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Federal Register, Volume 76 Issue 13 (Thursday, January 20, 2011)[Federal Register Volume 76, Number 13 (Thursday, January 20, 2011)]
[Proposed Rules]
[Pages 3698-3742]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2011-690]
[[Page 3697]]
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Part II
Commodity Futures Trading Commission
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17 CFR Part 39
Risk Management Requirements for Derivatives Clearing Organizations;
Proposed Rule
Federal Register / Vol. 76 , No. 13 / Thursday, January 20, 2011 /
Proposed Rules
[[Page 3698]]
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COMMODITY FUTURES TRADING COMMISSION
17 CFR Part 39
RIN 3038-AC98
Risk Management Requirements for Derivatives Clearing
Organizations
AGENCY: Commodity Futures Trading Commission.
ACTION: Notice of proposed rulemaking.
———————————————————————–
SUMMARY: The Commodity Futures Trading Commission (Commission) is
proposing regulations to implement Title VII and Title VIII of the
Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank
Act). Proposed regulations would establish the regulatory standards for
compliance with derivatives clearing organization (DCO) Core Principles
C (Participant and Product Eligibility), D (Risk Management), E
(Settlement Procedures), F (Treatment of Funds), G (Default Rules and
Procedures), and I (System Safeguards). For DCOs that are designated by
the Financial Stability Oversight Council as systemically important
DCOs (SIDCOs), the Commission is proposing heightened standards in the
area of system safeguards supporting business continuity and disaster
recovery and a provision that would implement the Commission’s special
enforcement authority over SIDCOs. The Commission also is proposing
certain additional amendments including replacement of the current part
39 appendix A, Application Guidance and Compliance With Core
Principles, with an application form for entities seeking to register
as DCOs, technical amendments to reorganize part 39 of the Commission’s
regulations, and amendments to supplement reporting and public
information requirements proposed in a previous rulemaking.
DATES: Submit comments on or before March 21, 2011.
ADDRESSES: You may submit comments, identified by RIN number, by any of
the following methods:
Agency Web site, via its Comments Online process: http://comments.cftc.gov. Follow the instructions for submitting comments
through the Web site.
Mail: David A. Stawick, Secretary of the Commission,
Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st
Street, NW., Washington, DC 20581.
Hand Delivery/Courier: Same as mail above.
Federal eRulemaking Portal: http://www.Regulations.gov.
Follow the instructions for submitting comments.
Please submit comments by only one method.
All comments must be submitted in English, or if not, accompanied
by an English translation. Comments will be posted as received to
http://www.cftc.gov. You should submit only information that you wish
to make available publicly. If you wish the Commission to consider
information that may be 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 in Sec. 145.9 of the Commission’s regulations.1 The
Commission reserves the right, but shall have no obligation, to review,
pre-screen, filter, redact, refuse, or remove any or all of your
submission from http://www.cftc.gov that it may deem to be
inappropriate for publication, such as obscene language. All
submissions that have been redacted or removed that contain comments on
the merits of 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
FOIA.
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1 Commission regulations referred to herein are found at 17
CFR Ch. 1 (2010). They are accessible on the Commission’s Web site
at http://www.cftc.gov.
FOR FURTHER INFORMATION CONTACT: John C. Lawton, Deputy Director, 202-
418-5480, [email protected]; Phyllis P. Dietz, Associate Director, 202-
418-5449, [email protected], Robert B. Wasserman, Associate Director,
202-418-5092, [email protected] (System Safeguards); and Jonathan
Lave, Special Counsel, 202-418-5983, [email protected], Division of
Clearing and Intermediary Oversight, Commodity Futures Trading
Commission, Three Lafayette Centre, 1155 21st Street, NW., Washington,
DC 20581; and Julie A. Mohr, Associate Director, 312-596-0568,
[email protected]; and Anne C. Polaski, Special Counsel, 312-596-0575,
[email protected], Division of Clearing and Intermediary Oversight,
Commodity Futures Trading Commission, 525 West Monroe Street, Chicago,
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Illinois 60661.
SUPPLEMENTARY INFORMATION:
Table of Contents
I. Background
A. Title VII of the Dodd-Frank Act
B. Title VIII of the Dodd-Frank Act
C. Dodd-Frank Act rulemaking initiative
II. Discussion
A. Registration procedures
B. Implementation of DCO core principles
1. Participant and product eligibility
(a) Participant eligibility
(i) Fair and open access
(ii) Financial resources
(iii) Operational requirements
(iv) Monitoring, reporting, and enforcement
(b) Product eligibility
2. Risk management
(a) General
(b) Risk management framework
(c) Chief risk officer
(d) Measurement of credit exposure
(e) Limitation of exposure to potential losses from defaults
(f) Margin requirements
(i) General
(ii) Methodology and coverage
(iii) Independent validation
(iv) Spread margins
(v) Price data
(vi) Daily review and back tests
(vii) Customer margin
(1) Gross margin for customer accounts
(2) Customer initial margin requirements
(3) Withdrawal of customer initial margin
(viii) Time deadlines
(g) Other risk control mechanisms
(i) Risk limits
(ii) Large trader reports
(iii) Stress tests
(iv) Portfolio compression
(v) Clearing members’ risk management policies and procedures
(vi) Additional authority
3. Settlement procedures
(a) Daily settlements
(b) Settlement banks
(c) Settlement finality
(d) Recordkeeping
(e) Netting arrangements
(f) Physical delivery
4. Treatment of funds
(a) Required standards and procedures
(b) Segregation of funds and assets
(c) Holding of funds and assets
(i) Types of assets
(ii) Valuation
(iii) Haircuts
(iv) Concentration limits
(v) Pledged assets
(d) Permissible investments
5. Default rules and procedures
(a) General
(b) Default management plan
(c) Default procedures
(d) Insolvency of a clearing member
6. System safeguards
(a) General
(i) Definitions
(ii) Program of risk analysis
(iii) Elements of program
(iv) Standards for program
(v) Business continuity and disaster recovery
(vi) Location of resources; outsourcing
(vii) Notification of Commission staff; recordkeeping
(viii) Testing
(ix) Coordination of business continuity and disaster recovery
plan
(b) SIDCOs
(i) Determining which DCOs will be subject to enhanced BC-DR
obligations
[[Page 3699]]
(ii) Recovery time objective
(iii) Geographic diversity
(iv) Testing
(v) Effective date
7. Special enforcement authority over SIDCOs
C. Additional amendments
1. Technical amendments to reorganize part 39
2. Supplemental provisions for proposed Sec. 39.19
3. Technical amendments to proposed Sec. 39.21
III. Effective Date
IV. Section 4(c)
V. Related Matters
A. Regulatory Flexibility Act
B. Paperwork Reduction Act
C. Cost-benefit analysis
I. Background
A. Title VII of the Dodd-Frank Act
On July 21, 2010, President Obama signed the Dodd-Frank Act.2
Title VII of the Dodd-Frank Act 3 amended the Commodity Exchange Act
(CEA) 4 to establish a comprehensive regulatory framework to reduce
risk, increase transparency, and promote market integrity within the
financial system by, among other things: (1) Providing for the
registration and comprehensive regulation of swap dealers and major
swap participants; (2) imposing clearing and trade execution
requirements on standardized derivative products; (3) creating rigorous
recordkeeping and real-time reporting regimes; and (4) enhancing the
Commission’s rulemaking and enforcement authorities with respect to all
registered entities and intermediaries subject to the Commission’s
oversight.
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2 See Dodd-Frank Wall Street Reform and Consumer Protection
Act, Pub. L. 111-203, 124 Stat. 1376 (2010). The text of the Dodd-
Frank Act may be accessed at http://www.cftc.gov/LawRegulation/OTCDERIVATIVES/index.htm.
3 Pursuant to section 701 of the Dodd-Frank Act, Title VII may
be cited as the “Wall Street Transparency and Accountability Act of
2010.”
4 7 U.S.C. 1 et seq.
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Section 725(c) of the Dodd-Frank Act amended Section 5b(c)(2) of
the CEA, which sets forth core principles with which a DCO must comply
to be registered and to maintain registration as a DCO.
The core principles were added to the CEA by the Commodity Futures
Modernization Act of 2000 (CFMA).5 The Commission did not adopt
implementing rules and regulations, but instead promulgated guidance
for DCOs on compliance with the core principles.6 Under section
5b(c)(2), as amended by the Dodd-Frank Act, Congress expressly
confirmed that the Commission may adopt implementing rules and
regulations pursuant to its rulemaking authority under section 8a(5) of
the CEA.7
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5 See Commodity Futures Modernization Act of 2000, Pub. L.
106-554, 114 Stat. 2763 (2000).
6 See 17 CFR part 39, app. A.
7 Section 8a(5) of the CEA authorizes the Commission to
promulgate such regulations “as, in the judgment of the Commission,
are reasonably necessary to effectuate any of the provisions or to
accomplish any of the purposes of [the CEA].” 7 U.S.C. 12a(5).
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The Commission continues to believe that each DCO should be
afforded an appropriate level of discretion in determining how to
operate its business within the statutory framework. At the same time,
the Commission recognizes that specific, bright-line regulations may be
necessary in order to facilitate DCO compliance with a given core
principle and, ultimately, to protect the integrity of the U.S.
clearing system. Accordingly, in developing the proposed regulations,
the Commission has endeavored to strike an appropriate balance between
establishing general prudential standards and prescriptive
requirements.
In this notice of proposed rulemaking, the Commission proposes to
adopt regulations to implement six DCO core principles. Those core
principles, all of which were amended by the Dodd-Frank Act, are C
(Participant and Product Eligibility), D (Risk Management), E
(Settlement Procedures), F (Treatment of Funds), G (Default Rules and
Procedures), and I (System Safeguards).
B. Title VIII of the Dodd-Frank Act
Section 802(b) of the Dodd-Frank Act states that the purpose of
Title VIII is to mitigate systemic risk in the financial system and
promote financial stability. Section 804 authorizes the Financial
Stability Oversight Council (Council) to designate entities involved in
clearing and settlement as systemically important.8
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8 See Advance Notice of Proposed Rulemaking Regarding
Authority to Designate Financial Market Utilities as Systemically
Important, available at http://www.treasury.gov/initiatives/Pages/FSOC-index.aspx.
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Section 805(a) of the Dodd-Frank Act allows the Commission to
prescribe regulations for those DCOs that the Council has determined
are systemically important. The Commission is proposing to adopt
enhanced requirements for SIDCOs regarding system safeguards for
business continuity and disaster recovery in proposed Sec. 39.30.
Section 807(c) of the Dodd-Frank Act provides the Commission with
special enforcement authority over SIDCOs, which the Commission is
proposing to implement in proposed Sec. 39.31.
C. Dodd-Frank Act Rulemaking Initiative
This proposed rulemaking is the last in a series of proposed
rulemakings issued for the purpose of implementing the DCO core
principles.9 Through the proposed regulations, the Commission seeks
to enhance legal certainty for DCOs, clearing members, and market
participants by providing a regulatory framework to support DCO risk
management practices overall and, in turn, strengthen the financial
integrity of the futures markets and swap markets subject to Commission
oversight.
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9 See e.g., 75 FR 78185 (Dec. 15, 2010) (Core Principles J,
Reporting; K, Recordkeeping; L, Public Information; and M,
Information Sharing); 75 FR 77576 (Dec. 13, 2010) (Core Principles
A, Compliance; H, Rule Enforcement; N, Antitrust Considerations; and
R, Legal Risk); 75 FR 63732 (Oct. 18, 2010) (Core Principle P,
Conflicts of Interest); and 75 FR 63113 (Oct. 14, 2010) (Core
Principle B, Financial Resources).
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With this in mind, the Commission also is proposing to establish
greater uniformity and transparency in the DCO application process by
adopting a registration application form that will facilitate greater
efficiency and consistency in processing submissions. The Commission is
further proposing certain technical amendments to update and conform
provisions of part 39 to the CEA, as amended by the Dodd-Frank Act.
The Commission requests comment on all aspects of the rules
proposed herein, as well as comment on the specific provisions and
issues highlighted in the discussion below.
II. Discussion
A. Registration Procedures
As proposed in an earlier notice of proposed rulemaking, the
Commission intends to continue to voluntarily apply a 180-day time
frame for review of DCO registration applications, but eliminate the
90-day expedited review period for such applications.10 Related to
this, the Commission is now proposing additional revisions to the
requirements for DCO registration in order to clarify the application
submission and review process and to achieve greater efficiency for
both applicants and the Commission.
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10 See 75 FR at 77586. Although the CEA does not require the
Commission to review DCO applications within a prescribed time
period or subject to any prescribed procedures, the Commission
adopted a 90-day expedited review period and, in the alternative,
the 180-day time period and procedures specified in section 6(a) of
the CEA for review of applications for designation of a contract
market.
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The Commission is proposing to revise appendix A to part 39,
“Application Guidance and Compliance With Core Principles,” by
removing the current content and substituting in its
[[Page 3700]]
place Form DCO, which would be comprised of two parts: (i) An
application cover sheet for basic information about the DCO applicant,
its ownership structure, officers, and application contact information,
and (ii) instructions for a series of accompanying exhibits that would
contain information demonstrating compliance with each of the DCO core
principles. An application for DCO registration would consist of the
completed Form DCO, including all applicable exhibits, and any
supplemental information submitted to the Commission.11
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11 In separate rulemakings, the Commission is proposing
applications for designation as a contract market and registration
as a swap execution facility. This approach is similar to the SEC’s
use of the Form CA for securities clearing agency applications,
available at https://www.sec.gov.
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The Commission’s objective in adopting an application form is to
streamline the DCO registration process, having learned from experience
that the general guidance contained in the current appendix A does not
provide sufficiently specific instructions to applicants. As a result,
the registration process has been prolonged in some cases because of
the need for Commission staff to provide applicants with additional
guidance about the nature of the information that is required in order
for the Commission to conclude that the applicant has demonstrated its
ability to comply with the core principles.
The Commission proposes to amend Sec. 39.3(d), “Guidance for
applicants and registrants,” and redesignate it as Sec. 39.3(a)(2).
The amended provision would state that any person seeking to register
as a DCO would be required to submit a completed Form DCO as provided
in appendix A to part 39, including all applicable exhibits. Use of the
Form DCO also would be required for amendments to a pending application
or requests for an amendment to an existing DCO registration. Section
39.3(a)(2) would clarify that an applicant, upon its own initiative,
could file additional information that might be necessary or helpful to
the Commission in processing the application. The Commission strongly
encourages prospective applicants to submit any additional information
that could be useful to the Commission.
The proposed appendix A containing the Form DCO is set forth in
this notice of proposed rulemaking. The Commission requests comment on
the potential benefits and disadvantages of requiring the use of a
standardized application. In addition, the Commission requests comment
on the content of the proposed application including specific exhibits.
Proposed Sec. 39.3(a)(3) would clarify that the filing of a
completed Form DCO would be a minimum requirement and would not create
a presumption that the application is materially complete 12 or that
supplemental information will not be required by the Commission. At any
time during the application review process, the Commission may request
that the applicant submit supplemental information in order for the
Commission to process the application.
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12 Section 6(a) of the CEA, 7 U.S.C. 8(a), provides that the
Commission must approve or deny an application for designation of a
contract market within 180 days of the filing of the application.
However, “[i]f the Commission notifies the person that its
application is materially incomplete and specifies the deficiencies
in the application, the running of the 180-day period shall be
stayed from the time of such notification until the application is
resubmitted in completed form.”
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Under proposed Sec. 39.3(a)(4), an applicant would be required to
promptly amend its Form DCO if it discovered a material omission or
error, or if there is a material change in any information already
provided to the Commission.
Proposed Sec. 39.3(a)(5) would largely incorporate applicable
language of Sec. 40.8(a), which identifies those parts of a DCO
application that are available to the public.13 Those parts are: the
first page of the cover sheet, proposed rules (Exhibit A-1), the
applicant’s regulatory compliance chart (Exhibit A-2), a narrative
summary of the applicant’s proposed clearing activities (Exhibit A-3),
documents establishing the applicant’s legal status (Exhibit A-8),
documents setting forth the applicant’s corporate and governance
structure (Exhibits A-7 and Q), and any other part of the application
not covered by a request for confidential treatment subject to FOIA and
filed in accordance with the requirements of Sec. 145.9 of the
Commission’s regulations.14 The Commission notes that it expects to
continue its practice of posting DCO applications on its Web site for a
public comment period (typically 30 days).
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13 See 75 FR 67282 (Nov. 2, 2010) (provisions common to
registered entities).
14 See 5 U.S.C. 552 and Sec. 145.9 of the Commission’s
regulations (regarding petitions for confidential treatment of
information submitted to the Commission).
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Proposed Sec. 39.3(b)(1) would stay the running of the 180-day
review period if an application was materially incomplete, consistent
with the Commission’s authority with respect to the designation of a
contract market under section 6(a) of the CEA. The delegation provision
of current Sec. 39.3(g) would be redesignated as paragraph (b)(2).
This provision authorizes the Director of the Division of Clearing and
Intermediary Oversight or the Director’s designee, with the concurrence
of the General Counsel or the General Counsel’s designee, to notify an
applicant that the application is materially incomplete and the running
of the 180-day period is stayed.
The Commission requests comment on all aspects of the proposed
amendments to Sec. 39.3, including the costs associated with the
application process and possible means for streamlining the process
further.
B. Implementation of DCO Core Principles
1. Participant and Product Eligibility
Core Principle C, as amended by the Dodd-Frank Act,15 requires
each DCO to establish appropriate admission and continuing eligibility
standards for members of, and participants in, the DCO,16 including
sufficient financial resources and operational capacity to meet the
obligations arising from participation. Core Principle C further
requires that such participation and membership requirements be
objective, be publicly disclosed, and permit fair and open access. Core
Principle C also requires that each DCO establish and implement
procedures to verify compliance with each participation and membership
requirement, on an ongoing basis. With respect to product eligibility,
Core Principle C requires that each DCO establish appropriate standards
for determining the eligibility of agreements, contracts, or
transactions submitted to the DCO for clearing.17 The Commission is
proposing to adopt
[[Page 3701]]
Sec. 39.12 to establish requirements that a DCO would have to meet in
order to comply with Core Principle C.
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15 Section 5b(c)(2)(C) of the CEA; 7 U.S.C. 7a-1(c)(2)(C)
(Core Principle C).
16 Core Principle C, as well as the other core principles that
are discussed herein, refer to “members of, and participants in” a
DCO. The Commission interprets this phrase to mean persons with
clearing privileges, and has used the term “clearing member” in
describing the requirements of each core principle and in the text
of the proposed regulations described herein. In a separate notice
of proposed rulemaking, the Commission has proposed to amend the
definition of “clearing member” in Sec. 1.3(c) to mean “any
person that has clearing privileges such that it can process, clear
and settle trades through a derivatives clearing organization on
behalf of itself or others. The derivatives clearing organization
need not be organized as a membership organization.” See 75 FR at
77585.
17 Prior to amendment by the Dodd-Frank Act, Core Principle C
provided that
[t]he applicant shall establish–
(i) appropriate admission and continuing eligibility standards
(including appropriate minimum financial requirements) for members
of and participants in the organization; and
(ii) appropriate standards for determining eligibility of
agreements, contracts, or transactions submitted to the applicant.
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(a) Participant eligibility.
As noted above, Core Principle C requires that a DCO’s admission
and continuing eligibility standards for clearing members must be
objective and publicly disclosed.18 Proposed Sec. 39.12(a) would
codify these requirements, and would make clear that such requirements
must be risk-based.
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18 Section 5b(c)(2)(C)(iii) of the CEA; 7 U.S.C. 7a-
1(c)(2)(C)(iii) (Core Principle C).
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(i) Fair and open access.
Core Principle C mandates that participation requirements must
“permit fair and open access.” 19 It also mandates that clearing
members must have “sufficient financial resources and operational
capacity to meet obligations arising from participation in the
derivatives clearing organization.” 20 Although there is potential
for tension between these goals, the Commission believes that they can
be harmonized. Proposed Sec. 39.12 is designed to ensure that
participation requirements do not unreasonably restrict any entity from
becoming a clearing member while, at the same time, limiting risk to
the DCO and its clearing members. The Commission believes that more
widespread participation could reduce the concentration of clearing
member portfolios and diversify risk. It could also increase
competition by allowing more entities to become clearing members.
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19 Id.
20 Id.
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Proposed Sec. 39.12(a)(1) would require a DCO to establish
participation requirements that permit fair and open access. To achieve
fair and open access, proposed Sec. 39.12(a)(1)(i) would prohibit a
DCO from adopting a particular restrictive participation requirement if
it could adopt a less restrictive requirement that would not materially
increase risk to the DCO or its clearing members.
Proposed Sec. 39.12(a)(1)(ii) would require a DCO to permit a
market participant to become a clearing member if it met the DCO’s
participation requirements. Proposed Sec. 39.12(a)(1)(iii) would
prohibit participation requirements that have the effect of excluding
or limiting clearing membership of certain types of market participants
unless the DCO can demonstrate that the restriction is necessary to
address credit risk or deficiencies in the participants’ operational
capabilities that would prevent them from fulfilling their obligations
as clearing members. Section 39.12(a)(1)(iv) would prohibit a DCO from
requiring that clearing members must be swap dealers. Section
39.12(a)(1)(v) would prohibit a DCO from requiring that clearing
members maintain a swap portfolio of any particular size, or that
clearing members meet a swap transaction volume threshold.
The access and participation requirements discussed above meet or
exceed international recommendations.21
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21 In November 2004, the Task Force on Securities Settlement
Systems, jointly established by the Committee on Payment and
Settlement Systems (CPSS) of the central banks of the Group of Ten
countries and the Technical Committee of the International
Organization of Securities Commissions (IOSCO), issued
Recommendations for Central Counterparties. CPSS & Technical Comm.
of IOSCO Recommendations for Central Counterparties, CPSS Publ’n No.
64 (Nov. 2004), available at http://www.bis.org/publ/cpss64.pdf
(CPSS-IOSCO Recommendations). CPSS-IOSCO Recommendation 2 provides,
in part, that “[a] CCP’s participation requirements should be
objective, publicly disclosed, and permit fair and open access.”
The CPSS-IOSCO Recommendations further state that
[t]o avoid discriminating against classes of participants and
introducing competitive distortions, participation requirements
should be objective and avoid limiting competition through
unnecessarily restrictive criteria, thereby permitting fair and open
access within the scope of services offered by the CCP. [footnote
omitted] Participation requirements that limit access on grounds
other than risks should be avoided.
(CPSS-IOSCO Recommendations, pg. 16). The Commission notes that
CPSS and IOSCO are currently reviewing the CPSS-IOSCO
Recommendations, which may be revised.
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(ii) Financial resources.
Core Principle C mandates that participation requirements must
ensure that clearing members have “sufficient financial resources and
operational capacity to meet obligations arising from participation in
the [DCO].” 22 Proposed Sec. 39.12(a)(2)(i) would require a DCO to
establish participation requirements that require clearing members to
have access to sufficient financial resources to meet obligations
arising from participation in the DCO in extreme but plausible market
conditions. The financial resources could include a clearing member’s
capital, a guarantee from a clearing member’s parent, or a credit
facility funding arrangement. The proposed regulation would further
specify that, for purposes of proposed Sec. 39.12(a)(2), “capital”
would mean adjusted net capital as defined in Sec. 1.17 of the
Commission’s regulations, for futures commission merchants (FCMs), and
net capital as defined in SEC rule 15c3-1, for broker-dealers, or any
similar risk adjusted capital calculation for all other prospective
clearing members.
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22 Section 5b(c)(2)(C)(i)(I) of the CEA; 7 U.S.C. 7a-
1(c)(2)(C)(i)(I).
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The Commission invites comment regarding whether a guarantee or a
credit facility funding arrangement is sufficiently reliable and liquid
such that it should be considered as a resource that would be available
to meet obligations arising from participation in a DCO in extreme but
plausible market conditions.
Proposed Sec. 39.12(a)(2)(ii) would require a DCO to establish
capital requirements that are based on objective, transparent, and
commonly accepted standards that appropriately match capital to risk.
The proposed regulation would require capital requirements to be
scalable so that they are proportional to the risks posed by clearing
members.
With respect to persons that seek clearing membership in order to
clear swaps, proposed Sec. 39.12(a)(2)(iii) would specify that a DCO
is not permitted to set a minimum capital requirement of more than $50
million.
If the capital requirement is satisfied by a prospective clearing
member, the DCO is prohibited from making a determination that the
prospective clearing member does not satisfy its scalable capital
requirements. Proposed Sec. Sec. 39.12(a)(2)(ii) and 39.12(a)(2)(iii),
considered together, would require a DCO to admit any person to
clearing membership for the purpose of clearing swaps, if the person
had $50 million in capital, but would permit a DCO to require each
clearing member to hold capital proportional to its risk exposure.23
Thus, if a clearing member’s risk exposure were to increase in a non-
linear manner, the DCO could increase the clearing member’s
corresponding scalable capital requirement in a non-linear manner.
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23 Conversely, as discussed, infra, in section II.B.2.g.i,
proposed Sec. 39.13(h)(1)(i) would require a DCO to impose risk
limits on a clearing member to prevent a clearing member from
carrying positions where the risk exposure of those positions
exceeded a threshold specified by the DCO relative to the financial
resources of the clearing member, the DCO, or both.
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The Commission requests comment on whether establishing a capital
threshold is an effective approach to promoting fair and open access.
If it is, the Commission further requests views on whether the $50
million figure is an appropriate amount and, if not, what alternative
amount might be more appropriate.
(iii) Operational requirements.
Proposed Sec. 39.12(a)(3) would require a DCO to establish
participation requirements that ensure that clearing members have
adequate operational
[[Page 3702]]
capacity to meet obligations arising from participation in the DCO. The
requirements would have to include, at a minimum, the ability to
process expected volumes and values of transactions cleared by the
clearing member within required time frames, including at peak times
and on peak days; the ability to fulfill collateral, payment, and
delivery obligations imposed by the DCO; and the ability to participate
in default management activities under the rules of the DCO and in
accordance with Sec. 39.16 of the Commission’s regulations.
(iv) Monitoring, reporting, and enforcement.
Strong participation requirements will not limit risk if clearing
members do not satisfy the requirements on an ongoing basis.
Accordingly, Core Principle C requires each DCO to “establish and
implement procedures to verify, on an ongoing basis, the compliance of
each participation and membership requirement of the derivatives
clearing organization.” 24 Proposed Sec. 39.12(a)(4) would codify
this requirement.
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24 See section 5b(c)(2)(C)(ii) of the CEA; 7 U.S.C. 7a-
1(c)(2)(C)(ii). Based on context, the Commission interprets the
phrase “compliance of each participation and membership
requirement” to mean compliance “with” each participation and
membership requirement.
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A DCO cannot effectively monitor clearing members if it is not
adequately informed about their financial status. Proposed Sec.
39.12(a)(5) would address this concern. Specifically, proposed Sec.
39.12(a)(5)(i) would require a DCO to require all of its clearing
members, including non-FCMs, to file periodic financial reports with
the DCO that contain any financial information that the DCO determines
is necessary to assess whether participation requirements are met on an
ongoing basis. A DCO would have to require its clearing members that
are FCMs to file the financial reports that are specified in Sec. 1.10
of the Commission’s regulations with the DCO. The proposed regulation
also would require a DCO to review these financial reports for risk
management purposes. Proposed Sec. 39.12(a)(5)(i) would further
require a DCO to require its clearing members that are not FCMs to make
the periodic financial reports that they file with the DCO available to
the Commission upon the Commission’s request. Proposed Sec.
39.12(a)(5)(ii) would require a DCO to adopt rules that require a
clearing member to provide to the DCO, in a timely manner, information
that concerns any financial or business developments that could
materially affect the clearing member’s ability to continue to comply
with participation requirements.
Finally, proposed Sec. 39.12(a)(6) would require a DCO to have the
ability to enforce compliance with its participation requirements. In
particular, the DCO would be required to establish procedures for the
suspension and orderly removal of clearing members that no longer meet
the DCO’s participation requirements.
(b) Product eligibility.
Core Principle C requires each DCO to establish “appropriate
standards for determining the eligibility of agreements, contracts, or
transactions submitted to the [DCO] for clearing.” 25 Proposed Sec.
39.12(b)(1) would require a DCO to establish appropriate requirements
for determining the eligibility of agreements, contracts, or
transactions submitted to the DCO for clearing, taking into account the
DCO’s ability to manage the risks associated with such agreements,
contracts, or transactions. Factors to be considered in determining
product eligibility would include, but would not be limited to: (i)
trading volume; (ii) liquidity; (iii) availability of reliable prices;
(iv) ability of market participants to use portfolio compression 26
with respect to a particular swap product; (v) ability of the DCO and
clearing members to gain access to the relevant market for purposes of
creating and liquidating positions; (vi) ability of the DCO to measure
risk for purposes of setting margin requirements; and (vii) operational
capacity of the DCO and clearing members to address any unique risk
characteristics of a product.
—————————————————————————
25 Section 5b(c)(2)(C)(i)(II) of the CEA; 7 U.S.C. 7a-
1(c)(2)(C)(i)(II).
26 Portfolio compression is a mechanism by which superfluous
transactions among two or more counterparties are compressed,
terminated and replaced with a smaller number of transactions of
decreased notional principal value in an effort to reduce the risk,
cost, and inefficiency of maintaining unnecessary transactions on
the counterparties’ books.
—————————————————————————
Section 2(h)(1)(B) of the CEA requires a DCO to adopt rules
providing that all swaps with the same terms and conditions submitted
to the DCO for clearing are economically equivalent within the DCO and
may be offset with each other within the DCO. Section 2(h)(1)(B)
further requires a DCO to provide for non-discriminatory clearing of a
swap executed bilaterally or on or subject to the rules of an
unaffiliated designated contract market (DCM) or swap execution
facility (SEF). Proposed Sec. 39.12(b)(2) would codify these
requirements in the Commission’s regulations.
Proposed Sec. 39.12(b)(3) would require a DCO to select contract
unit sizes that maximize liquidity, open access, and risk management.
To the extent appropriate to further these objectives, the proposed
regulation would require a DCO to select contract units for clearing
purposes that may be smaller than the contract units in which trades
submitted for clearing were executed. The contract unit size of a
particular swap executed bilaterally may reflect the immediate
circumstances of the two parties to the transaction. Once submitted for
clearing, it may be possible to split the trade into smaller units
without compromising the interests of the two original parties. Smaller
units can promote liquidity by permitting more parties to trade the
product, facilitate open access by permitting more clearing members to
clear the product, and aid risk management by enabling a DCO, in the
event of a default, to have more potential counterparties for
liquidation.
Finally, proposed Sec. 39.12(b)(4) would require each DCO that
clears swaps to have rules stating that upon acceptance of a swap by
the DCO for clearing, (i) the original swap is extinguished, (ii) it is
replaced by equal and opposite swaps between clearing members and the
DCO, (iii) all terms of the cleared swaps must conform to templates
established under DCO rules, and (iv) if a swap is cleared by a
clearing member on behalf of a customer, all terms of the swap, as
carried in the customer account on the books of the clearing member,
must conform to the terms of the cleared swap established under the
DCO’s rules.
The purpose of this provision is to encourage the standardization
of swaps and to avoid any differences between the terms of a swap as
carried at the DCO level and as carried at the clearing member level.
Any such differences would raise both customer protection and systemic
risk concerns. From a customer protection standpoint, if the terms of
the swap at the customer level differ from those at the clearing level,
then the customer position cannot really be said to have been cleared.
If the customer position differs from the cleared position, the
customer may not receive the full transparency and liquidity benefits
of clearing. Similarly, from a systemic perspective, any differences
could diminish overall price discovery and liquidity. Standardizing the
terms of a swap upon clearing would facilitate trading and promote the
mitigation of risk for all participants in the swap markets.
Furthermore, standardization would support the requirement in section
2(h)(1)(B) of the CEA and proposed Sec. 39.12(b)(2) that a DCO must
adopt rules providing that all swaps with the same terms and conditions
submitted to the DCO are
[[Page 3703]]
economically equivalent within the DCO and may be offset with each
other.
2. Risk Management Requirements
Core Principle D, as amended by the Dodd-Frank Act,27 requires
each DCO to ensure that it possesses the ability to manage the risks
associated with discharging the responsibilities of the DCO through the
use of appropriate tools and procedures. It further requires each DCO
to measure its credit exposures to each clearing member not less than
once during each business day and to monitor each such exposure
periodically during the business day. Core Principle D also requires
each DCO to limit its exposure to potential losses from defaults by
clearing members, through margin requirements and other risk control
mechanisms, to ensure that its operations would not be disrupted and
that nondefaulting clearing members would not be exposed to losses that
nondefaulting clearing members cannot anticipate or control. Finally,
Core Principle D requires that the margin that the DCO requires from
each clearing member must be sufficient to cover potential exposures in
normal market conditions and that each model and parameter used in
setting such margin requirements must be risk-based and reviewed on a
regular basis.28 The Commission is proposing to adopt Sec. 39.13 to
establish requirements that a DCO would have to meet in order to comply
with Core Principle D.
—————————————————————————
27 Section 5b(c)(2)(D) of the CEA; 7 U.S.C. 7a-1(c)(2)(D)
(Core Principle D).
28 Prior to amendment by the Dodd-Frank Act, Core Principle D
provided that “[t]he applicant shall have the ability to manage the
risks associated with discharging the responsibilities of a
derivatives clearing organization through the use of appropriate
tools and procedures.”
—————————————————————————
(a) General.
Proposed Sec. 39.13(a) would require a DCO to ensure that it
possesses the ability to manage the risks associated with discharging
its responsibilities through the use of appropriate tools and
procedures. The specific requirements that are addressed in the
remainder of proposed Sec. 39.13, in addition to margin requirements,
describe various tools and procedures that the Commission believes are
necessary to ensure that DCOs are able to effectively manage the risks
that are inherent in their roles as central counterparties. Many of
those requirements reflect the current practices of most or all DCOs,
and others may describe enhancements that would assist existing and new
DCOs in mitigating their risks as they assume new responsibilities in
connection with the clearing of swaps.
(b) Risk management framework.
Proposed Sec. 39.13(b) would require a DCO to establish and
maintain written policies, procedures, and controls, approved by its
Board of Directors, which establish an appropriate risk management
framework that, at a minimum, clearly identifies and documents the
range of risks to which the DCO is exposed, addresses the monitoring
and management of the entirety of those risks, and provides a mechanism
for internal audit. Those risks may include, but are not limited to,
legal risk, credit risk, liquidity risk, custody and investment risk,
concentration risk, default risk, operational risk, market risk, and
business risk. A DCO would be required to regularly review its risk
management framework and update it as necessary.
The Commission believes that a DCO should adopt a comprehensive and
documented risk management framework that addresses all of the various
types of risks to which it is exposed, including the manner in which
they may relate to each other. A DCO’s risk management framework should
be subject to the approval of its Board of Directors, as the Board is
ultimately responsible for managing a DCO’s risks. The Commission is
proposing to leave it to the discretion of each DCO to determine the
frequency with which it reviews its risk management framework as long
as it is reviewed on a regular basis.
(c) Chief risk officer.
Proposed Sec. 39.13(c) would require a DCO to have a chief risk
officer who would be responsible for the implementation of the risk
management framework and for making appropriate recommendations
regarding the DCO’s risk management functions to the DCO’s Risk
Management Committee or Board of Directors, as applicable. In a
separate rulemaking, the Commission has proposed to adopt Sec.
39.13(d) to require DCOs to have a Risk Management Committee with
defined composition requirements and specified minimum functions.29
—————————————————————————
29 See 75 FR at 63750. In that proposed rulemaking, the
provisions relating to the Risk Management Committee were designated
as Sec. 39.13(g). In the final rulemaking, the provisions will be
redesignated as Sec. 39.13(d).
—————————————————————————
DCOs generally have a chief risk officer or an individual who
performs such a function, and the Commission believes this is a “best
practice.” Although Core Principle D does not specifically require a
DCO to have a chief risk officer, the Commission believes that given
the importance of the risk management function, each DCO should have a
member of senior management who is responsible for overseeing the
implementation of the DCO’s comprehensive risk management framework and
making appropriate recommendations regarding risk management issues to
the DCO’s Risk Management Committee (for matters within its
jurisdiction) or directly to the Board.
The CEA, as amended by the Dodd-Frank Act, requires a DCO to have a
chief compliance officer with defined responsibilities.30 These
requirements have been addressed in a separate rulemaking.31 Given
the importance of the risk management function and the comprehensive
nature of the responsibilities of the chief compliance officer as
defined in the statute, the Commission expects that the chief risk
officer and the chief compliance officer would be two different
individuals.
—————————————————————————
30 See section 5b(i) of the CEA; 7 U.S.C. 7a-1(i).
31 75 FR at 77587.
—————————————————————————
(d) Measurement of credit exposure.
Proposed Sec. 39.13(e) would require a DCO to measure and monitor
its credit exposures to its clearing members. The proposed regulation
uses the term “credit exposure” in order to be consistent with the
statutory language of Core Principle D. In this context, “credit
exposure” does not refer to an extension of credit by the DCO to a
clearing member. Rather, it refers to any amounts that a clearing
member would owe to a DCO if the clearing member were to default in its
obligations to the DCO. It includes both current exposures and
potential future exposures.
Specifically, Sec. 39.13(e) would require a DCO to: (1) Measure
its credit exposure to each clearing member and mark to market such
clearing member’s open positions at least once each business day; and
(2) monitor its credit exposure to each clearing member periodically
during each business day. Proposed Sec. 39.13(e) goes hand in hand
with proposed Sec. 39.14(b), which addresses daily settlements based
on a DCO’s measurement of its credit exposures to its clearing
members.32
—————————————————————————
32 See infra section II.B.3.a of this notice.
—————————————————————————
(e) Limitation of exposure to potential losses from defaults.
Proposed Sec. 39.13(f) would require a DCO, through margin
requirements and other risk control mechanisms, to limit its exposure
to potential losses from defaults by its clearing members to ensure
that: (1) Its operations would not be disrupted; and (2) nondefaulting
clearing members would not be exposed to losses that nondefaulting
clearing members cannot anticipate or control. The language of proposed
Sec. 39.13(f) is virtually identical to the language in
[[Page 3704]]
section 5b(c)(2)(D)(iii) of the CEA, as amended by the Dodd-Frank Act.
(f) Margin requirements.
(i) General.
As specified in section 5b(c)(2)(D)(iv) of the CEA, proposed Sec.
39.13(g)(1) would require that the initial margin that a DCO requires
from each clearing member must be sufficient to cover potential
exposures in normal market conditions and that each model and parameter
used in setting initial margin requirements must be risk-based and
reviewed on a regular basis.33 The Commission has not defined
“normal market conditions” in the proposed regulation. Current
international recommendations define “normal market conditions” as
“price movements that produce changes in exposures that are expected
to breach margin requirements or other risk control mechanisms only 1%
of the time, that is, on average on only one trading day out of 100.”
34 The Commission invites comment regarding whether a definition of
“normal market conditions” should be included in the proposed
regulation and, if so, how normal market conditions should be defined.
—————————————————————————
33 The Commission has proposed to define “initial margin” as
“money, securities, or property posted by a party to a futures,
option, or swap as performance bond to cover potential future
exposures arising from changes in the market value of the
position.” See 75 FR at 77585 (proposing Sec. 1.3(lll)).
34 CPSS-IOSCO Recommendations, pg. 21.
—————————————————————————
(ii) Methodology and coverage.
Proposed Sec. 39.13(g)(2) would set forth requirements regarding
margin methodology and coverage. First, it would require a DCO to
establish initial margin requirements that are commensurate with the
risks of each product or portfolio, including any unique
characteristics of, or risks associated with, particular products or
portfolios. In particular, proposed 39.13(g)(2)(i) would require a DCO
that clears credit default swaps (CDS) to appropriately address jump-
to-default risk in setting initial margins.35 With the exception of
jump-to-default risk, the Commission has not defined specific risks
that a DCO should consider in light of the fact that such risks would
be product-specific and portfolio-specific. In addition, there may be
risks that might apply to products or portfolios that are cleared in
the future that cannot be anticipated at this time. The Commission
invites comment regarding whether there are specific risks that should
be identified and addressed in the proposed regulation in addition to
jump-to-default risk.
—————————————————————————
35 Jump-to-default risk refers to the possibility that a CDS
portfolio with large net sales of protection on an underlying
reference entity could experience significant losses over a very
short period of time following an unexpected event of default by the
reference entity.
—————————————————————————
Proposed Sec. 39.13(g)(2)(ii) would require a DCO to use margin
models that generate initial margin requirements sufficient to cover
the DCO’s potential future exposures to clearing members based on price
movements in the interval between the last collection of variation
margin 36 and the time within which the DCO estimates that it would
be able to liquidate a defaulting clearing member’s positions
(liquidation time). A DCO would be required to use a liquidation time
that is a minimum of five business days for cleared swaps that are not
executed on a DCM, whether the swaps are carried in a customer account
subject to section 4d(a) or 4d(f) of the CEA, or a house account.37 A
DCO would be required to use a liquidation time that is a minimum of
one business day for all other products that it clears, although it
would be required to use longer liquidation times, if appropriate,
based on the unique characteristics of particular products or
portfolios.
—————————————————————————
36 The Commission has proposed to define “variation margin”
as “a payment made by a party to a futures, option, or swap to
cover the current exposure arising from changes in the market value
of the position since the trade was executed or the previous time
the position was marked to market.” See 75 FR at 77585 (proposing
Sec. 1.3(ooo)).
37 See infra section II.B.4.b of this notice, discussing
commingling of customer futures and cleared swaps positions.
—————————————————————————
A minimum of one business day is the current standard that DCOs
generally apply to futures and options on futures contracts. The
Commission believes that a minimum of five business days is appropriate
for cleared swaps that are not executed on a DCM in that such a time
period may be necessary to close out swap positions in a cost-effective
manner.38 Several clearing organizations currently use a five-day
liquidation time in determining margin requirements for certain cleared
swaps. The Commission invites comment regarding whether the minimum
liquidation times specified in proposed Sec. 39.13(g)(2)(ii) are
appropriate, or whether there are minimum liquidation times that are
more appropriate.
—————————————————————————
38 Pursuant to section(s) 4(c) and/or 4d of the CEA, the
Commission has previously issued several orders allowing funds
margining cleared swaps to be commingled with funds margining
futures and options on futures. In those orders, the Commission
permitted such swaps to be margined using liquidation times that
were less than five business days. See, e.g., 74 FR 12316 (Mar. 24,
2009) (corn, wheat and soybean swaps); 73 FR 77015 (Dec. 18, 2008)
(coffee, sugar and cocoa swaps); and Order of the Commodity Futures
Trading Commission, dated Sep. 26, 2008, entitled “Treatment of
Funds Held in Connection with the Clearing of Over-the-Counter
Products by The Chicago Mercantile Exchange,” available at http://www.cftc.gov/stellent/groups/public/@requestsandactions/documents/ifdocs/cbot4dorder9-26-08.pdf (ethanol swaps). The Commission
intends to grandfather the swaps subject to previously issued
orders, such that the relevant liquidation time periods for those
swaps would continue to be governed by the terms of the orders.
—————————————————————————
Proposed Sec. 39.13(g)(2)(iii) would require that the actual
coverage of the initial margin requirements produced by a DCO’s margin
models, along with projected measures of the models’ performance, would
have to meet a confidence level of at least 99%, based on data from an
appropriate historic time period with respect to: (A) Each product that
is margined on a product basis; (B) each spread within or between
products for which there is a defined spread margin rate, as described
in proposed Sec. 39.13(g)(3); (C) each account held by a clearing
member at the DCO, by customer origin and house origin, and (D) each
swap portfolio, by beneficial owner. These requirements meet or exceed
international recommendations.39
—————————————————————————
39 For example, on September 15, 2010, the European Commission
(EC) proposed the European Market Infrastructure Regulation (EMIR),
available at http://ec.europa.eu/internal_market/financial-markets/docs/derivatives/20100915_proposal_en.pdf, “to ensure
implementation of the G20 commitments to clear standardized
derivatives [which can be accessed at http://www.g20.org/Documents/pittsburgh_summit_leaders_statement_250909.pdf], and that
Central Counterparties (CCPs) comply with high prudential standards
* * *,” among other things, and expressed its intent to be
consistent with the Dodd-Frank Act. (EMIR, pg. 2-3). The EMIR
requires that margins “* * * shall be sufficient to cover losses
that result from at least 99 per cent of the exposures movements
over an appropriate time horizon . * * *” (EMIR, Article 39,
paragraph 1, pg. 46).
—————————————————————————
The Commission recognizes that while some DCOs generally apply a
99% confidence level to some or all products that they clear, other
DCOs apply a confidence level of between 95% and 99% with respect to
certain products. In addition, certain DCOs may achieve an average
confidence level of 99% across all products that they clear, although
not every product may meet the 99% confidence level. The Commission
invites comment regarding whether a confidence level of 99% is
appropriate with respect to all applicable products, spreads, accounts,
and swap portfolios.40
—————————————————————————
40 For example, the CPSS-IOSCO Recommendations state that
“[m]argin requirements for new and low-volume products might be set
at a lower coverage level [than the major products cleared by a CCP]
if the potential losses resulting from such products are minimal.”
(CPSS-IOSCO Recommendations, pg. 23).
—————————————————————————
Proposed Sec. 39.13(g)(2)(iv) does not specify the historic time
period that a DCO would have to use when calculating a 99% confidence
level for any particular product, account, or portfolio. Rather, it
would permit each
[[Page 3705]]
DCO to exercise its discretion with respect to the appropriate time
periods that should be used in each instance, based on the
characteristics, including volatility patterns, as applicable, of the
products, spreads, accounts, or portfolios.
(iii) Independent validation.
Historically, many U.S. DCOs have used Chicago Mercantile
Exchange’s (CME) proprietary risk-based portfolio margining system,
Standard Portfolio Analysis of Risk[supreg] (SPAN) as the basis for
their margin models for futures and options. However, there is at least
one other margin model that is currently being used for futures and
options, and there are also multiple margin models that DCOs are using
for swaps that are currently cleared. As DCOs begin to clear additional
swaps it can be anticipated that they will develop new margin models to
address the risks of particular products.
Proposed Sec. 39.13(g)(3) would require that, on a regular basis,
a DCO’s systems for generating initial margin requirements, including
the DCO’s theoretical models, would have to be reviewed and validated
by a qualified and independent party. A validation should include a
comprehensive analysis to ensure that such systems and models achieve
their intended goals. Although the proposed regulation does not define
the term “regular basis,” the Commission would expect that, at a
minimum, a DCO would obtain such an independent validation prior to
implementation of a new margin model and when making any significant
change to a model that is in use by the DCO. Significant changes would
be those that could materially affect the nature or level of risks to
which a DCO would be exposed. The Commission would expect a DCO to
obtain an independent validation prior to any significant change that
would relax risk management standards. However, if a DCO needed to
adopt a significant change in an expedited manner to enhance risk
protections, the Commission would expect the DCO to obtain an
independent validation promptly after the change was made.
The Commission has not proposed a definition of the term
“qualified and independent party.” The Commission invites comment
regarding whether a qualified and independent party must be a third
party or whether there may be circumstances under which an employee of
the relevant DCO could be considered to be independent.
(iv) Spread margins.
Proposed Sec. 39.13(g)(4)(i) would permit a DCO to allow
reductions in initial margin requirements for related positions (spread
margins), if the price risks with respect to such positions were
significantly and reliably correlated. Under the proposed regulation,
the price risks of different positions would only be considered to be
reliably correlated if there was a theoretical basis for the
correlation in addition to an exhibited statistical correlation. A non-
exclusive list of possible theoretical bases includes the following:
(A) The products on which the positions are based are complements of,
or substitutes for, each other; (B) one product is a significant input
into the other product(s); (C) the products share a significant common
input; or (D) the prices of the products are influenced by common
external factors. An example of such an external factor might be
interest rates. An offset may not be based solely on the fact that the
prices of certain products have exhibited a statistical correlation in
the past. The DCO would be required to be able to articulate a
theoretical explanation for such a correlation. The Commission requests
comment regarding the appropriateness of requiring a theoretical basis
for the correlation between related positions before reductions in
initial margin requirements would be permitted.
Proposed Sec. 39.13(g)(4)(ii) would require a DCO to regularly
review its spread margins and the correlations on which they are based.
(v) Price data.
Proposed Sec. 39.13(g)(5) would require a DCO to have a reliable
source of timely price data to measure its credit exposure accurately,
and to have written procedures and sound valuation models for
addressing circumstances where pricing data is not readily available or
reliable. Both initial margin and variation margin calculations require
timely and reliable price data to be effective. DCOs should rely on
prices from continuous, transparent, and liquid markets, wherever
possible. It may be difficult to determine current market prices for
certain over-the-counter (OTC) products if there is no continuous
liquid market or if bid-ask spreads are volatile. In these
circumstances, DCOs would need to ensure that they would be able to
measure their credit exposures accurately through the use of sound
valuation models. The nature of such valuation models would necessarily
depend on the particular products and the source of any relevant
pricing data.
(vi) Daily review and back tests.
Daily review and periodic back testing are essential to enable a
DCO to ensure that its margin models continue to provide adequate
coverage of the DCO’s risk exposures to its clearing members. Proposed
Sec. 39.13(g)(6) would require a DCO to determine the adequacy of its
initial margin requirements for each product, on a daily basis, with
respect to those products that are margined on a product basis.
Proposed Sec. 39.13(g)(7) would require a DCO to conduct certain back
tests. The Commission has proposed to define “back test” in a
separate rulemaking, as “a test that compares a derivatives clearing
organization’s initial margin requirements with historical price
changes to determine the extent of actual margin coverage.” 41 Thus,
the back tests required by proposed Sec. 39.13(g)(7), which would
require a comparison of initial margin requirements with historical
price changes, are distinguished from the daily review required by
proposed Sec. 39.13(g)(6), which would require a determination of
whether a margin breach had occurred on the particular day under
review. For purposes of proposed Sec. 39.13(g)(7)(i) and (ii),
proposed Sec. 39.13(g)(7) specifies that, in conducting back tests, a
DCO would be required to use historical price change data based on a
time period that is equivalent in length to the historic time period
used by the applicable margin model for establishing the minimum 99%
confidence level or a longer time period. The applicable time period is
separately specified for the back tests required by proposed Sec.
39.13(g)(7)(iii), as discussed below.
—————————————————————————
41 See 75 FR at 77585 (proposing definitions in Sec. 39.1(b),
to be redesignated as Sec. 39.2).
—————————————————————————
Proposed Sec. 39.13(g)(7)(i) would require a DCO, on a daily
basis, to conduct back tests with respect to products that are
experiencing significant market volatility. Specifically, a DCO would
be required to test the adequacy of its initial margin requirements and
its spread margin requirements for such products that are margined on a
product basis.
Proposed Sec. 39.13(g)(7)(ii) would require a DCO, on at least a
monthly basis, to conduct back tests to test the adequacy of its
initial margin requirements and spread margin requirements for each
product that is margined on a product basis. The Commission requests
comment regarding whether initial margin requirements for all products
should be subject to back tests on a monthly basis or whether some
other time period, such as quarterly, would be sufficient to meet
prudent risk management standards.
Proposed Sec. 39.13(g)(7)(iii) would require a DCO, on at least a
monthly basis, to conduct back tests to test the adequacy of its
initial margin
[[Page 3706]]
requirements for each clearing member’s accounts, by customer origin
and house origin, and each swap portfolio, by beneficial owner, over at
least the previous 30 days. The Commission has proposed that the
initial margin requirements for such clearing member accounts and swap
portfolios must be compared to 30 days of historical data since the
composition of such accounts and swap portfolios may change on a daily
basis. The Commission anticipates that back tests with respect to such
accounts and portfolios would involve a review of the initial margin
requirements for each account and portfolio as it existed on each day
during the 30-day period. The Commission requests comment regarding
whether initial margin requirements for all clearing members’ accounts,
by origin, and swap portfolios, by beneficial owner, should be subject
to back tests on a monthly basis or whether some other time period,
such as quarterly (based on the previous quarter’s historical data),
would be sufficient to meet prudent risk management standards.
(vii) Customer margin.
Proposed Sec. 39.13(g)(8) addresses three different proposed
requirements regarding customer margin, including the collection of
gross margin for customer accounts, customer initial margin levels, and
withdrawals of customer initial margin.42
—————————————————————————
42 The Commission has proposed to define “customer initial
margin” as “initial margin posted by a customer with a futures
commission merchant, or by a non-clearing futures commission
merchant with a clearing member.” See 75 FR at 77585 (proposing
Sec. 1.3(kkk)).
—————————————————————————
(1) Gross margin for customer accounts.
Proposed Sec. 39.13(g)(8)(i) would require a DCO to collect
initial margin on a gross basis for each clearing member’s customer
account equal to the sum of the initial margin amounts that would be
required by the DCO for each individual customer within that account if
each individual customer were a clearing member. A DCO would not be
permitted to net positions of different customers against one another,
but it could collect initial margin for its clearing members’ house
accounts on a net basis.
The Commission recognizes that gross margining of customer accounts
would be a change from current margin practices at certain DCOs.
However, the Commission believes that gross margining of customer
accounts would more appropriately address the risks posed to a DCO by
its clearing members’ customers than margining all of a particular
clearing member’s customer accounts on a net basis. Gross margining
would increase the financial resources available to a DCO in the event
of a customer default. Moreover, with respect to cleared swaps, the
requirement for gross margining of customers’ portfolios supports the
requirement in proposed Sec. 39.13(g)(2)(iii) that a DCO would have to
margin each swap portfolio at a minimum 99% confidence level.
The Commission recently proposed a new Sec. 39.19(c)(1)(iv) under
which a DCO would be required, on a daily basis, to report the end-of-
day positions for each clearing member, by origin.43 In connection
with the proposed Sec. 39.13(g)(8)(i) requirement for DCOs to collect
initial margin for customer accounts on a gross basis, the Commission
is proposing to amend proposed Sec. 39.19(c)(1)(iv) to additionally
require a DCO, for the customer origin, to report the gross positions
of each beneficial owner.
—————————————————————————
43 See 75 FR at 78195.
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(2) Customer initial margin requirements.
Proposed Sec. 39.13(g)(8)(ii) would require a DCO to require its
clearing members to collect customer initial margin from their
customers for non-hedge positions at a level that is greater than 100%
of the DCO’s initial margin requirements with respect to each product
and swap portfolio. Such a cushion would enable clearing members to
deposit additional margin with a DCO on behalf of their customers, as
necessitated by adverse market movements, without the need for the
clearing members to make frequent margin calls to their customers.
Historically, DCMs have mandated the amounts of customer initial
margin and maintenance margin that their FCM members must collect from
their customers.44 DCMs typically impose customer initial margin
requirements that are higher, by a specified percentage, than the
initial margin requirements imposed upon clearing FCMs by the relevant
DCO, and maintenance margin requirements that are equivalent to the
DCO’s initial margin requirements. Customer initial margin requirements
have typically been between 125% and 140% of a DCO’s initial margin
requirements.
—————————————————————————
44 “Maintenance margin” refers to an amount that must be
maintained on deposit at all times. If the equity in a customer’s
account drops below the level of maintenance margin because of
adverse price movement, the FCM must issue a margin call to restore
the customer’s equity to the customer initial margin level.
—————————————————————————
The Commission believes that DCOs should determine how much margin
their FCM clearing members must collect from their customers because a
DCO must ensure that its clearing members are able to meet their
obligations to the DCO. Moreover, although it may be appropriate for a
DCM to determine the customer initial margin requirements for non-
clearing FCM members of the DCM, with respect to products traded on the
DCM, a DCO may be the only entity in a position to assume any
responsibility for setting customer initial margin requirements for
cleared swaps that may be traded on SEFs or executed bilaterally.
Proposed Sec. 39.13(g)(8)(ii) would permit a DCO to have
reasonable discretion in determining the percentage by which customer
initial margins would have to exceed the DCO’s initial margin
requirements with respect to particular products or swap portfolios. A
DCO would be familiar with the risk characteristics of particular
products and swap portfolios that it clears, which should enable it to
determine the extent of the cushion that a clearing member should have
with respect to customer initial margins. However, under the proposed
regulation, the Commission may review such percentage levels and
require different percentage levels, but not specific margin amounts,
if the Commission deems the levels insufficient to protect the
financial integrity of the clearing members or the DCO.
The customer initial margin requirement set forth in proposed Sec.
39.13(g)(8)(ii) would only apply with respect to customers’ non-hedge
positions. Hedge margins are typically equal to maintenance margins.
(3) Withdrawal of customer initial margin.
Proposed Sec. 39.13(g)(8)(iii) would require a DCO to require its
clearing members to prohibit their customers from withdrawing funds
from their accounts with such clearing members unless the net
liquidating value plus the margin deposits remaining in the customer’s
account after the withdrawal would be sufficient to meet the customer
initial margin requirements with respect to the products or portfolios
in the customer’s account, which were cleared by the DCO. This is
consistent with the definition of “Margin Funds Available for
Disbursement” in the Margins Handbook prepared by the Joint Audit
Committee 45 and, therefore, codifies current practices.
—————————————————————————
45 See http;//www.nfa.futures.org/NFA-compliance/publication-library/margins-handbook.pdf.
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(viii) Time deadlines.
[[Page 3707]]
Proposed Sec. 39.13(g)(9) would require a DCO to establish and
enforce time deadlines for initial and variation margin payments. If
margin payments are not made on time, DCOs and clearing members face
uncollateralized risk.
(g) Other Risk Control Mechanisms
(i) Risk limits.
Proposed Sec. 39.13(h)(1)(i) would require a DCO to impose risk
limits on each clearing member, by customer origin and house origin, in
order to prevent a clearing member from carrying positions where the
risk exposure of those positions exceeds a threshold set by the DCO
relative to the clearing member’s financial resources, the DCO’s
financial resources, or both. The DCO would have reasonable discretion
in determining: (A) the method of computing risk exposure; (B) the
applicable threshold(s); and (C) the applicable financial resources,
provided however, that the ratio of exposure to capital would have to
remain the same across all capital levels. The Commission could review
any of these determinations and require different methods, thresholds,
or financial resources, as appropriate.
Proposed Sec. 39.13(h)(1)(ii) would allow a DCO to permit a
clearing member to exceed the threshold(s) applied pursuant to
paragraph (h)(1)(i) provided that the DCO required the clearing member
to post additional initial margin that the DCO deemed sufficient to
appropriately eliminate excessive risk exposure at the clearing member.
The Commission could review the amount of additional initial margin and
require a different amount, as appropriate.
(ii) Large trader reports.
Proposed Sec. 39.13(h)(2) would require a DCO to obtain from its
clearing members, copies of all reports that such clearing members were
required to file with the Commission pursuant to part 17 of the
Commission’s regulations, i.e., large trader reports. A DCO would be
required to obtain such reports directly from the relevant reporting
market if the reporting market exclusively listed self-cleared
contracts, and were therefore required to file such reports on behalf
of clearing members, pursuant to Sec. 17.00(i).
Proposed Sec. 39.13(h)(2) would require a DCO to review the large
trader reports that it received from its clearing members, or reporting
markets, as applicable, on a daily basis to ascertain the risk of the
overall portfolio of each large trader. A DCO would be required to
review large trader positions for each large trader, across all
clearing members carrying an account for the large trader. A DCO would
also be required to take additional actions with respect to such
clearing members in order to address any risks posed by a large trader,
when appropriate. Such actions would include actions specified in
proposed Sec. 39.13(h)(6), as discussed in section II.B.2(g)(vi)
below.
(iii) Stress tests.
Proposed Sec. 39.13(h)(3) would require a DCO to conduct certain
daily and weekly stress tests. The Commission has proposed to define
“stress test” in a separate rulemaking, as “a test that compares the
impact of a potential price move, change in option volatility, or
change in other inputs that affect the value of a position, to the
financial resources of a derivatives clearing organization, clearing
member, or large trader, to determine the adequacy of such financial
resources.” 46 The Commission has not proposed a definition of
financial resources in this context, although it would be expected to
include, at a minimum, margin on deposit, and with respect to a
clearing member, its capital.
—————————————————————————
46 See 75 FR at 77585-86 (proposing definitions in Sec.
39.1(b), to be redesignated as Sec. 39.2).
—————————————————————————
Proposed Sec. 39.13(h)(3) would require a DCO to conduct certain
types of stress tests with respect to certain large traders on a daily
basis and with respect to all clearing member accounts and swap
portfolios on at least a weekly basis.
Proposed Sec. 39.13(h)(3)(i) would require a DCO to conduct daily
stress tests with respect to each large trader who poses significant
risk to a clearing member or the DCO in the event of default, including
positions at all clearing members carrying accounts for the large
trader. The DCO would have reasonable discretion in determining which
traders to test and the methodology used to conduct the stress tests.
However, the Commission could review the selection of accounts and the
methodology and require changes, as appropriate.
Proposed Sec. 39.13(h)(3)(ii) would require a DCO to conduct
stress tests, at least once a week with respect to each account held by
a clearing member at the DCO, by customer origin and house origin, and
each swap portfolio, by beneficial owner, under extreme but plausible
market conditions. The DCO would have reasonable discretion in
determining the methodology used to conduct these stress tests.
However, the Commission may review the methodology and require any
appropriate changes. The Commission requests comment regarding whether
all clearing member accounts, by origin, and all swap portfolios should
be subject to such stress tests on a weekly basis or whether some other
time period, such as monthly, would be sufficient to meet prudent risk
management standards.
(iv) Portfolio compression.
Proposed Sec. 39.13(h)(4)(i) would require a DCO to offer
multilateral portfolio compression exercises, on a regular basis, for
its clearing members that clear swaps, to the extent that such
exercises are appropriate for those swaps that it clears. The
Commission has not specified the frequency with which DCOs must offer
multilateral portfolio compression exercises in proposed Sec.
39.13(h)(4)(i), other than to state that they would have to be offered
on a regular basis. The Commission requests comment regarding whether
such exercises should be offered monthly, quarterly, or another
frequency. In addition, the Commission requests comment regarding
whether the frequency of such exercises should vary for different
categories of swaps.
Under proposed Sec. 39.13(h)(4)(ii), a DCO must require its
clearing members to participate in all multilateral portfolio
compression exercises offered by the DCO, to the extent that any swap
in the applicable portfolio is eligible for inclusion in the exercise,
unless including the swap would be reasonably likely to significantly
increase the risk exposure of the clearing member. Proposed Sec.
39.13(h)(4)(iii) would permit a DCO to allow clearing members
participating in such exercises to set risk tolerance limits for their
portfolios, provided that the clearing member could not set such risk
tolerances at an unreasonable level or use such risk tolerances to
evade the requirements of proposed Sec. 39.13(h)(4).
(v) Clearing members’ risk management policies and procedures.
The Commission believes that in order for a DCO to adequately
manage its own risks, it must ensure that its clearing members also
have adequate risk management policies and procedures. In order to do
this, a DCO must have the authority to obtain documents and information
from its clearing members regarding such policies and procedures, and
must review their implementation on a periodic basis.
Proposed Sec. 39.13(h)(5) would impose several requirements upon
DCOs relating to their clearing members’ risk management policies and
procedures. Specifically, a DCO must adopt rules that: (a) Require its
clearing members to maintain current written risk management policies
and procedures; (b) ensure that the DCO has the authority to request
and obtain information and documents from its
[[Page 3708]]
clearing members regarding their risk management policies, procedures,
and practices, including, but not limited to, information and documents
relating to the liquidity of their financial resources and their
settlement procedures; and (c) require its clearing members to make
information and documents regarding their risk management policies,
procedures, and practices available to the Commission upon the
Commission’s request. In addition, a DCO would be required to review
the risk management policies, procedures, and practices of each of its
clearing members on a periodic basis and document such reviews.
Proposed Sec. 39.13(h)(5) does not define how DCOs would have to
conduct clearing member risk management reviews, and has not specified
a required frequency of such reviews except to state that they would
have to be conducted on a periodic basis. The Commission invites
comment regarding whether it should require that a DCO must conduct
risk reviews of its clearing members on an annual basis or within some
other time frame. The Commission also requests comment regarding
whether the Commission should require that such reviews be conducted in
a particular manner, e.g., whether there must be an on-site visit or
whether any particular testing should be required. In addition, the
Commission invites comment regarding whether, and to what extent, a DCO
should be permitted to vary the method and depth of such reviews based
upon the nature, risk profiles, or other regulatory supervision of
particular clearing members.
The risk management reviews contemplated by proposed Sec.
39.13(h)(5) would also support DCOs’ compliance with Core Principle C
and proposed Sec. 39.12, by providing a means for the DCO and the
Commission to ensure that clearing members continue to meet
participation requirements relating to risk management.
(vi) Additional authority.
Proposed Sec. 39.13(h)(6) would require a DCO to take additional
actions with respect to particular clearing members, when appropriate,
based on the application of objective and prudent risk management
standards. Such actions would include, but would not be limited to: (i)
Imposing enhanced capital requirements; (ii) imposing enhanced margin
requirements; (iii) imposing position limits; (iv) prohibiting an
increase in positions; (v) requiring a reduction of positions; (vi)
liquidating or transferring positions; and (vii) suspending or revoking
clearing membership. The Commission believes that a DCO should have the
authority to take any of the specified actions or other appropriate
actions, and should take such actions, when necessary to address risks
posed to the DCO by particular clearing members or their customers.
However, a DCO would have the discretion to determine when to take
additional actions, and what actions to take, based on its exercise of
objective and prudent risk management standards.
3. Settlement Procedures
Core Principle E, as amended by the Dodd-Frank Act,47 requires a
DCO to: (a) Complete money settlements on a timely basis, but not less
frequently than once each business day; (b) employ money settlement
arrangements to eliminate or strictly limit its exposure to settlement
bank risks (including credit and liquidity risks from the use of banks
to effect money settlements); (c) ensure that money settlements are
final when effected; (d) maintain an accurate record of the flow of
funds associated with money settlements; (e) possess the ability to
comply with the terms and conditions of any permitted netting or offset
arrangement with another clearing organization; (f) establish rules
that clearly state each obligation of the DCO with respect to physical
deliveries; and (g) ensure that it identifies and manages each risk
arising from any of its obligations with respect to physical
deliveries.48 The Commission is proposing to adopt Sec. 39.14 to
establish requirements that a DCO would have to meet in order to comply
with Core Principle E.
—————————————————————————
47 Section 5b(c)(2)(E) of the CEA; 7 U.S.C. 7a-1(c)(2)(E)
(Core Principle E).
48 Prior to amendment by the Dodd-Frank Act, Core Principle E
provided that [t]he applicant shall have the ability to–
(i) complete settlements on a timely basis under varying
circumstances;
(ii) maintain an adequate record of the flow of funds associated
with each transaction that the applicant clears; and
(iii) comply with the terms and conditions of any permitted
netting or offset arrangements with other clearing organizations.
—————————————————————————
Proposed Sec. 39.14(a) would define “settlement” and
“settlement bank” for purposes of Sec. 39.14. In particular,
“settlement” is defined in proposed Sec. 39.14(a)(1) to include: (i)
Payment and receipt of variation margin for futures, options and swap
positions; (ii) payment and receipt of option premiums; (iii) deposit
and withdrawal of initial margin for futures, options and swap
positions; (iv) all payments due in final settlement of futures,
options and swap positions on the final settlement date with respect to
such positions; and (v) all other cash flows collected from or paid to
each clearing member, including but not limited to, payments related to
swaps such as coupon amounts. “Settlement bank” is defined in
proposed Sec. 39.14(a)(2) as “a bank that maintains an account either
for the [DCO] or for any of its clearing members, which is used for the
purpose of transferring funds and receiving transfers of funds in
connection with settlements with the [DCO].”
(a) Daily settlements.
The daily settlement of financial obligations arising from the
addition of new positions and price changes with respect to all open
positions is an essential element of the clearing process at a DCO.
Proposed Sec. 39.14(b) would require a DCO to effect a settlement with
each clearing member at least once each business day, and to have the
authority and operational capacity to effect a settlement with each
clearing member, on an intraday basis, either routinely, when
thresholds specified by the DCO were breached, or in times of extreme
market volatility.
Proposed Sec. 39.14(b) would permit DCOs to exercise their
discretion regarding whether they would effect routine intraday
settlements or whether they would settle positions on an intraday basis
only when certain thresholds were breached or in times of extreme
market volatility. Moreover, a DCO would have the discretion to
establish any relevant thresholds and to define extreme market
volatility in the context of the products and portfolios that it
clears. These provisions are consistent with international
recommendations.49
—————————————————————————
49 See CPSS-IOSCO Recommendations, pg. 21; EMIR, Article 39,
paragraph 3, pg. 46.
—————————————————————————
(b) Settlement banks.
A DCO generally requires its clearing members to effect settlement
through one of a specified set of settlement banks. In addition, a DCO
itself often has a lead, concentration, or central settlement bank.
Proposed Sec. 39.14(c) would set forth three specific requirements
in furtherance of the general requirement that DCOs must employ
settlement arrangements to eliminate or strictly limit their exposure
to settlement bank risks. First, proposed Sec. 39.14(c)(1) would
require a DCO to have documented criteria for those banks that it would
use, and that it would permit its clearing members to use, as
settlement banks, including criteria addressing the capitalization,
creditworthiness, access to liquidity, operational reliability, and
regulation or supervision of such banks. Second, proposed Sec.
39.14(c)(2) would require a DCO to monitor each approved
[[Page 3709]]
settlement bank on an ongoing basis to ensure that it continues to meet
the documented criteria. Finally, proposed Sec. 39.14(c)(3) would
require a DCO to monitor the full range and concentration of its
exposures to its own and its clearing members’ settlement banks 50
and assess its own and its clearing members’ potential losses and
liquidity pressures in the event that the settlement bank with the
largest share of settlement activity were to fail. If action were
reasonably necessary in order to eliminate or strictly limit exposures
to settlement banks, a DCO would be required to: (i) Maintain
settlement accounts at additional settlement banks; (ii) approve
additional settlement banks for use by its clearing members; (iii)
impose concentration limits with respect to its own or its clearing
members’ settlement banks; and/or (iv) take any other appropriate
actions. The determination of whether any such actions were necessary
would be left to the discretion of the DCO in the first instance, but
such determination would have to be reasonable.
—————————————————————————
50 A DCO may have multiple exposures to a settlement bank,
e.g., if the bank is also a clearing member or extends a credit
facility funding arrangement to the DCO.
—————————————————————————
(c) Settlement finality.
Proposed Sec. 39.14(d) would require that a DCO must ensure that
settlement fund transfers are irrevocable and unconditional when the
DCO’s accounts are debited or credited. In addition, the proposed
regulation would require that a DCO’s legal agreements with its
settlement banks would have to state clearly when settlement fund
transfers would occur and a DCO would have to routinely confirm that
its settlement banks were effecting fund transfers as and when required
by those legal agreements.
(d) Recordkeeping.
Proposed Sec. 39.14(e) would incorporate Core Principle E’s
requirement that a DCO must maintain an accurate record of the flow of
funds associated with each settlement.51
—————————————————————————
51 Section 5b(c)(2)(E)(iv) of the CEA; 7 U.S.C. 7a-
1(c)(2)(E)(iv).
—————————————————————————
(e) Netting arrangements.
Proposed Sec. 39.14(f) would incorporate Core Principle E’s
requirement that a DCO must possess the ability to comply with each
term and condition of any permitted netting or offset arrangement with
any other clearing organization.52
—————————————————————————
52 Section 5b(c)(2)(E)(v) of the CEA; 7 U.S.C. 7a-
1(c)(2)(E)(v).
—————————————————————————
(f) Physical delivery.
Proposed Sec. 39.14(g) would set forth requirements with respect
to contracts, agreements, and transactions that are settled by physical
transfers of the underlying instruments or commodities. In particular,
the proposed regulation would require a DCO to establish rules clearly
stating each obligation that the DCO has assumed with respect to
physical deliveries, including whether it has an obligation to make or
receive delivery of a physical instrument or commodity, or whether it
indemnifies clearing members for losses incurred in the delivery
process, and to ensure that the risks of each such obligation are
identified and managed. Proposed Sec. 39.14(g) would not require DCOs
to assume any particular obligations in connection with physical
deliveries, in recognition of the fact that DCOs would need to
determine what, if any, obligations to assume on a product-specific
basis, in the exercise of prudent risk management standards.
4. Treatment of Funds
Core Principle F, as amended by the Dodd-Frank Act,53 requires a
DCO to:(a) Establish standards and procedures that are designed to
protect and ensure the safety of its clearing members’ funds and
assets; (b) hold such funds and assets in a manner by which to minimize
the risk of loss or of delay in the DCO’s access to the assets and
funds; and (c) only invest such funds and assets in instruments with
minimal credit, market, and liquidity risks.54 The Commission is
proposing to adopt Sec. 39.15 to establish requirements that a DCO
would have to meet in order to comply with Core Principle F.
—————————————————————————
53 Section 5b(c)(2)(F) of the CEA; 7 U.S.C. 7a-1(c)(2)(F)
(Core Principle F).
54 Prior to amendment by the Dodd-Frank Act, Core Principle F
provided that “[t]he applicant shall have standards and procedures
designed to protect and ensure the safety of member and participant
funds.”
—————————————————————————
(a) Required standards and procedures.
Proposed Sec. 39.15(a) would require a DCO to establish standards
and procedures that are designed to protect and ensure the safety of
funds and assets belonging to clearing members and their customers.55
—————————————————————————
55 Such “assets” would include any securities or property
that clearing members deposit with a DCO in order to satisfy initial
margin obligations, which are also sometimes referred to as
“collateral.” Proposed Sec. 39.15 uses the term “assets” rather
than “securities or property” or “collateral” in order to be
consistent with the statutory language.
—————————————————————————
(b) Segregation of funds and assets.
Proposed Sec. 39.15(b)(1) would require a DCO to comply with the
segregation requirements of section 4d of the CEA and Commission
regulations thereunder, or any other applicable Commission regulation
or order requiring that customer funds and assets be segregated, set
aside, or held in a separate account. The Commission has included this
language because it is an essential element of the standards and
procedures described in proposed Sec. 39.15(a). However, proposed
Sec. 39.15(b)(1) would not impose any new requirements on DCOs that
are in addition to those required by section 4d of the CEA and those
that are currently required, or may in the future be required, by
applicable Commission regulations or orders.
Proposed Sec. 39.15(b)(2)(i) would permit a DCO to commingle, and
a DCO to permit clearing member FCMs to commingle, customer positions
in futures, options on futures, and swaps, and any money, securities,
or property received to margin, guarantee, or secure such positions, in
an account subject to the requirements of section 4d(f) of the CEA
(cleared swap account), pursuant to DCO rules that have been approved
by the Commission under Sec. 40.5 of the Commission’s regulations. The
proposed regulation would establish minimum informational requirements
for such rule submissions, consistent with the informational
requirements the Commission has previously imposed upon petitioners
requesting orders under section 4d of the CEA.
The rule filing would have to be submitted electronically to the
Commission, in the form and manner required by the Commission, and
would have to include, at a minimum, the following: (A) An
identification of the futures, options on futures, and swaps that would
be commingled, including contract specifications or the criteria that
would be used to define eligible futures, options on futures, and
swaps; (B) an analysis of the risk characteristics of the eligible
products; (C) a description of whether the swaps would be executed
bilaterally and/or executed on a DCM and/or a SEF; (D) an analysis of
the liquidity of the respective markets for the futures, options on
futures, and swaps that would be commingled, the ability of clearing
members and the DCO to offset or mitigate the risks of such products in
a timely manner, without compromising the financial integrity of the
account, and, as appropriate, proposed means for addressing
insufficient liquidity; (E) an analysis of the availability of reliable
prices for each of the eligible products; (F) a description of the
financial, operational, and managerial standards or requirements for
clearing members that would be permitted to commingle the eligible
products; (G) a description of the systems and procedures that would be
used by the DCO to oversee such clearing members’ risk management of
the commingled positions; (H) a
[[Page 3710]]
description of the financial resources of the DCO, including the
composition and availability of a guaranty fund with respect to the
commingled products; (I) a description and analysis of the margin
methodology that would be applied to the commingled products, including
any margin reduction applied to correlated positions, and any
applicable margin rules with respect to both clearing members and
customers; 56 (J) an analysis of the ability of the DCO to manage a
potential default with respect to any of the commingled products; (K) a
discussion of the procedures that the DCO would follow if a clearing
member defaulted, and the procedures that a clearing member would
follow if a customer defaulted, with respect to any of the commingled
products; and (L) a description of the arrangements for obtaining daily
position data from each beneficial owner of the commingled products.
—————————————————————————
56 See supra section II.B.2.f.ii of this notice, discussing
the minimum liquidation time of five business days for margining
cleared swaps that are not executed on a DCM.
—————————————————————————
Proposed Sec. 39.15(b)(2)(ii) addresses situations where customer
positions in futures, options on futures, and cleared swaps could be
carried in a futures account subject to section 4d(a) of the CEA. In
recent years, the Commission, in its discretion, has issued orders
permitting cleared swaps to be carried in a futures account, on a case-
by-case basis.57 Proposed Sec. 39.15(b)(2)(ii) would incorporate the
informational requirements of proposed Sec. 39.15(b)(2)(i), but would
still require that the Commission issue an order granting permission to
commingle customer positions in futures, options on futures, and swaps
in a futures account.
—————————————————————————
57 See supra n.38.
—————————————————————————
Proposed Sec. 39.15(b)(2)(iii)(A) would provide that the
Commission may request additional information in support of a rule
submission and it may approve the rules in accordance with Sec.
40.5.58 Proposed Sec. 39.15(b)(2)(iii)(B) would provide that the
Commission may request additional information in support of a petition
and it may issue an order under section 4d of the CEA in its
discretion.
—————————————————————————
58 Rules submitted for prior approval would be approved unless
the rule is inconsistent with the CEA or the Commission’s
regulations. See section 5c(c)(5) of the CEA; 7 U.S.C. 7a-2(c)(5);
and 75 FR at 67295.
—————————————————————————
In the case of a rule approval under Sec. 39.15(b)(2)(i), as well
as the issuance of an order under Sec. 39.15(b)(2)(ii), the Commission
would take action pursuant to section 4d of the CEA (permitting
commingling) and section 4(c) of the CEA (exempting the DCO and
clearing members from the requirement to hold customer positions in a
particular account, as applicable, 4d(a) or 4d(f)).59
—————————————————————————
59 7 U.S.C. 6(c). See infra section IV. (further discussing
the 4(c) exemption and requesting comment).
—————————————————————————
The Commission requests comment on whether it should take the same
approach (rule submission or petition for an order) with respect to the
futures account and the cleared swap account and, if so, what that
approach should be. In addition, the Commission requests comment on
whether the enumerated informational requirements fully capture the
relevant considerations for making a determination on either rule
approval or the granting of an order, and whether the Commission’s
analysis should take into consideration the type of account in which
the positions would be carried, the particular type of products that
would be involved, or the financial resources of the clearing members
that would hold such accounts. The Commission further requests comment
on what, if any, additional or heightened requirements should be
imposed to manage the increased risks introduced to a futures account
that also holds cleared swaps.
(c) Holding of funds and assets.
Proposed Sec. 39.15(c) would require that a DCO must hold funds
and assets belonging to clearing members and their customers in a
manner that minimizes the risk of loss or of delay in the DCO’s access
to those funds and assets. In furtherance of this objective, the
Commission has proposed certain requirements addressing types of assets
that a DCO may accept, the valuation of such assets, applicable
haircuts, concentration limits, and requirements that would apply if
assets were pledged to a DCO but were held in the name of a clearing
member, as described below.
(i) Types of assets.
Proposed Sec. 39.15(c)(1) would require a DCO to limit the assets
it accepts as initial margin to those that have minimal credit, market,
and liquidity risks. The proposed regulation would also state that a
DCO may not accept letters of credit as initial margin. The Commission
has not specified the assets that a DCO may accept, and with the
exception of letters of credit, it has not specified the assets that a
DCO may not accept. In general, proposed Sec. 39.15(c)(1) would set
forth the criteria of minimal credit, market, and liquidity risks and
would leave it to the discretion of each DCO to determine which assets
the DCO would accept, subject to their meeting those criteria. The
Commission has proposed to prohibit the acceptance of letters of credit
because they are unfunded financial resources with respect to which
funds might be unavailable when most needed. The Commission expects
that DCOs would continue their current practice of re-evaluating the
types of assets that they would accept as initial margin as
necessitated by changes in market conditions that could affect the
credit, market, and liquidity risks of those assets.
(ii) Valuation.
Proposed Sec. 39.15(c)(2) would require a DCO to use prudent
valuation practices to value assets posted as initial margin on a daily
basis. The Commission has not specified what such valuation practices
should entail, as the nature of the valuations would depend on the
nature of the particular assets. However, whatever method would be used
to determine the value of margin assets, it is crucial that such assets
be valued daily, because a DCO cannot evaluate the adequacy of margin
coverage on a daily basis without knowing the value of the assets that
are components of the margin on deposit. Such daily valuation of margin
assets is currently the standard practice of DCOs.
(iii) Haircuts.
Proposed Sec. 39.15(c)(3) would require a DCO to apply appropriate
reductions in value to reflect the market and credit risk of the assets
that it accepts in satisfaction of initial margin obligations. Such
reductions are known as haircuts, and DCOs currently apply haircuts to
the margin assets that they accept as initial margin. Haircuts are
designed to mitigate the potential future exposure that could result
from potential changes in the value of particular assets.
Haircut levels would be dependent on the nature of the particular
assets. DCOs would be required to calculate their haircuts taking into
account stressed market conditions. Incorporating stressed market
conditions into the calculation of haircuts can limit the effects of
procyclicality, which refers to changes that are positively correlated
with business or credit cycle fluctuations and that may cause or
exacerbate financial instability.60 In
[[Page 3711]]
addition, the proposed regulation would require a DCO to evaluate the
appropriateness of its haircuts on at least a quarterly basis.
—————————————————————————
60 While changes in collateral values tend to be procyclical,
collateral arrangements can increase procyclicality if haircut
levels fall during periods of low-market stress and increase during
periods of high-market stress. For example, in a stressed market, if
a DCO required the posting of additional collateral due to both the
decline of asset prices and an increase in haircut levels, it could
exacerbate market stress and drive down asset prices further,
resulting in additional collateral requirements. This cycle could
exert further downward pressure on asset prices in already stressed
markets. To limit the effects of this procyclicality, a DCO should
establish stable and conservative haircuts that are calibrated to
include periods of stressed market conditions.
—————————————————————————
(iv) Concentration limits.
Proposed Sec. 39.15(c)(4) would require a DCO to apply appropriate
limitations on the concentration of assets posted as initial margin, as
necessary, in order to ensure the DCO’s ability to liquidate those
assets quickly with minimal adverse price effects. Any concentration
limits would be set by the DCO, in its discretion, depending on the
nature of the assets. The proposed regulation would require a DCO to
evaluate the appropriateness of its concentration limits, on at least a
monthly basis.
(v) Pledged assets.
Some DCOs permit their clearing members to pledge assets for
initial margin while retaining those assets in accounts in the names of
the pledging clearing members. Proposed Sec. 39.15(c)(5) would require
that if such pledged assets were held in an account in the name of a
clearing member, the DCO would have to ensure that the assets were
unencumbered and that the pledge had been validly created and validly
perfected in the relevant jurisdiction, in order to ensure that the DCO
had immediate access to those assets.
(d) Permissible investments.
Proposed Sec. 39.15(d) would require that clearing members’ funds
and assets that are invested by a DCO must be held in instruments with
minimal credit, market, and liquidity risks.61 The proposed
regulation further adds that any investment of customer funds or assets
by a DCO would have to comply with Sec. 1.25 of the Commission’s
regulations, which itself is designed to ensure that such investments
would be subject to minimal credit, market, and liquidity risks.
Moreover, the proposed regulation would apply the limitations contained
in Sec. 1.25 to all customer funds and assets, whether they were the
funds and assets of futures and options customers subject to the
segregation requirements of section 4d(a) of the CEA, or the funds and
assets of swaps customers subject to the segregation requirements of
section 4d(f) of the CEA.
The proposed regulation does not enumerate the specific instruments
in which DCOs may invest clearing members’ own funds and assets,
leaving it to the discretion of each DCO to determine which instruments
have minimal credit, market, and liquidity risks. As regards those
assets that DCOs would accept as initial margin, the Commission expects
that DCOs would continue their current practice of re-evaluating the
instruments in which they would invest clearing members’ own funds and
assets, as necessitated by changes in market conditions that could
affect the credit, market, and liquidity risks of those instruments.
—————————————————————————
61 IOSCO Recommendation 7 (custody and investment risks) also
states, in part, that “[a]ssets invested by a CCP should be held in
instruments with minimal credit, market, and liquidity risks.”
(CPSS-IOSCO Recommendations, pg. 31).
—————————————————————————
5. Default Rules and Procedures
Core Principle G, as amended by the Dodd-Frank Act,62 requires
each DCO to have rules and procedures designed to allow for the
efficient, fair, and safe management of events during which clearing
members become insolvent or otherwise default on their obligations to
the DCO. In addition, Core Principle G requires each DCO to clearly
state its default procedures, make its default rules publicly
available, and ensure that it may take timely action to contain losses
and liquidity pressures and to continue meeting its obligations.63
The Commission is proposing to adopt Sec. 39.16 to establish
requirements that a DCO would have to meet in order to comply with Core
Principle G.
—————————————————————————
62 Section 5b(c)(2)(G) of the CEA; 7 U.S.C. 7a-1(c)(2)(G)
(Core Principle G).
63 Prior to amendment by the Dodd-Frank Act, Core Principle G
provided that “[t]he applicant shall have rules and procedures
designed to allow for efficient, fair, and safe management of events
when members or participants become insolvent or otherwise default
on their obligations to the derivatives clearing organization.”
—————————————————————————
(a) General.
It is essential that DCOs have clearly defined and effective
default management rules and procedures in order to protect the
defaulting clearing members’ customers, non-defaulting clearing
members, and the DCO, to the extent possible. Proposed Sec. 39.16(a)
would require DCOs to adopt rules and procedures designed to allow for
the efficient, fair, and safe management of events during which
clearing members become insolvent or default on the obligations of such
clearing members to the DCO.64 Existing DCOs have rules and
procedures to address possible defaults.
—————————————————————————
64 Core Principle G specifically refers to events during which
clearing members “(I) become insolvent; or (II) otherwise default *
* *.” However, it is possible that a clearing member could become
insolvent and not default on its obligations to the DCO. For
example, the insolvency could be a consequence of a clearing
member’s meeting all such obligations. Nevertheless, the Commission
believes that a clearing member should be required to follow certain
procedures, beginning with notifying the DCO, if it becomes subject
to a bankruptcy petition, receivership proceeding, or the
equivalent, and such proposed requirements are contained in proposed
Sec. 39.16(d), discussed infra in section II.B.5.d.
—————————————————————————
(b) Default management plan.
Proposed Sec. 39.16(b) would require a DCO to maintain a current
written default management plan that delineates the roles and
responsibilities of its Board of Directors, its Risk Management
Committee, any other committee that has responsibilities for default
management, and the DCO’s management, in addressing a default,
including any necessary coordination with, or notification of, other
entities and regulators. The proposed regulation would also require the
default management plan to address any differences in procedures with
respect to highly liquid contracts (such as certain futures) and less
liquid contracts (such as certain swaps). In addition, proposed Sec.
39.16(b) would require a DCO to conduct and document a test of its
default management plan on at least an annual basis.
(c) Default procedures.
Proposed Sec. 39.16(c)(1) would require a DCO to adopt procedures
that would permit the DCO to take timely action to contain losses and
liquidity pressures and to continue meeting its obligations in the
event of a default on the obligations of a clearing member to the
DCO.65
—————————————————————————
65 Similarly, IOSCO Recommendation 6 (Default procedures)
states that “[a] CCP’s default procedures should be clearly stated,
and they should ensure that the CCP can take timely action to
contain losses and liquidity pressures and to continue meeting its
obligations.” (CPSS-IOSCO Recommendations, pg. 27).
—————————————————————————
Proposed Sec. 39.16(c)(2) would require a DCO to include certain
identified procedures in its default rules. In particular, proposed
Sec. 39.16(c)(2)(i) would require a DCO to set forth its definition of
a default. Proposed Sec. 39.16(c)(2)(ii) would require a DCO to set
forth the actions that it is able to take upon a default, which must
include the prompt transfer, liquidation, or hedging of the customer or
proprietary positions of the defaulting clearing member, as applicable.
Proposed Sec. 39.16(c)(2)(ii) would further state that such procedures
could also include, in the DCO’s discretion, the auctioning or
allocation of such positions to other clearing members. Proposed Sec.
39.16(c)(2)(iii) would require a DCO to include in its default rules
any obligations that the DCO imposed on its clearing members to
participate in auctions, or to accept allocations, of a defaulting
clearing member’s positions, and specifically would provide that any
allocation would have to be proportional to the size of the
participating or accepting clearing member’s positions at the DCO. For
example, certain DCO rules currently address the DCO’s authority to
auction a defaulting clearing member’s
[[Page 3712]]
swaps to other clearing members that participate in the market for that
category of swaps.
Proposed Sec. 39.16(c)(2)(iv) would require that a DCO’s default
rules address the sequence in which the funds and assets of the
defaulting clearing member and the financial resources maintained by
the DCO would be applied in the event of a default. The proposed
regulation would not specify the sequence in which a DCO would be
required to apply its own resources or those of the defaulting clearing
member, but it would set forth two related requirements.
First, proposed Sec. 39.16(c)(2)(v) would require that a DCO’s
default rules contain a provision that customer margin posted by a
defaulting clearing member could not be applied in the event of a
proprietary default. This is consistent with the segregation
requirements of section 4d of the CEA and Sec. 1.20 of the
Commission’s regulations.
Second, proposed Sec. 39.16(c)(2)(vi) would require that a DCO’s
default rules contain a provision that proprietary margins posted by a
defaulting clearing member would have to be applied in the event of a
customer default, if the relevant customer margin were insufficient to
cover the shortfall. This is consistent with Sec. 190.08(a)(ii)(J),
which defines customer property to include the trading accounts of an
FCM, to the extent that other enumerated customer property is
insufficient to satisfy all claims of public customers in the
bankruptcy of the FCM.
Proposed Sec. 39.16(c)(3) would incorporate the Core Principle G
requirement that a DCO must make its default rules publicly
available,66 and it cross-references proposed Sec. 39.21, which has
been proposed in a separate rulemaking and which also addresses this
requirement.67
—————————————————————————
66 See section 5b(c)(2)(G)(ii)(II) of the CEA; 7 U.S.C. 7a-
1(c)(2)(G)(ii)(II).
67 See 75 FR at 78197.
—————————————————————————
(d) Insolvency of a clearing member.
Proposed Sec. 39.16(d) would set forth specific procedures that a
DCO would have to require its clearing members to follow, and that a
DCO itself would have to follow, if a clearing member became the
subject of a bankruptcy petition (either voluntary or involuntary), a
receivership proceeding, or an equivalent proceeding, e.g., a foreign
liquidation proceeding. The Commission believes that such procedures
would be necessary in order to provide for “the efficient, fair, and
safe management of events” when a clearing member becomes insolvent,
as required by Core Principle G.
Proposed Sec. 39.16(d)(1) would require a DCO to adopt rules that
would require a clearing member to provide prompt notice to the DCO of
such a petition or proceeding. Proposed Sec. 39.13(d)(2) would require
a DCO to review the clearing member’s continuing eligibility for
clearing membership upon receiving such notice. Proposed Sec.
39.16(d)(3) would require a DCO to take any appropriate action, in its
discretion, with respect to the clearing member or its positions,
including but not limited to liquidation or transfer of positions, and
suspension or revocation of clearing membership. Proposed Sec.
39.16(d)(2) does not outline specific review procedures, and Sec.
39.16(d)(3) would leave it to the discretion of the DCO to determine
whether any particular action were appropriate with respect to the
clearing member.
6. System Safeguards
Core Principle I, as amended by the Dodd-Frank Act,68 requires
each DCO to establish and maintain a program of risk analysis and
oversight to identify and minimize sources of operational risk through
the development of appropriate controls and procedures, and automated
systems that are reliable, secure, and have adequate scalable capacity.
Core Principle I also requires each DCO to establish and maintain
emergency procedures, backup facilities, and a plan for disaster
recovery that allows for the timely recovery and resumption of
operations of, and the fulfillment of each obligation and
responsibility of, the DCO. Finally, Core Principle I requires each DCO
to periodically conduct tests to verify that its backup resources are
sufficient to ensure daily processing, clearing, and settlement.69
The Commission is proposing to adopt Sec. 39.18 to establish
requirements that a DCO would have to meet in order to comply with Core
Principle I.
—————————————————————————
68 Section 5b(c)(2)(I) of the CEA; 7 U.S.C. 7a-1(c)(2)(I)
(Core Principle I).
69 Prior to amendment by the Dodd-Frank Act, Core Principle I
provided that
[t]he applicant shall demonstrate that the applicant (i) has
established and will maintain a program of oversight and risk
analysis to ensure that the automated systems of the applicant
function properly and have adequate capacity and security; and (ii)
has established and will maintain emergency procedures, and a plan
for disaster recovery, and will periodically test backup facilities
sufficient to ensure daily processing, clearing, and settlement of
transactions.
—————————————————————————
(a) General.
Proposed Sec. 39.18 would codify the requirements of Core
Principle I and would establish additional standards for a DCO’s
business continuity and disaster recovery procedures. On July 14,
2010,70 the Commission published proposed regulations regarding
business continuity and disaster recovery applicable to DCOs and DCMs.
After consideration of the provisions of the Dodd-Frank Act, the
Commission has determined to re-propose the provisions concerning DCOs.
The Commission appreciates the comments made with respect to those
earlier proposed regulations, and has taken them into account in
developing the proposed regulations described below.
—————————————————————————
70 See 75 FR 42633 (July 22, 2010) (July Proposal).
—————————————————————————
(i) Definitions.
Proposed Sec. 39.18(a) would set forth relevant definitions for
the system safeguards provisions applicable to DCOs set forth in Sec.
39.18 and the modified system safeguards provisions applicable to
SIDCOs set forth in Sec. 39.30, including “recovery time objective”
(the time period, after disruption, within which a DCO should be able
to achieve recovery and resumption of clearing activities) (RTO),
“relevant area” (the geographic area within which a DCO has necessary
resources, as well as adjacent communities), and “wide-scale
disruption” (an event that causes severe disruption of critical
infrastructure, or an evacuation or unavailability of the population,
in a relevant area).71
—————————————————————————
71 The Commission may consider, in a future rulemaking,
placing an expanded version of these definitions (to include, e.g.,
recovery time objectives with respect to DCMs and other registered
entities) in part 1, and, as appropriate, incorporating those
definitions by reference in part 39 of its regulations.
—————————————————————————
(ii) Program of risk analysis.
Because automated systems play a central and critical role in
today’s electronic financial market environment, oversight of core
principle compliance by DCOs with respect to automated systems is an
essential part of effective clearing oversight. Sophisticated computer
systems are crucial to a DCO’s ability to meet its obligations and
responsibilities. Safeguarding the reliability, security, and capacity
of such systems is also essential to mitigation of systemic risk for
the nation’s financial sector as a whole.
Proposed Sec. 39.18(b) would require that a DCO maintain a program
of risk analysis and oversight with respect to its operations and
automated systems to identify and minimize sources of operational risk,
establish and maintain resources that allow for the fulfillment of the
DCO’s obligations and responsibilities in light of those risks, and
verify that those resources are
[[Page 3713]]
adequate to ensure daily processing, clearing, and settlement.
(iii) Elements of program.
Proposed Sec. 39.18(c) would require that the program of risk
analysis and oversight address each of six categories: information
security, business continuity and disaster recovery (BC-DR), capacity
and performance planning, systems operations, systems development and
quality assurance, and physical security and environmental controls.
(iv) Standards for program.
DCO compliance with generally accepted standards and best practices
with respect to the development, operation, reliability, security, and
capacity of automated systems can reduce the frequency and severity of
automated system security breaches or functional failures, thereby
augmenting efforts to mitigate systemic risk. Accordingly, proposed
Sec. 39.18(d) would require that a DCO follow generally accepted
standards and industry best practices with respect to the development,
operation, reliability, security, and capacity of automated systems.
(v) Business continuity and disaster recovery.
Proposed Sec. 39.18 (e) would require that a DCO maintain a BC-DR
plan, procedures, and physical (e.g., buildings, generators, and
related physical infrastructure), technological (e.g., computers,
replacement parts, and software), and personnel resources (e.g.,
trained employees or other committed human resources) sufficient to
enable timely recovery and resumption of operations, and fulfillment of
responsibilities (e.g., daily processing, clearing and settlement of
transactions cleared) of the DCO following a disruption. The required
recovery time objective would be no later than the next business day.
As noted below, proposed Sec. 39.30 would set a more stringent RTO for
SIDCOs.
(vi) Location of resources; outsourcing.
Proposed Sec. 39.18(f) would clarify that a DCO could maintain the
resources required pursuant to Sec. 39.18(e) on its own or through an
outsourcing arrangement with another DCO or other service provider.
Proposed Sec. 39.18(f)(i) would provide that an outsourcing DCO would
retain complete liability for any failure to meet the specified
responsibilities, and must employ personnel with the expertise
necessary to enable the DCO to supervise the service provider. Proposed
Sec. 39.18(f)(ii) would require that testing include all of the DCO’s
own and outsourced resources, and verify that such resources will work
effectively together.
In response to the July Proposal, a number of commenters expressed
concern that it was impractical for DCOs to have all key job functions
fully duplicated. The proposed regulation clarifies that a DCO may
maintain such functions on its own (including, e.g., through cross-
training) or through written outsourcing arrangements, including with
another DCO.
The Commission seeks comment on whether these provisions governing
outsourcing are appropriate, and whether the clarifications concerning
the retention of responsibility and the necessity for integrated
testing should be expanded to cover all functions of a DCO.
(vii) Notification of Commission staff; recordkeeping.
Proposed Sec. 39.18(g) would require each DCO to notify Commission
staff of various exceptional events, such as technology malfunctions,
system security-related incidents, or targeted threats. The proposed
regulation attempts to achieve a reasonable balance, requiring
notification only of such events that materially impair, or create a
significant likelihood of material impairment, of automated system
operation, reliability, security, or capacity. The proposed regulation
would also require notification of any activation of the DCO’s BC-DR
plan.
Proposed Sec. 39.18(h) would require a DCO to give Commission
staff timely advance notice of planned changes, either changes to
automated systems that are likely to have a significant impact on such
systems, or changes to the DCO’s program of risk analysis and
oversight.
Proposed Sec. 39.18(i) would require a DCO to maintain current
copies of its business continuity plan and other emergency procedures,
its assessments of its operational risks, and records of testing
protocols and results; to provide copies of such records to Commission
staff pursuant to Sec. 1.31; and to provide other documents requested
by Commission staff for the purpose of maintaining a current profile of
the DCO’s automated systems.
(viii) Testing.
Proposed Sec. 39.18(j) would require a DCO to conduct regular,
periodic, objective testing and review of its automated systems to
ensure that they are reliable, secure, and have adequate scalable
capacity, and of its BC-DR capabilities, using testing protocols
adequate to ensure that the DCO’s backup resources are sufficient to
meet the RTO specified in Sec. 39.18(e). The testing would be required
to be conducted by qualified, independent professionals. While such
professionals could include employees of the DCO, they could not be
persons responsible for development or operation of the systems or
capabilities being tested.
Reports setting forth the protocols for, and results of, such tests
would be required to be communicated to, and reviewed by, senior
management of the DCO. Because tests that result in few or no
exceptions raise the possibility of an insufficiently rigorous
protocol, such results would be required to be subject to more
searching review.
(ix) Coordination of business continuity and disaster recovery
plans.
Proposed Sec. 39.18(k) would require each DCO, to the extent
practicable, to coordinate its BC-DR plan with those of its clearing
members, to initiate coordinated testing of such plans, and to take
into account in its own BC-DR plan the BC-DR plans of its providers of
essential services, including telecommunications, power, and water.
(b) SIDCOs.
(i) Determining which DCOs will be subject to enhanced BC-DR
obligations.
As DCOs, SIDCOs would remain subject to the requirements of Title
VII and the regulations thereunder, except to the extent the Commission
promulgates higher standards pursuant to Title VIII of the Dodd-Frank
Act.
Unlike the July Proposal,72 these proposed regulations do not
provide a means for the Commission to determine which DCOs are “core
clearing and settlement organizations.” In light of the provisions of
section 804 of the Dodd-Frank Act for designation of systemically
important clearing or settlement activities, the Commission proposes to
avoid duplication by applying the enhanced BC-DR obligations described
below to SIDCOs.
—————————————————————————
72 See id. at 42639 (proposed appendix E to part 40–Guidance
on Critical Financial Market and Core Clearing and Settlement
Organization Determination).
—————————————————————————
(ii) Recovery time objective.
Proposed Sec. 39.30(a) would set an RTO for SIDCOs of recovery no
later than two hours following the disruption, for any disruption
including a wide-scale disruption,73 in light of the important
[[Page 3714]]
role that SIDCOs play in the financial system. The term “wide-scale
disruption” is defined in proposed Sec. 39.18(a).
—————————————————————————
73 See Interagency Paper on Sound Practices To Strengthen the
Resilience of the U.S. Financial System, 68 FR 17809, 17812 (Apr.
11, 2003) (White Paper) which states
“core clearing and settlement organizations are necessary to
the completion of most transactions in critical markets;
accordingly, they must recover and resume their critical functions
in order for other market participants to process pending
transactions and complete large-value payments. It also is
reasonable to assume that there will be firms that play significant
roles and other market participants in locations not affected by a
particular disruption that will need to clear and settle pending
transactions in critical markets. Therefore, core clearing and
settlement organizations should plan both to recover and resume
their processing and other activities that support critical markets.
In light of the large volume and value of transactions/payments that
are cleared and settled on a daily basis, failure to complete the
clearing and settlement of pending transactions within the business
day could create systemic liquidity dislocations, as well as
exacerbate credit and market risk for critical markets. Therefore,
core clearing and settlement organizations should develop the
capacity to recover and resume clearing and settlement activities
within the business day on which the disruption occurs with the
overall goal of achieving recovery and resumption within two hours
after an event”
—————————————————————————
(iii) Geographic diversity.
Because of the importance of SIDCOs to the financial system, and
the fact that a wide-scale disruption may cause the physical or
technological resources that are located within the relevant area, or
personnel who live or work within the relevant area, to be temporarily
or permanently unavailable, proposed Sec. 39.30(b) would require each
SIDCO to maintain geographic dispersal of physical and technological
resources and personnel.
Physical and technological resources must, pursuant to proposed
Sec. 39.30(b)(1), be located outside the relevant area of the
infrastructure the entity normally relies upon to conduct activities
necessary to the clearance and settlement of existing and new
contracts, and the SIDCO could not rely on the same critical
transportation, telecommunications, power, water, or other critical
infrastructure components the entity normally relies upon for such
activities. Moreover, proposed Sec. 39.30(b)(2) would require
personnel, sufficient to enable the SIDCO to meet the recovery time
objective after interruption of normal clearing by a wide-scale
disruption affecting the relevant area, who live and work outside that
relevant area.
While these proposed requirements would likely lead to a
considerable expense, the Commission believes that the systemic
importance of SIDCOs carries with it a responsibility to be reliably
available on a near-continuous basis, to fulfill their obligations.
Moreover, to provide an opportunity to meet this responsibility in a
flexible manner, proposed Sec. 39.30(b)(3) would make it explicit that
the outsourcing provisions of proposed Sec. 39.18(f) would apply to
these resource requirements.
(iv) Testing.
Proposed Sec. 39.30(c) would require each SIDCO to conduct
regular, periodic tests of its business continuity and disaster
recovery plans and resources and its capacity to achieve the required
recovery time objective in the event of a wide-scale disruption, and
would state that the provisions of proposed Sec. 39.18(j), concerning
testing by DCOs, would apply. Moreover, with respect to outsourcing,
proposed Sec. 39.18(f)(2)(ii) would provide that the testing
referenced in proposed Sec. 39.30(c) “shall include all [of the
DCO’s] own and outsourced resources, and shall verify that all such
resources will work effectively together.”
(v) Effective date.
A number of commenters on the July Proposal suggested that the
establishment of geographically diverse capabilities would require an
extended implementation period, such as 24 months. The Commission
observes with approval, however, that a number of potential SIDCOs
already have geographic dispersal of certain resources, and/or are
already working to achieving such dispersal. Accordingly, the
Commission proposes an effective date for the SIDCO requirements of the
later of one year from the effective date of these regulations, or July
30, 2012. Moreover, Sec. 39.30(d) provides that proposed Sec. 39.30
will apply to a DCO no earlier than one year after such DCO is
designated as systemically important.
7. Special Enforcement Authority Over SIDCOs
Under section 807(c) of the Dodd-Frank Act, for purposes of
enforcing the provisions of Title VIII, a SIDCO is subject to, and the
Commission has authority under the provisions of subsections (b)
through (n) of section 8 of, the Federal Deposit Insurance Act 74 in
the same manner and to the same extent as if the SIDCO were an insured
depository institution and the Commission were the appropriate Federal
banking agency for such insured depository institution. This special
authority is codified in proposed Sec. 39.31.
—————————————————————————
74 12 U.S.C. 1818.
—————————————————————————
C. Additional Amendments
1. Technical Amendments To Reorganize Part 39
The Commission is proposing to reorganize part 39 into three
subparts. Subpart A would contain general provisions applicable to all
DCOs including definitions, procedures for DCO registration, and
procedures for implementation of DCO rules and clearing new products.
Subpart B would contain the regulations that codify and implement the
DCO core principles. The regulations in subpart B would apply to all
DCOs except to the extent that a DCO is a SIDCO and there are
superseding provisions in subpart C. Subpart C would contain
regulations that apply only to SIDCOs. As proposed, for purposes of
clarity, each subpart would have an introductory section stating the
scope of the subpart.75
—————————————————————————
75 See proposed subpart A, Sec. 39.1; proposed subpart B,
Sec. 39.9; and proposed subpart C, Sec. 39.28.
—————————————————————————
The Commission is proposing to amend Sec. 39.1 to update the
citation to the definition of the term “derivatives clearing
organization” and to restate the scope of part 39 to reflect the
reorganization of part 39 into subparts A, B, and C.
The Commission is additionally proposing to remove Sec. 39.2,
which exempts DCOs from all Commission regulations except those
explicitly enumerated in the exemption.76 The Commission believes
that this exemption is inconsistent with the regulatory approach
established by the Dodd-Frank Act. Moreover, a preliminary review
indicates that by eliminating the exemption, DCOs would be subject to
only one additional regulation of significance, Sec. 1.49
(denomination of customer funds and location of depositories).77
Section 1.49 was promulgated after Sec. 39.2 was adopted. It is
noteworthy that, notwithstanding Sec. 39.2, the Commission and the
industry have proceeded as if the requirements of Sec. 1.49 applied to
DCOs. The absence of a reference in Sec. 39.2 to Sec. 1.49 in the
exemption was an oversight. This situation points out the unintended
consequences of attempting to carve out “reverse” exemptions in this
manner, and the Commission believes it is a better regulatory policy to
amend the terms of inapplicable regulations or rescind them, as
appropriate, rather than attempt to maintain an up-to-date list of
applicable regulations.
—————————————————————————
76 Section 39.2 provides, in relevant part, as follows:
A derivatives clearing organization and the clearing of
agreements, contracts and transactions on a derivatives clearing
organization are exempt from all Commission regulations except for
the requirements of this part 39, Sec. Sec. 1.3, 1.12(f)(1), 1.20,
1.24, 1.25, 1.26, 1.27, 1.29, 1.31, 1.36, 1.38(b), part 40 and part
190 of this chapter, and as applicable to the agreement, contract,
or transaction cleared, parts 15 through 18 of this chapter.
77 The other provisions relate to governance and conflicts of
interest issues, and may be superseded by pending rules. See Sec.
1.59 (activities of self-regulatory organization employees,
governing board members, committee members, and consultants); Sec.
1.63 (service on self-regulatory organization governing boards or
committees by persons with disciplinary histories); and Sec. 1.69
(voting by interested members of self-regulatory organization
governing boards and various committees).
—————————————————————————
[[Page 3715]]
In place of the exemption, the Commission proposes to insert the
definitions proposed as Sec. 39.1(b) in an earlier proposed
rulemaking.78 Section 39.1(a), as proposed in the earlier rulemaking,
would be redesignated as Sec. 39.1.79
—————————————————————————
78 See 75 FR at 77585-86.
79 Id.
—————————————————————————
2. Supplemental Provisions for Proposed Sec. 39.19
The Commission recently proposed a new Sec. 39.19(c) which would
require certain reports to be made by a DCO to the Commission.80
Where the primary reporting requirement would be specified elsewhere in
the Commission’s regulations, the Commission intends to cross-reference
these requirements in Sec. 39.19. The following are recently proposed
reporting requirements for which the Commission proposes to add a
cross-reference in proposed Sec. 39.19:
—————————————————————————
80 See 75 FR at 78194.
—————————————————————————
(1) The Commission recently proposed a new Sec. 39.24(b)(4) which
would require each DCO to collect and verify certain information
related to governance fitness standards and provide that information to
the Commission on an annual basis.81 By this notice, the Commission
is proposing a new Sec. 39.19(c)(3)(iii) 82 under which a DCO would
be required to satisfy the annual reporting requirements of Sec.
39.24(b)(4). The Commission also is proposing to amend proposed Sec.
39.24(b)(4) to require the report to be submitted in accordance with
the requirements of proposed Sec. 39.19(c)(3)(iv) (which would require
the report to be filed not more than 90 days after the end of the DCO’s
fiscal year).
—————————————————————————
81 See 76 FR 722, 736 (Jan. 6, 2011).
82 The Commission is proposing to redesignate what is
currently proposed as Sec. 39.19(c)(3)(iii) as Sec.
39.19(c)(3)(iv). This proposed regulation currently states:
The reports required by this paragraph (c)(3) shall be submitted
concurrently to the Commission not more than 90 days after the end
of the derivatives clearing organization’s fiscal year; provided
that, a derivatives clearing organization may request from the
Commission an extension of time to submit either report, provided
the derivatives clearing organization’s failure to submit the report
in a timely manner could not be avoided without unreasonable effort
or expense. Extensions of the deadline will be granted at the
discretion of the Commission.
—————————————————————————
(2) The Commission recently proposed a new Sec. 39.25(b) under
which a DCO would be required to submit a report to the Commission in
the event that the Board of Directors of a DCO rejects a recommendation
or supersedes an action of the Risk Management Committee, or the Risk
Management Committee rejects a recommendation or supersedes an action
of its subcommittee.83 The report would have to include the following
details: (i) The recommendation or action of the Risk Management
Committee (or subcommittee thereof); (ii) the rationale for such
recommendation or action; (iii) the rationale of the Board of Directors
(or the Risk Management Committee, if applicable) for rejecting such
recommendation or superseding such action; and (iv) the course of
action that the Board of Directors (or the Risk Management Committee,
if applicable) decided to take contrary to such recommendation or
action. By this notice, the Commission is proposing a new Sec.
39.19(c)(4)(xvi) under which a DCO would be required to report to the
Commission as required by Sec. 39.25(b). The Commission also is
proposing to amend proposed Sec. 39.25(b) to require the report to be
submitted to the Commission within 30 days of such a rejection or
supersession.
—————————————————————————
83 See supra n.81.
—————————————————————————
(3) The Commission also recently proposed a new Sec.
40.9(b)(1)(iii) under which a DCO (as well as other registered
entities) would have to submit to the Commission, within 30 days after
the election of its Board of Directors, certain information regarding
the Board of Directors.84 By this notice, the Commission is proposing
a new Sec. 39.19(c)(4)(xvii) under which a DCO would have to submit to
the Commission a report in accordance with the requirements of proposed
Sec. 40.9(b)(1)(iii).
—————————————————————————
84 Id.
—————————————————————————
(4) In this notice, the Commission is proposing that a DCO notify
staff of the Division of Clearing and Intermediary Oversight of certain
exceptional events and certain planned changes related to system
safeguards (Core Principle I).85 The Commission is proposing a new
Sec. 39.19(c)(4)(xviii) under which a DCO would be required to notify
staff of the Division of Clearing and Intermediary Oversight of
exceptional events related to system safeguards in accordance with
proposed Sec. 39.18(g) and of planned changes related to system
safeguards in accordance with proposed Sec. 39.18(h).
—————————————————————————
85 See supra, section II.B.6.a.vii.
—————————————————————————
3. Technical Amendments to Proposed Sec. 39.21
The Commission recently proposed a new Sec. 39.24(a)(2) which
would require each DCO to make available to the public and to the
relevant authorities, including the Commission, a description of the
manner in which its governance arrangements permit the consideration of
the views of its owners, whether voting or non-voting, and its
participants, including, without limitation, clearing members and
customers.86 The Commission also recently proposed Sec. 40.9(d)
which would require a DCO (as well as other registered entities) to, at
a minimum, make certain information available to the public and
relevant authorities, including the Commission.87
—————————————————————————
86 See 76 FR at 735.
87 Id. at 736.
—————————————————————————
The Commission also recently proposed a new Sec. 39.21(c) which
lists certain information a DCO would be required to disclose publicly
and to the Commission.88 By this notice, the Commission is proposing
to amend proposed Sec. 39.21(c) to cross-reference the transparency
requirements of proposed Sec. Sec. 39.24(a)(2) and 40.9(d).
—————————————————————————
88 See 75 FR at 78197.
—————————————————————————
III. Effective Date
The Commission is proposing that the requirements proposed in this
notice become effective 180 days from the date the final rules are
published in the Federal Register, with the exception of (1) the system
safeguard requirements that would be applicable to SIDCOs, set forth in
proposed Sec. 39.30, for which the proposed effective date is
discussed in section II.B.6(b)(v) above, and (2) the provisions of
Sec. 39.15(b)(2) relating to the commingling of customer futures,
options on futures, and swaps positions, which would become effective
30 days after the date of publication of the final rules. The
provisions relating to commingling of customer funds do not require
additional time for planning and implementation because they relate to
a voluntary action on the part of a DCO.
The Commission believes that a period of 180 days would give DCOs
adequate time to implement any additional technology and enhanced
procedures that may be necessary to fulfill the proposed requirements
related to participant and product eligibility, risk management,
settlement procedures, treatment of funds, default rules and
procedures, and system safeguards (insofar as they would apply to all
DCOs). The Commission requests comment on whether 180 days is an
appropriate time frame for compliance with these proposed rules. The
Commission further requests comment on possible alternative effective
dates and the basis for any such alternative dates.
IV. Section 4(c)
Section 4(c) of the CEA provides that, in order to promote
responsible
[[Page 3716]]
economic or financial innovation and fair competition, the Commission,
by rule, regulation or order, after notice and opportunity for hearing,
may exempt any agreement, contract, or transaction, or class thereof,
including any person or class of persons offering, entering into,
rendering advice or rendering other services with respect to, the
agreement, contract, or transaction, from the contract market
designation requirement of section 4(a) of the CEA, or any other
provision of the CEA other than certain enumerated provisions, if the
Commission determines that the exemption would be consistent with the
public interest.89
—————————————————————————
89 7 U.S.C. 6(c).
—————————————————————————
Proposed Sec. Sec. 39.15(b)(2)(i) and 39.15(b)(2)(ii) would be
promulgated under Core Principle F, which sets forth requirements for
treatment of funds by a DCO.90 Proper treatment of customer funds
requires, among other things, segregation of customer money, securities
and property received to margin, guarantee, or secure positions in
futures or options on futures, in an account subject to section 4d(a)
of the CEA (i.e., a futures account), and segregation of customer
money, securities and property received to margin, guarantee, or secure
positions in cleared swaps, in an account subject to section 4d(f) of
the CEA (i.e., a cleared swap account). Customer funds required to be
held in a futures account cannot be commingled with non-customer funds
and cannot be held in an account other than an account subject to
section 4d(a), absent Commission approval in the form of a rule,
regulation or order. Section 4d(f) of the CEA mirrors these limitations
as applied to customer positions in cleared swaps.
—————————————————————————
90 Section 5b(c)(2)(F) of the CEA; 7 U.S.C. 7a-1(c)(2)(F).
—————————————————————————
In proposing a regulation that would permit futures and options on
futures to be carried in a cleared swap account if the Commission
approves DCO rules providing for such treatment of funds, and in
proposing a regulation that would permit cleared swap positions to be
carried in a futures account if the Commission issues an order
permitting such treatment of funds, the Commission is exercising its
authority to grant an exemption under section 4(c) of the CEA. In this
regard, the DCO and its clearing members would be exempt from complying
with the segregation requirements of section 4d(a) when holding
customer segregated funds in a cleared swap account subject to section
4d(f) of the CEA, instead of a futures account; and similarly, the DCO
and its clearing members would be exempt from complying with the
segregation requirements of section 4d(f) when holding customer funds
related to cleared swap positions in a futures account subject to
section 4d(a) of the CEA, instead of a cleared swap account.
While this rule-based exemption would streamline the approval
process for commingling customer positions in futures, options on
futures, and cleared swaps, the Commission would still conduct a case-
by case analysis when permitting cleared swaps to be carried in a
futures account, in keeping with its past practice in issuing orders
under section 4d. The Commission believes that there can be benefits to
commingling customer positions in futures, options on futures, and
cleared swaps, primarily in the area of greater capital efficiency due
to margin reductions for correlated positions. The Commission views
this form of portfolio margining as a positive step toward financial
innovation within a framework of responsible oversight, and it believes
that the public can benefit from such innovation.
In light of the foregoing, the Commission believes that the
adoption of proposed Sec. Sec. 39.15(b)(2)(i) and 39.15(b)(2)(ii)
would promote responsible economic and financial innovation and fair
competition, and would be consistent with the “public interest,” as
that term is used in section 4(c) of the CEA.
The Commission solicits public comment on whether the proposed
regulation satisfies the requirements for exemption under section 4(c)
of the CEA.
V. Related Matters
A. Regulatory Flexibility Act
The Regulatory Flexibility Act (RFA) requires that agencies
consider whether the rules they propose will have a significant
economic impact on a substantial number of small entities and, if so,
provide a regulatory flexibility analysis respecting the impact.91
The rules proposed by the Commission will affect only DCOs (some of
which will be designated as SIDCOs). The Commission has previously
established certain definitions of “small entities” to be used by the
Commission in evaluating the impact of its regulations on small
entities in accordance with the RFA.92 The Commission has previously
determined that DCOs are not small entities for the purpose of the
RFA.93 Accordingly, the Chairman, on behalf of the Commission, hereby
certifies pursuant to 5 U.S.C. 605(b) that the proposed rules will not
have a significant economic impact on a substantial number of small
entities.
—————————————————————————
91 5 U.S.C. 601 et seq.
92 47 FR 18618 (Apr. 30, 1982).
93 See 66 FR 45605, 45609 (Aug. 29, 2001).
—————————————————————————
B. Paperwork Reduction Act
The Paperwork Reduction Act (“PRA”) 94 imposes certain
requirements on Federal agencies in connection with their conducting or
sponsoring any collection of information as defined by the PRA. An
agency may not conduct or sponsor, and a person is not required to
respond to, a collection of information unless it displays a currently
valid control number. OMB has not yet assigned a control number to the
new collection.
—————————————————————————
94 44 U.S.C. 3501 et seq.
—————————————————————————
This proposed rulemaking would result in new collection of
information requirements within the meaning of the PRA. The Commission
therefore is submitting this proposal to the Office of Management and
Budget (“OMB”) for review. If adopted, responses to this collection
of information would be mandatory.
The Commission will protect proprietary information according to
FOIA and 17 CFR part 145, “Commission Records and Information.” In
addition, section 8(a)(1) of the CEA strictly prohibits the Commission,
unless specifically authorized by the CEA, from making public “data
and information that would separately disclose the business
transactions or market positions of any person and trade secrets or
names of customers.” The Commission also is required to protect
certain information contained in a government system of records
according to the Privacy Act of 1974, 5 U.S.C. 552a.
1. Information Provided by Reporting Entities/Persons
The proposed regulations would require each respondent to maintain
records of all activities related to its business as a DCO, including
all information required to be created, generated, or reported under
part 39, including but not limited to the results of and methodology
used for all tests, reviews, and calculations.
The Commission staff estimates this would result in a total of one
response per respondent on an annual basis and that respondents could
expend up to $500 annually, based on an hourly rate of $10, to comply
with the proposed regulations. This would result in an aggregated cost
of $6,000 per annum (12 respondents x $500).
[[Page 3717]]
The proposed regulations also would require the submission of an
application form by entities seeking to register as DCOs. The applicant
burden is estimated to take, on average, approximately 400 hours, with
an hourly rate ranging from $75-$400, for a total estimated cost of
$100,000 per application. These estimates include the time needed to
review instructions and to develop, acquire, install, and utilize
technology and systems for the purposes of collecting, validating, and
verifying information. Staff estimates that three entities will seek to
register as a DCO on an annual basis.
2. Information Collection Comments
The Commission invites the public and other Federal agencies to
comment on any aspect of the reporting and recordkeeping burdens
discussed above. Pursuant to 44 U.S.C. 3506(c)(2)(B), the Commission
solicits comment in order to: (i) Evaluate whether the proposed
collection of information is necessary for the proper performance of
the functions of the Commission, including whether the information will
have practical utility; (ii) evaluate the accuracy of the Commission’s
estimate of the burden of the proposed collection of information; (iii)
determine whether there are ways to enhance the quality, utility, and
clarity of the information to be collected; and (iv) minimize the
burden of the collection of information on those who are to respond,
including through the use of automated collection techniques or other
forms of information technology.
Comments may be submitted directly to the Office of Information and
Regulatory Affairs, by fax at (202) 395-6566 or by e-mail at
[email protected]. Please provide the Commission with a copy
of submitted comments so that all comments can be summarized and
addressed in the final rule preamble. Refer to the Addresses section of
this notice of proposed rulemaking for comment submission instructions
to the Commission. A copy of the supporting statements for the
collections of information discussed above may be obtained by visiting
RegInfo.gov. OMB is required to make a decision concerning the
collection of information between 30 and 60 days after publication of
this document in the Federal Register. Therefore, a comment is best
assured of having its full effect if OMB receives it within 30 days of
publication.
C. Cost-Benefit Analysis
Section 15(a) of the CEA requires the Commission to consider the
costs and benefits of its actions before issuing a rulemaking under the
CEA. By its terms, section 15(a) does not require the Commission to
quantify the costs and benefits of a rule or to determine whether the
benefits of the rulemaking outweigh its costs; rather, it requires that
the Commission “consider” the costs and benefits of its action.
Section 15(a) further specifies that the costs and benefits shall
be evaluated in light of five broad areas of market and public concern:
(1) Protection of market participants and the public; (2) efficiency,
competitiveness, and financial integrity of futures markets; (3) price
discovery; (4) sound risk management practices; and (5) other public
interest considerations. The Commission may in its discretion give
greater weight to any one of the five enumerated areas and could in its
discretion determine that, notwithstanding its costs, a particular
regulation is necessary or appropriate to protect the public interest
or to effectuate any of the provisions or to accomplish any of the
purposes of the CEA.
Summary of proposed requirements. The proposed regulations would
implement the participant and product eligibility, risk management,
settlement procedures, treatment of funds, default procedures and
system safeguards core principles for DCOs and would adopt an
application form for DCO registration under the CEA, as amended by the
Dodd-Frank Act.
Costs. With respect to costs, the Commission has determined that
the costs to market participants and the public if these regulations
are not adopted are substantial. Significantly, without these
regulations to ensure that DCOs fully comply with the core principles
of participant and product eligibility, risk management, settlement
procedures, treatment of funds, default procedures and system
safeguards, sound risk management and the financial integrity of the
futures and swap markets would not be enhanced, to the detriment of
market participants and the public.
The Commission has also determined that the costs of the new
reporting requirements imposed on DCOs will consist primarily of
recordkeeping requirements, which the Commission estimates will cost
DCOs $500 annually. For purposes of this rulemaking, the estimated
reporting and recordkeeping costs do not include other costs addressed
by other rulemakings. However, the costs do take into account the costs
of implementing certain reporting requirements which many DCOs already
have in place, and thus, the actual costs to many DCOs may be far less
than the Commission’s estimates.
Benefits. With respect to benefits, the Commission has determined
that the benefits of the proposed rules are many and substantial. DCO
registration applications will be processed transparently and
efficiently, making clearing services available to the futures and swap
markets in order to protect the integrity of these markets through the
sound risk management practices associated with clearing and the
efficiency that competition between clearinghouses will foster. The
protection of market participants, financial integrity of the markets,
and sound risk management will further be promoted by the compliance of
each DCO with the rules and standards that are being adopted to
implement the core principles, notably those associated with
participant and product eligibility, risk management, settlement
procedures, treatment of funds, default procedures and system
safeguards.
The Commission has also determined that the recordkeeping
requirements allow for making certain records available for Commission
inspection, which helps further the goals of the reporting requirements
and is necessary for the Commission to effectively monitor a DCO’s
financial integrity and compliance with the CEA and Commission
regulations.
Public Comment. The Commission invites public comment on its cost-
benefit considerations. Commenters are also invited to submit any data
or other information that they may have quantifying or qualifying the
costs and benefits of the proposal with their comment letters.
List of Subjects in 17 CFR Part 39
Commodity futures, Participant and product eligibility, Risk
management, Settlement procedures, Treatment of funds, Default rules
and procedures, System safeguards, Enforcement authority application
form.
In light of the foregoing, the Commission hereby proposes to amend
part 39 of Title 17 of the Code of Federal Regulations as follows:
PART 39–DERIVATIVES CLEARING ORGANIZATIONS
1. Revise the authority citation for part 39 to read as follows:
Authority: 7 USC 2, 5, 6, 6d, 7a-1, 7a-2, and 7b as amended by
the Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub.
L. 111-203, 124 Stat. 1376.
[[Page 3718]]
Subpart A–General Provisions Applicable to Derivatives Clearing
Organizations
2. Designate existing Sec. Sec. 39.1 through 39.7 as subpart A and
add a subpart heading to read as set forth above.
3. Revise Sec. 39.1 to read as follows:
Sec. 39.1 Scope.
The provisions of this subpart A apply to any derivatives clearing
organization, as defined under section 1a(15) of the Act and Sec.
1.3(d) of this chapter, which is registered or deemed to be registered
with the Commission as a derivatives clearing organization, is required
to register as such with the Commission pursuant to section 5b(a) of
the Act, or which voluntarily registers as such with the Commission
pursuant to section 5b(b) or otherwise.
4. Revise Sec. 39.2 to read as follows:
Sec. 39.2 Definitions.
For the purposes of this part,
Back test means a test that compares a derivatives clearing
organization’s initial margin requirements with historical price
changes to determine the extent of actual margin coverage.
Compliance policies and procedures means all policies, procedures,
codes, including a code of ethics, safeguards, rules, programs, and
internal controls that are required to be adopted or established by a
derivatives clearing organization pursuant to the Act, Commission
regulations, or orders, or that otherwise facilitate compliance with
the Act and Commission regulations.
Customer account or customer origin means a clearing member’s
account held on behalf of customers, as defined in Sec. 1.3(k) of this
chapter. A customer account is also a futures account, as that term is
defined by Sec. 1.3(vv) of this chapter.
House account or house origin means a clearing member’s combined
proprietary accounts, as defined in Sec. 1.3(y) of this chapter.
Key personnel means derivatives clearing organization personnel who
play a significant role in the operations of the derivatives clearing
organization, the provision of clearing and settlement services, risk
management, or oversight of compliance with the Act and Commission
regulations and orders. Key personnel include, but are not limited to,
those persons who are or perform the functions of any of the following:
chief executive officer; president; Chief compliance officer; chief
operating officer; Chief risk officer; chief financial officer; chief
technology officer; and emergency contacts or persons who are
responsible for business continuity or disaster recovery planning or
program execution.
Stress test means a test that compares the impact of a potential
price move, change in option volatility, or change in other inputs that
affect the value of a position, to the financial resources of a
derivatives clearing organization, clearing member, or large trader, to
determine the adequacy of such financial resources.
Systemically important derivatives clearing organization means a
financial market utility that is a derivatives clearing organization
registered under section 5b of the Act (7 U.S.C. 7a-1), which has been
designated by the Financial Stability Oversight Council to be
systemically important.
5. Amend Sec. 39.3 by revising paragraphs (a)(2), (a)(3), (b),
(c), (d) and (e) and by adding paragraphs (a)(4) and (a)(5) to read as
follows:
Sec. 39.3 Procedures for registration.
(a) * * *
(2) Application. Any person seeking to register as a derivatives
clearing organization, any applicant amending its pending application,
or any registered derivatives clearing organization seeking to amend
its order of registration (applicant), shall submit to the Commission a
completed Form DCO, which shall include a cover sheet, all applicable
exhibits, and any supplemental materials, including amendments thereto,
as provided in appendix A to this part 39 (application). The Commission
will not commence processing an application unless the applicant has
filed the application as required by this section. Failure to file a
completed application will preclude the Commission from determining
that an application is materially complete, as provided in section 6(a)
of the Act. Upon its own initiative, an applicant may file with its
completed application additional information that may be necessary or
helpful to the Commission in processing the application.
(3) Submission of supplemental information. The filing of a
completed application is a minimum requirement and does not create a
presumption that the application is materially complete or that
supplemental information will not be required. At any time during the
application review process, the Commission may request that the
applicant submit supplemental information in order for the Commission
to process the application. The applicant shall file electronically
such supplemental information with the Secretary of the Commission in
the form and manner provided by the Commission.
(4) Application amendments. An applicant shall promptly amend its
application if it discovers a material omission or error, or if there
is a material change in the information provided to the Commission in
the application or other information provided in connection with the
application.
(5) Public information. The following sections of all applications
to become a registered derivatives clearing organization will be
public: first page of the Form DCO cover sheet, proposed rules,
regulatory compliance chart, narrative summary of proposed clearing
activities, documents establishing the applicant’s legal status,
documents setting forth the applicant’s corporate and governance
structure, and any other part of the application not covered by a
request for confidential treatment, subject to Sec. 145.9 of this
chapter.
(b) Stay of application review. (1) The Commission may stay the
running of the 180-day review period if an application is materially
incomplete, in accordance with section 6(a) of the Act.
(2) Delegation of authority. (i) The Commission hereby delegates,
until it orders otherwise, to the Director of the Division of Clearing
and Intermediary Oversight or the Director’s designee, with the
concurrence of the General Counsel or the General Counsel’s designee,
the authority to notify an applicant seeking registration under section
6(a) of the Act that the application is materially incomplete and the
running of the 180-day period is stayed.
(ii) The Director of the Division of Clearing and Intermediary
Oversight may submit to the Commission for its consideration any matter
which has been delegated in this paragraph.
(iii) Nothing in this paragraph prohibits the Commission, at its
election, from exercising the authority delegated in paragraph
(b)(2)(i) of this section.
(c) Withdrawal of application for registration. An applicant for
registration may withdraw its application submitted pursuant to
paragraph (a) of this section by filing electronically such a request
with the Secretary of the Commission in the form and manner provided by
the Commission. Withdrawal of an application for registration shall not
affect any action taken or to be taken by the Commission based upon
actions, activities, or events occurring during the time that the
application for registration was pending with the Commission.
[[Page 3719]]
(d) Reinstatement of dormant registration. Before listing or
relisting products for clearing, a dormant registered derivatives
clearing organization as defined in Sec. 40.1 of this chapter must
reinstate its registration under the procedures of paragraph (a) of
this section; provided, however, that an application for reinstatement
may rely upon previously submitted materials that still pertain to, and
accurately describe, current conditions.
(e) Request for vacation of registration. A registered derivatives
clearing organization may vacate its registration under section 7 of
the Act by filing electronically such a request with the Secretary of
the Commission in the form and manner provided by the Commission.
Vacation of registration shall not affect any action taken or to be
taken by the Commission based upon actions, activities or events
occurring during the time that the entity was registered by the
Commission.
* * * * *
Sec. 39.7 [Redesignated as Sec. 39.8]
6. Redesignate Sec. 39.7 as Sec. 39.8.
Sec. 39.6 [Redesignated as Sec. 39.7]
7. Redesignate Sec. 39.6 as Sec. 39.7.
8. Add subpart B to read as follows:
Subpart B–Compliance with Core Principles
Sec.
39.9 Scope.
39.10 [Reserved]
39.11 [Reserved]
39.12 Participant and product eligibility.
39.13 Risk management.
39.14 Settlement procedures.
39.15 Treatment of funds.
39.16 Default rules and procedures.
39.17 [Reserved]
39.18 System safeguards.
39.19 Reporting.
39.20 [Reserved]
39.21 Public information.
39.22 [Reserved]
39.23 [Reserved]
39.24 Governance fitness standards.
39.25 Conflicts of interest.
Subpart B–Compliance with Core Principles
Sec. 39.9 Scope.
Except as otherwise provided with respect to systemically important
derivatives clearing organizations subject to subpart C of this part,
the provisions of this subpart B apply to any derivatives clearing
organization, as defined under section 1a(15) of the Act and Sec.
1.3(d) of this chapter, which is registered or deemed to be registered
with the Commission as a derivatives clearing organization, is required
to register as such with the Commission pursuant to section 5b(a) of
the Act, or which voluntarily registers as such with the Commission
pursuant to section 5b(b) or otherwise.
Sec. 39.10 [Reserved]
Sec. 39.11 [Reserved]
Sec. 39.12 Participant and product eligibility.
(a) Participant eligibility. A derivatives clearing organization
shall establish appropriate admission and continuing participation
requirements for clearing members of the derivatives clearing
organization that are objective, publicly disclosed, and risk-based.
(1) Fair and open access for participation. The participation
requirements shall permit fair and open access;
(i) A derivatives clearing organization shall not adopt restrictive
clearing member standards if less restrictive requirements that would
not materially increase risk to the derivatives clearing organization
or clearing members could be adopted;
(ii) A derivatives clearing organization shall allow all market
participants who satisfy participation requirements to become clearing
members;
(iii) A derivatives clearing organization shall not exclude or
limit clearing membership of certain types of market participants
unless the derivatives clearing organization can demonstrate that the
restriction is necessary to address credit risk or deficiencies in the
participants’ operational capabilities that would prevent them from
fulfilling their obligations as clearing members.
(iv) A derivatives clearing organization shall not require that
clearing members must be swap dealers.
(v) A derivatives clearing organization shall not require that
clearing members maintain a swap portfolio of any particular size, or
that clearing members meet a swap transaction volume threshold.
(2) Financial resources. (i) The participation requirements shall
require clearing members to have access to sufficient financial
resources to meet obligations arising from participation in the
derivatives clearing organization in extreme but plausible market
conditions. The financial resources may include, but are not limited
to, a clearing member’s capital, a guarantee from the clearing member’s
parent, or a credit facility funding arrangement. For purposes of this
paragraph, “capital” means adjusted net capital as defined in Sec.
1.17 of this chapter, for futures commission merchants, and net capital
as defined in Sec. 15c3-1 of this title, for broker-dealers, or any
similar risk adjusted capital calculation for all other prospective
clearing members.
(ii) The participation requirements shall set forth capital
requirements that are based on objective, transparent, and commonly
accepted standards that appropriately match capital to risk. Capital
requirements shall be scalable so that they are proportional to the
risks posed by clearing members.
(iii) A derivatives clearing organization shall not set a minimum
capital requirement of more than $50 million for any person that seeks
to become a clearing member in order to clear swaps.
(3) Operational requirements. The participation requirements shall
require clearing members to have adequate operational capacity to meet
obligations arising from participation in the derivatives clearing
organization. The requirements shall include, but are not limited to:
the ability to process expected volumes and values of transactions
cleared by a clearing member within required time frames, including at
peak times and on peak days; the ability to fulfill collateral,
payment, and delivery obligations imposed by the derivatives clearing
organization; and the ability to participate in default management
activities under the rules of the derivatives clearing organization and
in accordance with Sec. 39.16 of this part.
(4) Monitoring. A derivatives clearing organization shall establish
and implement procedures to verify, on an ongoing basis, the compliance
of each clearing member with each participation requirement of the
derivatives clearing organization.
(5) Reporting. (i) A derivatives clearing organization shall
require all clearing members, including those that are not futures
commission merchants, to file periodic financial reports with the
derivatives clearing organization which contain any financial
information that the derivatives clearing organization determines is
necessary to assess whether participation requirements are met on an
ongoing basis. A derivatives clearing organization shall require
clearing members that are futures commission merchants to file the
financial reports that are specified in Sec. 1.10 of this chapter with
the derivatives clearing organization. The derivatives clearing
organization shall review all such financial reports for risk
management purposes. A derivatives clearing organization shall also
require clearing members that are not futures commission merchants to
make such periodic financial reports available to
[[Page 3720]]
the Commission upon the Commission’s request.
(ii) A derivatives clearing organization shall adopt rules that
require clearing members to provide to the derivatives clearing
organization, in a timely manner, information that concerns any
financial or business developments that may materially affect the
clearing members’ ability to continue to comply with participation
requirements.
(6) Enforcement. A derivatives clearing organization shall have the
ability to enforce compliance with its participation requirements and
shall establish procedures for the suspension and orderly removal of
clearing members that no longer meet the requirements.
(b) Product eligibility. (1) A derivatives clearing organization
shall establish appropriate requirements for determining the
eligibility of agreements, contracts, or transactions submitted to the
derivatives clearing organization for clearing, taking into account the
derivatives clearing organization’s ability to manage the risks
associated with such agreements, contracts, or transactions. Factors to
be considered in determining product eligibility include, but are not
limited to:
(i) Trading volume;
(ii) Liquidity;
(iii) Availability of reliable prices;
(iv) Ability of market participants to use portfolio compression
with respect to a particular swap product;
(v) Ability of the derivatives clearing organization and clearing
members to gain access to the relevant market for purposes of creating
and liquidating positions;
(vi) Ability of the derivatives clearing organization to measure
risk for purposes of setting margin requirements; and
(vii) Operational capacity of the derivatives clearing organization
and clearing members to address any unique risk characteristics of a
product.
(2) A derivatives clearing organization shall adopt rules providing
that all swaps with the same terms and conditions submitted to the
derivatives clearing organization for clearing are economically
equivalent within the derivatives clearing organization and may be
offset with each other within the derivatives clearing organization. A
derivatives clearing organization shall also provide for non-
discriminatory clearing of a swap executed bilaterally or on or subject
to the rules of an unaffiliated designated contract market or swap
execution facility.
(3) A derivatives clearing organization shall select contract unit
sizes that maximize liquidity, open access, and risk management. To the
extent appropriate to further these objectives, a derivatives clearing
organization shall select contract units for clearing purposes that are
smaller than the contract units in which trades submitted for clearing
were executed.
(4) A derivatives clearing organization that clears swaps shall
have rules providing that, upon acceptance of a swap by the derivatives
clearing organization for clearing:
(i) The original swap is extinguished;
(ii) The original swap is replaced by equal and opposite swaps
between clearing members and the derivatives clearing organization;
(iii) All terms of the cleared swaps must conform to templates
established under derivatives clearing organization rules; and
(iv) If a swap is cleared by a clearing member on behalf of a
customer, all terms of the swap, as carried in the customer account on
the books of the clearing member, must conform to the terms of the
cleared swap established under the derivatives clearing organization’s
rules.
Sec. 39.13 Risk management.
(a) In general. A derivatives clearing organization shall ensure
that it possesses the ability to manage the risks associated with
discharging the responsibilities of the derivatives clearing
organization through the use of appropriate tools and procedures.
(b) Documentation requirement. A derivatives clearing organization
shall establish and maintain written policies, procedures, and
controls, approved by its Board of Directors, which establish an
appropriate risk management framework that, at a minimum, clearly
identifies and documents the range of risks to which the derivatives
clearing organization is exposed, addresses the monitoring and
management of the entirety of those risks, and provides a mechanism for
internal audit. The risk management framework shall be regularly
reviewed and updated as necessary.
(c) Chief risk officer. A derivatives clearing organization shall
have a chief risk officer who shall be responsible for implementing the
risk management framework, including the procedures, policies and
controls described in paragraph (b) of this section, and for making
appropriate recommendations to the derivatives clearing organization’s
Risk Management Committee or Board of Directors, as applicable,
regarding the derivatives clearing organization’s risk management
functions.
(d) [Reserved]
(e) Measurement of credit exposure. A derivatives clearing
organization shall:
(1) Measure its credit exposure to each clearing member and mark to
market such clearing member’s open positions at least once each
business day; and
(2) Monitor its credit exposure to each clearing member
periodically during each business day.
(f) Limitation of exposure to potential losses from defaults. A
derivatives clearing organization, through margin requirements and
other risk control mechanisms, shall limit its exposure to potential
losses from defaults by its clearing members to ensure that:
(1) The operations of the derivatives clearing organization would
not be disrupted; and
(2) Non-defaulting clearing members would not be exposed to losses
that nondefaulting clearing members cannot anticipate or control.
(g) Margin requirements–(1) In general. The initial margin that a
derivatives clearing organization requires from each clearing member
shall be sufficient to cover potential exposures in normal market
conditions. Each model and parameter used in setting initial margin
requirements shall be risk-based and reviewed on a regular basis.
(2) Methodology and coverage. (i) A derivatives clearing
organization shall establish initial margin requirements that are
commensurate with the risks of each product and portfolio, including
any unique characteristics of, or risks associated with, particular
products or portfolios. A derivatives clearing organization that clears
credit default swaps shall appropriately address jump-to-default risk
in setting initial margins.
(ii) A derivatives clearing organization shall use models that
generate initial margin requirements sufficient to cover the
derivatives clearing organization’s potential future exposures to
clearing members based on price movements in the interval between the
last collection of variation margin and the time within which the
derivatives clearing organization estimates that it would be able to
liquidate a defaulting clearing member’s positions (liquidation time);
provided, however, that a derivatives clearing organization shall use a
liquidation time that is a minimum of five business days for cleared
swaps that are not executed on a designated contract market, whether
the swaps are carried in a customer account subject to section 4d(a) or
4d(f) of the Act, or carried in a house account, and a liquidation time
that is a minimum of one business day for all other products that it
clears, and shall use longer
[[Page 3721]]
liquidation times, if appropriate, based on the unique characteristics
of particular products or portfolios.
(iii) The actual coverage of the initial margin requirements
produced by such models, along with projected measures of the models’
performance, shall meet an established confidence level of at least
99%, based on data from an appropriate historic time period, for:
(A) Each product (that is margined on a product basis);
(B) Each spread within or between products for which there is a
defined spread margin rate, as described in paragraph (g)(4) of this
section;
(C) Each account held by a clearing member at the DCO, by customer
origin and house origin; and
(D) Each swap portfolio, by beneficial owner.
(iv) A derivatives clearing organization shall determine the
appropriate historic time period based on the characteristics,
including volatility patterns, as applicable, of each product, spread,
account, or portfolio.
(3) Independent validation. A derivatives clearing organization’s
systems for generating initial margin requirements, including its
theoretical models, must be reviewed and validated by a qualified and
independent party, on a regular basis.
(4) Spread margins. (i) A derivatives clearing organization may
allow reductions in initial margin requirements for related positions
(spread margins) if the price risks with respect to such positions are
significantly and reliably correlated. The price risks of different
positions will only be considered to be reliably correlated if there is
a theoretical basis for the correlation in addition to an exhibited
statistical correlation. That theoretical basis may include, but is not
limited to, the following:
(A) The products on which the positions are based are complements
of, or substitutes for, each other;
(B) One product is a significant input into the other product(s);
(C) The products share a significant common input; or
(D) The prices of the products are influenced by common external
factors.
(ii) A derivatives clearing organization shall regularly review its
spread margins and the correlations on which they are based.
(5) Price data. A derivatives clearing organization shall have a
reliable source of timely price data in order to measure the
derivatives clearing organization’s credit exposure accurately. A
derivatives clearing organization shall also have written procedures
and sound valuation models for addressing circumstances where pricing
data is not readily available or reliable.
(6) Daily review. On a daily basis, a derivatives clearing
organization shall determine the adequacy of its initial margin
requirements for each product (that is margined on a product basis).
(7) Back tests. A derivatives clearing organization shall conduct
back tests, as defined in Sec. 39.2 of this part, using historical
price changes based on a time period that is equivalent in length to
the historic time period used by the applicable margin model for
establishing the confidence level described in paragraph (g)(2) of this
section or a longer time period, unless another time period is
specified by this paragraph.
(i) On a daily basis, a derivatives clearing organization shall
conduct back tests with respect to products that are experiencing
significant market volatility, to test the adequacy of its initial
margin requirements and spread margin requirements for such products
that are margined on a product basis.
(ii) On at least a monthly basis, a derivatives clearing
organization shall conduct back tests to test the adequacy of its
initial margin requirements and spread margin requirements for each
product that is margined on a product basis.
(iii) On at least a monthly basis, a derivatives clearing
organization shall conduct back tests to test the adequacy of its
initial margin requirements for each account held by a clearing member
at the DCO, by origin, house and customer, and each swap portfolio, by
beneficial owner, over at least the previous 30 days.
(8) Customer margin–(i) Gross margin. A derivatives clearing
organization shall collect initial margin on a gross basis for each
clearing member’s customer account equal to the sum of the initial
margin amounts that would be required by the derivatives clearing
organization for each individual customer within that account if each
individual customer were a clearing member. A derivatives clearing
organization may not net positions of different customers against one
another. A derivatives clearing organization may collect initial margin
for its clearing members’ house accounts on a net basis.
(ii) Customer initial margin requirements. A derivatives clearing
organization shall require its clearing members to collect customer
initial margin, as defined in Sec. 1.3 of this chapter, from their
customers, for non-hedge positions, at a level that is greater than
100% of the derivatives clearing organization’s initial margin
requirements with respect to each product and swap portfolio. The
derivatives clearing organization shall have reasonable discretion in
determining the percentage by which customer initial margins must
exceed the derivatives clearing organization’s initial margin
requirements with respect to particular products or swap portfolios.
The Commission may review such percentage levels and require different
percentage levels if the Commission deems the levels insufficient to
protect the financial integrity of the clearing members or the
derivatives clearing organization.
(iii) Withdrawal of customer initial margin. A derivatives clearing
organization shall require its clearing members to ensure that their
customers do not withdraw funds from their accounts with such clearing
members unless the net liquidating value plus the margin deposits
remaining in a customer’s account after such withdrawal are sufficient
to meet the customer initial margin requirements with respect to all
products and swap portfolios held in such customer’s account which are
cleared by the derivatives clearing organization.
(9) Time deadlines. A derivatives clearing organization shall
establish and enforce time deadlines for initial and variation margin
payments to the derivatives clearing organization.
(h) Other risk control mechanisms–(1) Risk limits. (i) A
derivatives clearing organization shall impose risk limits on each
clearing member, by customer origin and house origin, in order to
prevent a clearing member from carrying positions for which the risk
exposure exceeds a specified threshold relative to the clearing
member’s and/or the derivatives clearing organization’s financial
resources. The derivatives clearing organization shall have reasonable
discretion in determining:
(A) The method of computing risk exposure;
(B) The applicable threshold(s); and
(C) The applicable financial resources under this provision;
provided however, that the ratio of exposure to capital must remain the
same across all capital levels. The Commission may review such methods,
thresholds, and financial resources and require the application of
different methods, thresholds, or financial resources, as appropriate.
(ii) A derivatives clearing organization may permit a clearing
member to exceed the threshold(s) applied pursuant to paragraph
(h)(1)(i) of this section provided that the derivatives clearing
organization requires the clearing member to post additional initial
margin that the derivatives clearing organization deems sufficient to
[[Page 3722]]
appropriately eliminate excessive risk exposure at the clearing member.
The Commission may review the amount of additional initial margin and
require a different amount of additional initial margin, as
appropriate.
(2) Large trader reports. A derivatives clearing organization shall
obtain from its clearing members, copies of all reports that are
required to be filed with the Commission by such clearing members
pursuant to part 17 of this chapter. With respect to exclusively self-
cleared contracts, a derivatives clearing organization shall obtain
from the relevant reporting market, copies of all reports that are
required to be filed with the Commission on behalf of such clearing
members by the relevant reporting market, pursuant to Sec. 17.00(i) of
this chapter. A derivatives clearing organization shall review such
reports on a daily basis to ascertain the risk of the overall portfolio
of each large trader, including positions at all clearing members
carrying accounts for each such large trader, and shall take additional
actions with respect to such clearing members, when appropriate, as
specified in paragraph (h)(6) of this section, in order to address any
risks posed by any such large trader.
(3) Stress tests. A derivatives clearing organization shall conduct
stress tests, as defined in Sec. 39.2 of this part, as follows:
(i) On a daily basis, a derivatives clearing organization shall
conduct stress tests with respect to each large trader who poses
significant risk to a clearing member or the derivatives clearing
organization, including positions at all clearing members carrying
accounts for each such large trader. The derivatives clearing
organization shall have reasonable discretion in determining which
traders to test and the methodology used to conduct such stress tests.
The Commission may review the selection of accounts and the methodology
and require changes, as appropriate.
(ii) On at least a weekly basis, a derivatives clearing
organization shall conduct stress tests with respect to each clearing
member account, by customer origin and house origin, and each swap
portfolio, by beneficial owner, under extreme but plausible market
conditions. The derivatives clearing organization shall have reasonable
discretion in determining the methodology used to conduct such stress
tests. The Commission may review the methodology and require changes,
as appropriate.
(4) Portfolio compression. (i) A derivatives clearing organization
shall offer multilateral portfolio compression exercises, on a regular
basis, for its clearing members that clear swaps, to the extent that
such exercises are appropriate for those swaps that it clears.
(ii) A derivatives clearing organization shall require its clearing
members to participate in all such exercises, to the extent that any
swap in the applicable portfolio is eligible for inclusion in the
exercise, unless including the swap would be reasonably likely to
significantly increase the risk exposure of the clearing member.
(iii) A derivatives clearing organization may permit clearing
members participating in compression exercises to set risk tolerance
limits for their portfolios, provided that the clearing members do not
set such risk tolerances at an unreasonable level or use such risk
tolerances to evade the requirements of this paragraph.
(5) Clearing members’ risk management policies and procedures. (i)
A derivatives clearing organization shall adopt rules that:
(A) Require its clearing members to maintain current written risk
management policies and procedures;
(B) Ensure that it has the authority to request and obtain
information and documents from its clearing members regarding their
risk management policies, procedures, and practices, including, but not
limited to, information and documents relating to the liquidity of
their financial resources and their settlement procedures; and
(C) Require its clearing members to make information and documents
regarding their risk management policies, procedures, and practices
available to the Commission upon the Commission’s request.
(ii) A derivatives clearing organization shall review the risk
management policies, procedures, and practices of each of its clearing
members on a periodic basis and document such reviews.
(6) Additional authority. A derivatives clearing organization shall
take additional actions with respect to particular clearing members,
when appropriate, based on the application of objective and prudent
risk management standards including, but not limited to:
(i) Imposing enhanced capital requirements;
(ii) Imposing enhanced margin requirements;
(iii) Imposing position limits;
(iv) Prohibiting an increase in positions;
(v) Requiring a reduction of positions;
(vi) Liquidating or transferring positions; and
(vii) Suspending or revoking clearing membership.
Sec. 39.14 Settlement procedures.
(a) Definitions–(1) Settlement. For purposes of this section,
“settlement” means:
(i) Payment and receipt of variation margin for futures, options,
and swap positions;
(ii) Payment and receipt of option premiums;
(iii) Deposit and withdrawal of initial margin for futures,
options, and swap positions;
(iv) All payments due in final settlement of futures, options, and
swap positions on the final settlement date with respect to such
positions; and
(v) All other cash flows collected from or paid to each clearing
member, including but not limited to, payments related to swaps such as
coupon amounts.
(2) Settlement bank. For purposes of this section, “settlement
bank” means a bank that maintains an account either for the
derivatives clearing organization or for any of its clearing members,
which is used for the purpose of transferring funds and receiving
transfers of funds in connection with settlements with the derivatives
clearing organization.
(b) Daily settlements. A derivatives clearing organization shall
effect a settlement with each clearing member at least once each
business day, and shall have the authority and operational capacity to
effect a settlement with each clearing member, on an intraday basis,
either routinely, when thresholds specified by the derivatives clearing
organization are breached, or in times of extreme market volatility.
(c) Settlement banks. A derivatives clearing organization shall
employ settlement arrangements that eliminate or strictly limit its
exposure to settlement bank risks, including the credit and liquidity
risks arising from the use of such banks to effect settlements with its
clearing members.
(1) A derivatives clearing organization shall have documented
criteria with respect to those banks that are acceptable settlement
banks for the derivatives clearing organization and its clearing
members, including criteria addressing the capitalization,
creditworthiness, access to liquidity, operational reliability, and
regulation or supervision of such banks.
(2) A derivatives clearing organization shall monitor each approved
settlement bank on an ongoing basis to ensure that such bank continues
to meet the criteria established pursuant to paragraph (c)(1) of this
section.
[[Page 3723]]
(3) A derivatives clearing organization shall monitor the full
range and concentration of its exposures to its own and its clearing
members’ settlement banks and assess its own and its clearing members’
potential losses and liquidity pressures in the event that the
settlement bank with the largest share of settlement activity were to
fail. A derivatives clearing organization shall:
(i) Maintain settlement accounts at additional settlement banks;
(ii) Approve additional settlement banks for use by its clearing
members;
(iii) Impose concentration limits with respect to its own or its
clearing members’ settlement banks; and/or
(iv) Take any other appropriate actions, if any such actions are
reasonably necessary in order to eliminate or strictly limit such
exposures.
(d) Settlement finality. A derivatives clearing organization shall
ensure that settlements are final when effected by ensuring that
settlement fund transfers are irrevocable and unconditional when the
derivatives clearing organization’s accounts are debited or credited. A
derivatives clearing organization’s legal agreements with its
settlement banks shall state clearly when settlement fund transfers
will occur and a derivatives clearing organization shall routinely
confirm that its settlement banks are effecting fund transfers as and
when required by such legal agreements.
(e) Recordkeeping. A derivatives clearing organization shall
maintain an accurate record of the flow of funds associated with each
settlement.
(f) Netting arrangements. A derivatives clearing organization shall
possess the ability to comply with each term and condition of any
permitted netting or offset arrangement with any other clearing
organization.
(g) Physical delivery. With respect to contracts, agreements, and
transactions that are settled by physical transfers of the underlying
instruments or commodities, a derivatives clearing organization shall:
(1) Establish rules that clearly state each obligation that the
derivatives clearing organization has assumed with respect to physical
deliveries, including whether it has an obligation to make or receive
delivery of a physical instrument or commodity, or whether it
indemnifies clearing members for losses incurred in the delivery
process; and
(2) Ensure that the risks of each such obligation are identified
and managed.
Sec. 39.15 Treatment of funds.
(a) Required standards and procedures. A derivatives clearing
organization shall establish standards and procedures that are designed
to protect and ensure the safety of funds and assets belonging to
clearing members and their customers.
(b) Segregation of funds and assets–(1) Segregation. A derivatives
clearing organization shall comply with the segregation requirements of
section 4d of the Act and Commission regulations thereunder, or any
other applicable Commission regulation or order requiring that customer
funds and assets be segregated, set aside, or held in a separate
account.
(2) Commingling of futures, options on futures, and swaps
positions–(i) Cleared swap account. In order for a derivatives
clearing organization and its clearing members to commingle customer
positions in futures, options on futures, and swaps, and any money,
securities, or property received to margin, guarantee or secure such
positions, in an account subject to the requirements of section 4d(f)
of the Act, the derivatives clearing organization shall file rules for
Commission approval pursuant to Sec. 40.5 of this chapter. Such rule
submission shall include, at a minimum, the following:
(A) An identification of the futures, options on futures, and swaps
that would be commingled, including contract specifications or the
criteria that would be used to define eligible futures, options on
futures, and swaps;
(B) An analysis of the risk characteristics of the eligible
products;
(C) A description of whether the swaps would be executed
bilaterally and/or executed on a designated contract market and/or a
swap execution facility;
(D) An analysis of the liquidity of the respective markets for the
futures, options on futures, and swaps that would be commingled, the
ability of clearing members and the derivatives clearing organization
to offset or mitigate the risk of such futures, options on futures, and
swaps in a timely manner, without compromising the financial integrity
of the account, and, as appropriate, proposed means for addressing
insufficient liquidity;
(E) An analysis of the availability of reliable prices for each of
the eligible products;
(F) A description of the financial, operational, and managerial
standards or requirements for clearing members that would be permitted
to commingle such futures, options on futures, and swaps;
(G) A description of the systems and procedures that would be used
by the derivatives clearing organization to oversee such clearing
members’ risk management of any such commingled positions;
(H) A description of the financial resources of the derivatives
clearing organization, including the composition and availability of a
guaranty fund with respect to the futures, options on futures, and
swaps that would be commingled;
(I) A description and analysis of the margin methodology that would
be applied to the commingled futures, options on futures, and swaps,
including any margin reduction applied to correlated positions, and any
applicable margin rules with respect to both clearing members and
customers;
(J) An analysis of the ability of the derivatives clearing
organization to manage a potential default with respect to any of the
futures, options on futures, or swaps that would be commingled;
(K) A discussion of the procedures that the derivatives clearing
organization would follow if a clearing member defaulted, and the
procedures that a clearing member would follow if a customer defaulted,
with respect to any of the commingled futures, options on futures, or
swaps in the account; and
(L) A description of the arrangements for obtaining daily position
data from each beneficial owner of futures, options on futures, and
swaps in the account.
(ii) Futures account. In order for a derivatives clearing
organization and its clearing members to commingle customer positions
in futures, options on futures, and swaps, and any money, securities,
or property received to margin, guarantee or secure such positions, in
an account subject to the requirements of section 4d(a) of the Act, the
derivatives clearing organization shall file with the Commission a
petition for an order pursuant to section 4d(a) of the Act. Such
petition shall include, at a minimum, the information required under
paragraph (b)(2)(i) of this section.
(iii) Commission action. (A) The Commission may request additional
information in support of a rule submission filed under paragraph
(b)(i) of this section, and may grant approval of such rules in
accordance with Sec. 40.5 of this chapter.
(B) The Commission may request additional information in support of
a petition filed under paragraph (b)(ii) of this section, and may issue
an order under section 4d of the Act in its discretion.
(c) Holding of funds and assets. A derivatives clearing
organization shall hold funds and assets belonging to clearing members
and their customers in a manner which minimizes the risk
[[Page 3724]]
of loss or of delay in the access by the derivatives clearing
organization to such funds and assets.
(1) Types of assets. A derivatives clearing organization shall
limit the assets it accepts as initial margin to those that are have
minimal credit, market, and liquidity risks. A derivatives clearing
organization may not accept letters of credit as initial margin.
(2) Valuation. A derivatives clearing organization shall use
prudent valuation practices to value assets posted as initial margin on
a daily basis.
(3) Haircuts. A derivatives clearing organization shall apply
appropriate reductions in value to reflect market and credit risk
(haircuts), including in stressed market conditions, to the assets that
it accepts in satisfaction of initial margin obligations, and shall
evaluate the appropriateness of such haircuts on at least a quarterly
basis.
(4) Concentration limits. A derivatives clearing organization shall
apply appropriate limitations on the concentration of assets posted as
initial margin, as necessary, in order to ensure its ability to
liquidate such assets quickly, with minimal adverse price effects, and
shall evaluate the appropriateness of any such concentration limits, on
at least a monthly basis.
(5) Pledged assets. If a derivatives clearing organization permits
its clearing members to pledge assets for initial margin while
retaining such assets in accounts in the names of such clearing
members, the derivatives clearing organization shall ensure that such
assets are unencumbered and that such a pledge has been validly created
and validly perfected in the relevant jurisdiction.
(d) Permitted investments. Funds and assets belonging to clearing
members and their customers that are invested by a derivatives clearing
organization shall be held in instruments with minimal credit, market,
and liquidity risks. Any investment of customer funds or assets by a
derivatives clearing organization shall comply with Sec. 1.25 of this
part, as if all such funds and assets comprise customer funds subject
to segregation pursuant to section 4d(a) of the Act and Commission
regulations thereunder.
Sec. 39.16 Default rules and procedures.
(a) In general. A derivatives clearing organization shall adopt
rules and procedures designed to allow for the efficient, fair, and
safe management of events during which clearing members become
insolvent or default on the obligations of such clearing members to the
derivatives clearing organization.
(b) Default management plan. A derivatives clearing organization
shall maintain a current written default management plan that
delineates the roles and responsibilities of its Board of Directors,
its Risk Management Committee, any other committee that has
responsibilities for default management, and the derivatives clearing
organization’s management, in addressing a default, including any
necessary coordination with, or notification of, other entities and
regulators. Such plan shall address any differences in procedures with
respect to highly liquid contracts (such as certain futures) and less
liquid contracts (such as certain swaps). A derivatives clearing
organization shall conduct and document a test of its default
management plan on at least an annual basis.
(c) Default procedures. (1) A derivatives clearing organization
shall adopt procedures that would permit the derivatives clearing
organization to take timely action to contain losses and liquidity
pressures and to continue meeting its obligations in the event of a
default on the obligations of a clearing member to the derivatives
clearing organization.
(2) A derivatives clearing organization shall adopt rules that set
forth its default procedures, including:
(i) The derivatives clearing organization’s definition of a
default;
(ii) The actions that the derivatives clearing organization may
take upon a default, which shall include the prompt transfer,
liquidation, or hedging of the customer or proprietary positions of the
defaulting clearing member, as applicable, and which may include, in
the discretion of the derivatives clearing organization, the auctioning
or allocation of such positions to other clearing members;
(iii) Any obligations that the derivatives clearing organization
imposes on its clearing members to participate in auctions, or to
accept allocations, of a defaulting clearing member’s positions,
provided that any allocation shall be proportional to the size of the
participating or accepting clearing member’s positions at the
derivatives clearing organization;
(iv) The sequence in which the funds and assets of the defaulting
clearing member and the financial resources maintained by the
derivatives clearing organization would be applied in the event of a
default;
(v) A provision that customer margin posted by a defaulting
clearing member shall not be applied in the event of a proprietary
default;
(vi) A provision that proprietary margins posted by a defaulting
clearing member shall be applied in the event of a customer default, if
the relevant customer margin is insufficient to cover the shortfall;
and
(3) A derivatives clearing organization shall make its default
rules publicly available as provided in Sec. 39.21 of this part.
(d) Insolvency of a clearing member.
(1) A derivatives clearing organization shall adopt rules that
require a clearing member to provide prompt notice to the derivatives
clearing organization if it becomes the subject of a bankruptcy
petition, receivership proceeding, or the equivalent;
(2) Upon receipt of such notice, a derivatives clearing
organization shall review the continuing eligibility of the clearing
member for clearing membership; and
(3) Upon receipt of such notice, a derivatives clearing
organization shall take any appropriate action, in its discretion, with
respect to such clearing member or its positions, including but not
limited to liquidation or transfer of positions, and suspension or
revocation of clearing membership.
Sec. 39.17 [Reserved]
Sec. 39.18 System safeguards.
(a) Definitions. For purposes of this section and of Sec. 39.30 of
this part:
Relevant area means the metropolitan or other geographic area
within which a derivatives clearing organization has physical
infrastructure or personnel necessary for it to conduct activities
necessary to the clearance and settlement of existing and new
contracts. The term “relevant area” also includes communities
economically integrated with, adjacent to, or within normal commuting
distance of that metropolitan or other geographic area.
Recovery time objective means the time period within which an
entity should be able to achieve recovery and resumption of clearing
and settlement of existing and new contracts, after those capabilities
become temporarily inoperable for any reason up to or including a wide-
scale disruption.
Wide-scale disruption means an event that causes a severe
disruption or destruction of transportation, telecommunications, power,
water, or other critical infrastructure components in a relevant area,
or an event that results in an evacuation or unavailability of the
population in a relevant area.
(b) In general–(1) Program of risk analysis. Each derivatives
clearing organization shall establish and
[[Page 3725]]
maintain a program of risk analysis and oversight with respect to its
operations and automated systems to identify and minimize sources of
operational risk through:
(i) The development of appropriate controls and procedures; and
(ii) The development of automated systems that are reliable,
secure, and have adequate scalable capacity.
(2) Resources. Each derivatives clearing organization shall
establish and maintain resources that allow for the fulfillment of each
obligation and responsibility of the derivatives clearing organization
in light of the risks identified pursuant to paragraph (b)(1) of this
section.
(3) Verification of adequacy. Each derivatives clearing
organization shall periodically verify that resources described in
paragraph (b)(2) are adequate to ensure daily processing, clearing, and
settlement.
(c) Elements of program. A derivatives clearing organization’s
program of risk analysis and oversight with respect to its operations
and automated systems, as described in paragraph (b) of this section,
shall address each of the following categories of risk analysis and
oversight:
(1) Information security;
(2) Business continuity and disaster recovery planning and
resources;
(3) Capacity and performance planning;
(4) Systems operations;
(5) Systems development and quality assurance; and
(6) Physical security and environmental controls.
(d) Standards for program. In addressing the categories of risk
analysis and oversight required under paragraph (c) of this section, a
derivatives clearing organization shall follow generally accepted
standards and industry best practices with respect to the development,
operation, reliability, security, and capacity of automated systems.
(e) Business continuity and disaster recovery–(1) Plan and
resources. A derivatives clearing organization shall maintain a
business continuity and disaster recovery plan, emergency procedures,
and physical, technological, and personnel resources sufficient to
enable the timely recovery and resumption of operations and the
fulfillment of each obligation and responsibility of the derivatives
clearing organization following any disruption of its operations.
(2) Responsibilities and obligations. The responsibilities and
obligations described in paragraph (e)(1) shall include, without
limitation, daily processing, clearing, and settlement of transactions
cleared.
(3) Recovery time objective. The derivatives clearing
organization’s business continuity and disaster recovery plan described
in paragraph (e)(1) of this section shall have the objective of, and
the physical, technological, and personnel resources described therein
shall be sufficient to, enable the derivatives clearing organization to
resume daily processing, clearing, and settlement no later than the
next business day following the disruption.
(f) Location of resources; outsourcing. A derivatives clearing
organization may maintain the resources required under paragraph (e)(1)
of this section either:
(1) Using its own employees as personnel, and property that it
owns, licenses, or leases (own resources); or
(2) Through written contractual arrangements with another
derivatives clearing organization or other service provider
(outsourcing).
(i) Retention of responsibility. A derivatives clearing
organization that enters into such a contractual arrangement shall
retain complete liability for any failure to meet the responsibilities
specified in paragraph (e) of this section, although it is free to seek
indemnification from the service provider. The outsourcing derivatives
clearing organization must employ personnel with the expertise
necessary to enable it to supervise the service provider’s delivery of
the services.
(ii) Testing. The testing referred to in paragraph (j) of this
Sec. 39.18 and Sec. 39.30(c) of this part shall include all own and
outsourced resources, and shall verify that all such resources will
work effectively together.
(g) Notice of exceptional events. A derivatives clearing
organization shall notify staff of the Division of Clearing and
Intermediary Oversight promptly of:
(1) Any hardware or software malfunction, cyber security incident,
or targeted threat that materially impairs, or creates a significant
likelihood of material impairment, of automated system operation,
reliability, security, or capacity; or
(2) Any activation of the derivatives clearing organization’s
business continuity and disaster recovery plan.
(h) Notice of planned changes. A derivatives clearing organization
shall give staff of the Division of Clearing and Intermediary Oversight
timely advance notice of all:
(1) Planned changes to automated systems that are likely to have a
significant impact on the reliability, security, or adequate scalable
capacity of such systems; and
(2) Planned changes to the derivatives clearing organization’s
program of risk analysis and oversight.
(i) Recordkeeping. A derivatives clearing organization shall
maintain, and provide to Commission staff promptly upon request,
pursuant to Sec. 1.31 of this chapter, current copies of its business
continuity plan and other emergency procedures, its assessments of its
operational risks, and records of testing protocols and results, and
shall provide any other documents requested by Commission staff for the
purpose of maintaining a current profile of the derivatives clearing
organization’s automated systems.
(j) Testing–(1) Purpose of testing. A derivatives clearing
organization shall conduct regular, periodic, and objective testing and
review of:
(i) Its automated systems to ensure that they are reliable, secure,
and have adequate scalable capacity; and
(ii) Its business continuity and disaster recovery capabilities,
using testing protocols adequate to ensure that the derivatives
clearing organization’s backup resources are sufficient to meet the
requirements of paragraph (e) of this section.
(2) Conduct of testing. Testing shall be conducted by qualified,
independent professionals. Such qualified independent professionals may
be independent contractors or employees of the derivatives clearing
organization, but shall not be persons responsible for development or
operation of the systems or capabilities being tested.
(3) Reporting and review. Reports setting forth the protocols for,
and results of, such tests shall be communicated to, and reviewed by,
senior management of the derivatives clearing organization. Protocols
of tests which result in few or no exceptions shall be subject to more
searching review.
(k) Coordination of business continuity and disaster recovery
plans. A derivatives clearing organization shall, to the extent
practicable:
(1) Coordinate its business continuity and disaster recovery plan
with those of its clearing members, in a manner adequate to enable
effective resumption of daily processing, clearing, and settlement
following a disruption;
(2) Initiate and coordinate periodic, synchronized testing of its
business continuity and disaster recovery plan and the plans of its
clearing members; and
(3) Ensure that its business continuity and disaster recovery plan
takes into account the plans of its providers of essential services,
including telecommunications, power, and water.
[[Page 3726]]
Sec. 39.19 Reporting.
(a) [Reserved]
(b) [Reserved]
(c) (1) [Reserved]
(i) [Reserved]
(ii) [Reserved]
(iii) [Reserved]
(iv) End-of-day positions for each clearing member, by customer
origin and house origin.
(2) [Reserved]
(3)(i) [Reserved]
(ii) [Reserved]
(iii) The annual verification required by Sec. 39.24(b)(4) of this
part.
(iv) Time of report. The reports required by this paragraph (c)(3)
shall be submitted concurrently to the Commission not more than 90 days
after the end of the derivatives clearing organization’s fiscal year;
provided that, a derivatives clearing organization may request from the
Commission an extension of time to submit either report, provided the
derivatives clearing organization’s failure to submit the report in a
timely manner could not be avoided without unreasonable effort or
expense. Extensions of the deadline will be granted at the discretion
of the Commission.
(4) (i)-(xv) [Reserved]
(xvi) Action of Board of Directors or Risk Management Committee. A
report when (A) the Board of Directors of a derivatives clearing
organization rejects a recommendation or supersedes an action of the
Risk Management Committee; or
(B) The Risk Management Committee rejects a recommendation or
supersedes an action of its subcommittee, as required by Sec. 39.25(b)
of this part.
(xvii) Election of Board of Directors. A report after each election
of its Board of Directors in accordance with Sec. 40.9(b)(1)(iii) of
this chapter.
(xviii) System safeguards. A report of (A) exceptional events as
required by Sec. 39.18(g) of this part; or
(B) Planned changes as required by Sec. 39.18(h) of this part.
Sec. 39.20 [Reserved]
Sec. 39.21 Public information.
(a) [Reserved]
(b) [Reserved]
(c)(1)-(5) [Reserved]
(6) The derivatives clearing organization’s rules and procedures
for defaults in accordance with Sec. 39.16 of this part;
(7) Governance and conflicts of interest in accordance with Sec.
39.24(a)(2) of this part and Sec. 40.9(d) of this chapter; and
(8) Any other matter that is relevant to participation in the
clearing and settlement activities of the derivatives clearing
organization.
Sec. 39.22 [Reserved]
Sec. 39.23 [Reserved]
Sec. 39.24 Governance fitness standards.
(a) [Reserved]
(b)(1)-(3) [Reserved]
(4) Verification. Each derivatives clearing organization must
collect and verify information that supports compliance with the
standards in paragraphs (b)(2) and (3) of this section, and provide
that information to the Commission on an annual basis in accordance
with the requirements of Sec. 39.19(c)(3)(iv) of this part. Such
information may take the form of a certification based on verifiable
information, an affidavit from the general counsel of the derivatives
clearing organization, registration information, or other
substantiating information.
Sec. 39.25 Conflicts of interest.
(a) [Reserved]
(b) Reporting to the Commission. In the event that:
(1) The Board of Directors of a derivatives clearing organization
rejects a recommendation or supersedes an action of the Risk Management
Committee, or
(2) The Risk Management Committee rejects a recommendation or
supersedes an action of its subcommittee (as described in Sec.
39.13(d)(5) of this part), the derivatives clearing organization shall
submit a written report to the Commission within 30 days of such a
rejection or supersession detailing:
(i) The recommendation or action of the Risk Management Committee
(or subcommittee thereof);
(ii) The rationale for such recommendation or action;
(iii) The rationale of the Board of Directors (or the Risk
Management Committee, if applicable) for rejecting such recommendation
or superseding such action; and
(iv) The course of action that the Board of Directors (or the Risk
Management Committee, if applicable) decided to take contrary to such
recommendation or action.
9. Add subpart C to read as follows:
Subpart C–Provisions applicable to systemically important derivatives
clearing organizations.
Sec.
39.28 Scope.
39.29 [Reserved]
39.30 System safeguards.
30.31 Special enforcement authority.
Subpart C–Provisions applicable to systemically important
derivatives clearing organizations.
Sec. 39.28 Scope.
(a) The provisions of this subpart C apply to any derivatives
clearing organization, as defined in section 1a(15) of the Act and
Sec. 1.3(d) of this chapter,
(1) Which is registered or deemed to be registered with the
Commission as a derivatives clearing organization, is required to
register as such with the Commission pursuant to section 5b(a) of the
Act, or which voluntarily registers as such with the Commission
pursuant to section 5b(b) or otherwise; and
(2) Which is a systemically important derivatives clearing
organization as defined in Sec. 39.2 of this part.
(b) A systemically important derivatives clearing organization is
subject to the provisions of subparts A and B of this part 39 except to
the extent different requirements are imposed by provisions of this
subpart C.
(c) A systemically important derivatives clearing organization
shall provide notice to the Commission in advance of any proposed
change to its rules, procedures, or operations that could materially
affect the nature or level of risks presented by the systemically
important derivatives clearing organization, in accordance with the
requirements of Sec. 40.10 of this chapter.
Sec. 39.29 [Reserved]
Sec. 39.30 System safeguards.
(a) Notwithstanding Sec. 39.18(e)(3) of this part, the business
continuity and disaster recovery plan described in Sec. 39.18(e)(1)
for each systemically important derivatives clearing organization shall
have the objective of enabling, and the physical, technological, and
personnel resources described in Sec. 39.18(e)(1) shall be sufficient
to enable, the derivatives clearing organization to recover its
operations and resume daily processing, clearing, and settlement no
later than two hours following the disruption, for any disruption
including a wide-scale disruption.
(b) To ensure its ability to achieve the recovery time objective
specified in paragraph (a) of this section in the event of a wide-scale
disruption, each systemically important derivatives clearing
organization must maintain a degree of geographic dispersal of
physical, technological and personnel resources consistent with the
following:
(1) Physical and technological resources, sufficient to enable the
entity
[[Page 3727]]
to meet the recovery time objective after interruption of normal
clearing by a wide-scale disruption, must be located outside the
relevant area of the infrastructure the entity normally relies upon to
conduct activities necessary to the clearance and settlement of
existing and new contracts, and must not rely on the same critical
transportation, telecommunications, power, water, or other critical
infrastructure components the entity normally relies upon for such
activities;
(2) Personnel, sufficient to enable the entity to meet the recovery
time objective after interruption of normal clearing by a wide-scale
disruption affecting the relevant area in which the personnel the
entity normally relies upon to engage in such activities are located,
must live and work outside that relevant area;
(3) The provisions of Sec. 39.18(f) of this part shall apply to
these resource requirements.
(c) Each systemically important derivatives clearing organization
must conduct regular, periodic tests of its business continuity and
disaster recovery plans and resources and its capacity to achieve the
required recovery time objective in the event of a wide-scale
disruption. The provisions of Sec. 39.18(j) of this part apply to such
testing.
(d) The requirements of this section shall apply to a derivatives
clearing organization not earlier than one year after such derivatives
clearing organization is designated as systemically important.
Sec. 39.31 Special enforcement authority.
For purposes of enforcing the provisions of Title VIII of the Dodd-
Frank Act, a systemically important derivatives clearing organization
shall be subject to, and the Commission has authority under the
provisions of subsections (b) through (n) of section 8 of, the Federal
Deposit Insurance Act (12 U.S.C. 1818) in the same manner and to the
same extent as if the systemically important derivatives clearing
organization were an insured depository institution and the Commission
were the appropriate Federal banking agency for such insured depository
institution.
10. Revise appendix A to read as follows:
Appendix A to Part 39–Form DCO Derivatives Clearing Organization
Application for Registration
BILLING CODE 6351-01-P
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BILLING CODE 6351-01-C
Description of Exhibits
Exhibit A–General Information/Compliance
Attach as Exhibit A-1, a regulatory compliance chart
setting forth each Core Principle and providing citations to the
Applicant’s relevant rules, policies, and procedures that address
each Core Principle, and a brief summary of the manner in which
Applicant will comply with each Core Principle.
Attach as Exhibit A-2, a current copy of Applicant’s
rulebook. The rulebook must consist of all the rules necessary to
carry out Applicant’s role as a derivatives clearing organization.
Applicant must certify that its rules constitute a binding agreement
between Applicant and its clearing members and, in addition to the
separate clearing member agreements, establish rights and
obligations between Applicant and its clearing members.
Attach as Exhibit A-3, a narrative summary of
Applicant’s proposed clearing activities including (i) the
anticipated start date of clearing products (or, if Applicant is
already clearing products, the anticipated start date of activities
for which Applicant is seeking an amendment to its registration) and
(ii) a description of the scope of Applicant’s proposed clearing
activities (e.g., clearing for a designated contract market;
clearing for a swap execution facility; clearing over-the-counter
(“OTC”) products).
Attach as Exhibit A-4, a detailed business plan setting
forth, at a minimum, the nature of and rationale for Applicant’s
activities as a derivatives clearing organization, the context in
which it is beginning or expanding its activities, and the nature,
terms, and conditions of the products it will clear.
Attach as Exhibit A-5, a list of the names of any
person (i) who owns 5% or more of Applicant’s stock or other
ownership or equity interests; or (ii) who, either directly or
indirectly, through agreement or otherwise, may control or direct
the management or policies of Applicant. Provide as part of Exhibit
A-5 the full name and address of each such person, indicate the
person’s ownership percentage, and attach a copy of the agreement
or, if there is no agreement, an explanation of the basis upon which
such person exercises or may exercise such control or direction.
Attach as Exhibit A-6, a list of Applicant’s current
officers, directors, governors, general partners, LLC managers, and
members of all standing committees (including any committee
referenced in Section (a)(2) of Exhibit P herein), as applicable, or
persons performing functions similar to any of the foregoing,
indicating for each:
a. Name and Title (with respect to a director, such title must
include participation on any committee of Applicant);
b. Phone number (both work and mobile) and e-mail contact
information;
c. Dates of commencement and, if appropriate, termination of
present term of office or position;
d. Length of time each such person has held the same office or
position;
e. Brief description of the business experience of each person
over the last ten years;
f. Any other current business affiliations in the financial
services industry;
g. If such person is not an employee of Applicant, list any
compensation paid to the person as a result of his or her position
at Applicant. For a director, describe any performance-based
compensation;
h. A certification for each such person that the individual
would not be disqualified under Section 8a(2) of the Act or Sec.
1.63; and
i. With respect to a director, whether such director is a public
director or a clearing member customer, and the basis for such a
determination as to the director’s status.
If another entity “operates” Applicant, attach for such entity
all of the items indicated in Exhibit A-6. For this purpose, the
term “operate” shall be as defined in Sec. 40.9(b)(2)
Attach as Exhibit A-7, a diagram of the entire
corporate organizational structure of Applicant including the legal
name of all entities within the organizational structure and the
applicable percentage ownership among affiliated entities.
Additionally, provide (i) a list of all jurisdictions in which
Applicant or its affiliated entities are doing business; (iii) the
registration status of Applicant and its affiliated entities,
including pending applications or exemption requests and whether any
applications or exemptions have been denied (e.g., country,
regulator, registration category, date of registration or request
for exemption, date of denial, if applicable); and (ii) the address
for
[[Page 3736]]
legal service of process for Applicant (which cannot be a post
office box) for each applicable jurisdiction.
Attach as Exhibit A-8, a copy of the constituent
documents, articles of incorporation or association with all
amendments thereto, partnership or limited liability agreements, and
existing bylaws, operating agreement, and rules or instruments
corresponding thereto, of Applicant. Provide a certificate of good
standing or its equivalent for Applicant for each jurisdiction in
which Applicant is doing business, including any foreign
jurisdiction, dated within one month of the date of the Form DCO.
Attach as Exhibit A-9, a brief description of any
material pending legal proceeding(s) or governmental
investigation(s) to which Applicant or any of its affiliates is a
party or is subject, or to which any of its or their property is at
issue. Include the name of the court or agency where the
proceeding(s) is pending, the date(s) instituted, the principal
parties involved, a description of the factual allegations in the
complaint(s), the laws that were allegedly violated, and the relief
sought. Include similar information as to any such proceeding(s) or
any investigation known to be contemplated by any governmental
agency.
If Applicant intends to use the services of an outside
service provider (including services of its clearing members or
market participants), to enable Applicant to comply with any of the
Core Principles, Applicant must submit as Exhibit A-10 all
agreements entered into or to be entered into between Applicant and
the outside service provider, and identify (1) the services that
will be provided; (2) the staff who will provide the services; and
(3) the Core Principles addressed by such arrangement. If a
submitted agreement is not final and executed, the Applicant must
submit evidence that constitutes reasonable assurance that such
services will be provided as soon as operations require.
Attach as Exhibit A-11, documentation that demonstrates
compliance with the Chief Compliance Officer (“CCO”) requirements
set forth in Sec. 39.10(c), including but not limited to:
a. Evidence of the designation of an individual to serve as
Applicant’s CCO with full responsibility and authority to develop
and enforce appropriate compliance policies and procedures;
b. A description of the background and skills of the person
designated as the CCO and a certification that the individual would
not be disqualified under Section 8a(2) of the Act or Sec. 1.63;
c. To whom the CCO reports (i.e., the senior officer or the
Board of Directors);
d. Any plan of communication or regular or special meetings
between the CCO and the Board of Directors or senior officer as
appropriate;
e. A job description setting forth the CCO’s duties;
f. Procedures for the remediation of noncompliance issues; and
g. A copy of Applicant’s Compliance Manual (including a code of
ethics and conflict of interest policy).
Exhibit B–Financial Resources
Attach as Exhibit B, documents that demonstrate
compliance with the financial resources requirements set forth in
Sec. 39.11, including but not limited to:
a. General–Provide as Exhibit B-1:
(1) The most recent set of audited financial statements of
Applicant or of its parent company, including the balance sheet,
income statement, statement of cash flows, notes to the financial
statements, and accountant’s opinion;
(2) If the audited financial statements are not dated within 1
month of the date of filing of the Form DCO, Applicant must provide
a set of unaudited financial statements current within 1 month of
the date of filing of the Form DCO;
(3) If Applicant does not have audited financial statements,
Applicant must provide a balance sheet as of a date within 1 month
of the date of filing of the Form DCO and an income statement and
statement of cash flows reflecting the period since Applicant’s
formation and a date that is within 1 month of the date of filing of
the Form DCO. These statements must be accompanied by an independent
certified public accountant’s review report; and
(4) Evidence of ability to satisfy the requirements of Exhibits
B-2 and B-3 below which may include (i) pro forma financial
statements setting forth all projections and assumptions used
therein, and (ii) a narrative description of how Applicant will fund
its financial resources obligations on the first day of its
operation as a derivatives clearing organization.
b. Default Resources–Provide as Exhibit B-2:
(1) A calculation of the financial resources needed to enable
Applicant to meet its requirements under Sec. 39.11(a)(1).
Applicant must provide hypothetical default scenarios designed to
reflect a variety of market conditions, and the assumptions and
variables underlying the scenarios must be explained. All results of
the analysis must be included. This calculation requires a start-up
enterprise to estimate its largest anticipated financial exposure. A
start-up must be able to explain the basis for its estimate;
(2) Proof of unencumbered assets sufficient to satisfy Sec.
39.11(a)(1). This may be demonstrated by a copy of a bank balance
statement(s) in the name of Applicant and may be combined with the
types of financial resources set forth in Sec. 39.11(b)(1). If
relying on Sec. 39.11(b)(1)(vi), such other resources must be
thoroughly explained. If relying on Sec. 39.11(b)(1)(ii) and/or
(vi), Applicant cannot also count these assets when demonstrating
its compliance with its operating resources requirement under Sec.
39.11(a)(2) and Applicant must detail the amounts or percentages of
such assets that apply to each financial resource requirement;
(3) A demonstration that Applicant can perform the monthly
calculations required by Sec. 39.11(c)(1);
(4) A demonstration that Applicant’s financial resources are
sufficiently liquid as required by Sec. 39.11(e)(1);
(5) A demonstration of how Applicant will be able to maintain,
at all times, the level of resources required by Sec. 39.11(a)(1);
and
(6) A demonstration of how default resources financial
information will be updated and reported to clearing members and the
public under Sec. 39.21, and to the Commission as required by Sec.
39.11(f)(1) and Sec. 39.19.
c. Operating Resources–Provide as Exhibit B-3:
(1) A calculation of the financial resources needed to enable
Applicant to meet its requirements under Sec. 39.11(a)(2);
(2) Proof of assets sufficient to satisfy the amount required
under Sec. 39.11(a)(2). This may be demonstrated by a copy of a
bank balance statement(s) in the name of Applicant and may be
combined with the types of financial resources set forth in Sec.
39.11(b)(2). If relying on Sec. 39.11(b)(2)(ii), such other
resources must be thoroughly explained. If relying on Sec.
39.11(b)(2)(i) or (ii), Applicant cannot also count these assets
when demonstrating its compliance with meeting its default resources
requirement under Sec. 39.11(a)(1) and Applicant must detail the
amounts or percentages of such assets that apply to each financial
resource requirement;
(3) Proof of adequate physical infrastructure to carry out
business operations, which includes an office(s) (separate from any
personal dwelling) with a U.S. street address (not merely a post
office box number) that has electricity, HVAC, and running water and
meets all local building and fire codes. This location must be the
same as the principal executive offices address identified on the
cover sheet of the Form DCO;
(4) Proof of adequate technological systems necessary to carry
out operations including properly working computers, networks,
appropriate software, telephones, fax machines, Internet access, and
photocopiers;
(5) A calculation pursuant to Sec. 39.11(c)(2), including the
total projected operating costs for Applicant’s first year of
operation, calculated on a monthly basis with an explanation of the
basis for calculating each cost and a discussion of the type,
nature, and number of the various costs included;
(6) A demonstration that Applicant’s financial resources are
sufficiently liquid and unencumbered, as required by Sec.
39.11(e)(2);
(7) A demonstration of how Applicant will maintain, at all
times, the level of resources required by Sec. 39.11(a)(2) with an
explanation of asset valuation methodology and calculation of
projected revenue, if applicable; and
(8) A demonstration of how operating resources financial
information will be updated and reported to clearing members and the
public under Sec. 39.21, and to the Commission as required by Sec.
39.11(f)(1) and Sec. 39.19.
d. Human Resources–Provide as Exhibit B-4:
(1) An organizational chart showing Applicant’s current and
planned staff by position and title, including key personnel (as
such term is defined in Sec. 39.2) and, if applicable, managerial
staff reporting to key personnel.
(2) A discussion and description of the staffing requirements
needed to fulfill all operations and associated functions, tasks,
[[Page 3737]]
services, and areas of supervision necessary to operate Applicant on
a day-to-day basis; and
(3) The names and qualifications of individuals who are key
personnel or other managerial staff who will carry out the
operations and associated functions, tasks, services, and
supervision needed to run the Applicant on day-to-day basis. In
particular, Applicant must identify such individuals who are
responsible for risk management, treasury, clearing operations and
compliance (and specify whether each such person is an employee or
consultant/agent).
Exhibit C–Participant and Product Eligibility
Attach as Exhibit C, documents that demonstrate
compliance with the participant and product eligibility requirements
set forth in Sec. 39.12 of the Commission’s regulations, including
but not limited to:
a. Participant Eligibility–Provide as Exhibit C-1, an
explanation of the requirements for becoming a clearing member and
how those requirements satisfy Sec. 39.12 and, where applicable,
support Applicant’s compliance with other Core Principles. Applicant
must address how its participant eligibility requirements comply
with the core principles and regulations thereunder for financial
resources, risk management and operational capacity. The explanation
also must include:
(1) A final version of the membership agreement between
Applicant and its clearing members that sets forth the full scope of
respective rights and obligations;
(2) A discussion of how Applicant will monitor for and enforce
compliance with its eligibility criteria, especially minimum
financial requirements;
(3) An explanation of how the eligibility criteria are objective
and allow for fair and open access to Applicant. Applicant must
include an explanation of the differences between various classes of
membership or participation that might be based on different levels
of capital and/or creditworthiness. Applicant must also include
information about whether any differences exist in how Applicant
will monitor and enforce the obligations of its various clearing
members including any differences in access, privilege, margin
levels, position limits, or other controls;
(4) If Applicant allows intermediation, Applicant must describe
the requirements applicable to those who may act as intermediaries
on behalf of customers or other market participants;
(5) A description of the program for monitoring the financial
status of the clearing members on an ongoing basis;
(6) The procedures that Applicant will follow in the event of
the bankruptcy or insolvency of a clearing member, which did not
result in a default to Applicant;
(7) A description of whether and how Applicant would adjust
clearing member participation under continuing eligibility criteria
based on the financial, risk, or operational status of a clearing
member;
(8) A discussion of whether Applicant’s clearing members will be
required to be registered with the Commission; and
(9) A list of current or prospective clearing members. If a
current or prospective clearing member is a Commission registrant,
Applicant must identify the member’s designated self-regulatory
organization.
b. Product Eligibility–Provide as Exhibit C-2, an explanation
of the criteria for instruments acceptable for clearing including:
(1) The regulatory status of each market on which a contract to
be cleared by Applicant is traded (e.g., DCM, SEF, not a registered
market), and whether the market for which Applicant clears intends
to join the Joint Audit Committee. For OTC agreements, contracts, or
transactions not traded on a registered market, Applicant must
describe the nature of the OTC market and its interest in having the
particular OTC agreement, contract, or transaction cleared;
(2) The criteria, and the factors considered in establishing the
criteria, for determining the types of products that will be
cleared;
(3) An explanation of how the criteria for deciding what
products to clear take into account the different risks inherent in
clearing different agreements, contracts, or transactions and how
those criteria affect maintenance of assets to support the guarantee
function in varying risk environments;
(4) A precise list of all the agreements, contracts, or
transactions to be covered by Applicant’s registration order,
including the terms and conditions of all agreements, contracts, or
transactions;
(5) A forecast of expected volume and open interest at the
outset of clearing operations, after six months, and after one year
of operation; and
(6) The mechanics of clearing the contract, such as reliance on
exchange for physical, exchange for swap, or other substitution
activity; whether the contracts are matched prior to submission for
clearing or after submission; and other aspects of clearing
mechanics that are relevant to understanding the products that would
be eligible for clearing.
Exhibit D–Risk Management
Attach as Exhibit D, documents that demonstrate
compliance with the risk management requirements set forth in Sec.
39.13 of the Commission’s regulations, including but not limited to:
a. Risk Management Framework–Provide as Exhibit D-1, a copy of
Applicant’s written policies, procedures, and controls, as approved
by Applicant’s Board of Directors, that establish Applicant’s risk
management framework as required by Sec. 39.13(b). Applicant must
also provide a description of the composition and responsibilities
of Applicant’s Risk Management Committee.
b. Measuring Risk–Provide as Exhibit D-2, a narrative
explanation of how Applicant has projected and will continue to
measure its counterparty risk exposure, including:
(1) A description of the risk-based margin calculation
methodology;
(2) The assumptions upon which the methodology was designed,
including the risk analysis tools and procedures employed in the
design process;
(3) An explanation as to why a particular methodology was chosen
over other methodologies that might have been suitable, including a
comparison of margin levels calculated using other margin
methodologies;
(4) A demonstration of the margin methodology as applied to real
or hypothetical clearing scenarios;
(5) A description of the data sources for inputs used in the
methodology, e.g. historical price data reflecting market volatility
over various periods of time;
(6) A description of the sources of price data for the
measurement of current exposures and the valuation models for
addressing circumstances where pricing data is not readily available
or reliable;
(7) The frequency and circumstances under which the margin
methodology will be reviewed and the criteria for deciding how often
to review and whether to modify a margin methodology;
(8) An independent validation of Applicant’s systems for
generating initial margin requirements, including its theoretical
models;
(9) The frequency of measuring counterparty risk exposures (mark
to market), whether counterparty risk exposures are routinely
measured on an intraday basis, whether Applicant has the operational
capacity to measure counterparty risk exposures on an intraday
basis, and the circumstances under which Applicant would conduct a
non-routine intraday measurement of counterparty risk exposures;
(10) Preliminary forecasts regarding future counterparty risk
exposure and assumptions upon which such forecasts of exposure are
based;
(11) A description of any systems or software that Applicant
will require clearing members to use in order to margin their
positions in their internal bookkeeping systems, and whether and
under what terms and conditions Applicant will provide such systems
or software to clearing members; and
(12) A description of the extent to which counterparty risk can
be offset through the clearing process (i.e., the limitations, if
any, on Applicant’s duty to fulfill its obligations as the buyer to
every seller and the seller to every buyer).
c. Limiting Risk–Provide as Exhibit D-3, a narrative discussion
addressing the specifics of Applicant’s clearing activities,
including:
(1) How Applicant will collect financial information about its
clearing members and other traders or market participants, monitor
price movements, and mark to market, on a daily basis, the products
and/or portfolios it clears;
(2) How Applicant will monitor accounts carried by clearing
members, the accumulation of positions by clearing members and other
market participants, and compliance with position limits; and how it
will use large trader information;
(3) How Applicant will determine variation margin levels and
outstanding initial margin due;
(4) How Applicant will identify unusually large pays on a
proactive basis before they occur;
(5) Whether and how Applicant will compare price moves and
position information to historical patterns and to the
[[Page 3738]]
financial information collected from its clearing members; how it
will identify unusually large pays on a daily basis;
(6) How Applicant will use various risk tools and procedures
such as: (i) value-at-risk calculations; (ii) stress testing; (iii)
back testing; and/or (iv) other risk management tools and
procedures;
(7) How Applicant will communicate with clearing members,
settlement banks, other derivatives clearing organizations,
designated contract markets, swap execution facilities, major swap
participants, swap data repositories, and other entities in
emergency situations or circumstance that might require immediate
action by the Applicant;
(8) How Applicant will monitor risk outside business hours;
(9) How Applicant will review its clearing members’ risk
management practices;
(10) Whether Applicant will impose credit limits and/or employ
other risk filters (such as automatic system denial of entry of
trades under certain conditions);
(11) Plans for handling “extreme market volatility” and how
Applicant defines that term;
(12) An explanation of how Applicant will be able to offset
positions in order to manage risk including: (i) ensuring both
Applicant and clearing members have the operational capacity to do
so; and (ii) liquidity of the relevant market, especially with
regard to OTC products and OTC markets;
(13) Plans for managing accounts that are “too big” to
liquidate and for conducting “what if” analyses on these accounts;
(14) If options are involved, how Applicant will manage the
different and more complex risk presented by these products;
(15) If Applicant intends to clear swaps, whether and how often
Applicant will offer multilateral portfolio compression exercises
for its clearing members; and
(16) If Applicant intends to clear credit default swaps, how
Applicant will manage the unique risks associated with clearing
these products, such as jump-to-default risk.
d. Existence of collateral (funds and assets) to apply to losses
resulting from realized risk–Provide as Exhibit D-4:
(1) An explanation of the factors, process, and methodology used
for calculating and setting required collateral levels, the required
inputs, the appropriateness of those inputs, and an illustrative
example;
(2) An analysis supporting the sufficiency of Applicant’s
collateral levels for capturing all or most price moves that may
take place in one settlement cycle;
(3) A description of how Applicant will value open positions and
collateral assets;
(4) A description and explanation of the forms of assets allowed
as collateral, why they are acceptable, and whether there are any
haircuts or concentration limits on certain kinds of assets,
including how often any such haircuts and concentration limits are
reviewed;
(5) An explanation of how and when Applicant will collect
collateral, whether and under what circumstances it will collect
collateral on an intraday basis, and what will happen if collateral
is not received in a timely manner. Include a proposed collateral
collection schedule based on changes in market positions and
collateral values; and
(6) If options are involved, a full explanation of how it will
manage the associated risk through the use of collateral including,
if applicable, a discussion of its option pricing model, how it
establishes its implied volatility scan range, and other matters
related to the complex matter of managing the risk associated with
the clearing of option contracts.
Exhibit E–Settlement Procedures
Attach as Exhibit E, documents that demonstrate
compliance with the settlement procedures requirements set forth in
Sec. 39.14 of the Commission’s regulations, including but not
limited to:
a. Settlement–Provide as Exhibit E-1, a full description of the
daily process of settling financial obligations on all open
positions being cleared. This must include:
(1) Procedures for completing settlements on a timely basis
during normal market conditions (and no less frequently than once
each business day);
(2) Procedures for completing settlements on a timely basis in
varying market circumstances including in the event of a default by
the clearing member creating the largest financial exposure for
Applicant in extreme but plausible market conditions;
(3) A description of how contracts will be marked to market on
at least a daily basis;
(4) Identification of the settlement banks used by Applicant
(including identification of the lead settlement bank, if
applicable) and a copy of Applicant’s settlement bank agreement(s).
Such settlement bank agreements must (i) outline daily cash
settlement procedures, (ii) state clearly when settlement fund
transfers will occur, (iii) provide procedures for settlements on
bank holidays when the markets are open, and (iv) ensure that
settlements are final when effected;
(5) Identification of settlement banks that Applicant will allow
its clearing members to use for margin calls and variation
settlements;
(6) A description of the criteria and review process used by
Applicant when selecting settlement banks; procedures for monitoring
the continued appropriateness of all settlement banks including a
description of how Applicant monitors its concentration risk or
exposure to each settlement bank;
(7) The specific means by which settlement instructions are
communicated from Applicant to the settlement bank(s);
(8) A timetable showing the flow of funds associated with the
settlement of products for a 24-hour period or such other settlement
timeframe specified by a particular product; this may be presented
in the form of a chart, as in the following example:
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[GRAPHIC] [TIFF OMITTED] TP20JA11.026
(9) A description of what happens in the event that there are
insufficient funds in a clearing member’s settlement account;
(10) An explanation of how and when Applicant will collect
variation margin, whether and under what circumstances it will
collect variation margin on an intraday basis, what will happen if
variation margin is not received in a timely manner, and a proposed
variation margin collection schedule based on changes in market
prices;
(11) All the information above, to the extent relevant, for any
products cleared that may be denominated in a foreign currency; and
(12) With respect to physical settlements, identify Applicant’s
rules that clearly state each obligation of Applicant with respect
to physical deliveries, and explain how Applicant intends to
identify and manage risks arising from physical settlement.
b. Recordkeeping–Provide as Exhibit E-2, a full description of
the following:
(1) The nature and quality of the information collected
concerning the flow of funds involved in clearing and settlement;
and
(2) How such information will be recorded, maintained, and
accessed.
c. Interfaces with other clearing organizations–Provide as
Exhibit E-3, a description of Applicant’s relationships with other
derivatives clearing organizations, clearing agencies, financial
market utilities or foreign entities that perform similar functions
including how compliance with the terms and conditions of agreements
or arrangements with such other entities will be satisfied, e.g.,
any netting or offset arrangements, cross-margining, portfolio
margining, linkage, common banking, common clearing programs or
limited guaranty agreements or arrangements.
Exhibit F–Treatment of Funds
Attach as Exhibit F, documents that demonstrate
compliance with the treatment of funds requirements set forth in
Sec. 39.15 of the Commission’s regulations, including but not
limited to:
a. Safe custody–Provide as Exhibit F-1, documents that
demonstrate:
(1) How Applicant will ensure the safekeeping of funds and
collateral in depositories and how Applicant will minimize the risk
of loss or of delay in accessing such funds and collateral;
(2) The depositories that will hold the funds and collateral and
any written agreements between or among such depositories, Applicant
or its clearing members regarding the legal status of the funds and
collateral and the specific conditions or prerequisites for movement
of the funds and collateral; and
(3) How Applicant will limit the concentration of risk in
depositories where funds and collateral are deposited.
b. Segregation of customer and proprietary funds–Provide as
Exhibit F-2, documents that demonstrate:
(1) The appropriate segregation of customer funds and associated
acknowledgement documentation; and
(2) Requirements or restrictions regarding commingling customer
funds with proprietary funds, obligating customer funds for any
purpose other than to purchase, clear, and settle the products
Applicant is clearing, procedures regarding customer funds which are
subject to cross-margin or similar agreements, and any other aspects
of customer fund segregation.
c. Investment standards–Provide as Exhibit F-3, documents that
demonstrate:
(1) How customer funds would be invested in instruments with
minimal credit, market, and liquidity risks, and in compliance with
the requirements of Sec. 1.25; and
(2) How Applicant will obtain and keep associated records and
data regarding the details of such investments.
[[Page 3740]]
Exhibit G–Default Rules and Procedures
Attach as Exhibit G, documents that demonstrate
compliance with the default rules and procedures requirements set
forth in Sec. 39.16 of the Commission’s regulations, including but
not limited to:
a. Default Management Plan–Applicant must provide a copy of its
written default management plan which must contain all of the
information required by Sec. 39.16(b), along with Applicant’s most
recently documented results of a test of its default management
plan.
b. Definition of default–Applicant must describe or otherwise
document:
(1) The events (activities, lapses, or situations) that will
constitute a clearing member default;
(2) What action Applicant can take upon a default and how
Applicant will otherwise enforce the rules applicable in the event
of default, including the steps and the sequence of the steps that
will be followed. Identify whether a Default Management Committee
exists and, if so, its role in the default process; and
(3) An example of a hypothetical default scenario and the
results of the default management process used in the scenario.
c. Remedial action–Applicant must describe or otherwise
document:
(1) The authority and methods by which Applicant may take
appropriate action in the event of the default of a clearing member
which may include, among other things, liquidating positions,
hedging, auctioning, allocating (including any obligations of
clearing members to participate in auctions or to accept
allocations), and transferring of customer accounts to another
clearing member (including an explanation of the movement of
positions and collateral on deposit); and
(2) Actions taken by a clearing member or other events that
would put a clearing member on Applicant’s “watch list” or similar
device.
d. Process to address shortfalls–Applicant must describe or
otherwise document:
(1) Procedures for the prompt application of Applicant and/or
clearing member financial resources to address monetary shortfalls
resulting from a default;
(2) How Applicant will make publicly available its default rules
including a description of the priority of application of financial
resources in the event of default (i.e., the “waterfall”); and
(3) How Applicant will take timely action to contain losses and
liquidity pressures and to continue to meet each obligation of
Applicant.
e. Use of cross-margin programs–Describe or otherwise document,
as applicable, how cross-margining programs will provide for fair
and efficient means of covering losses in the event of a default of
any clearing member participating in the program.
f. Customer priority rule–Describe or otherwise document rules
and procedures regarding priority of customer accounts over
proprietary accounts of defaulting clearing members and, where
applicable, specifically in the context of specialized margin
reduction programs such as cross-margining or common banking
arrangements with other derivatives clearing organizations, clearing
agencies, financial market utilities or foreign entities that
perform similar functions.
Exhibit H–Rule Enforcement
Attach as Exhibit H, documents that demonstrate
compliance with the rule enforcement requirements set forth in Sec.
39.17 of the Commission’s regulations, including but not limited to:
a. Surveillance–Describe or otherwise document arrangements and
resources for the effective monitoring and enforcement of compliance
with Applicant’s rules and the resolution of disputes.
b. Enforcement–Applicant must describe or otherwise document:
(1) Arrangements and resources for the effective enforcement of
rules and authority and ability to discipline and limit or suspend a
member’s activities pursuant to clear and fair standards;
(2) Arrangements for enforcing compliance with its rules and
addressing instances of non-compliance, including: Disciplinary
tools such as limiting, suspending, or terminating a clearing
member’s access or member privileges;
(3) How Applicant will address situations related to, but which
may not constitute an event of default, such as a clearing member’s
failure to comply with certain rules or to maintain eligibility
standards, or actions taken by other regulatory bodies;
(4) The standards and any procedural protections Applicant will
follow in imposing any such enforcement measure; and
(5) Processes for reporting to the Commission Applicant’s rule
enforcement activities and possible sanctions that could be imposed
against clearing members.
c. Dispute resolution–Describe or otherwise document
arrangements and resources for resolution of disputes between
customers and clearing members, and between clearing members.
Exhibit I–System Safeguards
Attach as Exhibit I, documents that demonstrate
compliance with the system safeguards requirements set forth in
Sec. 39.18 of the Commission’s regulations, including but not
limited to:
a. A description of Applicant’s program of risk analysis and
oversight with respect to its operations and automated systems. This
program must be designed to ensure daily processing, clearing, and
settlement of transactions and address each of the following
categories of risk:
(1) Information security;
(2) Business continuity-disaster recovery planning and
resources;
(3) Capacity and performance planning;
(4) Systems operations;
(5) Systems development and quality assurance; and
(6) Physical security and environmental controls.
b. An explanation of how Applicant will establish and maintain
resources that allow for the fulfillment of its program of risk
analysis and oversight with respect to its operations and automated
systems, and a description of such resources, including:
(1) A description of how Applicant will periodically verify that
its resources are adequate to ensure daily processing, clearing, and
settlement;
(2) A demonstration that Applicant’s automated systems are
reliable, secure, and have (and will continue to have) adequate
scalable capacity;
(3) A description of the physical, technological and personnel
resources and procedures used by Applicant as part of its business
continuity and disaster recovery plan, and support for the
conclusion that these resources are sufficient to enable the
Applicant to resume daily processing, clearing and settlement no
later than the next business day following a disruption; and
(4) A statement identifying which such resources are Applicant’s
own resources and which are provided by a service provider
(outsourced). For resources that are outsourced, provide (i) all
contracts governing the outsourcing arrangements, including all
schedules and other supplemental materials, and (ii) a demonstration
that Applicant employs personnel with the expertise necessary to
enable them to supervise the service provider’s delivery of the
services.
c. An explanation of how Applicant will ensure the proper
functioning of its systems, including its program for the periodic
objective testing and review of its systems and back-up facilities
(including all of its own and outsourced resources), and
verification that all such resources will work effectively together;
d. Identification of the persons conducting the testing,
including information as to their qualifications and independence;
e. A description of Applicant’s emergency procedures, including
a copy of its written plan for business continuity and disaster
recovery and a description of how Applicant will coordinate its
business continuity and disaster recovery plan (including testing)
with those of its clearing members and providers of essential
services such as telecommunications, power and water; and
f. A description of how Applicant will report exceptional events
and planned changes to the Commission as required by Sec. Sec.
39.18(g) and 39.18(h).
Exhibit J–Reporting
Attach as Exhibit J, documents that demonstrate
compliance with the reporting requirements set forth in Sec. 39.19
of the Commission’s regulations including but not limited to:
a. How Applicant will make available to Commission staff all the
information Commission staff need in order to carry out effective
oversight. This must include a discussion of what will be made
available on a routine basis, how often it will be made available,
and the method of its transmission. The same items must be addressed
for information it will make available on a non-routine basis and
what events would precipitate the generation of such data or
information. Applicant must also address the manner in which any
information will be made available to clearing members, customers,
market participants and/or the general public. If not part of an
initial application, Applicant must provide a representation that it
will provide the
[[Page 3741]]
following when initially generated or when content changes occur:
(1) A list of current members/market participants;
(2) A list of all products currently eligible for clearing;
(3) The initial margin collection schedule;
(4) Information on any disciplinary actions (such as
suspensions, etc.);
(5) Information concerning any physical or other emergencies;
(6) All information concerning any default by a member and the
impact of the default on Applicant’s financial resources;
(7) A copy of any examination/evaluation/compliance report of
any regulatory body other than the Commission that oversees
Applicant;
(8) A copy of any internal examination/evaluation/compliance
reports such as, but not limited to, those related to stress testing
and systems testing;
(9) Key personnel that have particular knowledge of the
market(s) for which Applicant clears and any changes in those
personnel, especially those to be contacted in case of market
volatility or to respond to inquiries and emergencies;
(10) Copies of audited financial statements of Applicant; and
(11) Information regarding counterparties and their positions,
stress test results, internal governance, legal proceedings, and
other clearing activities.
b. Forms or templates to be used to satisfy the daily,
quarterly, annual, and event-specific reporting requirements
specified in Sec. 39.19(c) of the Commission’s regulations.
Exhibit K–Recordkeeping
Attach as Exhibit K, documents that demonstrate
compliance with the recordkeeping requirements set forth in Sec.
39.20 of the Commission’s regulations including but not limited to:
a. Applicant’s recordkeeping and record retention policies and
procedures;
b. The different activities related to the entity as a
derivatives clearing organization for which it must maintain
records;
c. The manner in which records relating to swaps and swap data
are gathered and maintained; and
d. How Applicant will satisfy the performance standards of Sec.
1.31 as applicable to derivatives clearing organizations, including:
(1) What “full” or “complete” will encompass with respect to
each type of book or record that will be maintained;
(2) The form and manner in which books or records will be
compiled and maintained with respect to each type of activity for
which such books or records will be kept;
(3) Confirmation that books and records will be open to
inspection by any representative of the Commission or of the U.S.
Department of Justice;
(4) How long books and records will be readily available and how
they will be made readily available during the first two years; and
(5) How long books and records will be maintained (and
confirmation that, in any event, they will be maintained as required
in Sec. 1.31).
Exhibit L–Public Information
Attach as Exhibit L, documents that demonstrate
compliance with the public information requirements set forth in
Sec. 39.21 of the Commission’s regulations including but not
limited to:
a. Applicant’s procedures for making its rulebook, a list of all
current clearing members, and the information listed in Sec.
39.21(c) readily available to the general public, in a timely
manner, by posting such information on Applicant’s Web site no later
than the business day following the day to which the information
pertains;
b. Any other information routinely made available to the public
by Applicant;
c. How Applicant will make information available to clearing
members and market participants in order to allow such persons to
become familiar with Applicant’s procedures before participating in
clearing operations; and
d. How clearing members will be informed of their specific
rights and obligations preceding a default and upon a default, and
of the specific rights, options and obligations of Applicant
preceding and upon a clearing member’s default.
Exhibit M–Information Sharing
Attach as Exhibit M, documents that demonstrate
compliance with the information sharing requirements set forth in
Sec. 39.22 of the Commission’s regulations, including but not
limited to:
a. The appropriate and applicable information sharing agreements
to which Applicant is, or intends to be, a party including any
domestic or international information-sharing agreements or
arrangements, whether formal or informal, which involve or relate to
Applicant’s operations, especially as it relates to measuring and
addressing counterparty risk;
b. A description of the types of information expected to be
shared and how that information will be shared;
c. An explanation as to how information obtained pursuant to any
information-sharing agreements or arrangements would be used to
further the objectives of Applicant’s risk management program and
any of its surveillance programs including financial surveillance
and continuing eligibility of its clearing members; and
d. An explanation as to how Applicant expects to obtain accurate
information pursuant to the information-sharing agreement or
arrangement and the mechanisms or procedures which would allow for
timely use and application of all information.
Exhibit N–Antitrust Considerations
Attach as Exhibit N, documents that demonstrate
compliance with the antitrust considerations requirements set forth
in Sec. 39.23 of the Commission’s regulations, including but not
limited to policies or procedures to ensure compliance with the
antitrust considerations requirements.
Exhibit O–Governance Fitness Standards
Attach as Exhibit O, documents that demonstrate
compliance with the governance fitness standards requirements set
forth in Sec. 39.24 of the Commission’s regulations, including but
not limited to:
a. The manner in which its governance arrangements permit
consideration of the views of Applicant’s owners, whether voting or
non-voting, and its participants (clearing members and customers)
including (i) the general method by which Applicant will learn of
the views of Applicant’s owners, other than through their exercise
of voting power, or the views of participants, other than through
representation on the Board of Directors or any committee of
Applicant, and (ii) the manner in which Applicant will consider such
views;
b. The fitness standards applicable to members of the Board of
Directors, members of any Disciplinary Panel, members of any
Disciplinary Committee, clearing members, any individual or entity
with direct access to settlement or clearing activities, and any
party affiliated with any of the above individuals or entities, as
well as natural persons who, directly or indirectly, own greater
than 10% of any one class of equity interest in Applicant; including
a description or other documentation explaining how Applicant will
collect and verify information that supports compliance with the
fitness standards; and
c. The manner in which Applicant will condition clearing member
access and other direct access to its settlement and clearing
activities on agreement to be subject to the jurisdiction of
Applicant.
Exhibit P–Conflicts of Interest
Attach as Exhibit P, documents that demonstrate
compliance with the conflicts of interest requirements set forth in
Sec. Sec. 39.13(d), 39.25, and 40.9 of the Commission’s
regulations, including but not limited to:
a. A copy of:
(1) The charter (or mission statement) of Applicant (if not
attached as Exhibit A-8).
(2) The charter (or mission statement) of Applicant’s Board of
Directors, each committee with a composition requirement (including
any Executive Committee), as well as each other committee that has
the authority to amend or constrain actions of Applicant’s Board of
Directors (if not attached as Exhibit A-8).
(3) If another entity “operates” the Applicant, the charter
(or mission statement) of such entity’s Board of Directors (if not
attached as Exhibit A-8); and a description of the manner in which
the Applicant will ensure that the entity complies with Sec.
40.9(b)(2)(ii)(B) and (C) (Officers and Directors; Books and
Records).
(4) An internal organizational chart showing the lines of
responsibility and accountability for each operational unit.
b. Describe or otherwise document:
(1) Applicant’s rules and procedures for ensuring compliance
with the requirements of Sec. 39.25(b) (including ensuring parent
compliance with Sec. 39.25(b)(4)), including through remediation as
detailed in Sec. 39.25(b)(5);
(2) Applicant’s nominations process for the Board of Directors
and the process for assigning members of the Board of Directors or
other persons to any committee referenced in item a.(2) above;
1. The manner in which the Board of Directors reviews its
performance and the
[[Page 3742]]
performance of its members on an annual basis; and
2. The procedures for removing a member of the Board of
Directors, including where the conduct of such member is likely to
be prejudicial to the sound and prudent management of Applicant;
(3) The composition of its Nominating Committee, including the
number or percentage of public directors, and the identity of the
Chairman of the Committee;
(4) The composition of any Executive Committee, including the
number or percentage of public directors;
(5) The composition of the Risk Management Committee, including
the number or percentage of public directors, the number or
percentage of customer representatives, and the identity of the
Chairman of the committee;
1. Whether the Risk Management Committee is an executive
committee or an advisory committee; and
2. Whether the Risk Management Committee has delegated certain
functions to the Risk Management Subcommittee, including a
description or other documentation of the functions so delegated;
(6) The form of report to be used in reporting to the Commission
those instances in which the Board rejects a recommendation or
supersedes an action of the Risk Management Committee, or the Risk
Management Committee rejects a recommendation or supersedes an
action of its subcommittee;
(7) The manner in which Applicant will ensure compliance with
Sec. 39.13(d)(6) (Discretion); and the manner in which Applicant
will ensure compliance with Sec. 40.9(c)(ii)(A) and (B)
(Prohibition on Domination of and Recusal Procedures with respect to
the Disciplinary Panel), and Sec. 40.9(c)(iii) (Appeals), including
whether the Board of Directors has delegated the functions of the
Disciplinary Panel to any other committee;
(8) The manner in which Applicant will record and summarize
“significant decisions,” as such term is described in Sec.
40.9(d);
(9) The manner in which Applicant will ensure that all
information required under Sec. 40.9(d) is current, accurate,
clear, and readily accessible to both the Commission and the public;
(10) Any written procedures that Applicant intends to adopt to
identify, on an ongoing basis, existing and potential conflicts of
interest;
(11) Applicant’s process for making fair and non-biased
decisions in the event of a conflict of interest; and
(12) Applicant’s written policies or procedures on safeguarding
non-public information, and the manner in which such policies or
procedures fulfill the minimum standards set forth in Sec.
40.9(f)(2).
Exhibit Q–Composition of Governing Boards
Attach as Exhibit Q, documents that demonstrate
compliance with the composition of governing boards requirements set
forth in Sec. 39.26, including but not limited to documentation
describing the composition of Applicant’s Board of Directors,
including the number or percentage of public directors and customer
representatives.
Exhibit R–Legal Risk Considerations
Attach as Exhibit R, documents that demonstrate
compliance with the legal risk considerations requirements set forth
in Sec. 39.27 of the Commission’s regulations, including but not
limited to:
a. A discussion of how Applicant operates pursuant to a well-
founded, transparent, and enforceable legal framework that addresses
each aspect of the activities of Applicant. The framework must
provide for Applicant to act as a counterparty, including, as
applicable:
(1) Novation;
(2) Netting arrangements;
(3) Applicant’s interest in collateral (including margin);
(4) The steps that Applicant can take to address a default of a
clearing member, including but not limited to, the unimpeded ability
to liquidate collateral and close out or transfer positions in a
timely manner;
(5) Finality of settlement and funds transfers that are
irrevocable and unconditional when effected (when Applicant’s
accounts are debited and credited); and
(6) Other significant aspects of Applicant’s operations, risk
management procedures, and related requirements.
b. If Applicant provides, or will provide, clearing services
outside the United States, Applicant must (i) provide a memorandum
from local counsel analyzing insolvency issues in the foreign
jurisdiction where Applicant is based and (ii) describe or otherwise
document:
(1) How Applicant has identified and addressed any conflict of
law issues;
(2) Which jurisdiction’s law is intended to apply to each aspect
of Applicant’s operations;
(3) The enforceability of Applicant’s choice of law in relevant
jurisdictions; and
(4) That its rules, procedures, and products are enforceable in
all relevant jurisdictions.
Issued in Washington, DC, on December 16, 2010, by the
Commission.
Sauntia S. Warfield,
Assistant Secretary of the Commission.
Appendices to Risk Management Requirements for Derivatives Clearing
Organizations–Commission Voting Summary and Statements of
Commissioners
Note: The following appendices will not appear in the Code of
Federal Regulations.
Appendix 1–Commission Voting Summary
On this matter, Chairman Gensler and Commissioners Dunn,
Sommers, Chilton and O’Malia voted in the affirmative; no
Commissioner voted in the negative.
Appendix 2–Statement of Chairman Gary Gensler
I support the proposed rulemaking for risk management
requirements for derivatives clearing organizations (DCOs). The
proposal establishes robust risk management standards, which is
particularly important as more swaps are moved into central
clearinghouses. The proposed rule meets or exceeds international
standards and recommendations. It establishes methodologies for
clearinghouses to set margin with regard to swaps contracts.
The proposed regulations will enhance legal certainty for DCOs,
clearing members and market participants by providing a regulatory
framework to support DCO risk management practices. This will help
strengthen the financial integrity of the futures and swap markets.
The proposed participant eligibility requirements will promote fair
and open access to clearing. Importantly, the proposal addresses
rules of how a futures commission merchant can become a member of a
swaps clearinghouse. The proposal promotes more inclusiveness while
allowing the clearinghouses to scale a member’s participation and
risk based upon its capital.
The proposal would establish a registration application form to
bring about greater uniformity and transparency in the DCO
application process and facilitate greater efficiency and
consistency in processing submissions.
[FR Doc. 2011-690 Filed 1-19-11; 8:45 am]
BILLING CODE 6351-01-P
Last Updated: January 20, 2011
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