contents of the SEF disciplinary or access denial
notice be limited to the information specified under Sec. Sec.
9.11(b)(3)(i)-(vi).
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\539\ 17 CFR part 37 app. B (guidance to Core Principle 2--
paragraph (a)(9)(iii)--``Settlement offers'').
\540\ 17 CFR part 37 app. B (guidance to Core Principle 2--
paragraph (a)(11)(iv)--``Right to appeal'').
\541\ Section 9.11(b)(3) requires that the notice of a
disciplinary action or access denial action include the following:
(i) The name of the person against whom the disciplinary action or
access denial action was taken; (ii) a statement of the reasons for
the disciplinary action or access denial action, detailing the
exchange product which was involved, as applicable, and whether the
violation that resulted in the action also resulted in financial
harm to any customers together with a listing of any rules which the
person who was the subject of the disciplinary action or access
denial action was charged with having violated or which otherwise
serve as the basis of the exchange action; (iii) a statement of the
conclusions and findings made by the exchange with regard to each
rule violation charged or, in the event of settlement, a statement
specifying those rule violations which the exchange has reason to
believe were committed; (iv) the terms of the disciplinary action or
access denial action; (v) the date on which the action was taken and
the date the exchange intends to make the disciplinary or access
denial action effective; and (vi) except as otherwise provided under
Sec. 9.1(b), a statement informing the party subject to the
disciplinary action or access denial action of the availability of
Commission review of the exchange action pursuant to section 8c of
the Act and this part. 17 CFR 9.11(b)(3).
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Under Sec. 9.1(b)(2), Sec. 9.2(k), and Sec. 9.12(a)(3), the
Commission also proposes to eliminate references to paragraph (a)(13)
of the guidance to Core Principle 2 in Appendix B, which addresses the
issuance of summary fines for failing to submit certain records in a
timely manner. To replace those references, the Commission proposes to
add new regulatory language that accounts for summary fines being
permitted under the rules of the SEF for recordkeeping or reporting
violations.
Under Sec. 9.2(k) and Sec. 9.12(a)(2), the Commission further
proposes to eliminate references to paragraph (a)(10)(vi) of the
guidance to Core Principle 2 in Appendix B, which addresses the use of
sanctions for persons who impede the progress of disciplinary hearings.
To replace those references, the Commission proposes new regulatory
language that accounts for SEFs imposing disciplinary action on a
person for impeding the progress of a hearing under the rules of the
SEF.
VIII. Part 37--Subpart D: Core Principle 3 (Swaps Not Readily
Susceptible to Manipulation)
Core Principle 3 specifies that a SEF shall permit trading only in
swaps that are not readily susceptible to manipulation.\542\
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\542\ The Commission codified Core Principle 3 under Sec.
37.300. 17 CFR 37.300.
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A. Sec. 37.301--General Requirements
Section 37.301 further implements Core Principle 3 by requiring a
SEF, at the time that it submits a new swap contract to the Commission,
to demonstrate that the swap is not readily susceptible to manipulation
by providing the information required in Appendix C to part 38.\543\
Section 37.301 also states that in addition to referring to Appendix C
to part 38, a SEF may refer to the guidance to Core Principle 3 in
Appendix B.\544\ With respect to swaps, this guidance is similar in
scope to the guidance to Appendix C to part 38.
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\543\ Appendix C to part 38--``Demonstration of Compliance That
a Contract Is Not Readily Susceptible to Manipulation''--provides
guidance regarding (i) the information that a new futures contract
submission should include; (ii) estimations of deliverable supplies;
(iii) contract terms and conditions that should be specified for
physically-delivered contracts; (iv) demonstration that a cash-
settled contract is reflective of the underlying cash market and is
not readily subject to manipulation or distortion; (v) contract
terms and conditions that should be specified for cash-settled
contracts; (vi) requirements for options on futures contracts; (vii)
the terms and conditions for non-price based futures contracts; and
(vii) the terms and conditions for swap contracts. 17 CFR part 38
app. C (``Appendix C to part 38''). The Commission amended and
updated this guidance to address swap transactions in 2012 as part
of a part 38 rulemaking for designated contract markets. Core
Principles and Other Requirements for Designated Contract Markets,
77 FR 36612 (Jun. 19, 2012).
\544\ 17 CFR 37.301.
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Appendix C to part 38 for DCMs, as applied by Sec. 37.301 to SEFs,
provides guidance regarding the relevant considerations for evaluating
if a new or existing swap contract is readily susceptible to
manipulation.\545\ The objective of this guidance, which applies the
guidance for futures contracts to swaps as applicable, is intended to
ensure that a given contract is not readily susceptible to manipulation
and will provide a reliable pricing basis, as well as promote cash and
swaps price convergence. Among other things, the guidance states that a
swap contract submitted under part 40 should conform to prevailing
commercial practices, such that the settlement or delivery procedures
adopted for a swap contract should reflect the underlying cash
market.\546\ For cash-settled swap contracts, the guidance explains
that the cash settlement index should be based on a reliable price
reference series that accurately reflects the underlying market value,
is not readily susceptible to manipulation, and is highly regarded by
industry/market participants.\547\ For physically-settled swap
contracts, the guidance explains that the terms and conditions should
provide for adequate deliverable supply and be designed to avoid
impediments to the delivery of the commodity.\548\
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\545\ See generally Appendix C to part 38.
\546\ See paragraph (g)(4) of Appendix C to part 38, which
references various provisions related to contract terms and
conditions requirements for futures contracts.
\547\ See paragraph (g)(1) of Appendix C to part 38.
\548\ Paragraph (g)(4) of Appendix C to part 38, which applies
to swaps, refers to paragraph (b)(2), which specifies contract term
and condition requirements for futures contracts settled by physical
delivery. Paragraph (b)(2) specifies various criteria related to
quality standards of the underlying commodity, delivery point/area
specifications, and specification of the delivery period. The
Commission notes that paragraph (b)(1) generally specifies that the
terms and conditions should be designed to avoid any impediments to
delivery so as to promote convergence between the price of the
futures contract and the cash market value of the commodity at the
expiration of the contract. Paragraph (b)(1)(i)(A) specifies that
the terms and conditions should result in a deliverable supply that
is sufficient to ensure that the contract is not susceptible to
price manipulation or distortion.
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1. Appendix C to Part 37--Demonstration of Compliance That a Swap
Contract Is Not Readily Susceptible to Manipulation
The Commission proposes to eliminate the existing cross-reference
to Appendix C to part 38 under Sec. 37.301 and establish a separate
Appendix C to part 37 to provide specific guidance to SEFs for
complying with the requirements of Core Principle 3.\549\ In
conjunction with the Commission's proposal to create a separate
Appendix C to part 37, the Commission also proposes to adopt conforming
changes to the guidance to Core Principle 3 in Appendix B.\550\
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\549\ The Commission also proposes a conforming non-substantive
amendment to Sec. 37.301 to update the reference to Appendix C to
part 37.
\550\ The proposed amendments to Appendix B would eliminate the
existing explanatory guidance to Core Principle 3, which the
Commission is proposing to address in the proposed Appendix C to
part 37; and replace the existing cross-reference to sections of
Appendix C to part 38 with a general reference to Appendix C to part
37.
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[[Page 62012]]
Specifically, proposed Appendix C to part 37 specifies (1) measures
that a SEF should take to determine that a cash-settled swap 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; (2) terms and
conditions that should be specified for cash-settled swap contracts;
(3) terms and conditions that should be specified for physically-
settled swap contracts; (4) methodologies that should be utilized in
estimating deliverable supplies; (5) terms and conditions that should
be specified for options on swap contracts; and (6) guidance for
options on physicals contracts.\551\
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\551\ ``Options 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. See
proposed Appendix C to part 37--paragraph (d)--``Guidance for
options on physicals contracts.''
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The Commission believes that the proposed amendments would
streamline the guidance to Core Principle 3 in a single appendix that
is dedicated to part 37. A separate appendix for SEFs and swaps trading
from the guidance provided in Appendix C to part 38, which primarily
applies to DCMs and futures trading, reflects good regulatory practice
that provides greater clarity and certainty. The proposed Appendix C to
part 37 would serve as a streamlined source of guidance for new and
existing SEFs when developing new swap products to list for trading and
when monitoring their existing swap products.\552\ Based on the number
of swap contracts that SEFs currently list for trading and will likely
submit in the future, the Commission believes that a separate guidance
in part 37 is appropriate for SEFs.
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\552\ The guidance in Appendix C to this part is based on best
practices that were developed over the past three decades by the
Commission and other market regulators in their review of product
submissions. See Core Principles and Other Requirements for
Designated Contract Markets, 75 FR 80572, 80582 (proposed Dec. 22,
2010).
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The Commission believes that the proposed Appendix C to part 37
also clarifies a SEF's obligations pursuant to Core Principle 3 because
the guidance specifically addresses swap contracts and reflects the
diverse and non-standardized nature of the swaps market, including
swaps traded on SEFs. In particular, the guidance provides SEFs with
additional flexibility for certain terms and conditions for non-
standardized swap contracts.\553\ This flexibility reflects the
negotiated nature of non-standardized swap contracts. Similarly, the
proposed Appendix C includes specific guidance for options on swap
contracts. This guidance is not currently included in Appendix C to
part 38, which focuses primarily on futures products. This proposed
guidance, however, is consistent with previous Commission expectations
with respect to contract design and transparency of option contract
terms.
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\553\ The Commission notes that for purposes of establishing the
terms and conditions of a swap that it lists for trading, a SEF has
discretion to determine whether the swap is standardized or non-
standardized in nature. For example, the Commission understands that
the swaps subject to the current trade execution requirement are
generally standardized swaps. See supra notes 33-34 (describing the
characteristics of the swaps that have been submitted as ``available
to trade'').
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Request for Comment
The Commission requests comments on all aspects of the proposed
guidance to Core Principle 3 in Appendix C to part 37. In particular,
the Commission requests comment on the following questions:
(68) Is the scope and content of the proposed guidance
appropriately tailored for swap contracts? If not, then please explain
any changes.
(69) Is the additional flexibility for certain terms and conditions
for non-standardized swap contracts appropriate? If not, please explain
why.
IX. Part 37--Subpart E: Core Principle 4 (Monitoring of Trading and
Trade Processing)
Core Principle 4 requires a SEF to establish and enforce rules or
terms and conditions that define, or specifications that detail, the
trading procedures to be used in entering and executing orders traded
on or through the facilities of the SEF and procedures for trade
processing of swaps on or through the facilities of the SEF.\554\ Core
Principle 4 also requires a SEF to monitor trading in swaps to prevent
manipulation, price distortion, and disruptions of the delivery or cash
settlement process through surveillance, compliance, and disciplinary
practices and procedures.\555\ As part of its monitoring
responsibilities, a SEF must establish methods for conducting real-time
monitoring of trading and comprehensive and accurate trade
reconstructions.\556\ As described below, Sec. Sec. 37.401-408 further
implement Core Principle 4 by establishing requirements that a SEF
monitor trading activity on its facility and beyond its own market in
certain circumstances.
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\554\ 7 U.S.C. 7b-3(f)(4). The Commission codified Core
Principle 4 under Sec. 37.400. 17 CFR 37.400.
\555\ Id.
\556\ Id.
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The Commission received feedback from SEFs during the part 37
implementation that certain Core Principle 4 requirements are
unnecessarily broad and create impracticable monitoring burdens upon
SEFs, especially those requiring a SEF to monitor activity beyond its
own markets. Based on its experience, the Commission has assessed this
feedback and proposes amendments that would establish more practical
monitoring requirements. These amendments, which in many cases would
narrow a SEF's monitoring obligations to trading activity on its own
facility, allow a SEF greater discretion to devise its own monitoring
systems and protocols to suit the products that it offers for trading
in a manner compliant with Core Principle 4. The Commission also
proposes several amendments to the regulations under Core Principle 4
to conform to the proposed Appendix C to part 37, which sets forth
guidance for SEFs to mitigate a swap contract's susceptibility to
manipulation when developing new products and monitoring existing
products.\557\
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\557\ See supra Section VIII.A.1.--Appendix C--Demonstration of
Compliance that a Swap Contract is Not Readily Susceptible to
Manipulation.
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A. Sec. 37.401--General Requirements
Section 37.401 currently implements Core Principle 4 by setting
forth requirements for SEFs to monitor market activity for the purpose
of detecting manipulation, price distortions, and disruptions.\558\
Existing Sec. 37.401(a) creates an ongoing obligation for a SEF to
collect and evaluate data on its market participants' market activity
to detect and prevent, among other things, disruptions to the physical-
delivery or cash-settlement process where possible.\559\ Existing Sec.
37.401(b) requires a SEF to examine general market data in order to
detect and prevent manipulative activity that would result in the
failure of market prices to reflect the normal forces of supply and
demand.\560\ Existing Sec. 37.401(c) requires a SEF to demonstrate an
effective program for conducting real-time monitoring of trading for
the purpose of detecting and resolving abnormalities.\561\ Existing
[[Page 62013]]
Sec. 37.401(d) requires a SEF to demonstrate the ability to
comprehensively and accurately reconstruct daily trading activity.\562\
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\558\ 17 CFR 37.401.
\559\ 17 CFR 37.401(a).
\560\ 17 CFR 37.401(b).
\561\ 17 CFR 37.401(c). The guidance to Core Principle 4 in
Appendix B provides that an acceptable program may include some
monitoring on a T+1 basis. 17 CFR part 37 app. B (guidance to Core
Principle 4--paragraph (a)(1)--``General requirements'').
\562\ 17 CFR 37.401(d).
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In the preamble to the SEF Core Principles Final Rule, the
Commission clarified that Sec. 37.401(a) requires a SEF to monitor its
market participants' trading activity and reference data beyond its own
market on an ongoing basis in certain instances.\563\ The Commission
also clarified that Sec. 37.401(b) requires a SEF to monitor and
evaluate ``general market data,'' such as the pricing of the underlying
commodity or a third-party index or instrument used as a reference
price of its swaps.\564\ The Commission further clarified that the
requirements with respect to ``general market data'' means that a SEF
shall monitor and evaluate general market conditions related to its
swaps.\565\ Despite commenters' concerns about the lack of available
information to meet the scope of these requirements, the Commission
stated that such monitoring would be necessary to comply with Core
Principle 4.\566\
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\563\ SEF Core Principles Final Rule at 33528, 33530.
\564\ Id. at 33528.
\565\ Id.
\566\ Id. at 33527-28. See also ISDA, Path Forward for
Centralized Execution of Swaps 6 (2015) (explaining that a SEF
should not be required to monitor other markets for manipulation
because SEFs do not have, and cannot be expected to obtain,
sufficient information about other marketplaces).
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The Commission proposes to amend Sec. 37.401 to establish more
practical trade monitoring requirements that are based on information
about trading activity that is actually accessible to SEFs and,
therefore, are more consistent with current practice in swaps and other
derivatives markets. First, the Commission proposes to clarify under
proposed Sec. 37.401(a) that a SEF must conduct real-time market
monitoring of ``trading activity'' on its own facility to identify (i)
disorderly trading; (ii) any market or system anomalies; and (iii)
instances or threats of manipulation, price distortion, and
disruption.\567\ This proposed amendment, among other things,
incorporates the existing requirement under Sec. 37.203(e) that
requires a SEF to conduct real-time market monitoring.\568\ Second, the
Commission proposes to specify under proposed Sec. 37.401(b) that a
SEF has discretion to determine when to collect and evaluate data on
its market participants' trading activity beyond its own market, i.e.,
as necessary to detect and prevent manipulation, price distortion, and,
where possible, disruptions of the physical-delivery or cash-settlement
process, rather than on an ``ongoing basis.'' \569\ This data would
include market participants' trading in (i) the index or instrument
used as a reference price; (ii) the underlying commodity for the listed
swap; and (iii) any related derivatives markets.
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\567\ The Commission also proposes to renumber subsection (c) to
subsection (a) and amend the requirement as described.
\568\ The Commission notes that existing Sec. 37.203(e)
specifies that a SEF must conduct real-time market monitoring of all
trading activity on its system(s) or platform(s) to identify
``disorderly trading and any market or system anomalies.'' As
discussed above, the Commission is proposing to eliminate this
provision and establish those requirements under proposed Sec.
37.401(a) to streamline the existing regulations. See supra note
438.
\569\ The Commission proposes to renumber existing subsection
(a) to subsection (b) and amend the requirement as described. In the
adopting part 37, the Commission also clarified that ``market
activity'' in existing Sec. 37.401(a) means the ``trading
activity'' of a SEF's market participants. SEF Core Principles Final
Rule at 33528. The Commission proposes a non-substantive revision to
replace ``market activity'' with ``trading activity.''
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In proposing these changes, the Commission recognizes that Core
Principle 4 does not explicitly mandate the existing requirements under
Sec. Sec. 37.401(a)-(b) and has also learned that requiring a SEF to
monitor trading activity beyond its own market on an ``ongoing basis''
has imposed impractical burdens, particularly given that many swaps
trade both on multiple SEFs and on an OTC basis. For a swap subject to
the trade execution requirement, a SEF is currently required to
continually monitor trading for the same or similar swap listed on
multiple SEFs. For a listed swap not subject to the requirement, the
SEF must additionally monitor trading for the same swap or similar swap
traded bilaterally away from a SEF.\570\ Given that many SEFs list the
same or similar swaps that are traded bilaterally--with a large amount
of related trading activity occurring away from a SEF's own market--
expecting each SEF to maintain an ongoing collection and monitoring
program for these elements is impractical and not consistent with
current practice in other derivatives markets.\571\ SEFs have also
demonstrated that this scope and frequency of monitoring is difficult
because they currently lack the capability to obtain sufficient trading
information. Accordingly, the Commission's proposed changes are
intended to align a SEF's obligation to monitor beyond its own market
more closely with current practice and obligations in other derivatives
markets, where there is not an ongoing monitoring requirement.
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\570\ For example, the Commission notes that multiple SEFs offer
the same fixed-to-floating USD-denominated IRS in standard benchmark
tenors that are currently subject to the trade execution
requirement.
\571\ For example, a SEF offering an FX non-deliverable forward
cannot reasonably monitor over a dozen SEFs that offer equivalent
non-deliverable forward products and the market participants
engaging in hundreds of equivalent bilateral transactions away from
a SEF.
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Given the practical challenges discussed above in complying with
the existing Core Principle 4 monitoring requirements, the Commission
believes that a SEF should monitor beyond its own market as necessary
to detect and prevent manipulation, price distortion, and, where
possible, disruptions of the physical-delivery or cash-settlement
processes. Further, such monitoring should be conducted when necessary
to detect manipulative activity that would result in the failure of the
market price to reflect the normal forces of supply and demand. In such
cases, the SEF should be able to determine the instances in which it
needs to collect and evaluate data related to that activity. As
proposed, the scope of this data corresponds to the existing
requirements of Sec. 37.404, which require a SEF to have the ability
to obtain this trading information.\572\ These amendments would ensure
that SEFs can still collect additional information based on a
legitimate need, but would also reduce the significant and otherwise
duplicative effort among SEFs to collect and evaluate trading and other
information on an ongoing basis. The Commission believes that these
revised monitoring requirements not only reflect current practice in
other markets, but also would continue to protect the integrity of the
swaps markets.
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\572\ The Commission notes that a SEF may collect this data on
market participants' trading activity directly from its market
participants pursuant to Core Principle 5, which requires a SEF to
establish and enforce rules that provide the authority to obtain
information from its participants. 17 CFR 37.501. Further, Sec.
37.503 requires a SEF to share information, as required by the
Commission or as necessary and appropriate, to fulfill its
regulatory responsibilities. 17 CFR 37.503. The Commission notes
that it is proposing various amendments to the Core Principle 5
regulations, as discussed below, but is maintaining these
requirements. See infra Section X.--Part 37--Subpart F: Core
Principle 5 (Ability to Obtain Information).
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The Commission also proposes to amend Sec. 37.401(c) to establish
more practical monitoring requirements with respect to a SEF's
obligation to monitor general market data. The Commission proposes to
clarify that a SEF has the discretion to determine when to monitor and
evaluate such data beyond its own market, i.e., as necessary to detect
and prevent manipulative activity that would result in the failure of
the market
[[Page 62014]]
price to reflect the normal forces of supply and demand.\573\ The
Commission notes that the existing provision does not specify the
required scope or frequency of monitoring such data, which is used to
evaluate market conditions and includes, among other things, pricing in
a third-party index or instrument used as a reference price. As noted
further below with respect to monitoring requirements for cash-settled
swaps, the Commission has observed that SEFs do not have full access to
certain types of data, such as the pricing of proprietary third-party
indexes.\574\ Therefore, providing a SEF with the discretion to monitor
and evaluate general market data on an as-needed basis would align the
requirement to SEF capabilities and current market practices.
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\573\ The Commission proposes to renumber existing subsection
(b) to subsection (c) and amend the requirement as described.
\574\ See infra Section IX.C.--Sec. 37.403--Additional
Requirements for Cash-Settled Swaps (discussing the proposed
elimination of the requirement to monitor the pricing of the
reference price where a third-party index or instrument is used).
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Finally, the Commission proposes to consolidate the trade
reconstruction requirements under existing Sec. 37.401(d) and existing
Sec. 37.406 into a new proposed Sec. 37.401(d), which would require a
SEF to have the ability to comprehensively and accurately reconstruct
all trading activity on its facility for the purpose of detecting
instances or threats of manipulation, price distortion, and
disruptions.
The Commission also proposes certain non-substantive changes to
eliminate demonstration-based requirements under existing Sec. Sec.
37.401(c)-(d). As noted above, the Commission proposes to set forth an
affirmative monitoring requirement, rather than a demonstration
requirement. The Commission notes that demonstration of compliance
could otherwise be required upon Commission request under Sec.
37.5(b), which requires a SEF to provide a written demonstration that
it is in compliance with its obligations under the Act.\575\
---------------------------------------------------------------------------
\575\ 17 CFR 37.5(b).
---------------------------------------------------------------------------
The Commission further proposes to eliminate duplicative language
and adopt various conforming changes to the guidance to Core Principle
4 in Appendix B.\576\
---------------------------------------------------------------------------
\576\ The Commission proposes these changes in paragraph (a)(1)
to the guidance to Core Principle 4 in Appendix B. 17 CFR part 37
app. B.
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Request for Comment
The Commission requests comment on all aspects of proposed Sec.
37.401 and the associated guidance to Core Principle 4 in Appendix B.
In particular, the Commission requests comment on the following
question:
(70) The Commission has observed that SEFs may provide input into
market pricing information, such as third-party indexes, that is
available to market participants, which includes executed prices,
prices from executable or indicative bids and offers, views of trading
specialists, or prices from related instruments in other markets.
Should the Commission's general market monitoring requirements require
SEFs to monitor this type of information--for example, pricing provided
by its own trading specialists?
B. Sec. 37.402--Additional Requirements for Physical-Delivery Swaps
For swaps settled by physical delivery, Sec. 37.402 requires that
a SEF monitor each swap's terms and conditions as they relate to the
underlying commodity market and monitor the ``availability of supply''
of the underlying commodity, as specified by the swap's delivery
requirements.\577\ The Commission also provided additional guidance to
Core Principle 4 in Appendix B to specify that a SEF should monitor the
general ``availability'' of the commodity specified by the swap; the
commodity's characteristics; the delivery locations; and if available,
information related to the size and ownership of deliverable
supplies.\578\ In the SEF Core Principles Final Rule, the Commission
explained that using the phrase ``availability of supply'' and
providing the associated guidance was intended to provide a SEF with
additional flexibility in response to commenter feedback that the
proposed regulation was, among other things, duplicative, unmanageable,
and created the risk of conflicting conclusions.\579\
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\577\ 17 CFR 37.402.
\578\ 17 CFR part 37 app. B (guidance to Core Principle 4--
paragraph (a)(2)--``Physical-delivery swaps'').
\579\ See SEF Core Principles Final Rule at 33529 (explaining
the Commission's revision of the proposed requirement that a SEF
monitor whether the supply is ``adequate'' to the ``availability''
of the supply; and replacing detailed proposed requirements to
monitor the supply, marketing, and ownership of the commodity to be
physically delivered with similar guidance in Appendix B).
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The Commission proposes to clarify a SEF's monitoring obligations
with respect to physical-delivery swaps under Sec. 37.402 to be
consistent with the guidance in proposed Appendix C to part 37 and
ensure that the SEF can comply with Core Principles 3 and 4.\580\ Among
other things, a swap contract's terms and conditions should assure the
availability of adequate deliverable supplies, such that the contract
is not readily susceptible to price manipulation.\581\ To ensure that a
swap contract's terms and conditions remain appropriately designed,
Sec. 37.402 would require a SEF to (i) monitor the swap's terms and
conditions as they relate to the underlying commodity market by
reviewing the convergence between the swap's price and the price of the
underlying commodity, and make a good-faith effort to resolve
conditions that are interfering with convergence or notify the
Commission of such conditions; and (ii) monitor the availability of the
supply of the commodity specified by the delivery requirements of the
swap, and make a good-faith effort to resolve conditions that threaten
the adequacy of supplies or the delivery process or notify the
Commission of such conditions.\582\
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\580\ Proposed Appendix C to part 37, among other things,
provides related guidance on the design of physically-settled swap
contracts that should be adopted by a SEF to minimize their
susceptibility to manipulation. See paragraph (b) of the proposed
Appendix C to part 37--``Guidance for physically-settled swaps.'' 17
CFR part 37 app. C.
\581\ Proposed Appendix C to part 37 specifies that a SEF should
estimate the deliverable supply for which the swap is not readily
susceptible to price manipulation. To assure the availability of
adequate deliverable supplies, the swap contract terms and
conditions, in particular, should be designed based upon an adequate
assessment of the potential range of deliverable supplies and should
account for variations in the patterns of production, consumption,
and supply over a period of at least three years. See id. (paragraph
(b)(iii)--``Accounting for variations in deliverable supplies'').
\582\ The Commission also proposes to (i) amend the guidance to
Core Principle 4 in Appendix B to define ``price convergence'' as
the process whereby the price of a physically-delivered swap
converges to the spot price of the underlying commodity as the swap
nears expiration; and (ii) make conforming changes. 17 CFR part 37
app. B.
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The Commission notes that Core Principles 3 and 4 place affirmative
obligations on SEFs to permit trading only in swaps that are not
readily susceptible to manipulation and prevent manipulation, price
distortion, and disruptions of the delivery or cash-settlement process,
respectively. As such, proposed Sec. 37.402 places affirmative
obligations on a SEF to make a good-faith effort to resolve conditions
that are interfering with convergence or that threaten the adequacy of
supplies or the delivery process. The Commission recognizes, however,
that a SEF may not always be able to resolve these conditions;
therefore, proposed Sec. 37.402 allows the SEF to notify the
Commission of such conditions.\583\
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\583\ A SEF should provide electronic notification to the
Commission at [email protected] and DMO at
[email protected].
---------------------------------------------------------------------------
The Commission further proposes corresponding amendments to the
associated guidance to Core Principle 4
[[Page 62015]]
in Appendix B.\584\ The Commission proposes a non-substantive revision
to clarify that a SEF should monitor physical-delivery swaps listed on
its facility. To conform to Core Principle 4, the Commission also
proposes to clarify that a SEF should monitor for conditions that may
cause a swap to become susceptible to manipulation, price distortion,
or disruptions; \585\ such conditions would include those that
influence the convergence between the swap's price and the price of the
underlying commodity. This proposed language would conform to the
proposed guidance for physically-settled swaps in the proposed Appendix
C to part 37, which states that a physically-settled swap contract's
terms and conditions should be designed to avoid any impediments to the
delivery of the commodity so as to promote convergence between the
value of the swap contract and the cash market value of the commodity
at the expiration of the swap contract.\586\
---------------------------------------------------------------------------
\584\ 17 CFR part 37 app. B (guidance to Core Principle 4--
paragraph (a)(2)--``Physical-delivery swaps'').
\585\ Id.
\586\ See 17 CFR part 37 app. C (paragraph (b)(iv) of the
proposed Appendix C to part 37--``Contract terms and conditions'').
---------------------------------------------------------------------------
The Commission also proposes a non-substantive change to eliminate
the demonstration-based requirement under Sec. 37.402. As noted above,
the Commission proposes to set forth an affirmative monitoring
requirement for SEFs, rather than a demonstration requirement. The
Commission notes that demonstration of compliance could otherwise be
required upon Commission request under Sec. 37.5(b), which requires a
SEF to provide a written demonstration that it is in compliance with
its obligations under the Act.\587\
---------------------------------------------------------------------------
\587\ 17 CFR 37.5(b).
---------------------------------------------------------------------------
Request for Comment
The Commission requests comment on all aspects of proposed Sec.
37.402 and the associated guidance to Core Principle 4 in Appendix B.
C. Sec. 37.403--Additional Requirements for Cash-Settled Swaps
For cash-settled swaps, Sec. 37.403(a) requires that a SEF monitor
the pricing of the reference price used to determine cash flows or
settlement of a swap.\588\ Where the reference price is formulated or
computed by the SEF, Sec. 37.403(b) requires a SEF to demonstrate that
it monitors the continued appropriateness of its methodology for
deriving that price.\589\ Where the reference price relies on a third-
party index or instrument, Sec. 37.403(c) requires a SEF to
demonstrate that it monitors the continued appropriateness of the index
or instrument.\590\ The Commission provided additional guidance to Core
Principle 4 in Appendix B to specify that a SEF should monitor pricing
abnormalities in the index or instrument used to calculate the
reference price to avoid manipulation, price disruptions, or market
distortions.\591\ For self-formulated or self-computed reference
prices, the SEF should amend the existing methodology or impose new
methodologies where such threats exist. For pricing based on a third-
party index or instrument, a SEF should conduct due diligence to ensure
that the contract is not susceptible to manipulation.\592\
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\588\ 17 CFR 37.403(a).
\589\ 17 CFR 37.403(b).
\590\ 17 CFR 37.403(c).
\591\ 17 CFR part 37 app. B (guidance to Core Principle 4--
paragraph (a)(3)--``Cash-settled swaps''). See SEF Core Principles
Final Rule at 33529 (stating that market participants may have
incentives to disrupt or manipulate reference prices for cash-
settled swaps and stating that SEFs must monitor the pricing of the
reference price in order to comply with Core Principle 4's
requirement to prevent manipulation, price distortion, and
disruptions of the cash settlement process).
\592\ Id.
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Based on its experience, the Commission acknowledges that the
requirement imposed by Sec. 37.403(a) to monitor the methodologies
behind third-party indexes or instruments is not realistic due to the
proprietary nature of these indexes and instruments. The Commission has
observed that many SEFs offer swaps for which pricing is based on
benchmark prices or benchmark indices owned or administered by third
parties, such as the Intercontinental Exchange, Inc. (``ICE''),\593\
IHS Markit Ltd. (``IHS Markit''),\594\ and the European Money Markets
Institute (``EMMI'').\595\ For example, many SEFs offer IRS for trading
that rely on LIBOR or EURIBOR as the underlying benchmark, which are
based upon submissions from panel banks. The Commission believes that
requiring a SEF to monitor the inputs and calculations involved in
ICE's or EMMI's methodologies when calculating their respective
benchmarks on an ongoing basis is impractical.\596\ The Commission
understands that as a general matter, certain aspects of these
benchmarks remain proprietary in nature. Therefore, the Commission
acknowledges that SEFs do not necessarily have full access to the
information to monitor trading to detect disruptions or manipulations
of indexes or reference rates administered by other industry
participants. Further, the Commission notes that these entities are
subject to their own monitoring and oversight mechanisms.\597\
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\593\ ICE serves as the current administrator for ICE Swap Rate
(formerly known as ISDAFix), which serves as a benchmark for swap
rates and spreads for IRS. ICE, About ICE Swap Rate, https://www.theice.com/iba/ice-swap-rate. ICE also serves as the current
administrator for ICE LIBOR (formerly known as BBA LIBOR), which is
a widely-adopted benchmark for short-term interest rates that is
used to specify the floating rate for fixed-to-floating IRS. ICE,
ICE Libor-Overview, https://www.theice.com/iba/libor.
\594\ IHS Markit owns and operates several tradeable CDS indices
that are based on a basket of single-name CDS. IHS Markit, Indices,
https://ihsmarkit.com/products/indices.html.
\595\ EMMI, a non-profit making association whose members are
national banking associations in the EU-member states, serves as the
current administrator for Euribor and EONIA, which are widely-
adopted benchmarks for euro-denominated IRS. EMMI, 2 Benchmarks,
https://www.emmi-benchmarks.eu.
\596\ The Commission notes, however, that ICE and EMMI offer
general information on the methodologies for calculating their
respective benchmarks. For example, ICE states that it determines
the ICE Swap Rate benchmark, which represents the mid-price for the
fixed leg of IRS, based on tradeable quotes from regulated,
electronic, multilateral trading venues. See ICE, Calculation of ICE
Swap Rate from Tradeable Quotes, available at https://www.theice.com/publicdocs/ICE_Swap_Rate_Full_Calculation_Methodology.pdf; see also EMMI,
Euribor Code of Conduct, available at https://www.emmi-benchmarks.eu/assets/files/D2712J-2014-Euribor%20Code%20of%20Conduct%2001Oct2013%20-%20Revised%201%20June%202016-%20final%20new.pdf.
\597\ ICE maintains an oversight committee for LIBOR, which is
responsible for reviewing the methodology, scope, and definition of
the benchmark (including assessing its underlying market and usage);
overseeing any changes to the benchmark; and overseeing and
reviewing an associated code of conduct. ICE, Governance &
Oversight, https://www.theice.com/iba/libor#methodology. EMMI
maintains a Steering Committee, which is responsible for similar
functions with respect to Euribor. EMMI, Steering Committee, https://www.emmi-benchmarks.eu/euribor-org/steering-committee.html.
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Based on these considerations, the Commission proposes to eliminate
the requirement under Sec. 37.403(a) that SEFs monitor the ``pricing''
of the reference price used to determine cash flows or settlement.\598\
Where the reference price relies on a third-party index or instrument,
a SEF would continue to be required under proposed Sec. 37.403(b)
(existing Sec. 37.403(c)) to monitor the ``appropriateness'' of the
index or instrument; the Commission, however, proposes to amend this
requirement to additionally require a SEF to take appropriate action,
including selecting an alternate index or instrument for deriving the
reference price, where there is a threat of manipulation, price
[[Page 62016]]
distortion, or market disruption.\599\ The Commission believes that
sufficient information is generally available to SEFs to comply with
this proposed requirement. Based on this proposed requirement, the
Commission expects that a SEF would take action with respect to its use
of a third-party index or instrument for a listed swap contract that
would inhibit the SEF's ability to prevent manipulation pursuant to
Core Principles 3 and 4. Where a SEF formulates and computes the
reference price, the Commission proposes to amend Sec. 37.403(b) to
require a SEF to take appropriate action, including amending the
methodology, where there is a threat of manipulation, price distortion,
or market disruption.\600\ In contrast to the circumstances where a SEF
relies on a third-party index or instrument, the SEF could monitor its
own methodology for deriving the reference price.
---------------------------------------------------------------------------
\598\ The Commission notes, however, that a SEF would be
required under proposed Sec. 37.401(b) to monitor trading in the
index or instrument used as a reference price.
\599\ The Commission proposes to renumber existing subsection
(c) to subsection (b) and amend the language as described.
\600\ The Commission proposes to renumber existing subsection
(b) to subsection (a) and amend the language as described.
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The Commission believes that these proposed amendments would
provide greater clarity and establish more practical requirements for
SEFs to monitor the reference prices, including the index or instrument
used to calculate them, in a manner that is consistent with Core
Principle 4. Further, the Commission believes that these proposed
amendments are consistent with the proposed guidance in Appendix C to
part 37 regarding the design of cash-settled swap contracts. Among
other things, that guidance specifies that the SEF should ensure that
the reference price used for its contract is not readily susceptible to
manipulation by assessing its reliability as an indicator of cash
market values in the underlying commercial market.\601\
---------------------------------------------------------------------------
\601\ See 17 CFR part 37 app. C (paragraph (a)(ii) of the
proposed Appendix C to part 37--``Reference price susceptibility to
manipulation'').
---------------------------------------------------------------------------
The Commission also proposes a non-substantive change to eliminate
the demonstration-based requirements under Sec. 37.403. As noted
above, the Commission proposes to set forth an affirmative monitoring
requirement, rather than a demonstration requirement. The Commission
notes that demonstration of compliance could otherwise be required upon
Commission request under Sec. 37.5(b), which requires a SEF to provide
a written demonstration that it is in compliance with its obligations
under the Act.\602\
---------------------------------------------------------------------------
\602\ 17 CFR 37.5(b).
---------------------------------------------------------------------------
Given the changes to Sec. 37.403 proposed above, the Commission
proposes to delete the existing associated guidance in Core Principle 4
in Appendix B.\603\
---------------------------------------------------------------------------
\603\ The Commission proposes to eliminate paragraph (a)(3).
---------------------------------------------------------------------------
Request for Comment
The Commission requests comment on all aspects of proposed Sec.
37.403 and the elimination of the associated guidance to Core Principle
4 in Appendix B.
D. Sec. 37.404--Ability To Obtain Information
Section 37.404(a) provides that a SEF must demonstrate that it has
access to sufficient information to assess whether trading in swaps
listed on its market, in the index or instrument used as a reference
price, or in the underlying commodity for its listed swaps is being
used to affect prices on its market.\604\ Section 37.404(b) requires a
SEF to have rules that require its market participants to keep records
of their trading, including records of their activity in the index or
instrument used as a reference price, the underlying commodity, and
related derivatives markets; and make those records available to the
SEF, its regulatory service provider if applicable, and the
Commission.\605\ The Commission specified in the guidance to Core
Principle 4 in Appendix B that a SEF may limit the application of these
requirements to market participants who conduct ``substantial trading''
on its facility.\606\
---------------------------------------------------------------------------
\604\ 17 CFR 37.404(a).
\605\ 17 CFR 37.404(b).
\606\ 17 CFR part 37 app. B (guidance to Core Principle 4--
paragraph (a)(4)--``Ability to obtain information'').
---------------------------------------------------------------------------
The Commission proposes several amendments to the associated
guidance to Core Principle 4 in Appendix B. In particular, the
Commission proposes to eliminate a SEF's ability to limit the
application of proposed Sec. 37.404(a) and proposed Sec. 37.404(b) to
only those market participants who conduct ``substantial trading'' on
its facility. The Commission notes that it has not provided SEFs with
any additional guidance, e.g., volume-based metrics or similar factors,
as to what constitutes ``substantial trading'' by a market participant.
Eliminating this guidance would not only remove an ambiguity as to whom
Sec. 37.404 applies, but also promote a more comprehensive and
effective monitoring requirement that would require a SEF to have the
ability to obtain information from all of its market participants,
thereby better fulfilling the objectives of Core Principle 4.\607\ In
addition, based on its experience, the Commission believes that market
participants are keeping records of their related trading, so
eliminating the ``substantial'' requirement should not impose
additional burdens. In addition to this amendment, the Commission also
proposes several non-substantive amendments to the guidance.\608\
---------------------------------------------------------------------------
\607\ The Commission notes, however, that the scope of this
requirement would be based on the proposed definition of ``market
participant'' under Sec. 37.2(b), which would limit Sec. 37.404 to
persons who access the SEF directly or through a third-party
functionality, or otherwise direct an intermediary to trade on their
behalf. See supra Section IV.B.2.a.--Applicability of Sec.
37.404(b) to Market Participants.
\608\ The Commission proposes to streamline and move the
guidance that currently specifies that a SEF can adopt information-
sharing agreements with other trading venues or a third-party
regulatory service provider where position and trading information
is not available directly from market participants. The Commission
proposes to move this guidance to paragraph (a) of the guidance to
Core Principle 5 because the applicable requirements for a SEF to
adopt information-sharing practices are addressed under proposed
Sec. 37.503, as discussed below.
---------------------------------------------------------------------------
The Commission also proposes a non-substantive change to eliminate
the demonstration-based requirement under Sec. 37.404(a).\609\ As
noted above, the Commission proposes to set forth an affirmative
monitoring requirement, rather than a demonstration requirement. The
Commission notes that demonstration of compliance could otherwise be
required upon Commission request under Sec. 37.5(b), which requires a
SEF to provide a written demonstration that it is in compliance with
its obligations under the Act.\610\
---------------------------------------------------------------------------
\609\ The Commission also proposes to eliminate similar
associated guidance to Core Principle 4 in Appendix B.
\610\ 17 CFR 37.5(b).
---------------------------------------------------------------------------
Request for Comment
The Commission requests comment on all aspects of proposed Sec.
37.404 and the associated guidance to Core Principle 4 in Appendix B.
E. Sec. 37.405--Risk Controls for Trading
Section 37.405 requires that a SEF establish and maintain risk
control mechanisms to prevent and 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 SEF.\611\
The associated guidance to Core Principle 4 in Appendix B, among other
things, provides examples of the different types of risk controls that
a SEF may adopt based on whether or not they are appropriate to the
characteristics of the trading platform or
[[Page 62017]]
market offered by the SEF.\612\ Among those types of controls, the
guidance specifies that a SEF may establish clear error-trade and order
cancellation policies.
---------------------------------------------------------------------------
\611\ 17 CFR 37.405.
\612\ 17 CFR part 37 app. B (guidance to Core Principle 4--
paragraph (a)(5)--``Risk controls for trading'').
---------------------------------------------------------------------------
The Commission proposes two amendments to Sec. 37.405 to align the
existing requirement with the proposed amendments to other Core
Principle 4 regulations. First, the Commission proposes to clarify that
a SEF is required to have risk control mechanisms to prevent and reduce
market disruptions, as well as price distortions on their facility.
This proposed change is consistent with Core Principle 4, which
requires a SEF to monitor trading to prevent price distortions and
disruptions to the delivery or cash settlement process.\613\ Second,
the Commission proposes to limit this requirement to swaps trading
activity occurring on a SEF's own facility, which would be consistent
with the proposed changes to Sec. 37.401(a).
---------------------------------------------------------------------------
\613\ 7 U.S.C. 7b-3(f)(4)(b).
---------------------------------------------------------------------------
The Commission also proposes several amendments to the associated
guidance to Core Principle 4 in Appendix B. First, the Commission
proposes to eliminate the reference to intraday position limit risk
controls, which generally do not apply to a SEF because the Commission
has yet to establish position limit rules for swaps. Second, the
Commission proposes to clarify that a SEF's risk controls should be
adapted to the swap contracts that it lists for trading; this amendment
does not reflect a substantive change, but rather would be consistent
with the proposed guidance in Appendix C to part 37, which provides
that a SEF may adapt certain risk controls for swap contracts based on
whether they are standardized or non-standardized.\614\ Third, the
Commission proposes to eliminate the language specifying that a SEF may
adopt an error trade policy; the Commission notes that, as described
above, proposed Sec. 37.203(e) would require a SEF to adopt an error
trade policy for trading on its facility. The Commission also proposes
to make several other non-substantive conforming and clarifying
amendments to the guidance.
---------------------------------------------------------------------------
\614\ See supra Section VIII.A.1.--Appendix C--Demonstration of
Compliance that a Swap Contract is Not Readily Susceptible to
Manipulation.
---------------------------------------------------------------------------
Request for Comment
The Commission requests comment on all aspects of proposed Sec.
37.405 and the associated guidance to Core Principle 4 in Appendix B.
F. Sec. 37.406--Trade Reconstruction
Section 37.406 requires that a SEF have the ability to
comprehensively and accurately reconstruct all trading on its facility,
and that audit-trail data and reconstructions be made available to the
Commission in a form, manner, and time that is acceptable to the
Commission.\615\
---------------------------------------------------------------------------
\615\ 17 CFR 37.406.
---------------------------------------------------------------------------
Given the proposed consolidation with Sec. 37.401(d), as described
above, the Commission proposes to eliminate Sec. 37.406.\616\ The
Commission also notes that the requirement to make information
available to the Commission is already addressed under Core Principle 5
regulations, discussed further below.\617\
---------------------------------------------------------------------------
\616\ As discussed above, proposed Sec. 37.401(d) would require
a SEF to have the ability to comprehensively and accurately
reconstruct all trading activity on its facility for the purpose of
detecting instances or threats of manipulation, price distortion,
and disruptions.
\617\ See infra Section X.B.--Sec. 37.502--Provide Information
to the Commission.
---------------------------------------------------------------------------
Request for Comment
The Commission requests comment on all aspects of the proposed
elimination of Sec. 37.406.
G. Sec. 37.407--Regulatory Service Provider; Sec. 37.408--Additional
Sources for Compliance 618
---------------------------------------------------------------------------
\618\ The Commission proposes to renumber Sec. Sec. 37.407-408
to Sec. Sec. 37.406-407, given the proposed elimination of existing
Sec. 37.406.
---------------------------------------------------------------------------
The Commission is not proposing any amendments to Sec. Sec.
37.407-408.
X. Part 37--Subpart F: Core Principle 5 (Ability To Obtain Information)
Core Principle 5 requires a SEF to establish and enforce rules that
allow the facility to obtain any ``necessary information'' to perform
any of the functions described in CEA section 5h; provide the
information to the Commission upon request; and have the capacity to
carry out international information-sharing agreements as the
Commission may require.\619\ The Commission further implemented Core
Principle 5 under Sec. Sec. 37.501-504. Based on the Commission's
understanding of current SEF operational practices, the Commission is
proposing several amendments, including non-substantive changes, to
these implementing regulations, as described below.
---------------------------------------------------------------------------
\619\ 7 U.S.C. 7b-3(f)(5). The Commission codified Core
Principle 5 under Sec. 37.500. 17 CFR 37.500.
---------------------------------------------------------------------------
A. Sec. 37.501--Establish and Enforce Rules
Section 37.501 specifies that a SEF's rules must allow it to obtain
sufficient information to fulfill its functions and obligations under
part 37, including the capacity to carry out such international
information-sharing agreements as the Commission may require.\620\ The
Commission proposes a non-substantive amendment to eliminate the
duplicative language under Sec. 37.501 regarding a SEF's capacity to
carry out international information-sharing agreements. The Commission
notes that this requirement is already established under Core Principle
5.
---------------------------------------------------------------------------
\620\ 17 CFR 37.501.
---------------------------------------------------------------------------
B. Sec. 37.502--Provide Information to the Commission
Existing Sec. 37.502 requires a SEF to adopt rules that allow it
to collect information on a routine basis, allow for the collection of
non-routine data from its market participants, and allow for its
examination of books and records kept by its market participants.\621\
---------------------------------------------------------------------------
\621\ 17 CFR 37.502.
---------------------------------------------------------------------------
The Commission proposes to eliminate existing Sec. 37.502.\622\
The Commission notes that the language of this requirement is
duplicative of the general requirement that SEFs have the ability to
obtain information from their market participants, as already set forth
in Core Principle 5 and Sec. 37.501. Eliminating the requirement that
a SEF must have rules to allow it to examine books and records is also
consistent with the Commission's proposed amendment to Sec. 37.203(b),
which would replace a similar existing requirement with a more general
rule that would allow a SEF to tailor its rules for collecting books
and records from market participants.\623\
---------------------------------------------------------------------------
\622\ The Commission proposes to renumber existing Sec. 37.503
to Sec. 37.502 and retitle the provision to ``Provide information
to the Commission'' from ``Collection of information'' based on the
proposed changes described below.
\623\ See supra Section VII.B.2.--Sec. 37.203(b)--Authority to
Collect Information (proposing an amendment to require that a SEF
have the authority to collect information required to be kept by
persons subject to the SEF's recordkeeping rules).
---------------------------------------------------------------------------
Request for Comment
The Commission requests comment on all aspects of the proposed
elimination of existing Sec. 37.502.
C. Sec. 37.503--Information-Sharing 624
---------------------------------------------------------------------------
\624\ The Commission proposes to renumber existing Sec. 37.504
to Sec. 37.503 and retitle the provision to ``Information-sharing''
from ``Provide information to the Commission'' based on the proposed
changes described below.
---------------------------------------------------------------------------
Existing Sec. 37.504 requires a SEF to share information with
other regulatory organizations, data repositories, and third-party data
reporting services as required by the Commission or as otherwise
necessary and appropriate to fulfill its self-regulatory and reporting
[[Page 62018]]
responsibilities.\625\ Section 37.504 also states that appropriate
information-sharing agreements can be established with the specified
entities or the Commission can act in conjunction with the SEF to carry
out such information sharing.
---------------------------------------------------------------------------
\625\ 17 CFR 37.504.
---------------------------------------------------------------------------
The Commission proposes to establish a more straightforward and
streamlined information-sharing requirement by eliminating the
specifically enumerated list of entities with which a SEF must share
information and adopting conforming amendments. Instead, a SEF would be
required to generally share information, as required by the Commission,
or as appropriate to fulfill its self-regulatory and reporting
responsibilities. Rather than limiting the types of entities that a SEF
may share information with, however, a SEF would have the flexibility
to share information with third parties that it may utilize to carry
out those responsibilities, including affiliated entities. This broader
and more adaptive approach to information-sharing practices would
better accommodate, for example, a SEF's ability to use different types
of regulatory service providers pursuant to the proposed amendments
under Sec. 37.204. The Commission emphasizes, however, that SEFs would
not be required to share information with competitor entities. In
relevant situations where information or data may need to be shared
across different markets to help identify manipulation, price
distortions or other disruptions, for example, the Commission
anticipates that it will continue working in conjunction with SEFs to
help establish such information-sharing arrangements.
The Commission also proposes a non-substantive revision by moving
certain provisions from the existing guidance to Core Principle 4 to
the guidance to Core Principle 5 in Appendix B.\626\ This proposed
guidance would specify that if position and trading information is
available through information-sharing agreements with other trading
venues or a third-party regulatory service provider, then the SEF
should cooperate, to the extent practicable, in such information-
sharing agreements.
---------------------------------------------------------------------------
\626\ The Commission proposes to move this guidance from
paragraph (a)(4) to Core Principle 4 to paragraph (a) to Core
Principle 5 in Appendix B.
---------------------------------------------------------------------------
Request for Comment
The Commission requests comment on all aspects of proposed Sec.
37.503 and the associated guidance to Core Principle 5 in Appendix B.
D. Sec. 37.504--Prohibited Use of Data Collected for Regulatory
Purposes \627\
---------------------------------------------------------------------------
\627\ The Commission proposes to retitle Sec. 37.504 to
``Prohibited use of data collected for regulatory purposes'' from
``Information-sharing agreements'' based on the proposed changes
described below.
---------------------------------------------------------------------------
Section 37.7--``Prohibited use of data collected for regulatory
purposes''--prohibits a SEF from using, 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, unless the person clearly
consents to the SEF's use of such data or information in such
manner.\628\ The purpose of this provision is to protect customer
privacy and prevent a SEF from using information, obtained for
compliance purposes, to otherwise advance its commercial
interests.\629\ Section 37.7 also provides that a SEF, where necessary
for regulatory purposes, may share such data or information with one or
more SEFs or DCMs registered with the Commission.\630\
---------------------------------------------------------------------------
\628\ 17 CFR 37.7.
\629\ SEF Core Principles Final Rule at 33492.
\630\ 17 CFR 37.7.
---------------------------------------------------------------------------
The Commission proposes to create a more cohesive rule with respect
to information-sharing practices under Core Principle 5 by moving
existing Sec. 37.7 to a new proposed Sec. 37.504 and amending the
current language of the requirement. Consistent with the existing
prohibition, the Commission proposes that a SEF that shares such
proprietary data or personal information with a third party shall
ensure that that third party does not use the data or information for
business or marketing purposes, unless the person from whom such data
or information was obtained clearly consents to its use for business or
marketing purposes (including consent to use by those third parties
with whom the SEF may share such information). This proposed amendment
corresponds to the Commission's other proposed amendments that would
expand the scope of entities with whom a SEF may share information,
including Sec. 37.503, which would provide a SEF with greater
flexibility in selecting a third-party provider to fulfill its self-
regulatory and reporting responsibilities; and Sec. 37.204, which
would allow the SEF to utilize a broader scope of third-party entities,
including non-registered affiliates to provide regulatory services,
subject to Commission approval.\631\
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\631\ In this regard, the Commission notes that under its
proposed amendments to Sec. 37.204, a SEF would be permitted to
contract with any entity for the provision of services to assist in
complying with the Act and Commission regulations, subject to
Commission approval. See supra Section VII.C.1.--Sec. 37.204(a)--
Use of Regulatory Service Provider Permitted.
---------------------------------------------------------------------------
In the course of using such a provider, a SEF may need to share
proprietary data or personal information with that third party. To the
extent that Sec. 37.504 would continue to limit SEFs from using this
type of information for non-regulatory purposes, the Commission
believes that the objective of protecting customer privacy and
preventing the use of data for commercial purposes should also equally
apply to third parties that obtain access to such data or information
from a SEF for regulatory purposes. The Commission believes that the
proposed amendments achieve this objective.
Request for Comment
The Commission requests comments on all aspects of proposed Sec.
37.504.
XI. Part 37--Subpart G: Core Principle 6 (Position Limits or
Accountability)
Core Principle 6 requires a SEF that is a trading facility to
adopt, as is necessary and appropriate, position limits or position
accountability levels for each swap contract to reduce the potential
threat of market manipulation or congestion.\632\ For contracts that
are subject to a federal position limit under CEA section 4a(a), the
SEF must set its position limits at a level that is no higher than the
limit established by the Commission; and monitor positions established
on or through the SEF for compliance with the Commission's limit and
the limit, if any, set by the SEF.\633\
---------------------------------------------------------------------------
\632\ 7 U.S.C. 7b-3(f)(6). The Commission codified Core
Principle 6 under Sec. 37.600. 17 CFR 37.600.
\633\ Id.
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A. Sec. 37.601--Additional Sources for Compliance; Guidance to Core
Principle 6 in Appendix B
Section 37.601 further implements Core Principle 6 and specifies
that until such time that compliance is required under part 151 of the
Commission's regulations, a SEF may refer to the associated guidance
and/or acceptable practices set forth in Appendix B to part 37.\634\
The guidance to Core Principle 6 in Appendix B provides a SEF with
reasonable discretion to comply with Core Principle 6 and sets forth
how a SEF may demonstrate compliance for trading that occurs on its own
market.\635\ The Commission notes that it has proposed new language for
Sec. 37.601 and new corresponding guidance to Core Principle 6 in
Appendix B in a re-proposal of a position limits
[[Page 62019]]
rulemaking, pending further Commission action.\636\
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\634\ 17 CFR 37.601.
\635\ 17 CFR part 37 app. B (guidance to Core Principle 6--
paragraph (a)--``Guidance'').
\636\ Position Limits for Derivatives, 81 FR 96704 (proposed
Dec. 30, 2016).
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The Commission proposes to eliminate the language of Sec. 37.601
and the existing corresponding guidance to Core Principle 6, based on
its intent to address this issue in a separate rulemaking. Until that
time, the Commission clarifies that SEFs have reasonable discretion to
determine how to comply with Core Principle 6 pursuant to Core
Principle 1.\637\ This approach is consistent with the existing
approach under Sec. 37.601 and the associated guidance to Core
Principle 6.
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\637\ 7 U.S.C. 7b-3(f)(1).
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Request for Comment
The Commission requests comment on all aspects of the proposed
elimination of Sec. 37.601 and the associated guidance to Core
Principle 6 in Appendix B.
XII. Part 37--Subpart H: Core Principle 7 (Financial Integrity of
Transactions); Sec. 39.12--Participant and Product Eligibility
Core Principle 7 requires a SEF to establish and enforce rules and
procedures for ensuring the financial integrity of swaps entered on or
through the facilities of the SEF, including the clearance and
settlement of the swaps pursuant to CEA section 2(h)(1).\638\ As
described further below, Sec. Sec. 37.700-703 implement Core Principle
7 by establishing requirements for SEFs to facilitate the processing
and routing of swap transactions to a DCO for clearing. Section
39.12(b)(7), which implements Core Principle C for DCOs, sets forth
corresponding requirements for registered DCOs that specify the time
frame for acceptance or rejection of transactions submitted to the
registered DCO from DCMs and SEFs.\639\
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\638\ The Commission codified Core Principle 7 under Sec.
37.700. 17 CFR 37.700.
\639\ 17 CFR 39.12(b)(7). Core Principle C for DCOs, among other
things, requires that each DCO establish appropriate standards for
determining the eligibility of agreements, contracts, or
transactions submitted to the DCO for clearing. 7 U.S.C. 7a-
1(c)(2)(C)(i)(II). Section 39.12(b) implements Core Principle C for
DCOs by setting forth product eligibility requirements. 17 CFR
39.12(b).
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As described further below, the Commission is proposing several
amendments to the implementing regulations and Sec. 39.12(b)(7),
including amendments to certain ``straight-through processing''
obligations that apply to SEFs, DCMs, and DCOs.\640\
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\640\ The Commission notes that Sec. 39.12(b)(7) also applies
to the acceptance or rejection for clearing by a DCO of (i) futures
and options on futures transactions and (ii) swaps submitted by a
DCM. Accordingly, the Commission's proposed amendments to Sec.
39.12(b)(7) would also apply to those transactions. See infra
Section XII.B.2.b.(2)--Sec. 39.12(b)(7)(ii)--AQATP Standard for
Registered DCOs.
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A. Sec. 37.701--Required Clearing
Section 37.701 requires that transactions executed on or through a
SEF that are subject to the clearing requirement, or are voluntarily
cleared by the counterparties, must be cleared through a registered DCO
or an exempt DCO.\641\
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\641\ 17 CFR 37.701.
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The Commission proposes to amend Sec. 37.701 to require a SEF to
establish a direct and independent clearing agreement with each
registered DCO or exempt DCO to which the SEF submits swap transactions
for clearing.\642\ During the part 37 implementation, the Commission
observed that some SEFs would route swap transactions to certain exempt
DCOs for clearing without having established a direct clearing
agreement with those DCOs. Rather than enter a direct agreement with
the exempt DCO, the SEF would establish the capacity to route
transactions through the use of a third-party service provider. Such
routing arrangements occurred pursuant to a services agreement between
the SEF and the provider; the provider, in turn, maintained a separate
agreement with the exempt DCO.
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\642\ The Commission proposes to renumber the existing
requirement under Sec. 37.701 as subsection (a) based on a new
requirement proposed under subsection (b), described below.
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A SEF's use of a third-party service provider to route swap
transactions to a DCO for clearing may generally be appropriate, but
the Commission believes that the indirect routing of transactions for
clearing must occur pursuant to a direct and independent clearing
services agreement between the SEF and each DCO utilized by the SEF.
The Commission believes that maintaining a direct agreement between a
SEF and DCO, notwithstanding the use of a third-party provider, is
consistent with Sec. 37.702(b), which requires each SEF to coordinate
with a DCO to develop rules and procedures to facilitate prompt and
efficient processing of transactions in accordance with the DCO's
obligations under Sec. 39.12(b)(7)(i)(A).\643\ Such an agreement would
provide greater certainty to market participants that the SEF has the
appropriate processes to facilitate swaps clearing. The Commission also
believes that the terms established in a direct clearing agreement
between the SEF and DCO would help the SEF and DCO resolve any problems
that arise at the DCO that could diminish the SEF's ability to submit
transactions for clearing.
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\643\ Section 39.12(b)(7)(i)(A) requires each DCO to coordinate
with DCMs and SEFs to develop rules and procedures to facilitate
prompt, efficient, and accurate processing of transactions to the
DCO for clearing. 17 CFR 39.12(b)(7)(i)(A). As discussed below,
Sec. 39.12(b)(7)(i)(A), as amended, would apply to both the
processing and routing of transactions to the DCO for clearing. See
infra Section XII.B.2.b.(1)--Sec. 37.702(b)(1) and Sec.
39.12(b)(7)(i)(A)--``Prompt, Efficient, and Accurate'' Standard.
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The Commission also proposes a non-substantive amendment to Sec.
37.701 to eliminate ``or through'' from the language of the existing
requirement. The Commission notes that this proposed amendment is a
conforming change to other part 37 regulations and does not affect the
scope of transactions that are required to be cleared pursuant to the
clearing requirement in CEA section 2(h)(1)(A).\644\
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\644\ The Commission notes that Core Principle 7 refers to swaps
``entered on or through'' the SEF, but notes that the existing
requirement under Sec. 37.701 specifically applies to ``executed''
transactions, which are submitted for clearing.
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Request for Comment
The Commission requests comment on all aspects of proposed Sec.
37.701.
B. Sec. 37.702--General Financial Integrity
1. Sec. 37.702(a)
Section 37.702(a) requires a SEF to establish minimum financial
standards for its members, which include at a minimum a requirement
that each member qualifies as an ECP pursuant to CEA section
1a(18).\645\ The Commission proposes a non-substantive amendment to
Sec. 37.702(a) to replace the term ``member'' with ``market
participant.'' The Commission notes that its proposed definition of
``market participant'' under Sec. 37.2(b) would capture the universe
of persons and entities that participate on SEFs and would be subject
to minimum financial requirements, including a SEF's members.\646\
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\645\ 17 CFR 37.702(a).
\646\ See supra Section IV.B.2.--Sec. 37.2(b)--Definition of
``Market Participant.'' The Commission notes that CEA section 2(e)
limits swaps trading to ECPs, as defined by section 1a(18) of the
Act. 7 U.S.C. 2(e).
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2. Sec. 37.702(b) and Sec. 39.12(b)(7)--Time Frame for Clearing
Existing Sec. 37.702(b) and Sec. 39.12(b)(7) require SEFs and
registered DCOs, respectively, to coordinate with one another to
facilitate the clearing of swap transactions executed on or through the
SEF.\647\ The two provisions are intended to ensure that SEFs and
registered DCOs coordinate and work together to
[[Page 62020]]
facilitate the ``straight-through processing'' of transactions from
execution through clearing,\648\ which the Divisions have described as
the ``near[-]instantaneous acceptance or rejection of each trade. . .
.'' \649\ In order for a DCO to clear a SEF swap transaction, existing
Sec. 37.702(b)(1) requires a SEF to ensure that it has the capacity to
route transactions to the DCO in a manner acceptable to the registered
DCO for purposes of clearing.\650\ Existing Sec. 37.702(b)(2) requires
a SEF to coordinate with each registered DCO to which it submits
transactions for clearing to develop rules and procedures to facilitate
``prompt and efficient'' transaction processing in accordance with the
requirements of Sec. 39.12(b)(7).\651\ Section 39.12(b)(7)(i)(A)
requires each registered DCO to coordinate with a relevant SEF or DCM
to develop rules and procedures to facilitate ``prompt, efficient, and
accurate'' processing of all transactions, including swaps submitted to
the registered DCO for clearing by the SEF or DCM (emphasis
added).\652\
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\647\ The Commission notes that part 39 only applies to
registered DCOs and does not apply to exempt DCOs. Accordingly, the
Commission notes that Sec. 37.702(b) only refers to registered
DCOs.
\648\ Customer Clearing Documentation, Timing of Acceptance for
Clearing, and Clearing Member Risk Management, 77 FR 21278, 21283
(Apr. 9, 2012) (``Timing of Acceptance for Clearing Final Rule'').
\649\ 2013 Staff STP Guidance at 2. See also infra notes 658-659
and accompanying discussion. The Commission has previously stated
that the ``acceptance or rejection for clearing in close to real
time is crucial for both effective risk management and for the
efficient operation of trading venues.'' Timing of Acceptance for
Clearing Final Rule at 21285. The Commission notes that Sec.
39.12(b)(7) applies to a DCO with respect to (i) futures and options
on futures transactions and (ii) swaps submitted by a DCM for
clearing. To the extent that the Commission is addressing the
proposed amendments to Sec. 39.12(b)(7), as discussed further
below, in conjunction with proposed amendments to Sec.
37.702(b)(2), the discussion focuses on swaps routed by a SEF to a
DCO for clearing. See also infra note 673 (noting that at this time
the Commission is not proposing corresponding amendments to Sec.
38.601(b), which establishes analogous processing and routing
requirements for DCMs). As discussed below, however, the proposed
amendments to Sec. 39.12(b)(7) would also apply to those
transactions, including swaps, futures, and options on futures,
submitted by a DCM to a DCO for clearing. See infra Section
XII.B.2.b.(2)--Sec. 39.12(b)(7)(ii)--AQATP Standard for Registered
DCOs.
\650\ 17 CFR 37.702(b)(1).
\651\ 17 CFR 37.702(b)(2).
\652\ 17 CFR 39.12(b)(7)(i)(A). The Commission notes that
``transactions'' refers to swaps submitted by a SEF or DCM, as well
as futures and options on futures submitted by a DCM.
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Sections 39.12(b)(7)(ii)-(iii) each further require a registered
DCO to establish standards to accept or reject transactions for
clearing as quickly as would be technologically practicable as if fully
automated systems were used (the ``AQATP'' standard).\653\ Section
39.12(b)(7)(ii) applies this standard to registered DCOs for
transactions, including swaps, that are ``executed competitively on or
subject to the rules'' of a SEF or DCM and requires the registered DCO
to accept or reject a transaction for clearing pursuant to the AQATP
standard ``after execution'' of the transaction.\654\ For swaps ``not
executed on or subject to the rules'' of a SEF or DCM or ``executed
non-competitively on or subject to the rules'' of a SEF or DCM, Sec.
39.12(b)(7)(iii) requires a registered DCO to accept or reject a swap
for clearing pursuant to the AQATP standard ``after submission'' of the
swap to the DCO.\655\ In adopting the AQATP standard, the Commission
noted that it intended for the requirement to track the evolving
industry standard, based on technological developments.\656\
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\653\ 17 CFR 39.12(b)(7).
\654\ 17 CFR 39.12(b)(7)(ii).
\655\ 17 CFR 39.12(b)(7)(iii).
\656\ Timing of Acceptance for Clearing Final Rule at 21285-86.
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The Divisions subsequently issued the 2013 Staff STP Guidance to
further clarify the application of ``straight-through processing''
obligations for swaps that apply to SEFs, DCMs, and DCOs under Sec.
37.702(b), Sec. 38.601(b),\657\ and Sec. 39.12(b)(7),
respectively.\658\ The Divisions stated that the standard for straight-
through processing, i.e., the ``near instantaneous acceptance or
rejection'' of a transaction by a DCO, is critical to providing
certainty of execution and clearing, which in turn would reduce costs
and reduce risk.\659\ To achieve that standard, the guidance expressed
the view that SEFs, DCMs, and registered DCOs must facilitate swap
transaction processing through several requirements. With respect to
SEFs, the guidance expressed the view that a SEF must ensure that a
clearing FCM has been identified in advance for each party on an order-
by-order basis; and facilitate the mandatory pre-execution screening of
orders by each clearing FCM for compliance with risk-based limits,
i.e., ``pre-execution credit screening,'' in accordance with a clearing
FCM's obligations under Sec. 1.73.\660\ The guidance also expressed
the view that a DCO must meet a specific time frame, i.e., ten seconds,
to satisfy its obligation under the AQATP standard.\661\
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\657\ Section 38.601(b) applies to DCMs and establishes
processing and routing requirements that are analogous to Sec.
37.702(b) for SEFs. 17 CFR 38.601.
\658\ 2013 Staff STP Guidance at 2. The 2013 Staff STP Guidance
also specified straight-through processing requirements for FCMs
under Sec. 1.74. Id. at 2-3. See infra note 660.
\659\ 2013 Staff STP Guidance at 2.
\660\ 2013 Staff STP Guidance at 3. Section 1.74 applies similar
straight-through processing requirements to FCMs, including the
requirement that a FCM to coordinate with any DCO to which it is a
clearing member to establish systems that enable the FCM, or the DCO
acting on its behalf, to accept or reject each trade submitted to
the DCO for clearing as quickly as would be technologically
practicable if fully automated systems were used. 17 CFR 1.74.
\661\ 2013 Staff STP Guidance at 5.
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a. ``Prompt and Efficient'' Standard and AQATP Standard
Based on data received by DCR, the 2013 Staff STP Guidance
expressed the view that compliance with the AQATP standard under Sec.
39.12(b)(7)(ii) means that a registered DCO must accept or reject such
trades for clearing within ten seconds after submission to the
DCO.\662\ Given that existing Sec. 37.702(b)(2) and Sec. 38.601(b)
require SEFs and DCMs, respectively, to coordinate with DCOs in
processing transactions for clearing, the 2013 Staff STP Guidance
accordingly expressed the view that a SEF or DCM must route swaps to a
DCO in compliance with the AQATP standard.\663\
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\662\ Id.
\663\ Id. at 4.
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The 2013 Staff STP Guidance also expressed the view that the AQATP
standard applies to swap transactions that are routed to a DCO through
a SEF's or DCM's use of a post-execution, third-party manual
affirmation hub (``affirmation hub'').\664\ The Divisions further
explained in a follow-up letter to the 2013 Staff STP Guidance (the
``2015 Supplementary Staff Letter'') that a SEF or DCM may send
executed trade terms to such a hub to be manually affirmed by the
counterparties prior to routing the transaction to the DCO for
clearing.\665\ According to market participants, this process may take
minutes or hours, or occasionally may occur overnight.\666\ The
Divisions acknowledged that such affirmation hubs can promote prompt
and efficient processing by helping counterparties identify and correct
potential errors in a transaction's terms prior to routing to a DCO for
clearing.\667\ The Divisions also stated their belief, however, that
the Commission intended the AQATP standard to account for the need to
[[Page 62021]]
refine and reduce errors to facilitate prompt and efficient
processing.\668\
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\664\ Id.
\665\ Straight Through Processing and Affirmation of SEF Cleared
Swaps, CFTC Letter No. 15-67 (Dec. 21, 2015) (``2015 Supplementary
Staff Letter'').
\666\ Id. at 2.
\667\ The Divisions noted that if an erroneous swap is cleared
immediately after execution, the counterparties would have to
address the errors after clearing, which may be difficult and
costly. Additionally, counterparties may have to bear significant
margin costs until an error is corrected because the swap may have
been cleared at the wrong DCO; the swap terms may contain the wrong
counterparty; or the swap may contain incorrect economic terms. Id.
\668\ Id. at 3. The Commission previously stated that the use of
an affirmation hub for routing a swap to a DCO for clearing would be
permissible, provided that such routing complies with Sec.
37.702(b) and the trade is processed in accordance with Sec. 39.12,
among other related Commission requirements. SEF Core Principles
Final Rule at 33535.
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The 2015 Supplementary Staff Letter expressed the view that the
AQATP standard for transactions routed to an affirmation hub would be
satisfied if the transactions were routed to and received by the
relevant DCO no more than ten minutes after execution.\669\ In
establishing this standard, the Divisions noted the interaction between
a DCO's requirements under Sec. 39.12(b)(7) with a SEF's or a DCM's
requirements under Sec. 37.702(b) and Sec. 38.601(b),
respectively.\670\ Accordingly, based on the interaction between these
respective requirements, the staff letter expressed the view that a SEF
or DCM is also obligated under the AQATP standard--at least to the
extent that the SEF uses a third-party affirmation hub acting as its
agent--to ensure that the DCO receives the transaction no later than
ten minutes after execution.\671\ The Divisions stated, however, that
they would continue to review this standard and take further action as
necessary, based in part on industry developments.\672\
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\669\ 2015 Supplementary Staff Letter at 3.
\670\ Id. at 1-2.
\671\ Id. at 3.
\672\ Id. The Commission also previously stated that it would
monitor the implementation of the AQATP standard and propose
amendments in the future. Timing of Acceptance for Clearing Final
Rule at 21286.
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b. Proposed Approach to Straight-Through Processing
The Commission notes that the Divisions provided views regarding
several aspects of straight-through processing in the 2013 Staff STP
Guidance and the 2015 Supplementary Staff Letter. The Commission also
understands that certain aspects of the guidance and staff letter may
be unclear when read in conjunction with existing regulations.
Therefore, the Commission seeks to provide clarity under the proposed
regulatory framework with respect to the straight-through processing
requirements for SEFs and DCOs through the proposed clarifications and
amendments described below.\673\
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\673\ Notwithstanding the fact that Sec. 39.12(b)(7), the 2013
Staff STP Guidance, and the 2015 Supplementary Letter also apply to
DCMs as described above, the scope of this proposed rule does not
include a similar proposed amendment to Sec. 38.601(b) for DCMs
that submit (i) futures and options on futures; and (ii) swaps to a
DCO for clearing. The Commission may propose a conforming amendment
in a future proposed rulemaking that applies to DCMs. As discussed
herein, however, a DCO's obligations under the proposed amendments
to Sec. 39.12(b)(7) would apply equally to futures and options on
futures and swaps executed on a SEF or DCM, or executed pursuant to
the rules of a DCM. See supra note 640.
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(1) Sec. 37.702(b)(1) and Sec. 39.12(b)(7)(i)(A)--``Prompt,
Efficient, and Accurate'' Standard
The Commission proposes several amendments to streamline and align
the straight-through processing requirements between SEFs and
DCOs.\674\ First, the Commission proposes to eliminate the duplicative
requirement under existing Sec. 37.702(b)(1) that requires SEFs to
have the capacity to route transactions to the DCO for purposes of
clearing. Accordingly, the Commission proposes to renumber existing
Sec. 37.702(b)(2) to a new proposed Sec. 37.702(b)(1) and revise the
existing ``prompt and efficient'' standard for SEFs to ``prompt,
efficient, and accurate'' to conform to the requirement for DCOs
(emphasis added). The Commission notes that this proposed amendment
would establish the same requirement for both SEFs and DCOs,
respectively, to coordinate with one another to facilitate the
processing of swaps for clearing. To clarify the functions that are
subject to straight-through processing requirements, the Commission
also proposes to specify under proposed Sec. 37.702(b)(1) that this
standard applies to the ``routing'' of swaps by a SEF to a DCO for
clearing.\675\ Further, the Commission proposes a non-substantive
amendment to specify that a SEF's obligation to coordinate with DCOs
should be in accordance with the DCOs' obligations under Sec.
39.12(b)(7)(i)(A).\676\
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\674\ To the extent that the Commission is addressing the
proposed amendments to Sec. 39.12(b)(7)(i)(A) in conjunction with
the proposed amendments to Sec. 37.702(b)(1), the discussion
focuses on swaps routed by a SEF to a DCO for clearing. See also
supra note 673 (noting that the Commission is not proposing
corresponding amendments to Sec. 38.601(b), which establishes
analogous processing and routing requirements for DCMs, at this
time). The proposed amendments to Sec. 39.12(b)(7)(i)(A), however,
would also apply to those transactions, including swaps, futures,
and options on futures submitted by a DCM to a DCO for clearing.
\675\ The Commission acknowledges that the term ``processing''
in the existing requirement may encompass the routing of swaps from
a SEF to a DCO, but proposes to amend the language to include
``routing'' for greater clarity and the avoidance of doubt.
\676\ The current language under Sec. 37.702(b)(2) requires
SEFs to work with each DCO in accordance with the requirements of
Sec. 39.12(b)(7). The Commission's proposal would amend the
requirement to specify Sec. 39.12(b)(7)(i)(A), which imposes a
corresponding obligation on DCOs to work with SEFs to develop rules
to facilitate the ``prompt, efficient, and accurate processing'' of
transactions.
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The Commission also notes that some uncertainty exists about the
interaction between the ``prompt, efficient, and accurate'' standard
\677\ and the AQATP standard for registered DCOs, based in part on the
2013 Staff STP Guidance and 2015 Supplementary Staff Letter.
Accordingly, the Commission proposes that the ``prompt, efficient, and
accurate'' standard applies to (i) each SEF, under proposed Sec.
37.702(b)(1), with respect to the processing and routing of
transactions to a DCO; and (ii) each registered DCO, under Sec.
39.12(b)(7)(i)(A), with respect to any coordination needed to assist a
SEF with implementing any procedures or systems to facilitate the
processing and routing of swaps to the DCO. For the avoidance of doubt,
the Commission proposes that the AQATP standard does not apply to the
processing and routing of transactions. As discussed further below, the
Commission proposes that the AQATP standard set forth under Sec. Sec.
39.12(b)(7)(ii)-(iii) specifically applies to a registered DCO's
acceptance or rejection of a transaction from a SEF or DCM, i.e., when
the DCO receives the transaction.\678\ The Commission believes that
this proposed approach establishes a requirement for a SEF that
addresses its functions--to process and route swaps to the DCO--that is
appropriately distinct from a DCO's functions--to accept or reject a
swap from clearing upon submission of the swap to the DCO, among other
things. For further clarity, the Commission specifies that the SEF's
requirement to process and route swaps in a prompt, efficient, and
accurate manner also includes the SEF's transmission and delivery of
the swap to the DCO; accordingly, the ``submission'' of a swap by the
SEF to the DCO is deemed to have occurred upon the DCO's receipt of the
swap.
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\677\ As noted above, the Commission is proposing to amend the
existing standard for SEFs under Sec. 37.702(b)(2) (renumbered as
Sec. 37.702(b)(1)) to ``prompt, efficient, and accurate.''
\678\ The Commission notes that it is proposing amendments to
streamline Sec. 39.12(b)(7)(ii)-(iii), as discussed below. See
infra Section XII.B.2.b.(2)--Sec. 39.12(b)(7)(ii)--AQATP Standard
for Registered DCOs.
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In particular, the Commission proposes that the ``prompt,
efficient, and accurate'' standard also applies to the processing and
routing of swaps from a SEF to a DCO via affirmation hubs.\679\ The
Commission acknowledges
[[Page 62022]]
the beneficial role of these mechanisms and intends to facilitate their
use to reduce error rates and related costs prior to routing a swap to
the DCO. Instead of the ten-minute time frame set forth in the 2015
Supplementary Staff Letter, however, the Commission proposes that the
``prompt, efficient, and accurate'' standard would allow swaps subject
to affirmation via third-party hubs to be processed and routed to the
DCO in a manner that accounts for existing market practices and
technology, as well as market conditions at the time of execution.
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\679\ The Commission notes that the 2015 Supplementary Staff
Letter expresses the view that the AQATP standard applies to a SEF's
use of affirmation hubs to process and route trades to a DCO. 2015
Supplementary Staff Letter at 3. As discussed further below,
however, the Commission proposes that the AQATP standard applies to
a registered DCO after submission of the trade to the DCO for
clearing. Proposed Sec. 37.702(b)(1) and Sec. 39.12(b)(7)(i)(A),
as amended, would require SEFs and DCOs to respectively coordinate
and work together to effect the ``prompt, efficient, and accurate''
standard.
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Based on the Divisions' experience with the ten-minute time frame,
the Commission believes that a qualitative interpretation of ``prompt,
efficient, and accurate'' is more appropriate than imposing a specific
time standard upon SEFs for processing and routing transactions to the
DCO. The Commission has observed that many SEFs, particularly those
that offer voice-based or voice-assisted trading systems or platforms,
have not been able to meet the time frame when using manual affirmation
hubs. Further, the Commission believes that maintaining a specific time
standard would be inconsistent with the proposed expansion of the trade
execution requirement and the availability of flexible execution
methods under the proposed framework. In particular, the expansion of
the trade execution requirement will lead to the trading of a broader
array of swaps on SEFs, many of which are likely more complex in nature
and require more time for affirmation to occur. The inability to comply
with a specific time frame could hinder the anticipated growth of
trading in additional products on SEFs and impede the ability to
utilize flexible means of execution. Further, a specific time frame may
also limit the use--and therefore the benefits--of affirmation hubs.
Therefore, the Commission believes that a rigid time frame for
processing and routing trades from a SEF to a DCO is inappropriate
under the proposed regulatory framework.
The ``prompt, efficient, and accurate'' standard may result in
varying lengths of time for transactions to be processed and routed to
a DCO, including some longer instances, e.g., a time period that
exceeds ten minutes. The Commission, however, expects that market and
technological developments will enable processing and routing through
affirmation hubs to occur in increasingly shorter time intervals.
Further, the Commission notes that under the qualitative standard,
transactions that can be reasonably affirmed on a fully automatic basis
after execution should be affirmed in that manner.\680\ In such cases,
the Commission believes that ``prompt, efficient, and accurate''
processing and routing would occur in a much shorter time frame, e.g.,
less than ten minutes.
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\680\ The Commission notes that this statement is consistent
with the views expressed by the Divisions in the 2015 Supplementary
Staff Letter. Id. at 3.
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Where affirmation hubs are not utilized, the Commission believes
that the ``prompt, efficient, and accurate'' standard would also result
in a trade being processed and routed from a SEF to a DCO in a much
shorter time frame. As noted above, that exact time frame would depend
on swap market practices and technology, as well as market conditions
at the time of execution. The Commission expects that the industry will
continue to reduce time frames for transaction processing and routing
to a DCO. The Commission emphasizes that it will continue to monitor
time frames and industry developments with respect to transaction
processing to ensure that SEFs and DCOs facilitate prompt, efficient,
and accurate transaction processing and routing.
(2) Sec. 39.12(b)(7)(ii)--AQATP Standard for Registered DCOs
In addition to specifying that the ``prompt, efficient, and
accurate'' standard applies to SEFs with respect to processing and
routing transactions, the Commission proposes to clarify that the AQATP
standard applies to a DCO's acceptance or rejection of a transaction
for clearing upon submission to the DCO, i.e., when the DCO receives
the transaction. The Commission also proposes to delete existing Sec.
39.12(b)(7)(iii) as unnecessary.\681\ The Commission notes that this
approach is generally consistent with the 2013 Staff STP Guidance with
respect to swaps, but this proposal specifies that the AQATP standard
applies exclusively to the DCO and is triggered upon submission of the
agreement, contract, or transaction \682\ to the DCO from a SEF, a DCM,
or counterparties that submit swaps directly to the DCO for clearing.
Therefore, a DCO's ability to comply with the AQATP standard for
accepting or rejecting a trade is distinct from the length of time it
takes an entity such as a SEF or DCM to process and route a trade to
the DCO.\683\ As discussed below, the DCO's obligation to comply with
the AQATP standard is also independent from the method of execution or
venue by which counterparties execute an agreement, contract, or
transaction, given that the DCO's obligation to accept or reject that
executed agreement, contract, or transaction only begins from the point
after which it has been submitted to the DCO, i.e., when the DCO
receives the transaction. If a SEF, DCM, or counterparty to a
bilaterally-executed agreement, contract, or transaction delays the
submission of a cleared swap to a DCO for clearing, then it would not
impact the DCO's obligation to accept or reject on an AQATP basis after
it has received the transaction.
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\681\ As discussed below, the Commission notes that it is
proposing amendments to streamline Sec. Sec. 39.12(b)(7)(ii)-(iii)
into a single provision.
\682\ The Commission notes that both CEA section 1a(15), which
defines a DCO, and Sec. 39.12(b)(1), which establishes product
eligibility for DCOs, refer to ``agreements, contracts, or
transactions.'' Similarly, CEA section 1a(47), which defines a
``swap,'' also refers to an ``agreement, contract, or transaction.''
To conform to these provisions, the Commission proposes non-
substantive amendments to Sec. Sec. 39.12(b)(7)(i)-(ii) to apply to
all ``agreements, contracts, and transactions.'' The Commission
notes that this conforming change does not alter the substantive
scope of a DCO's obligations under proposed Sec. 39.12(b)(7). Core
Principle 7 and its implementing regulations, however, refer to
``swaps'' and ``transactions'' interchangeably without intending to
impose a substantive distinction on a SEF's obligations. For
example, Sec. 37.700 refers to ``swaps'' while Sec. Sec. 37.701-
702 refer to ``transactions,'' but the Commission's use of
``transaction'' is intended to refer generally to transactions of
swaps on the SEF and not intended to differentiate among agreements,
contracts, or transactions that constitute swaps (emphasis added).
\683\ Under proposed Sec. 37.702(b)(1), a SEF's obligation to
submit swaps for clearing to the DCO includes the SEF's obligation
to process and route swaps and is subject to the prompt, efficient,
and accurate standard.
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In conjunction with clarifying that the AQATP standard applies to
registered DCOs, the Commission proposes to streamline and consolidate
Sec. Sec. 39.12(b)(7)(ii)-(iii) to establish one AQATP standard for
registered DCOs under a new proposed Sec. 39.12(b)(7)(ii) for all
agreements, contracts, and transactions, regardless of whether they (i)
are executed competitively or non-competitively; (ii) are executed on
or pursuant to the rules of a SEF or DCM; or (iii) are swaps, futures
contracts, or options on futures contracts.\684\ The Commission also
proposes that this AQATP standard would apply to all such agreements,
contracts, and transactions after submission to the DCO, rather than
after execution, as currently required for competitively executed
transactions on or subject to
[[Page 62023]]
the rules of a DCM or SEF under existing Sec. 39.12(b)(7)(ii)
(emphasis added). The Commission believes that a DCO should be able to
accept or reject a trade for clearing in a similar AQATP standard time
frame after receiving the transaction, regardless of the manner of
execution--competitive or non-competitive--or whether the trade has
been processed and routed by a SEF or DCM, a third-party affirmation
hub, or the counterparties themselves on a direct basis. As applied to
swaps, a DCO would be subject to the same AQATP standard, regardless of
whether the swap is subject to the trade execution requirement or
otherwise voluntarily cleared.
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\684\ Based on this consolidation, the Commission proposes to
eliminate the existing language of Sec. 39.12(b)(7)(iii).
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The AQATP standard reflects the Commission's belief that acceptance
or rejection for clearing in close to real time is crucial both for
effective risk management and for the efficient operation of trading
venues.\685\ While the Commission did not prescribe a rigid time frame
for acceptance or rejection for clearing when adopting existing
Sec. Sec. 39.12(b)(7)(ii)-(iii), the Commission did note that the
performance standard would require action in a matter of milliseconds
or seconds, or at most, a few minutes, not hours or days.\686\ The
Commission notes that Commission staff continues to monitor reports
from DCOs about their ability to accept or reject trades for clearing
in a timely matter. To date, the Commission has not been made aware of
significant delays or difficulties meeting the ten-second standard
articulated in the 2013 Staff STP Guidance. Accordingly, as DCOs have
been able to accept or reject trades within ten seconds after
submission by the SEF for the past five years, the Commission proposes
that this standard continue for registered DCOs under the AQATP
standard under proposed Sec. 39.12(b)(7)(ii).
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\685\ See Timing of Acceptance for Clearing Final Rule at 21285.
In recognizing that some trading venues may not be fully automated,
the Commission stated that the use of manual steps would be
permitted, as long as the process could operate within the same
timeframes as the automated systems. Id. The Commission also noted
that the timeframe for acceptance by clearing FCMs (outlined under
Sec. 1.74) and DCOs is stricter than the timeframes for submission
by SDs and MSPs. Id. The Commission noted that ``where execution is
bilateral and clearing is voluntary, the delay between execution and
submission to clearing is, of necessity, within the discretion of
the parties to some degree. The Commission believes, however, that
prudent risk management dictates that once a trade has been
submitted to a clearing member or a DCO, the clearing member or DCO
must accept or reject it as quickly as possible.'' Id.
\686\ See id. For example, IRS were executed and cleared with an
average time of 1.9 seconds on CME platforms in early 2012. Id.
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(3) Sec. Sec. 37.702(b)(2)-(3)--Pre-Execution Credit Screening
With respect to the pre-execution credit screening of orders for
compliance with risk-based limits, the 2013 Staff STP Guidance
expressed the view that (i) a clearing FCM must be identified in
advance for each counterparty on an order-by-order basis for trades
intended for clearing; and (ii) a SEF must facilitate pre-execution
screening by each clearing FCM in accordance with Sec. 1.73 on an
order-by-order basis.\687\ To facilitate such screening in practice,
SEFs have provided their respective clearing FCMs with a ``pre-trade
credit screening'' functionality that allows them to screen orders
executed on the facility.\688\ The Divisions have viewed pre-trade
credit screening functionalities as beneficial to facilitate ``prompt
and efficient'' transaction processing in accordance with straight-
through processing requirements.\689\
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\687\ 2013 Staff STP Guidance at 3.
\688\ SEFs have been able to facilitate the use of their pre-
trade credit screening functionalities by clearing FCMs for swap
block trades pursuant to time-limited no-action relief provided by
Commission staff, which allows market participants to execute swap
block trades on the SEF that are intended to be cleared. See infra
Section XXII.A.--Sec. 43.2--Definition--Block Trade; Sec.
37.203(a)--Elimination of Block Trade Exception to Pre-Arranged
Trading. As discussed below, the Commission is proposing to amend
the definition of ``block trade'' under Sec. 43.2 to continue to
allow clearing FCMs to comply with Sec. 1.73 by using pre-execution
credit screenings on the SEF.
\689\ 2013 Staff STP Guidance at 2-3. With respect to
establishing pre-execution credit screenings, the 2013 Staff STP
Guidance expressed the view that SEFs and FCMs should work together
to effect the risk-based limits to ensure straight-through
processing of swaps. Id.
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With respect to pre-execution screening by each clearing FCM, the
2013 Staff STP Guidance viewed Sec. Sec. 1.73(a)(2)(i)-(ii) as
requiring a clearing FCM to conduct pre-execution screening of orders
for execution on a SEF or DCM for compliance with risk-based
limits.\690\ The 2013 Staff STP Guidance further expressed the view
that Sec. 1.73 provides FCMs with the ability to reject orders before
execution; as a result, orders that have satisfied clearing FCMs' pre-
execution limits are deemed accepted for clearing and thereby subject
to a guarantee by the clearing FCM upon execution.\691\ Accordingly,
the 2013 Staff STP Guidance expressed the view that a clearing FCM may
not reject a trade that has passed its pre-execution credit screening
filter because this would violate the AQATP standard, under which
trades should be accepted or rejected for clearing as soon as
technologically practicable as if fully automated systems were
used.\692\
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\690\ 2013 Staff STP Guidance at 1-2. Section 1.73(a)(1)
requires each clearing FCM to establish risk-based limits for each
proprietary account and each customer account that are based on
position size, order size, margin requirements, or similar factors.
17 CFR 1.73(a)(1). Similarly, Sec. 1.73(a)(2)(i) states that when a
clearing FCM provides electronic market access or accepts orders for
automated execution, the FCM must use automated means to screen
orders for compliance with such risk-based limits. 17 CFR
1.73(a)(2)(i). Section 1.73(a)(2)(ii) states that when a clearing
FCM accepts orders for non-automated execution, the FCM must
establish and maintain systems of risk controls reasonably designed
to ensure compliance with the limits. 17 CFR 1.73(a)(2)(ii). Section
1.73(a)(2)(iii) states that when a clearing FCM accepts transactions
that were executed bilaterally and then submitted for clearing, the
FCM must establish and maintain systems of risk controls reasonably
designed to ensure compliance with the limits. 17 CFR
1.73(a)(2)(iii). The Commission notes that paragraph (a)(2)(i)-(ii)
apply to ``orders,'' while paragraph (a)(2)(iii) applies to
``transactions.'' In addition, paragraph (a)(2)(iii) is limited to
transactions executed ``bilaterally.'' In contrast, the Commission
stated in the final rule adopting Sec. 1.73 that paragraph
(a)(2)(i) refers to ``automated trading systems,'' such as CME's
Globex, while paragraph (a)(2)(ii) includes ``non-automated markets
such as open outcry exchanges or voice brokers.'' See Timing of
Acceptance for Clearing Final Rule at 21288. As the Commission
affirmatively included voice brokers in connection with paragraph
(a)(2)(ii), transactions executed through voice brokers do not fall
under paragraph (a)(2)(iii). Accordingly, Sec. 1.73(a)(2)(iii) only
applies where two parties transact directly with one another,
outside of a SEF or DCM.
\691\ 2013 Staff STP Guidance at 3.
\692\ Id.
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With respect to the requirement that a clearing FCM must be
identified in advance for trades intended for clearing, the 2013 Staff
STP Guidance noted that the Commission has already required parties to
have a clearing arrangement in place with a clearing FCM in advance of
execution and that in cases where more than one DCO offered clearing
services, the parties would also need to specify in advance where the
trade should be sent for clearing.\693\ Accordingly, the 2013 Staff STP
Guidance expressed the view that no trade intended for clearing may be
executed on or subject to the rules of a SEF unless a clearing FCM was
identified in advance for each party on an order-by-order basis.\694\
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\693\ See Timing of Acceptance for Clearing Final Rule at 21284.
\694\ 2013 Staff STP Guidance at 3.
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In conjunction with the Commission's proposal to clarify and amend
straight-through processing requirements, the Commission proposes to
adopt these two obligations--that each market participant identify a
clearing member in advance and that a SEF facilitate pre-execution
credit screening--under Sec. Sec. 37.702(b)(2)-(3), respectively. The
Commission believes that the proposed requirements are consistent with
the proposed approach to straight-through processing as described
above. In
[[Page 62024]]
particular, the use of pre-execution credit screening functionalities
help SEFs and DCOs to both meet their respective straight-through
processing requirements by reducing the number of transactions that are
rejected from clearing by a DCO. The Commission notes that pre-
execution credit screening has become a fundamental component of the
swaps clearing infrastructure.\695\
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\695\ As noted above, the 2013 Staff STP Guidance expressed the
view that a clearing FCM may not reject a trade that has passed its
pre-execution credit screening filter because such a rejection would
violate the AQATP requirement. 2013 Staff STP Guidance at 3. The
Commission expects that this practice which is beneficial to market
participants by providing trade certainty in as minimal a time delay
as possible, will continue. The screening of transactions by a
clearing FCM does not, however, prevent the DCO from rejecting a
swap for clearing.
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Request for Comment
The Commission requests comment on all aspects of proposed Sec.
37.702 and Sec. Sec. 39.12(b)(7)(i)-(ii). In particular, the
Commission requests comment on the following questions:
(71) The proposed ``prompt, efficient, and accurate'' standard, as
applied to trades submitted to a DCO for clearing via third-party
affirmation hubs would take into consideration evolving swap market
practices and technology, as well as current market conditions at the
time of execution. Is the proposed approach appropriate? Why or why
not? Does the approach provide sufficient guidance regarding the
standard?
(72) Is the distinction sufficiently clear between (i) the
submission and related processing and routing of a swap by a SEF to a
DCO under the ``prompt, efficient, and accurate'' standard and (ii) the
DCO's decision to accept or not accept a swap under the AQATP standard?
Does the approach provide sufficient clarity regarding the distinct,
but interrelated, roles of SEFs and DCOs? Why or why not?
(73) The 2013 Staff STP Guidance and 2015 Supplementary Staff
Letter apply to ``intended to be cleared swaps,'' including swaps
subject to the clearing requirement and swaps that are voluntarily
cleared by the counterparties. Should these requirements apply to
voluntarily-cleared swaps?
(74) Proposed Sec. Sec. 39.12(b)(7)(ii) would eliminate the
distinction when applying the AQATP standard between (i) trades that
are executed competitively and (ii) trades that are not executed
competitively or are executed away from a SEF or DCM. Is the proposed
approach appropriate? Why or why not?
(75) Proposed Sec. 39.12(b)(7)(ii) would apply the AQATP standard
after submission to the DCO, rather than after execution. Is the
proposed approach appropriate? Why or why not?
(76) Proposed Sec. 39.12(b)(7)(ii) would apply the AQATP standard
after submission to the DCO, rather than after execution, for all
swaps, futures, and options on futures submitted for clearing. Proposed
Sec. 39.12(b)(7)(ii) would apply to all agreements, contracts, and
transactions submitted to the DCO for clearing. Is the proposed
approach appropriate? Why or why not?
(77) Should a DCO have the flexibility to have additional time to
address instances in which a clearing member has insufficient credit on
deposit for the DCO to accept an agreement, contract, or transaction
for clearing? If so, should the Commission require the DCO to have
rules and procedures for the DCO's process to address those instances?
3. Applicability of Sec. 37.702(b) to SEFs That Do Not Facilitate
Clearing
The Commission proposes to amend the introductory language under
proposed Sec. 37.702(b) to specify that its requirements apply only to
those transactions routed through a SEF to a registered DCO for
clearing rather than, as currently required, to any transaction cleared
by a DCO. While not meant to reflect a substantive change, the
Commission believes that this amendment would clarify that the
requirements of Sec. 37.702(b) do not apply to a SEF that does not
facilitate the clearing of applicable listed swaps that are not subject
to the clearing requirement. The requirements would apply, however, if
the SEF offers to facilitate the clearing of such swaps.\696\
Therefore, to the extent counterparties choose to voluntary clear such
transactions through a SEF that offers to facilitate clearing for such
swaps, Sec. 37.702(b) would then apply to the SEF.
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\696\ The Commission notes that certain SEFs, such as those that
facilitate trading in FX non-deliverable forward products, do not
hold themselves out as offering services to facilitate clearing with
a DCO. As a result, the straight-through processing requirements,
including the ``prompt, efficient, and accurate'' standard and pre-
execution credit screening requirements, would not apply to such
SEFs, even if the counterparties subsequently voluntarily clear a
swap away from the SEF. The Commission notes that a SEF could offer
to facilitate the clearing of certain listed swaps, to which Sec.
37.702(b)'s requirements would apply, while not offering to
facilitate the clearing of other of its listed swaps, to which Sec.
37.702(b)'s requirements would not apply. The Commission notes,
however, that the requirements of Sec. 39.12(b)(7)(ii) apply to all
agreements, contracts, and transactions submitted to a DCO for
clearing, regardless of whether a particular swap is subject to the
clearing requirement pursuant to section 2(h)(1) of the CEA.
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C. Sec. 37.703--Monitoring for Financial Soundness
Section 37.703(a) requires a SEF to monitor its members to ensure
that they continue to qualify as an ECP pursuant to CEA section
1a(18).\697\ The Commission proposes a non-substantive amendment to
proposed Sec. 37.703 to replace the term ``member'' with ``market
participant.'' The Commission notes that its proposed definition of
``market participant'' under Sec. 37.2(b) would capture the universe
of persons and entities that participate on SEFs and would be subject
to minimum financial requirements, including a SEF's members.\698\
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\697\ 17 CFR 37.703.
\698\ See supra Section IV.B.2.--Sec. 37.2(b)--Definition of
``Market Participant.'' The Commission notes that CEA section 2(e)
limits swaps trading to ECPs, as defined by section 1a(18) of the
Act. 7 U.S.C. 2(e).
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XIII. Part 37--Subpart I: Core Principle 8 (Emergency Authority)
Core Principle 8 requires a SEF to adopt rules to provide for the
exercise of emergency authority, in consultation or cooperation with
the Commission, as is necessary and appropriate, including the
authority to liquidate or transfer open positions in any swap or to
suspend or curtail trading in a swap.\699\
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\699\ 7 U.S.C. 7b-3(f)(8). The Commission codified Core
Principle 8 under Sec. 37.800. 17 CFR 37.800.
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A. Sec. 37.801--Additional Sources for Compliance
Section 37.801 further implements Core Principle 8 by referring
SEFs to associated guidance and/or acceptable practices set forth in
Appendix B to comply with Sec. 37.800.\700\ The guidance to Core
Principle 8 specifies, among other things, the types of emergency
actions that a SEF should take in particular to address perceived
market threats, and states that the SEF should promptly notify the
Commission of its exercise of emergency action.
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\700\ 17 CFR 37.801.
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The Commission proposes to amend the guidance to Core Principle 8
by eliminating references to certain emergency actions that the
Commission understands a SEF, as a matter of general market practice,
would not be able to adopt, including imposing special margin
requirements and transferring customer contracts and the margin. Since
SEFs do not own the contracts, they do not have the ability to impose
margin or transfer contracts. Additionally, the Commission proposes
[[Page 62025]]
several non-substantive amendments to the guidance.\701\
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\701\ For example, the Commission proposes to eliminate the
reference to Sec. 40.9, as this section is currently reserved by
the Commission.
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Request for Comment
The Commission requests comment on all aspects of the proposed
associated guidance to Core Principle 8 in Appendix B.
XIV. Part 37--Subpart J: Core Principle 9 (Timely Publication of
Trading Information)
The Commission is not proposing any amendments to the regulations
under Core Principle 9.
XV. Part 37--Subpart K: Core Principle 10 (Recordkeeping and Reporting)
Core Principle 10 requires a SEF, among other things, to maintain
records of all activities related to the business of the facility,
including a complete audit trail, in a form and manner acceptable to
the Commission for a period of five years.\702\ Section 37.1001
implements this requirement by requiring a SEF to maintain an audit
trail for all swaps executed on or subject to the rules of the SEF,
among other types of records. The Commission proposes a non-substantive
amendment to Sec. 37.1001 to eliminate ``or subject to the rules of''
from the existing requirement. This proposed amendment confirms to
conforms to the proposed amendment to the ``block trade'' definition
under Sec. 43.2, discussed further below.\703\
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\702\ 7 U.S.C. 7b-3(f)(10). The Commission codified Core
Principle 10 under Sec. 37.1000. 17 CFR 37.1000.
\703\ See infra Section XXII.--Part 43--Sec. 43.2--Definition
of ``Block Trade.''
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XVI. Part 37--Subpart L: Core Principle 11 (Antitrust Considerations)
The Commission is not proposing any amendments to the regulations
under Core Principle 11.
XVII. Part 37--Subpart M: Core Principle 12 (Conflicts of Interest)
The Commission has not adopted any regulations under Core Principle
12 and is not proposing any regulations at this time.
XVIII. Part 37--Subpart N: Core Principle 13 (Financial Resources)
Core Principle 13 requires a SEF to have adequate financial,
operational, and managerial resources to discharge each of its
responsibilities.\704\ To achieve financial resource adequacy, a SEF
must maintain financial resources sufficient to cover its operating
costs for a period of at least one year, calculated on a rolling
basis.\705\ The Commission implemented Core Principle 13 by adopting
Sec. Sec. 37.1301-1307 to specify (i) the eligible types of financial
resources that may be counted toward compliance (Sec. 37.1302); (ii)
the computation of projected operating costs (existing Sec. 37.1303);
(iii) valuation requirements (existing Sec. 37.1304); (iv) a liquidity
requirement for those financial resources that is equal to six months
of a SEF's operating costs (existing Sec. 37.1305); and (v) reporting
obligations to the Commission (Sec. 37.1306).
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\704\ 7 U.S.C. 7b-3(f)(13). The Commission codified Core
Principle 13 under Sec. 37.1300. 17 CFR 37.1300.
\705\ Id.
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The Commission implemented these regulations to ensure a SEF's
financial strength so that it could discharge its responsibilities,
ensure market continuity, and withstand unpredictable market
events.\706\ During the part 37 implementation, the Commission has
continued to receive feedback from several SEFs that the existing
requirements impose impractical financial and operating burdens.\707\
Among other things, these SEFs have contended that the amount of
financial resources that a SEF is required to maintain has proven to be
unnecessary and confines resources that could otherwise be allocated
toward operational growth and further innovation. To address some of
these concerns, Commission staff issued two guidance documents
regarding the calculation of operating costs.\708\
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\706\ When the Commission adopted Sec. 37.1301(a), it
recognized that a ``SEF's financial strength is vital to ensure that
the SEF can discharge its core principle responsibilities. . . .''
SEF Core Principles Final Rule at 33538-39.
\707\ See WMBAA, Re: Project KISS at 5 (Sept. 29, 2017) (``2017
WMBAA Letter'').
\708\ CFTC Letter No. 17-25; CFTC Letter No. 15-26, Division of
Market Oversight Guidance on Calculating Projected Operating Costs
by Swap Execution Facilities (Apr. 23, 2015) (``CFTC Letter No. 15-
26'').
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Based on its experience with overseeing the financial resources
requirements, the Commission proposes several amendments to the Core
Principle 13 regulations that would achieve a better balance between
ensuring SEF financial stability, promoting SEF growth and innovation,
and reducing unnecessary costs. The Commission's proposed amendments,
which include the addition of acceptable practices to Core Principle 13
in Appendix B, are based in part on existing Commission staff guidance,
feedback received from SEFs, and Commission experience gained from
ongoing oversight. As discussed in detail further below, the
Commission's proposed changes consist of (i) clarification of the scope
of operating costs that a SEF must cover with adequate financial
resources; (ii) acceptable practices, based on existing Commission
staff guidance, that address the discretion that a SEF has when
calculating projected operating costs pursuant to proposed Sec.
37.1304; (iii) amendments to the existing six-month liquidity
requirement for financial resources held by a SEF; and (iv) streamlined
requirements with respect to financial reports filed with the
Commission. The proposed changes also would include non-substantive
amendments to clarify certain existing requirements, including the
renumbering of several provisions to present the requirements in a more
cohesive manner.
A. Sec. 37.1301--General Requirements
1. Sec. 37.1301(a)
Existing Sec. 37.1301(a) requires a SEF to maintain financial
resources that are sufficient to enable it to perform its functions in
compliance with the SEF core principles set forth in section 5h of the
Act (emphasis added).\709\ Existing Sec. 37.1301(c) relates to this
requirement and specifies that a SEF's financial resources are
sufficient if their value is ``at least equal to'' the SEF's operating
costs for a one-year period, on a rolling basis.\710\
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\709\ 17 CFR 37.1301(a).
\710\ 17 CFR 37.1301(c).
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Certain SEFs have stated that existing Sec. 37.1301(a), when read
in conjunction with Sec. existing 37.1301(c), can be construed to
state that operational costs incurred for functions that are not
germane to discharging SEF core principle responsibilities must be
included in a financial resources calculation. According to those SEFs,
requiring those costs to be included would require a SEF to allocate
additional resources to comply with the requirement, which would hinder
its ability to allocate that capital to operational growth and
innovation, thereby creating unnecessary burdens.\711\
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\711\ See 2017 WMBAA Letter at 6 (stating that the financial
resource requirements should focus on fixed costs required for
compliance, rather than variable costs and staff-related costs that
are not essential).
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The Commission proposes to consolidate the requirement under
existing Sec. 37.1301(c) into a new proposed Sec. 37.1301(a) and
adopt several amendments. First, the Commission proposes to amend the
types of operating costs that must be included in a SEF's financial
resources determination. As proposed, a SEF would be required to
maintain adequate financial resources to cover the
[[Page 62026]]
operating costs that a SEF needs to ``comply'' with the SEF core
principles and any applicable Commission regulations, rather than
``perform its functions in compliance with'' the core principles. For
example, under the current requirement, a SEF must maintain financial
resources to continue to afford all of its existing activities (for
example, activities such as product research or business development),
even if such activities are not mandated by any core principle or
regulatory requirement. Under the proposed amendment, a SEF would not
need to include costs that are not necessary to comply with the SEF
core principles and any applicable Commission regulations when
calculating its operating costs.
The Commission believes that the proposed regulation represents a
better and more balanced regulatory approach to implementing the Core
Principle 13 requirements. Some SEF operational costs may not be
necessary for discharging core principle and regulatory
responsibilities, and therefore, should not be included when
calculating a SEF's financial resources. Rather than require a SEF to
allocate capital to account for such operating costs, the proposed
amendment permits SEFs to allocate their capital to other areas,
thereby furthering the goal of promoting SEF growth and
innovation.\712\ Therefore, proposed Sec. 37.1301(a) would achieve a
better balance between ensuring that a SEF is financially stable, while
also providing the SEF with greater discretion to allocate its limited
resources.\713\ Further, the proposed amendment would remove a
potential barrier for new SEF entrants who may otherwise have been
deterred by the relatively higher capital costs posed by a broad
reading of the existing requirement.
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\712\ The Commission understands that businesses, particularly
nascent SEFs or SEFs developing new product lines, may incur
relatively greater expenses in growing new business, compared to
established SEFs or existing product lines. The Commission notes
that under the proposed acceptable practices to Core Principle 13 in
Appendix B, costs related to marketing and business development
could be excluded from a SEF's projected operating cost
calculations. See infra Section XVIII.D.1.--Acceptable Practices to
Core Principle 13 in Appendix B.
\713\ The Commission believes that the proposed financial
resources obligations in the aggregate would better ensure market
stability and the financial viability of SEFs. While proposed Sec.
37.1301(a), along with the associated acceptable practices to Core
Principle 13, may reduce the total amount of financial resources
that a SEF must hold under Sec. 37.1301(a), the Commission believes
that such a change should not affect market integrity or the
financial viability of SEFs. SEFs may include illiquid financial
assets, as opposed to cash or cash equivalents, towards satisfying
this requirement. The Commission, however, has also recognized that
based on its experience, illiquid resources are less effective for
ensuring an entity's viability, especially in times of market
volatility where it may be difficult to timely sell illiquid assets
or avoid a significant haircut on such assets. Consequently, the
Commission believes that the amount of liquid assets that a SEF must
hold, which the Commission addresses under proposed Sec. 37.1303,
more effectively protects market integrity and the financial
viability of SEFs. As discussed below, proposed Sec. 37.1303 would
explicitly require SEFs to maintain sufficient liquidity to cover
their projected wind-down costs, with a minimum liquidity level in
an amount no less than three months of projected operating costs
where wind-down costs would be less than three months of projected
operating costs. See infra Section XVIII.C.--Sec. 37.1303--
Liquidity of Financial Resources.
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The Commission also proposes several non-substantive changes to
align proposed Sec. 37.1301(a) more closely to Core Principle 13
requirements. To reflect the ongoing nature of the Core Principle 13
requirements, the Commission proposes to specify that a SEF must
maintain adequate financial resources on an ``ongoing basis.'' For
consistency purposes with Core Principle 13, the Commission also
proposes to replace the word ``sufficient'' with ``adequate'' and adopt
additional language to specify that a SEF's financial resources will be
considered ``adequate'' if their value ``exceeds,'' rather than is ``at
least equal to,'' one year's worth of operating costs,\714\ calculated
on a rolling basis pursuant to the requirements for calculating such
costs under proposed Sec. 37.1304.\715\
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\714\ The Commission notes that it is also proposing a non-
substantive amendment to refer to ``projected operating costs''
instead of ``operating costs'' to conform to existing Sec. 37.1304
and Sec. 37.1307, both of which refer to ``projected operating
costs.'' The Commission notes that during informal discussions with
SEFs, Commission staff and SEFs have generally referred to SEFs'
``projected'' operating costs.
\715\ As discussed below, proposed Sec. 37.1304 (which the
Commission proposes to renumber from existing Sec. 37.1303) would
continue to provide SEFs with reasonable discretion to calculate
their projected operating costs to determine their financial
resources requirement under Sec. 37.1301(a) and their liquidity
requirement under proposed Sec. 37.1303.
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Further, as noted above, the Commission proposes to adopt
additional language to clarify that a SEF's financial resources must be
adequate to comply with the SEF core principles and any ``applicable
Commission regulations.'' This amendment is intended to clarify that a
SEF's resource adequacy obligation under proposed Sec. 37.1301(a) also
applies to any resources needed for complying with any additional
regulatory requirements that the Commission has promulgated.\716\ The
Commission notes that SEFs are already complying with this
clarification in practice.
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\716\ The Commission notes that under Core Principle 1, a SEF
must comply with any rule or regulation promulgated by the
Commission pursuant to section 8a(5) of the Act. 17 CFR 37.100. For
a SEF to discharge its responsibilities pursuant to Core Principle
13, which include complying with the SEF core principles, it is
required to ensure that its financial resources are adequate to
comply with those rules or regulations.
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Request for Comment
The Commission requests comment on all aspects of proposed Sec.
37.1301(a). In particular, the Commission requests comment on the
following question:
(78) To what extent does a requirement for SEFs to maintain
financial resources to cover operational costs needed only for core
principle and regulatory compliance reduce the financial resources that
a SEF needs to maintain, as opposed to the current requirement? Would
such a reduction, if any, impair the stability of either the SEF or the
marketplace or the marketplace's confidence in the SEF market
structure? Would this proposed change encourage innovation or new
entrants into the marketplace?
2. Sec. 37.1301(b)
Section 37.1301(b) requires a SEF that also operates as a DCO to
also comply with the financial resource requirements for DCOs under
Sec. 39.11.\717\ The Commission proposes to amend Sec. 37.1301(b) to
permit SEFs that also operate as DCOs to file a single financial report
under Sec. 39.11 that covers both the SEF and DCO.\718\ This proposed
approach would streamline and simplify the SEF financial report filing
process set forth under Sec. 37.1306 and would also be consistent with
the requirement for DCMs under Sec. 38.1101(a)(3), which permits DCMs
that operate as a DCO to file a single financial report.\719\
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\717\ 17 CFR 37.1301(b).
\718\ See Derivatives Clearing Organization General Provisions
and Core Principles, 76 FR 69334 (Nov. 8, 2011). Section 39.11
establishes requirements that a DCO will have to meet in order to
comply with Core Principle B (Financial Resources) for DCOs. 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 a 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 one year, as calculated
on a rolling basis. 7 U.S.C. 7a-1(c)(2)(B)(ii).
\719\ 17 CFR 38.1101(a)(3).
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Request for Comment
The Commission requests comment on all aspects of proposed Sec.
37.1301(b).
[[Page 62027]]
3. Sec. 37.1301(c)
Given the proposed consolidation with Sec. 37.1301(a), as
described above, the Commission proposes to eliminate Sec. 37.1301(c).
B. Sec. 37.1302--Types of Financial Resources
Section 37.1302 sets forth the types of financial resources
available to SEFs to satisfy the general financial resources
requirement.\720\ These resources include the SEF's own capital,
meaning its assets minus liabilities calculated in accordance with U.S.
generally accepted accounting principles; and any other financial
resource deemed acceptable by the Commission.\721\ The Commission
proposes a non-substantive amendment to the current language by
referring to generally accepted accounting principles ``in the United
States'' to conform to the proposed amendments to Sec. 37.1306
described further below.\722\
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\720\ 17 CFR 37.1302.
\721\ Id.
\722\ See infra Section XVIII.F.1.--Sec. 37.1306(a).
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C. Sec. 37.1303--Liquidity of Financial Resources \723\
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\723\ The Commission proposes to renumber existing Sec. 37.1305
to Sec. 37.1303 and amend the requirement as described.
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Existing Sec. 37.1305--``Liquidity of financial resources''--
currently requires a SEF to maintain unencumbered, liquid financial
assets, i.e., cash and/or highly liquid securities, that are equal to
at least six months of a SEF's operating costs.\724\ If any portion of
a SEF's financial resources is not sufficiently liquid, then a SEF is
permitted to take into account a committed line of credit or similar
facility to meet this requirement.\725\ In adopting this rule, the
Commission explained that the liquidity requirement is intended to
ensure that a SEF could continue to operate and wind down its
operations in an orderly fashion, if necessary.\726\ The Commission
also determined that a six-month period would be an accurate assessment
of how long it would take for a SEF to wind down in an orderly manner,
absent support for alternative time frames.\727\
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\724\ 17 CFR 37.1305.
\725\ Id.
\726\ The Commission stated that ``the purpose of the liquidity
requirement is so that all SEFs have liquid financial assets to
allow them to continue to operate and to wind down in an orderly
fashion'' and that the Commission ``view[ed] a six month period as
appropriate for a wind-down period . . . .'' SEF Core Principles
Final Rule at 33540.
\727\ Id.
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The Commission proposes to amend the minimum amount of liquid
financial resources that a SEF must include from six months of
operating costs to the greater of (i) three months of a SEF's projected
operating costs or (ii) the projected costs for a SEF to wind down its
business, as determined by the SEF.\728\ The Commission acknowledges
that in the SEF Core Principles Final Rule, it rejected a three-month
requirement based on a lack of cited support for a shorter time
frame.\729\ Based on its own past oversight of SEFs and DCMs and
feedback from registered SEFs since the adoption of part 37, however,
the Commission recognizes that the existing six-month requirement is
not necessary. Rather, the Commission believes that the proposed
requirement, which sets the minimum amount of unencumbered, liquid
financial assets that a SEF must maintain at three months of projected
operating costs, would be sufficient to fulfill the goal of ensuring
that a SEF can continue to operate and, if necessary, wind down its SEF
operations in an orderly fashion.
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\728\ The Commission notes that it is proposing to specify
``projected'' operating costs for consistency with the cost
calculation requirement under Sec. 37.1304, discussed below. See
infra Section XVIII.D.--Sec. 37.1304--Computation of Costs to Meet
Financial Resources Requirement.
\729\ SEF Core Principles Final Rule at 33540.
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Since the adoption of part 37, many SEFs have continued to maintain
that a six-month minimum requirement is not necessary and that some of
their liquid assets would be better applied toward growth
initiatives.\730\ Consistent with that feedback, the Commission has
observed over time that the wind downs or ownership changes of several
registered trading platforms, including SEFs and DCMs, have occurred
within a much shorter time frame.\731\ Based on this experience, the
Commission acknowledges that a SEF may be better positioned to
determine the amount of liquid financial resources needed to continue
its operations and to conduct an orderly wind down. Under the proposed
change, SEFs would be able to use the additional resources to invest in
other areas of their operations. Accordingly, compared to the existing
static six-month requirement, the Commission believes that a liquid
resources requirement of the ``greater of'' either (i) three months of
projected operating costs or (ii) projected wind-down costs would
better ensure an orderly wind down for SEFs and ensure a more efficient
allocation of resources for SEFs that require a wind-down period of
less than six months. Further, by explicitly requiring a SEF to
maintain sufficient liquidity to conduct an orderly wind down of its
business, this approach would also better protect against the risk of
failure in the unlikely event that a SEF would require a wind-down
period of longer than six months.
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\730\ See 2017 WMBAA Letter at 5 (citing argument that a shorter
liquidity requirement would allow for a SEF to allocate capital for
innovation).
\731\ For example, the Commission notes that the DCM Green
Exchange LLC had its designation vacated and ceased operations.
Similarly, the DCM Kansas City Board of Trade was acquired by CME
Group and had its designation vacated; it ultimately ceased
operations. Likewise, Javelin SEF, LLC was acquired by Bats Global
Markets, Inc., which in turn was subsequently acquired by CBOE SEF,
LLC. In each case, the Commission observed a relatively efficient
process.
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The Commission also proposes a non-substantive amendment to clarify
that if a SEF has a deficiency in satisfying this requirement, then it
may overcome that deficiency by obtaining a committed line of credit or
similar facility in an amount at least equal to that deficiency.
Request for Comment
The Commission requests comment on all aspects of proposed Sec.
37.1303. In particular, the Commission requests responses to the
questions below.
(79) Is the Commission's proposed requirement for a SEF to have
liquid assets equal to the greater of either three months of projected
operating costs or projected wind-down costs an appropriate approach?
If not, then what should the Commission adopt as a more appropriate
liquidity requirement and why? Would a SEF's wind-down period generally
be longer or shorter than three months?
(80) Would the change to the liquidity requirement under proposed
Sec. 37.1303 impair the stability of either the SEF or the
marketplace? Would proposed Sec. 37.1303 encourage innovation or new
entrants into the marketplace?
D. Sec. 37.1304--Computation of Costs To Meet Financial Resources
Requirement 732
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\732\ The Commission also proposes to renumber existing Sec.
37.1303 to Sec. 37.1304 and amend the requirement as described.
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Existing Sec. 37.1303--``Computation of projected operating costs
to meet financial resource requirement''--currently requires a SEF to
make a reasonable calculation of its projected operating costs for each
fiscal quarter over a twelve-month period to determine the amount of
financial resources needed to comply with the financial resource
requirement.\733\ Existing Sec. 37.1303 further provides that a SEF
has reasonable discretion to determine the methodology that it uses to
compute its projected operating costs, although the Commission may
review
[[Page 62028]]
the SEF's methodology and require the SEF to make changes as
appropriate.\734\
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\733\ 17 CFR 37.1303.
\734\ Id.
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The Commission proposes to amend the existing requirement to
specify that a SEF must also make a reasonable calculation of projected
wind-down costs, but would have reasonable discretion in adopting the
methodology for calculating such costs. This proposed addition is
consistent with the reasonable discretion already provided for
calculating projected operating costs and corresponds to Sec. 37.1303,
which incorporates the calculation of a SEF's wind-down costs into the
liquidity determination. The Commission also proposes two non-
substantive amendments that would add a reference to Sec. 37.1303,
given that a SEF must calculate projected operating costs to determine
how to comply with the liquidity requirement; and eliminate the twelve-
month requirement, given that proposed Sec. 37.1301(a) already
establishes that the financial resource requirement applies on a one-
year, rolling basis.
1. Acceptable Practices to Core Principle 13 in Appendix B
To help SEFs comply with Core Principle 13, which requires a SEF to
calculate its operating costs as part of a financial resources
determination, the Commission is proposing acceptable practices to Core
Principle 13 in Appendix B associated with Sec. 37.1304. The proposed
acceptable practices expound upon the reasonable discretion that SEFs
have for computing projected operating costs in determining their
financial resource requirements. Among other things, these acceptable
practices would further explain which operating costs are not necessary
to comply with the SEF core principles and the Commission's
regulations. The Commission notes that these acceptable practices
generally incorporate existing guidance provided by Commission
staff.\735\
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\735\ The proposed acceptable practices to Core Principle 13 in
Appendix B are based in part upon existing DMO staff guidance. See
CFTC Letter No. 17-25 and CFTC Letter No. 15-26.
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The proposed acceptable practices state that calculations of
projected operating costs, i.e., those that are necessary for the SEF
to comply with the SEF core principles and any applicable Commission
regulations, should be based on a SEF's current business model and
anticipated business volume.\736\ In particular, if the SEF offers more
than one bona fide execution method, then a SEF would be allowed to
include the costs of only one of those methods in calculating projected
operating costs.\737\ A bona fide method refers to a method actually
used by SEF participants and not established by a SEF on a pro forma
basis merely for the purpose of complying with--or evading--the
financial resources requirement.
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\736\ In determining a SEF's projected operating costs under
Sec. 37.1301(a) or Sec. 37.1303, a calculation based upon a
hypothetical business model that has lower associated costs or lower
business volume, and is intended to underestimate or minimize the
level of required financial resources, would not be appropriate. As
stated in the proposed acceptable practices, however, a SEF may
account for any projected modification to its business model, e.g.,
the addition or subtraction of business lines or operations or other
changes, in its calculations and therefore any projected increase or
decrease in revenue or operating costs from those changes over the
next 12 months.
\737\ For example, if a SEF offers both an order book and RFQ
system, then the SEF may include the costs associated with one of
those methods and exclude the costs associated with the other
method.
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This approach would still require SEFs to maintain sufficient
financial resources to ensure their financial viability, but also
provide greater flexibility to SEFs to compute operating costs,
consistent with the reasonable discretion provided under proposed Sec.
37.1304. Although neither the CEA nor the Commission's regulations
require a SEF to have more than one execution method, this flexibility
could encourage SEFs to innovate and experiment in offering a variety
of trading systems or platforms compared to the current requirements.
Accordingly, this flexibility would mitigate possible disincentives for
a SEF to limit the number and types of execution methods that it might
otherwise develop and offer, were it required to account for the
associated operating costs for all offered execution methods in a
calculation. In excluding any of these expenses, however, a SEF would
need to document and justify those exclusions pursuant to proposed
requirements under Sec. 37.1306, discussed further below.\738\
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\738\ See infra Section XVIII.F.3.--Sec. 37.1306(c).
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The proposed acceptable practices would also specify that a SEF may
exclude certain expenses in making a ``reasonable'' calculation of
projected operating costs. These expenses include, in part, marketing
and development costs; variable commissions paid to SEF trading
specialists, the payment of which is contingent on whether the SEF
collects associated revenue from transactions on its systems or
platforms; \739\ and costs for other SEF personnel who are not
necessary to enable a SEF to comply with the core principles, based on
its current business model and business volume.\740\ Further, a SEF may
exclude any non-cash costs, including depreciation and amortization.
The Commission notes that excluding these expenses would be consistent
with the proposed financial resource requirement and proposed liquidity
requirement because they do not reflect costs necessary for a SEF to
comply with the SEF core principles or Commission regulations.
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\739\ See CFTC Letter No. 17-25.
\740\ For example, if a SEF requires a certain amount of SEF
trading specialists to operate a voice-based or voice-assisted
trading system or platform, but hires additional personnel to
enhance its operations to benefit market participants, then the SEF
would only need to include the minimum number of trading specialists
needed to operate the trading system or platform based on its
current business volume and take into account any projected increase
or decrease in business volume in its projected operating cost
calculations.
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In addition to allowing a SEF to exclude certain projected
operating costs, the proposed acceptable practices further specify that
a SEF may pro-rate, but not exclude, certain expenses in calculating
projected operating costs. The Commission recognizes that some costs
may be only partly attributable to a SEF's ability to comply with the
SEF core principles and the Commission's regulations; therefore, only
those attributed costs would need to be included in a SEF's projected
operating costs. Accordingly, a SEF may pro-rate expenses that are
shared with affiliates, e.g., the costs of administrative staff or
seconded employees that a SEF shares with affiliates. Further, a SEF
may also pro-rate expenses that are attributable in part to operational
aspects that are not required to comply with the SEF core principles,
e.g., costs of a SEF's office rental space, to the extent that it is
also used to house marketing personnel. In pro-rating any such
expenses, however, a SEF would need to document and justify those pro-
rated expenses pursuant to proposed requirements under Sec. 37.1306,
discussed further below.\741\
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\741\ See infra Section XVIII.F.3.--Sec. 37.1306(c).
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Request for Comment
The Commission requests comment on all aspects of proposed Sec.
37.1304 and the associated acceptable practices to Core Principle 13 in
Appendix B. In particular, the Commission requests comment on the
following question:
(81) The proposed acceptable practices would permit a SEF to
include only the costs related to one of the bona fide execution
methods that it offers. Should a SEF instead be required to include in
its projected operating costs the expenses related to all of its
execution methods? Why or why not?
[[Page 62029]]
E. Sec. 37.1305--Valuation of Financial Resources 742
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\742\ The Commission proposes to renumber Sec. 37.1304 to Sec.
37.1305 and amend the requirement as described.
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Section 37.1304--``Valuation of financial resources''--currently
requires a SEF, at least once each fiscal quarter, to compute the
current market value of each financial resource used to meet its
financial resources requirement under Sec. 37.1301.\743\ The
requirement is designed to address the need to update valuations when
there may have been material fluctuations in market value that could
impact a SEF's ability to satisfy its financial resource
requirement.\744\ When valuing a financial resource, the SEF must
reduce the value, as appropriate, to reflect any market or credit risk
specific to that particular resource, i.e., apply a haircut.\745\
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\743\ 17 CFR 37.1304.
\744\ SEF Core Principles Final Rule at 33539.
\745\ A ``haircut'' is a deduction taken from the value of an
asset to reserve for potential future adverse price movement in such
asset. Id. at 33539 n.772.
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The Commission proposes a non-substantive amendment to add an
applicable reference to Sec. 37.1303. The Commission notes that in
addition to calculating the current market value of each financial
resource used to satisfy its financial resource requirement, compliance
with the liquidity requirement would require a SEF to utilize the
current market value of the applicable financial resources.
F. Sec. 37.1306--Reporting to the Commission
1. Sec. 37.1306(a)
Section 37.1306 establishes a SEF's financial reporting
requirements to the Commission. Section 37.1306(a)(1) currently
requires that at the end of each fiscal quarter or upon Commission
request, a SEF must report to the Commission (i) the amount of
financial resources necessary to meet the financial resources
requirement of Sec. 37.1301; and (ii) the value of each financial
resource available to meet those requirements as calculated under Sec.
37.1304.\746\ Section 37.1306(a)(2) additionally requires a SEF to
provide the Commission with a financial statement, including a balance
sheet, income statement, and statement of cash flows of the SEF or its
parent company.\747\ In lieu of submitting its own financial
statements, a SEF may submit the financial statements of its parent
company.\748\
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\746\ 17 CFR 37.1306(a)(1).
\747\ 17 CFR 37.1306(a)(2).
\748\ Id.
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The Commission proposes several amendments to Sec. 37.1306(a)(2).
First, the Commission proposes to require a SEF to prepare its
financial statements in accordance with generally accepted accounting
principles in the United States (``GAAP''). For a SEF that is not
domiciled in the U.S. and is not otherwise required to prepare its
financial statements in accordance with GAAP, the Commission would
allow that SEF to prepare its statements in accordance with either the
International Financial Reporting Standards issued by the International
Accounting Standards Board, or a comparable international standard as
the Commission may accept in its discretion. The Commission notes that
the quality and transparency of SEF financial reports submitted under
the existing requirement have varied and believes that the GAAP-based
requirement would promote consistency and better ensure a minimum
reporting standard across financial submissions.
The Commission also proposes to require a SEF to provide its own
financial statements, rather than allow a SEF the option of submitting
the statements of its parent company. The Commission notes that it may
lack jurisdiction over a SEF's parent company or its affiliates; in
such instances, the Commission could not consider the parent company's
financial resources in determining whether the SEF itself possesses
adequate financial resources. Therefore, the Commission believes that a
separate SEF financial statement would more clearly demonstrate
evidence of the SEF's compliance with Core Principle 13.
In addition to the proposed amendments to Sec. 37.1306(a)(2), the
Commission proposes non-substantive revisions to Sec. 37.1306(a)(1) to
add appropriate references to Sec. 37.1303 to Sec. 37.1305, as
discussed above. In addition to specifying the amount of financial
resources necessary to comply with Sec. 37.1301, a SEF's quarterly
report must include the amount of financial resources necessary to
comply with the liquidity requirement. Further, the amounts specified
in the report must be based on the current market value of each
financial resource and computed as reasonable calculations of the SEF's
projected operating costs and wind-down costs.
Request for Comment
The Commission requests comment on all aspects of proposed Sec.
37.1306(a). In particular, the Commission requests comment on the
questions below:
(82) Should the Commission require a SEF's financial reports to be
audited? Would requiring an audited annual financial report improve
Commission oversight? What costs would be associated with an audit
requirement?
(83) Instead of submitting four financial reports as currently
required, should the Commission require a semi-annual report and an
audited annual report?
(84) Would providing the Commission with the discretionary
authority to request that SEFs provide audited financial statements, as
necessary or appropriate, help the Commission meet its oversight
responsibilities?
(85) Financial statements currently submitted by SEFs do not need
to comply with GAAP. What are the costs and benefits of requiring GAAP-
compliant financial submissions?
2. Sec. 37.1306(b)
Section 37.1306(b) currently requires a SEF to make its financial
resource calculations on the last business day of its fiscal
quarter.\749\ The Commission proposes a non-substantive amendment to
Sec. 37.1306(b) that would add the word ``applicable'' before ``fiscal
quarter'' in the existing rule text.
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\749\ 17 CFR 37.1306(b).
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3. Sec. 37.1306(c)
Section 37.1306(c) sets forth documentation requirements for a
SEF's financial reporting obligations. Section 37.1306(c)(1) requires a
SEF to provide the Commission with sufficient documentation explaining
the methodology used to calculate its financial resource requirements
under Sec. 37.1301.\750\ Section 37.1306(c)(2) requires a SEF to
provide sufficient documentation explaining the basis for its valuation
and liquidity determinations.\751\ To provide such documentation, Sec.
37.1306(c)(3) requires SEFs to provide copies of certain agreements
that evidence or otherwise support its conclusions.\752\
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\750\ 17 CFR 37.1306(c)(1)
\751\ 17 CFR 37.1306(c)(2).
\752\ 17 CFR 37.1306(c)(3).
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Based on the proposed amendments to the Core Principle 13
regulations described above, the Commission proposes conforming
amendments to Sec. 37.1306(c) to require a SEF to specify the
methodology used to compute its financial resource and liquidity
requirements. The documentation to be provided must be sufficient for
the Commission to determine that the SEF has made reasonable
calculations of projected operating costs and wind-down costs under
Sec. 37.1304. As
[[Page 62030]]
proposed, Sec. Sec. 37.1306(c)(2)(i)-(iv) \753\ would require that the
SEF, at a minimum (i) list all of its expenses, without exclusion; (ii)
identify all of those expenses that the SEF excluded or pro-rated in
its projected operating cost calculations and explain the basis for
excluding or pro-rating any expenses; (iii) include documentation
related to any committed line of credit or similar facility used to
meet the liquidity requirement; \754\ and (v) identify estimates of all
of the costs and the projected amount of time required for any wind
down of operations, including the basis for those estimates.
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\753\ The Commission proposes to consolidate paragraphs (c)(1)-
(3) into paragraphs (c)(1)-(2) and adopt the proposed requirements
as described.
\754\ The Commission notes that it is also proposing a non-
substantive change to eliminate the current language in paragraph
(c)(3) regarding copies of insurance coverage or other arrangement
evidencing or otherwise supporting the SEF's conclusions. The
Commission notes that subsection (c) still requires a SEF to provide
sufficient documentation explaining the methodology used to compute
its financial resource requirements; therefore, if insurance
coverage or other arrangements are necessary to explain a SEF's
methodology, then the SEF must submit such documentation. The
Commission also notes, however, that such documentation may not be
required in all cases; proposed paragraph (c)(2) provides minimum
requirements.
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The proposed requirement does not necessarily create new
obligations, but rather clarifies a SEF's existing obligations based
upon existing guidance provided by Commission staff.\755\ Further, the
proposed requirement is specifically intended to ensure that a SEF has
sufficient financial resources, particularly in light of the discretion
provided to SEFs to compute their projected operating costs and wind-
down costs. Therefore, the Commission believes that maintaining the
general obligation for each SEF to identify all of its expenses in its
financial report, including those that correspond to activities that
are not needed for compliance or otherwise are excluded or pro-rated
from projected operating costs, is appropriate on an ongoing basis.
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\755\ See CFTC Letter No. 17-25 at 4.
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The Commission further believes that proposed Sec. Sec.
37.1306(c)(2)(i)-(iv) would address the current lack of adequate
documentation or insufficient identification of excluded or pro-rated
expenses by some SEFs in submitting their projected operating costs
based on Commission staff guidance. Absent the guidance, the Commission
notes that the existing rule has created burdens for Commission staff
when determining whether a SEF complies with Core Principle 13. In its
experience thus far, the Commission recognizes that Commission staff
has devoted additional effort to obtain the appropriate documentation
from SEFs. Therefore, the Commission believes that adding greater
specificity to the existing requirement would mitigate the time and
resources required to determine a SEF's compliance with the financial
resource requirements.
Request for Comment
The Commission requests comment on all aspects of proposed Sec.
37.1306(c).
4. Sec. 37.1306(d)
Section 37.1306(d) requires a SEF to file its financial report no
later than forty calendar days after the end of each of the SEF's first
three fiscal quarters and no later than sixty calendar days after the
end of the SEF's fourth fiscal quarter, or at such later time as the
Commission may permit.\756\
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\756\ 17 CFR 37.1306(d).
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The Commission proposes to extend the due date for each SEF's
fourth fiscal quarter report from sixty to ninety days following the
end of the quarter. This new proposed due date conforms with the due
date for the SEF annual compliance report under proposed Sec.
37.1501(e)(2).\757\ The Commission recognizes that preparing multiple
year-end reports, which includes a fourth-quarter financial report and
an annual compliance report, for concurrent submission imposes resource
constraints on a SEF.\758\ Therefore, the Commission believes that such
potential constraints justify an additional thirty days to prepare and
concurrently file the SEF's fourth quarter financial report along with
its annual compliance report.
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\757\ See infra Section XX.A.5.--Sec. 37.1501(e)--Submission of
Annual Compliance Report and Related Matters.
\758\ The Commission also notes that it is proposing to require
a SEF to submit an updated Technology Questionnaire under Sec.
37.1401(g) at the same time on an annual basis. See infra Section
XIX.B.--Sec. 37.1401(g)--Program of Risk Analysis and Oversight
Technology Questionnaire.
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Request for Comment
The Commission requests comment on all aspects of proposed Sec.
37.1306(d).
5. Sec. 37.1306(e)
The Commission proposes to add a new requirement under Sec.
37.1306(e) for each SEF to provide notice to the Commission of its non-
compliance with the financial resource requirements no later than
forty-eight hours after the SEF knows or reasonably should have known
of its non-compliance.\759\ Each SEF has an ongoing obligation to
comply with the requirements under Core Principle 13. The proposed
requirement would clarify that the SEF cannot wait until filing its
quarterly financial reports to notify the Commission that it no longer
satisfies the Core Principle 13 financial resources requirements. In
some instances, the Commission has not been informed of a SEF's non-
compliance with the financial resource requirements until the filing of
a quarterly financial report. The Commission believes, however, that
prompt notification of non-compliance is necessary for the Commission
to conduct proper market oversight and ensure market stability on an
ongoing basis.
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\759\ For example, if a SEF knows or reasonably should know that
its assets will no longer cover its projected operating costs for
the next twelve months, as calculated on a rolling basis, then the
SEF should notify the Commission within forty-eight hours.
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Request for Comment
The Commission requests comment on all aspects of proposed Sec.
37.1306(e).
G. Sec. 37.1307--Delegation of Authority
Section 37.1307(a) currently delegates authority to the Director of
DMO, or other staff as the Director may designate, to perform certain
functions that are reserved to the Commission under the Core Principle
13 regulations, including reviewing the methodology used to compute
projected operating costs.\760\
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\760\ 17 CFR 37.1307(a).
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The Commission proposes to amend Sec. 37.1307(a)(2) to clarify
that the Commission may additionally delegate the authority to review
and make changes to the methodology used by a SEF to determine the
market value of its financial resources under Sec. 37.1305 and the
methodology that SEFs use to determine their wind-down costs under
Sec. 37.1304. Further, the Commission would delegate the ability to
request the additional documentation related to the calculation
methodologies used under Sec. 37.1306(c) and the notification of non-
compliance under Sec. 37.1306(e). The proposed amendments also include
several additional non-substantive amendments based on the proposed
amendments to Core Principle 13 regulations, as described above.
Request for Comment
The Commission requests comment on all aspects of proposed Sec.
37.1307.
XIX. Part 37--Subpart O: Core Principle 14 (System Safeguards)
Core Principle 14 requires that SEFs (i) establish and maintain a
program of risk analysis and oversight to identify and minimize sources
of operational risk, through the development of
[[Page 62031]]
appropriate controls and procedures, and automated systems that are
reliable, secure, and have adequate scalable capacity; (ii) 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 SEFs' responsibilities and
obligations; and (iii) 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.\761\ The Commission promulgated
rules under Sec. 37.1401 to further implement those requirements.\762\
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\761\ 7 U.S.C. 7b-3(f)(14). The Commission codified Core
Principle 14 under Sec. 37.1400. 17 CFR 37.1400.
\762\ 17 CFR 37.1401.
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The Commission is not proposing any amendments to existing
Sec. Sec. 37.1401(a)-(b), (e)-(f), (g)-(i), or (k)-(m), other than
non-substantive changes to paragraph references that are based on the
changes described below.
A. Sec. 37.1401(c)
Section 37.1401(c) requires each SEF to maintain a business
continuity-disaster recovery plan and resources, emergency procedures,
and backup facilities sufficient to enable timely recovery, resumption
of its operations, and resumption of its ongoing fulfillment of its
responsibilities and obligations as a SEF following any disruption of
its operations.\763\ A SEF's business continuity-disaster recovery plan
and resources generally should enable resumption of trading and
clearing of swaps executed on or pursuant to the rules of the SEF
during the next business day following the disruption.
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\763\ 17 CFR 37.1401(c).
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As noted above, the Commission proposes to move the existing
requirement under Sec. 37.205(b)(4)--``Safe storage capability''--that
a SEF must protect audit trail data from unauthorized alteration,
accidental erasure, or other loss to a more appropriate provision under
proposed Sec. 37.1401(c).\764\ The Commission also proposes additional
non-substantive amendments to Sec. 37.1401(c). First, the Commission
proposes to eliminate the sentence that references ``critical financial
markets'' and Sec. 40.9, which do not exist.\765\ Second, the
Commission proposes to replace the reference to ``designated clearing
organization'' with ``derivatives clearing organization,'' which is the
appropriate term under the Commission's regulations. Finally, the
Commission proposes to eliminate the reference to swaps executed
``pursuant to the rules of'' a SEF, which conforms to the proposed
amendment to the ``block trade'' definition under Sec. 43.2, discussed
further below.\766\
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\764\ See supra Section VII.D.2.a.--Sec. 37.205(b)(1)--Original
Source Documents; Sec. 37.205(b)(2)--Transaction History Database;
Sec. 37.205(b)(3)--Electronic Analysis Capability.
\765\ The Commission further proposes to eliminate the reference
to ``critical financial market'' under Sec. 37.1401(d).
\766\ See infra Section XXII.--Part 43--Sec. 43.2--Definition
of ``Block Trade.''
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B. Sec. 37.1401(g)--Program of Risk Analysis and Oversight Technology
Questionnaire
Existing Exhibit V to Form SEF in Appendix A requires an applicant
for SEF registration to file an Operational Capability Technology
Questionnaire (``Questionnaire'') in order to demonstrate compliance
with Core Principle 14 and Sec. 37.1401.\767\ The current version of
the Questionnaire requests documents and information pertaining to the
following eight areas of an applicant's program of risk analysis and
oversight: (i) Organizational structure, system descriptions, facility
locations, and geographic distribution of staff and equipment; (ii)
risk analysis and oversight; (iii) system operations; (iv) systems
development methodology; (v) information security; (vi) physical
security and environmental controls; (vii) capacity planning and
testing; and (viii) business continuity and disaster recovery. The
current version of the Questionnaire is located on the Commission's
website.\768\
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\767\ 17 CFR part 37 app. A.
\768\ SEF Operational Capability Technology Questionnaire,
available at https://www.cftc.gov/sites/default/files/idc/groups/public/@industryoversight/documents/file/seftechnologyquestionnaire.pdf.
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The Commission proposes a new provision under Sec. 37.1401(g) to
require each SEF to annually prepare and submit an up-to-date
Questionnaire to Commission staff not later than 90 calendar days after
the SEF's fiscal year-end.\769\ The Commission notes that where
information previously submitted on the Questionnaire remains current,
the annual update may note that fact, rather than fully describe the
same information again.
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\769\ The Commission notes that based on the proposed amendments
to Form SEF in Appendix A discussed above, Exhibit V would be re-
designated as Exhibit Q of Form SEF. The up-to-date questionnaire
would be called the ``Program of Risk Analysis and Oversight
Technology Questionnaire'' and would be located in Appendix A to
part 37. See supra note 169 and accompanying discussion. Based on
the proposed addition of subsection (g), the Commission proposes to
renumber the existing provisions under subsections (g)-(i) to
subsections (h)-(j), respectively. Based on the renumbering of these
provisions, the Commission also proposes conforming non-substantive
amendments to update applicable cross-references to these provisions
in proposed paragraphs (a)(3), (h)(5), (i)(1)-(i)(7), and subsection
(m).
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The updated version of the Questionnaire requests documents and
information in the following nine areas to assist the Commission in
assessing a SEF's compliance with the Act and Commission regulations:
(i) Organizational structure, system descriptions, facility locations,
and geographic distribution of staff and equipment, including
organizational charts and diagrams; (ii) enterprise risk management
program and governance, including information regarding the Board of
Directors, audits, and third-party providers; (iii) information
security, including storage of records, access controls, and
cybersecurity threat intelligence capabilities; (iv) business
continuity and disaster recovery plan and resources, including testing
and recovery time objectives; (v) capacity planning and testing; (vi)
system operations, including configuration management and event
management; (vii) systems development methodology, including quality
assurance; (viii) physical security and environmental controls; and
(ix) testing, including vulnerability, penetration, and controls
testing. While the majority of the updated Questionnaire is unchanged
from the current version, the Commission is making certain amendments,
including the addition of enterprise technology risk assessments, board
of director and committee information, third-party service provider
information, and cybersecurity threat intelligence capabilities to keep
up-to-date with the rapidly changing field of system safeguards and
cybersecurity.
The proposed annual update is designed to reduce overall
compliance-related burdens and enhance internal operational efficiency
for SEFs. First, the Commission would use the Questionnaire as the
basis for Systems Safeguards Examination (``SSE'') document requests.
The Commission believes that maintaining an updated Questionnaire would
limit SSE document requests and the effort required to respond to these
requests--a SEF would be able to provide updated information and
documents for sections of the Questionnaire that have changed since the
last annual filing.\770\ Second,
[[Page 62032]]
the Commission would use the Questionnaire to conduct required system
safeguards oversight and maintain a current profile of the SEF's
automated systems.\771\ Annual updates would reduce the need for
separate requests and the burden of responding to these requests.
Third, annual updates would assist a SEF's obligation to provide timely
advance notice of all material (i) planned changes to automated systems
that may impact the reliability, security, or adequate scalable
capacity of such systems; and (ii) planned changes to the SEF's program
of risk analysis and oversight.\772\ Fourth, annual updates, which a
SEF would submit concurrently with its annual compliance report, could
provide information and documents that are potentially useful in
preparing that report.\773\
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\770\ To the extent that still-current information and documents
were provided in the most recent update to the Questionnaire, a SEF
responding to an SSE document request would be able to reference
that fact, rather than resubmit such information and documents.
\771\ The Commission notes that proposed subsection (h)
(renumbered from existing subsection (g)) requires a SEF to provide
to the Commission system safeguards-related books and records,
including (i) current copies of its business continuity-disaster
recovery plans and other emergency procedures; (ii) all assessments
of its operational risks or system safeguards-related controls;
(iii) all reports concerning system safeguards testing and
assessment required by this chapter; and (iv) all other books and
records requested by Commission staff in connection with Commission
oversight of system safeguards or maintenance of a current profile
of the SEF's automated systems. Id.
\772\ 17 CFR 37.1401(f)(1)-(2).
\773\ The Commission is proposing under Sec. 37.1306(d) and
Sec. 37.1501(e)(2), respectively, to require a SEF to submit its
fourth quarter financial report and annual compliance report no
later than ninety days after the SEF's fiscal year end.
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Request for Comment
The Commission requests comment on all aspects of proposed Sec.
37.1401(g).
C. Sec. 37.1401(j)
Section 37.1401(j) specifies that for registered entities deemed by
the Commission to be ``critical financial markets,'' Sec. 40.9 sets
forth requirements for maintaining and dispersing disaster recovery
resources in a manner sufficient to meet a same-day recovery time
objective in the event of a wide-scale disruption. The Commission
proposes to eliminate this provision, given that the Commission has not
defined ``critical financial markets'' and such requirements do not
exist under Sec. 40.9.
XX. Part 37--Subpart P: Core Principle 15 (Designation of Chief
Compliance Officer)
Core Principle 15 requires each SEF to designate a CCO and sets
forth its corresponding duties.\774\ Among other responsibilities, a
CCO is required to ensure that the SEF complies with the CEA and
applicable rules and regulations, as well as establish and administer
required policies and procedures.\775\ Core Principle 15 also requires
the CCO to prepare and file an annual compliance report (``ACR'') to
the Commission.\776\ The Commission further promulgated requirements
under Sec. 37.1501 to implement these requirements.\777\ Based on its
experience during part 37 implementation, the Commission proposes
several amendments to Sec. 37.1501, in particular to streamline
requirements related to the composition of the ACR and provide more
useful information to the Commission.
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\774\ 7 U.S.C. 7b-3(f)(15). The Commission codified Core
Principle 15 under Sec. 37.1500. 17 CFR 37.1500.
\775\ 7 U.S.C. 7b-3(f)(15)(B)(iv)-(v).
\776\ 7 U.S.C. 7b-3(f)(15)(D).
\777\ 17 CFR 37.1501.
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A. Sec. 37.1501--Chief Compliance Officer
1. Sec. 37.1501(a)--Definitions
Core Principle 15 requires a CCO to report directly to the SEF's
``board [of directors]'' or the SEF's ``senior officer'' \778\ and
consult either the board or the senior officer to resolve conflicts of
interest.\779\ Section 37.1501(a) defines ``board of directors,'' \780\
but does not define ``senior officer.'' \781\ In the SEF Core
Principles Final Rule, the Commission noted that it would not adopt a
definition of ``senior officer,'' but noted that the statutory term
would only include the most senior executive officer of the legal
entity registered as a SEF.\782\
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\778\ 7 U.S.C. 7b-3(f)(15)(B)(i). The Commission also notes that
the CEA does not define ``senior officer.''
\779\ 7 U.S.C. 7b-3(f)(15)(B)(iii).
\780\ Section 37.1501(a) defines ``board of directors'' as the
board of directors of a SEF, or for those SEFs whose organizational
structure does not include a board of directors, a body performing a
function similar to a board of directors. 17 CFR 37.1501(a).
\781\ 17 CFR 37.1501(a).
\782\ SEF Core Principles Final Rule at 33544.
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The Commission proposes to define a ``senior officer'' under Sec.
37.1501(a) as the chief executive officer or other equivalent officer
of the SEF. Across the various organizational structures that SEFs have
established, the Commission has observed that a senior officer often
may be the appropriate individual to whom a CCO would report regarding
SEF activities. Therefore, this proposed definition would clarify the
permissible reporting lines for the CCO and would provide specificity
to the Commission's proposed amendments to the Core Principle 15
regulations, as described below. Among other things, the proposed
requirements would enable the senior officer to have greater oversight
responsibilities over the CCO consistent with Core Principle 15.
Request for Comment
The Commission requests comment on all aspects of proposed Sec.
37.1501(a). In particular, the Commission requests comment on the
questions below.
(86) Is the Commission's proposed definition of ``senior officer''
sufficiently clear and complete? If not, then please provide an
explanation of those aspects of the definition that you believe are
insufficiently clear or inadequately addressed.
(87) Are there any officers that may meet the definition of
``senior officer,'' but pose a potential conflict of interest? If so,
identify such officers and the types of conflicts that may arise.
(88) Should the Commission add any other definitions to proposed
Sec. 37.1501(a)?
2. Sec. 37.1501(b)--Chief Compliance Officer \783\
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\783\ The Commission proposes to retitle Sec. 37.1501(b) to
``Chief compliance officer'' from ``Designation and qualifications
of chief compliance officer'' based on the proposed changes
described below.
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Sections 37.1501(b)-(c) set forth certain baseline requirements for
the SEF CCO position. Section 37.1501(b)--``Designation and
qualifications of chief compliance officer''-- requires a SEF to
designate an individual to serve as the CCO; requires the CCO to have
the authority and resources to help fulfill the SEF's statutory and
regulatory duties, including supervisory authority over compliance
staff; and establishes minimum qualifications for the designated
CCO.\784\ Section 37.1501(c)--``Appointment, supervision, and removal
of chief compliance officer''--establishes the respective authorities
of the SEF board of directors and senior officer to designate,
supervise, and remove the CCO; and requires the CCO to meet with the
SEF's board and regulatory oversight committee (``ROC'') on an annual
and quarterly basis, respectively, and provide them with information as
requested.\785\
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\784\ 17 CFR 37.1501(b).
\785\ 17 CFR 37.1501(c).
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The Commission proposes to amend, clarify, and eliminate various
existing requirements under Sec. Sec. 37.1501(b)-(c) and consolidate
the remaining provisions into Sec. 37.1501(b), as described below. The
Commission proposes to eliminate duplicative rules to Core Principle
15, including requirements that a SEF designate a
[[Page 62033]]
CCO \786\ and the CCO report directly to the board or the senior
officer.\787\ With respect to the CCO's obligations to a ROC, Core
Principle 15 does not require a SEF to establish a ROC and the
Commission has not finalized a rule that establishes requirements for a
ROC; therefore, the Commission proposes to eliminate the existing ROC-
related requirements from part 37.\788\
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\786\ The Commission proposes to eliminate this requirement
under existing paragraph (b)(1), which the Commission proposes to
retitle to ``Authority of chief compliance officer'' from ``Chief
compliance officer required.''
\787\ The Commission proposes to eliminate this requirement
under existing paragraph (c)(2).
\788\ These requirements include a mandatory quarterly meeting
with the ROC under existing subparagraph (c)(1)(iii); and the
requirement that the CCO provide self-regulatory program information
to the ROC under existing subparagraph (c)(1)(iv). Conflicts of
Interest Proposed Rule at 36741-42.
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Consistent with Core Principle 15, which requires the CCO to report
to the SEF's board or senior officer, the Commission also proposes
amendments to the consolidated requirement under Sec. 37.1501(b) to
allow the SEF's senior officer to have the same oversight
responsibilities over the CCO as the board. First, the Commission
proposes to allow a CCO to consult with the board of directors or
senior officer of the SEF as the CCO develops the SEF's policies and
procedures.\789\ Second, the Commission also proposes to allow a CCO to
meet with the senior officer of the SEF, in addition to the board of
directors, on an annual basis.\790\ Third, the Commission further
proposes to allow the CCO to provide self-regulatory program
information to the SEF's senior officer, in addition to the board of
directors.\791\
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\789\ The Commission proposes the amendment under proposed
subparagraph (b)(1)(i).
\790\ The Commission proposes to renumber existing subparagraph
(c)(1)(iii) to paragraph (b)(5), based on the proposed consolidation
of existing subsections (b)-(c), and amend the requirement as
described.
\791\ The Commission proposes to renumber existing subparagraph
(c)(1)(iv) to paragraph (b)(6), based on the proposed consolidation
of existing subsections (b)-(c), and amend the requirement as
described.
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The Commission further proposes to eliminate the limitations on
authority to remove a CCO, which currently restricts that removal
authority to a majority of the board, or in the absence of a board, a
senior officer.\792\ Instead, the Commission proposes a more simplified
requirement under proposed Sec. 37.1501(b) to establish that (i) the
board or the senior officer may appoint or remove the CCO; \793\ and
(ii) the SEF must notify the Commission within two business days of the
appointment or removal (on an interim or permanent basis) of the
CCO.\794\ Based on its experience, the Commission recognizes that in
many instances, the senior officer may be better positioned than the
board to provide day-to-day oversight of the SEF and the CCO, as well
as to determine whether to remove a CCO. Therefore, consistent with
Core Principle 15, the Commission believes that a SEF's senior officer
should have the same CCO oversight authority as the SEF's board of
directors. This proposed amendment is consistent with Core Principle
15, which does not mandate a voting percentage to approve or remove the
CCO. The Commission also believes that these proposed amendments would
not only allow a SEF to more appropriately designate, appoint,
supervise, and remove a CCO based on the SEF's particular corporate
structure, size, and complexity, but also continue to ensure a level of
independence for its CCO that is appropriate to comply with Core
Principle 15.
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\792\ The Commission proposes to eliminate this requirement
under existing paragraph (c)(3).
\793\ The Commission proposes to consolidate and amend the
requirements under existing subparagraph (c)(1)(i) in part, which
addresses the appointment of a CCO by the board or senior officer,
with existing subparagraph (c)(3)(i), which currently addresses the
removal of a CCO. Based on the proposed consolidation of existing
subsections (b)-(c), the Commission proposes to renumber this
consolidated provision to paragraph (b)(3) and retitle the
consolidated provision to ``Appointment and removal of chief
compliance officer.''
\794\ The Commission notes that notification to the Commission
of the appointment and removal of a CCO is currently required under
existing subparagraph (c)(1)(i) and existing subparagraph
(c)(3)(ii), respectively. Based on the proposed consolidation of
existing subsections (b)-(c), the Commission proposes to consolidate
and amend these notification requirements, and renumber the
consolidated requirement to subparagraph (b)(3)(i).
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Based on the proposed consolidation of existing Sec. Sec.
37.1501(b)-(c), the Commission also proposes several non-substantive
amendments to the remaining provisions under proposed Sec. 37.1501(b),
including the renumbering of certain existing provisions.\795\
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\795\ The Commission proposes to renumber the requirements under
existing paragraph (b)(2)--``Qualifications of chief compliance
officer''--to proposed subparagraphs (b)(2)(i)-(ii). The Commission
also proposes to retitle existing subparagraph (c)(1)(ii), which
specifies that the board or the senior officer must approve the
CCO's compensation, to ``Compensation of the chief compliance
officer.'' Based on the proposed consolidation of existing
subsections (b)-(c), the Commission is proposing to renumber this
requirement to paragraph (b)(4).
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a. Acceptable Practices to Core Principle 15 in Appendix B
The Commission proposes a new acceptable practice to Core Principle
15 in Appendix B associated with Sec. 37.1501(b)(2)(i), which requires
a CCO to have the background and skills appropriate to the
position.\796\ The proposed acceptable practice would provide a non-
exclusive list of factors that a SEF may consider when evaluating an
individual's qualifications to be a CCO and state that a SEF may make a
determination based on the totality of a person's qualifications. The
Commission believes that a non-exclusive list provides the clarity that
SEFs have sought as to a CCO's requisite qualifications, but still
allows a board and senior officer reasonable flexibility in appointing
a CCO.
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\796\ The Commission proposes to add this provision in paragraph
(b)(1) of the acceptable practices to Core Principle 15 in Appendix
B. 17 CFR part 37 app. B.
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The proposed acceptable practice also states that a SEF should be
especially vigilant regarding potential conflicts of interest when
appointing a CCO. The Commission notes that the preamble to the SEF
Core Principles Final Rule stated ``a conflict of interest may
compromise a CCO's ability to effectively fulfill his or her
responsibilities as a CCO . . . .'' \797\ The Commission continues to
believe that conflicts of interest could affect a CCO's ability to
effectively fulfill his or her responsibilities. Accordingly, a SEF
should be especially vigilant in this regard when appointing a CCO. The
Commission also continues to believe that a SEF should have policies
and procedures in place to handle instances where its CCO has conflicts
of interest.
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\797\ SEF Core Principles Final Rule at 33543-44.
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Request for Comment
The Commission requests comment on all aspects of proposed Sec.
37.1501(b) and the associated acceptable practices to Core Principle 15
in Appendix B.
3. Sec. 37.1501(c)--Duties of Chief Compliance Officer \798\
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\798\ The Commission proposes to renumber existing subsection
(d) to subsection (c).
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Section 37.1501(d)--``Duties of chief compliance officer''--
currently requires a CCO, at a minimum, to (i) oversee and review the
SEF's compliance with the Act and Commission regulations; \799\ (ii)
resolve any conflicts of interest that may arise, including in certain
enumerated circumstances; \800\ (iii) establish and administer written
policies and procedures reasonably designed to prevent violations of
the Act and
[[Page 62034]]
Commission regulations; \801\ (iv) take reasonable steps to ensure
compliance with the Act and Commission regulations; \802\ (v) establish
procedures for the remediation of noncompliance issues identified by
the CCO through certain specified protocols; \803\ (vi) establish and
follow appropriate procedures for the handling, management response,
remediation, retesting, and closing of noncompliance issues; \804\
(vii) establish and administer a compliance manual and a written code
of ethics; \805\ (viii) supervise a SEF's self-regulatory program;
\806\ and (ix) supervise the effectiveness and sufficiency of any
regulatory services provided to the SEF in accordance with Sec.
37.204.\807\
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\799\ 17 CFR 37.1501(d)(1).
\800\ 17 CFR 37.1501(d)(2). A CCO is specifically required to
address conflicts between (i) business considerations and compliance
requirements; (ii) business considerations and the requirement that
the SEF provide fair, open, and impartial access under Sec. 37.202;
and (iii) a SEF's management and board members. 17 CFR
37.1501(d)(2)(i)-(iii).
\801\ 17 CFR 37.1501(d)(3).
\802\ 17 CFR 37.1501(d)(4).
\803\ 17 CFR 37.1501(d)(5).
\804\ 17 CFR 37.1501(d)(6).
\805\ 17 CFR 37.1501(d)(7).
\806\ 17 CFR 37.1501(d)(8).
\807\ 17 CFR 37.1501(d)(9).
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The Commission proposes to adopt several substantive and non-
substantive amendments to clarify and streamline these duties. The
Commission proposes to consolidate certain existing provisions and
specify that the CCO may identify noncompliance matters through ``any
means,'' in addition to the currently prescribed means; and clarify
that the procedures followed to address noncompliance issues must be
``reasonably designed'' by the CCO to handle, respond, remediate,
retest, and resolve noncompliance issues identified by the CCO.\808\
These proposed amendments acknowledge that a CCO may not be able to
design procedures that detect all possible noncompliance issues and
reflect that a CCO may utilize a variety of resources to identify
noncompliance issues beyond a limited set of means.
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\808\ Existing paragraph (d)(5) requires a CCO to establish
procedures for remediation of noncompliance issues identified
through a compliance office review, look-back, internal or external
audit finding, self-reported error, or validated complaint. Existing
paragraph (d)(6) requires a CCO to establish and follow appropriate
procedures for the handling, management response, remediation,
retesting, and closing of non-compliance issues. The Commission
proposes to consolidate and amend these requirements and renumber
the consolidated requirement to paragraph (c)(5).
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The Commission also proposes to amend a CCO's duty to resolve
conflicts of interest.\809\ First, the Commission proposes to limit a
CCO's duty to address only ``material'' conflicts of interest. This
proposed amendment reflects the Commission's view that the current
requirement is overly broad and impractical because a CCO cannot
reasonably be expected to resolve every potential conflict of interest
that may arise. Consistent with this view, the Commission also proposes
to refine the scope of the CCO's duty to taking only ``reasonable
steps'' to resolve ``material'' conflicts of interest that may
arise.\810\ The Commission further proposes to eliminate the existing
enumerated conflicts of interest to avoid any inference that they are
an exhaustive list of conflicts that a CCO must address.\811\
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\809\ The Commission proposes to renumber existing paragraph
(d)(2), which addresses the CCO's duty to resolve conflicts of
interest, to paragraph (c)(2) and amend the requirement as
described.
\810\ The Commission also proposes to eliminate ``a body
performing a function similar to the board of directors'' under
proposed paragraph (c)(2) (existing paragraph (d)(2)), as this
phrase is already included in the definition of ``board of
directors'' under Sec. 37.1501(a).
\811\ These provisions are currently set forth under existing
subparagraphs (d)(2)(i)-(iii). See supra note 800.
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The Commission believes that these proposed amendments do not
weaken a CCO's statutory duty to address conflicts of interest, but
rather reflect the CCO's practical ability to detect and resolve
conflicts. Moreover, the proposed amendments reflect the Commission's
belief that a CCO should have discretion to determine the conflicts
that are material to his or her SEF's ability to comply with the Act
and the Commission's regulations. The Commission believes that these
proposed changes are consistent with Core Principle 15.
Request for Comment
The Commission requests comment on all aspects of proposed Sec.
37.1501(c).
4. Sec. 37.1501(d)--Preparation of Annual Compliance Report \812\
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\812\ The Commission proposes to renumber existing subsection
(e) to subsection (d).
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Existing Sec. 37.1501(e)--``Preparation of annual compliance
report''--currently requires the CCO to annually prepare and sign an
ACR that, at a minimum (i) describes the SEF's written policies and
procedures, including the code of ethics and conflicts of interest
policies; \813\ (ii) reviews the SEF's compliance with the Act and
Commission regulations in conjunction with the SEF's policies and
procedures; \814\ (iii) provides a self-assessment of the effectiveness
of the SEF's policies and procedures, including areas of improvement
and related recommendations for the SEF's compliance program or
resources; \815\ (iv) lists material changes to the policies and
procedures; \816\ (v) describes the SEF's financial, managerial, and
operational resources, including compliance program staffing and
resources, a catalogue of investigations and disciplinary actions, and
a review of the disciplinary committee's performance; \817\ (vi)
describes any material compliance matters identified through certain
enumerated mechanisms, e.g., compliance office review or lookback, and
explains how they were resolved; \818\ and (vii) certifies that, to the
best of the CCO's knowledge and reasonable belief and under penalty of
law, the ACR report is accurate and complete.\819\
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\813\ 17 CFR 37.1501(e)(1).
\814\ 17 CFR 37.1501(e)(2)(i).
\815\ 17 CFR 37.1501(e)(2)(ii)-(iii).
\816\ 17 CFR 37.1501(e)(3).
\817\ 17 CFR 37.1501(e)(4).
\818\ 17 CFR 37.1501(e)(5).
\819\ 17 CFR 37.1501(e)(6).
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During part 37 implementation, the Commission has gained experience
and received feedback with respect to the ACR requirements. The
Commission notes that some of the required ACR content has provided the
Commission with minimal meaningful insight into a SEF's compliance
program. For example, some of the content is duplicative of information
obtained by the Commission from other reporting channels, such as the
system-related information that a SEF must file pursuant to Core
Principle 14 \820\ and rule certifications filed pursuant to part 40 of
the Commission's regulations.\821\ Various SEF CCOs have also provided
feedback that certain ACR content requires substantial time to prepare
and includes some information that does not change frequently.\822\
They have requested that the Commission simplify these requirements and
provide additional time to file the reports. The Commission also notes,
however, that many SEFs have not provided sufficient details that
describe and assess whether their respective policies and procedures
[[Page 62035]]
(e.g., rulebooks, compliance manuals, conflict of interest policies,
code of ethics, governance documentation, and third-party service
agreements) comply with the Act and Commission regulations.
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\820\ The Commission notes that proposed subsection (h)
(existing subsection (g)) requires a SEF to produce system
safeguards-related books and records that include current copies of
its business continuity-disaster recovery plans and emergency
procedures, assessments of its operational risks and controls, and
reports concerning system safeguards testing and assessments.
\821\ Among other information required to be submitted to the
Commission pursuant to part 40, a SEF is required to provide the
Commission with amendments to its rulebook and compliance manual.
\822\ See CFTC Letter No. 17-61, No-Action Relief for Swap
Execution Facilities from Compliance with the Timing Requirements of
Commission Regulation 37.1501(f)(2) Relating to Chief Compliance
Officer Annual Compliance Reports and Commission Regulation
37.1306(d) Relating to Fourth Quarter Financial Reports at 2-3 (Nov.
20, 2017) (``NAL No. 17-61'') (citing testimonials from SEFs that
the preparation of an ACR requires an extensive information
gathering process, including a review and documentation of
information gathered on an entity-wide basis).
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Based upon its experience in reviewing ACRs, the Commission is
proposing certain amendments that would eliminate duplicative or
unnecessary information requirements and streamline existing
requirements. These amendments would reduce unnecessary regulatory
burdens and compliance costs associated with certain aspects of ACRs.
The Commission is also proposing certain amendments to enhance the
usefulness of ACRs by enabling the Commission to assess the
effectiveness of a SEF's compliance and self-regulatory programs. The
proposed revisions represent a simplified approach that continues to
effectuate Core Principle 15.
The Commission proposes to refine the scope of some of the required
ACR content that it believes is otherwise duplicative, unnecessary, or
burdensome. Under the proposed approach, a SEF would no longer need to
include in its ACR either a review of all the Commission regulations
applicable to a SEF or an identification of the written policies and
procedures designed to ensure compliance with the Act and Commission
regulations.\823\ The Commission believes that instead requiring an ACR
to include a description and self-assessment of the effectiveness of
the SEF's written policies and procedures to ``reasonably ensure''
compliance with the Act and applicable Commission regulations is more
closely aligned with the corresponding provisions of Core Principle 15
and would still allow the Commission to properly assess the SEF's
compliance and self-regulatory programs.\824\ Similarly, the Commission
also proposes to eliminate a required discussion of the SEF's
compliance staffing and structure; a catalogue of investigations and
disciplinary actions taken over the last year; and a review of
disciplinary committee and panel performance.\825\ An ACR would
continue to be required to describe a SEF's financial, managerial, and
operational resources set aside for compliance, which the Commission
believes is sufficient information to assess a SEF's self-regulatory
program.\826\ By refining the scope of information required to be
included in the ACR, the Commission anticipates that a SEF will be to
devote its resources in providing more detailed, and ultimately better
quality, information that will better help assess its compliance.
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\823\ The Commission proposes to eliminate these requirements in
existing subparagraph (e)(2)(i) and the introductory language of
existing paragraph (e)(2).
\824\ As proposed, a SEF would continue to be required to
describe the SEF's written policies and procedures, consistent with
Core Principle 15. In addition to the required description, the
Commission proposes to consolidate and amend existing subparagraph
(e)(2)(ii), which requires a SEF to provide a self-assessment as to
the effectiveness of its policies and procedures in the ACR, with
existing paragraph (e)(1), and renumber the consolidated requirement
to paragraph (d)(1). Further, the Commission proposes to consolidate
and amend existing subparagraph (e)(2)(iii), which requires an ACR
to discuss areas for improvement and recommend potential or
prospective changes or improvements to a SEF's compliance program
and resources, with existing paragraph (e)(3) and renumber the
consolidated requirement to paragraph (d)(2). The Commission expects
that the CCO will provide more nuanced and in-depth discussions
through these consolidated provisions, rather than merely providing
generalized responses.
\825\ The Commission proposes to eliminate these requirements
under existing paragraph (e)(4).
\826\ The Commission proposes to renumber the remaining
requirements under existing paragraph (e)(4) to paragraph (d)(3) and
adopt minor non-substantive amendments.
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To facilitate the Commission's ability to assess a SEF's written
policies and procedures regarding compliance matters, the Commission
also proposes to require a SEF to discuss only material noncompliance
matters and explain the corresponding actions taken to resolve such
matters.\827\ The Commission believes that requiring SEFs to focus on
describing material non-compliance matters, rather than describing all
compliance matters in similar depth, will streamline this requirement
and provide more useful information to the Commission. Further, the
Commission proposes to eliminate the enumerated mechanisms for
identifying non-compliance issues, which conforms to the ability of a
CCO to establish procedures to address non-compliance issues through
``any means,'' as described above.\828\
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\827\ The Commission proposes to renumber this requirement under
existing paragraph (e)(5) to paragraph (d)(4) and adopt the
amendments as described above and other non-substantive amendments.
\828\ The Commission proposes to eliminate these enumerated
mechanisms under existing paragraph (e)(5).
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Consistent with these proposed amendments, the Commission also
proposes to limit a SEF CCO's certification of an ACR's accuracy and
completeness to ``all material respects'' of the report.\829\ The
Commission recognizes that CCOs have been hesitant to certify that an
entire ACR is accurate and complete under the penalty of the law,
without regard to whether a potential inaccuracy or omission would be a
material error or not. Therefore, the Commission believes this proposed
change will provide an appropriate balance between the SEF CCOs'
concerns of potential liability with the material accuracy of an ACR
submitted to the Commission.
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\829\ The Commission proposes to renumber existing paragraph
(e)(6) to paragraph (d)(5) and amend the requirement as described.
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Request for Comment
The Commission requests comment on all aspects of proposed Sec.
37.1501(d). In particular, the Commission requests comment to the
questions below.
(89) Are the proposed revisions to the required content for ACRs
appropriate? If not, then how should the Commission modify the required
content?
(90) Are there any unintended consequences to removing the specific
requirements regarding a description of a SEF's self-regulatory
program's staffing and structure, a catalogue of investigations and
disciplinary actions taken since the last ACR, and a review of the
performance of the disciplinary committees and panels?
(91) Is it appropriate to limit the discussion of non-compliance
matters to only those that are material in nature? If not, then why?
5. Sec. 37.1501(e)--Submission of Annual Compliance Report and Related
Matters \830\
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\830\ The Commission proposes to renumber existing subsection
(f) to subsection (e). The Commission also proposes to retitle
subsection (e) to ``Submission of annual compliance report and
related matters'' from ``Submission of annual compliance report''
based on the proposed changes described below.
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Existing Sec. 37.1501(f)(1) currently requires a CCO to provide an
ACR to the board or, in the absence of a board, the senior officer for
review.\831\ The board of directors and senior officer may not require
the CCO to change the ACR.\832\ The SEF's board minutes or a similar
written record must reflect the submission of the ACR to the board of
directors or senior officer and any subsequent discussion of the
report.\833\ Additionally, the SEF must concurrently file the ACR and
the fourth quarter financial statements with the Commission within 60
calendar days of the end of the SEF's fiscal year end.\834\ The CCO
must certify and promptly file an amended ACR with the Commission upon
the discovery of any material error or omission in the report.\835\ A
SEF may
[[Page 62036]]
request an extension to file the ACR with the Commission based on
substantial, undue hardship in filing the ACR on time.\836\
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\831\ 17 CFR 37.1501(f)(1).
\832\ Id.
\833\ Id.
\834\ 17 CFR 37.1501(f)(2).
\835\ 17 CFR 37.1501(f)(3).
\836\ 17 CFR 37.1501(f)(4).
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The Commission proposes several amendments to simplify the ACR
submission procedures. First, the Commission proposes to provide SEFs
with an additional thirty days to file the ACR with the Commission, but
no later than ninety calendar days after a SEF's fiscal year end.\837\
This proposed extension is consistent with the basis provided by
Commission staff in granting current no-action relief to SEFs that
provides an additional thirty days to prepare and file an ACR.\838\ In
particular, the Commission recognizes that in addition to the ACR, a
CCO has other reporting obligations, such as the fourth quarter
financial report required to be submitted under Core Principle 13 and
other year-end reports; SEFs have indicated that these multiple
reporting obligations present resource constraints on SEFs and their
CCOs.\839\ In addition to an extended deadline, the Commission proposes
to replace the ``substantial and undue hardship'' standard required for
filing ACR extensions with a ``reasonable and valid'' standard.\840\
Further, the Commission proposes to eliminate the requirement that each
SEF must document the submission of the ACR to the SEF's board of
directors or senior officer in board minutes or some other similar
written record; \841\ the Commission notes that the Core Principle 15
recordkeeping requirement under proposed Sec. 37.1501(f), as discussed
further below, would incorporate this requirement.\842\ The Commission
also proposes to require a CCO to submit an amended ACR to the SEF's
board of directors or, in the absence of a board of directors, the
senior officer of the SEF, for review prior to submitting the amended
ACR to the Commission; this approach is the same as the requirements
that exist for submitting an initial ACR.\843\
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\837\ The Commission proposes to renumber existing paragraph
(f)(2) to paragraph (e)(2) and amend the requirement as described.
The Commission also proposes to add a title to this paragraph--
``Submission of annual compliance report to the Commission.''
\838\ NAL No. 17-61 at 4.
\839\ Id. at 2-3.
\840\ The Commission proposes to renumber existing paragraph
(f)(4) to paragraph (e)(4) and amend the provision as described. The
Commission also proposes to add a title--``Request for extension.''
\841\ The Commission proposes to eliminate this requirement
under existing paragraph (f)(1).
\842\ The Commission notes that existing Sec. 37.1501(g) sets
forth recordkeeping requirements for SEFs related to the CCO's
duties. As discussed below, the Commission is proposing to amend
those requirements. See infra Section XX.A.6.--Sec. 37.1501(f)--
Recordkeeping.
\843\ The Commission proposes to renumber existing paragraph
(f)(3) to paragraph (e)(3) and add a title--``Amendments to annual
compliance report.'' The Commission proposes to adopt this
requirement under subparagraph (e)(3)(i). The Commission notes that
under proposed subparagraph (e)(3)(ii), an amended ACR would be
subject to the amended certification requirement, i.e., a CCO must
certify that the ACR is accurate and complete in all material
respects.
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In addition to the proposed amendments described above related to
submitting the ACR, the Commission proposes certain non-substantive
amendments to the remaining provisions under proposed Sec.
37.1501(e).\844\
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\844\ The Commission proposes to renumber existing paragraph
(f)(1) to paragraph (e)(1), adopt non-substantive amendments to the
existing language, and add a title--``Furnishing the annual
compliance report prior to submission to the Commission.''
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Request for Comment
The Commission requests comment on all aspects of proposed Sec.
37.1501(e).
6. Sec. 37.1501(f)--Recordkeeping \845\
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\845\ The Commission proposes to renumber existing subsection
(g) to subsection (f).
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Existing Section 37.1501(g)(1) currently requires a SEF to maintain
a copy of written policies and procedures adopted in furtherance of
compliance with the Act and the Commissions regulations; \846\ copies
of all materials created in furtherance of the CCO's duties under
existing Sec. Sec. 37.1501(d)(8)-(9); \847\ copies of all materials in
connection with the review and submission of the ACR; \848\ and any
records relevant to the ACR.\849\ Existing Sec. 37.1501(g)(2) requires
the SEF to maintain these records in accordance with Sec. 1.31 and
part 45 of the Commission's regulations.\850\
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\846\ 17 CFR 37.1501(g)(1)(i).
\847\ 17 CFR 37.1501(g)(1)(ii).
\848\ 17 CFR 37.1501(g)(1)(iii).
\849\ 17 CFR 37.1501(g)(1)(iv).
\850\ 17 CFR 37.1501(g)(2).
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The Commission proposes streamline the recordkeeping requirements
that pertain to the CCO's duties and the preparation and submission of
the ACR. Accordingly, the Commission proposes a revised general
requirement under proposed Sec. 37.1501(f) that would require the SEF
to keep all records demonstrating compliance with the duties of the CCO
and the preparation and submission of the ACR consistent with the
recordkeeping requirements under Sec. Sec. 37.1000-1001.
7. Sec. 37.1501(g)--Delegation of Authority \851\
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\851\ The Commission proposes to renumber existing subsection
(h) to subsection (g) based on the changes described above.
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Section 37.1501(h)--``Delegation of authority''--currently
delegates the authority to grant or deny a SEF's request for an
extension of time to file its ACR to the Director of DMO.\852\ In
addition to renumbering the provision based on the amendments described
above, the Commission proposes to adopt non-substantive amendments that
conform to the proposed amendments to the Core Principle 15 regulations
discussed above.
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\852\ 17 CFR 37.1501(h).
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XXI. Part 36--Trade Execution Requirement
The Commission is proposing regulations under part 36 to address
the broadened scope of swaps that will become subject to the trade
execution requirement based on the proposed interpretation of ``makes
the swap available to trade'' in CEA section 2(h)(8). In addition to an
implementing regulation, the Commission proposes several exemptions
from the requirement for certain types of swap transactions, as
discussed below. Further, the Commission proposes to require that SEFs
and DCMs file a standardized form with the Commission that details the
swaps that they respectively list for trading that are subject to the
requirement. The Commission also proposes a new provision to compel the
Commission to establish a centralized registry on its website that
reflects (i) the SEFs and DCMs that list swaps subject to the
requirement; and (ii) the particular swaps listed on each of those
entities. To transition trading of additional swaps onto SEFs or DCMs
pursuant to the requirement, the Commission additionally proposes a
revised compliance schedule.
A. Sec. 36.1--Trade Execution Requirement
1. Sec. 36.1(a)--Trade Execution Requirement
The Commission proposes Sec. 36.1(a) to codify the statutory
language of the trade execution requirement, which requires
counterparties to execute a swap that is subject to the clearing
requirement on a DCM, a SEF or an exempt SEF unless no such entity
``makes the swap available to trade'' or the swap is subject to a
clearing exception in CEA section 2(h)(7).\853\ The
[[Page 62037]]
Commission believes that the statutory phrase ``makes the swap
available to trade'' specifies the listing of a swap by a DCM, a SEF,
or an exempt SEF on its facility for trading.\854\ Accordingly, Sec.
36.1(a) would specify that counterparties must execute a transaction
subject to the clearing requirement on a DCM, a SEF, or an Exempt SEF
that lists the swap for trading.\855\
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\853\ 7 U.S.C. 2(h)(8)(B). The Commission interprets ``swap
execution facility'' in CEA section 2(h)(8)(B) to include a swap
execution facility that is exempt from registration pursuant to CEA
section 5h(g). See supra note 10. See also supra Section IV.I.4.a.--
Sec. 36.1(a)--Trade Execution Requirement.
\854\ See supra Section IV.I.4.a.--Sec. 36.1(a)--Trade
Execution Requirement. As discussed below, the Commission is
proposing an exemption from the requirement for swap transactions
involving swaps that are listed for trading only by an Exempt SEF.
See infra Section XXI.A.2.--Sec. 36.1(b)--Exemption For Certain
Swaps Listed Only By Exempt SEFs.
\855\ See supra Section IV.I.4.a.--Sec. 36.1(a)--Trade
Execution Requirement.
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The Commission also proposes to exempt certain types of swap
transactions from the trade execution requirement pursuant to its
exemptive authority in CEA section 4(c). For the purposes of promoting
responsible economic or financial innovation and fair competition, CEA
section 4(c)(1) provides the Commission with the authority to exempt
any agreement, contract, or transaction from any CEA provision, subject
to specified factors.\856\ CEA section 4(c)(2) prohibits the Commission
from providing an exemption from any requirements in CEA section
4(c)(1), unless the Commission determines that (i) the requirement
should not be applied to the agreement, contract, or transaction for
which the exemption is sought; (ii) the exemption would be consistent
with the public interest and the purposes of the Act; (iii) the
agreement, contract, or transaction at issue will be entered into
solely between appropriate persons; \857\ and (iv) the agreement,
contract, or transaction at issue will not have a material adverse
effect on the ability of the Commission or exchange to discharge its
regulatory or self-regulatory duties under the Act.\858\
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\856\ 7 U.S.C. 6(c)(1). CEA section 4(c)(1) is intended to allow
the Commission to ``provid[e] certainty and stability to existing
and emerging markets so that financial innovation and market
development can proceed in an effective and competitive manner.''
House Conf. Report No. 102-978, 102d Cong. 2d Sess. at 81 (Oct. 2,
1992), reprinted in 1992 U.S.C.C.A.N. 3179, 3213.
\857\ 7 U.S.C. 6(c)(3). CEA section 4(c)(3) includes a number of
specified categories of persons within ``appropriate persons'' that
are deemed as appropriate to enter into swaps exempted pursuant to
CEA section 4(c). This includes persons the Commission determines to
be appropriate in light of their financial profile or other
qualifications, or the applicability of appropriate regulatory
protections. For purposes of considering the CEA section 4(c)
exemptions within this proposal, the Commission believes that ECPs
would qualify as ``appropriate persons.''
\858\ 7 U.S.C. 6(c)(2). Notwithstanding the adoption of
exemptions from the Act, the Commission emphasizes that their use is
subject to the Commission's antifraud and anti-manipulation
enforcement authority. In this connection, Sec. 50.10(a) prohibits
any person from knowingly or recklessly evading or participating in,
or facilitating, an evasion of CEA section 2(h) or any Commission
rule or regulation adopted thereunder. 17 CFR 50.10(a). Further,
Sec. 50.10(c) prohibits any person from abusing any exemption or
exception to CEA section 2(h), including any associated exemption or
exception provided by rule, regulation, or order. 17 CFR 50.10(c).
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As discussed below, the Commission specifically proposes exemptions
from the trade execution requirement for the following transactions
that would otherwise be subject to that requirement: (i) Swap
transactions involving swaps that are listed for trading only by an
Exempt SEF; (ii) swap transactions for which the clearing exceptions in
CEA section 2(h)(7) or the clearing exceptions or exemptions under part
50 apply; (iii) swap transactions that are executed as a component of a
package transaction that includes a component that is a new issuance
bond; and (iv) swap transactions between ``eligible affiliate
counterparties'' (``inter-affiliate counterparties'') that elect to
clear such transactions, notwithstanding their ability to elect the
relevant clearing exemption under Sec. 50.52.
2. Sec. 36.1(b)--Exemption For Certain Swaps Listed Only By Exempt
SEFs
The Commission proposes Sec. 36.1(b) to establish an exemption
from the trade execution requirement that may be elected by
counterparties to a swap that is subject to the trade execution
requirement, but is listed for trading only by Exempt SEFs.\859\ The
Commission believes that exempting these types of transactions from the
trade execution requirement would be consistent with the objectives of
CEA section 4(c).
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\859\ The Commission notes, however, that once a swap subject to
the clearing requirement is listed by a SEF or a DCM, then
counterparties may not use this exemption and would be required to
comply with the trade execution requirement.
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As noted above, CEA section 2(h)(8)(A) provides that counterparties
to transactions involving a swap subject to the clearing requirement
must execute the transaction on a DCM designated under CEA section 5, a
SEF registered under CEA section 5h or a SEF that is exempt from
registration under CEA 5h(g).\860\ CEA section 2(h)(8)(B), however,
specifies that this requirement does not apply if no DCM or swap
execution facility makes the swap available to trade (emphasis
added).\861\ The Commission interprets the phrase ``swap execution
facility'' in CEA section 2(h)(8)(B) to include both registered SEFs
and SEFs that are exempt from registration pursuant to section 5h(g),
given the references in section 2(h)(8)(A) and the applicability of
section 5h to both types of entities.\862\ Therefore, under the
Commission's proposed interpretation of ``makes the swap available to
trade,'' either a registered SEF or an Exempt SEF that lists a swap
subject to the clearing requirement for trading can make the swap
``available to trade,'' thereby triggering the trade execution
requirement for that swap.
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\860\ 7 U.S.C. 2(h)(8)(A).
\861\ 7 U.S.C. 2(h)(8)(B).
\862\ See supra note 10.
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While the Commission interprets CEA section 2(h)(8) to mean that
the listing of a swap by an Exempt SEF would trigger the trade
execution requirement, the Commission believes that it would be
appropriate to exempt such listings from the requirement, given that
the Commission does not oversee the listing of swaps by Exempt SEFs. To
list new contracts SEFs submit their products for Commission review
pursuant to the part 40 filing requirements.\863\ The Commission
reviews a new swap contract to ensure that it is consistent with the
CEA and applicable Commission regulations, including the requirement
that the contract not be susceptible to manipulation. Upon listing, a
SEF, under Commission oversight, remains responsible for ensuring that
the contract continues to comport with the CEA and applicable
Commission regulations. In contrast, the Commission does not have
oversight authority with respect to the listing of new contracts by
Exempt SEFs.
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\863\ 17 CFR 40.2-3.
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The Commission believes that exempting swaps subject to the
clearing requirement that are listed exclusively by Exempt SEFs should
have little practical impact on the number of products that become
subject to the trade execution requirement. Given the internationally
competitive nature of the swaps industry, the Commission believes that
SEFs and DCMs will likely list many of the same swaps listed by Exempt
SEFs. The Commission also emphasizes that once the trade execution
requirement is triggered for a particular swap by a SEF or DCM that
lists the swap, the requirement may be satisfied by executing the swap
on not only a SEF or DCM, but also on an Exempt SEF as well.
[[Page 62038]]
a. Discussion of CEA Section 4(c) Enumerated Factors
For the reasons stated above, the Commission believes that
exempting a swap subject to the clearing requirement that is listed for
trading only on an Exempt SEF from triggering the trade execution
requirement would be consistent with the objectives of CEA section
4(c).
Given that the number of swaps that are subject to the clearing
requirement and only listed by Exempt SEFs is likely small, the
Commission believes that the proposed exemption is appropriate and
would be consistent with the public interest and purposes of the CEA.
The Commission believes that the proposed regulation would not have a
material adverse effect on the ability of the Commission or any SEF or
DCM to discharge its regulatory or self-regulatory duties under the
Act. The Commission notes that under the proposed exemption, swap
agreements, contracts, and transactions would still be entered into
solely between ECPs,\864\ who the Commission believes, for purposes of
this proposal, to be appropriate persons.
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\864\ As noted above, pursuant to CEA section 2(e), it is
unlawful for any U.S. person other than an ECP, as defined in CEA
section 1a(18), to enter into a swap unless the swap is entered into
on, or subject to the rules of, a DCM. 7 U.S.C. 2(e).
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Request for Comment
The Commission requests comment on all aspects of proposed Sec.
36.1(b), including whether the proposed exemptive relief is consistent
with the public interest and the other requirements of CEA section
4(c). In particular, the Commission requests comment on the following
question:
(92) Pursuant to its authority in CEA section 4(c), should the
Commission exempt swaps that are subject to the clearing requirement
and listed for trading only by an Exempt SEF from the trade execution
requirement, until such swaps are listed by a SEF or DCM?
3. Sec. 36.1(c)--Exemption for Swap Transactions Excepted or Exempted
From the Clearing Requirement Under Part 50
The Commission proposes Sec. 36.1(c) to establish an exemption to
the trade execution requirement for swap transactions for which an
exception or exemption has been elected pursuant to part 50. The
proposed exemption would apply to any transaction for which (i) a
clearing exception under Sec. 50.50 or a clearing exemption under
Sec. 50.51 or Sec. 50.52 has been elected; or (ii) a future exemption
that has been adopted by the Commission under part 50 would apply. The
Commission has determined that exempting these types of transactions
from the trade execution requirement would be consistent with the
objectives of CEA section 4(c).
The Act and the Commission's regulations specify that certain
transactions that are not subject to the clearing requirement are not
subject to the trade execution requirement. CEA section 2(h)(8) clearly
establishes that transactions that are not subject to the clearing
requirement pursuant to a clearing exception in CEA section 2(h)(7) are
not subject to the trade execution requirement.\865\ CEA section
2(h)(7), i.e., the end-user exception, provides a clearing exception to
a swap transaction if one of the counterparties (i) is not a financial
entity; (ii) is using the swap to hedge or mitigate commercial risk;
and (iii) notifies the Commission about how it generally meets its
financial obligations associated with entering into uncleared
swaps.\866\ The Commission adopted requirements under Sec. 50.50 to
implement this exception.\867\
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\865\ 7 U.S.C. 2(h)(8)(B).
\866\ 7 U.S.C. 2(h)(7).
\867\ 7 U.S.C. 2(h)(7). Among other things, Sec. 50.50
establishes when a swap transaction is considered to hedge or
mitigate commercial risk; specifies how to satisfy the reporting
requirement; and exempts small financial institutions from the
definition of ``financial entity.'' 17 CFR 50.50.
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In contrast to swaps that are eligible for the end-user exception,
however, swaps that are not subject to the clearing requirement based
on other statutory authority are currently not expressly exempted from
the trade execution requirement. Pursuant to its exemptive authority in
CEA section 4(c), the Commission has provided additional exemptions
from the clearing requirement for swaps between certain types of
entities, as well as for certain types of swap transactions. Section
50.51 allows certain cooperatives--those that otherwise consist
entirely of entities that would qualify for the end-user exception--to
elect a clearing exemption for swaps executed with a member of an
exempt cooperative.\868\ Section 50.52 allows inter-affiliate
counterparties who have ``eligible affiliate counterparty status'' to
elect a clearing exemption for swaps that are entered into between the
affiliated parties.\869\ The Commission notes that it has also
proposed, pursuant to CEA section 4(c), to exempt transactions by
eligible bank holding companies, savings and loan holding companies,
and community development financial institutions from the clearing
requirement.\870\
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\868\ 17 CFR 50.51. The exemption applies to swaps that are
executed in connection with originating a loan or loans for the
member of the cooperative, or hedging or mitigating commercial risk
related to member loans or arising from swaps related to originating
loans for members. 17 CFR 50.51(b)(1)-(2).
\869\ 17 CFR 50.52. Counterparties have ``eligible affiliate
counterparty status'' if one counterparty, directly or indirectly,
holds a majority ownership interest in the other counterparty; or a
third party, directly or indirectly, holds a majority ownership
interest in both counterparties. 17 CFR 50.52(a)(1)(i)-(ii). To
elect the exemption, such counterparties must also meet additional
conditions, including reporting requirements. 17 CFR 50.52(b)-(c).
\870\ Amendments to Clearing Exemption for Swaps Entered Into by
Certain Bank Holding Companies, Savings and Loan Holding Companies,
and Community Development Financial Institutions, 83 FR 44001
(proposed Aug. 29, 2018).
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The Commission believes that applying the trade execution
requirement to swaps that are eligible for a clearing exception or
clearing exemption potentially mitigates the benefits that are
associated with that exception or exemption. For example, a
counterparty that determines not to clear a swap pursuant to a clearing
exemption, but otherwise remains subject to the trade execution
requirement, would be limited in where it may trade or execute that
swap and may incur additional costs related to SEF onboarding.
Therefore, in order to fully preserve the benefits of a clearing
exception or clearing exemption, the Commission believes swaps that are
excepted or exempted from the clearing requirement should not be
subject to the trade execution requirement.
a. Discussion of CEA Section 4(c) Enumerated Factors
For the reasons stated above, the Commission believes that
exempting a swap transaction, for which a clearing exception or
clearing exemption have been elected pursuant to part 50, from the
trade execution requirement would be consistent with the objectives of
CEA section 4(c).
Given that the scope of this proposed exemption is limited and
applies to transactions that are already excepted or exempted from the
clearing requirement, the Commission believes that the proposed
regulation would not have a material adverse effect on the ability of
the Commission or any SEF or DCM to discharge its regulatory or self-
regulatory responsibilities under the CEA and the Commission's
regulations. The Commission believes that under the proposed exemption,
swap transactions would still be entered into solely between ECPs, who
the Commission believes, for purposes of this proposal, to be
appropriate persons.\871\
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\871\ See supra note 857 (discussing the scope of ``appropriate
persons'').
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[[Page 62039]]
Request for Comment
The Commission requests comment on all aspects of proposed Sec.
36.1(c), including whether the proposed exemptive relief is consistent
with the public interest and the other requirements of CEA section
4(c). In particular, the Commission requests comment on the following
question:
(93) Pursuant to its authority in CEA section 4(c), should the
Commission exempt swap transactions that are subject to a clearing
exception or clearing exemption under part 50 from the trade execution
requirement?
4. Sec. 36.1(d)--Exemption for Swaps Executed With Bond Issuance
The Commission proposes Sec. 36.1(d) to establish an exemption to
the trade execution requirement for swap transactions that are
components of a ``New Issuance Bond'' package transaction. The
Commission believes that exempting these types of transactions from the
trade execution requirement would be consistent with the objectives of
CEA section 4(c). This proposed approach is consistent with the time-
limited no-action relief provided by Commission staff for this category
of package transactions.\872\
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\872\ See supra note 334 (describing the no-action relief from
the trade execution requirement provided by Commission staff for
categories of package transactions).
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New Issuance Bond package transactions include at least one
individual swap component that is subject to the trade execution
requirement and at least one individual component that is a bond \873\
issued and sold in the primary market.\874\ An underwriter (on behalf
of an issuer) arranges the issuance of a bond packaged with a fixed-to-
floating IRS that features the issuer as a counterparty. The terms of
the IRS, which include tenor and payment terms, typically match the
terms of the bond issuance. By issuing a bond with a fixed-to-floating
IRS, issuers are able to effectively turn fixed-rate liabilities into
variable rate liabilities, or vice versa.\875\ To correspond the terms
between these two components and facilitate the bond issuance in an
efficient and cost-effective manner, the IRS component is customized
and negotiated in a manner that closely corresponds to the bond
issuance process.
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\873\ The Commission notes that this proposed exemption would
not apply to swap components of package transactions that include
sovereign debt, such as U.S. Treasury bonds, notes, and bills.
\874\ The Commission understands that a bond issued and sold in
the primary market that may constitute part of a package transaction
is a ``security,'' as defined in section 2(a)(1) of the Securities
Act of 1933 or section 3(a)(10) of the Securities Exchange Act of
1934. To the extent that counterparties may be facilitating package
transactions that involve a security, or any component agreement,
contract, or transaction over which the Commission does not have
exclusive jurisdiction, the Commission does not opine on whether
such activity complies with other applicable law and regulations.
\875\ For example, a bond issuer seeks to pay variable rates on
its bonds, but prospective investors may seek a fixed rate of
return. By arranging a New Issuance Bond package transaction, the
bond issuer can issue a fixed-rate bond and simultaneously enter
into an offsetting IRS. The IRS enables the issuer to receive a
fixed rate that matches the fixed rate on its bond to be issued,
while paying the variable rate that it originally sought.
Ultimately, this arrangement may allow the bond issuer to issue the
fixed-rate bond at a lower cost.
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Given the role of the issuer in the package transaction--both as
issuer of the bond and a counterparty to the swap--and the process
under which the swap is negotiated,\876\ this type of package
transaction has not been conducive to execution on a SEF trading system
or platform. The Commission notes that the no-action relief that has
been provided by Commission staff for these swaps components reflects
the ongoing lack of an available execution method on an appropriate
venue.\877\ Based on the integral role of the bond issuance in
facilitating the component swap execution, the Commission believes that
the IRS component is not suitable for execution on a SEF, even where a
SEF may offer flexible means of execution.
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\876\ The Commission notes that these types of package
transactions differ from other package transactions that involve the
purchase or sale of a security in the secondary market, given that
they involve the issuance of a new security.
\877\ NAL No. 17-55 at 2-3.
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Therefore, consistent with current no-action relief provided by
Commission staff, the Commission proposes to exempt swap components of
a New Bond Issuance package transaction from the trade execution
requirement. The proposed exemption would establish that a ``package
transaction'' consists of two or more component transactions executed
between two or more counterparties, where (i) execution of each
component transaction is contingent upon the execution of all other
components transactions; and (ii) the component transactions are priced
or quoted together as one economic transaction with simultaneous or
near simultaneous execution of all components. The Commission
recognizes the inherent challenges in trading or executing these swap
components on a SEF or DCM and, therefore, recognizes the benefits of
continuing to allow market participants to maintain established market
practices with respect to this type of package transaction.
a. Discussion of CEA Section 4(c) Enumerated Factors
The Commission believes that exempting swap components of New
Issuance Bond package transactions from the trade execution requirement
would be consistent with the objectives of CEA section 4(c).
The Commission recognizes the importance of new bond issuances in
helping market participants to raise capital and fund origination loans
for businesses and homeowners. Accordingly, the Commission recognizes
that allowing the swap components of New Bond Issuance package
transaction to be executed away from a SEF or DCM--consistent with
current market practice--is integral to facilitating the bond issuance.
Further, the Commission recognizes that the proposed exemption is
limited in nature, i.e., the swap transaction remains subject to all
other applicable Commission rules and regulations.
The Commission believes, therefore, that the proposed exemption
from the trade execution requirement for swap components of New
Issuance Bond package transactions is appropriate and would be
consistent with the public interest and purposes of the CEA. The
Commission further believes that the proposed regulation would not have
a material adverse effect on the ability of the Commission or any SEF
or DCM to discharge its regulatory or self-regulatory duties under the
CEA. The Commission notes that under the proposed exemption, swap
transactions would still be entered into solely between ECPs, who the
Commission believes, for purposes of this proposal, to be appropriate
persons.
Request for Comment
The Commission requests comment on all aspects of the proposed
exemption of swap components of New Issuance Bond package transactions
from the trade execution requirement under proposed Sec. 36.1(d),
including whether the proposed exemptive relief is consistent with the
public interest and the other requirements of CEA section 4(c). The
Commission specifically requests comment on the following questions:
(94) Pursuant to its authority in CEA section 4(c), should the
Commission exempt the swap components of a New Issuance Bond package
transaction from the trade execution requirement?
(95) Is the proposed definition of ``package transaction'' in
proposed Sec. 36.1(d)(1) appropriate?
[[Page 62040]]
(96) Are there additional package transactions that should be
exempt from the trade execution requirement? If so, then please
describe in detail why such package transactions should be exempt from
the trade execution requirement, especially in light of the flexible
means of execution the Commission is proposing to allow for all swaps
listed by a SEF.
5. Sec. 36.1(e)--Exemption for Swaps Executed Between Affiliates That
Elect To Clear
The Commission proposes Sec. 36.1(e) to establish an exemption
from the trade execution requirement that may be elected by inter-
affiliate counterparties to a swap that is submitted for clearing.
Counterparties would be eligible to elect the exemption by meeting the
conditions set forth under Sec. 50.52(a) for ``eligible affiliate
counterparty'' status.\878\ The Commission notes that this proposed
exemption would apply to transactions that inter-affiliate
counterparties elect to clear, notwithstanding their ability to elect
the clearing exemption.
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\878\ See supra note 869 (describing requirements for meeting
``eligible affiliate counterparty'' status).
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Based on time-limited no-action relief granted by Commission staff,
inter-affiliate counterparties that do not elect the Sec. 50.52
clearing exemption are executing swaps away from a SEF or DCM that are
otherwise subject to the trade execution requirement.\879\ The relief
has been granted to address the difficulty cited by market participants
in executing inter-affiliate swap transactions through the required
methods of execution prescribed for swaps subject to the trade
execution requirement under Sec. 37.9, i.e., Order Book and RFQ
System. In particular, executing these transactions via competitive
means of execution would be difficult because inter-affiliate swaps are
generally not intended to be executed on an arm's-length basis or based
on fully competitive pricing.\880\ Rather, such swaps are used as tools
to manage risk between affiliates and are carried out through internal
accounting processes.\881\ Market participants have asserted that
forcing these transactions to be executed through a SEF would impose
unnecessary costs and inefficiencies without any related benefits.\882\
The Commission believes that requiring these types of transactions to
be executed on a SEF would likely confer less benefit to the overall
swaps markets and inhibit inter-affiliate counterparties from
efficiently executing these types of transactions for operational
purposes.
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\879\ CFTC Letter No. 17-67, Re: Extension of No-Action Relief
from Commodity Exchange Act Section 2(h)(8) for Swaps Executed
Between Certain Affiliated Entities that Are Not Exempt from
Clearing Under Commission Regulation 50.52 (Dec. 14, 2017) (``NAL
No. 17-67''); CFTC Letter No. 16-80, Re: Extension of No-Action
Relief from Commodity Exchange Act Section 2(h)(8) for Swaps
Executed Between Certain Affiliated Entities that Are Not Exempt
from Clearing Under Commission Regulation 50.52 (Nov. 28, 2016);
CFTC Letter No. 15-62, Re: Extension of No-Action Relief from
Commodity Exchange Act Section 2(h)(8) for Swaps Executed Between
Certain Affiliated Entities that Are Not Exempt from Clearing Under
Commission Regulation 50.52 (Nov. 17, 2015); CFTC Letter No. 14-136,
Re: Extension of No-Action Relief from Commodity Exchange Act
Section 2(h)(8) for Swaps Executed Between Certain Affiliated
Entities that Are Not Exempt from Clearing Under Commission
Regulation 50.52 (Nov. 7, 2014); CFTC Letter No. 14-26, Time-Limited
No-Action Relief from the Commodity Exchange Act Section 2(h)(8) for
Swaps Executed Between Certain Affiliated Entities Not Electing
Commission Regulation Sec. 50.52 (Mar. 6, 2014). As discussed
above, the Commission previously stated that transactions subject to
the inter-affiliate exemption from clearing would also be exempt
from the trade execution requirement. See supra Section XXI.A.3.--
Sec. 36.1(c)--Exemption for Swap Transactions Excepted or Exempted
from the Clearing Requirement under Part 50.
\880\ See NAL No. 17-67 at 2.
\881\ In the 2013 Inter-Affiliate Final Rule, commenters
explained that corporate groups can use a single conduit in the
market on behalf of multiple affiliates within the group, which
permits the corporate group to net affiliates' trades. This netting
effectively reduces the overall risk of the corporate group and the
number of open positions with external market participants, which in
turn reduces operational, market, counterparty credit, and
settlement risk. Clearing Exemption for Swaps Between Certain
Affiliated Entities, 78 FR 21750, 21753-54 (Apr. 11, 2013).
\882\ NAL No. 17-67 at 2.
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a. Discussion of CEA Section 4(c) Enumerated Factors
The Commission believes that exempting a swap executed between
inter-affiliate counterparties that is submitted for clearing from the
trade execution requirement would be consistent with the objectives of
CEA section 4(c).
As noted above, these transactions are not intended to be arm's-
length, market-facing, or competitively executed under any
circumstance, irrespective of the type of swap involved. Therefore, the
nature of these transactions mitigates the potential benefits of their
execution on a SEF or a DCM. The Commission believes this proposed
exemption would ensure that inter-affiliate counterparties would be
able to efficiently utilize the risk management approach that best
suits their individual needs, such as clearing inter-affiliate swaps,
without being unduly influenced by whether that choice would require
them to execute swaps on a SEF. Notably, the Commission's proposed
rules would allow SEFs to provide more flexible means of execution and,
thus, could address some of the issues currently cited with respect to
executing inter-affiliate transactions on a SEF. Nevertheless, the
Commission believes that the policy justifications described above
support an exemption for such inter-affiliate swap transactions from
the trade execution requirement.
The Commission believes, therefore, that the proposed exemption
from the trade execution requirement for inter-affiliate counterparties
is appropriate, and it would be consistent with the public interest and
purposes of the CEA. Given the limited applicability of this proposed
exemption to transactions only executed between inter-affiliates, the
Commission believes that the proposed regulation would not have a
material adverse effect on the ability of the Commission or any SEF or
DCM to discharge its regulatory or self-regulatory duties under the
CEA. Finally, the Commission notes that under the proposed exemption,
swap transactions would still be entered into solely between ECPs, who
the Commission believes, for purposes of this proposal, to be
appropriate persons.\883\
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\883\ See supra note 857 (discussing the scope of ``appropriate
persons'').
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Request for Comment
The Commission requests comment on all aspects of proposed Sec.
36.1(e), including whether the proposed exemptive relief is consistent
with the public interest and the other requirements of CEA section
4(c). In particular, the Commission requests comment on the following
questions:
(97) Pursuant to its authority in CEA section 4(c), should the
Commission exempt transactions between inter-affiliate counterparties
who do not elect the inter-affiliate clearing exemption from the trade
execution requirement?
(98) Should the Commission also consider exempting end-users that
meet the criteria for a clearing exception in CEA section 2(h)(7) from
the trade execution requirement regardless of whether they elect to use
the end-user clearing exception?
B. Sec. 36.2--Registry of Registered Entities Listing Swaps Subject to
the Trade Execution Requirement; Appendix A to Part 36--Form TER
The Commission currently provides information on its website
regarding the swaps that are subject to the trade execution
requirement. In addition to providing a chart that identifies those
swaps,\884\ the Commission also posts the
[[Page 62041]]
corresponding MAT determinations submitted pursuant to part 40's rule
filing procedures.\885\ While this approach has been effective in
informing market participants about the limited number of swaps
currently subject to the trade execution requirement, the Commission
expects that the number of swaps that would be subject to the
requirement will increase. To ensure that market participants have
notice of the swaps that are subject to the trade execution requirement
and the venues listing those swaps, the Commission proposes to create a
registry under Sec. 36.2(a) that will set forth the swaps that are
subject to the trade execution requirement, and the SEFs and DCMs that
list such swaps.\886\
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\884\ CFTC, Industry Filings--Swaps Made Available to Trade,
available at https://www.cftc.gov/idc/groups/public/@otherif/documents/file/swapsmadeavailablechart.pdf.
\885\ CFTC, Industry Filings--Swaps Made Available to Trade
Determination, available at https://sirt.cftc.gov/sirt/sirt.aspx?Topic=%20SwapsMadeAvailableToTradeDetermination.
\886\ The Commission notes that the proposed registry would not
include information regarding the swaps subject to the trade
execution requirement that are listed by Exempt SEFs. The
Commission, however, anticipates that it will provide a list of the
Exempt SEFs on which market participants may execute those swaps,
subject to their availability on those facilities.
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To help the Commission publish and maintain such a registry, the
Commission also proposes a requirement under Sec. 36.2(b) and Appendix
A to part 36 that SEFs and DCMs submit a standardized Form TER. Form
TER would detail the swaps that they list that are subject to or
subsequently become subject to the clearing requirement. The Commission
further proposes to require that a SEF or DCM submit a Form TER
concurrently with any Sec. 40.2 or Sec. 40.3 product filing that
consists of a swap that is subject to the clearing requirement. In
addition, the Commission proposes that SEFs and DCMs file a Form TER,
for any swaps they currently list that are subject to the clearing
requirement, ten business days prior to the effective date of any final
rule adopted from this notice. To effectuate this proposed change
initially, the Commission is proposing that the effective date for
proposed Sec. 36.2 occur twenty days prior to effective date for the
rest of this proposed rule. The Commission believes that this earlier
effective period would provide SEFs and DCMs sufficient time to file
their initial Form TERs and give Commission staff sufficient time to
review and process these initial Form TERs. Finally, for swaps that are
listed by a SEF or DCM that subsequently become subject to the clearing
requirement, the Commission proposes to require that SEFs and DCMs file
Form TER ten business days prior to the effective date of that
requirement for such swaps. By requiring SEFs and DCMs to file Form TER
prior to the effective date of such requirements, Commission staff
would have sufficient time to review, compile Form TERs, and publish
its trade execution requirement registry on its website.
Form TER in Appendix A to part 36 would require a SEFs or DCM to
provide the specific relevant economic terms of the swaps that it lists
for trading. Each SEF or DCM that lists a swap that is subject to or
becomes subject to the clearing requirement would be required to file
an initial Form TER that details all such listed swaps. Any subsequent
changes to a SEF's or DCM's listing of such swaps, such as additional
listed swaps that later become subject to the clearing requirement,
would require the SEF or DCM to amend its Form TER to reflect that
scope. For IRS listed for trading, Form TER would require a SEF or DCM
to specify (i) product class/specification; (ii) currency; (iii)
floating rate index; (iv) stated termination date; (v) optionality;
(vi) dual currencies; and (vii) conditional notional amounts. For CDS
listed for trading, Form TER would require a SEF or DCM to specify (i)
product class/specification; (ii) reference entities; (iii) region;
(iv) indices; (v) tenor; (vi) applicable series; and (vii) tranche. The
Commission notes that the scope of required information corresponds to
the scope of information provided under Sec. 50.4 for IRS and CDS that
are subject to the clearing requirement.
The Commission believes that Form TER would provide the information
needed to efficiently produce a trade execution requirement registry
under Sec. 36.2. Given the potentially large number of filings and
swaps that would comprise the trade execution requirement registry, the
Commission believes that uniform submissions through a standardized
Form TER will foster efficient processing of the submissions and
uniform presentation of relevant information in the registry.
The Commission also proposes to require under Sec. 36.2(c) that
DCMs and SEFs publicly post their respective Form TER filings on their
respective websites, and promptly amend any inaccurate Form TERs.
Request for Comment
The Commission requests comment on all aspects of proposed Sec.
36.2 and proposed Form TER in Appendix A to part 36. In particular, the
Commission requests comment on the following questions:
(99) Does the proposed Form TER request appropriate and sufficient
information? If not, then what information should the Commission
request, and why?
(100) What information should the Commission include in the trade
execution requirement registry, and why?
C. Sec. 36.3--Trade Execution Requirement Compliance Schedule
The Commission observes that with the proposed elimination of the
existing MAT determination process and the expanded scope of swaps that
would be subject to the trade execution requirement under proposed
Sec. 36.1, counterparties may require additional time to prepare and
update their business practices and technological and operational
capabilities to trade and execute these swaps on a SEF or DCM. For
example, market participants would have to directly on-board to a SEF
or DCM, or otherwise avail themselves of other means of access, to
continue trading those swaps that become newly subject to the trade
execution requirement. Therefore, the Commission proposes to eliminate
the existing trade execution requirement compliance schedule \887\ and
to replace it with a new compliance schedule, based on participant
type, for the additional swaps that become subject to the expanded
trade execution requirement. The proposed compliance schedule would be
triggered on the effective date of any final rule adopted from this
notice. The Commission has designed this proposed compliance schedule
to ensure a smooth and timely implementation of the expanded
requirement.
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\887\ 17 CFR 37.12, 38.11.
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In formulating the proposed compliance schedule, the Commission
considered the expanded scope of swaps that would become subject to the
trade execution requirement. The Commission also referred to the
compliance schedule previously established for the initial
implementation of the clearing requirement, with a focus on the defined
categories of market participants and respective levels of swap trading
activity.\888\ Accordingly, the proposed approach recognizes that
different categories of counterparties have different abilities and
resources for achieving compliance and is designed to provide
counterparties with sufficient time to adapt to the expanded trade
execution requirement.
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\888\ 17 CFR 50.25.
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[[Page 62042]]
The proposed schedule would establish different compliance dates
for different categories of counterparties, as described below. As
specified under proposed Sec. 36.3(d), however, nothing in this
proposed compliance schedule should be construed to prohibit
counterparties from voluntarily complying with the trade execution
requirement sooner than prescribed in the proposed compliance schedule.
Finally, the Commission notes that pursuant to proposed Sec. 36.3(b),
the compliance schedule would not apply to swaps that are already
subject to the trade execution requirement before the effective date of
any final rule. Accordingly, market participants must continue to
comply with the existing trade execution requirement for those swaps.
1. Sec. 36.3(c)(1)--Category 1 Entities
Under Sec. 36.3(c)(1), a Category 1 entity, which would include
swap dealers, major swap participants, security-based swap dealers, or
major security-based swap participants, would have ninety days to
comply with the expanded trade execution requirement when it executes a
swap transaction with another Category 1 entity or a non-Category 1
entity that voluntarily seeks to execute the swap on a SEF, a DCM, or
an Exempt SEF. The Commission believes that a ninety-day time frame
would be a reasonable period for these entities because they possess
experience in the swaps market and resources to comply with the
requirement sooner than other counterparties. Further, the Commission
believes that Category 1 entities are generally the most active
participants in the swaps market, often serving as market makers and
liquidity providers to other participants. As the initial category of
participants that are required to comply with the expanded trade
execution requirement, the Commission believes that Category 1 entities
are best equipped to work internally and with the trading venues, i.e.,
SEFs and DCMs, to operate under the expanded trade execution
requirement.
The Commission also believes that ninety days is a reasonable
period of time for SEFs and DCMs to prepare to facilitate trading in
additional swaps that would become subject to the expanded trade
execution requirement. In particular, the Commission notes that some
SEFs already list many of the types of swaps that would become subject
to the expanded requirement.\889\ Therefore, the Commission expects
that the SEFs and DCMs that list these types of swaps would be both
technologically and operationally ready to offer the expanded number of
swaps within ninety days.
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\889\ See supra note 280.
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2. Sec. 36.3(c)(2)--Category 2 Entities
The Commission proposes Sec. 36.3(c)(2) to provide Category 2
entities with 180 days to comply with the expanded trade execution
requirement when they execute swap transactions with a Category 1
entity, another Category 2 entity, or other counterparties that
voluntarily seek to execute the swap on a SEF, a DCM, or an Exempt SEF.
Category 2 entities would include commodity pools; private funds as
defined in section 202(a) of the Investment Advisers Act of 1940; or
persons predominantly engaged in activities related to the business of
banking, or in activities that are financial in nature as defined in
section 4(k) of the Bank Holding Company Act of 1956.
The Commission believes that a significant amount of swaps trading
would migrate to SEFs or DCMs upon the compliance date for Category 2
entities because they consist of many active liquidity takers.
Nevertheless, the Commission believes that an additional ninety days to
comply with the expanded trade execution requirement would be
reasonable for Category 2 entities, given that they may not have the
same level of swaps trading expertise or resources as Category 1
entities. The Commission believes that it is essential for these
entities to have sufficient time to transition their trading to venue-
based environments.
3. Sec. 36.3(c)(3)--Other Counterparties
The Commission proposes Sec. 36.3(c)(3) to provide all entities
that are not either Category 1 entities or Category 2 entities with 270
days to comply with the expanded trade execution requirement. The
Commission believes that entities that do not qualify as either a
Category 1 entity or Category 2 entity should be provided the greatest
amount of time to comply with the expanded trade execution requirement
because they likely have less sophistication in swaps trading. Of all
of the participants in the swaps market, the Commission believes that
the participants in this category are least likely to have on-boarded
to or have experience trading swaps through SEFs or DCMs. Further, the
Commission understands that onboarding onto such venues can be an
intensive and time-consuming process. Therefore, the Commission
believes that this additional time will help ensure that these
participants have sufficient time to onboard or establish means of
access and are prepared to trade on a SEF or DCM.
4. Sec. 36.3(e)--Future Compliance Schedules
Under proposed Sec. 36.3(e), the Commission would devise an
appropriate compliance schedule when additional swaps listed by a SEF
or DCM are subject to the trade execution requirement in the future
i.e., after the effective date of any final rules that are associated
with this part and upon the issuance of additional clearing requirement
determinations. The Commission believes that this approach will provide
it with sufficient flexibility to promote compliance in a manner that
balances the Commission's policy goal of promoting trading on SEFs and
DCMs while also accounting for different considerations, such as the
nature of the swap products, their availability on multiple trading
venues, and the readiness of relevant market participants to trade
those products through a SEF or DCM.
Request for Comment
The Commission requests comment on all aspects of the proposed
compliance schedule in proposed Sec. 36.3. The Commission specifically
requests comment on the following questions:
(101) Are the proposed compliance schedules for Category 1
Entities, Category 2 Entities, and all other entities appropriate? If
not, then should the Commission consider longer or shorter compliance
time frames and why?
(102) Are the entities included in Category 1 and Category 2
appropriate? If not, then please explain why. Should additional
entities be included within either Category 1 or Category 2 and why?
(103) Are the compliance schedule time frames adequate for SEFs and
DCMs to be technologically and operationally ready for the expanded
trade execution requirement? If not, then what alternative compliance
schedule time frame should the Commission consider and why?
(104) How should the Commission handle the compliance schedules for
any future expansions of the trade execution requirement?
XXII. Part 43--Sec. 43.2--Definition of ``Block Trade''
Section 43.2 defines a swap ``block trade'' as a publicly
reportable swap transaction that (i) involves a swap that is listed on
a SEF or DCM; (ii) occurs away from the SEF's or DCM's trading system
or platform and is executed pursuant to the SEF's or DCM's rules
[[Page 62043]]
and procedures; (iii) has a notional or principal amount at or above
the appropriate minimum block trade size applicable to such swap; and
(iv) is reported subject to the rules or procedures of the SEF or DCM
and the rules set forth under part 43, including the appropriate time
delay requirements set forth under Sec. 43.5.\890\ In specifying these
elements, the Commission considered the treatment of block trades in
various swap and non-swap markets.\891\ In particular, the Commission
looked to the futures markets, where futures block trades are
``permissible, privately-negotiated transaction[s] that equal[ ] or
exceed[ ] a DCM's specified minimum quantity of futures or options
contracts and is executed away from the DCM's centralized market but
pursuant to its rules.'' \892\ Accordingly, the Commission's regulatory
definition of a ``block trade'' for swaps closely tracks this futures
market concept of a block trade.
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\890\ 17 CFR 43.2.
\891\ Real-Time Public Reporting of Swap Transaction Data, 75 FR
76140, 76159 (proposed Dec. 7, 2010) (discussion of block trades
with respect to futures).
\892\ Id.
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Similar to futures block trades, the Commission requires that swap
block trades ``occur away'' from a SEF's or a DCM's trading system or
platform, but pursuant to the SEF's or a DCM's rules and
procedures.\893\ The Commission clarified the ``block trade''
definition by stating that ``[a]ny swap that is executed on a SEF or a
DCM's trading system or platform, regardless of whether it is for a
size at or above the appropriate minimum block size for such swap, is
not a block trade under this definition. . . .'' \894\ Accordingly, to
receive the fifteen-minute public reporting delay that block trades are
entitled to under Sec. 43.5(d), the swap transaction not only must
have a notional amount at or above the appropriate minimum block size,
but must also ``occur away'' from the SEF's or the DCM's trading system
or platform.\895\
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\893\ 17 CFR 43.2.
\894\ Procedures To Establish Appropriate Minimum Block Sizes
for Large Notional Off-Facility Swaps and Block Trades, 78 FR 32866,
32904 n.425 (May 31, 2013).
\895\ CEA section 2(a)(13) requires the Commission to establish
rules that govern the real-time reporting of swap transaction and
pricing data to the public, but also directs the Commission, among
other things, to prescribe rules that specify the appropriate
reporting time delay for block trades, including the criteria for
determining what constitutes a block trade. 7 U.S.C. 2(a)(13).
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Given that block trades must occur away from a SEF's or a DCM's
trading system or platform, the enumerated prohibition on pre-arranged
trading as an abusive trading practice under Sec. 37.203(a) allows
block trades as an exception.\896\ This exception allows transactions
that meet or exceed the requisite block size to be privately negotiated
to avoid potentially significant, adverse price impacts that would
occur if traded on trading systems or platforms that offer pre-trade
price transparency.
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\896\ ``Pre-arranged trading'' is prohibited as an abusive
trading practice under Sec. 37.203(a). This prohibition generally
applies to market participants who communicate with one another to
pre-negotiate the terms of a trade away from a trading system or
platform, but then execute the trade on the trading system or
platform in a manner that appears competitive and subject to market
risk. Accordingly, the Commission intended the prohibition to
maintain the integrity of price competition and market risk that is
incident to trading in the market. See supra Section VI.A.2.--Sec.
37.203(a)--Pre-Arranged Trading Prohibition; Sec. 37.9--Time Delay
Requirement.
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A. Sec. 43.2--Definition--Block Trade; Sec. 37.203(a)--Elimination of
Block Trade Exception to Pre-Arranged Trading
During the part 37 implementation process, SEFs and market
participants informed the Commission that for swap transactions that
are intended to be cleared, requiring that such swaps to ``occur away''
from a SEF's trading system or platform creates an issue with carrying
out pre-execution credit screening.\897\ These market participants note
that, in many cases, clearing FCMs are unable to conduct pre-execution
credit screening for such block trades because they are unaware that a
block trade has occurred away from a SEF until after it has been
executed and reported to the SEF.\898\ Accordingly, SEFs were unable to
facilitate pre-execution credit checks for block trades.
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\897\ For the Commission's discussion of pre-execution credit
screening requirements, see supra Section XII.B.2.b.(3)--Sec. Sec.
37.702(b)(2)-(3)--Pre-Execution Credit Screening.
\898\ CFTC Letter No. 17-60, Re: Extension of No-Action Relief
for Swap Execution Facilities from Certain ``Block Trade''
Requirements in Commission Regulation 43.2 at 2 (Nov. 14, 2017)
(``NAL No. 17-60'').
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DMO acknowledged this operational challenge and accordingly has
granted ongoing no-action relief from the requirement that swap block
trades ``occur away'' from a SEF.\899\ Based on Commission staff no-
action relief, a SEF may allow market participants to execute swap
block trades that are intended to be cleared on a SEF's non-Order Book
trading system or platform.\900\ As a result, FCMs and SEFs have been
able to comply with their respective pre-execution credit screening
obligations.
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\899\ NAL No. 17-60; CFTC Letter No. 16-74, Re: Extension of No-
Action Relief for Swap Execution Facilities from Certain ``Block
Trade'' Requirements in Commission Regulation 43.2 (Oct. 7, 2016);
CFTC Letter No. 15-60, Re: Extension of No-Action Relief for Swap
Execution Facilities from Certain ``Block Trade'' Requirements in
Commission Regulation 43.2 (Nov. 2, 2015); CFTC Letter No. 14-118,
No-Action Relief for Swap Execution Facilities from Certain ``Block
Trade'' Requirements in Commission Regulation 43.2 (Sept. 19, 2014).
\900\ NAL No. 17-60 at 2-3.
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The Commission proposes to revise certain elements of the ``block
trade'' definition under Sec. 43.2. First, the Commission proposes to
eliminate the ``occurs away'' requirement for swap block trades.
Second, the Commission proposes to require that to the extent
counterparties seek to execute any swap that has a notional or
principal amount at or above the appropriate minimum block trade size
applicable to such swap on a SEF, they must do so on a SEF's trading
system or platform. For swaps listed by a SEF for trading that
participants intend to execute on the SEF and submit for clearing, the
Commission believes that the proposed revised definition would (i)
allow FCMs to conduct pre-execution credit screenings in accordance
with Sec. 1.73; and (ii) allow SEFs to facilitate those screenings in
accordance with the Commission's proposed requirement under Sec.
37.702(b).\901\ In addition, for swaps listed by a SEF that
participants intend to execute on the SEF, but do not intend to submit
for clearing, participants would no longer be permitted to submit an
already-executed block trade to the SEF pursuant to its rules; such
transactions would be required to be executed on the SEF.
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\901\ The Commission notes that proposed Sec. 37.702(b) applies
to SEFs that list (i) swaps that are subject to the clearing
requirement; and/or (ii) swaps that are not subject to the clearing
requirement, but for which the SEF facilitates processing and
routing to a DCO for clearing. See supra Section XII.B.3.--
Applicability of Sec. 37.702(b) to SEFs that Do Not Facilitate
Clearing.
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The Commission notes that this revised block trade definition is
consistent with the provisions of the Dodd-Frank Act. CEA section
2(a)(13), as amended by the Dodd-Frank Act, directs the Commission to
prescribe criteria for determining what constitutes a block trade for
the purpose of establishing appropriate post-trade reporting time
delays. The provision, however, does not set forth any pre-trade
requirements, such as a requirement that the transaction be executed
away from a SEF. Second, requiring block trades to be executed on a SEF
for those swaps listed by the SEF, rather than allowing them to be
executed away from the SEF, would also facilitate the statutory SEF
goal of promoting swaps trading on SEFs.\902\
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\902\ See 7 U.S.C. 7b-3(e).
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[[Page 62044]]
The revised definition also corresponds with other proposed changes
to the SEF regulatory framework. For example, the Commission believes
that allowing SEFs to use flexible means of execution for swap
transactions negates the need to allow swap block trade execution to
occur away from SEFs. Similarly, the Commission's proposed approach to
pre-execution communications should facilitate swap block trade
execution on SEFs; proposed Sec. 37.201(b) would generally prohibit
participants from conducting such communications away from the SEF,
except for communications regarding a listed swap that is not subject
to the trade execution requirement, among other exceptions.\903\
Accordingly, participants may pre-negotiate block trades with one
another for those swaps away from a SEF and submit them to the SEF for
execution. This approach would allow participants to comply with the
proposed definition, i.e., the swap must be executed on a SEF, but also
facilitate compliance with pre-execution credit screening requirements
if the swap is intended to be cleared.
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\903\ See supra Section VI.A.2.a.--Sec. 37.201(b)--Pre-
Execution Communications.
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To conform to the amended block trade definition, the Commission
also proposes to eliminate the block trade exception to the pre-
arranged trading prohibition under Sec. 37.203(a). Given that block
trades would no longer occur away from a SEF, but would be executed on
a SEF via flexible means of execution, the Commission expects that
market participants will have sufficient ability to continue to execute
such transactions through a SEF's trading system or platform.
Request for Comment
The Commission requests comments on all aspects of proposed Sec.
43.2. The Commission specifically requests comment on the following
questions:
(105) Should the Commission limit the type of execution methods
that may be utilized to permit block trades to receive a public
reporting delay as set forth in Commission regulation Sec. 43.5(d)? If
so, then which methods of execution for block trades should be
precluded from receiving a public reporting delay, and why? Would views
on this question change if the public dissemination delay for a block
trade was extended beyond fifteen minutes? If so, then please explain
why.
(106) Should the Commission allow all swap block trades on SEFs to
be negotiated through pre-execution communications and then submitted
to SEFs for execution? Please explain why or why not.
XXIII. Related Matters
A. Regulatory Flexibility Act
The Regulatory Flexibility Act \904\ requires Federal agencies, in
promulgating regulations, to consider the impact of those regulations
on small businesses. The regulations adopted herein will directly
affect SEFs, DCMs, DCOs, SDs, MSPs and certain ECPs. The Commission has
previously established certain definitions of ``small entities'' to be
used by the Commission in evaluating the impact of its regulations on
small entities in accordance with the Regulatory Flexibility Act.\905\
The Commission has also previously determined that SEFs,\906\
DCMs,\907\ DCOs,\908\ SDs,\909\ MSPs \910\ and ECPs \911\ are not small
entities for the purpose of the Regulatory Flexibility Act.
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\904\ 5 U.S.C. 601 et seq.
\905\ Policy Statement and Establishment of Definitions of
``Small Entities'' for Purposes of the Regulatory Flexibility Act,
47 FR 18618 (Apr. 30, 1982)(``1982 Policy Statement'').
\906\ Core Principles and Other Requirements for Swap Execution
Facilities, 78 FR 33476, 33548 (Jun. 4, 2013).
\907\ 1982 Policy Statement.
\908\ A New Regulatory Framework for Clearing Organizations, 66
FR 45604, 45609 (Aug. 29, 2001).
\909\ Further Definition of ``Swap Dealer,'' ``Security-Based
Swap Dealer,'' ``Major Swap Participant,'' ``Major Security-Based
Swap Participant'' and ``Eligible Contract Participant,'' 77 FR
30596, 30701 (May 23, 2012).
\910\ Id.
\911\ See 66 FR 20740, 20743 (Apr. 25, 2001).
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Therefore, the Chairman, on behalf of the Commission, pursuant to 5
U.S.C. 605(b), hereby certifies that the proposed rules will not have a
significant economic impact on a substantial number of small entities.
B. Paperwork Reduction Act
The Paperwork Reduction Act of 1995, 44 U.S.C. 3501 et seq.
(``PRA'') imposes certain requirements on Federal agencies (including
the Commission) in connection with conducting or sponsoring any
``collection of information,'' \912\ as defined by the PRA. Among its
purposes, the PRA is intended to minimize the paperwork burden to the
private sector, to ensure that any collection of information by a
government agency is put to the greatest possible uses, and to minimize
duplicative information collections across the government.\913\
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\912\ For purposes of this PRA discussion, the terms
``information collection'' and ``collection of information'' have
the same meaning, and this section will use the terms
interchangeably.
\913\ 44 U.S.C. 3501.
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The PRA applies to all information, regardless of form or format,
whenever the government is obtaining, causing to be obtained, or
soliciting information, and includes required disclosure to third
parties or the public, of facts or opinions, when the information
collection calls for answers to identical questions posed to, or
identical reporting or recordkeeping requirements imposed on, ten or
more persons.\914\ The PRA requirements have been determined to include
not only mandatory, but also voluntary information collections, and
include both written and oral communications.\915\
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\914\ 44 U.S.C. 3502.
\915\ 5 CFR 1320.3(c)(1).
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The Commission's proposed amendments would result in a collection
of information within the meaning of the PRA, as discussed below. Under
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 from the Office of Management and
Budget (``OMB''). The proposed rulemaking would amend parts 9, 36, 37,
38, 39, and 43 of the Commission's regulations to include new
information collections, eliminate certain existing information
collections, and modify existing information collections.\916\
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\916\ The proposed amendments would not substantially or
materially modify existing information collection burdens, or create
new information collection burdens, under parts 9, 39, and 43.
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OMB control number 3038-0074 currently covers, among other things,
all information collections arising in part 37 (other than the
information collections related to existing Sec. 37.10) and part
9.\917\ OMB control number
[[Page 62045]]
3038-0052 covers, among other things, information collections arising
in part 38 (other than the information collections related to Sec.
38.12).\918\ OMB control number 3038-0099 covers the information
collections related to the ``available to trade'' determination (``MAT
determination'') process under Sec. 37.10 and Sec. 38.12.
Accordingly, the proposed rulemaking would amend OMB control numbers
3038-0074 and 3038-0052; however, the Commission proposes to eliminate
OMB control number 3038-0099 along with the corresponding MAT
determination information collections under Sec. 37.10 and Sec.
38.12. Instead, the Commission proposes to transfer the corresponding
MAT determination information collections under Sec. 37.10 and Sec.
38.12 to part 36, and the related information collections related to
the MAT determination process for SEFs and DCMs will be incorporated
under OMB control numbers 3038-0074 and 3038-0052, respectively. The
Commission, therefore, is submitting this proposal to OMB for review in
accordance with 44 U.S.C. 3507(d) and 5 CFR 1320.11.
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\917\ The Commission notes that this OMB control number covers
all information collections in part 37, including Subpart A and the
SEF core principles, i.e., Subparts B through P, and the appendices
thereto, i.e., Appendix A (Form SEF), Appendix B (guidance and
acceptable practices), and proposed Appendix C (guidance to Core
Principle 3). This OMB control number also includes all information
collections related to part 9 to the extent applicable to SEFs. For
clarity, existing Sec. 37.10(a) is not covered under this OMB
control number, but rather is subject to a separate information
collection under OMB control number 3038-0099. The Commission
further notes that in the most recent request for an extension of
OMB control number 3038-0074, the Commission stated in the renewal
notice that OMB control number 3038-0074 ``covers all information
collections in part 37 of the Commission's regulations, including
Subpart A and the SEF core principles (i.e., Subparts B and C) . . .
. [other than] any information collections related to Sec. 37.10 .
. . .'' The Commission notes that the reference to ``Subparts B and
C'' should specify ``Subparts B through P'' instead. Agency
Information Collection Activities Under OMB Review, 81 FR 65630, n.1
(Sep. 23, 2016) (``2016 Part 37 PRA Renewal'').
\918\ The Commission notes that this OMB control number covers
all information collections in part 38 of the Commission's
regulations, including Subpart A and the DCM core principles, i.e.,
Subparts B through X. This OMB control number also includes all
information collections related to part 9 to the extent applicable
to DCMs. The Commission also notes for clarity that existing Sec.
38.12 is not covered under this OMB control number, but rather is
subject to a separate information collection with OMB control number
3038-0099.
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The collections of information under these proposed amendments are
necessary to implement certain provisions of the CEA, as amended by the
Dodd-Frank Act. Among other provisions in the CEA, CEA section 8a(5)
provides the Commission with authority to promulgate rules as
reasonably necessary to effectuate any of the provisions or to
accomplish any of the purposes of the CEA.\919\
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\919\ The full authority provided under part 37 of the
Commission's regulations includes: 7 U.S.C. 1a, 2, 5, 6, 6c, 7, 7a-
2, 7b-3, and 12a, as amended by Titles VII and VIII of the Dodd-
Frank Wall Street Reform and Consumer Protection Act, Public Law
111-203, tit. VII-VIII, 124 Stat. 1376 (2010).
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If the proposed amendments are adopted, responses to the proposed
collections of information generally would be mandatory, although
certain collections of information could vary based upon a SEF's
discretion or level of business. For example, a SEF has the discretion
to establish the scope of its trading operations, e.g., determining
which swaps to list for trading, which may affect the various burden
hours discussed herein.
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.
As discussed in the preamble to the final rules for part 37 (``SEF
Core Principles Final Rule''), the methodology the Commission used to
formulate the proposed estimates reflect an average across all SEFs
(and in respect to proposed part 36, all SEFs and DCMs).\920\ By
definition, averages are meant to serve as only a reference point; the
Commission understands that due to both discretionary and mandatory
requirements, some SEFs may go above the estimated burden hours to
complete information collection requirements, while others may stay
below those estimates.\921\
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\920\ Core Principles and Other Requirements for Swap Execution
Facilities, 78 FR 33476, 33551 (Jun. 4, 2013).
\921\ Id.
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1. Information Provided by Reporting Entities/Persons
The following is a brief description of the information collections
for SEFs, and as applicable DCMs and other market participants, under
the proposed amendments to parts 36, 37 and 38.\922\ To the extent that
the Commission does not identify a specific provision, the Commission
does not believe that any associated change substantively or materially
modifies an existing information collection burden or creates a new
one.\923\
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\922\ As noted above, the Commission proposes to eliminate the
MAT determination process for DCMs under Sec. 38.12.
\923\ For the purposes of the PRA discussion herein, the
Commission will not discuss the proposed amendments to parts 9, 39,
and 43 because it has determined that they would not impose new
information collection burdens or substantively or materially modify
existing burdens therein. Further, the Commission will not discuss
any proposed amendments to parts 36, 37, and 38 unless the
Commission has determined that such changes would create, eliminate,
or substantively or materially modify existing information
collections or related burden hours.
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The Commission notes that some of the proposed amendments are
covered by other OMB control numbers. For example, some amendments
would require SEFs to promulgate new rules that are required to be
submitted to the Commission pursuant to part 40 of the Commission's
regulations.\924\ PRA burdens, if any, related to the submission by a
SEF to the Commission of new rules, policies and procedures, and
amendments have been accounted for in the previous information
collection burden estimate associated with part 40, which governs the
process by which SEFs must submit rules and amendments to the
Commission.\925\ Additionally, some of the hours associated with those
information collections would not be deemed to be ``burden hours'' if
they result from ``usual and customary'' business practices.\926\
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\924\ For example, proposed Sec. Sec. 37.201(a)(1)-(3) would
require a SEF to establish rules governing its operation that
specify (i) the protocols and procedures for trading and execution,
including entering, amending, cancelling, or executing orders for
each execution method; (ii) the manner or circumstances in which the
swap execution facility may exercise discretion in facilitating
trading and execution for each execution method; and (iii) the
sources and methodology for generating any market pricing
information provided to facilitate trading and execution for each
execution method.
\925\ Provisions Common to Registered Entities, 76 FR 44776,
44789 (July 27, 2011).
\926\ 5 CFR 1320.3(b)(2). For example, proposed Sec.
37.6(b)(2)(iii) would require a SEF to establish and enforce rules
to require the intermediary to transmit the confirmation or trade
evidence record to the respective counterparty ``as soon as
technologically practicable'' upon receipt of the confirmation or
trade evidence record from the SEF. The Commission notes that SEF
members and market participants acting in an intermediary capacity
and executing swaps on behalf of customers, as a matter of industry
practice, generally make such confirmations available to their
customers, i.e., the swap counterparties. Accordingly, this proposed
amendment reflects an existing ``usual and customary practice'' that
would create a new information collection but would not impose any
associated burden hours.
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a. Sec. 37.3(a)--Requirements for Registration
The Commission expects that as a result of the proposed application
of the SEF registration requirement under Sec. 37.3(a), additional
swaps broking entities will register as SEFs. For PRA purposes, the
Commission previously had revised the current number of registered SEFs
from 23 \927\ to the current 25 \928\ and had estimated approximately 4
new SEF applicants per year.\929\
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\927\ 2016 Part 37 PRA Renewal at 65631.
\928\ Agency Information Collection Activities: Notice of Intent
To Revise Collection Numbers 3038-0052 and 3038-0074, Core
Principles and Other Requirements for Designated Contract Markets,
and Core Principles and Other Requirements for Swap Execution
Facilities, 83 FR 1609, 1611 (Jan. 12, 2018).
\929\ 2016 Part 37 PRA Renewal at 65631.
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The Commission notes that based on data from the National Futures
Association (``NFA''), more than 300 interdealer brokers that are
registered
[[Page 62046]]
with the NFA as ``introducing brokers'' are also ``swap firms,'' i.e.,
interdealer brokers that are registered as introducing brokers and also
designated to deal with swap products. The Commission, however, does
not expect that proposed Sec. 37.3(a) will result in all swap
interdealer brokers registering as SEFs. The Commission understands
that some of these entities may (i) already be affiliated with current
SEFs and could operate as part of their respective affiliated SEFs
rather than registering as new, separate SEFs; (ii) merge, become
affiliated with, or otherwise be acquired by registered SEFs; or (iii)
adjust their business practices such that they would not be required to
register as a SEF. Additionally, some of these entities may be
currently registered as introducing broker swap firms, but are not
currently in the business of swaps trading and therefore do not trigger
the SEF registration requirement. Additionally, the Commission notes
that certain non-U.S. interdealer brokers may also be affiliated with
platforms that are currently exempt or may become exempt in the future
from Commission registration, and therefore, would not need to
separately register as SEFs.
The Commission initially estimates that up to 60 swaps broking
entities, including interdealer brokers, and one Single-Dealer
Aggregator Platform would register as SEFs as a result of the proposed
application of the SEF registration requirement under Sec.
37.3(a).\930\ Consequently, for the purposes of this PRA analysis, the
Commission estimates that the proposed application of Sec. 37.3(a)
will impose an initial, non-recurring information collection burden of
295 burden hours associated with the SEF registration process for these
60 entities.\931\ The Commission does not believe that the proposed
application of the SEF registration requirement in Sec. 37.3(a) would
impose new information collection burdens or substantively or
materially modify existing burdens for registered SEFs.
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\930\ The Commission estimates that approximately 40-60 swaps
broking entities, including interdealer brokers would be required to
register as SEFs as a result of the proposed application of the SEF
registration requirement in Sec. 37.3(a). Similarly, the Commission
is aware of one Single-Dealer Aggregator Platform, which is
affiliated with a SEF. For the purposes of this PRA, the Commission
estimates and assumes that 60 such swaps broker entities and the one
Single-Dealer Aggregator Platform of which it is aware would
register as SEFs. For further discussion, see infra Section
XXIII.C.3.c.--Costs (cost discussion related to the SEF registration
requirement).
\931\ As noted below, based on the proposed changes to the SEF
registration requirements described herein, the Commission is
reducing the estimated burden hours associated with the registration
process by 5 hours from 300 hours to 295 hours.
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In connection with the Commission's proposed clarification of the
registration requirement, the Commission would propose to delay the
application of the registration requirement with respect to (i) swaps
broking entities, including interdealer brokers for a six-month period;
and (ii) foreign swaps broking entities, including foreign interdealer
brokers that facilitate swaps trading for U.S. persons for two-year
period, provided that in each case the subject entity submits a request
to the Commission with certain information.\932\ As noted above, the
Commission expects in the aggregate that approximately 60 such
entities, including swaps broking entities and foreign swaps broking
entities, would be required to register as SEFs, and the Commission
estimates that all such relevant entities would request a delay.
Accordingly, the Commission estimates that the voluntary request to
delay the registration requirement will impose an initial, non-
recurring information collection burden of 1 burden hour associated
with the SEF registration process for each of these 60 entities. The
Commission does not believe that the clarification in proposed Sec.
37.3(a) would impose new information collection burdens or
substantively or materially modify existing burdens for registered
SEFs.
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\932\ The request would include the (i) entity's name as it
appears in the entity's charter; (ii) name and address of the
entity's ultimate parent company; (iii) any names under which the
entity does business; (iv) address of principal executive office;
(v) a contact person's name, address, phone number, and email
address; (vi) asset classes and swap products for which the entity
facilitates trading; and (vii) any registrations, authorizations, or
licenses held. Foreign broking entities additionally would need to
provide (viii) certification that it currently arranges or
negotiates swap transactions for U.S. persons; (ix) home country
regulator or regulators; and (x) any registrations, authorizations,
or licenses held in the entity's home country.
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b. Sec. 37.3(b)--Procedures for Registration
Proposed Sec. 37.3(b) would streamline Form SEF by consolidating,
amending, and eliminating several of the existing exhibits.\933\ The
Commission believes that these changes would establish a clearer and
more simplified application for SEF applicants that would still provide
the Commission with sufficient information needed to determine
compliance. The Commission believes that the proposed streamlined Form
SEF will reduce the initial, non-recurring burden hours associated with
the application process for SEF registration by approximately 5 burden
hours.
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\933\ For further discussion on the specific changes, see supra
Section IV.C.3.b.--Sec. 37.3(b)(1)--Application for Registration.
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c. Sec. 37.3(c)--Amendment to an Order of Registration
Proposed Sec. 37.3(c) would eliminate the requirement that a SEF
amend Form SEF when requesting an amended order of registration from
the Commission. Instead, a registered SEF would file a request with the
Commission for an amended order pursuant to proposed Sec. 37.3(c), but
would no longer be required to file updated exhibits to Form SEF,
although a SEF would be required to provide the Commission with any
additional information and documentation as the Commission deems
necessary.\934\ The Commission estimates that approximately 1 SEF per
year seeks to amend its registration order and that the proposed change
would save that SEF approximately 2 burden hours.
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\934\ The Commission notes that it proposes to eliminate the
existing language under Sec. 37.3(b) that specifies the use of part
40 to file application amendments subsequent to registration. The
Commission emphasizes that not all of the information from the Form
SEF exhibits need to be updated pursuant to part 40 subsequent to
registration--for example, certain part 37 provisions already
require SEFs to update their information on an ongoing basis. Under
Sec. 37.1306, a SEF is required to file financial reports,
including fiscal year end reports, which precludes the need to amend
new Exhibit G (existing Exhibit I) and file it through part 40. As
discussed above, the Commission clarifies that part 40 only applies
to information from application exhibits that constitute a ``rule,''
as defined under Sec. 40.1(i). The Commission generally interprets
the Sec. 40.1(i) rule definition broadly to encompass governance
documentation (proposed Exhibit C); fees (proposed Exhibit H);
rulebooks (proposed Exhibit J); compliance manuals (proposed Exhibit
K); participant agreements (proposed Exhibit L); SDR-related
agreements (proposed Exhibit M); clearing-related agreements
(proposed Exhibit N); other third-party agreements (proposed Exhibit
O); and information related to execution methods (proposed Exhibit
P). Therefore, registered SEFs have already been submitting changes
to these types of documentation pursuant to the part 40 rule filing
procedures.
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d. Sec. 37.5(c)--Provision of Information Relating to a Swap Execution
Facility
Proposed Sec. 37.5(c) would amend the existing notification
requirements related to transfers of equity interest in a SEF. Proposed
Sec. 37.5(c)(1) would require a SEF to file a notice with the
Commission regarding any transaction that results in the transfer of
direct or indirect ownership of fifty percent or more of the equity
interest of a SEF as opposed to only direct ownership transfers as
currently required.\935\ As part of that notification, a SEF may
[[Page 62047]]
incur burdens that are similar to those incurred when providing a
notice of a direct change, including providing details of the proposed
transaction and how the transaction would not adversely impact the
SEF's ability to comply with the SEF core principles and the
Commission's regulations, responding to any requests for supporting
documentation from the Commission, and updating any ongoing changes to
the transaction. Accordingly, the Commission estimates that
approximately 1 additional SEF per year would need to notify the
Commission as a result of an indirect equity transfer and that the
proposed amendment would impose a one-time, non-recurring information
collection of approximately 10 burden hours on such SEF.
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\935\ Transfer of ownership in an ``indirect'' manner may occur
through a transaction that involves the transfer of ownership of a
SEF's direct parent or an indirect parent, and therefore, implicates
effective change in ownership of the SEF's equity interest.
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e. Sec. 37.6(b)(1)--Legally Binding Documentation
Proposed Sec. Sec. 37.6(b)(1)(i)-(ii) would amend the existing
swap documentation requirements by establishing separate transaction
documentation requirements for cleared and uncleared swaps,
respectively. Under existing Sec. 37.6(b), a SEF is required to
provide each counterparty to a transaction with a written
``confirmation'' that contains all of the terms of a swap transaction
at the time of the swap's execution for both cleared and uncleared swap
transactions, including (i) ``economic terms'' specific to the
transaction and (ii) non-transaction specific ``relationship terms''
governing the relationship between the two counterparties.\936\ To
include all of the terms of a uncleared swap into a confirmation, a SEF
would comply with Sec. 37.6(b) by incorporating by reference the
relevant terms set forth in the previously-negotiated agreements and
documents, as long as the SEF had obtained these agreements prior to
execution.\937\
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\936\ As noted above, economic terms include, for example, swap
product, price, trade date, settlement date, and notional amount.
``Relationship terms'' generally govern all transactions between two
counterparties, e.g., default provisions, margin requirements, and
governing law. See supra Section IV.F.--Sec. 37.6--Enforceability.
\937\ SEF Core Principles Final Rule at 33491 n.195.
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Proposed Sec. 37.6(b)(1)(i), which would continue to apply the
existing confirmation requirement to cleared swap transactions, would
not alter the information collection burdens with respect to cleared
swaps. For uncleared swaps, however, proposed Sec. 37.6(b)(1)(ii)
would require a SEF to provide a ``trade evidence record'' that
memorializes the terms that are agreed upon by the counterparties on
the SEF. In contrast to the requirement for cleared swaps, proposed
Sec. 37.6(b)(1)(ii) would not require the trade evidence record to
include all the terms of the swap transaction, including relationship
terms contained in underlying documentation between the counterparties,
nor would the SEF need to obtain or maintain the underlying agreements
prior to the execution of the swap transaction.\938\ To the extent that
such terms either (i) are agreed upon between the counterparties in
underlying documentation established away from the SEF and continue to
govern the transaction post-execution or (ii) are not required to
establish legal certainty for a specific transaction, a SEF would not
be required to incorporate those terms into a trade evidence record.
The proposed approach would address the challenges that have prevented
SEFs from fully complying with Sec. 37.6(b) by reducing the
administrative burdens for SEFs, who under the proposal would not be
required to obtain, incorporate, or reference those previous
agreements; and for counterparties, who would not be required to submit
all of their relevant documentation with other potential counterparties
to the SEF.
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\938\ The Commission anticipates that the terms listed in a
trade evidence record would include, at a minimum, the transaction's
``economic terms,'' e.g., trade date, notional amount, settlement
date, and price.
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As a result, the Commission believes that the proposed amendments
would reduce a SEF's annual recurring information collection burden for
uncleared swap transactions. Accordingly, the Commission estimates that
proposed Sec. 37.6(b)(1)(ii) would reduce annual recurring information
collection burdens by about 375 hours per SEF.\939\
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\939\ The Commission previously estimated that the process to
obtain, review, incorporate, and maintain the previously-negotiated
agreements takes approximately 1.5 hour per SEF participant and that
on average, a SEF has about 375 participants. For purposes of this
PRA discussion herein, however, the Commission is revising its
estimate of the number of burden hours that the proposal would
eliminate and will assume that each such agreement takes
approximately 1.0 hours per SEF participant. Accordingly, 375
participants x 1.0 hour per participant = 375 estimated burden
hours. The Commission also notes that this estimate of 375 burden
hours includes the burden estimates in connection with Sec.
37.1001, which establishes a SEF's recordkeeping obligations.
Supporting Statement for New and Revised Information Collections,
Core Principles and Other Requirements for Swap Execution
Facilities, OMB Control Number 3038-0074, (Sept. 23, 2016), https://www.reginfo.gov/public/do/PRAViewICR?ref_nbr=201609-3038-005.
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f. Sec. 37.203(d)--Automated Trade Surveillance System
Proposed Sec. 37.203(d) would eliminate the prescriptive automated
trade surveillance system capabilities requirements enumerated in
existing Sec. 37.203(d), except for the ability of a SEF to
reconstruct sequence of market activity, and would instead require that
a SEF's automated trade surveillance system be capable of detecting and
``reconstructing'' potential trade practice violations.\940\
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\940\ The Commission notes that this proposed change is
consistent with the proposed amendments to Sec. Sec. 37.205(b)(2)-
(3), as discussed below, that would similarly limit a SEF's
electronic transaction history database and electronic analysis
capability requirements. The Commission, however, emphasizes that a
SEF must continue to have the capability to load and process all
executed trades, including those resulting from orders entered by
voice or certain other electronic communications, such as instant
messaging and email.
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As a result, the proposed rule would provide each SEF with the
flexibility to determine what capabilities its automated trade
surveillance system must have, based on the nature of the SEF's trading
systems or platforms, to satisfy its core principle compliance
responsibilities. Although it is possible that SEFs use their
discretion to decrease the information collections and related burden
hours, SEFs would still be obligated to comply with the same underlying
core principle obligations with which they must currently comply. As a
result, the Commission estimates and assumes that SEFs would continue
to fulfill their information collection burdens in a manner similar to
the status quo. Accordingly, the Commission assumes that proposed Sec.
37.203(d) would not impose new information collection burdens or
substantively or materially affect SEFs' total burden hours.
g. Sec. 37.203(e)--Error Trade Policy
Proposed Sec. 37.203(e) would require SEFs to establish an error
trade policy that, among other things, would notify all market
participants of (i) any swap transaction that is under review; (ii) any
determination by the SEF that the swap transaction under review either
has been determined to be or not to be an error trade; and (iii) the
resolution of any error trade, including any trade term adjustment or
trade cancellation. To the extent that SEFs currently are not
explicitly required to provide market participants with notice of any
of these events, proposed Sec. 37.203(e) would impose a new
information collection burden on SEFs.\941\ The Commission
[[Page 62048]]
estimates that proposed Sec. 37.203(e) would increase a SEF's annual
recurring information collection burden by approximately 15 burden
hours, based on an estimate that a SEF on average would incur
approximately 15 error trade reviews per year.\942\ Because most SEFs
already have established and currently maintain the necessary personnel
and systems to provide such notices to its market participants, the
Commission believes that the proposed amendment would not require SEFs
to expend initial, non-recurring burden hours in order to comply.
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\941\ The Commission notes that existing Sec. 37.203(e)
provides SEFs with the authority to cancel or adjust prices for
error trades if necessary to mitigate market disruption; in
connection with this authority, existing Sec. 37.203(e) also
requires SEFs to make any such adjustments and cancellations
transparent to market participants. 17 CFR 37.203(e). To the extent
that proposed Sec. 37.203(e) requires SEFs to provide notice to
market participants for error trades in additional circumstances,
the proposed amendment imposes a new collection of information.
\942\ As noted above, proposed Sec. 37.203(e) would require a
SEF to provide market participants with a first notice upon the
initiation of a review of an alleged error trade, a second notice
upon any determination as to whether such swap transaction is or is
not an error trade, and a third notice upon the resolution of the
review, including any trade term adjustment or trade cancellation.
The Commission estimates that each notice requires about \1/3\
burden hours, for a total of 1 burden hour per error trade (\1/3\
burden hours x 3 notices = 1 burden hour per error trade for
notices). Further, the Commission estimates that each SEF on average
will have approximately 15 error trade reviews per year.
Accordingly, 1 burden hour x 15 error trade reviews per year = 15
burden hours per year. The Commission notes, however, that certain
error trades may be resolved more quickly than 1 hour or take longer
than 1 hour depending on the availability and coordination of the
counterparties and relevant SEF personnel.
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h. Sec. 37.205(a)--Audit Trail Required
Proposed Sec. 37.205(a) would make several changes to SEFs' audit
trail compliance obligations. First, the proposed amendment would
replace the requirement that SEFs must ``detect, investigate, and
prevent'' customer and market abuse with a requirement instead that
SEFs must be able to ``reconstruct all trading on its facility, detect
and investigate customer and market abuses, and take appropriate
disciplinary action.'' Second, the Commission proposes to move the
requirement that audit trail data shall be sufficient to reconstruct
all indications of interest, requests for quotes, orders and trades, to
the guidance to Core Principle 2 in Appendix B.\943\ Third, the
Commission proposes to eliminate the requirement that SEFs capture
post-execution allocation information in their audit trail data; in
lieu of requiring the audit trail track a customer order through
``fill, allocation, or other disposition,'' the Commission proposes to
require SEFs to capture the audit trail data only through execution on
the SEF since the Commission has learned from SEFs' representations
that SEFs are unable to routinely obtain post-allocation information as
required by Sec. Sec. 37.205(a) and (b)(2) from third parties, such as
DCOs and SDRs.
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\943\ The Commission proposes to add this guidance to paragraph
(a)(4) to Core Principle 2 in Appendix B. The Commission proposes to
eliminate the existing language in paragraph (a)(4). See infra
Section VII.E.2.--Sec. 37.206(b)--Disciplinary Program.
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To the extent that the Commission is providing SEFs with greater
discretion in fulfilling their information collection obligations with
respect to audit trail requirements under Sec. 37.205, the Commission
estimates and assumes that SEFs would continue to fulfill their
information collection burdens in a manner similar to the status quo.
Accordingly, the Commission assumes that proposed Sec. 37.205(a) would
not substantively or materially affect a SEF's total information
collection burden hours.\944\
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\944\ As the Commission discussed above, certain existing
requirements under Sec. 37.205(a) are either unfeasible or impose
greater information collection burdens than the Commission
originally had estimated, e.g., the requirement to collect post-
execution trade allocation information. Subsequently, Commission
staff provided no-action relief with respect to such obligations.
See, e.g., CFTC Letter No. 15-68, Re: No-Action Relief for Swap
Execution Facilities from Certain Audit Trail Requirements in
Commission Regulation 37.205 Related to Post-Execution Allocation
Information (Dec. 22, 2015) (subsequently extended in CFTC Letter
No. 17-54, Re: No-Action Relief for Swap Execution Facilities from
Certain Audit Trail Requirements in Commission Regulation 37.205
Related to Post-Execution Allocation Information (Oct. 31, 2017)).
Accordingly, the 2016 Part 37 PRA Renewal took into consideration in
its revised PRA burden hour estimates the unfeasibility with
complying with such requirements and the corresponding no-action
relief. As a result, the Commission's proposal to eliminate such
information collections under the proposal would not result in a net
change to a SEF's aggregate burden hours because the 2016 Part 37
PRA Renewal already considered such relief and non-compliance with
such requirements in its revised estimate. The Commission notes
that, otherwise, the burden hour estimate in the 2016 Part 37 PRA
Renewal would have been even greater.
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i. Sec. 37.205(b)--Elements of an Acceptable Audit Trail Program
Proposed Sec. 37.205(b) would narrow the scope of audit trail data
that must be captured in a transaction history database under existing
Sec. 37.205(b)(2) by eliminating the requirement that SEFs include in
their electronic transaction history database ``all indications of
interest, requests for quotes, and order and trades entered into'' a
SEF's trading system or platform. Instead, the SEFs would be required
to include only ``trades'' executed via voice or via entry into a SEF's
electronic trading system but must include all ``orders'' that are
entered into an electronic trading system. The Commission additionally
proposes to eliminate the remaining requirements of Sec. 37.205(b)(2)
detailing the information that must be included in transaction history
database. Consistent with the changes to Sec. 37.205(b)(2), the
Commission further proposes to amend Sec. 37.205(b)(3) to clarify that
a SEF's electronic analysis capability must enable the SEF to
reconstruct transactions, rather than ``indications of interest,
requests for quotes, orders, and trades.''
To the extent that the Commission is providing SEFs with greater
discretion in fulfilling their information collection obligations with
respect to audit trail requirements under Sec. 37.205, the Commission
estimates and assumes that SEFs would continue to fulfill their
information collection burdens in a manner similar to the status quo.
Accordingly, the Commission assumes that proposed Sec. 37.205(b) would
not substantively or materially affect a SEF's total information
collection burden hours.
j. Sec. 37.205(c)--Audit Trail Reconstruction
Proposed Sec. 37.205(c) would eliminate the existing requirements
for a SEF to establish an annual audit trail review and a related
enforcement program and instead require the SEF to ``establish a
program to verify its ability to comprehensively and accurately
reconstruct all trading on its facility. . . .'' The Commission
believes that this change will provide SEFs with discretion regarding
what records they must maintain in order to comply with their
information collection requirements, i.e., to determine what components
of their audit, if incomplete or inaccurate, could impair their ability
to conduct effective surveillance, and to determine and implement the
most effective means for enforcing compliance with their audit trail
and recordkeeping requirements.\945\ The Commission also proposes to
adopt guidance to Core Principle 2 in Appendix B specifying that an
effective audit trail reconstruction program should annually review an
adequate sample of executed and unexecuted orders and trades from each
execution
[[Page 62049]]
method offered to verify compliance with Sec. 37.205(c).\946\
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\945\ Notwithstanding these proposed changes, the Commission
notes that to comply with the general audit trail requirement under
proposed Sec. 37.205(a), a SEF must capture all audit trail data
necessary to reconstruct all trading on its facility, detect and
investigate customer and market abuses, and take disciplinary
action, the SEF must ensure that market participants are submitting
accurate and complete audit trail data.
\946\ The Commission proposes to add this guidance to paragraph
(a)(5) to Core Principle 2 in Appendix B. 17 CFR part 37 app. B. As
discussed below, the Commission proposes to eliminate the existing
language in paragraph (a)(5) to Core Principle 2 in Appendix B, see
supra Section VII.E.2.---Sec. 37.206(b)--Disciplinary Program.
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To the extent that the Commission is providing SEFs greater
discretion in fulfilling their information collection obligations with
respect to audit trail requirements under Sec. 37.205, the Commission
estimates and assumes that SEFs would continue to fulfill their
information collection burdens in a manner similar to the status quo.
Accordingly, the Commission will assume that proposed Sec. 37.205(c)
would not substantively or materially affect a SEF's total information
collection burden hours.
k. Sec. Sec. 37.206(b)-(d)--Disciplinary Program
The Commission proposes to eliminate the existing requirements
under (i) Sec. 37.206(c), which currently specify certain minimum
requirements for a SEF disciplinary hearing, including providing a
transcript of the hearing to a respondent under certain conditions; and
(ii) Sec. 37.206(d), which requires that a disciplinary panel render a
written decision promptly following a hearing, along with a detailed
list of information that the SEF must include in the decision. Proposed
Sec. 37.206(b) would generally require a SEF to establish a
disciplinary program to enforce its rules and provide the SEF with the
discretion to administer that program through compliance staff instead
of mandatory disciplinary panels. The Commission also proposes to add
guidance to Core Principle 2 in Appendix B to specify that a SEF's
rules governing the adjudication of a matter by the SEF's disciplinary
panel should be fair, equitable, and publicly available and that a
SEF's rules should require the disciplinary panel to promptly issue a
written decision following a hearing or the acceptance of a settlement
offer.\947\
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\947\ The Commission proposes to add this guidance as part of a
new paragraph (a)(7) to Core Principle 2 in Appendix B.
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To the extent that the Commission is providing SEFs greater
discretion in fulfilling their information collection requirements with
respect to carrying out disciplinary hearing and issuing hearing
decisions, the Commission estimates and assumes that SEFs would
continue to fulfill their information collection burdens in a manner
similar to the status quo. Accordingly, the Commission will assume that
proposed Sec. Sec. 37.206(b)-(d) would not substantively or materially
affect a SEF's total information collection burden hours.
l. Sec. 37.401--General Requirements for Monitoring of Trading and
Trade Processing
Proposed Sec. 37.401(b) would require that a SEF collect and
evaluate data on its market participants' trading activity outside of
the SEF ``as necessary'' rather than ``on an ongoing basis'' as
currently required.\948\ Similarly, proposed Sec. 37.401(c) would
require a SEF to monitor and evaluate general market data to detect and
prevent manipulative activity ``as necessary.'' \949\ The Commission
anticipates that this will reduce annual recurring information
collection burden hours by approximately 50 burden hours per SEF.
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\948\ The proposed amendment would renumber existing subsection
(a) to subsection (b).
\949\ The proposed amendment would renumber existing subsection
(b) to subsection (c).
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m. Sec. 37.1301(b)--General Requirements for Financial Resources
Proposed Sec. 37.1301(b) would permit SEFs that also operate as
DCOs to file a single financial report under Sec. 39.11 that covers
both the SEF and DCO. Because this proposed approach would streamline
and simplify the SEF financial reporting requirement process under
Sec. 37.1306, the Commission estimates that the proposed change would
decrease annual recurring information collection burden by 5 burden
hours. The Commission also estimates that 1 SEF will take advantage of
this approach per year.
n. Sec. 37.1306--Financial Reporting to the Commission
Proposed Sec. 37.1306 would make several changes that would affect
SEFs' information collection burden hours. First, proposed Sec.
37.1306(a) would require SEFs' quarterly financial statement to be
prepare in accordance with GAAP.\950\ Because GAAP-compliant financial
statements generally require additional effort compared to non-GAAP
compliance financial statements, the Commission estimates that the
proposed change would increase annual recurring information collection
burden hours by 10 burden hours and not impose an initial, non-
recurring burden.
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\950\ Alternatively, if a SEF is not domiciled in the United
States and is not otherwise required to prepare financial statements
in accordance with GAAP, then proposed Sec. 37.1306(a)(2)(ii) would
allow the SEF to submit financial statements prepared in accordance
with either International Financial Reporting Standards issued by
the International Accounting Standards Board, or a comparable
international standard that the Commission may otherwise accept in
its discretion.
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Second, proposed Sec. 37.1306(c), among other things, would
require a SEF to determine all of the costs that a SEF would incur to
wind down its operations and the amount of time for the projected wind-
down period, as well as explain the basis for its determinations. The
Commission estimates that proposed Sec. 37.1306(c) will impose an
initial, non-recurring information collection of 20 burden hours
associated with the SEF's obligation to provide a description of the
costs and timing of a projected wind-down scenario, along with the
basis for its determination. Additionally, the Commission estimates
that this information collection burden would impose 5 annual recurring
information collection burden hours after the initial year to update
this information.\951\
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\951\ The Commission notes that existing Sec. 37.1306(c)
requires a SEF to provide ``[s]ufficient documentation'' explaining
both the methodology it used to compute its financial resources
requirement as well as the basis for its determinations regarding
its liquidity requirements. In addition to the change discussed
above, proposed Sec. 37.1306(c) would clarify the type of
information that SEFs must include in the financial statements they
submit to the Commission, including (i) list all of its expenses,
without exclusion, and (ii) identification of all expenses that the
SEF excluded or pro-rated in its projected operating cost
calculations and explain the basis for excluding or pro-rating any
expenses. The Commission believes that these changes are neither an
addition nor modification to existing burden hours since the
Commission is merely clarifying the type of documentation that must
be provided to be deemed ``sufficient'' and are not intended to
increase burden hours or the information that the Commission
originally intended for SEFs to provide. Accordingly, other than as
discussed above, the Commission believes that the proposed amendment
to Sec. 37.1306(c) would not impose new information collection
burdens on SEFs or substantively or materially modify existing
burdens.
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o. Sec. 37.1401(g)--Program of Risk Analysis and Oversight Technology
Questionnaire
Proposed Sec. 37.1401(g) would require a SEF to annually submit an
up-to-date questionnaire that would be located in Appendix A to part 37
(``Questionnaire'') based on the existing Operational Capability
Technology Questionnaire located in Exhibit V to Form SEF in Appendix
A.\952\ A SEF
[[Page 62050]]
would only need to