```

[Federal Register Volume 76, Number 216 (Tuesday, November 8, 2011)]
[Rules and Regulations]
[Pages 69334-69480]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2011-27536]

[[Page 69333]]

Vol. 76

Tuesday,

No. 216

November 8, 2011

Part II

Commodity Futures Trading Commission

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17 CFR Parts 1, 21, 39 et al.

Derivatives Clearing Organization General Provisions and Core 
Principles; Final Rule

Federal Register / Vol. 76 , No. 216 / Tuesday, November 8, 2011 / 
Rules and Regulations

[[Page 69334]]

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COMMODITY FUTURES TRADING COMMISSION

17 CFR Parts 1, 21, 39, and 140

RIN 3038-AC98

Derivatives Clearing Organization General Provisions and Core 
Principles

AGENCY: Commodity Futures Trading Commission.

ACTION: Final rule.

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SUMMARY: The Commodity Futures Trading Commission (Commission) is 
adopting final regulations to implement certain provisions of Title VII 
and Title VIII of the Dodd-Frank Wall Street Reform and Consumer 
Protection Act (Dodd-Frank Act) governing derivatives clearing 
organization (DCO) activities. More specifically, the regulations 
establish the regulatory standards for compliance with DCO Core 
Principles A (Compliance), B (Financial Resources), C (Participant and 
Product Eligibility), D (Risk Management), E (Settlement Procedures), F 
(Treatment of Funds), G (Default Rules and Procedures), H (Rule 
Enforcement), I (System Safeguards), J (Reporting), K (Recordkeeping), 
L (Public Information), M (Information Sharing), N (Antitrust 
Considerations), and R (Legal Risk) set forth in Section 5b of the 
Commodity Exchange Act (CEA). The Commission also is updating and 
adding related definitions; adopting implementing rules for DCO chief 
compliance officers (CCOs); revising procedures for DCO applications 
including the required use of a new Form DCO; adopting procedural rules 
applicable to the transfer of a DCO registration; and adding 
requirements for approval of DCO rules establishing a portfolio 
margining program for customer accounts carried by a futures commission 
merchant (FCM) that is also registered as a securities broker-dealer 
(FCM/BD). In addition, the Commission is adopting certain technical 
amendments to parts 21 and 39, and is adopting certain delegation 
provisions under part 140.

DATES: The rules will become effective January 9, 2012. DCOs must 
comply with Sec. Sec.  39.11; 39.12; 39.13 (except for 39.13(g)(8)(i)); 
and 39.14 by May 7, 2012; with Sec. Sec.  39.10(c); 39.13(g)(8)(i); 
39.18; 39.19; and 39.20 by November 8, 2012; and all other provisions 
of these rules by January 9, 2012.

FOR FURTHER INFORMATION CONTACT: Phyllis P. Dietz, Deputy Director, 
(202) 418-5449, pdietz@cftc.gov; John C. Lawton, Deputy Director, (202) 
418-5480, jlawton@cftc.gov; Robert B. Wasserman, Chief Counsel, (202) 
418-5092, rwasserman@cftc.gov; Eileen A. Donovan, Associate Director, 
(202) 418-5096, edonovan@cftc.gov; Jonathan Lave, Special Counsel, 
(202) 418-5983, jlave@cftc.gov, Division of Clearing and Risk; and 
Jacob Preiserowicz, Special Counsel, (202) 418-5432, 
jpreiserowicz@cftc.gov, Division of Swap Dealer and Intermediary 
Oversight, Commodity Futures Trading Commission, Three Lafayette 
Centre, 1155 21st Street NW., Washington, DC 20581; and Julie A. Mohr, 
Deputy Director, (312) 596-0568, jmohr@cftc.gov; and Anne C. Polaski, 
Special Counsel, (312) 596-0575, apolaski@cftc.gov, Division of 
Clearing and Risk, Commodity Futures Trading Commission, 525 West 
Monroe Street, Chicago, 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. Regulatory Framework for DCOs
II. Part 1 Amendments--Definitions
III. Part 39 Amendments--General Provisions
    A. Scope
    B. Definitions
    C. Procedures for Registration
    D. Procedures for Implementing DCO Rules and Clearing New 
Products
    E. Reorganization of Part 39
    F. Technical Amendments
IV. Part 39 Amendments--Core Principles
    A. Compliance with Core Principles
    B. Financial Resources
    C. Participant and Product Eligibility
    D. Risk Management
    E. Settlement Procedures
    F. Treatment of Funds
    G. Default Rules and Procedures
    H. Rule Enforcement
    I. System Safeguards
    J. Reporting
    K. Recordkeeping
    L. Public Information
    M. Information Sharing
    N. Antitrust Considerations
    O. Legal Risk Considerations
    P. Special Enforcement Authority for SIDCOs
V. Part 140 Amendments--Delegations of Authority
VI. Effective Dates
VII. Section 4(c)
VIII. Consideration of Costs and Benefits
IX. Related Matters
    A. Regulatory Flexibility Act
    B. Paperwork Reduction Act

I. Background

A. Title VII of the Dodd-Frank Act

    On July 21, 2010, President Obama signed the Dodd-Frank Act.\1\ 
Title VII of the Dodd-Frank Act \2\ amended the CEA \3\ to establish a 
comprehensive statutory 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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    \1\ See Dodd-Frank Wall Street Reform and Consumer Protection 
Act, Public Law 111-203, 124 Stat. 1376 (2010). The text of the 
Dodd-Frank Act may be accessed at http://www.cftc.gov/LawRegulation/OTCDERIVATIVES/index.htm.
    \2\ Pursuant to Section 701 of the Dodd-Frank Act, Title VII may 
be cited as the ``Wall Street Transparency and Accountability Act of 
2010.''
    \3\ 7 U.S.C. 1 et seq.
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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 
in order 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).\4\ The Commission did not adopt 
implementing rules and regulations, but instead promulgated guidance 
for DCOs on compliance with the core principles.\5\ Under Section 
5b(c)(2) of the CEA, 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.\6\
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    \4\ See Commodity Futures Modernization Act of 2000, Public Law 
106-554, 114 Stat. 2763 (2000).
    \5\ See 66 FR 45604 (Aug. 29, 2001) (adopting 17 CFR part 39, 
app. A).
    \6\ 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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    In light of Congress's explicit affirmation of the Commission's 
authority to adopt regulations to implement the core principles, the 
Commission has chosen to adopt regulations (which have the force of 
law) rather than guidance (which does not have the force of law). By 
issuing regulations, the Commission expects to increase legal certainty 
for DCOs, clearing members, and market participants, and prevent DCOs 
from lowering risk management standards for competitive reasons and 
taking on more risk than is prudent. The imposition of legally 
enforceable standards provides

[[Page 69335]]

assurance to market participants and the public that DCOs are meeting 
minimum risk management standards. This can serve to increase market 
confidence which, in turn, can increase open interest and free up 
resources that market participants might otherwise hold in order to 
compensate for weaker DCO risk management practices. Regulatory 
standards also can reduce search costs that market participants would 
otherwise incur in determining that DCOs are managing risk effectively.

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 (FSOC) to designate entities involved in 
clearing and settlement as systemically important.\7\
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    \7\ See 76 FR 44763 (July 27, 2011) (FSOC authority to designate 
financial market utilities as systemically important; final rule).
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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 (SIDCOs). The Commission proposed heightened 
requirements for SIDCO financial resources and system safeguards for 
business continuity and disaster recovery.
    Section 807(c) of the Dodd-Frank Act provides the Commission with 
special enforcement authority over SIDCOs, which the Commission 
proposed to codify in its regulations.

C. Regulatory Framework for DCOs

    The Commission, now responsible for regulating swaps markets as 
well as futures markets, has undertaken an unprecedented rulemaking 
initiative to implement the Dodd-Frank Act. As part of this initiative, 
the Commission has issued a series of eight proposed rulemakings that, 
together, would establish a comprehensive regulatory framework for the 
clearing and settlement activities of DCOs. Through these proposed 
regulations, the Commission sought to enhance legal certainty for DCOs, 
clearing members, and market participants, to strengthen the risk 
management practices of DCOs, and to promote financial integrity for 
swaps and futures markets.
    In this notice of final rulemaking, the Commission is adopting 
regulations to implement 15 DCO core principles: A (Compliance), B 
(Financial Resources), C (Participant and Product Eligibility),\8\ D 
(Risk Management), E (Settlement Procedures), F (Treatment of Funds), G 
(Default Rules and Procedures), H (Rule Enforcement), I (System 
Safeguards), J (Reporting), K (Recordkeeping), L (Public Information), 
M (Information Sharing), N (Antitrust Considerations), and R (Legal 
Risk).\9\ In addition, the Commission is adopting regulations to 
implement the CCO provisions of Section 725 of the Dodd-Frank Act.\10\
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    \8\ The Commission is reserving for a future final rulemaking 
certain proposed amendments relating to participant and product 
eligibility. See 76 FR 13101 (Mar. 10, 2011) (requirements for 
processing, clearing, and transfer of customer positions (Straight-
Through Processing)); and 76 FR 45730 (Aug. 1, 2011) (customer 
clearing documentation and timing of acceptance for clearing 
(Customer Clearing)).
    \9\ The Commission is reserving for a future final rulemaking 
regulations to implement DCO Core Principles O (Governance Fitness 
Standards) and Q (Composition of Governing Boards) (76 FR 722 (Jan. 
6, 2011) (Governance)); and Core Principle P (Conflicts of Interest) 
(75 FR 63732 (Oct. 18, 2010) (Conflicts of Interest)).
    \10\ See Section 5b(i) of the CEA, 7 U.S.C 7a-1(i).
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    The final rules adopted herein were proposed in five separate 
notices of proposed rulemaking.\11\ Each proposed rulemaking was 
subject to an initial 60-day public comment period and a re-opened 
comment period of 30 days.\12\ After the second comment period ended, 
the Commission informed the public that it would continue to accept and 
consider late comments and did so until August 25, 2011. The Commission 
received a total of approximately 119 comment letters directed 
specifically at the proposed rules, in addition to many other comments 
applicable to the Dodd-Frank Act rulemaking initiative more 
generally.\13\ The Chairman and Commissioners, as well as Commission 
staff, participated in numerous meetings with representatives of DCOs, 
FCMs, trade associations, public interest groups, traders, and other 
interested parties. In addition, the Commission has consulted with 
other U.S. financial regulators including the Board of Governors of the 
Federal Reserve System and Securities and Exchange Commission (SEC).
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    \11\ See 76 FR 13101 (Mar. 10, 2011) (Straight-Through 
Processing); 76 FR 3698 (Jan. 20, 2011) (Core Principles C, D, E, F, 
G, and I (Risk Management)); 75 FR 78185 (Dec. 15, 2010) (Core 
Principles J, K, L, and M (Information Management)); 75 FR 77576 
(Dec. 13, 2010) (Core Principles A, H, N, and R (General 
Regulations)); and 75 FR 63113 (Oct. 14, 2010) (Core Principle B 
(Financial Resources)).
    \12\ See 76 FR 25274 (May 4, 2011) (extending or re-opening 
comment periods for multiple Dodd-Frank proposed rulemakings); see 
also 76 FR 16587 (Mar. 24, 2011) (re-opening 30-day comment period 
for reporting requirement with clause omitted in the notice of 
proposed rulemaking).
    \13\ Comment files for each proposed rulemaking can be found on 
the Commission Web site, www.cftc.gov.
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    The Commission is mindful of the benefits of harmonizing its 
regulatory framework with that of its counterparts in foreign 
countries. The Commission has therefore monitored global advisory, 
legislative, and regulatory proposals, and has consulted with foreign 
regulators in developing the proposed and final regulations for DCOs.
    The Commission is of the view that each DCO should be afforded an 
appropriate level of discretion in determining how to operate its 
business within the legal framework established by the CEA, as amended 
by the Dodd-Frank Act. At the same time, the Commission recognizes that 
specific, bright-line regulations may be necessary to facilitate DCO 
compliance with a given core principle and, ultimately, to protect the 
integrity of the U.S. derivatives clearing system. Accordingly, in 
developing the proposed regulations and in finalizing the regulations 
adopted herein, taking into consideration public comments and views 
expressed by U.S. and foreign regulators, the Commission has endeavored 
to strike an appropriate balance between establishing general 
prudential standards and specific requirements.
    In determining the scope and content of the final rules, the 
Commission has taken into account concerns raised by commenters 
regarding the implications of specific rules for smaller versus larger 
DCOs, DCOs that do not clear customer positions versus those with a 
traditional customer model, clearinghouses that are registered as both 
a DCO and a securities clearing agency, and clearinghouses that operate 
in foreign jurisdictions as well as in the United States. The 
Commission addresses these issues in its discussion of specific rule 
provisions, below.
    The Commission has carefully considered the costs and benefits 
associated with each proposed rule, with particular attention to public 
comments. For the reasons discussed in this notice of final rulemaking, 
in the analyses of specific rule provisions as well as in the formal 
cost-benefit analysis, the Commission has determined that the final 
rules appropriately balance the costs and benefits associated with 
oversight and supervision of DCOs pursuant to the CEA, as amended by 
the Dodd-Frank Act.
    The Commission is herein adopting regulations to implement the core 
principles applicable to DCOs, to implement CCO requirements 
established under the Dodd-Frank Act, and to update the regulatory 
framework for DCOs to reflect standards and practices that have evolved 
over the past decade since the enactment of the

[[Page 69336]]

CFMA. The Commission is largely adopting final rules as proposed, 
although there are a number of proposed provisions that, upon further 
consideration in light of comments received, the Commission has 
determined to either revise or decline to adopt. In the discussion 
below, the Commission highlights topics of particular interest to 
commenters and discusses comment letters that are representative of the 
views expressed on those topics. The discussion does not explicitly 
respond to every comment submitted; rather, it addresses the most 
significant issues raised by the proposed rulemakings and it analyzes 
those issues in the context of specific comments.
    The final rules include a number of technical revisions to the 
proposed rule text, intended variously to clarify certain provisions, 
standardize terminology within part 39, conform terminology to that 
used in other parts of the Commission's rules, and more precisely state 
regulatory standards and requirements. These are non-substantive 
changes. For example, the proposed DCO rules used the terms 
``contract'' and ``product'' interchangeably, and some provisions used 
the statutory language ``contracts, agreements and transactions'' to 
refer to the products subject to Commission regulation. In the final 
rules adopted herein, the Commission has revised the terminology to 
uniformly refer to ``products,'' which encompasses contracts, 
agreements, and transactions, except where the language of the rule 
codifies statutory language. In those cases, the rule text is 
unchanged.
    For easy reference and for purposes of clarification, in this 
notice of final rulemaking the Commission is publishing the complete 
part 39 as currently adopted. This means that certain longstanding 
rules that are not being amended (e.g., Sec.  39.8 (formerly designated 
as Sec.  39.7, fraud in connection with the clearing of transactions of 
a DCO), and rules recently adopted (Sec.  39.5, review of swaps for 
Commission determination on clearing requirement) are being re-
published along with the newly-adopted rules. Rules that have been 
proposed but not yet adopted in final form are identified in part 39 as 
``reserved.''

II. Part 1 Amendments--Definitions

    The Commission proposed to amend the definitions of ``clearing 
member,'' ``clearing organization,'' and ``customer'' found in Sec.  
1.3 of its regulations to conform the definitions with the terminology 
and substantive provisions of the CEA, as amended by the Dodd-Frank 
Act. The Commission also proposed to add to Sec.  1.3, definitions for 
``clearing initial margin,'' ``customer initial margin,'' ``initial 
margin,'' ``margin call,'' ``spread margin,'' and ``variation margin.''
    ISDA commented that the margin definitions are appropriate for 
futures and cleared derivatives, but less readily applicable in the 
uncleared OTC derivatives context. It suggested that the definitions 
should expressly provide that they apply only to cleared transactions. 
The Commission notes that some of the definitions by their terms 
already apply only to cleared trades, e.g., ``clearing initial 
margin.'' Other terms, however, have applicability to both cleared and 
uncleared trades, e.g., ``initial margin.'' \14\
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    \14\ See Section 4s of the CEA, 7 U.S.C. 6s.
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    The Commission proposed to define ``spread margin'' as ``reduced 
initial margin that takes into account correlations between certain 
related positions held in a single account.'' Better Markets commented 
that the definition of ``spread margin'' omits key characteristics of 
netting initial margin which are needed to precisely define spread 
margin. Better Markets proposed to define it as ``initial margin 
relating to two positions in a single account that has been reduced 
from the aggregate initial margin otherwise applicable to the two 
positions by application of an algorithm that measures statistical 
correlations between the historic price movements of the two 
positions.'' The Commission is adopting the definition of ``spread 
margin'' as proposed because it believes that Better Markets' 
definition adds unnecessary details that could have the unintended 
effect of imposing substantive margin methodology requirements in a 
definition.
    In light of proposed rulemakings issued after the Commission 
proposed the definition of ``customer; commodity customer; swap 
customer,'' the Commission is making certain technical 
modifications.\15\ First, instead of placing the definition in Sec.  
1.3, which serves as the general definition section for all of the 
Commission's regulations, this definition is being moved to Sec.  39.2, 
which sets forth definitions applicable only to regulations found in 
part 39 or as otherwise explicitly provided. This accommodates the need 
for further consideration of other proposals before a global definition 
is adopted, while satisfying the need for a definition for purposes of 
part 39 as adopted herein. Second, the Commission has made certain 
technical changes to the rule text in connection with the definition's 
redesignation in 39.2 and to conform phraseology when incorporating by 
reference definitions that appear in the CEA and Sec.  1.3. These 
changes include limiting the term to ``customer,'' because the terms 
``commodity customer'' and ``swap customer'' are not used in Part 39.
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    \15\ See 76 FR 33818 (June 9, 2011) (Protection of Cleared Swaps 
Customer Contracts and Collateral; Conforming Amendments to the 
Commodity Broker Bankruptcy Provisions); 76 FR 33066 (June 7, 2011) 
(Adaptation of Regulations to Incorporate Swaps).
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    The Commission is adopting the other definitions as proposed.

III. Part 39 Amendments--General Provisions

A. Scope--Sec.  39.1

    As originally proposed, Sec.  39.1 included an updated statement of 
scope and definitions applicable to other provisions in part 39. The 
Commission later revised proposed Sec.  39.1 to include only the 
statement of scope. The Commission did not receive any comments on the 
statement of scope, which was updated to include references to the 
definition of ``derivatives clearing organization'' in newly-renumbered 
Section 1(a)(15) of the CEA and Sec.  1.3(d) of the Commission's 
regulations. The Commission is adopting Sec.  39.1 as proposed.

B. Definitions--Sec.  39.2

    The Commission proposed definitions of the terms ``back test,'' 
``compliance policies and procedures,'' ``customer account '' or 
``customer origin,'' ``house account'' or ``house origin,'' ``key 
personnel,'' ``stress test,'' and ``systemically important derivatives 
clearing organization.'' The definitions set forth in proposed Sec.  
39.2 would apply specifically to provisions contained in part 39 and 
such other rules as may explicitly cross-reference these definitions. 
The Commission is adopting the definitions as proposed, with the 
exceptions discussed below.
    CME Group, Inc. (CME) commented that the proposed definition of 
``compliance policies and procedures'' was too broad. That definition 
was proposed as an adjunct to the proposed rules for a DCO's CCO. The 
Commission is not adopting a definition of ``compliance policies and 
procedures,'' as it has concluded that a DCO's compliance policies and 
procedures will likely encompass a limited, self-evident body of 
documents, and a regulatory definition could invite more scrutiny than 
is necessary or helpful to the DCO or the Commission.
    The Commission proposed to define ``stress test'' as ``a test that 
compares the impact of a potential price move, change

[[Page 69337]]

in option volatility, or change in other inputs that affect the value 
of a position, to the financial resources of a [DCO], clearing member, 
or large trader to determine the adequacy of such financial 
resources.'' Better Markets, Inc. (Better Markets) expressed the view 
that a stress test can only be useful if it tests unprecedented 
circumstances of illiquidity, and that basing the test on historic 
price data would make it meaningless. In response to this comment, the 
Commission is modifying the definition in one respect. The word 
``extreme'' is being inserted after the word ``potential'' to make 
clear that a stress test does not include typical events. The 
Commission further addresses Better Markets' concerns in its discussion 
of stress tests in Sec.  39.13(h)(3).\16\
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    \16\ See discussion of stress tests in section IV.D.7.c, below.
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    The Commission proposed to define the term ``systemically important 
derivatives clearing organization'' to mean ``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.'' 
The Options Clearing Corporation (OCC) submitted a comment on this 
definition in connection with the Commission's proposed Sec.  40.10 
(special certification procedures for submission of certain risk-
related rules by SIDCOs).\17\ OCC pointed out that, under this proposed 
definition, a DCO could be a SIDCO even if the Commission were not its 
Supervisory Agency pursuant to Section 803(8) of the Dodd-Frank Act. 
The Commission, recognizing that some DCOs like OCC may be regulated by 
more than one federal agency, is adopting a revised definition to 
clarify that the term ``systemically important derivatives clearing 
organization'' means a ``financial market utility that is a derivatives 
clearing organization registered under Section 5b of the Act, which has 
been designated by the Financial Stability Oversight Council to be 
systemically important and for which the Commission acts as the 
Supervisory Agency pursuant to Section 803(8) of the Dodd-Frank Wall 
Street Reform and Consumer Protection Act.'' \18\
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    \17\ See 76 FR 44776 at 44783-84 (July 27, 2011) (Provisions 
Common to Registered Entities; final rule).
    \18\ See id. for further discussion of this topic.
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    The Commission also is making a technical change to the definition 
of ``customer account or customer origin.'' The proposed definition 
would provide, in part, that ``[a] customer account is also a futures 
account, as that term is defined by Sec. 1.3(vv) of this chapter.'' The 
Commission is removing this reference and defining ``customer account 
or customer origin'' to mean ``a clearing member account held on behalf 
of customers, as that term is defined in this section, and which is 
subject to section 4d(a) or section 4d(f) of the Act.'' This clarifies 
that the term encompasses both customer futures accounts and customer 
cleared swaps accounts, respectively.
    Similarly, the Commission is making a technical revision to the 
term ``house account or house origin'' to delete the proposed reference 
to proprietary accounts, which are currently defined in Sec.  1.3(y) 
only in terms of futures and options (not swaps). The term ``house 
account or house origin'' is now defined as a ``clearing member account 
which is not subject to section 4d(a) or 4d(f) of the Act.''
    In connection with the proposal to adopt a definitions section 
designated as Sec.  39.2, the Commission proposed to rescind the 
existing Sec.  39.2, which exempted DCOs from all Commission 
regulations except those explicitly enumerated in the exemption. This 
action would result in clarifying the applicability of Sec.  1.49 
(denomination of customer funds and location of depositories) to DCOs 
and, insofar as the rule exempted DCOs from regulations relating to DCO 
governance and conflicts of interest, those regulations are expected to 
themselves be replaced by rules to implement DCO Core Principles O 
(Governance Fitness Standards), P (Conflicts of Interest), and Q 
(Composition of Governing Boards).\19\ The Commission did not receive 
any comments on the proposed rescission of the exemption provided by 
existing Sec.  39.2 and is herein rescinding that exemption, as 
proposed.
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    \19\ See 76 FR 722 (Jan. 6, 2011) (Governance); and 75 FR 63732 
(Oct. 18, 2010) (Conflicts of Interest).
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C. Procedures for Registration as a DCO--Sec.  39.3

    The Commission proposed several revisions to its procedures for DCO 
registration, including the elimination of the 90-day expedited review 
period and the required use of an application form, proposed Form DCO. 
The Commission is adopting Sec.  39.3 as proposed, and is adopting the 
Form DCO with the revisions discussed below.
1. Form DCO
    The Commission proposed to revise appendix A to part 39, 
``Application Guidance and Compliance with Core Principles,'' by 
removing the existing guidance and substituting the Form DCO in its 
place. An application for DCO registration would consist of the 
completed Form DCO, which would include all applicable exhibits, and 
any supplemental information submitted to the Commission.
    CME commented that the proposed Form DCO would require the 
applicant to create and submit to the Commission a large number of 
documents. It questioned why certain documents were necessary and 
whether Commission staff would be able to meaningfully review all of 
the materials within the 180-day timeframe contemplated in the proposed 
regulations.
    The Commission is adopting the Form DCO as proposed, except for the 
modifications discussed below. The Commission notes that the Form DCO 
standardizes and clarifies the information that the Commission has 
required from DCO applicants in the past and the Form DCO Exhibit 
Instructions, in an effort to reduce the burden on applicants, state 
that ``If any Exhibit requires information that is related to, or may 
be duplicative of, information required to be included in another 
Exhibit, Applicant may summarize such information and provide a cross-
reference to the Exhibit that contains the required information.'' 
Based on the Commission's experience with the DCO registration process 
over the past decade, it believes that its staff can meaningfully 
review the required information within the 180-day time frame. In 
addition, the Commission believes that by standardizing informational 
requirements, the Form DCO will allow the Commission to process 
applications more quickly and efficiently. This will benefit applicants 
as well as free Commission staff to handle other regulatory matters.
    CME specifically questioned whether, as part of the Form DCO cover 
sheet, applicants should be required to identify and list ``all outside 
service providers and consultants, including accountants and legal 
counsel.'' This comment mischaracterizes the information required by 
the Form DCO, which requires contact information for enumerated outside 
service providers (Certified Public Accountant, legal counsel, records 
storage or management, business continuity/disaster recovery) and 
``other'' outside service providers ``such as consultants, providing 
services related to this application.'' Such contact information is 
helpful to the Commission staff in processing the application and 
making a determination as to whether the applicant has obtained the 
services it needs to effectively

[[Page 69338]]

operate as a DCO.\20\ Nonetheless, in response to CME's comments and in 
order to clarify the scope of requesting contact information for ``any 
other outside service providers,'' the Commission has decided to revise 
section 12.e. of the Form DCO cover sheet to provide for contact 
information for any ``Professional consultant providing services 
related to this application.''
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    \20\ This requirement focuses on outside services ``related to 
this application.'' Similarly, if the applicant intends to use the 
services of an outside service provider (including services of its 
clearing members or market participants), to enable it to comply 
with any of the core principles, the applicant must submit as 
exhibit A-10 all agreements entered into or to be entered into 
between the 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. This exhibit does not require that the applicant 
submit information and documentation related to all outside service 
providers. Rather, the requirement is directed at contractual 
arrangements related to compliance with the core principles, i.e., 
the DCO's core business functions.
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    CME commented that proposed exhibit A-1, which would require the 
applicant to produce a chart demonstrating in detail how its rules, 
procedures, and policies address each DCO core principle, is not 
necessary. The Commission believes exhibit A-1 is necessary because it 
will provide a clear picture of which rules, procedures, and policies 
address each DCO core principle. The chart will greatly assist 
Commission staff in tracking and evaluating the materials supplied by 
the applicant and should reduce the need for staff to seek follow-up 
clarifications from the applicant. Again, this will also reduce the 
costs to the applicant.
    CME commented that the Commission has not explained its reasons for 
requiring an applicant to supply ``telephone numbers, mobile phone 
numbers and email addresses of all officers, managers, and directors of 
the DCO,'' as provided in proposed exhibit A-6. The Commission notes 
that the exhibit A-6 instructions request contact and other information 
for ``current officers, directors, governors, general partners, LLC 
managers, and members of all standing committees.'' The exhibit is not 
directed at ``all managers'' or ``all directors,'' but rather at those 
persons who are in key decision-making positions (for example, key 
personnel, directors serving on a board of directors and a manager or 
managing member of a DCO organized in the form of a limited liability 
corporation). The purpose of obtaining contact information is to enable 
the Commission to start building an emergency contact database.
    CME commented that proposed exhibit A-7 would require the applicant 
to list all jurisdictions where the applicant and its affiliates are 
doing business, and the registration status of the applicant and its 
affiliates. CME questioned the Commission's need for such information 
with respect to affiliates of the applicant. The Commission believes 
that such information is necessary because it allows the Commission to 
develop a more complete understanding of the applicant's entire 
corporate organizational structure including potential financial 
commitments and regulatory obligations of the applicant's affiliates 
inclusive of its parent organization.
    CME commented that proposed exhibit B-3, which would require the 
applicant to provide proof that each of its physical locations meets 
all building and fire codes, and that it has running water and a 
heating, ventilation and air conditioning system, and adequate office 
technology, is not necessary. The Commission believes that it is 
important for an applicant to demonstrate that it has a physical 
presence capable of supporting clearing and settlement services and is 
not a ``shoestring'' operation. Typically, Commission staff will 
conduct a site visit to an applicant's headquarters and other 
facilities, and one of the purposes of such visits is to evaluate the 
suitability of the applicant's physical facilities. Site visits, 
however, are conducted after a DCO application is deemed to be 
materially complete, and there are instances when it might not be 
feasible to conduct a site visit. Accordingly, at a minimum, a 
narrative statement discussing the applicant's physical facilities and 
office technology must be submitted to the Commission as part of the 
application package so that staff can complete its initial review for 
``adequate * * * operational resources'' under Core Principle B.
    In response to CME's comments, the Commission has decided to revise 
exhibit B-3 to require the following:

    (3) A narrative statement demonstrating the adequacy of 
Applicant's physical infrastructure to carry out business 
operations, which includes a principal executive office (separate 
from any personal dwelling) with a U.S. street address (not merely a 
post office box number). For its principal executive office and 
other facilities Applicant plans to occupy in carrying out its DCO 
functions, a description of the space (e.g., location and square 
footage), use of the space (e.g., executive office, data center), 
and the basis for Applicant's right to occupy the space (e.g., 
lease, agreement with parent company to share leased space).
    (4) A narrative statement demonstrating the adequacy of the 
technological systems necessary to carry out Applicant's business 
operations, including a description of Applicant's information 
technology and telecommunications systems and a timetable for full 
operability.

    CME questioned the value of proposed exhibits C-1(9) and C-2(5), 
which would, respectively, require an applicant to provide a list of 
current and prospective clearing members, and to forecast expected 
volumes and open interest at launch date, six months, and one year 
thereafter. The Commission believes that this information is important 
because it would enable the Commission to understand the nature and 
level of the DCO's expected start-up activities and to appropriately 
evaluate whether the applicant has adequate resources to manage the 
expected volume of business.
    CME questioned the benefits of what it termed the ``incredibly 
burdensome'' requirements of proposed exhibit D-2(b)(3), which would 
require an applicant to explain why a particular margin methodology was 
chosen over other potentially suitable methodologies, and to include a 
comparison of margin levels that would have been generated by using 
such other potential methodologies. To address CME's comment, the 
Commission is revising exhibit D-2(b)(3) to require an explanation of 
whether other margining methodologies were considered and, if so, 
explain why they were not chosen. This information will be sufficient 
in the first instance and, when evaluating an applicant's proposed 
margin methodology, Commission staff can request additional information 
if needed to complete its review for compliance with Core Principle D 
and Sec.  39.13 (risk management).
    The Commission proposed to require use of the Form DCO by a 
registered DCO when requesting an amendment to its DCO registration 
order. CME and Minneapolis Grain Exchange, Inc. (MGEX) suggested that 
the Form DCO be modified so that a currently registered DCO would not 
have to expend as much time and resources to complete an amendment 
request as a new applicant for DCO registration, unless there are 
extenuating circumstances. In response to this suggestion, the 
Commission is revising the Form DCO General Instructions to clarify 
that if the Form DCO is being filed as an amendment to a pending 
application for registration or for the purpose of amending an existing 
registration order, the applicant need only submit the information and 
exhibits relevant to the application

[[Page 69339]]

amendment or request for an amended registration order.
    CME also noted that a DCO applicant would be required to represent 
that its Form DCO submission is true, correct, and complete. It 
suggested that the Commission modify this language so that the 
applicant is required to certify that, ``to the best of its 
knowledge,'' its Form DCO submission is true, correct, and complete 
``in all material respects.'' The Commission is revising the language 
as suggested by CME, in recognition of the fact that some of the 
information contained in the exhibits may have been provided by third 
parties and there is a limit to the reach of an applicant's due 
diligence with respect to such information.
    In addition to the above changes, the Commission has made non-
substantive editorial changes to the Form DCO for purposes of internal 
consistency and conformity with the Form SDR for swap data repositories 
(SDRs) and proposed Form DCM and Form SEF for designated contract 
markets (DCMs) and swap execution facilities (SEFs), respectively.\21\ 
The Commission also has made changes to Form DCO to remove references 
to proposed regulations that remain pending.\22\
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    \21\ See 76 FR 54538 (Sept. 1, 2011) (SDRs: Registration 
Standards, Duties and Core Principles; final rule); 75 FR 80572 
(Dec. 22, 2010) (Core Principles and Other Requirements for 
Designated Contract Markets); 76 FR 1214 (Jan. 7, 2011) (Core 
Principles and Other Requirements for Swap Execution Facilities).
    \22\ For example, the Commission has removed the specific cross-
references located in exhibit P to Form DCO to the proposed 
conflicts of interest rules, 75 FR 63732 (Oct. 18, 2010) (Conflicts 
of Interest), and replaced such references with a description of the 
required information. When the Commission finalizes such proposed 
rules, the Commission intends to make technical changes to the Form 
DCO to include cross-references to such final rules where, in the 
opinion of the Commission, doing so will facilitate compliance with 
the Form DCO, the CEA and/or Commission regulations.
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2. Request for Transfer of Registration and Open Interest--Sec.  
39.3(h)
    The Commission proposed Sec.  39.3(h) to clarify the procedures 
that a DCO must follow when requesting the transfer of its DCO 
registration and positions comprising open interest for clearing and 
settlement, in anticipation of a corporation change.\23\ The Commission 
received a comment from OCC suggesting that a request to transfer a 
DCO's registration and open interest should be published in the Federal 
Register for public comment.
---------------------------------------------------------------------------

    \23\ As a technical matter, the Commission is removing proposed 
Sec.  39.3(g)(1) and adopting proposed Sec.  39.3(h) as Sec.  
39.3(f); proposed Sec.  39.3(g)(1) was a typographical error which 
repeats a delegation of authority already provided by Sec.  
39.3(b)(2)(i).
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    The Commission recognizes the value of public comment, but it has 
determined not to formalize the public comment process through 
publication in the Federal Register. This procedure could unnecessarily 
delay the review process and completion of the transfer, and the 
Commission believes that posting the request on its Web site, which it 
currently does for DCO registration applications, will provide an 
opportunity for public comment without potential delay.
3. Technical Amendments
    The Commission proposed a set of technical amendments to Sec.  39.3 
to update filing procedures, to conform various provisions to reflect 
the elimination of the 90-day expedited review period for DCO 
applications, and to correct terminology in the delegation provisions 
of Sec.  39.3(g). The Commission did not receive any comments on the 
proposed technical amendments and the Commission is adopting the 
amendments as proposed.

D. Procedures for Implementing DCO Rules and Clearing New Products--
Sec.  39.4

1. Acceptance of Certain New Products for Clearing--Sec.  39.4(c)(2)
    The Commission proposed a technical amendment to existing Sec.  
39.4(c)(2), which would require a DCO to certify to the Commission the 
terms and conditions of new over-the-counter (OTC) products that it 
intended to clear. The Commission proposed removing the reference to 
new products ``not traded on a designated contract market or a 
registered derivatives transaction execution facility'' and inserting a 
reference to new products ``not traded on a designated contract market 
or a registered swap execution facility.'' The proposed provision would 
retain the reference to filing the terms and conditions of the new 
product ``pursuant to the procedures of Sec.  40.2 of this chapter.''
    Since proposing that technical amendment, the Commission has 
adopted a new Sec.  39.5 (review of swaps for Commission determination 
on clearing requirement) \24\ and revisions to Sec.  40.2 (listing 
products for trading by certification).\25\ As a result, a DCO seeking 
to clear new products that are not traded on a designated contract 
market or swap execution facility must submit to the Commission the 
terms and conditions of the product pursuant to the procedures of Sec.  
39.5, not Sec.  40.2. The Commission is therefore adopting a technical 
revision to conform Sec.  39.4(c)(2) to the current procedural 
requirements.
---------------------------------------------------------------------------

    \24\ See 76 FR 44464, at 44473-44474 (July 26, 2011) (Process 
for Review of Swaps for Mandatory Clearing; final rule).
    \25\ See 76 FR 44776 (July 27, 2011) (Provisions Common to 
Registered Entities; final rule).
---------------------------------------------------------------------------

2. Holding Securities in a Futures Portfolio Margining Account--Sec.  
39.4(e)
    The CEA, as amended by Section 713 of the Dodd-Frank Act, permits, 
pursuant to an exemption, rule or regulation, futures and options on 
futures to be held in a portfolio margining account that is carried as 
a securities account and approved by the SEC.\26\ Reciprocally, the 
Securities Exchange Act of 1934 (SEA), as amended by Section 713 of the 
Dodd-Frank Act, permits, pursuant to an exemption, rule, or regulation, 
cash and securities to be held in a portfolio margining account that is 
carried as a futures account and approved by the Commission.\27\ Those 
provisions of the CEA and SEA further require consultation between the 
Commission and the SEC in drafting implementing regulations. As a first 
step toward meeting this goal, proposed Sec.  39.4(e) would establish 
the procedural requirements applicable to a DCO seeking approval for a 
futures portfolio margining account program.
---------------------------------------------------------------------------

    \26\ Section 4d(h) of the CEA, 7 U.S.C. 6d(h).
    \27\ Section 15(c)(3)(C) of the SEA, 15 U.S.C. 78o(c)(3).
---------------------------------------------------------------------------

    OCC, Newedge USA, LLC (Newedge), New York Portfolio Clearing, LLC 
(NYPC), and MetLife Inc. urged the Commission to propose rules that 
would permit portfolio margining, not just establish procedural 
requirements. The Commission agrees that it should propose substantive 
portfolio margining rules, but it must move forward on proposing 
substantive rules with the SEC's participation.
    Accordingly, the Commission is adopting the procedural requirements 
as proposed and anticipates consulting with the SEC in the future to 
determine the substantive requirements it would impose in approving a 
futures portfolio margining program and, additionally, in granting an 
exemption under Section 4(c) of the CEA to permit futures and options 
on futures to be held in a securities portfolio margining account. The 
Dodd-Frank Act does not set a deadline for these actions, and the 
Commission believes that it is important to give this matter due 
consideration, both in terms of consultation with the SEC and, more 
broadly, in obtaining industry views on the topic before

[[Page 69340]]

proposing substantive regulations or other guidance.

E. Reorganization of Part 39

    With the adoption of regulations relating to implementation of the 
core principles and other provisions of the Dodd-Frank Act, the 
Commission is reorganizing part 39 of its regulations into two 
subparts, with a new appendix.
    Subpart A, ``General Provisions Applicable to Derivatives Clearing 
Organizations'' contains Sec. Sec.  39.1 through 39.8, which are 
general provisions including procedural requirements for DCO 
applications and other activities such as transfer of a DCO 
registration, clearing of new products, and submission of swaps for a 
mandatory clearing determination. Subpart A also includes pre-existing 
provisions regarding enforceability and fraud in connection with 
clearing transactions on a DCO.\28\ Subpart B, ``Compliance with Core 
Principles,'' contains Sec. Sec.  39.9 through 39.27, which are rules 
that implement the core principles under Section 5b of the CEA, as 
amended by the Dodd-Frank Act.
---------------------------------------------------------------------------

    \28\ As part of the reorganization of Part 39, Sec.  39.6 
(Enforceability) is being redesignated as Sec.  39.7 and Sec.  39.7 
(Fraud in connection with the clearing of transactions on a 
derivatives clearing organization) is being redesignated as Sec.  
39.8.
---------------------------------------------------------------------------

    As discussed above, the Commission is replacing appendix A 
``Application Guidance and Compliance with Core Principles,'' with a 
new appendix to part 39, ``Form DCO Derivatives Clearing Organization 
Application for Registration.''

F. Technical Amendments

    With the objective of listing all DCO reporting requirements in a 
new Sec.  39.19, the Commission proposed redesignating Sec.  39.5(a) 
and (b) (information relating to DCOs) as proposed Sec. Sec.  
39.19(c)(5)(i) and (ii), respectively, in substantially the same form. 
The Commission also proposed removing Sec.  39.5(c) (large trader 
reporting by DCOs), redesignating Sec.  39.5(d) (special calls) as 
Sec.  21.04 (and current Sec.  21.04 as Sec.  21.05), and adding Sec.  
21.06, which would delegate authority under Sec.  21.04 to the Director 
of the Division of Clearing and Risk.
    The Commission did not receive any comments on these proposals. 
Therefore, the Commission is adopting these revisions as proposed, 
except for non-substantive changes to Sec. Sec.  39.19(c)(5)(i) and 
(c)(5)(ii) to clarify the language.\29\
---------------------------------------------------------------------------

    \29\ After these technical amendments were proposed, the 
Commission adopted a final rule governing the process for review of 
swaps for mandatory clearing. That rule was designated as Sec.  
39.5, and the former Sec.  39.5 was redesignated as Sec.  39.8. See 
76 FR at 44473 (July 26, 2011) (Process for Review of Swaps for 
Mandatory Clearing; final rule). In connection with adoption of the 
technical amendments described above, the provisions regarding fraud 
in connection with the clearing of transactions on a DCO (former 
Sec.  39.7) are now redesignated as Sec.  39.8.
---------------------------------------------------------------------------

IV. Part 39 Amendments--Compliance With Core Principles

    Proposed Sec.  39.9 would establish the scope of the rules 
contained in subpart B of part 39, stating that all provisions of 
subpart B apply to DCOs. The Commission did not receive any comments on 
the statement of scope, and the Commission is adopting Sec.  39.9 as 
proposed.

A. Core Principle A--Compliance With Core Principles--Sec.  39.10

1. Core Principle A
    Core Principle A,\30\ as amended by the Dodd-Frank Act, requires a 
DCO to comply with each core principle set forth in Section 5b(c)(2) of 
the CEA and any requirement that the Commission may impose by rule or 
regulation pursuant to Section 8a(5) of the CEA. Core Principle A also 
provides a DCO with reasonable discretion to establish the manner by 
which it complies with each core principle. Proposed Sec. Sec.  
39.10(a) and 39.10(b) would codify these provisions, respectively. The 
Commission received no comments on these proposed rules and is adopting 
the rules as proposed.
---------------------------------------------------------------------------

    \30\ Section 5b(c)(2)(A) of the CEA, 7 U.S.C. 7a-1(c)(2)(A).
---------------------------------------------------------------------------

2. Designation of a Chief Compliance Officer--Sec.  39.10(c)(1)
    Section 725(b) of the Dodd-Frank Act added a new paragraph (i) to 
Section 5b of the CEA to require each DCO to designate an individual as 
its CCO, responsible for the DCO's compliance with the CEA and 
Commission regulations and the filing of an annual compliance 
report.\31\ In proposed Sec.  39.10(c), the Commission set forth 
implementing requirements that would largely track the language of 
Section 5b(i).
---------------------------------------------------------------------------

    \31\ See Section 5b(i) of the CEA; 7 U.S.C. 7a-1(b)(i).
---------------------------------------------------------------------------

    Under the introductory provision of proposed Sec.  39.10(c)(1), 
each DCO would be required to appoint a CCO with ``the full 
responsibility and authority to develop and enforce in consultation 
with the board of directors or the senior officer, appropriate 
compliance policies and procedures, as defined in Sec.  39.1(b), to 
fulfill the duties set forth in the Act and Commission regulations.'' 
As previously noted, the Commission is not adopting the definition of 
``compliance policies and procedures'' included in proposed Sec.  
39.1(b).
    CME commented that the text of the Dodd-Frank Act does not require 
a CCO to ``enforce'' compliance policies and procedures and it 
suggested that Sec.  39.10 should not do so. According to CME, it is 
important to separate the functions of monitoring and advising on 
compliance issues from what it considers ``senior management 
functions'' of enforcing and supervising compliance policies.
    The Commission believes that Congress intended that the CCO have 
the full responsibility and authority to enforce compliance in 
consultation with the board of directors or the senior officer. Given 
the specified duties of the CCO set forth in Section 5b(i)(2), the 
Commission finds ample support for this interpretation and is adopting 
the rule as proposed.
    First, one definition of the term ``enforce'' is ``to ensure 
observance of laws and rules,'' \32\ and among the CCO duties set forth 
by the Dodd-Frank Act is the requirement that the CCO ``ensure 
compliance.'' \33\ Second, Section 5b(i)(2)(C) requires a CCO to 
``resolve any conflicts of interest that may arise'' in consultation 
with the board of the DCO or the senior officer of the DCO. This duty 
clearly indicates that the CCO is more than just an advisor to 
management and must have the ability to enforce compliance with the CEA 
and Commission regulations. The authority to resolve conflicts of 
interest is more an enforcement function than an audit function. 
Finally, Section 5b(i)(2)(D) requires the CCO to ``be responsible for 
administering each policy.''
---------------------------------------------------------------------------

    \32\ See http://www.websters-online-dictionary.org/definitions/enforce.
    \33\ See Section 5b(i)(2)(E) of the CEA, 7 U.S.C. 7a-
1(b)(i)(2)(E), which requires the CCO to ``ensure compliance with 
this Act (including regulations) relating to agreements, contracts, 
or transactions, including each rule prescribed by the Commission 
under this section.''
---------------------------------------------------------------------------

    While the CEA does not explicitly use the word ``enforce,'' the 
Commission believes that the use of this word in Sec.  39.10(c)(1) is 
appropriate to capture the meaning of Section 5b(i)(2)(C), i.e., that 
CCOs must have the authority to fulfill their statutory and regulatory 
obligations. Moreover, it is consistent with the statutory directive 
for the CCO to ensure compliance with the CEA. These considerations are 
particularly important given that the CCO of a DCO has unique 
responsibilities in connection with the DCO's critical role in 
providing financial integrity to derivatives markets. In particular, a 
CCO must have the ability to effectively address rules and practices 
that could compromise compliance with fair and open access requirements 
(Core Principle C), risk management

[[Page 69341]]

requirements (Core Principle D), and financial resource requirements 
(Core Principle B).
    The Commission, however, recognizes that the term ``enforce'' could 
imply that the DCO's CCO must have direct supervisory authority over 
employees not otherwise in his or her direct chain of command, or that 
the CCO has independent authority to discipline employees or terminate 
employment to facilitate compliance with the CEA and the Commission's 
regulations. To avoid confusion, the Commission herein clarifies that 
the term ``enforce,'' as used in Sec.  39.10(c)(1), is not intended to 
include the authority to supervise employees not in the CCO's direct 
chain of command, or the authority to terminate employment or 
discipline employees for conduct that results in noncompliance. The 
Commission notes that a DCO is not precluded from conferring such 
authority on its CCO; however, such action would be at the DCO's 
discretion and is not required by Sec.  39.10(c)(1).\34\
---------------------------------------------------------------------------

    \34\ See further discussion of a CCO's duties in section IV.A.7, 
below.
---------------------------------------------------------------------------

3. Individuals Qualifying To Serve as a CCO--Sec.  39.10(c)(1)(i)
    Proposed Sec.  39.10(c)(1)(i) would require a DCO to designate an 
individual with the background and skills appropriate for fulfilling 
the responsibilities of the CCO position. The Commission asked whether 
additional qualifications should be imposed and, in particular, whether 
the Commission should restrict the CCO position from being held by an 
attorney who represents the DCO or its board of directors, such as an 
in-house or general counsel. The Commission explained that the 
rationale for such a restriction would be based on concern that the 
interests of representing the DCO's board of directors or management 
could be in conflict with the duties of the CCO. Related to this, the 
Commission specifically sought comment on whether there is a need for a 
regulation requiring the DCO to insulate a CCO from undue pressure and 
coercion. It further asked if it is necessary to adopt rules to address 
the potential conflict between and among compliance interests, 
commercial interests, and ownership interests of a DCO and, if there is 
no need for such rules, requested comment on how such potential 
conflicts would be addressed.
    CME, OCC, MGEX, and the Kansas City Board of Trade Clearing 
Corporation (KCC) commented that additional restrictions should not be 
imposed. MGEX commented that smaller DCOs will need to maximize the 
utility of each employee. It also argued that there is little risk if a 
CCO serves as in-house counsel because attorneys have additional 
ethical duties which can complement the duties and obligations of a 
CCO. According to MGEX, if a conflict arose, the attorney could step 
out of one or both of the roles.
    Better Markets commented that there is potential conflict between a 
CCO and in-house counsel because in-house counsel is an advocate for 
the DCO or its board of directors regarding any controversy that may 
relate to regulatory compliance, while a CCO's duty is to ensure 
compliance. It suggested that the Commission prohibit a CCO from 
serving as in-house counsel.
    The Commission is adopting Sec.  39.10(c)(1)(i) as proposed. The 
Commission has considered prohibiting a CCO from working in the DCO's 
legal department or serving as general counsel, consistent with the 
Commission's approach to the CCO of an SDR.\35\ However, in response to 
public comments and in light of the fact that all currently registered 
DCOs have some form of compliance program already in place, with one or 
more staff members assigned to carry out compliance officer functions, 
the Commission has determined that the potential costs of hiring 
additional staff to satisfy such requirement could result in imposing 
an unnecessary burden on DCOs, particularly smaller ones. The 
Commission recognizes, however, that a conflict of interest could 
compromise a CCO's ability to effectively fulfill his or her 
responsibilities as a CCO. The Commission therefore expects that as 
soon as any conflict of interest becomes apparent, a DCO would 
immediately implement a back-up plan for reassignment or other measures 
to address the conflict and ensure that the CCO's duties can be 
performed without compromise.
---------------------------------------------------------------------------

    \35\ See 76 FR 54538 (Sept. 1, 2011) (SDRs: Registration 
Standards, Duties and Core Principles; final rule).
---------------------------------------------------------------------------

    MGEX and KCC also recommended that the Commission should permit the 
Chief Regulatory Officer to function as the CCO. Presumably, the 
commenters are referring to circumstances in which a DCO (which 
typically would not have a Chief Regulatory Officer) is also registered 
as a DCM (which typically would have a Chief Regulatory Officer). The 
Commission notes that the rule does not prohibit the person serving as 
CCO from also serving as the Chief Regulatory Officer.
4. CCO Reporting Structure--Sec.  39.10(c)(1)(ii)
    Section 5b(i)(2)(A) of the CEA requires that a CCO report directly 
to the board of directors or the senior officer of the DCO.\36\ 
Proposed Sec.  39.10(c)(1)(ii) would codify this requirement. The 
proposed rule also would require the board of directors or the senior 
officer to approve the compensation of the CCO.
---------------------------------------------------------------------------

    \36\ 7 U.S.C. 7a-1(i)(2)(A).
---------------------------------------------------------------------------

    In the notice of proposed rulemaking, the Commission sought comment 
as to the degree of flexibility that should be provided in the 
reporting structure of the CCO. Specifically, the Commission requested 
comment on: (i) Whether it would be more appropriate for a CCO to 
report to the senior officer or the board of directors; (ii) as between 
the senior officer or board of directors, which generally is a stronger 
advocate of compliance matters within an organization; and (iii) 
whether the proposed rules allow for sufficient flexibility with regard 
to a DCO's business structure.
    CME, MGEX, and KCC commented that the proposed rules would provide 
DCOs with the appropriate degree of flexibility. CME, however, believes 
it would be ``logical'' for a CCO to report to the senior officer, and 
that the board of directors should oversee implementation of compliance 
policies and ensure that compliance issues are resolved effectively and 
expeditiously by the senior officer with the assistance of the CCO. 
MGEX noted that each DCO may have a different business and reporting 
structure and believes that rigid rules may hinder the effectiveness 
and independence of the CCO.
    Better Markets observed that, in the past, businesses have placed 
financial interests over other considerations like risk management and 
have created a climate where people were unwilling to speak out against 
financial considerations for fear of being fired. Better Markets 
suggested that there should be a strong reporting and working 
relationship between the CCO and independent directors, and suggested 
that independent directors have sole responsibility to designate or 
terminate the CCO and to set compensation levels for the CCO.
    The Commission is adopting Sec.  39.10(c)(1)(ii) as proposed, 
declining to prescribe whether the CCO can only report to the board of 
directors or to the senior officer. The Commission appreciates Better 
Markets' concern that a CCO who reports to the senior officer may be 
swayed by financial

[[Page 69342]]

considerations. However, the Dodd-Frank Act permits alternative 
reporting structures and the Commission has not been presented with a 
compelling reason to conclude that the structure and operations of a 
DCO require the imposition of this limitation on the ability of a DCO's 
board and management to establish lines of authority appropriate to the 
particular DCO.
    CME asked the Commission to clarify that the term ``senior 
officer'' may apply to the senior officer of a division that is engaged 
in clearing activities. The Commission notes that Section 5b(i)(2)(A) 
of the CEA requires a CCO to ``report directly to the board or to the 
senior officer of the derivatives clearing organization.'' If the 
division engaged in clearing activities is the registered DCO, then the 
senior officer of that division would be the ``senior officer'' for 
purposes of this provision.
    Finally, Better Markets suggested that compliance should be 
addressed on an entire-group basis by a senior CCO. According to Better 
Markets, a single senior CCO should have overall responsibility for 
each affiliated and controlled entity, even if the individual entities 
within the group have CCOs. The final rules do not require a business 
organization to have a ``senior'' CCO as Better Markets suggested. The 
Commission believes this would be overly prescriptive and that a DCO 
should have the flexibility to manage compliance functions across 
divisions or affiliates to accommodate its particular organizational 
structure.
5. Annual Compliance Meeting--Sec.  39.10(c)(1)(iii)
    Proposed Sec.  39.10(c)(1)(iii) would require a CCO to meet with 
the board of directors or the senior officer at least once a year to 
discuss the effectiveness of the DCO's compliance policies and 
procedures, as well as the administration of those policies and 
procedures by the CCO. Better Markets suggested that a CCO meet with 
the board of directors at least quarterly. No comments were received on 
the proposed topics to be discussed at the annual meeting.
    The Commission is adopting Sec.  39.10(c)(1)(iii) in modified form. 
The final rule retains the requirement that the CCO meet with the board 
of directors or senior officer annually, but eliminates the required 
topics to be discussed at the meeting. As the Commission noted in the 
notice of proposed rulemaking, the requirement for an annual discussion 
would not preclude the board of directors or the senior officer from 
meeting with the CCO more frequently. While more frequent communication 
between the CCO and the DCO's board or senior officer may be desirable, 
the Commission has concluded that adopting requirements to that effect 
would be overly prescriptive. Similarly, upon further consideration, 
the Commission has concluded that the purpose of the meeting should be 
self-evident (i.e., compliance) and it is not necessary for the 
Commission, by regulation, to prescribe the business that must be 
conducted at that meeting.
6. Change in the Designation of the CCO--Sec.  39.10(c)(1)(iv)
    Proposed Sec.  39.10(c)(1)(iv) would require that a change in the 
designation of the individual serving as the CCO be reported to the 
Commission, in accordance with the requirements of proposed Sec.  
39.19(c)(4)(xi). The Commission received no comments on the proposed 
rule and is adopting the provision as proposed.\37\
---------------------------------------------------------------------------

    \37\ See discussion in section IV.J.5.h. (The Commission is 
adopting proposed Sec.  39.19(c)(4)(xi) as a renumbered Sec.  
39.19(c)(4)(ix)).
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7. Duties of the CCO--Sec.  39.10(c)(2)
    Section 5b(i)(2) of the CEA, added by Section 725(a) of the Dodd-
Frank Act, sets forth the duties of a CCO,\38\ and proposed Sec.  
39.10(c)(2) would codify those enumerated duties in paragraphs 
(c)(2)(i)-(vii).
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    \38\ 7 U.S.C. 7a-1(i)(2).
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    The Commission received comments on the CCO's duties from CME, KCC, 
and OCC. In general, the commenters expressed the view that the 
proposed regulations are too broad because they improperly provide the 
CCO with what CME calls ``senior management functions'' like enforcing 
and supervising compliance policies. Instead, the commenters believe 
that the role of a CCO is only to serve as an auditor who monitors 
compliance and informs senior management of noncompliance. The 
Commission has carefully considered the comments and is adopting the 
rule as proposed, except as discussed below.
    CME acknowledged that proposed Sec.  39.10(c)(2)(ii) mirrors the 
language in the Dodd-Frank Act. However, CME believes that Congress did 
not intend to mean ``resolve'' in the executive or managerial sense 
such that the CCO alone would examine the facts and determine and 
affect the course of action. CME believes that Congress intended the 
CCO to identify, advise, and escalate, as appropriate, and to assist 
senior management in resolving conflicts of interest.
    KCC also believes that the board of directors or senior officer 
should resolve any conflict of interest in consultation with the CCO. 
KCC commented that compliance policies and procedures should be 
administered by DCO staff and not by the CCO. According to KCC, a DCO's 
staff is most familiar with the day-to-day operations of the DCO and is 
in the best position to manage the policies and procedures. KCC 
believes that a CCO's role should be that of oversight of the DCO's 
compliance program and filing an annual report.
    The Commission disagrees with assertions that a CCO should only 
assist senior management in resolving conflicts of interest or that the 
board or senior management should resolve conflicts of interest in 
consultation with the CCO. Section 5b(i)(2)(C) of the CEA states that a 
CCO shall ``in consultation with the board of the derivatives clearing 
organization, a body performing a function similar to the board of the 
derivatives clearing organization, or the senior officer of the 
derivatives clearing organization, resolve any conflicts of interest 
that may arise.'' Given this express statutory direction, the 
Commission is not revising the proposed rule.
    The Commission points out that a CCO's duty to administer 
compliance policies and procedures is set forth in Section 5b(i)(2)(D) 
of the CEA. It requires a CCO to ``be responsible for administering 
each policy and procedure that is required to be established pursuant 
to this section.'' By administering compliance policies and procedures, 
a CCO is not required to perform staff functions that have compliance 
implications. Rather, the CCO is responsible for oversight of such 
functions.
    The Commission is revising Sec.  39.10(c)(2)(iii) to require a CCO 
to have the duty of ``[e]stablishing and administering written policies 
and procedures reasonably designed to prevent violation of the Act.'' 
This does not change the substance of the requirement or alter the 
implementation of the statutory standard, as it is consistent with 
Sec.  39.10(c)(1) which requires a CCO to ``develop * * * appropriate 
policies and procedures * * * to fulfill the duties set forth in the 
Act and Commission regulations.'' The Commission believes that the 
revised language eliminates the possibility of ambiguity and prevents 
too narrow a reading of the reference to policies and procedures that 
are ``required'' under the CEA.
    CME described as ``impracticable'' the proposed standard that a CCO 
must ''ensure'' a DCO's compliance and

[[Page 69343]]

suggested that an appropriate and ``achievable'' standard would be to 
require a CCO to put in place measures ``reasonably designed to ensure 
compliance'' with the CEA and Commission regulations.
    The Commission is revising Sec.  39.10(c)(2)(iv) in response to 
CME's comment. Although Section 5b(i)(2)(E) of the CEA requires a CCO 
to ``ensure'' compliance, the Commission agrees that a CCO cannot fully 
guarantee compliance because, as a practical matter, he or she will 
have to rely to some extent on information provided by other DCO 
employees or representatives of the DCO's service providers. 
Accordingly, Sec.  39.10(c)(2)(iv) is being modified to include as a 
duty of the CCO, ``[t]aking reasonable steps to ensure compliance with 
the Act and Commission regulations * * * '' (added text in italics). 
The Commission believes that this revision addresses CME's concern 
while retaining the emphasis on the CCO's actions rather than focusing 
on the nature of measures put in place by the CCO.\39\
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    \39\ See also 76 FR at 54584 (Sept. 1, 2011) (SDRs: Registration 
Standards, Duties and Core Principles; final rule) (adopting Sec.  
49.22(d)(4), which applies this standard to the CCO of an SDR).
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    CME recommended that the Commission revise proposed Sec.  
39.10(c)(2)(vi) to require a CCO to ``[e]stablish[] appropriate 
procedures [for] the handling, management response, remediation, 
retesting, and closing of noncompliance issues,'' and to eliminate the 
requirement that a CCO ``follow[]'' such procedures. According to CME, 
this is a function of senior management and Congress did not intend for 
a CCO to exercise senior management functions. OCC agrees with CME.
    Specifically, CME suggested that proposed Sec.  39.10(c)(2)(vi) be 
modified to eliminate the requirement that a CCO ``follow'' appropriate 
procedures because following procedures is a function of senior 
management. However, a CCO's performance of this ``senior management'' 
function is explicitly set forth in Section 5b(i)(2)(G) of the CEA, 
which states that ``[t]he chief compliance officer shall * * * 
establish and follow appropriate procedures for the handling, 
management response, remediation, retesting, and closing of 
noncompliance issues.'' The Commission does not believe that CME has 
provided a persuasive basis for its suggested modification of Sec.  
39.10(c)(2)(vi), and the Commission is adopting the provision as 
proposed.
    Finally, the Commission, on its own initiative, is revising Sec.  
39.10(c)(2)(vii) to eliminate the requirement that a CCO establish a 
compliance manual. While having a compliance manual is a good practice, 
incorporating this requirement into a regulation may be overly 
prescriptive and the Commission has concluded that a DCO should have 
discretion as to the vehicles through which it will carry out its 
compliance program.
8. Annual Report--Sec.  39.10(c)(3)
    Section 5b(i)(3) of the CEA, added by Section 725(b) of the Dodd-
Frank Act, requires a CCO to prepare an annual report that describes 
the DCO's compliance with the CEA, regulations promulgated under the 
CEA, and each policy and procedure of the DCO, including the code of 
ethics and conflicts of interest policies.\40\ Implementation of these 
statutory requirements was addressed at proposed Sec.  39.10(c)(3)(i), 
(c)(3)(ii)(A), and (c)(3)(v) and (v).
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    \40\ 7 U.S.C. 7a-1(i)(3).
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    With respect to proposed Sec.  39.10(c)(3)(i), CME suggested that 
the Commission eliminate it and KCC commented that the requirement for 
a DCO to show compliance with respect to the CEA and Commission 
regulations is ambiguous and overreaching. KCC also suggested that the 
scope of the annual report should not go beyond reviewing the DCO core 
principles and identifying the compliance policies and procedures that 
are in place to satisfy the core principles.
    Although paragraph (i) mirrors the language and requirements set 
forth in Section 5b(i)(3)(A)(i) of the CEA, to address CME's and KCC's 
comments, the Commission has decided to revise the language of 
Sec. Sec.  39.10(c)(3)(i) and (ii) to avoid submission of duplicative 
information and to clarify the scope of the annual report content 
requirements without altering the nature of the information that must 
be included in the report pursuant to the CEA. Final Sec.  39.10 
(c)(3)(i) requires that the annual report ``[c]ontain a description of 
the derivatives clearing organization's written policies and 
procedures, including the code of ethics and conflict of interest 
policies.'' Final Sec.  39.10 (c)(3)(ii) requires that the report '' 
[r]eview each core principle and applicable Commission regulations, and 
with respect to each: (A) Identify the compliance policies and 
procedures that are designed to ensure compliance with the core 
principle.'' The Commission notes that by specifying ``written'' 
policies and procedures, the rule more precisely establishes the scope 
of Sec.  39.10(c)(3)(i).
    Proposed Sec. Sec.  39.10(c)(3)(iii) and (c)(3)(iv) would require 
that the annual report list any material changes to compliance policies 
and procedures since the last annual report and describe the DCO's 
financial, managerial, and operational resources for compliance with 
the Act and Commission regulations, respectively. The Commission did 
not receive any comments on these provisions and is adopting Sec. Sec.  
39.10(c)(3)(iii) and (c)(3)(iv) as proposed.
    Proposed Sec.  39.10(c)(3)(v) would require that the annual report 
``[d]escribe any material compliance matters, including incidents of 
noncompliance, since the date of the last annual report and describe 
the corresponding action taken.'' CME suggested that the provision be 
revised to require that the annual report identify only material 
compliance issues that were not properly addressed by the DCO.
    The Commission is adopting Sec.  39.10(c)(3)(v) as proposed because 
receiving such information will enable the Commission to assess whether 
the DCO is addressing compliance matters effectively. It also will 
enable the Commission to become aware of possible future compliance 
issues across DCOs and to proactively identify best practices. An 
annual report that identifies only material compliance issues would not 
provide sufficient information.
    Finally, the Commission on its own initiative is not adopting 
proposed Sec.  39.10(c)(3)(vi) because information of this nature is 
not essential to the Commission's evaluation of the DCO's compliance 
program and, if it is relevant to a material compliance matter, it will 
be provided to the Commission pursuant to Sec.  39.10(c)(3)(v).
9. Submission of Annual Report to the Commission--Sec.  39.10(c)(4)
    Proposed Sec.  39.10(c)(4) would set forth the requirements for 
submitting an annual report to the Commission. Except as noted below, 
the Commission is adopting the rule as proposed.
    Better Markets suggested that the Commission change proposed Sec.  
39.10(c)(4)(i) to require a CCO to present the finalized annual report 
to the board of directors and executive management prior to its 
submission to the Commission. Better Markets also suggested that the 
independent directors as well as the entire board should be required to 
review and approve the report in its entirety and to detail any 
disagreement with any portion. In

[[Page 69344]]

addition, Better Markets commented that a CCO should be required to 
file the report with the Commission, either as approved or with 
statements of disagreement.
    The Commission is not revising proposed Sec.  39.10(c)(4)(i) per 
Better Markets' suggestion. The Commission believes that a DCO should 
have the flexibility to determine whether the annual report will be 
provided to the board of directors, the senior officer, or both. The 
Commission also is not requiring the board of directors to approve or 
submit comments on the report given that the board of directors might 
not have sufficient information to approve or disagree with the report. 
In addition, there is a risk that the board might try to influence the 
CCO to change the report if it were required to express approval. The 
Commission notes that the rules do not prohibit the board, any of its 
members, or the senior officer from approving or disagreeing with 
aspects of the annual report.
    Proposed Sec.  39.10(c)(4)(ii) would require that the annual report 
include a certification by the CCO that, to the best of his or her 
knowledge and reasonable belief, and under penalty of law, the annual 
report is accurate and complete. CME commented that the Commission 
should require the DCO's senior officer, and not the CCO, to make the 
necessary certification in the annual compliance report. According to 
CME, ``the best way to achieve the goal of a robust effective 
compliance program, and to close the loop on creating a culture of 
compliance, is to require the registrant's senior officer--and not the 
CCO--to complete the required certification.''
    KCC commented that a CCO should not have to certify ``under penalty 
of law'' that the annual report is accurate and complete, and a CCO 
should certify instead that to the best of his or her knowledge and 
belief the annual report is accurate and complete.
    The Commission is adopting Sec.  39.10(c)(4)(ii) as proposed. The 
CEA requires (1) the CCO to sign the annual report and (2) that the 
annual report contain a certification that, under penalty of law, the 
compliance report is accurate and complete.\41\ Accordingly, the 
Commission believes the regulation accurately reflects Congressional 
intent.
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    \41\ See Section 5b(i)(3)(B)(ii) of the CEA, 7 U.S.C. 7a-
1(i)(3)(B)(ii).
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10. Annual Report Confidentiality
    CME suggested that Commission regulations should expressly state 
that annual reports are confidential documents that are not subject to 
public disclosure by listing annual reports as a specifically exempt 
item in part 145 of the Commission's regulations. The Commission has 
not proposed and is not adopting CME's proposal, which would provide 
blanket confidentiality to all annual reports submitted by CCOs of 
DCOs, even though the Commission may determine that there is 
information contained in a report that should be public. Accordingly, a 
DCO must petition for confidential treatment of its annual report under 
Sec.  145.9 if it wants the Commission to determine that a particular 
annual report should be subject to confidentiality.
11. Insulating the CCO From Undue Influence
    The notice of proposed rulemaking solicited comments as to whether 
the Commission should adopt regulations that require a DCO to insulate 
its CCO from undue pressure and coercion. CME commented that the 
current regulations are sufficient to protect a CCO from undue 
influence and it does not believe additional regulations are necessary. 
The Commission agrees with CME and is not adopting such regulations.
12. Recordkeeping--Sec.  39.10(c)(5)
    Proposed Sec.  39.10(c)(5) would require a DCO to maintain: (i) A 
copy of the policies and procedures adopted in furtherance of 
compliance with the CEA and Commission regulations; (ii) copies of 
materials, including written reports provided to the board of directors 
or the senior officer in connection with review of the annual report; 
and (iii) any records relevant to the DCO's annual report, including 
work papers and financial data. The DCO would be required to maintain 
these records in accordance with Sec.  1.31 and proposed Sec.  39.20. 
The Commission did not receive any comment letters discussing proposed 
Sec.  39.10(c)(5). The Commission has adopted Sec.  39.10(c)(5) as 
proposed, except that the Commission has modified Sec.  39.10(c)(5)(A) 
to refer to ``all compliance policies and procedures'' rather than 
``the compliance policies and procedures, as defined in Sec.  39.1(b)'' 
in light of the Commission's decision not to adopt a definition of 
compliance policies and procedures, as discussed in section III.B, 
above.

B. Core Principle B--Financial Resources--Sec.  39.11

    Core Principle B,\42\ as amended by the Dodd-Frank Act, requires a 
DCO to possess financial resources that, at a minimum, exceed the total 
amount that would enable the DCO to meet its financial obligations to 
its clearing members notwithstanding a default by the clearing member 
creating the largest financial exposure for the DCO in extreme but 
plausible market conditions and to cover its operating costs for a 
period one year, as calculated on a rolling basis. Proposed Sec.  39.11 
would codify these requirements. The Commission received a total of 18 
comments on the proposed regulations. The Commission considered each of 
these comments in formulating the final regulations discussed below.
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    \42\ Section 5b(c)(2)(B) of the CEA, 7 U.S.C. 7a-1(c)(2)(B).
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1. Amount of Financial Resources Required--Sec. Sec.  39.11(a) and 
39.11(b)(3)
    Proposed Sec.  39.11(a)(1) would require a DCO to maintain 
sufficient financial resources to meet its financial obligations to its 
clearing members notwithstanding a default by the clearing member 
creating the largest financial exposure for the DCO in extreme but 
plausible market conditions, and proposed Sec.  39.11(a)(2) would 
require a DCO to maintain sufficient financial resources to cover its 
operating costs for at least one year, calculated on a rolling basis. 
Proposed Sec.  39.11(b)(3) would allow a DCO to allocate a financial 
resource, in whole or in part, to satisfy the requirements of either 
proposed Sec.  39.11(a)(1) or proposed Sec.  39.11(a)(2), but not both, 
and only to the extent that use of that financial resource is not 
otherwise limited by the CEA, Commission regulations, the DCO's rules, 
or any contractual arrangements to which the DCO is a party.
    The Futures Industry Association (FIA) recommended that all DCOs be 
required to maintain resources sufficient to withstand the default of 
the two clearing members representing the largest financial exposure to 
the DCO, but that the Commission give DCOs reasonable time to come into 
compliance with the enhanced requirement.
    The International Swaps and Derivatives Association (ISDA) also 
suggested that, in the clearing of certain OTC derivatives such as 
eligible credit default swaps and interest rate swaps, a DCO should 
have sufficient financial resources that, at a minimum, enable it to 
withstand a potential default by two of its largest clearing members, 
as measured by the two clearing members with the largest obligations to 
the DCO in extreme but plausible market conditions. ISDA further 
suggested, however, that this heightened financial resource level may 
not be appropriate for all other OTC or other derivatives products, and 
offered to work with the Commission to determine the

[[Page 69345]]

appropriate standard for derivatives in other asset classes.
    Similarly, Mr. Chris Barnard recommended that consideration be 
given to differentiating risk, and therefore resource requirements by 
broad derivative/product class, or at least by exchange-traded and OTC 
derivative types.
    Better Markets suggested that the default rate used in the stress 
test for DCOs should be the larger of (1) the member representing the 
largest exposure to the DCO, and (2) the members constituting at least 
25 percent of the exposures in aggregate to the DCO. Americans for 
Financial Reform (AFR) stated that the calculation in proposed Sec.  
39.11(a)(1) should be based on risk exposure as well as number of 
defaults.
    LCH.Clearnet Group Limited (LCH) concurred with all the provisions 
set forth by the Commission under proposed Sec.  39.11(a). NYPC also 
expressed support for proposed Sec. Sec.  39.11(a)(1) and 39.11(a)(2).
    The Commission is adopting Sec.  39.11(a) as proposed. Section 
39.11(a) is consistent with Core Principle B as amended by the Dodd-
Frank Act. As the Commission noted in its notice of proposed 
rulemaking, Sec.  39.11(a)(1) is also consistent with the Bank for 
International Settlements' Committee on Payment and Settlement Systems 
and the Technical Committee of the International Organization of 
Securities Commissions (CPSS-IOSCO) Recommendations for Central 
Counterparties (CCPs), issued in 2004 (2004 CPSS-IOSCO 
Recommendations).\43\ The Commission recognizes that those 
recommendations eventually will be replaced by the Principles for 
Financial Market Infrastructures (FMIs), which are currently being 
developed by CPSS and IOSCO and are expected to be finalized in 
2012.\44\ For financial resources requirements for CCPs, CPSS and IOSCO 
are considering three alternatives: (1) A ``cover one'' minimum 
requirement for all CCPs; (2) a ``cover two'' minimum requirement for 
all CCPs; and (3) either a ``cover one'' or a ``cover two'' minimum 
requirement for a particular CCP, depending upon the risk and other 
characteristics of the particular products it clears, the markets it 
serves, and the number and type of participants it has.\45\ The 
Commission may reconsider Sec.  39.11(a)(1) once CPSS and IOSCO have 
finished their work.
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    \43\ See Bank for International Settlements' Committee on 
Payment and Settlement Systems and Technical Committee of the 
International Organization of Securities Commissions, 
``Recommendations for Central Counterparties,'' CPSS Publ'n No. 64 
(November 2004), available at http://www.bis.org/publ/cpss64.pdf.
    \44\ See Bank for International Settlements' Committee on 
Payment and Settlement Systems and Technical Committee of the 
International Organization of Securities Commissions, ``Principles 
for financial market infrastructures: Consultative report,'' CPSS 
Publ'n No. 94 (March 2011), available at http://www.bis.org/publ/cpss94.pdf (CPSS-IOSCO Consultative Report).
    \45\ CPSS-IOSCO Consultative Report, Principle 4: Credit Risk, 
at 30.
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    MGEX noted that proposed Sec.  39.11(b)(3) would prohibit a DCO 
from using a financial resource for both default and operating cost 
purposes. While MGEX agreed this seems a logical approach to take to 
avoid counting an asset's value for two different purposes, MGEX stated 
that there are practical implications to consider. As a DCM and DCO, 
MGEX keeps one basic set of financial records that are compliant with 
various accounting standards. MGEX recommended that the Commission's 
proposal should not be interpreted to require a DCO to formally divide 
some assets and accounts. The Commission confirms that Sec.  
39.11(b)(3) does not require a DCO to formally divide its assets or 
accounts. The Commission is adopting Sec.  39.11(b)(3) as proposed.
2. Treatment of Affiliated Clearing Members--Sec.  39.11(a)(1)
    Proposed Sec.  39.11(a) would state, in part: ``A [DCO] shall 
maintain financial resources sufficient to cover its exposures with a 
high degree of confidence and to enable it to perform its functions in 
compliance with the core principles set out in Section 5b of the [CEA] 
* * * Financial resources shall be considered sufficient if their 
value, at a minimum, exceeds the total amount that would: (1) Enable 
the [DCO] to meet its financial obligations to its clearing members 
notwithstanding a default by the clearing member creating the largest 
financial exposure for the [DCO] in extreme but plausible market 
conditions; Provided that if a clearing member controls another 
clearing member or is under common control with another clearing 
member, the affiliated clearing members shall be deemed to be a single 
clearing member for purposes of this provision * * * ''
    In the notice of proposed rulemaking, the Commission stated: 
``There may be some instances in which one clearing member controls 
another clearing member or in which a clearing member is under common 
control with another clearing member. The Commission proposes to treat 
such affiliated clearing members as a single entity for purposes of 
determining the largest financial exposure because the default of one 
affiliate could have an impact on the ability of the other to meet its 
financial obligations to the DCO. However, to the extent that each 
affiliated clearing member is treated as a separate entity by the DCO, 
with separate capital requirements, separate guaranty fund obligations, 
and separate potential assessment liability, the Commission requests 
comment on whether a different approach might be warranted.''
    CME noted that it treats affiliated clearing members as separate 
entities, with separate capital requirements, separate guaranty fund 
obligations, and separate potential assessment liability. While CME 
acknowledged that the default of one affiliate may impact the ability 
of another affiliated clearing member to meet its financial obligations 
to the DCO, CME suggested that circumstances may exist in which a 
clearing member is sufficiently independent to continue operating 
notwithstanding a default by an affiliate. CME rules allow, but do not 
require, emergency action to be taken against a clearing member based 
upon the financial or operational condition of an affiliate (whether or 
not that affiliate is also a clearing member). CME urged the Commission 
to take a similar approach by revising the language of proposed Sec.  
39.11(a) to state that ``if a clearing member controls another clearing 
member or is under common control with another clearing member, the 
affiliated clearing members may be deemed to be a single clearing 
member * * *.''
    LCH agreed with the Commission's proposed requirement that the DCO 
must treat any clearing member, either controlled by another clearing 
member or under common control with another clearing member, as a 
single clearing member for the purposes of Sec.  39.11(a)(1).
    The Commission is adopting Sec.  39.11(a)(1) as proposed. The 
Commission believes this treatment appropriately addresses the 
potential risks of affiliates. The Commission notes that aggregating 
the potential losses of affiliated clearing members for purposes of 
this calculation would provide more coverage in the event of a default.
3. Operating Costs--Sec.  39.11(a)(2)
    Proposed Sec.  39.11(a)(2) would require a DCO to maintain 
sufficient financial resources to cover its operating costs for at 
least one year, calculated on a rolling basis.
    OCC commented that while the statutory requirement that a DCO have 
one year of operating costs, based on a rolling period, may be a 
reasonable

[[Page 69346]]

standard to ensure that a DCO is not forced out of business while there 
is still open interest in the contracts it clears, the requirement 
should be calculated based on essential operating expenses for the 
rolling period. According to OCC, an appropriate wind-down budget would 
include projected revenues during the wind-down and would not include 
expenses associated with activities having value only to a DCO that 
intends to remain in business (e.g., product development, technological 
enhancements, lobbying activities, investor education, etc.).
    ISDA stated that it is appropriate that a DCO hold equity capital 
sufficient to cover its operating costs and likely exit costs during 
any liquidation and this capital should be separate from any DCO equity 
contribution to the required default resources.
    Eurex Clearing AG (Eurex) agreed that having a requirement for 
operating resources is reasonable, especially in view of the 
flexibility implied in the Commission's proposed rules for types of 
financial resources, but cautioned that the one-year time frame may be 
unnecessarily long.
    FIA supported this aspect of the Commission's proposal, including 
the requirement that a DCO not be permitted to ``double-count'' its 
resources to cover both this and the default resources requirement.
    The Commission is adopting Sec.  39.11(a)(2) as proposed. The 
Commission notes that the language in Sec.  39.11(a)(2) is virtually 
identical to that of Core Principle B.

4. Types of Financial Resources--Sec.  39.11(b)

    Proposed Sec.  39.11(b)(1) lists the types of financial resources 
that would be available to a DCO to satisfy the requirements of 
proposed Sec.  39.11(a)(1): (1) The margin of the defaulting clearing 
member; (2) The DCO's own capital; (3) the guaranty fund deposits of 
the defaulting clearing member and non-defaulting clearing members; (4) 
default insurance; (5) if permitted by the DCO's rules, potential 
assessments for additional guaranty fund contributions on non-
defaulting clearing members; and (6) any other financial resource 
deemed acceptable by the Commission. Proposed Sec.  39.11(b)(2) lists 
the types of financial resources that would be available to a DCO to 
satisfy the requirements of proposed Sec.  39.11(a)(2): (1) The DCO's 
own capital and (2) any other financial resource deemed acceptable by 
the Commission.
    In the notice of proposed rulemaking, the Commission noted that a 
DCO would be able to request an informal interpretation from Commission 
staff on whether or not a particular financial resource may be 
acceptable to the Commission. The Commission also invited commenters to 
recommend particular financial resources for inclusion in the final 
regulation.
    ISDA encouraged the Commission to give prudent consideration to the 
use of standby letters of credit as an additional financial resource, 
given that many letter-of-credit issuing banks will be an affiliate of 
a clearing member.
    Natural Gas Exchange Inc. (NGX) requested that the Commission 
consider the acceptability of letters of credit as an asset of the 
guaranty fund and clarify in the final rule that letters of credit are 
acceptable as an asset of the guaranty fund if subject to certain 
safeguards. NGX also requested that the Commission make clear in the 
final regulation that it will interpret proposed Sec. Sec.  
39.11(b)(1)(vi) and 39.11(b)(2)(ii) broadly so as to permit a 
demonstration, on a case-by-case basis, that a DCO meets the overall 
policies of the regulation through a specific mix of financial 
resources.
    Mr. Barnard recommended splitting the types of financial resources 
permitted under proposed Sec.  39.11(b)(1) into two classes: Class A 
would consist of the financial resources listed in paragraphs (b)(i) 
through (b)(iii), and would be required to make up the significant part 
of the total financial resources, and class B would consist of the 
financial resources listed in paragraphs (b)(iv) through (b)(vi), on 
which larger prudential haircuts would be required. MGEX suggested that 
proposed Sec.  39.11(b)(2) should retain the ability for a DCO to 
provide its explanation and methodology for including a particular 
financial resource. MGEX further suggested that the list of potential 
financial resources should be broad and not pruned too quickly, 
particularly by initial regulation.
    Eurex commented that the Commission's proposed list of financial 
resources in proposed Sec.  39.11(b)(1) is appropriate.
    The Commission is adopting Sec.  39.11(b) as proposed, except for a 
technical amendment to clarify the scope of the use of margin as a 
financial resource to cover a default. As proposed, the Commission is 
not including letters of credit as an acceptable financial resource 
because they are only a promise by a bank to pay and not an asset that 
can be sold.\46\ However, both Sec.  39.11(b)(1) and Sec.  39.11(b)(2) 
permit ``any other financial resource deemed acceptable by the 
Commission,'' which means that the Commission could evaluate the use of 
letters of credit on a case-by-case basis.\47\
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    \46\ The Commission recognizes that assessment powers are also a 
promise to pay, but as the Commission noted in the notice of 
proposed rulemaking, a clearing member may have a strong financial 
incentive to pay an assessment. If a clearing member failed to pay 
its assessment obligation, that failure would be treated as a 
default and the clearing member would be subject to liquidation of 
its positions and forfeiture of the margin in its house account. 
Thus, in addition to a potential general interest in maintaining the 
viability of the DCO going forward, a non-defaulting clearing member 
may have a specific incentive to pay an assessment, depending on the 
size and profitability of its positions and the margin on deposit 
relative to the size of the assessment.
    \47\ See discussion of the prohibition on accepting letters of 
credit as initial margin in section IV.F.5, below.
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    The Commission also received inquiries from a few DCOs as to 
whether the Commission would deem projected revenue an acceptable 
financial resource to satisfy the requirements of Sec.  39.11(a)(2). 
The Commission expects that projected revenue generally would be deemed 
acceptable for established DCOs that can demonstrate a historical 
record of revenue, but not for DCO applicants or relatively new DCOs 
with no such record.
    With respect to any financial resource that is not enumerated in 
Sec.  39.11(b) and for which a DCO seeks a determination as to its 
acceptability based on the DCO's particular circumstances, DCO staff 
should contact Commission staff prior to submitting the DCO's quarterly 
financial resources report.
    The Commission is modifying Sec.  39.11(b)(1)(i) to more precisely 
reflect the fact that the use of margin as a financial resource 
available to satisfy the requirements of paragraph (a)(1) is subject to 
limitations imposed by the Commission and a DCO, e.g., relating to the 
use of customer margin to cover a default. As proposed, Sec.  
39.11(b)(1)(i) would permit the use of ``[m]argin of a defaulting 
clearing member.'' The provision now refers to ``[m]argin to the extent 
permitted under parts 1, 22, and 190 of this chapter and under the 
rules of the derivatives clearing organization.''
5. Capital Requirement
    Proposed Sec. Sec.  39.11(b)(1) and (b)(2) list the DCO's own 
capital as a type of financial resource that would be available to a 
DCO to satisfy the requirements of proposed Sec. Sec.  39.11(a)(1) and 
(a)(2), respectively. In the notice of proposed rulemaking, the 
Commission noted that Commission regulations do not prescribe capital 
requirements for DCOs. The Commission invited

[[Page 69347]]

comment on whether it should consider adopting such requirements and if 
so, what those requirements should be.
    J.P. Morgan Chase & Co. (J.P. Morgan) commented that if a DCO 
enumerates its own capital as part of its waterfall, that DCO should be 
required to provide sufficient assurances that the capital will be 
available to meet those obligations and will not be reallocated to 
serve other purposes at the DCO's discretion. In a separate comment 
letter on the proposed risk management requirements for DCOs, J.P. 
Morgan offered its support for regulations that would require a DCO to 
retain in a segregated deposit account, on a rolling basis, 50 percent 
of its earnings from the previous 4 years. In addition, J.P. Morgan 
stated that it would be appropriate for at least 50 percent of the 
retained earnings to have a first loss position. J.P. Morgan also 
recommended that the DCO contribution be subject to a minimum floor of 
$50 million.
    Mr. Michael Greenberger recommended that the Commission require 
DCOs to set aside a reasonable amount of capital, equal to an average 
size of one contract for that DCO, so that a DCO would have sufficient 
financial resources to absorb a default. In addition, Mr. Greenberger 
suggested that capital requirements for DCOs must require that the 
DCOs' capital be highly liquid so that a DCO can cure a default in a 
timely manner.
    Eurex noted that clearing organizations exhibit a variety of 
organizational and capital structures and suggested the Commission 
should allow DCOs to determine their own mixes of protective measures, 
which might include the DCO's own capital. Nevertheless, Eurex 
expressed support for an initial capital requirement of $25 million for 
DCOs.
    OCC commented that an equity capital requirement for DCOs is not 
appropriate because DCOs rely primarily on member-supplied resources, 
such as clearing fund deposits and margin, to meet their obligations. 
According to OCC, most, if not all, DCOs have little capital in 
relation to their obligations. OCC suggested that the critical question 
from a safeness and soundness standpoint is whether DCOs have adequate 
financial resources, not the form in which such resources are held.
    CME stated that the financial resources requirements contained in 
Core Principle B are better suited to achieve the goal of ensuring 
adequate capitalization of DCOs, and that further capital requirements 
would be unnecessary and essentially duplicative.
    KCC commented that, with proposed Sec.  39.11(a)(1) requiring a DCO 
to maintain sufficient financial resources to meets its financial 
obligations, a separate capital requirement would be redundant. KCC 
also stated that onerous capital requirements placed on DCOs could have 
an anti-competitive effect.
    NYPC cautioned that mandating that DCOs hold specific forms or 
amounts of capital could have a chilling effect on competition, at odds 
with the principles of the CEA by potentially shutting out various 
forms of organizational structures for DCOs. NYPC noted that Core 
Principle B requires that DCOs maintain sufficient financial resources 
to perform their functions as central counterparties in compliance with 
the CEA. NYPC suggested that whether such financial resources are 
derived from a DCO's own capital or other financial resources deemed 
acceptable to the Commission should be inconsequential to the extent 
such statutorily prescribed functions are fulfilled.
    MGEX stated that it does not support adopting specific capital 
requirements for DCOs. MGEX noted that the proposed regulation already 
requires a DCO to be able to withstand the default of its largest 
clearing member in extreme but plausible market conditions. MGEX 
further noted that a DCO's capital is only one element of the financial 
resources necessary to cover that risk, and suggested that a DCO should 
be able to determine how it best needs to allocate that risk among its 
various financial resources.
    The Commission is not adopting a capital requirement for DCOs at 
this time. The Commission believes that it is appropriate to provide 
flexibility to DCOs in designing their financial resources structure so 
long as the aggregate amount is sufficient. The Commission notes, 
however, that one of the principles in the CPSS-IOSCO Consultative 
Report would require an FMI to ``hold sufficiently liquid net assets 
funded by equity to cover potential general business losses so that it 
can continue providing services as a going concern.'' \48\ CPSS and 
IOSCO are considering, and requesting comment on, the establishment of 
a specific minimum quantitative requirement for liquid net assets 
funded by equity. If such a requirement is established, the Commission 
may consider a similar requirement for DCOs at that time.
---------------------------------------------------------------------------

    \48\ See CPSS-IOSCO Consultative Report, Principle 15: General 
Business Risk, at 70.
---------------------------------------------------------------------------

6. Assessments--Sec. Sec.  39.11(b)(1)(v) and 39.11(d)(2)
    Proposed Sec.  39.11(b)(1)(v) would list ``potential assessments 
for additional guaranty fund contributions, if permitted by the [DCO]'s 
rules'' as a type of financial resource that would be available to a 
DCO to satisfy the requirements of proposed Sec.  39.11(a)(1). Proposed 
Sec.  39.11(d)(2) would require a DCO: (i) To have rules requiring that 
its clearing members have the ability to meet an assessment within the 
time frame of a normal variation settlement cycle; (ii) to monitor, on 
a continual basis, the financial and operational capacity of its 
clearing members to meet potential assessments; (iii) to apply a 30 
percent haircut to the value of potential assessments; and (iv) to only 
count the value of assessments, after the haircut, to meet up to 20 
percent of its default resources requirement. The Commission requested 
comment on whether these limits and requirements are appropriate and, 
more generally, whether assessment powers should be considered to be a 
financial resource available to satisfy the requirements of proposed 
Sec.  39.11(a)(1).
    With regard to proposed Sec. Sec.  39.11(d)(2)(i) and (ii), OCC 
commented that the requirement that clearing members be able to meet an 
assessment within the time frame of a normal variation settlement cycle 
is an aggressive but appropriate standard that its clearing members 
would be able to meet in most circumstances, but that DCOs should have 
discretion to extend this deadline on a case-by-case basis where 
appropriate to avoid severe strains on clearing member liquidity in 
unusual circumstances. OCC objected to the requirement that DCOs must 
monitor ``on a continual basis'' a clearing member's ability to meet 
potential assessments, which OCC claimed is overly burdensome and 
difficult to administer. OCC suggested that a monthly review is 
reasonable and adequate.
    NYPC requested that the Commission clarify how the requirement of 
proposed Sec.  39.11(d)(2)(i) would be imposed on DCOs that conduct 
both end-of-day and intraday settlements each business day. In order to 
ensure that a uniform standard is applied across clearing members of 
all DCOs, whether the DCO conducts one or two settlements per business 
day, NYPC recommended that the Commission clarify that a DCO's rules 
should require clearing members to have the ability to meet an 
assessment within one business day.
    With regard to proposed Sec.  39.11(d)(2)(ii), NYPC requested that

[[Page 69348]]

the Commission provide guidance as to how it expects DCOs to determine 
whether a clearing member has the capacity to meet a potential 
assessment. In addition, NYPC expressed concern that the ``continual'' 
monitoring of clearing members' ability to meet potential assessments, 
which NYPC believes implies daily or even real-time monitoring, would 
be extremely difficult, if not impossible, to administer. NYPC 
suggested that it would be reasonable and more practicable for the 
Commission to require that monitoring of clearing members' ability to 
meet potential assessments be included as a mandatory component of the 
periodic financial reviews of clearing members that DCOs already 
conduct in the ordinary course of business.
    In response to these comments, the Commission is revising Sec.  
39.11(d)(2)(i) to read as follows (added text in italics): ``The 
derivatives clearing organization shall have rules requiring that its 
clearing members have the ability to meet an assessment within the time 
frame of a normal end-of-day variation settlement cycle.'' In response 
to OCC's comment, the Commission notes that Sec.  39.11(d)(2)(i) 
requires a DCO to have rules requiring that its clearing members have 
the ability to meet an assessment within the time frame of a normal 
end-of-day variation settlement cycle, but would permit a DCO, in its 
discretion, to provide some flexibility to clearing members as to 
timing.
    In addition, the requirement in Sec.  39.11(d)(2)(ii) that a DCO 
must monitor the financial and operational capacity of its clearing 
members to meet potential assessments ``on a continual basis'' was 
intended to mean only that the DCO must perform such monitoring often 
enough to enable it to become aware of any potential problems in a 
timely manner. To eliminate possible ambiguity, the Commission is 
revising the final rule by removing the phrase ``on a continual 
basis.'' Thus, Sec.  39.11(d)(2)(ii) establishes a standard whereby a 
DCO must monitor its clearing members, but the DCO can meet the 
standard through the exercise of its judgment in response to particular 
circumstances, e.g., a DCO might have reason to evaluate certain 
clearing members on a daily basis and evaluate others only as part of 
routine, periodic financial reviews.
    With regard to proposed Sec. Sec.  39.11(d)(2)(iii), FIA commented 
that the 30 percent haircut and 20 percent cap are reasonable and 
prudent safeguards, sufficient to ensure that a DCO does not unduly 
rely on its assessment power. J.P. Morgan supported the proposal and 
also recommended that regulators adopt a risk-based analysis to 
determine the likelihood that a clearing member will be able to meet 
its assessment obligations across all DCOs. Mr. Greenberger, citing 
J.P. Morgan's comments, agreed that it is absolutely critical that the 
Commission promulgate rules that would determine a clearing member's 
risk of default and its availability of financial resources across all 
clearinghouses. Similarly, ISDA suggested that the Commission evaluate 
the potential impact of multiple assessments from different DCOs on the 
same clearing member or affiliate group in a short time-frame.
    CME suggested that a DCO should be required to completely exclude 
the potential defaulting firm's assessment liability in calculating its 
available assessment resources. CME also commented that, in light of 
the requirements of proposed Sec. Sec.  39.11(d)(2)(i) and (ii), and 
the fact that a clearing member that failed to pay an assessment would 
itself be in default to the DCO, it does not believe that a further 
haircut on assessments is necessary, and it is aware of no valid reason 
to cap the use of assessments at 20 percent as proposed.
    KCC noted that the inclusion of assessment powers as financial 
resources is necessary for it to meet its obligations in the unlikely 
event of a default. KCC agreed that a reasonable haircut on the value 
of a DCO's assessment power may be a prudent measure, but stated that 
the proposed limits are unreasonable and excessive and seem arbitrary. 
KCC suggested that a better approach would be for the DCO to be allowed 
the latitude to determine clearing member assessment haircuts on an 
individual basis, based on each clearing member's financial 
capabilities.
    MGEX recommended that the Commission allow each DCO to provide its 
methodology and support for why any assessment might be considered a 
financial resource and how much. MGEX stated that the 30 percent 
haircut and 20 percent cap seem arbitrary and prescriptive. MGEX stated 
that the DCO should have the discretion to determine an appropriate 
haircut based on the clearing member's liquidity.
    Better Markets commented that the proposed haircuts for assessments 
are inadequate. According to Better Markets, it would be far more 
prudent to require funding of risk that can be anticipated in stress 
tests and rely on assessments as a financial resource only for 
conditions that are not anticipated in stress tests.
    LCH recommended that potential assessments not be allowed to 
satisfy the requirements of proposed Sec.  39.11(a)(1) because, in 
LCH's view, it is of the utmost importance that a DCO's resources 
following a clearing member default be immediately and unconditionally 
available. LCH suggested that assessments should be allowed as part of 
the DCO's ``waterfall'' of protections, but should not be taken into 
account to meet the specific test outlined under proposed Sec.  
39.11(a)(1).
    AFR urged the Commission to prohibit DCOs from including assessment 
powers in their calculation of financial resources because it is 
unclear, in a time of broad market distress, whether a DCO's members 
would be willing and able to pay their assessments.
    The Commission is adopting Sec.  39.11(d)(2)(iii) as proposed. In 
view of the wide range of comments on this issue, the Commission 
believes the rule strikes an appropriate balance. The 30 percent 
haircut recognizes that the defaulting firm, which by definition will 
not be paying an assessment, might represent a significant segment of 
the DCO's total risk. The 20 percent cap recognizes that given the 
contingent nature of assessments, they should only be relied upon as a 
last resort. In response to ISDA's comment, the Commission expects that 
as part of the evaluation of a clearing member's risk profile, a DCO 
would take into consideration the potential exposure of the clearing 
member at other DCOs, to the extent that it is able to obtain such 
information, including the possibility of assessments. The Commission 
notes, in response to MGEX's and KCC's comments, that a DCO may 
determine clearing member assessment haircuts on an individual basis 
because Sec.  39.11(d)(2)(iii) only requires a 30 percent haircut on an 
aggregate basis.
7. Computation of the Financial Resources Requirement--Sec.  
39.11(c)(1)
    Proposed Sec.  39.11(c)(1) would require a DCO to perform stress 
testing on a monthly basis in order to make a reasonable calculation of 
the financial resources it needs to meet the requirements of proposed 
Sec.  39.11(a)(1). The DCO would have reasonable discretion in 
determining the methodology used to make the calculation, but would be 
required to take into account both historical data and hypothetical 
situations. In the notice of proposed rulemaking, the Commission 
requested comment on whether monthly tests are appropriate.
    MGEX commented that monthly reporting seems reasonable as it 
already

[[Page 69349]]

performs stress tests on a routine basis. MGEX further commented that 
allowing DCOs discretion in selecting stress test scenarios is 
appropriate.
    CME suggested that annual stress testing would suffice for 
operating costs because operating costs are generally static. With 
regard to default coverage, CME suggested that stress testing should be 
done no less than monthly.
    LCH expressed concern over the requirement that the DCO perform 
stress testing only on a monthly basis. In LCH's view, stress testing 
should be carried out by the DCO on at least a daily basis, and LCH 
strongly urged the Commission to amend its proposal accordingly. LCH 
suggested that monthly stress testing is inadequate, as experience has 
shown that market conditions and member positions can change rapidly 
during periods of market turmoil.
    ISDA suggested that reverse stress tests \49\ should be required 
for determining the size of the financial resources package and that 
there should be public disclosure of the stress tests and their 
results.
---------------------------------------------------------------------------

    \49\ Reverse stress tests are stress tests that require a firm 
to assess scenarios and circumstances that would render its business 
model unviable, thereby identifying potential business 
vulnerabilities. Reverse stress testing starts from an outcome of 
business failure and identifies circumstances where this might 
occur. This is different from general stress testing, which tests 
for outcomes arising from changes in circumstances. See http://www.fsa.gov.uk/pages/About/What/International/stress_testing/firm_s/reverse_stress_testing/index.shtml.
---------------------------------------------------------------------------

    Mr. Barnard agreed that stress testing should be carried out at 
least monthly, and suggested that back testing should be carried out 
daily. Mr. Barnard also suggested that the Commission specifically 
refer to reverse stress testing in proposed Sec.  39.11(c)(1) because, 
in his view, it is a useful tool for managing expectations and for 
helping the DCO to anticipate financial resources requirements in 
extreme conditions.
    FIA recommended that the Commission make clear its expectation that 
the DCOs will, at a minimum: (1) Conduct a range of stress tests that 
reflect the DCO's product mix; (2) include the most volatile periods 
that have been experienced by the markets for which the DCO provides 
clearing services; (3) take into account the distribution of cleared 
positions between clearing members and their customers; and (4) test 
for unanticipated levels of volatility and for breakdowns in 
correlations within and across product classes.
    Mr. Greenberger recommended that historical market data that led up 
to the passage of the Dodd-Frank Act be taken into account in 
determining market conditions that could be defined as extreme but 
plausible.
    Better Markets commented that the passive role of the Commission in 
measuring the financial requirements for a DCO is inappropriate in 
light of the importance of this function. Better Markets proposed that 
the methodology, the historical data set, and the hypothetical 
scenarios be: (1) Jointly developed by the DCO and the Commission and 
(2) reviewed whenever ordered by the Commission, but no less frequently 
than quarterly. Better Markets also recommended that the Commission 
explicitly recognize the importance of illiquidity in developing 
hypothetical scenarios.
    AFR stated that it is critical that the Commission play a central 
role in establishing the standards by which DCOs will measure their 
exposure to future risks. AFR urged the Commission to define minimal 
standards that will ensure that DCO stress tests are stringent and 
incorporate realistic metrics of worst-case scenarios that DCOs may 
experience.
    The Commission is adopting Sec.  39.11(c)(1) as proposed. The 
Commission believes it is appropriate to allow the DCO discretion in 
designing stress tests because stress testing is an exercise that 
inherently entails the exercise of judgment at various stages. 
Furthermore, Sec.  39.11(c)(1) allows the Commission to evaluate the 
testing and require changes as appropriate. In response to the LCH 
comment, the Commission notes that there is a distinction between the 
type of stress testing carried out under this rule for the purpose of 
sizing the overall financial resource package and the type of stress 
testing carried out under Sec.  39.13(h)(3) for the purpose of 
ascertaining the risks that may be posed to the DCO by individual 
traders and clearing members. The former is a comprehensive test across 
all clearing members and all products with the goal of identifying the 
firms posing the greatest risk to the DCO and quantifying that risk. 
The regulations would require such testing to be completed monthly. The 
latter is targeted testing addressing the specific risks of specific 
positions at specific firms. The regulations would require such testing 
to be completed on either a daily or weekly basis, as described in 
Sec.  39.13(h)(3).\50\
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    \50\ See discussion of Sec.  39.13(h)(3) in section IV.D.7.c, 
below.
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8. Valuation of Financial Resources--Sec.  39.11(d)(1)
    Proposed Sec.  39.11(d)(1) would require a DCO, no less frequently 
than monthly, to calculate the current market value of each financial 
resource used to meet its obligations under proposed Sec.  39.11(a). 
When valuing a financial resource, a DCO would be required to reduce 
the value, as appropriate, to reflect any market or credit risk 
specific to that particular resource, i.e., apply a haircut. The 
Commission would permit each DCO to exercise its discretion in 
determining the applicable haircuts. However, the haircuts would have 
to be evaluated on a monthly basis, would be subject to Commission 
review, and would have to be acceptable to the Commission.
    OCC suggested that the proposed regulations should be modified or 
interpreted to accommodate the use of a true portfolio margining model 
that values collateral based on its relationship to an overall 
portfolio in lieu of applying fixed haircuts on margin collateral.
    ISDA stated that it would support an appropriate haircut for 
default insurance, potential assessments, and possibly other financial 
resources deemed acceptable by the Commission, as determined by the 
Commission upon review of the relevant DCO.
    FIA expressed reservations about the ability of a DCO to be paid 
promptly under the terms of a default insurance policy. FIA therefore 
recommended that default insurance coverage be subjected to a 30 
percent haircut and a 20 percent cap, similar to the policies that the 
Commission has proposed to apply to a DCO's assessment power.
    In discussions with Commission staff, Federal Reserve and Federal 
Reserve Bank of New York staff suggested that the liquidity of a 
financial resource should be an additional factor in determining an 
appropriate haircut. Considerations should include whether it is easy 
to value the financial resource (e.g., whether the pricing is 
transparent) and whether the financial resource could be divested in a 
short time period under normal market conditions. The Commission agrees 
that liquidity is an important factor in valuing financial resources.
    Accordingly, the Commission is revising Sec.  39.11(d)(1) to read 
as follows (added text in italics): ``At appropriate intervals, but not 
less than monthly, a derivatives clearing organization shall compute 
the current market value of each financial resource used to meet its 
obligations under paragraph (a) of this section. Reductions in value to 
reflect

[[Page 69350]]

credit, market, and liquidity risks (haircuts) shall be applied as 
appropriate and evaluated on a monthly basis.'' In response to OCC's 
comments, the Commission notes that Sec.  39.11(d)(1) does not prohibit 
the valuation method described by OCC in its comment letter.
    The Commission believes Sec.  39.11(d)(1) takes a balanced approach 
by permitting a DCO to exercise its discretion in determining 
applicable haircuts for each of its financial resources but making 
those haircuts subject to Commission review and approval. Section 
39.11(d)(1) requires a DCO to perform such valuations no less 
frequently than monthly, which means the Commission would expect a DCO 
to perform such valuations more frequently when appropriate, such as 
during periods of market volatility.
9. Liquidity of Financial Resources--Sec.  39.11(e)
    Proposed Sec.  39.11(e)(1) would require a DCO to have financial 
resources sufficiently liquid to enable the DCO to fulfill its 
obligations as a central counterparty during a one-day settlement 
cycle, including sufficient capital in the form of cash to meet the 
average daily settlement variation pay per clearing member over the 
last fiscal quarter. The DCO would be permitted to take into account a 
committed line of credit or similar facility for the purpose of meeting 
the remainder of the liquidity requirement. In the notice of proposed 
rulemaking, the Commission requested comment on whether the liquidity 
requirement should cover more than a one-day cycle. The Commission also 
requested comment on what standards might be applicable to lines of 
credit--e.g., should the Commission require that there be a diversified 
set of providers, or that a line of credit have same-day drawing 
rights?
    Proposed Sec.  39.11(e)(2) would require a DCO to maintain 
unencumbered liquid financial assets in the form of cash or highly 
liquid securities, equal to six months' operating costs. The DCO would 
be permitted to take into account a committed line of credit or similar 
facility to satisfy this requirement.
    Proposed Sec.  39.11(e)(3) would require that: (i) Assets in a 
guaranty fund have minimal credit, market, and liquidity risks and be 
readily accessible on a same-day basis, (ii) cash balances be invested 
or placed in safekeeping in a manner that bears little or no principal 
risk, and (iii) letters of credit not be a permissible asset for a 
guaranty fund.
    OCC recommended that the proposed regulations be modified or 
interpreted to provide DCOs some flexibility in determining the means 
of managing their ``cash'' liquidity needs by allowing DCOs to use 
secured credit facilities and tri-party repo facilities in addition to 
cash held in demand deposit accounts to satisfy the cash requirement. 
OCC observed that permitting these alternatives would allow a DCO to 
hold a significant portion of its financial resources in the form of 
U.S. Treasuries, with the ability to convert the Treasuries to cash as 
needed. According to OCC, cash must generally be held at banks, which 
presents a credit risk.
    NGX suggested that immediately accessible bank lines of credit 
should be acceptable to cover the cash requirement where the underlying 
commodity is itself traded in a liquid market.
    CME suggested the phrase ``average daily settlement variation pay 
per clearing member over the last fiscal quarter'' in proposed Sec.  
39.11(e)(1) is somewhat ambiguous. CME assumed that the Commission 
intended to refer to the average daily variation pay for a single 
clearing member, not the average daily settlement variation pay for all 
clearing members.
    CME also commented that the Commission's approach is not warranted 
given the potential amount of cash at issue and the reliability of 
liquidity facilities for short-term cash needs. CME suggested that the 
Commission revise the last sentence of proposed Sec.  39.11(e)(1) to 
read as follows: ``If any portion of such financial resources is not 
sufficiently liquid, the derivatives clearing organization may take 
into account a committed line of credit or similar facility for 
purposes of meeting these requirements.''
    In response to the Commission's request for comment on what 
standards might be applicable to a liquidity facility, CME stated that 
reviews and evaluations by Commission staff during regular DCO audits 
are a sufficient check on the adequacy and soundness of a committed 
line of credit, and that the Commission should not attempt to prescribe 
the terms and conditions of a DCO's liquidity facility.
    KCC found the language in proposed Sec.  39.11(e) to be ambiguous. 
KCC interpreted the average daily settlement variation pay per clearing 
member over the last fiscal quarter to mean the cumulative average of 
the pay-ins per each clearing member divided by the number of clearing 
members. In KCC's view, a line of credit with same-day drawing rights 
should be considered as liquid as cash and therefore should be allowed 
to be used by the DCO to fulfill its financial obligations during a 
one-day settlement cycle. KCC commented that the liquidity requirement 
should cover no more than one day of market price movement.
    LCH was unclear on what the Commission intends to mean in proposed 
Sec.  39.11(e)(1) by requiring that the DCO should allocate financial 
resources to meet the requirements of Sec.  39.11(a)(1) and fulfill its 
arising obligations during a ``one-day settlement cycle.'' LCH 
suggested that the requirement instead should be that the DCO is 
obliged to fulfill its arising obligations ``as they fall due.'' 
Additionally, LCH suggested that the requirement that the DCO must have 
``sufficient capital in the form of cash to meet the average daily 
settlement variation pay per clearing member over the last fiscal 
quarter'' is insufficient. LCH recommended that this requirement be 
replaced by a test that the DCO can meet its liquidity requirements 
``following the default of the clearing member(s) creating the largest 
liquidity requirement under stressed market conditions over the 
quarter.''
    Mr. Greenberger suggested that the standards for a committed line 
of credit or similar facility must be narrowly and strictly defined, so 
that the party can easily use such highly liquid line of credit or 
similar facility. Mr. Greenberger further suggested that greater 
participation by clearing members in a committed line of credit or a 
similar instrument at times of market distress would not provide 
necessary liquidity but rather would increase systemic risk.
    Eurex noted that proposed Sec.  39.11(e) requires DCOs to monitor 
the liquidity of assets and agreed that low-credit risk, highly liquid 
assets should comprise guaranty funds and that this rule would serve 
important purposes.
    FIA recommended that the Commission clarify that the cash 
requirement is intended to measure the average (and not the aggregate) 
clearing member variation margin requirement. FIA further recommended 
that the Commission permit a DCO to satisfy this requirement through 
the use of cash or cash equivalents, including U.S. government 
securities and repurchase agreements involving highly liquid securities 
if such repurchase agreement matures within one business day or is 
reversible upon demand. FIA additionally recommended that this aspect 
of the Commission's proposal be modified to clarify that DCOs are 
permitted to satisfy the liquidity requirement through the 
establishment of committed repo facilities. FIA supported allowing a 
DCO to obtain a

[[Page 69351]]

committed line of credit or similar credit facility to cover the 
remainder of its default resources requirement, but recommended that 
this proposal be strengthened by the diversification of credit 
providers, with concentration limits of 25 percent per provider.
    MGEX commented that proposed Sec.  39.11(e)(1) requires some 
clarity. MGEX interpreted it to mean that a DCO must have cash that 
will cover the average of all the clearing members' average daily 
settlement variation pays, which to MGEX would seem a logical and 
practical application. Rather than adopting multiple liquidity 
requirements (i.e., cash, clearing member default coverage, six months' 
worth of operating expenses), MGEX suggested the process could be 
simplified to address the most relevant, which appeared to MGEX to be 
the clearing member default coverage. In addition, MGEX recommended 
that proposed Sec.  39.11(e) should permit combining and then totaling 
its liquidity of financial resources as a single-entity DCO/DCM.
    AFR stated that DCOs should be required to have sufficient cash to 
fulfill their obligations for 10 business days and that lines of credit 
should not count toward liquidity requirements.
    NYPC commented that, to the extent the proposed requirement is 
intended to exclude cash equivalents, such as U.S. Treasury securities, 
the standard is inappropriate. NYPC recommended that the Commission 
allow DCOs to satisfy their liquidity needs through the use of any 
combination of cash held in demand deposit accounts, bank accounts 
meeting the requirements of CFTC Interpretative Letter 03-31,\51\ and 
secured credit facilities and repurchase agreements that allow DCOs to 
convert U.S. Treasury securities and other high quality collateral into 
cash on a same-day basis.
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    \51\ CFTC Interpretative Letter 03-31 concerned a bank that 
requested an interpretation that a trust deposit account product it 
developed would be acceptable for the deposit of customer segregated 
funds in accordance with Commission Regulation 1.20. Based on an 
analysis of the account, staff of the Commission's Division of 
Clearing and Intermediary Oversight issued an interpretation that 
the account would be acceptable as a deposit location because the 
account would be properly titled and covered by appropriate 
acknowledgements by the bank, and the funds in the account would at 
all times be immediately available for withdrawal on demand.
---------------------------------------------------------------------------

    In response to the comments, the Commission is revising Sec.  
39.11(e)(1) to provide greater clarity. In addition, the Commission is 
modifying the ``cash'' requirement to include ``U.S. Treasury 
obligations and high quality, liquid, general obligations of a 
sovereign nation.'' This conforms the requirement to existing liquidity 
practices and, in particular, it accommodates acceptable practices of 
foreign-based DCOs. However, the Commission is not including bank lines 
of credit as an acceptable financial resource for meeting the ``cash'' 
requirement because they are only a promise by the bank to pay and not 
an asset that can be sold. The Commission is revising Sec.  39.11(e)(1) 
by deleting the following language: ``The derivatives clearing 
organization shall have sufficient capital in the form of cash to meet 
the average daily settlement pay per clearing member over the last 
fiscal quarter. If any portion of the remainder of the financial 
resources is not sufficiently liquid, the derivatives clearing 
organization may take into account a committed line of credit or 
similar facility for the purpose of meeting this requirement.''
    The Commission is replacing the deleted language with the 
following: ``[(ii)] The derivatives clearing organization shall 
maintain cash, U.S. Treasury obligations, or high quality, liquid, 
general obligations of a sovereign nation, in an amount greater than or 
equal to an amount calculated as follows: (A) Calculate the average 
daily settlement pay for each clearing member over the last fiscal 
quarter; (B) Calculate the sum of those average daily settlement pays; 
and (C) Using that sum, calculate the average of its clearing members' 
average pays. (iii) The derivatives clearing organization may take into 
account a committed line of credit or similar facility for the purpose 
of meeting the remainder of the requirement under paragraph (e)(1)(ii) 
of this section.''
    The Commission notes that, in the CPSS-IOSCO Consultative Report, 
CPSS and IOSCO are considering a minimum liquidity requirement for CCPs 
that would be either: (1) A ``cover one'' minimum requirement for all 
CCPs; (2) a ``cover two'' minimum requirement for all CCPs; or (3) a 
``cover one'' or ``cover two'' minimum requirement for an individual 
CCP, depending on the particular risk and other characteristics of the 
particular products that it clears, the markets it serves, and the 
number and type of participants it has.\52\ The Commission might 
revisit the issue after CPSS and IOSCO determine what standard they 
will adopt.
---------------------------------------------------------------------------

    \52\ See CPSS-IOSCO Consultative Report, Principle 7: Liquidity 
Risk, at 46.
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10. Reporting Requirements--Sec.  39.11(f)
    Proposed Sec.  39.11(f) would require a DCO to report to the 
Commission, at the end of each fiscal quarter or at any time upon 
Commission request: (i) The amount of financial resources necessary to 
meet the requirements set forth in the regulation; and (ii) the value 
of each financial resource available to meet those requirements. The 
DCO would be required to include with its report a financial statement 
(including the balance sheet, income statement, and statement of cash 
flows) of the DCO or its parent company. A DCO would have 17 business 
days from the end of the fiscal quarter to file its report, but would 
also be able to request an extension of time from the Commission.
    NYPC suggested that, in light of the scope of information required 
to be submitted in the quarterly report (i.e., information regarding 
default risk financial resources and operating financial resources), 
the Commission should require that such reports be filed not later than 
30 calendar days, rather than 17 business days, following the end of 
the DCO's fiscal quarter.
    ISDA suggested that a DCO seeking an extension of the 17-day 
reporting deadline should be required to request the extension at least 
seven business days before the deadline.
    KCC noted that it does not prepare a statement of cash flows on a 
monthly basis, only on an annual basis as part of its audited financial 
statements. KCC commented that a monthly profit/loss statement is 
sufficient for determining its financial operating needs.
    MGEX suggested the Commission should consider a DCO's privacy 
concerns when permitting reasonable discretion in the data the DCO 
provides in the monthly reports required by the proposed regulations. 
MGEX stated that some detail as to projected revenue and expenses must 
remain proprietary if it involves potential business opportunities or 
other strategic business decisions, and that DCOs have a legitimate 
concern that confidential financial information could be subject to 
Freedom of Information Act requests.
    The Commission is adopting Sec.  39.11(f) as proposed. The 
Commission notes that the 17-business-day filing deadline is consistent 
with the deadline imposed on FCMs for the filing of monthly financial 
reports under Sec.  1.10(b). Moreover, a DCO may request an extension 
if it is unable to meet the deadline. The Commission does not believe 
it is appropriate to require a DCO to request an extension at least 
seven business days before the deadline, because a DCO may not know 
that far in advance that it will be unable to meet the deadline. With 
regard to the confidentiality of the information contained in the 
reports, the Commission notes that Core Principle L

[[Page 69352]]

and Sec.  39.21(c)(4) require a DCO to publicly disclose the size and 
composition of the financial resources package available in the event 
of a clearing member default. A DCO may request confidential treatment 
under Sec.  145.9 for other information submitted to the Commission 
under these regulations.
11. SIDCOs--Sec.  39.29
    Proposed Sec.  39.29(a) would require a SIDCO to maintain 
sufficient financial resources to meet its financial obligations to its 
clearing members notwithstanding a default by the two clearing members 
creating the largest combined financial exposure for the SIDCO in 
extreme but plausible market conditions. Proposed Sec.  39.29(b) would 
require that a SIDCO not count the value of assessments to meet the 
obligations arising from a default by the clearing member creating the 
single largest financial exposure and only count the value of 
assessments, after a 30 percent haircut, to meet up to 20 percent of 
the obligations arising from a default by the clearing member creating 
the second largest financial exposure. The Commission believes that it 
would be premature to take action regarding Sec.  39.29 at this time. 
The FSOC has not yet designated any DCOs as systemically important. As 
previously noted, the CPSS-IOSCO Principles for Financial Market 
Infrastructures, which are expected to be finalized in 2012, will 
address minimum financial resources requirements for CCPs. Similarly, 
certain foreign regulators, including the European Union, are also 
considering requirements in this area for the CCPs they regulate. The 
Commission is concerned that SIDCOs would be put at a competitive 
disadvantage if they are forced to comply with these requirements 
before non-U.S. CCPs are subject to comparable standards. The 
Commission is closely monitoring developments on this issue and is 
prepared to revisit the issue if the European Union or other foreign 
regulators move closer to implementation. Moreover, because it may be 
some time before any DCO is designated a SIDCO, the Commission believes 
it would be prudent to reconsider the regulation of SIDCOs in light of 
developments that may occur in the interim. The Commission expects to 
consider all the proposed rules relating to SIDCOs together.

C. Core Principle C--Participant and Product Eligibility--Sec.  39.12

1. Participant Eligibility
    Core Principle C,\53\ as amended by the Dodd-Frank Act, requires 
each DCO to establish appropriate admission and continuing eligibility 
standards for members of, and participants in, the DCO,\54\ 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. Proposed Sec.  39.12(a) would codify 
these requirements and establish the minimum requirements that a DCO 
would have to meet in order to comply with Core Principle C.
---------------------------------------------------------------------------

    \53\ Section 5b(c)(2)(C) of the CEA, 7 U.S.C. 7a-1(c)(2)(C).
    \54\ 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. The Commission is also 
amending the definition of ``clearing member'' in Sec.  1.3(c), 
adopted herein, 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.''
---------------------------------------------------------------------------

    Although there is potential tension between the goals of ``fair and 
open access'' and ``sufficient financial resources and operational 
capacity to meet obligations arising from participation in the 
derivatives clearing organization,'' the Commission believes the rules 
that it is adopting herein strike an appropriate balance. The 
Commission has crafted the provisions of Sec.  39.12 and related rules, 
e.g., the risk management requirements, to establish a regulatory 
framework that it believes can ensure that a DCO's 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 expects that more widespread 
participation will reduce the concentration of clearing member 
portfolios, thereby diversifying risk, increasing market liquidity, and 
increasing competition among clearing members.
a. Fair and Open Access--Sec.  39.12(a)(1)
    Proposed Sec.  39.12(a) would require a DCO to establish 
appropriate admission and continuing participation requirements for 
clearing members of the DCO, which are objective, publicly disclosed, 
and risk-based. Proposed Sec.  39.12(a)(1) would require a DCO to have 
participation requirements that permit fair and open access, setting 
forth specific standards.
    The Managed Funds Association (MFA), BlackRock, Inc. (BlackRock), 
State Street Corporation (State Street), and the Committee on Capital 
Markets Regulation (CCMR) supported the proposed rules. J.P. Morgan, 
ISDA, and FIA expressed support for the fair and open access provisions 
as long as there is prudent risk management.
    According to MFA, more inclusive DCO participation requirements 
would benefit DCOs and the markets by: (1) Reducing DCO concentration 
risk; (2) increasing diversity of market participants involved in DCO 
governance; (3) enhancing competition in the provision of clearing 
services; and (4) lowering overall costs for non-clearing members. 
State Street agreed that more widespread participation could increase 
competition by allowing more entities to become clearing members. 
Blackrock commented that the proposed rule would allow a diverse group 
of entities to become clearing members, which would increase 
competition, promote more inclusive DCO participation requirements, and 
lower costs to customers of clearing members.
    Each of the provisions of Sec.  39.12(a)(1) are discussed below.
b. Less Restrictive Standards--Sec.  39.12(a)(1)(i)
    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. BlackRock, the Swaps & Derivatives Market Association 
(SDMA), CME, LCH, Citadel, and CCMR supported the proposed rule. CCMR 
commented that the proposed rule would help to encourage an open 
marketplace.
    KCC, ICE, and MGEX did not support the proposed rule. According to 
KCC, the test is highly subjective and would be difficult to implement 
in practice. ICE commented that the proposal would require a DCO to 
dilute current prudent risk management practices. MGEX commented that 
the proposed rule

[[Page 69353]]

would require DCOs to consider only objective, hard number risk 
factors, which would force DCOs to bear other risks such as financial 
fraud convictions. MGEX suggested that the Commission should provide 
DCOs with latitude when determining the risks to which it will expose 
itself.
    The Commission is adopting Sec.  39.12(a)(1)(i) as proposed, except 
for the addition of clarifying language to provide that a DCO shall not 
adopt restrictive clearing member standards if less restrictive 
requirements ``that achieve the same objective and'' that would not 
materially increase risk to the derivatives clearing organization or 
clearing members could be adopted. The rule balances the dual 
Congressional mandate to provide for fair and open access while 
ensuring that such increased access does not materially increase risk. 
Because the rule does not require a DCO to provide access that 
materially increases risk to the DCO or clearing members, the 
Commission does not agree with ICE that the rule will subject a DCO to 
increased risk.
    The Commission does not agree with KCC that the rule will be highly 
subjective or difficult to implement in practice. The rule provides a 
DCO with discretion to balance restrictions on participation with 
legitimate risk management concerns and, in this regard, a DCO is in 
the best position in the first instance to determine the optimal 
balance. Only in circumstances where there is a question as to the 
impact of the rule would the Commission ask a DCO to justify the 
balance that the DCO has struck.
    In response to MGEX's comment, the Commission notes that the rule 
does not require a DCO to rely solely on objective, hard number risk 
factors. The rule permits a DCO to rely on both qualitative and 
quantitative analyses, providing each DCO with latitude to determine 
how it can facilitate open access while determining the risks to which 
it will expose itself.
    Except for certain bright-line participation requirements (e.g., 
capital requirements for clearing members), the Commission has not 
provided more specific guidance as to what participant eligibility 
requirements are permissible under Core Principle C. Such a 
clarification would only serve to limit a DCO's flexibility to 
formulate participation requirements.
    The Commission encourages each DCO to conduct a self-assessment to 
make sure that it can provide reasoned support to justify a conclusion 
that its rules do not violate the ``less restrictive'' standard 
contained in Sec.  39.12(a)(1)(i). Such an analysis should take into 
consideration the interaction of this provision with the other 
provisions of Sec.  39.12(a).
c. Clearing Member Qualification--Sec.  39.12(a)(1)(ii)
    Proposed Sec.  39.12(a)(1)(ii) would require a DCO to permit a 
market participant to become a clearing member if it meets the DCO's 
participation requirements. SDMA, LCH, and CCMR supported the proposed 
rule. According to CCMR, the proposed rule would help to encourage an 
open marketplace.
    KCC commented that the proposed rule is not workable because a DCO 
may not have the operational capacity to admit all applicants that 
satisfy the DCO's membership requirements. KCC proposed that the 
regulation clarify that a DCO may set limits on the number of market 
participants that may be admitted in light of the DCO's own operational 
constraints.
    The Commission is adopting Sec.  39.12(a)(1)(ii) as proposed. The 
Commission is concerned that permitting a DCO to set a limit on the 
number of market participants that may become clearing members could 
enable a DCO to evade the open access requirement imposed by Core 
Principle C. If a DCO were able to demonstrate that operational 
constraints prevented it from admitting additional clearing members, 
the DCO could petition the Commission for an exemption.
d. Non-Discriminatory Treatment--Sec.  39.12(a)(1)(iii)
    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. LCH 
and SDMA supported the proposed rule. CME commented that in addition to 
credit risk and deficiencies in operational capabilities, legal risk 
should be included in the text of this regulation as a basis upon which 
a DCO may exclude or limit clearing membership of certain types of 
participants.
    KCC did not support the proposed rule, commenting that a DCO's 
right to exclude or place limitation on certain clearing members should 
not be subject to ex-post determinations as to the necessity of such 
restrictions, as the DCO itself is in the best position to monitor the 
risks posed by the activities of its clearing members. According to 
KCC, the proposed rule would limit the risk management capabilities of 
a DCO, and DCOs should be accorded flexibility in their assessments of 
the operational capabilities of potential clearing members.
    The Commission is adopting Sec.  39.12(a)(1)(iii) as proposed. 
CME's concerns regarding heightened legal risk, such as the inability 
to attach property of a foreign clearing member under foreign law, are 
encompassed within the ``credit risk'' consideration. The Commission 
expects that most, if not all, bases for membership exclusion or 
limitation will fall within either financial or operational 
considerations. In addition, the Commission does not believe the rule 
would limit a DCO's risk management capabilities as KCC suggested 
because it would not prevent a DCO from excluding or limiting certain 
types of market participants from clearing if such participation would 
introduce genuine risk that cannot be adequately managed by the DCO. 
The Commission expects that DCOs will review their existing 
participation requirements for compliance with this rule.
e. Prohibition of Swap Dealer Requirement--Sec.  39.12(a)(1)(iv)
    Proposed Sec.  39.12(a)(1)(iv) would prohibit a DCO from requiring 
that clearing members be swap dealers. LCH commented that, in the event 
of default, it relies on non-defaulting clearing members to hedge the 
defaulting member's swap portfolio; to provide liquidity for such 
hedging; to bid on hedged portfolios; and, in extreme circumstances, to 
accept a forced allocation of swaps, which could be a risky, unhedged 
swaps portfolio. LCH commented that a clearing member who is not a swap 
dealer may not be able to participate in a DCO's default management 
process.
    The Commission is adopting Sec.  39.12(a)(1)(iv) as proposed. It is 
important to note that the regulation would not preclude participation 
by swap dealers (on which LCH currently relies). It simply requires 
that a DCO provide clearing access to other entities that could also 
participate in a DCO's default management process, even if to a lesser 
extent. Broader access is supported by other Commission regulations, 
e.g., Sec.  39.12(a)(3), which mandates that a DCO require its clearing 
members to have adequate operational capacity to participate in default 
management activities; Sec.  39.12(b)(5), which requires a DCO to 
select contract units for clearing purposes that maximize liquidity, 
facilitate

[[Page 69354]]

transparency in pricing, promote open access, and allow for effective 
risk management; and Sec.  39.16(c)(2)(iii), which permits a DCO to 
require its clearing members to accept an allocation, provided that any 
allocation must be proportional to the size of the clearing member's 
positions at the DCO. Thus, a DCO should be able to establish 
participation requirements that allow it to rely on non-defaulting 
clearing members to hedge a defaulting member's swap portfolio, to 
provide liquidity for such hedging, to bid on hedged portfolios, and to 
accept a forced allocation of swaps.
f. Prohibition of Swap Portfolio or Swap Transaction Volume 
Requirements--Sec.  39.12(a)(1)(v)
    Proposed Sec.  39.12(a)(1)(v) would prohibit a DCO from requiring 
clearing members to maintain a swap portfolio of any particular size, 
or that clearing members meet a swap transaction volume threshold.
    According to State Street, such requirements are intended to 
systematically favor membership for financial institutions that are 
also substantial dealers in swaps. They do not take into account the 
risk management capabilities of many DCO members such as State Street, 
which are able to closely monitor risk exposures and effectively 
liquidate exposures through networks of interdealer relationships. The 
Commission believes that such requirements would have the effect of 
permitting only large swap dealers to provide clearing services. This 
would be inconsistent with Core Principle C. Accordingly, the 
Commission is adopting Sec.  39.12(a)(1)(v) as proposed.
g. Financial Resources--Sec.  39.12(a)(2)(i)
    Core Principle C mandates that each DCO must ensure that its 
clearing members have ``sufficient financial resources and operational 
capacity to meet obligations arising from participation in the [DCO].'' 
\55\ 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.
---------------------------------------------------------------------------

    \55\ Section 5b(c)(2)(C)(i)(I) of the CEA; 7 U.S.C. 7a-
1(c)(2)(C)(i)(I).
---------------------------------------------------------------------------

    CME commented that it supports the inclusion of parent guarantees 
and credit facility funding arrangements as acceptable financial 
resources for clearing members, provided that each DCO retains the 
flexibility to determine the particular terms and conditions of such 
arrangements. LCH, however, commented that credit facilities or funding 
arrangements should not be allowed for the purposes of fulfilling 
financial participation requirements. According to LCH, all clearing 
members' resources should be immediately and unconditionally available. 
ISDA also commented that a credit facility funding arrangement from an 
unaffiliated entity should not be available to satisfy clearing member 
financial resource requirements. ISDA did not believe that such funding 
would be reliable.
    MGEX commented that testing for extreme but plausible market 
conditions would have minimal value because the test would be based on 
historical records or it would be based on future assumptions that are 
based on static conditions. MGEX believes that the proposed rule would 
require a DCO to devise tests for clearing members to use and would 
require a DCO to conduct the tests and provide the results to clearing 
members. MGEX commented that this specific rule seems unnecessary 
because DCOs have other methods to address risk, like increasing and 
decreasing margin. It noted further that it already requires clearing 
members to be in good financial standing, which includes minimum 
capital requirements and a requirement to provide a parent guarantee in 
certain circumstances.
    The Commission is adopting Sec.  39.12(a)(2)(i) with the 
modification described below. Per CME's comment, the rule provides a 
DCO with the flexibility to determine what constitutes sufficient 
financial resources to meet obligations arising from participation in 
the DCO in extreme but plausible market conditions, and to determine 
what financial resources are available to a clearing member to satisfy 
this requirement.
    Regarding the comments of LCH and ISDA, the rule does not require a 
DCO to allow clearing members to use a credit facility funding 
arrangement to meet financial resource requirements. Because such 
arrangements can serve as an important source of liquidity for clearing 
members, the Commission has not prohibited their possible use to 
satisfy clearing member financial resource requirements. The Commission 
is modifying Sec.  39.12(a)(2)(i) to clarify a DCO's discretion, by 
rephrasing the second sentence to read as follows: ``A derivatives 
clearing organization may permit such financial resources to include, 
without limitation, a clearing member's capital, a guarantee from the 
clearing member's parent, or a credit facility funding arrangement.'' 
To address concerns about reliability, a DCO can consider requiring 
that a credit facility funding arrangement be supported by multiple 
lenders.
    Finally, the Commission does not believe that MGEX's comment 
provides a basis for revising the proposed rule. As an initial matter, 
Core Principle C requires each DCO to establish participation standards 
that require a clearing member to have sufficient financial resources 
to meet obligations arising from participation in the DCO. Core 
Principle B requires a DCO to maintain financial resources that would 
enable it to meet its financial obligations in ``extreme but 
plausible'' market conditions. The Commission believes that it is 
appropriate for a DCO to subject its clearing members to a comparable 
financial standard to support its own compliance with statutory 
requirements. A DCO would have discretion in setting the terms of any 
tests to determine whether clearing members' financial resources are 
sufficient to meet their obligations in extreme but plausible market 
conditions.
h. Capital Requirements Must Match Capital to Risk--Sec.  
39.12(a)(2)(ii)
    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, which appropriately match capital to risk. 
The capital requirements also would have to be scalable so that they 
are proportional to the risks posed by clearing members.
    J.P. Morgan, MFA, ISDA, State Street, SDMA, Citadel LLC (Citadel), 
Better Markets, and FIA supported the proposed rule. According to 
Better Markets, the proposed rule is an important change of practices 
that will open DCO membership to more market participants while 
protecting the risk management system. FIA commented that a DCO, when 
it sets capital requirements, should take into account a clearing 
member's risk-derived exposures and its potential assessment 
obligations at each clearing organization of which it is a member. FIA 
recommended that a DCO should allow an FCM to clear positions in 
proportion to its capital net of those other risk-derived exposures and 
assessment obligations.
    The Commission is adopting Sec.  39.12(a)(2)(ii) as proposed, with 
one modification. In response to a comment from staff of the Federal 
Reserve and the Federal Reserve Bank of New York, the

[[Page 69355]]

Commission is deleting the phrase ``so that they are proportional'' 
from the rule. This is to make clear that a DCO should take into 
account nonlinear risk. In response to FIA's comment, the Commission 
notes that in setting scalable requirements, a DCO should take into 
consideration risks that a clearing member carries as a result of 
positions cleared at other DCOs, to the extent that it is able to 
obtain such information.
i. Minimum Capital Requirement--Sec.  39.12(a)(2)(iii)
    Proposed Sec.  39.12(a)(2)(iii) would prohibit a DCO from setting a 
minimum capital requirement of more than $50 million for any person 
that seeks to become a clearing member in order to clear swaps. 
Pierpont Securities LLC (Pierpont), Better Markets, SDMA, Newedge, MFA, 
Citadel, and Jefferies & Company (Jefferies) supported the proposed 
rule.
    Jefferies commented that the proposed rule would allow it to 
participate more actively in the swap market. Jefferies believes that 
taken together, the provisions of proposed Sec.  39.12(a) provide a DCO 
with more than sufficient authority to assure the financial integrity 
and efficient operation of its swaps clearing activities.
    Newedge commented that the proposed rule should not increase risk 
to a DCO because a DCO can mitigate risk by, among other things, 
imposing position limits, stricter margin requirements, or stricter 
default deposit requirements on lesser capitalized clearing members. 
Newedge proposed that the Commission prohibit DCOs from imposing a 
requirement that clearing members have an internal trading desk capable 
of liquidating or hedging a defaulting clearing member's positions. It 
said that there is no need for such a requirement because a non-
defaulting member can handle a default event in a variety of ways, 
including having a contingent default manager. Newedge noted that under 
proposed Sec.  39.16(c)(2)(iii), any obligation of a clearing member to 
participate in an auction, or to accept the allocation of a defaulting 
clearing member's positions, would be proportionate to the size of the 
clearing member's own position at the DCO. Thus, a clearing member 
should be able to hedge an allocated position and carry the position 
over time without having to take a substantial charge to its capital.
    MFA commented that the threshold should not impose additional risk 
on a DCO because a DCO could ensure the safety of itself and clearing 
members by scaling each clearing member's net capital obligation in 
proportion to that clearing member's risk exposure. MFA expressed 
concern that a DCO could comply with the $50 million net capital 
requirement but impose a non-risk-based and excessive threshold 
guaranty fund contribution requirement that would unnecessarily exclude 
clearing members. MFA proposed that the regulations require that such 
scaling be determined by objective, risk-based methodologies that are 
based on reasonable stress and default scenarios, and the tests be 
consistently applied to all clearing members, without use of ``tiers'' 
that could have discriminatory or anti-competitive effects.
    J.P. Morgan, the U.K. Financial Services Authority (FSA), CME, KCC, 
ISDA, IntercontinentalExchange, Inc. (ICE), State Street, Federal Home 
Loan Banks (FHLBanks), the Securities Industry and Financial Markets 
Association (SIFMA), and LCH expressed the view that the proposed rule 
could increase risk and the probability of default, and require DCOs to 
accept members who might not be able to participate in the default 
management process. FSA, KCC, and CME commented that a DCO must have 
reasonable discretion to determine the appropriate capital requirements 
for its clearing members based upon the DCO's analysis of the 
particular characteristics of the swaps that it clears.
    J.P. Morgan, however, commented that a cap on a member's minimum 
capital requirement would not impact the systemic stability of a DCO as 
long as: (1) Clearing members clear house and client business in 
proportion to their available capital; (2) DCOs employ real-time risk 
management processes to ensure compliance with this principle; (3) DCOs 
hold a sufficient amount of margin and funded default guarantee funds; 
and (4) the Commission monitors clearing members to ensure that they 
are able to meet their financial obligations with respect to all DCOs 
of which they are members.
    LCH and ISDA commented that the lower threshold could increase risk 
because a $50 million threshold would allow a clearing member to meet 
the eligibility requirements of multiple DCOs.
    LCH, CME, and FSA commented that the smaller firms may be unable to 
participate in the default management process. LCH and ISDA also 
commented that members should not be able to outsource default 
management to third parties because they may not be sufficiently 
reliable in times of stress.
    In addition, according to ISDA, there could be conflict-of-interest 
issues because the unaffiliated third party would not have ``skin in 
the game.'' As a result, through the actions of the unaffiliated third 
party, a clearing member could be assigned an unsuitable part of a 
defaulting clearing member's proprietary portfolio and/or at a sub-
optimal valuation and/or wrongly accept customer positions from the 
defaulting clearing member. This conflict-of-interest concern is 
exacerbated where the entity to whom the default management obligations 
are outsourced is a ``competing'' clearing member in the same DCO.
    State Street and SDMA, however, commented that clearing members 
should be permitted to enter into committed arrangements with non-
affiliated firms to perform default management functions. According to 
SDMA, there is no evidence to suggest that a legal arrangement with a 
third-party dealer somehow lessens the integrity to the system. 
Assuming the legal and financial arrangements between such firms are 
sufficiently strong to ensure performance when needed, State Street 
commented that there is no appreciable difference between the default 
management capacity of the traditional dealer-affiliated clearing 
member and a non-dealer clearing member outsourcing certain functions 
to a non-affiliate.
    Finally, SIFMA commented that the appropriate minimum capital 
requirement would be $300 million, while ISDA commented that if the 
Commission cannot monitor risk across all DCOs, a $1 billion capital 
requirement would be appropriate.
    After carefully considering the comments, the Commission is 
adopting Sec.  39.12(a)(2)(iii) as proposed. The Commission believes, 
as noted in numerous comments, that the rule will increase the number 
of firms clearing swaps, which will make markets more competitive, 
increase liquidity, reduce concentration, and reduce systemic risk. The 
Commission also believes that, as explained below, the $50 million 
threshold will not significantly increase risk or lead to admission of 
clearing members who are unable to meaningfully and responsibly 
participate in the clearing process.
    As an initial matter, the Commission emphasizes that the $50 
million threshold is not arbitrary. That number was arrived at by 
reviewing the capital of registered FCMs.\56\ This amount

[[Page 69356]]

captures firms that the Commission believes have the financial, 
operational, and staffing resources to participate in clearing swaps 
without posing an unacceptable level of risk to a DCO. This capital 
threshold is considered to be appropriate, particularly in light of 
other proposed rules (such as scaling capital and risk exposure and 
breaking down large swap positions into smaller units for more 
diversified allocation in the event of a clearing member default).
---------------------------------------------------------------------------

    \56\ See transcript of December 16, 2010 Commission meeting at 
77-81 available at www.cftc.gov (discussing $50 million threshold; 
Commission staff stating that of 126 FCMs, 63 currently have capital 
above $50 million and most FCMs with capital below that amount are 
not clearing members).
---------------------------------------------------------------------------

    The Commission considered whether to increase the capital threshold 
to $300 million as proposed by SIFMA or $1 billion as proposed by ISDA. 
The Commission analyzed the reduction in the number of firms that would 
be eligible to clear at CME, ICE Clear US, KCC, MGEX, and OCC using 
these thresholds. As set forth in the table below, depending on the 
basis used to measure capital, a capital threshold of $300 million 
would reduce the number of firms able to clear by 38-51 percent. A 
capital threshold of $1 billion would reduce the number of firms able 
to clear by 62-65 percent. The Commission believes that this reduction 
in participation would be contrary to the Congressional mandate for 
open access to clearing.\57\
---------------------------------------------------------------------------

    \57\ Clearing FCM and non-clearing FCM data for adjusted net 
capital and excess net capital was provided by FCM registrants and 
is available on the Commission Web site. The other data is non-
public. Ownership equity data was provided by FCM registrants 
through the monthly financial statements that are submitted to the 
Commission. The data from the monthly financial statements reside in 
the Commission's RSR Express system, and all data for clearing non-
FCMs was provided by the DCOs to the Commission's Risk Surveillance 
Group during the course of its routine oversight activities.
[GRAPHIC] [TIFF OMITTED] TR08NO11.000

    The Commission does not believe that the rule will increase risk. 
Section 39.12(a)(2)(ii) requires DCOs to impose capital requirements 
that are scalable to the risks posed by clearing members. Accordingly, 
a small clearing member should not be able to expose a DCO to 
significant risk even if it is able to clear at multiple DCOs because 
its exposure at each DCO would be limited. DCOs that participate in the 
Shared Market Information System (SHAMIS) will be able to see a 
clearing member's pays and collects across participating DCOs, and a 
DCO also could on its own initiative require clearing members to 
directly report their clearing activity at other DCOs. The Commission 
also will be able to monitor clearing member exposure by means of DCO 
end-of-day reporting under the reporting requirements of Sec.  
39.19(c)(1)(i), which the Commission is adopting herein. It will also 
be able to monitor the financial strength of clearing members that are 
registrants pursuant to financial reporting requirements.
    In addition, the Commission is adopting other rules that will 
reinforce a DCO's oversight of its clearing members. In this regard, 
Sec.  39.12(a)(4) requires a DCO to verify, on an ongoing basis, the 
compliance of each clearing member with each participation requirement; 
Sec.  39.12(a)(5) requires a DCO to require all clearing members to 
file periodic financial statements and timely information that concerns 
any financial or business developments that may materially affect the 
clearing members' ability to continue to comply with participation 
requirements; and Sec.  39.13(h)(5) further requires a DCO to adopt 
rules that require clearing members to maintain current risk management 
policies and procedures and requires a DCO to review such policies and 
procedures on a periodic basis. The Commission also has proposed 
requirements for clearing member risk management.\58\
---------------------------------------------------------------------------

    \58\ See 76 FR 45724 (Aug. 1, 2011) (Clearing Member Risk 
Management).
---------------------------------------------------------------------------

    The Commission does not believe that the $50 million threshold 
would lead to a DCO having to admit clearing members that are unable to 
participate in the default management process. As discussed above, the 
regulation does not preclude highly-capitalized entities (such as swap 
dealers) from participating in a DCO as clearing members. Thus, the 
addition of smaller clearing members does not eliminate the role that 
larger clearing members can play in default management--it merely 
spreads the risk.
    The Commission wishes to emphasize that it will review DCO 
membership rules as a package in light of all of the provisions of 
Sec.  39.12(a). Thus, a DCO may not circumvent Sec.  39.12(a)(2)(iii) 
by enacting some additional financial requirement that effectively 
renders the $50 million threshold meaningless for some potential 
clearing members. Such an arrangement would violate Sec.  
39.12(a)(1)(i) (less restrictive alternatives), or Sec.  
39.12(a)(1)(iii) (exclusion of certain types of firms).
    As discussed below, under Sec.  39.12(a)(3), a DCO's participation 
requirements must include provisions for adequate operational capacity. 
This requirement should be read in conjunction with Sec.  
39.12(a)(1)(i), which prohibits restrictive clearing member standards 
if less restrictive standards could be adopted; Sec.  39.12(a)(1)(iii), 
which prohibits DCOs from excluding certain types of market 
participants from clearing membership if they can fulfill the 
obligations of clearing membership; and Sec.  39.16(c)(2)(iii), which 
permits a DCO to require a clearing member to participate in an auction 
or to accept allocations of a defaulting clearing member's customer or 
house positions, provided the allocated positions are proportional to 
the size of the clearing member's positions at the DCO and are 
permitted to be outsourced to a qualified third party subject to 
safeguards imposed by the DCO.
    Several commenters discussed the use of outsourcing to satisfy 
default management obligations. The Commission believes that open 
access to clearing and effective risk management need not be viewed as 
conflicting goals. Subject to appropriate safeguards, outsourcing of 
certain obligations can be an effective means of harmonizing these 
goals. For example, a small clearing member might have less ability to 
contribute meaningfully to a DCO's

[[Page 69357]]

auction process acting on its own than if an entity with greater 
expertise in the relevant markets acted in its place.
    Therefore, the Commission believes that it would be inconsistent 
with Sec.  39.12(a)(1)(i) and Sec.  39.12(a)(1)(iii) for a DCO to 
prohibit outsourcing. Accordingly, as discussed below, the Commission 
is adopting revised default procedure rules to require a DCO to permit 
outsourcing to qualified third parties of obligations to participate in 
auctions or in allocations, subject to appropriate safeguards imposed 
by the DCO.\59\
---------------------------------------------------------------------------

    \59\ See discussion of revised Sec.  39.16(c)(2)(iii) in section 
IV.G.4, below.
---------------------------------------------------------------------------

    Finally, the Commission has determined that it will not permit a 
DCO to require members to post a minimum amount of liquid margin or 
default guarantee contributions, or to participate in a liquidity 
facility per J.P. Morgan's suggestion. The Commission believes that the 
rules are sufficient to ensure that each member has adequate resources 
to withstand another member's default and such requirements could be 
used by a DCO to evade the open access to clearing intended by the 
Dodd-Frank Act.
j. Operational Requirements--Sec.  39.12(a)(3)
    Proposed Sec.  39.12(a)(3) would require a DCO to require its 
clearing members to have adequate operational capacity to meet their 
obligations arising from participation in the DCO. The requirements 
would include, but not be 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 DCO; and the ability to participate in default 
management activities under the rules of the DCO and in accordance with 
proposed Sec.  39.16.
    LCH, FIA, Jefferies, and SDMA commented that the Commission has 
correctly identified the operational requirements. Jefferies commented 
that demonstrating sufficient operational capacity is more important 
than capital considerations. According to SDMA, these operational 
requirements are directly related to the core business of the clearing 
member and provide the services needed and relied upon by the DCO to 
clear trades. SDMA also believes that DCOs should be prohibited from 
imposing operational requirements that are not part of a clearing 
member's core business because they create discriminatory barriers to 
clearing, and it points to the following as examples of discriminatory 
operational eligibility requirements: Clearing members must (1) Have 
both execution and clearing capabilities; (2) provide end-of-day prices 
to mark its positions; and (3) have extensive experience in clearing 
swaps or ``sophistication.''
    J.P. Morgan and FIA commented that a DCO must ensure that each 
member has risk management resources to assist the DCO in its risk 
management process, and FIA suggested that the final rules add 
appropriate risk management requirements as a participant eligibility 
criterion, or make clear that nothing in the proposed rules is intended 
to prevent a DCO from adopting such requirements.
    ISDA commented that the ability to bid for portfolios of other 
clearing members of the DCO is critically important. According to ISDA, 
an appropriate risk management framework for a clearing member may be 
broadly categorized as follows: (1) Board and senior management 
oversight; (2) organizational structure; and (3) strong systems and 
procedures for controlling, monitoring and reporting risk.
    Finally, State Street commented that a clearing member must be able 
to demonstrate it can carry out its obligations to a DCO under a 
default scenario. That demonstration could include having the capacity 
to trade swaps using experienced swap traders, and the ability to 
execute transactions in the market by having appropriate trading 
relationships. A clearing member must also demonstrate an ability to 
monitor positions, calculate potential losses and market risk, perform 
stress tests, and maintain liquidity, among numerous other 
requirements.
    The Commission is adopting Sec.  39.12(a)(3) as proposed. The 
Commission believes that the rule correctly identifies the necessary 
operational requirements and is concerned that the heightened 
operational requirements suggested by some commenters could allow a DCO 
to evade the open access to DCO clearing intended by the Dodd-Frank 
Act. The Commission emphasizes that under the rule, any operational 
requirements must be necessary to meet clearing obligations. In 
addition, the Commission is adopting Sec.  39.13(h)(5) herein, which 
requires a DCO to adopt rules requiring clearing members to maintain 
current written risk management policies and procedures.\60\ The 
Commission has also proposed rules requiring clearing members that are 
FCMs (proposed Sec.  1.73) and swap dealers and major swap participants 
(proposed Sec.  23.609) to engage in specific risk management 
activities.\61\
---------------------------------------------------------------------------

    \60\ See discussion of Sec.  39.13(h)(5) in section IV.D.7.e, 
below.
    \61\ See 76 FR at 45729-45730 (Aug. 1, 2011) (Clearing Member 
Risk Management).
---------------------------------------------------------------------------

k. Monitoring, Reporting, and Enforcement--Sec.  39.12(a)(4)
    Core Principle C requires each DCO to ``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.'' \62\ Proposed Sec.  39.12(a)(4) would codify 
these requirements.
---------------------------------------------------------------------------

    \62\ See Section 5b(c)(2)(C)(ii) of the CEA; 7 U.S.C. 7a-
1(c)(2)(C)(ii).
---------------------------------------------------------------------------

    OCC supported the proposed rule ``if interpreted reasonably.'' J.P. 
Morgan commented that a clearing member may have committed to 
additional unfunded assessments at more than one clearinghouse and 
proposes that the Commission and DCOs monitor clearing members to 
ensure that they have sufficient liquid resources to support the 
business they clear at each DCO. According to J.P. Morgan, a DCO should 
monitor exposures against risk-based position limits on a real-time 
basis.
    The Commission is adopting Sec.  39.12(a)(4) as proposed. In 
response to J.P. Morgan's comments, the Commission notes that in 
monitoring firms, a DCO should take into consideration risks that the 
firm faces outside of that DCO. The Commission further notes that it is 
not prescribing the means by which DCOs should monitor compliance.
l. Reporting Requirements--Sec.  39.12(a)(5)
    Proposed Sec.  39.12(a)(5)(i) would mandate that a DCO require all 
clearing members, including those that are not FCMs, to file with the 
DCO periodic financial reports containing any financial information 
that the DCO determines is necessary to assess whether participation 
requirements are met on an ongoing basis. The proposed rule also would 
mandate that a DCO require 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, and would require the DCO to review all such 
financial reports for risk management purposes. Proposed Sec.  
39.12(a)(5)(i) would also 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

[[Page 69358]]

request. Proposed Sec.  39.12(a)(5)(ii) would mandate that a DCO adopt 
rules that require clearing members to provide to the DCO, 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.
    LCH commented that a DCO based outside the U.S. may have clearing 
members that are not subject to the Commission's jurisdiction and would 
be regulated in their home jurisdiction. LCH proposed this provision be 
revised such that only FCMs and U.S.-based members that are not FCMs 
are required to provide this information to the Commission upon 
request. According to LCH, all other members should be required to 
submit the information to the DCO only or to their equivalent local 
regulator.
    LCH and MGEX commented that proposed Sec.  39.12(a)(5)(ii) would be 
more appropriately imposed on clearing members themselves, rather than 
on the DCO. KCC suggested that the Commission should evaluate its 
statutory authority to enact the proposed rule. MGEX commented that the 
proposed rules appear to require clearing members to report to each DCO 
with which they clear, which would create an additional, duplicative 
burden on clearing members. MGEX suggested that the Commission regulate 
the clearing members directly. As an alternative, MGEX proposed a new 
industry group similar to the Joint Audit Committee (JAC) in which each 
DCO would be represented and participate in developing an overall risk 
management program that would be used in fulfilling the new proposed 
requirements.
    The Commission is adopting Sec.  39.12(a)(5) with modifications to 
(1) provide that the financial information provided by non-FCM clearing 
members may be submitted by the clearing members to the Commission 
pursuant to DCO rules or may be submitted to the Commission by the DCO, 
in either case, upon the Commission's request; and (2) eliminate the 
proposed requirement that the DCO must review clearing members' 
financial reports for risk management purposes.
    The rule is intended to address circumstances where the Commission 
must obtain information in the possession of a clearing member. The 
Commission anticipates such requests will be few in number. However, 
when those occasions arise, the Commission must be able to obtain the 
information as expeditiously as possible. The rule addresses this need 
by allowing the Commission to obtain the information directly from the 
source and to minimize the burden on DCOs. In response to the comments, 
the Commission is revising the rule to provide that a DCO may either 
provide the requested information directly to the Commission or require 
clearing members to provide the information to the Commission.
    The Commission is eliminating the requirement that the DCO must 
review clearing members' financial reports for risk management 
purposes. Upon further consideration, the Commission has concluded that 
although a DCO may review such financial reports for several reasons, 
including risk management and to ensure that clearing members continue 
to meet participation requirements, it is not necessary to be 
prescriptive in this regard.
    In response to MGEX suggestion of a new industry group, Commission 
staff is considering such a step.
    The Commission is making certain technical revisions to Sec.  
39.12(a)(5) in connection with these changes.
m. Enforcement of Participation Requirements--Sec.  39.12(a)(6)
    Proposed Sec.  39.12(a)(6) would require a DCO to enforce 
compliance with its participation requirements and establish procedures 
for the suspension and orderly removal of clearing members that no 
longer meet the requirements. MGEX commented that the proposed rule 
goes beyond the language of the Dodd-Frank Act.
    The Commission is adopting Sec.  39.12(a)(6) as proposed. A DCO 
must have the ability to enforce compliance with its participation 
requirements or its clearing members may not satisfy these 
requirements. A DCO also must have procedures for the suspension and 
orderly removal of clearing members that no longer meet the 
requirements. Otherwise, the enforcement process may not be orderly and 
could introduce additional risk to the DCO. This requirement 
complements Sec.  39.17, adopted herein, which implements Core 
Principle H (Rule Enforcement).\63\
---------------------------------------------------------------------------

    \63\ See discussion of Sec.  39.17 in section IV.H, below.
---------------------------------------------------------------------------

2. 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. Proposed Sec.  39.12(b) 
would codify these requirements.
a. General Comments
    Citadel and MFA supported the proposed rules. To ensure non-
discriminatory clearing, Citadel and MFA recommended the Commission 
make explicit that a DCO must provide highly standardized mechanisms 
and procedures for establishing connectivity with SEFs and any other 
permitted trading venue. According to Citadel, these mechanisms and 
procedures must be objective, commercially reasonable, publicly 
available, and treat all applicant execution facilities in an unbiased 
manner. Citadel and MFA also proposed that the rules mandate that a DCO 
keep the clearing acceptance process anonymous (i.e., without the 
customer's clearing member knowing the identity of the customer's 
executing counterparty).
    The Commission agrees that a DCO must provide mechanisms for 
establishing connectivity with SEFs and DCMs, which would provide 
executing counterparties with fair and open access. The Commission has 
proposed rules addressing this issue.\64\ The Commission also has 
proposed rules that address the anonymity issue.\65\
---------------------------------------------------------------------------

    \64\ See 76 FR 13101 (Mar. 10, 2011) (Straight-Through 
Processing).
    \65\ See 76 FR 45730 (Aug. 1, 2011) (Customer Clearing).
---------------------------------------------------------------------------

b. Products Eligible for Clearing--Sec.  39.12(b)(1)
    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: (1) Trading volume; (2) liquidity; (3) availability of reliable 
prices; (4) ability of market participants to use portfolio compression 
with respect to a particular swap product; (5) ability of the DCO and 
clearing members to gain access to the relevant market for purposes of 
creating and liquidating positions; (6) ability of the DCO to measure 
risk for purposes of setting margin requirements; and (7) operational 
capacity of the DCO and clearing members to address any unique risk 
characteristics of a product.\66\
---------------------------------------------------------------------------

    \66\ As proposed, Sec.  39.12(b)(1)(vii) referred to addressing 
any ``unique'' risk characteristics of a product. The Commission is 
revising this provision in the final rule to refer to any 
``unusual'' risk characteristics to clarify that such 
characteristics are not limited to those that are one of a kind.
---------------------------------------------------------------------------

    OCC noted that the factors to be considered are already among the 
factors that a DCO would naturally consider and that OCC in fact 
considers, and it suggested that the application of

[[Page 69359]]

this new rule be limited to swaps. OCC also noted that the trading 
volume of new products is often unknown and unpredictable and suggested 
that factor not be a barrier to accepting a product for clearing.
    MGEX commented that the proposed rule considers legitimate factors, 
but mandating that a DCO establish eligibility requirements is not 
necessary, other than requirements for the contract size of swaps. Like 
OCC, MGEX noted that DCOs already use these factors as part of their 
sound business judgment in making these types of decisions. MGEX 
recommended that the Commission issue suggested guidelines or core 
principles and, on an as-needed basis, request that a DCO file with the 
Commission the rationale supporting its conclusion that a contract 
qualifies for clearing.
    LCH expressed concerns with proposed Sec.  39.12(b)(1)(iv) and 
commented that compression services have been developed only when swap 
markets are relatively large and well-established, and the introduction 
of cleared facilities has largely pre-dated the introduction of 
compression services. According to LCH, making swap clearing contingent 
on swap portfolio compression may have the effect of permitting fewer 
swaps to be cleared. LCH proposed that the Commission encourage the use 
of compression services where suitable and available, but not constrain 
the ability of a DCO to clear a given swap based on the availability of 
such services.
    LCH also commented that it is imperative that a DCO have the 
ability to ``transfer,'' ``auction,'' or ``allocate'' cleared swaps. 
LCH proposed that the factor listed in proposed Sec.  39.12(b)(1)(v), 
the ``[a]bility of the [DCO] and clearing members to gain access to the 
relevant market for purposes of creating and liquidating positions'' be 
modified to reflect these additional actions.
    The Commission agrees with LCH that a DCO must have the ability to 
``transfer,'' ``auction,'' or ``allocate'' cleared swaps and it is 
revising Sec.  39.12(b)(1)(v) to incorporate LCH's suggestion.\67\ The 
Commission is otherwise adopting Section 39.12(b)(1) as proposed. The 
Commission believes that setting forth the minimum factors that all 
DCOs must consider when determining contract eligibility is necessary 
to prevent a DCO from seeking to clear transactions that present an 
unacceptable level of risk. The Commission also believes that OCC's and 
LCH's concerns are unfounded. The rule provides factors to be 
considered and does not prohibit a DCO from accepting a product for 
clearing if it does not satisfy one of the factors. Finally, the 
Commission is declining to limit the rule to swaps because it believes 
the eligibility factors are applicable to all products cleared by a 
DCO. The Commission is also declining to issue suggested guidelines or 
core principles, or to request that a DCO file with the Commission the 
rationale for why a contract qualifies for clearing. The Commission 
believes that Sec.  39.12(b)(1) is not burdensome because, as MGEX and 
OCC commented, these factors are already considered by DCOs. In 
contrast, filing rationales on an as-needed basis could be burdensome 
to the DCO and the Commission, and would not serve to mitigate risk 
more effectively.
---------------------------------------------------------------------------

    \67\ This is also consistent with Sec.  39.16(c)(2)(ii), adopted 
herein and discussed in section IV.G.4, below, which requires a DCO 
to adopt rules that set forth the actions that a DCO may take in the 
event of a default, which must include the prompt transfer, 
liquidation, or hedging of the defaulting clearing member's 
positions, and which may include the auctioning or allocation of 
such positions to other clearing members.
---------------------------------------------------------------------------

c. Economic Equivalence--Sec.  39.12(b)(2)
    Proposed Sec.  39.12(b)(2) would require a DCO to adopt rules 
providing that all swaps with the same terms and conditions (as defined 
by templates established under DCO rules) submitted to the DCO for 
clearing are economically equivalent within the DCO and may be offset 
with each other within the DCO.
    ISDA, CME, and FIA commented that the term ``template'' is 
inappropriate. According to ISDA, ``template'' has no clear meaning, 
and it assumes that the term refers to the contract specifications 
currently used by a variety of futures facilities. ISDA noted that the 
development of specific templates for swap transactions is a mixed 
business/technological project that requires significant discussion 
involving each DCO and its market participants. It suggested that the 
Commission's regulations guide the meaning of ``template'' to achieve 
as much individual transactional variability as possible within the 
transaction or range of transactions that a template may cover.
    CME commented that references to ``templates'' are confusing 
because swap dealers generally maintain standard templates for 
documenting their trading relationships, and their counterparties 
frequently negotiate changes to those templates. According to CME, a 
DCO does not define the templates used by OTC participants, and DCO 
rules do not function as templates from which counterparties may 
negotiate. Rather, a DCO sets forth in its rulebook the product 
specifications of each contract it accepts for clearing, including 
swaps. CME suggested that the Commission revise Sec.  39.12(b)(2) to 
state as follows (change in italics): ``A [DCO] shall adopt rules 
providing that all swaps with the same terms and conditions, as defined 
by product specifications established under [DCO] rules, submitted to 
the [DCO] for clearing are economically equivalent within the [DCO] and 
may be offset with each other within the [DCO].''
    FIA requested that Commission confirm that economically equivalent 
swaps must have the same cash flows, values, and liquidation dates. FIA 
also suggested that terms and conditions of such templates--for 
example, events of default--should also be consistent with market 
practice.
    Finally, KCC commented that the proposed rule is redundant because 
Chapter 21 of the KCC rulebook already defines the terms and conditions 
for swaps that KCC will clear.
    The Commission is revising Sec.  39.12(b)(2) as suggested by CME to 
substitute the phrase ``product specifications'' for the word 
``templates.'' As noted above, some commenters found the use of the 
word ``templates'' confusing. The Commission's intent was to ensure 
that a DCO sets the specifications for cleared products. The Commission 
is otherwise adopting the rule as proposed.
    In response to FIA, the Commission confirms that it regards cash 
flows, values, and liquidation dates as terms and conditions 
encompassed by this rule. The Commission, however, declines to require 
that terms and conditions be consistent with market practice. The 
Commission believes that a DCO should have the flexibility to determine 
whether to conform terms and conditions to market practice.
d. Non-Discriminatory Treatment of Swaps--Sec.  39.12(b)(3)
    Proposed Sec.  39.12(b)(3) would require a DCO to provide for non-
discriminatory clearing of a swap executed bilaterally or on or subject 
to the rules of an unaffiliated SEF or DCM. FIA and MFA commented in 
support of the proposed rule.
    OCC suggested that it should not be deemed a violation of Sec.  
39.12(b)(3) for a DCO to require a SEF or DCM desiring to transmit 
swaps to the DCO for clearing to enter into a non-exclusive clearing 
agreement on non-discriminatory terms similar to those offered by the 
DCO to other SEFs or DCMs for clearing of similar products. OCC 
believes that such agreements are

[[Page 69360]]

necessary and appropriate for purposes of addressing matters between 
the parties such as information sharing and furnishing price data by 
the exchange to the DCO.
    LCH suggested that the Commission clarify that ``non-
discriminatory'' includes costs, technology, and other related 
considerations. LCH also suggested that the Commission impose the 
reverse requirements on execution venues such as DCMs and SEFs, so that 
those venues are also required to provide trade feeds to DCOs on a non-
discriminatory basis.
    The Commission is adopting Sec.  39.12(b)(3) as proposed. In 
response to OCC, the Commission notes that the rule does not prohibit a 
DCO from requiring a SEF or DCM desiring to transmit swaps to the DCO 
for clearing to enter into a non-exclusive clearing agreement on non-
discriminatory terms similar to those offered by the DCO to other SEFs 
or DCMs for clearing of similar products. The Commission agrees that 
such agreements are necessary and appropriate for purposes of 
addressing matters between the parties such as information sharing and 
furnishing price data by the exchange to the DCO. The Commission notes 
that it expects DCOs to review clearing agreements for compliance with 
Sec.  39.12(b)(3), the open access requirements of Core Principle C, 
and any relevant requirements of other core principles.
    In response to LCH's comment, the Commission notes that the 
requirement applies to the factors LCH enumerated. The Commission also 
notes that LCH's suggestion regarding trading venues is outside the 
scope of this rulemaking
e. Prohibition on Requirement That Executing Party Is a Clearing 
Member--Sec.  39.12(b)(4)
    Proposed Sec.  39.12(b)(4) would prohibit a DCO from requiring one 
of the original executing parties to be a clearing member in order for 
a contract, agreement, or transaction to be eligible for clearing.
    CME concurred with the Commission's analysis and fully supported 
the proposed regulation. FIA, Citadel, and MFA also supported the 
proposed regulation.
    MFA suggested strengthening the proposed rule. According to MFA, 
when a non-clearing member trades with another non-clearing member, the 
clearing process should be identical and as prompt as when one of the 
parties is a clearing member, so long as the transaction satisfies the 
relevant DCO's rules, requirements, and standards otherwise applicable 
to such trades. MFA believes that providing this parity would allow new 
liquidity providers to efficiently and effectively enter into and 
compete within the market.
    MFA also suggested that the Commission revise the proposed rule to 
prohibit a DCO from adopting rules or engaging in conduct that is 
prejudicial to non-clearing members as compared to clearing members 
with respect to eligibility or the timing of clearing or processing of 
trades generally. The Commission has addressed this issue in the 
recently proposed rules on clearing documentation.\68\
---------------------------------------------------------------------------

    \68\ See 76 FR 45730 (Aug. 1, 2011) (Customer Clearing).
---------------------------------------------------------------------------

    ISDA commented that rules barring trades that don't involve a 
clearing member as a party are inappropriate in established DCOs, but 
new DCOs may need to roll out products and procedures in a contained 
way. According to ISDA, ``initial decisions on which market 
constituencies should have access to clearing must be the subject of 
legitimate, reasoned decision-making by each DCO with regard to its 
ability to properly serve each constituency and each constituency's 
readiness to participate in a cleared market.''
    Finally, NGX commented that if the proposed rule were applied to a 
non-intermediated DCO such as NGX, the rule would require a fundamental 
restructuring of the manner in which the DCO admits members, guarantees 
trades, and provides risk management. DCOs like NGX require all 
participants to become clearing participants at the DCO, and they do 
not clear contracts that involve non-clearing participants.
    The Commission is adopting Sec.  39.12(b)(4) as proposed. In 
response to the comments of ISDA and NGX, the Commission notes that 
some DCOs currently have only direct participants, i.e., participants 
that do not offer client clearing. NGX, for example, provides direct 
access to commercial end users who clear for themselves. The Commission 
notes that, consistent with principles of open access, a DCO must have 
rules in place to offer client clearing promptly if an FCM or a 
customer requests access. However, from a cost-benefit perspective, the 
Commission would expect that any DCO investment in building systems 
would be proportionate to evidence of demand for the service.
    Finally, in a separate rulemaking, the Commission has proposed 
rules that address MFA's suggestion that trades between indirect 
clearing members should have parity with trades between clearing 
members.\69\
---------------------------------------------------------------------------

    \69\ See 76 FR 45730 (Aug. 1, 2011) (Customer Clearing).
---------------------------------------------------------------------------

f. Product Standardization--Sec.  39.12(b)(5)
    Proposed Sec.  39.12(b)(5) would require a DCO to select contract 
unit sizes and other product terms and conditions that maximize 
liquidity, facilitate transparency in pricing, promote open access, and 
allow for effective risk management.\70\ To the extent appropriate to 
further these objectives, a DCO would be required to select contract 
units for clearing purposes that were smaller than the contract units 
in which trades submitted for clearing were executed. \71\
---------------------------------------------------------------------------

    \70\ See 76 FR 13101 (Mar. 10, 2011) (Straight-Through 
Processing).
    \71\ Id.
---------------------------------------------------------------------------

    ISDA supported the goals identified by the Commission; however, it 
commented that ``unit size'' is not a meaningful concept in swap 
transactions because contract size is not standardized. According to 
ISDA, the only meaningful size limit is the smallest unit of relevant 
currency or relevant underlying. ISDA suggested that the Commission 
avoid focusing on ``unit size'' and instead articulate its ultimate 
objectives, as it has, leaving DCOs with the discretion to set suitable 
terms and conditions to further those objectives.
    FIA did not support the requirement that a DCO select contract unit 
sizes because FIA does not believe that the swap market has evolved to 
the point where DCOs can do this. FIA also does not believe the market 
is at a point where it would be appropriate for a DCO to establish 
templates regarding the terms and conditions of standardized swaps 
eligible for clearing. FIA believes that requiring swaps to fit within 
artificial, prescribed templates would be disruptive to the market and 
would not benefit customers. FIA, however, would support a requirement 
that DCOs study this matter and submit a report to the Commission on 
the feasibility of establishing templates regarding the terms and 
conditions of standardized swaps as soon as practicable.
    Finally, LCH commented that it is not appropriate to require a DCO 
to select contract units for clearing purposes that are smaller than 
the contract units in which trades submitted for clearing were 
executed. According to LCH, a DCO clearing swaps should be able to 
accept such swaps in any size, and swaps submitted for clearing should 
not

[[Page 69361]]

be broken down into sub-units. LCH suggested that the Commission strike 
Sec.  39.12(b)(5) and that any rules addressing average size of 
exposure traded in the swap markets be addressed in rules pertaining to 
trading and execution venues.
    The Commission is adopting Sec.  39.12(b)(5) as proposed. The 
Commission believes that standardizing products, including swaps, by 
requiring a DCO to determine product terms and conditions, including 
product size, will increase liquidity, lower prices, and increase 
participation. In addition, standardized products should make it easier 
for members to accept a forced allocation in the event of bankruptcy.
    The Commission recognizes that standardized products may create 
basis risk for some hedge positions. However, this circumstance has 
long existed in the futures markets. The Commission believes that the 
benefits of standardization, such as competitive pricing, liquid 
markets, and open access, outweigh the costs of imperfect hedging.
    In response to LCH, the Commission notes that the product 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. The Commission notes that under the rule, DCOs retain some 
discretion in determining how best to promote liquidity, facilitate 
open access, and aid risk management.
g. Novation--Sec.  39.12(b)(6)
    Proposed Sec.  39.12(b)(6) would require a DCO that clears swaps to 
have rules providing that upon acceptance of a swap: (i) The original 
swap is extinguished; (ii) the original swap is replaced by equal and 
opposite swaps between clearing members and the DCO; (iii) the terms of 
the cleared swaps 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.
    Newedge supported this rule, in particular, the requirement for 
standardization.
    CME, FIA, and ICE commented that the proposed rule appears to 
presume the use of a ``principal'' model for all cleared swaps, even 
those swaps cleared on behalf of customers. CME noted that at CME, an 
FCM clearing customer business acts as an agent for undisclosed 
principals (i.e., the FCM's customers) vis-a-vis CME and guarantees its 
customers' performance to CME. CME suggested that in order to preserve 
the agency model for customer-cleared swaps, the Commission should 
adopt a revised Sec.  39.12(b)(6)(ii) to provide that, upon acceptance 
of a swap for clearing, ``the original swap is replaced by equal and 
opposite swaps with the DCO.'' As previously noted, CME also commented 
that the use of the term ``template'' is confusing. It suggested that 
the Commission revise Sec.  39.12(b)(6)(iii) to state: ``All terms of 
the cleared swaps must conform to product specifications established 
under [DCO] rules.''
    FIA commented that the proposed rule would conflict with the FCMs' 
position that, with respect to customer positions, FCMs are acting as 
agent, and not as principal, for customers in executing and clearing 
swaps (and futures) on behalf of customers. FIA suggested that the 
proposed rule be revised to confirm that, in clearing swaps on behalf 
of customers, a clearing member shall be deemed a guarantor and agent 
of a cleared swap and not a principal.
    ICE noted that U.S. futures markets may clear on an open offer 
basis, which allows straight-through processing. ICE commented that the 
Commission should not preclude open offer clearing of swaps by 
requiring the underlying swap to be novated.
    Finally, LCH suggested that the Commission revise the rule so that 
the obligation would fall on the clearing member rather than the DCO 
because the provisions relate to the clearing member's books and 
records, not the DCO's.
    The Commission is adopting Sec.  39.12(b)(6) with modifications to 
clarify its intended meaning. In response to the comments from CME, 
FIA, and ICE, the Commission is revising Sec.  39.12(b)(6)(ii) to 
provide that a DCO that clears swaps must have rules providing that, 
upon acceptance of a swap by the DCO for clearing, ``[t]he original 
swap is replaced by an equal and opposite swap between the derivatives 
clearing organization and each clearing member acting as principal for 
a house trade or acting as agent for a customer trade.''
    In response to the comment from CME, the Commission is revising 
Sec.  39.12(b)(6)(iii) to substitute the phrase ``product 
specifications'' for the word ``templates.'' This is consistent with 
the change to Sec.  39.12(b)(2), discussed above.
    In response to the comment by ICE, the Commission notes that ``open 
offer'' systems are acceptable under the rule. Effectively, under an 
open offer system there is no ``original'' swap between executing 
parties that needs to be novated; the swap that is created upon 
execution is between the DCO and the clearing member, acting either as 
principal or agent.
    Finally, with regard to LCH's comment, the Commission believes that 
it is proper for the requirement to fall on the DCO. The DCO is the 
central counterparty and is responsible for the transaction going 
forward.
h. Confirmation of Terms--Sec.  39.12(b)(8)
    Proposed Sec.  39.12(b)(8) would require a DCO to have rules that 
provide that all swaps submitted to the DCO for clearing must include 
written documentation that memorializes all of the terms of the 
transaction and legally supersedes any previous agreement.\72\ The 
confirmation of all terms of the transaction would be required to take 
place at the same time as the swap is accepted for clearing.
---------------------------------------------------------------------------

    \72\ This provision was originally designated as Sec.  
39.12(b)(7)(v) in 76 FR 13101 (Mar. 10, 2011) (Straight-Through 
Processing). It was later proposed to be renumbered as Sec.  
39.12(b)(8) in 76 FR 45730 (Aug. 1, 2011) (Customer Clearing). 
Section 39.12(b)(7), as currently proposed (76 FR at 13110), will be 
addressed in a separate final rulemaking.
---------------------------------------------------------------------------

    CME suggested that the Commission revise the proposed regulation to 
require a DCO to ``provide each clearing member carrying a cleared swap 
with a definitive record of the terms of the agreement, which will 
serve as a confirmation of the swap.''
    ISDA commented that it is not clear what efficiencies the proposed 
rule would achieve for the parties to the swap in confirming through a 
DCO. It suggested that the Commission be less prescriptive and 
recognize that the act of clearing a swap transaction through a DCO in 
and of itself should produce a definitive written record, tailored to 
the particular category of swap transaction by the DCO and its market 
constituency, which fulfills the Commission's objective of facilitating 
the timely processing and confirmation of swaps not executed on a SEF 
or a DCM.
    FIA requested that the Commission clarify the obligations of the 
parties under this proposed rule. According to FIA, the rule appears to 
place

[[Page 69362]]

responsibility on the parties to the swap to submit a written 
confirmation of the terms of the transaction to the DCO, which, upon 
acceptance by the DCO, will supersede any prior documents and serve as 
the confirmation of the trade. However, the notice of proposed 
rulemaking places responsibility on the DCO, explaining that the 
proposed rule ``would require that DCOs accepting a swap for clearing 
provide the counterparties with a definitive written record of the 
terms of their agreement, which will serve as a confirmation of the 
swap.'' Further, the proposed rule appears to apply to all swaps 
submitted for clearing, but the notice of proposed rulemaking appears 
to limit the requirement to swaps not executed on a SEF or DCM, noting 
that swaps executed on a SEF or DCM are confirmed upon execution.\73\
---------------------------------------------------------------------------

    \73\ The notice of proposed rulemaking states: ``Proposed Sec.  
39.12(b)(7)(v) would require that DCOs accepting a swap for clearing 
provide the counterparties with a definitive written record of the 
terms of their agreement, which will serve as a confirmation of the 
swap.'' 76 FR at 13105-13106 (Mar. 10, 2011) (Straight-Through 
Processing).
---------------------------------------------------------------------------

    OCC commented that the terms and conditions applicable to a cleared 
swap would already be specified in the DCO rules or product 
specifications, and it does not think it is necessary for a DCO to 
provide a confirmation that is similar in form to detailed trade 
documentation such as an ISDA Master Agreement. OCC believes that the 
term ``written documentation'' should be interpreted broadly to mean 
any documentation that sufficiently memorialized the agreement of the 
counterparties with respect to the terms of a swap, which may consist 
of a confirmation (electronic or otherwise) that confirms the values 
agreed upon for terms that can be varied by the parties.
    MarkitSERV noted that the proposed rule would require a 
confirmation of all terms of the transaction at the time the swap is 
accepted for clearing, and commented that the rule is unclear as to 
whether, when a swap is to be submitted for clearing, confirmation 
would ever be required of the pre-clearing initial transaction between 
the original counterparties. In contrast, the Commission has elsewhere 
stated that it expects a DCO to require pre-clearing transactions to be 
confirmed before clearing.\74\ MarkitSERV also noted that when a 
transaction is not rapidly accepted for clearing the parties will still 
be responsible for confirming the transaction under Commission 
regulations. It recommended that the Commission clarify that when a 
transaction is not accepted for clearing within the time frame 
established for mandatory confirmation the parties should be permitted 
to satisfy their confirmation obligations by confirming the transaction 
prior to clearing.
---------------------------------------------------------------------------

    \74\ See 75 FR 81519, at 81521 (Dec. 28, 2010) (Confirmation, 
Portfolio Reconciliation, and Portfolio Compression Requirements for 
Swap Dealers and Major Swap Participants) (``if a swap is executed 
bilaterally, but subsequently submitted to a DCO for clearing, the 
DCO will require a definitive written record of all terms to the 
counterparties' agreement prior to novation by the DCO'').
---------------------------------------------------------------------------

    The Commission is adopting Sec.  39.12(b)(8) in modified form to 
read as set forth in the regulatory text of this final rule.
    The change to the heading is responsive to the comment by FIA that 
it was unclear whether the rule applied to all cleared swaps or only to 
those that are executed bilaterally. Regardless of the execution venue, 
confirmation of a cleared swap is ultimately provided by the DCO. In 
the case of a trading facility with a central limit order book, 
execution and acceptance for clearing are simultaneous and confirmation 
occurs at that time. In all other cases, there is an interim time 
between execution and acceptance, or rejection, for clearing.
    The Commission notes that applicable confirmation requirements may 
depend on the length of time between execution and acceptance or 
rejection for clearing. For example, if a trade executed on a SEF is 
accepted for clearing within seconds, the DCO notification would serve 
as the single confirmation. But, if a trade is executed bilaterally and 
later submitted for clearing, there may need to be an initial bilateral 
confirmation that is later superseded by the clearing confirmation.
    The changes to the text are responsive to the comments of FIA, CME, 
ISDA, OCC, and MarkitSERV. As FIA pointed out, the proposed rule text 
seems to place the confirmation obligation on the submitting parties, 
while the discussion in the notice of proposed rulemaking places it on 
the DCO. Consistent with the language in the discussion and the 
recommendations of FIA, CME, and ISDA, the revised rule clarifies that 
DCOs provide confirmations of cleared trades. This interpretation was 
implicit in the proposal given that the second sentence of the rule 
provides that confirmation takes place when the trade ``is accepted'' 
for clearing.

D. Core Principle D--Risk Management--Sec.  39.13

    Core Principle D, \75\ as amended by the Dodd-Frank Act, 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 non-defaulting clearing members would not be exposed to losses 
that non-defaulting clearing members cannot anticipate or control. 
Finally, Core Principle D provides that a DCO must require margin from 
each clearing member 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. The Commission proposed to adopt Sec.  39.13 to establish 
requirements that a DCO would have to meet in order to comply with Core 
Principle D.
---------------------------------------------------------------------------

    \75\ Section 5b(c)(2)(D) of the CEA, 7 U.S.C. 7a-1(c)(2)(D).
---------------------------------------------------------------------------

1. General--Sec.  39.13(a)
    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 Commission did not receive any comments on proposed 
Sec.  39.13(a) and is adopting Sec.  39.13(a) as proposed.
2. Risk Management Framework--Sec.  39.13(b)
    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. In addition, proposed Sec.  39.13(b) would require 
a DCO to regularly review its risk management framework and update it 
as necessary.
    Mr. Barnard recommended that the Commission comprehensively and 
explicitly address all elements that make up a risk management 
framework, including organizational structure, governance, risk 
functions, internal controls, compliance, internal audit,

[[Page 69363]]

and legal functions.\76\ In particular, with respect to organizational 
structure, Mr. Barnard noted that reporting lines and the allocation of 
responsibilities and authority within a DCO should be clear, complete, 
well-defined and enforced.
---------------------------------------------------------------------------

    \76\ Mr. Barnard also recommended that the Commission focus more 
on operational risk and the role of reporting and public 
disclosures. With respect to operational risk, the Commission notes 
that it is adopting Sec.  39.18 herein, which addresses system 
safeguards, and which is discussed in section I, below. Reporting 
and public information are addressed in Sec. Sec.  39.19 and 39.21, 
respectively, also adopted herein, which are discussed in sections J 
and L, respectively, below.
---------------------------------------------------------------------------

    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 and the manner in which they may 
relate to each other. The Commission believes that a written risk 
policy is important because it will help to ensure the DCO has 
carefully considered its risk management framework, and it will provide 
guidance to DCO management, staff, and market participants. It will 
also allow the Commission to assess the DCO's risk management framework 
more efficiently. The risks to be addressed 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. However, the Commission does not 
believe that it is necessary to explicitly list such risks in the final 
rule.
    MGEX commented that the documentary and procedural requirements of 
proposed Sec.  39.13(b) would impose heavy costs and turn the goal of 
practical risk management into one of paperwork compliance, and that 
while having a framework containing all the various policies can be 
beneficial for DCOs, the development and implementation of such 
policies must be flexible and left to each DCO. The Commission notes 
that DCOs generally already have certain written risk management 
policies, procedures and controls, although the substance, level of 
detail, and integration of each DCO's documentation of such policies, 
procedures and controls may vary. The Commission believes that Sec.  
39.13(b) provides DCOs with the appropriate amount of flexibility with 
regard to the documentation of their risk management frameworks, 
without imposing significant additional costs upon DCOs.
    OCC noted that its risk management policies are highly complex and 
are embodied in multiple separate written documents, and much of its 
day-to-day operations are related to risk management. OCC stated that 
the Commission should make it clear that the proposal would not require 
the board to approve every document related to risk management, as it 
would be burdensome and would inappropriately require the board to 
micro-manage the day-to-day functions of a DCO. OCC indicated that it 
does not believe that the function of the committee that is responsible 
for the oversight of its risk management activities would be enhanced 
by the creation of additional written policies, procedures, and 
controls.
    The Commission recognizes that many of the day-to-day functions of 
a DCO are related to risk management, and Sec.  39.13(b) is not 
intended to require that a DCO's board must approve every document at a 
DCO that addresses risk management issues nor is it intended to require 
that a DCO's board must approve every day-to-day decision regarding the 
implementation of the DCO's risk management framework.
    CME and ICE took the position that a DCO's Risk Management 
Committee should have the authority to approve the written policies, 
procedures, and controls that establish a DCO's risk management 
framework, noting that this would be consistent with proposed Sec.  
39.13(c), which would require a DCO's Chief Risk Officer to make 
appropriate recommendations to the DCO's Risk Management Committee or 
board of directors, as applicable, regarding the DCO's risk management 
function.
    The Commission believes that a DCO's risk management framework 
should be subject to the approval of its board of directors. The 
Commission recognizes that a DCO's Risk Management Committee may play a 
crucial role in the development of the risk management policies of a 
DCO. However, the board has the ultimate responsibility for the 
management of the DCO's risks. Requiring board approval of a DCO's risk 
management framework is also consistent with proposed international 
standards.\77\
---------------------------------------------------------------------------

    \77\ See CPSS-IOSCO Consultative Report, Principle 2: 
Governance, Key Consideration 5, at 23.
---------------------------------------------------------------------------

    In addition, a requirement that a DCO's board approve its risk 
management framework is consistent with Sec.  39.13(c), which permits a 
DCO's Chief Risk Officer to make appropriate recommendations to the 
DCO's Risk Management Committee regarding the DCO's risk management 
functions. Although the board would approve the framework, it could 
delegate defined decision-making authority to the Risk Management 
Committee in connection with the implementation of the framework. The 
Commission is adopting Sec.  39.13(b) as proposed.
3. Chief Risk Officer--Sec.  39.13(c)
    Proposed Sec.  39.13(c) would require a DCO to have a Chief Risk 
Officer (CRO) 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.\78\
---------------------------------------------------------------------------

    \78\ See 75 FR at 63750 (Oct. 18, 2010) (Conflicts of Interest). 
In that proposed rulemaking, the provisions relating to the Risk 
Management Committee were designated as Sec.  39.13(g). In the final 
rulemaking with respect to that proposal, those provisions will be 
redesignated as Sec.  39.13(d).
---------------------------------------------------------------------------

    Better Markets commented that the proposal should provide 
substantive parameters for a CRO and that the CRO rules applicable to 
FCMs should be applied to DCOs. Mr. Greenberger indicated that the CRO 
of a DCO should be subject to the same rules regarding reporting and 
independence as the CROs of other registered entities.
    The Commission does not believe that it is necessary to further 
define the responsibilities of a DCO's CRO in the final rule. The 
Commission notes that it has not proposed any rules regarding a CRO for 
FCMs or any other registered entities, as suggested by Better Markets 
and Mr. Greenberger.\79\
---------------------------------------------------------------------------

    \79\ However, the Commission has proposed rules regarding a CCO 
for futures commission merchants, swap dealers, and major swap 
participants, at 75 FR 70881 (Nov. 19, 2010) (Designation of a Chief 
Compliance Officer; Required Compliance Policies; and Annual Report 
of a Futures Commission Merchant, Swap Dealer, or Major Swap 
Participant), with respect to which Better Markets filed a comment 
letter.
---------------------------------------------------------------------------

    As noted in the notice of proposed rulemaking, given the importance 
of the risk management function and the comprehensive nature of the 
responsibilities of a DCO's CCO, which are governed by Sec.  39.10, as 
adopted in this rulemaking, the Commission expects that a DCO's CRO and 
its CCO would be two different individuals. The Commission is adopting 
Sec.  39.13(c) as proposed.
4. Measurement of Credit Exposure--Sec.  39.13(e)
    Proposed 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

[[Page 69364]]

day; and (2) monitor its credit exposure to each clearing member 
periodically during each business day. Proposed Sec.  39.13(e) was a 
prerequisite for proposed Sec.  39.14(b), which would address daily 
settlements based on a DCO's measurement of its credit exposures to its 
clearing members.
    LCH commented that a DCO should be required to measure its credit 
exposures ``several times each business day'' and that a DCO should be 
obliged to recalculate initial and variation margin requirements more 
than once each business day. By contrast, OCC requested that the 
Commission clarify that the proposed requirement that a DCO monitor its 
credit exposure to each clearing member periodically during each 
business day would not require a DCO to update clearing member 
positions on an intra-day basis for purposes of monitoring risk, which 
would not be practical, and that intra-day monitoring of credit 
exposures based on periodic revaluation of beginning-of-day positions 
would be sufficient to comply with the proposed rule.
    The Commission does not believe that a DCO should be required to 
mark each clearing member's open positions to market and recalculate 
initial and variation margin requirements more than once each business 
day, and notes that the requirement that a DCO monitor its credit 
exposure to each clearing member periodically during each business day 
could be satisfied through intra-day monitoring of credit exposures 
based on periodic revaluation of beginning-of-day positions as 
suggested by OCC.
    However, as discussed in section IV.E.2, below, Sec.  39.14(b) 
requires 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 
are breached, or in times of extreme market volatility. Therefore, in 
order to comply with Sec.  39.14(b), a DCO would be required to have 
the authority and operational capacity to mark each clearing member's 
open positions to market and recalculate initial and variation margin 
requirements, on an intraday basis, under the circumstances defined in 
Sec.  39.14(b).
    The Commission is adopting Sec.  39.13(e) as proposed, except that 
the Commission is making a technical revision by replacing the phrase 
``such clearing member's open positions'' with the phrase ``such 
clearing member's open house and customer positions'' to eliminate 
possible ambiguity and to clarify the Commission's intent to reflect 
current industry practice and include both house and customer 
positions, not just house positions. The Commission notes that Sec.  
39.13(e) is consistent with international recommendations.\80\
---------------------------------------------------------------------------

    \80\ See CPSS-IOSCO Consultative Report, Principle 6: Margin, 
Key Consideration 4, at 40.
---------------------------------------------------------------------------

5. Limitation of Exposure to Potential Losses From Defaults--Sec.  
39.13(f)
    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) non-defaulting 
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 Section 
5b(c)(2)(D)(iii) of the CEA, as amended by the Dodd-Frank Act.
    FIA supported the proposal and MGEX stated that it appeared 
reasonable if applied appropriately. FIA acknowledged that clearing 
members understand and accept that they are subject to losses in the 
event of a default of another clearing member but noted that these 
potential losses must be measurable and subject to a reasonable cap 
over a period of simultaneous or multiple defaults. MGEX suggested that 
the Commission adopt an interpretation that each clearing member, by 
becoming a clearing member, can reasonably anticipate that another 
clearing member may potentially default and that a DCO can apply its 
rules accordingly.
    The Commission believes that every clearing member is aware that 
another clearing member may default. The Commission also notes that the 
potential losses resulting from such a default will be mitigated to the 
extent that a DCO is bound to comply with the CEA, Commission 
regulations, and its own rules, particularly with regard to financial 
resources and default rules and procedures.
    KCC commented that there would appear to be little cost/benefit 
justification for duplicating the statutory language of the core 
principle in the form of a rule.\81\ The Commission believes that 
codifying provisions of the CEA does not impose an additional cost on a 
DCO because a DCO must satisfy such requirements to comply with the 
law. At the same time, the Commission believes that codifying this 
statutory provision provides a DCO with a single location in which to 
identify the minimum standards necessary to fulfill the requirements of 
Core Principle D. The Commission is adopting Sec.  39.13(f) as 
proposed.
---------------------------------------------------------------------------

    \81\ See Section 5b(c)(2)(D)(iii) of the CEA, 7 U.S.C. 7a-
1(c)(2)(D)(iii).
---------------------------------------------------------------------------

6. Margin Requirements--Sec.  39.13(g)
a. General
    Several commenters made general comments about margin requirements 
that did not address specific provisions of proposed Sec.  39.13(g). 
The Commission has summarized those comments, and responded to those 
comments, below.
    KCC expressed its belief that the Commission's detailed proposed 
margin requirements are not consistent with the Dodd-Frank Act's 
changes to the CEA, which simply require that a DCO's margin models and 
parameters must be ``risk-based.'' The Commission notes that Section 
5b(c)(2) of the CEA, as amended by the Dodd-Frank Act, requires a DCO 
to comply with the statutory core principles ``and any requirement that 
the Commission may impose by rule or regulation pursuant to section 
8a(5).'' As noted in section I.A, above, legally enforceable standards 
set forth in regulations serve to increase legal certainty, prevent 
DCOs from lowering risk management standards for competitive reasons, 
and increase market confidence. These goals are especially important 
with respect to margin, which is one of the key tools used by DCOs in 
managing risk. Therefore, the Commission believes it is appropriate to 
impose more detailed margin requirements than those contained in the 
statutory language of Core Principle D.
    ISDA urged the Commission to adopt rules requiring DCOs to adopt 
risk methodologies that would reduce the impact that customer account 
risk has on the size of default fund contributions. ISDA noted that 
this would enable DCOs to better guaranty the portability of client 
portfolios, but would increase risk to the DCO; however, ISDA stated 
that this increased risk could be addressed by increasing the risk 
margin of the customer account. The Commission has not proposed and is 
not adopting such rules. The Commission believes that a DCO should have 
reasonable discretion to determine how it will calculate the amounts of 
any default fund contributions that it may require from its clearing 
members, and the extent to which customer risk will be a factor in such 
calculations.
    MFA and Citadel stated that it is important that a DCO's process 
for setting initial margin be transparent in order to give all market 
participants

[[Page 69365]]

certainty as to the margin they can expect the DCO to assess. 
Therefore, MFA and Citadel urged the Commission to adopt final rules 
that would require a DCO to make available to all market participants, 
at no cost, a margin calculation utility, so that they would be able to 
replicate the calculation of the margin that the DCO would assess.
    The Commission notes that it is adopting Sec. Sec.  39.21(c)(3) and 
(d) herein, which require a DCO to disclose information concerning its 
margin-setting methodology on its Web site. However, the Commission is 
not requiring a DCO to provide a margin calculation utility to market 
participants free of cost, although the Commission notes that some DCOs 
have chosen to do so.\82\ The Commission believes that whether a DCO 
will provide a margin calculation utility to market participants, and 
whether and how much it might charge for such a utility, is a business 
decision that should be left to the discretion of a DCO.
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    \82\ See e.g., http://www.cmegroup.com/clearing/cme-core-cme-clearing-online-risk-engine.html and https://www.theice.com/publicdocs/ice_trust/ICE_Margin_Simulation_Calculator_Training_Presentation.pdf.
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    The FHLBanks indicated that it may be appropriate, in some 
circumstances, for a DCO to waive its initial margin requirements with 
respect to certain highly creditworthy customers of a clearing member. 
Therefore, the FHLBanks urged the Commission to grant DCOs discretion 
to waive initial margin requirements when doing so would not pose risk 
to the DCO or its clearing members. In light of the fact that the Dodd-
Frank Act requires the removal of reliance on credit ratings, the 
FHLBanks recommended that the Commission adopt alternative criteria by 
which a DCO could exercise such discretionary waivers, or alternatively 
grant DCOs discretion to establish their own criteria, subject to 
Commission approval, or to guidelines established by the Commission in 
the final rule.
    The Commission has not proposed a rule that would permit it to 
grant DCOs the discretion to waive initial margin requirements and it 
is not adopting such a rule, as requested by the FHLBanks. Even if 
there were an objective way to define highly creditworthy customers, 
the Commission does not believe that permitting such waivers would 
constitute prudent risk management.
b. Amount of Initial Margin Required--Sec.  39.13(g)(1)
    Proposed Sec.  39.13(g)(1) would require that the initial margin 
\83\ 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. The Commission invited 
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.
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    \83\ The term ``initial margin'' is now defined in Sec.  
1.3(lll), adopted herein.
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    MFA, BlackRock, and Citadel expressed their support for the 
proposal. CME and OCC commented that the Commission should not define 
normal market conditions, while ISDA stated that the Commission should 
define normal market conditions. The Commission noted in the notice of 
proposed rulemaking that the 2004 CPSS-IOSCO Recommendations defined 
``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 percent of the time, that is, on average 
on only one trading day out of 100.'' \84\ The CPSS-IOSCO Consultative 
Report was published subsequent to the issuance of proposed Sec.  
39.13(g)(1). The CPSS-IOSCO Consultative Report replaced the concept of 
``normal market conditions'' with a proposed requirement that 
``[i]nitial margin should meet an established single-tailed confidence 
level of at least 99 percent for each product that is margined on a 
product basis, each spread within or between products for which 
portfolio margining is permitted, and for each clearing member's 
portfolio losses.'' \85\ The Commission had also proposed similar 
requirements for a 99 percent confidence level in proposed Sec.  
39.13(g)(2)(iii), discussed below. Therefore, in adopting Sec.  
39.13(g)(1), the Commission is declining to adopt the proposed explicit 
requirement that initial margin must be sufficient to cover potential 
exposures in normal market conditions, in order to avoid any ambiguity 
over the meaning of ``normal market conditions.''
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    \84\ See 2004 CPSS-IOSCO Recommendations at 21.
    \85\ See CPSS-IOSCO Consultative Report, Principle 6: Margin, 
Key Consideration 3, at 40.
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    FIA recommended that parameters used in setting initial margin 
requirements should be reviewed monthly and models should be reviewed 
annually and on an ad hoc basis if substantive changes are made, 
whereas OCC took the position that the Commission should permit a DCO 
to use its reasonable discretion in determining what constitutes a 
``regular basis'' for reviewing margin models and parameters. The 
Commission has determined not to specify the appropriate frequency of 
review, as it may differ based on the characteristics of particular 
products and markets, and the nature of the margin models and 
parameters that apply to those products and markets. However, although 
Sec.  39.13(g)(1) would permit a DCO to exercise its discretion in 
determining how often it should review its margin models and 
parameters, the Commission would apply a reasonableness standard in 
determining whether the frequency of reviews conducted by a particular 
DCO was appropriate.
    Moreover, as discussed in section IV.D.6.d, below, Sec.  
39.13(g)(3) requires that a DCO's systems for generating initial margin 
requirements, including the DCO's theoretical models, must be reviewed 
and validated by a qualified and independent party, on a regular basis. 
As the Commission noted in the notice of proposed rulemaking, the 
Commission would expect a DCO to obtain 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. This express expectation 
would address FIA's suggestion that a DCO should be required to review 
its margin models on an ad hoc basis if substantive changes are made. 
For the reasons discussed, the Commission is adopting Sec.  39.13(g)(1) 
with the modification described above.
c. Methodology and Coverage
(1) General--Sec.  39.13(g)(2)(i)
    Proposed Sec.  39.13(g)(2)(i) would require a DCO to 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.\86\ In 
particular, proposed Sec.  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.\87\ The Commission

[[Page 69366]]

invited comment regarding whether there are specific risks that should 
be identified and addressed in the proposed regulation in addition to 
jump-to-default risk.
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    \86\ As proposed, Sec.  39.13(g)(2)(i) referred to addressing 
any ``unique'' characteristics of, or risks associated with, 
particular products or portfolios. The Commission is revising this 
provision in the final rule to refer to any ``unusual'' 
characteristics of, or risks associated with, particular products or 
portfolios to clarify that such characteristics or risks are not 
limited to those that are one of a kind. See also n. 66, above.
    \87\ In the notice of proposed rulemaking, the Commission 
defined jump-to-default risk as referring 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.
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    CME and Nadex, Inc. (Nadex) expressed the opinion that it would not 
be beneficial to attempt to identify additional specific risks that a 
DCO must address in determining initial margins and LCH commented that 
the reference to jump-to-default risk should either be removed or 
amended to cover all other products that are subject to jump-to-default 
risk. The Commission agrees with CME and Nadex that it is not necessary 
to identify additional specific risks in the regulation, and also 
agrees with LCH that the reference to jump-to-default risk should 
generally apply to any product that may be subject to such risk. 
Therefore, the Commission is adopting a revised Sec.  39.13(g)(2)(i) 
that eliminates the specific reference to CDS. The Commission has also 
added the phrase ``or similar jump risk.'' This is intended to address 
the possibility of a large payment obligation in a product accumulating 
in a very short period of time following an extreme market event.
(2) Liquidation Time--Sec.  39.13(g)(2)(ii)
    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 \88\ and the time within which the DCO estimates that it would 
be able to liquidate a defaulting clearing member's positions 
(liquidation time). As proposed, a DCO would have to use a liquidation 
time that is a minimum of five business days for cleared swaps that 
were not executed on a DCM, and 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. The Commission invited comment regarding whether the 
minimum liquidation times specified in proposed Sec.  39.13(g)(2)(ii) 
were appropriate, or whether there were minimum liquidation times that 
were more appropriate.
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    \88\ The term ``variation margin'' is now defined in Sec.  
1.3(ooo), adopted herein.
---------------------------------------------------------------------------

    LCH suggested that ``or transfer'' should be inserted after 
``liquidate'' in the proposed rule and that an appropriate liquidation 
period should be a period that would be sufficient to enable a DCO to 
adequately hedge or close out a defaulting member's risk. The 
Commission does not believe that it is appropriate to add ``or 
transfer,'' or to interpret the liquidation period to include the time 
that would be sufficient to hedge a defaulting clearing member's 
positions. In a worst-case scenario, a DCO would need to liquidate a 
defaulting clearing member's positions, and the time it would take to 
do so should be the relevant consideration in setting initial margin 
requirements.
    ISDA commented that a DCO should continually monitor the risk 
associated with concentration in participants' positions, and if a DCO 
determines that a participant's cleared portfolio is so large that it 
could not be liquidated within the liquidation period assumed in the 
DCO's default management plan, the DCO should have the discretion to 
include an extra charge for concentration risk in the initial margin 
requirements of that participant. FIA made similar comments but 
suggested that prudent risk management should require the imposition of 
concentration margin in appropriate circumstances. FIA further noted 
that when a DCO imposes concentration margin on a clearing member, the 
additional margin should be included in the DCO's minimum margin 
calculations for any customers of the clearing member that generate the 
increased risk.
    Although the regulations adopted by the Commission herein do not 
specifically address concentration margin as described by ISDA and FIA, 
they do not limit a DCO's discretion to impose extra charges on its 
clearing members for concentration risk. It should also be noted that 
Sec.  39.13(h)(6), adopted herein,\89\ requires 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, which actions may include imposing enhanced 
margin requirements.
---------------------------------------------------------------------------

    \89\ See discussion of Sec.  39.13(h)(6)(ii) in section 
IV.D.7.f, below.
---------------------------------------------------------------------------

    Numerous commenters objected to the proposed difference in 
requirements that would subject swaps that were either executed 
bilaterally or executed on a SEF to a minimum five-day liquidation 
time, while permitting equivalent swaps that were executed on a DCM to 
be subject to a minimum one-day liquidation time. Commenters variously 
argued that the proposed one-day/five-day distinction for swap 
transactions depending on the venue of execution would: (1) Be 
inconsistent with the open access provisions of Section 2(h)(1)(B) of 
the CEA \90\ and/or proposed Sec.  39.12(b)(2) \91\ (GFI Group Inc. 
(GFI), VMAC, LCC (VMAC), BlackRock, Wholesale Markets Brokers' 
Association, Americas (WMBAA), and FX Alliance Inc. (FXall)); (2) be 
inconsistent with Congressional intent, expressed in Section 731 of the 
Dodd-Frank Act,\92\ which recognizes a difference in risk between 
cleared and uncleared swaps that could be addressed by differential 
margin requirements, but does not differentiate between the risk of 
swaps executed on a DCM and those executed on a SEF (Asset Management 
Group of the Securities Industry and Financial Markets Association 
(AMG)); (3) discriminate against trades not executed on DCMs by 
requiring DCOs to impose higher margin requirements for swaps that are 
executed on SEFs than for swaps that are executed on DCMs (GFI, VMAC, 
MarketAxess Corporation (MarketAxess), WMBAA, Tradeweb Markets LLC 
(Tradeweb), Nodal Exchange, LLC (Nodal), and FXall); (4) raise the cost 
of clearing for swaps traded on a SEF (National Energy Marketers 
Association (NEM), NGX, and BlackRock); \93\ (5) put SEFs at a 
competitive disadvantage to DCMs (GFI, MarketAxess, and BlackRock); (6) 
artificially restrict the ability of market participants, including 
asset managers, to select the best means of execution for their swap 
transactions (BlackRock); (7) penalize market participants that desire 
to effect swap transactions on a SEF rather than a DCM (WMBAA and 
Tradeweb); (8) undermine the goal of the Dodd-Frank Act to promote 
trading of swaps on SEFs (Tradeweb and FXall); (9) potentially create 
detrimental arbitrage between standardized swaps traded on a SEF and 
futures contracts with the same terms and conditions traded on a DCM 
(Nodal); (10) impose onerous and unnecessary administrative costs on 
DCOs, which would likely be passed on to clearing members and their 
customers (VMAC and BlackRock); (11) create a disincentive for DCOs to 
practice appropriate default management ``drills'' to reduce the

[[Page 69367]]

liquidation time of portfolios of swaps (ISDA); (12) remove the 
incentive for DCOs to detail, practice and leverage clearing member 
expertise in default management (FIA); (13) discourage voluntary 
clearing (NGX); and (14) require DCOs and clearing members to manage 
margin calls and netting based on the execution platform for the 
relevant swaps (VMAC and BlackRock).
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    \90\ See Section 2(h)(1)(B) of the CEA, 7 U.S.C. 2(h)(1)(B).
    \91\ See discussion of Sec.  39.12(b)(2) in section IV.C.2.c, 
above.
    \92\ Section 731 of the Dodd-Frank Act amended the CEA to insert 
Section 4s. See Section 4s(e)(3)(A)(ii) of the CEA, 7 U.S.C. 
6s(e)(3)(A)(ii).
    \93\ NGX estimated that the impact of transitioning from its 
current two-day requirement to a five-day requirement for all of the 
energy products that it clears would lead to an approximate 60 
percent increase in initial margins.
---------------------------------------------------------------------------

    In addition, a number of commenters argued that there was no basis 
for concluding that swaps executed on a SEF would be less liquid than 
swaps executed on a DCM (GFI, WMBAA, NGX, MarketAxess, AMG, and FXall).
    BlackRock recommended that the Commission require a DCO to use a 
consistent liquidation time for cleared swaps that are executed on SEFs 
and DCMs.
    Commenters variously contended that a liquidation time of five 
business days may be excessive for some swaps (CME and Citadel \94\), a 
one-day liquidation period is too short (LCH), a one-day liquidation 
period is appropriate for swaps executed on a DCM or a SEF (AMG), and a 
two-day liquidation period is appropriate for cleared swaps (NGX).
---------------------------------------------------------------------------

    \94\ Citadel further commented that excessive margin 
requirements relative to risk exposure could adversely affect market 
liquidity and deter clearing.
---------------------------------------------------------------------------

    Various commenters encouraged the Commission to permit a DCO to 
determine the appropriate liquidation time for all products that it 
clears based on the unique characteristics and liquidity of each 
relevant product or portfolio (CME, MFA, ISDA, LCH, NYPC, NGX, FIA,\95\ 
Nadex, Citadel, and FXall) or to grant DCOs such discretion subject to 
a one-day minimum for all products, including cleared swaps (GFI, VMAC, 
MarketAxess, Nodal, WMBAA, and Tradeweb).
---------------------------------------------------------------------------

    \95\ FIA also commented that liquidation times should be set at 
times appropriate to manage the liquidation of the vast majority of 
the portfolios carried by a DCO's clearing members, and not 
necessarily that of the largest clearing member.
---------------------------------------------------------------------------

    FIA and ISDA commented that the appropriate liquidation time should 
be derived from a DCO's default management plan and the results of its 
periodic testing of such plan. FIA further stated that a DCO should 
adjust its minimum margin requirements if its periodic testing of its 
default management plan demonstrates that a defaulting clearing 
member's positions could be resolved in a shorter period of time. 
Similarly, NGX stated that the Commission should permit a DCO to 
demonstrate through back testing and stress testing that a particular 
type of cleared transaction should be subject to a shorter liquidation 
time.
    MFA and Citadel recommended that if the Commission were to mandate 
minimum liquidation times in the final rules, it should allow DCOs to 
apply for exemptions for specific groups of swaps if market conditions 
prove that such minimum liquidation times are excessive. Citadel 
further recommended that the Commission make it explicit that the 
Commission may re-evaluate and, if necessary, re-calibrate such minimum 
liquidation times as markets evolve.
    The Commission is persuaded by the views expressed by numerous 
commenters that requiring different minimum liquidation times for 
cleared swaps that are executed on a DCM and equivalent cleared swaps 
that are executed on a SEF could have negative consequences. Therefore, 
after further consideration, the Commission has determined not to 
mandate different minimum liquidation times for cleared swaps based on 
their venue of execution, and has further determined that the same 
minimum liquidation time should be used with respect to cleared swaps 
that are executed bilaterally. This approach is consistent with the 
open access requirements of Section 2(h)(1)(B) of the CEA and Sec.  
39.12(b)(2), adopted herein.
    The Commission also acknowledges the concerns expressed by 
commenters that a five-day liquidation period may be excessive for some 
swaps. For example, for a number of years, CME and ICE have 
successfully cleared swaps based on physical commodities using a one-
day liquidation time.\96\ By contrast, as noted in the notice of 
proposed rulemaking, several DCOs currently use a five-day liquidation 
time in determining margin requirements for certain swaps based on 
financial instruments.\97\ These differences reflect differences in the 
risk characteristics of the products.
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    \96\ NYMEX, now CME, has cleared OTC swaps generally with a one 
day liquidation time since 2002. CME currently offers more than 
1,000 products for clearing through its ClearPort system.
    \97\ In particular, ICE Clear Credit LLC and CME use a five-day 
liquidation time for credit default swaps and LCH and CME use a 
five-day liquidation time for interest rate swaps.
---------------------------------------------------------------------------

    The Commission has carefully considered whether it should prescribe 
any liquidation time or, alternatively, permit each DCO to exercise its 
discretion in applying liquidation times based on the risk profile of 
particular products or portfolios. In this regard, the Commission notes 
that even without a specified minimum liquidation time, under Sections 
5b(c)(2)(D) and 8a(7)(D) of the CEA, the Commission can require a DCO 
to adjust its margin methodology if it determines that the current 
margin levels for a product or portfolio are inadequate based on back 
testing or current market volatility.
    Weighing the advantages and drawbacks of the alternatives, the 
Commission believes that a bright-line requirement, with a provision 
for making exceptions, will best serve the public interest. While a DCO 
will still have considerable latitude in setting risk-based margin 
levels, the Commission has determined that establishing a minimum 
liquidation time will provide legal certainty for an evolving 
marketplace, will offer a practical means for assuring that the 
thousands of different swaps that are going to be cleared subject to 
the Commission's oversight will have prudent minimum margin 
requirements, and will prevent a potential ``race to the bottom'' by 
competing DCOs. Moreover, given the large number of swaps already 
cleared, this alleviates the need for the Commission, with its limited 
staff resources, to evaluate immediately the liquidation time for each 
swap that is cleared.\98\
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    \98\ E.g., the 950,000 trades in LCH's SwapClear have an 
aggregate notional principal amount of over $295 trillion. Source: 
http://www.lch.com/swaps/swapclear_for_clearing_members/.
---------------------------------------------------------------------------

    Taking into account these considerations, and in response to the 
comments, the Commission is adopting Sec.  39.13(g)(2)(ii) with a 
number of modifications. First, the final rule requires a DCO to use 
the same liquidation time for a product whether it is executed on a 
DCM, a SEF, or bilaterally. This addresses the competitive concerns 
raised by numerous commenters and recognizes that once a swap is 
cleared, its risk profile is not affected by the method by which it was 
executed.\99\
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    \99\ See Section 2(h)(1)(B) of the CEA and Sec.  39.12(b)(2), 
adopted herein (swaps submitted to a DCO with the same terms and 
conditions are economically equivalent within the DCO and may be 
offset with each other within the DCO).
---------------------------------------------------------------------------

    Second, the final rule provides that the minimum liquidation time 
for swaps based on certain physical commodities, i.e., agricultural 
commodities,\100\ energy, and metals, is one day. For all other swaps, 
the minimum liquidation time is five days. This distinction is based on 
the differing risk characteristics of these product groups and is 
consistent with existing requirements that reflect the risk assessments 
DCOs have made over the course of their experience clearing these types 
of swaps. The longer liquidation time, currently five days for credit 
default swaps at ICE Clear Credit, LLC, and CME, and for interest rate

[[Page 69368]]

swaps at LCH and CME, is based on their assessment of the higher risk 
associated with these products.\101\ Contributing factors include a 
concentration of positions among clearing members, the number and 
variety of products listed, the complexity of the portfolios, the long-
dated expiration time for many swaps, and the challenges of the 
liquidation process in the event of a default.\102\
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    \100\ See 76 FR 41048 (July 13, 2011) (Agricultural Commodity 
Definition; final rule).
    \101\ See e.g., Cleared OTC Interest Rate Swaps at 7 (Aug. 
2011), available at http://www.cmegroup.com/clearing/cme-core-cme-clearing-online-risk-engine.html; ICE Clear Credit Clearing Rules, 
Schedule 401 (Jul. 16, 2011) available at https://www.theice.com/publicdocs/clear_credit/ICE_Clear_Credit_Rules.pdf.
    \102\ The liquidation of the Lehman interest rate swap portfolio 
in the fall of 2008 demonstrates that the actual liquidation time 
for a swap portfolio could be longer than 5 days. Between September 
15, 2008 (the day Lehman Bros. Holdings declared bankruptcy) and 
October 3, 2008, LCH and ``OTCDerivnet,'' an interest rate 
derivatives forum of major market dealers, wound down the cleared 
OTC interest rate swap positions of Lehman Bros. Special Financing 
Inc. (LBSFI). This portfolio had a notional value of $9 trillion and 
consisted of 66,390 trades across 5 major currencies. LCH and 
OTCDerivnet competitively auctioned off LBSFI's five hedge currency 
portfolios to their members between September 24 and October 3, 
2008. The margin held by LCH proved sufficient to cover the costs 
incurred. Source: LCH Press Release of October 8, 2008, available 
at: http://www.lchclearnet.com/Images/2008-10-08%20SwapClear%20default_tcm6-46506.pdf.
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    Third, to provide further flexibility, the Commission is adding a 
provision specifying that, by order, the Commission may provide for a 
different minimum liquidation time for particular products or 
portfolios. As markets evolve, it may become appropriate to ease the 
requirement for certain swaps subject to the five-day minimum. 
Conversely, analysis may reveal that for other products or portfolios 
the five-day or one-day minimum is insufficient. The Commission 
believes that in light of the novelty, complexity, and potential 
magnitude of the risk posed by financial swaps, prudential 
considerations dictate that this type of fine-tuning should be used in 
appropriate circumstances. Such an order could be granted upon the 
Commission's initiative or in response to a petition from a DCO.
    In this regard, the Commission emphasizes that it is retaining the 
proposed requirement that a DCO must use longer liquidation times, if 
appropriate, based on the specific characteristics of particular 
products or portfolios.\103\ Such longer liquidation times may be based 
on a DCO's testing of its default management plan. If a DCO determines 
that a longer liquidation time is appropriate for a particular swap, 
the Commission would expect that the DCO would use the same longer 
liquidation time for the equivalent swaps that it clears, whether the 
swaps are executed on a DCM, a SEF, or bilaterally. Among the factors 
that DCOs should consider in establishing minimum liquidation times 
are: (i) Average daily trading volume in a product; (ii) average daily 
open interest in a product; (iii) concentration of open interest; (iv) 
availability of a predictable basis relationship with a highly liquid 
product; and (v) availability of multiple market participants in 
related markets to take on positions in the market in question. The 
Commission would also consider these factors in determining whether a 
particular liquidation time was appropriate.
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    \103\ As proposed, Sec.  39.13(g)(2)(ii) referred to the 
``unique'' characteristics of particular products or portfolios. The 
Commission is revising this phrase in the final rule to refer to the 
``specific'' characteristics of a particular product or portfolio to 
clarify that such characteristics are not limited to those that are 
one of a kind.
---------------------------------------------------------------------------

    The Commission is adopting Sec.  39.13(g)(2)(ii) revised to read as 
set forth in the regulatory text of this final rule.\104\
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    \104\ In a technical revision, the Commission has eliminated the 
phrase, ``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,'' because it is superfluous.
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(3) Confidence Level--Sec.  39.13(g)(2)(iii)
    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 percent, 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,\105\ 
and (D) each swap portfolio, by beneficial owner. The Commission 
invited comment regarding whether a confidence level of 99 percent is 
appropriate with respect to all applicable products, spreads, accounts, 
and swap portfolios.
---------------------------------------------------------------------------

    \105\ The terms ``customer account or customer origin'' and 
``house account or house origin'' are now defined in Sec.  39.2, 
adopted herein.
---------------------------------------------------------------------------

    Alice Corporation supported the proposed 99 percent confidence 
level, especially for new swaps and swaps with non-linear 
characteristics. ISDA commented that the proposed 99 percent confidence 
level is appropriate given current levels of mutualization in a DCO 
default fund and mutualization in omnibus client accounts.\106\ MGEX 
stated that it did not oppose the proposed 99 percent confidence level 
for each account held by a clearing member at a DCO, by customer origin 
and house origin.\107\
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    \106\ ISDA contended that if there were a requirement to have 
individualized client accounts, the appropriate confidence level 
should be higher than 99 percent because the funds available to a 
DCO to manage a client account default would be reduced.
    \107\ MGEX requested that the Commission clarify that this 
proposed requirement applies to the net account of each clearing 
member and not the underlying accounts at each clearing member. The 
Commission did not intend proposed Sec.  39.13(g)(2)(iii)(C), which 
would refer to ``[e]ach account held by a clearing member at the 
DCO, by customer origin and house origin * * *, '' to apply to 
individual customer accounts by beneficial owner. However, the 
Commission notes that Sec.  39.13(g)(2)(iii)(D), as proposed and as 
adopted herein, applies the 99 percent confidence level requirement 
to ``[e]ach swap portfolio, by beneficial owner.''
---------------------------------------------------------------------------

    FIA opposed the proposed 99 percent requirement because it sets an 
artificial floor that may remove the incentive for DCOs to conduct the 
rigorous analysis necessary to establish an appropriate confidence 
level. FIA further stated that if a different regulatory scheme than 
loss mutualization for the protection of customer funds were to be 
adopted for cleared swaps, a much higher level of confidence may be 
required.
    CME, Nadex, KCC,\108\ and Citadel took the position that the 
Commission should not prescribe a specific confidence level, but should 
instead continue to give each DCO the discretion to determine the 
appropriate confidence levels. CME and Nadex noted that one or more of 
the following factors could be considered by a DCO in determining the 
appropriate confidence levels: the particular characteristics of the 
products and portfolios it clears, the depth of the underlying markets, 
the existence of multiple venues trading similar products on which a 
defaulting clearing member's portfolio could be liquidated or hedged, 
the duration of the products, the size of the DCO and its systemic 
importance, its customer base, or its other risk management tools.
---------------------------------------------------------------------------

    \108\ KCC also expressed its belief that ultra-high confidence 
level modeling does not protect against risk as well as direct 
margin intervention by the DCO in the case of significant market 
movements, such as retaining the right to review recent price 
movements to re-establish margins at a higher level and retaining 
the right to demand special margin from certain clearing members. 
The Commission believes that a DCO should retain the right to take 
such actions in addition to, rather than instead of, using a 99 
percent confidence level, as required by Sec.  39.13(g)(2)(iii). For 
example, Sec.  39.13(h)(6)(ii), discussed below, requires a DCO to 
take additional actions with respect to particular clearing members, 
when appropriate, including imposing enhanced margin requirements.
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    The Commission does not agree such discretion is appropriate and 
has

[[Page 69369]]

determined to establish a minimum confidence level. The Commission 
believes that a minimum confidence level will provide legal certainty 
for an evolving marketplace, will offer a practical means for assuring 
market participants that the thousands of different products that are 
going to be cleared subject to the Commission's oversight will have 
prudent minimum margin requirements, and will prevent a potential 
``race to the bottom'' by competing DCOs. Moreover, given the large 
number of products already cleared, this alleviates the need for the 
Commission, with its limited staff resources, to evaluate immediately 
the confidence level requirements for each product that is cleared.
    The Commission is adopting the proposed minimum 99 percent 
confidence level. This is consistent with proposed international 
standards.\109\ Moreover, given the potential costs of default, the 
Commission agrees with those commenters who stated that a 99 percent 
level is appropriate. An individual DCO may determine to set a higher 
confidence level, in its discretion.
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    \109\ See CPSS-IOSCO Consultative Report, Principle 6: Margin, 
Key Consideration 3, at 40. In addition, 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, at 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, at 46).
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    NASDAQ OMX Commodities Clearing Company (NOCC) supported an 
approach that would allow DCOs to set margin requirements for new and 
low-volume products at a lower coverage level if the potential losses 
resulting from such products are minimal. According to NOCC, this would 
allow DCOs to include more products and market participants by 
attracting them at an early stage without materially increasing the 
risk of the DCO.
    VMAC suggested that the Commission add to the requirement that 
initial margin levels must be based upon ``an established confidence 
level of at least 99 percent,'' language that states ``or, subject to 
specific authorization from the CFTC, a lower confidence level.'' In 
particular, VMAC commented that although a DCO should be required to 
demonstrate that the given confidence level results in an initial 
margin amount which is sufficient to allow the DCO to fully discharge 
its obligations upon a clearing member default, a DCO should not be 
required to collect margin substantially in excess of its obligations 
to clearing members in a default scenario.
    The Commission is not modifying the language of Sec.  
39.13(g)(2)(iii) in a manner that would permit DCOs to set margin 
requirements at a lower coverage level for new and low-volume products, 
as recommended by NOCC, or provide for a lower confidence level subject 
to specific Commission authorization, as suggested by VMAC. In the 
notice of proposed rulemaking, the Commission noted that the 2004 CPSS-
IOSCO Recommendations stated 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.'' \110\ However, the CPSS-IOSCO Consultative 
Report, which was issued subsequent to the Commission's proposed rules, 
does not contain similar language. The Commission believes that it is 
prudent to apply the same standard to all products.
---------------------------------------------------------------------------

    \110\ See 2004 CPSS-IOSCO Recommendations at 23.
---------------------------------------------------------------------------

    OCC and NYPC encouraged the Commission to modify its proposal to 
make clear that, when swaps are commingled in either a Section 4d(a) 
futures account or a Section 4d(f) cleared swaps account, pursuant to 
Sec.  39.15(b)(2),\111\ the 99 percent test need not be separately 
applied to the swaps positions alone. The Commission agrees with OCC 
and NYPC that if swaps and futures are held in the same customer 
account pursuant to rules approved by the Commission or a 4d order 
issued by the Commission, as specified in Sec.  39.15(b)(2), the 99 
percent test would apply to the entire commingled account, and not just 
the swap positions, under Sec.  39.13(g)(2)(iii)(D). Therefore, the 
Commission is modifying Sec.  39.13(g)(2)(iii)(D) to add ``including 
any portfolio containing futures and/or options and held in a 
commingled account pursuant to Sec.  39.15(b)(2) of this part,'' after 
``[e]ach swap portfolio.'' The Commission is making similar 
modifications in Sec.  39.13(g)(7) with respect to back testing 
requirements, which are discussed in section IV.D.6.g, below.
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    \111\ See discussion of Sec.  39.15(b)(2), adopted herein, in 
section IV.F.3, below.
---------------------------------------------------------------------------

    OCC also requested that the Commission clarify that, in the case of 
a margin system that calculates margin for all positions in an account 
on the basis of the net risk of those positions based upon historical 
price correlations rather than on a product or a pre-defined spread 
basis, the 99 percent confidence level would be applied only on an 
account-by-account basis, and not to individual products, product 
groups, or specified spread positions. NYPC made a similar request, 
stating that its historical Value at Risk (VaR)-based margin model 
calculates initial margin requirements at the portfolio level, rather 
than on a product or spread basis.
    The Commission notes that, as proposed, Sec.  39.13(g)(2)(iii)(A) 
would require the application of the 99 percent confidence level to 
``[e]ach product (that is margined on a product basis)'' and Sec.  
39.13(g)(2)(iii)(B) would require the application of the 99 percent 
confidence level to ``[e]ach spread within or between products for 
which there is a defined spread margin rate * * *.'' The Commission's 
intent was that Sec. Sec.  39.13(g)(2)(iii)(A) and (B) would apply to 
products and pre-defined spreads under margin models that calculate 
initial margin requirements on a product and pre-defined spread basis, 
respectively. Further, with respect to margin models that do not 
calculate margin on a product or pre-defined spread basis, the 99 
percent requirement would apply with respect to each account held by a 
clearing member at the DCO by house origin and by each customer origin, 
and to each swap portfolio, by beneficial owner, pursuant to Sec. Sec.  
39.13(g)(2)(iii)(C) and (D), respectively.\112\
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    \112\ For purposes of clarification, certain references to 
customer origin in Sec. Sec.  39.13 and 39.19 have been replaced 
with references to ``each customer origin'' to clarify the 
distinction between customer positions in futures and options 
segregated pursuant to Section 4d(a) of the CEA, and customer 
positions in swaps segregated pursuant to Section 4d(f) of the CEA.
---------------------------------------------------------------------------

    In order to clarify the Commission's intent, the Commission is 
adopting Sec.  39.13(g)(2)(iii)(A) to read as follows: ``[e]ach product 
for which the derivatives clearing organization uses a product-based 
margin methodology,'' while striking ``(that is margined on a product 
basis).'' In addition, the Commission is adopting Sec.  
39.13(g)(2)(iii)(B) to read as follows: ``[e]ach spread within or 
between products for which there is a defined spread margin rate,'' 
while striking ``as described in paragraph (g)(4) of this section.''
    LCH commented that the Commission's approach to setting margin 
based on products and spreads, while appropriate for futures, is not

[[Page 69370]]

suitable or sufficient for swaps. LCH proposed that the key requirement 
for swaps should be for the DCO to ensure that it has enough margin and 
guarantee funds to cover its exposures, and for the DCO to prove this 
on an individual client and clearing member basis. The Commission did 
not intend to suggest that swaps should be margined pursuant to a 
product-based margin methodology, nor that they should be subject to 
defined spread margin rates. The Commission recognizes that swaps are 
often margined on a portfolio basis and specifically addressed swap 
portfolios in Sec.  39.13(g)(2)(iii)(D). The Commission would also like 
to clarify that a 99 percent confidence level, as applied to swap 
portfolios, means that each portfolio is covered 99 percent of the 
time, and not that a collection of portfolios is covered 99 percent of 
the time on an aggregate basis.
    The Commission is adopting Sec.  39.13(g)(2)(iii) with the 
modifications described above.
(4) Appropriate Historic Time Period--Sec.  39.13(g)(2)(iv)
    Proposed Sec.  39.13(g)(2)(iv) would require each DCO to determine 
the appropriate historic time period of data that it would use for 
establishing the 99 percent confidence level based on the 
characteristics, including volatility patterns, as applicable, of each 
product, spread, account, or portfolio.
    LCH recommended that the Commission define the ``historic time 
period'' as a minimum of one calendar year in order to provide for 
adequate historical observations. The Commission believes that a DCO 
should be permitted to exercise its discretion with respect to the 
appropriate time periods that should be used, based on the 
characteristics, including volatility patterns, as applicable, of the 
relevant products, spreads, accounts, or portfolios. The Commission 
also notes that proposed international standards do not specify a 
historic time period that would be appropriate in all circumstances, 
recognizing that either a shorter or a longer historic time period may 
be appropriate based on the volatility patterns of a particular 
product.\113\ The Commission expects that DCOs would include periods of 
significant financial stress. Therefore, the Commission is adopting 
Sec.  39.13(g)(2)(iv) as proposed.
---------------------------------------------------------------------------

    \113\ See CPSS-IOSCO Consultative Report, Principle 6: Margin, 
Explanatory Note 3.6.7, at 43.
---------------------------------------------------------------------------

d. Independent Validation--Sec.  39.13(g)(3)
    Proposed Sec.  39.13(g)(3) would require that a DCO's systems for 
generating initial margin requirements, including the DCO's theoretical 
models, must be reviewed and validated by a qualified and independent 
party, on a regular basis. The Commission invited comment regarding 
whether a qualified and independent party must be a third party or 
whether there may be circumstances under which an employee of a DCO 
could be considered to be independent.
    In the notice of proposed rulemaking, the Commission explained that 
a validation should include a comprehensive analysis to ensure that 
such systems and models achieve their intended goals. The Commission 
also noted that, although the proposed regulation did not define the 
meaning of ``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 was in use by the DCO.\114\ The Commission 
further stated that significant changes would be those that could 
materially affect the nature or level of risks to which a DCO would be 
exposed, and that the Commission would expect a DCO to obtain an 
independent validation prior to any significant change that would relax 
risk management standards. However, the Commission noted that 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.
---------------------------------------------------------------------------

    \114\ The Commission also notes that the CPSS-IOSCO Consultative 
Report recommends that a CCP's initial margin models should be 
independently validated at least on a yearly basis. CPSS-IOSCO 
Consultative Report, Principle 6: Margin, Explanatory Note 3.6.8, at 
43. The Commission is not requiring an annual validation at this 
time, although it may revisit this issue in the future.
---------------------------------------------------------------------------

    CME, OCC, MGEX, and KCC all expressed the view that an employee of 
a DCO could be independent in appropriate circumstances. CME commented 
that permitting employees of a DCO to conduct the required reviews 
would be consistent with proposed Sec.  39.18(j)(2), which would allow 
employees of a DCO to conduct the required testing of a DCO's business 
continuity and disaster recovery systems, provided that such employees 
are not the persons responsible for developing or operating the systems 
being tested.\115\ OCC and MGEX took the position that employees of a 
DCO could be independent as long as they are not, or have not been, 
involved in designing the models, and OCC further stated that internal 
personnel must not otherwise be biased due to their involvement in 
implementation of the models.\116\ However, FIA argued that margin 
models should be required to be validated by an independent third party 
with expertise in risk and the product being cleared.
---------------------------------------------------------------------------

    \115\ Section 39.18(j)(2), as proposed, and as adopted herein, 
states that 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.
    \116\ In particular, OCC noted that the Office of the 
Comptroller of the Currency, the Department of the Treasury, the 
Federal Reserve System and the Federal Deposit Insurance Corporation 
recently proposed revisions to their risk-based capital guidelines, 
which would require that, with respect to the validation of banks' 
internal risk models, ``[t]he review personnel [would] not 
necessarily have to be external to the bank in order to achieve the 
required independence'' but that ``[a] bank should ensure that 
individuals who perform the review are not biased in their 
assessment due to their involvement in the development, 
implementation, or operation of the models.'' See 76 FR 1890, at 
1897 (Jan. 11, 2011) (Risk-Based Capital Guidelines: Market Risk).
---------------------------------------------------------------------------

    The Commission recognizes that a third party could be more critical 
of a DCO's margin model than an employee of a DCO, even if that 
employee is ``qualified and independent.'' However, the Commission also 
believes that a third party could be less critical if, for example, it 
seeks to provide services to the DCO or the industry in the future.
    The Commission agrees with CME, OCC, MGEX, and KCC that an employee 
of a DCO could be a ``qualified and independent party,'' and thus could 
review and validate the DCO's systems for generating initial margin 
requirements, under appropriate circumstances. It would probably be 
more costly for a DCO to use a third party for this purpose rather than 
an employee.
    On balance, the Commission believes that it may be appropriate for 
a DCO to have an employee review and validate its margin systems. 
Therefore, the Commission is adopting Sec.  39.13(g)(3) with the 
addition of a sentence stating that ``[s]uch qualified and independent 
parties may be independent contractors or employees of the derivatives 
clearing organization, but shall not be persons responsible for 
development or operation of the systems and models being tested.'' This 
is consistent with the language contained in Sec.  39.18(j)(2), as 
adopted herein, as well as the

[[Page 69371]]

proposed approach of other financial regulators.\117\ The Commission 
also notes that the reference to independent contractors as well as 
employees in the added language will also prohibit a DCO from using a 
particular third party to conduct the validation if that third party 
was or is responsible for development or operation of the relevant 
systems and models.
---------------------------------------------------------------------------

    \117\ Id.
---------------------------------------------------------------------------

    KCC requested that the Commission clarify that the CRO or other 
comparable personnel with responsibility for overall risk management at 
the DCO would meet the requirements of a ``qualified and independent 
party.'' The Commission does not believe that a DCO's CRO or personnel 
responsible for overall risk management would categorically qualify as 
an ``independent party.'' This determination would need to be made on a 
case-by-case basis depending on whether the CRO or other similar person 
was or is responsible for development or operation of the systems and 
models being tested.
    MGEX requested that the Commission clarify whether the requirement 
for independent validation would apply to the primary risk-based 
portfolio system such as SPAN,\118\ or each DCO's analysis program for 
determining margins, noting its belief that requiring independent tests 
on the latter would be excessive. It is not clear what MGEX means by 
``each DCO's analysis program for determining margins.'' However, Sec.  
39.13(g)(3) requires independent validation with respect to a DCO's 
underlying model, e.g., SPAN or OCC's STANS model, as well as the 
methodology used to compute the inputs to any such model. On the other 
hand, a DCO would not be required to obtain an independent validation 
of a change in SPAN parameters as described by CME.\119\
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    \118\ For a description of SPAN, see CME's Web site, at http://www.cmegroup.com/clearing/risk-management/span-overview.html#works.
    \119\ See id. for a description of SPAN parameters. Therefore, 
Sec.  39.13(g)(1), which requires that a DCO review its margin 
models and parameters, on a regular basis, requires a broader review 
than would be met by compliance with Sec.  39.13(g)(3).
---------------------------------------------------------------------------

    OCC commented that, as described in the notice of proposed 
rulemaking, the ``could materially affect'' standard is deficient in 
two respects in that: (1) It fails to include any reference to the 
likelihood that a change would actually materially affect the nature or 
level of risk, and (2) it omits any reference to the direction of the 
change in level of risk. OCC contended that a more appropriate standard 
would be to provide that significant changes are those that ``are 
reasonably likely to materially change the nature or increase the level 
of risks to which the DCO would be exposed.''
    In response to this comment, the Commission is modifying the 
standard to provide that significant changes are those for which there 
is a reasonable possibility that they would materially affect the 
nature or level of risks to which a DCO would be exposed. While this 
standard identifies the likelihood that a change would materially 
affect the nature or level of such risks, the Commission believes that 
it is more appropriate than identifying significant changes as only 
those that are ``reasonably likely to materially change'' the nature or 
level of such risks.
    The Commission does not believe that significant changes should be 
limited to those that are likely to increase the level of risks. As 
described in the notice of proposed rulemaking, the Commission would 
expect a DCO to obtain an independent validation prior to any 
significant change that would relax risk management standards, but the 
Commission would permit a DCO to obtain an independent validation 
promptly after a significant change that would enhance risk 
protections, in appropriate circumstances. A DCO should obtain such a 
validation even if the change were designed to enhance risk 
protections, in order to ensure that the change would be effective in 
achieving its objective.
    OCC also requested that the Commission clarify that the addition of 
a new product or new underlying interest would not inherently be deemed 
to trigger the independent evaluation requirement. The Commission 
believes that whether the addition of a new product or a new underlying 
interest would trigger the independent validation requirement would 
need to be determined on a case-by-case basis, depending on whether 
there is a reasonable possibility that such addition will materially 
change the nature or level of risks to which the DCO would be exposed. 
One example would be if the addition necessitates a significant change 
to the margin model as it applies to the new product or new underlying 
interest. Thus, the addition of a futures contract based on a new 
broad-based securities index where the DCO already clears futures 
contracts based on broad-based securities indexes might not require a 
significant change to the applicable margin model. However, the 
addition of a new category of swaps, even if the DCO already clears 
swaps, might require a significantly different margin model. Another 
example might be if a swap cleared by a DCO became subject to a 
clearing mandate and the risk profile changed because of changes in 
volume and open interest.
e. Spread and Portfolio Margins--Sec.  39.13(g)(4)(i)
    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 were a theoretical basis for the 
correlation in addition to an exhibited statistical correlation. 
Proposed Sec.  39.13(g)(4)(i) would include a non-exclusive list of 
possible theoretical bases, including 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. 
The Commission requested comment regarding the appropriateness of 
requiring a theoretical basis for the correlation between related 
positions before reductions in initial margin requirements would be 
permitted. In addition, 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.\120\
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    \120\ In addition to the other comments discussed herein, Alice 
Corporation noted that it supported the cautious approach taken by 
the Commission and that offsets across products with different 
maturities and risk profiles should be avoided where possible, and 
ISDA stated that spread margins should only permitted when a DCO can 
demonstrate a strong correlation in stressed market conditions and 
agrees to periodic public disclosure of its methodology and results. 
With respect to ISDA's comment, the Commission notes that Sec.  
39.13(g)(2)(iii), discussed in section IV.D.6.c.(3), above, requires 
a DCO to ensure that the actual coverage of its initial margin 
requirements, along with projected measures of the performance of 
its margin models, must meet an established confidence level of at 
least 99 percent, based on data from an appropriate historic time 
period, for, among other things, spreads within or between products 
for which there is a defined spread margin rate, for each account 
held by a clearing member at the DCO, by customer and house origin, 
and for each swap portfolio, by beneficial owner, and Sec.  
39.13(g)(7), discussed in section IV.D.6.g, below, imposes related 
back testing requirements. In addition, Sec.  39.21(c)(3), discussed 
in section IV.L, below, requires a DCO to publicly disclose its 
margin methodology.
---------------------------------------------------------------------------

    KCC and OCC addressed the proposed requirement that the price risks 
of related positions would only be considered to be reliably 
correlated, and thus be eligible for initial margin reductions, if 
there were a theoretical basis for the correlation in addition to

[[Page 69372]]

an exhibited statistical correlation. KCC contended that the proposed 
requirement would be difficult for the Commission to implement and 
unnecessary because DCOs have no incentive to offer margin reductions 
in the absence of high correlation between positions. KCC further noted 
that the proposal does not detail what level of observed statistical 
correlation is required, and the proposed requirement to articulate a 
theoretical basis is vague.
    OCC also questioned the appropriateness of the requirement that 
there must be a theoretical basis for the correlation, noting that a 
theoretical basis for correlation is, by definition, theoretical and 
may not be directly observable or verifiable except through the 
correlation. OCC stated that it is difficult to imagine a correlation 
for which no theoretical basis can be constructed, and in many if not 
most cases, the theoretical basis for any significant correlation is 
obvious.
    The Commission continues to believe that reductions in initial 
margin requirements should only be allowed if a DCO is able to 
articulate a reasonable theoretical explanation for an observed 
statistical correlation to ensure that the positions are reliably 
correlated. The Commission notes that it is a matter of basic 
statistics that correlation does not equal causation. The world is 
replete with examples of events or data that are highly correlated at 
various points in time but for which there is no theoretical 
relationship. If there is no theoretical relationship, a DCO has no 
basis to believe that a statistical relationship--no matter how 
strong--is stable, and a margin based on such a relationship may be 
insufficient to capture price variation.
    Several commenters addressed the appropriateness of applying 
proposed Sec.  39.13(g)(4) to portfolio-based margin systems. LCH 
commented that the spread margin measure which the Commission proposed 
is unsuited and inappropriate for swaps clearing and that the Portfolio 
Approach to Interest Rate Scenarios (PAIRS), the historical simulation 
method that LCH uses, is more suitable to non-standardized swaps. 
Therefore, LCH urged the Commission to amend proposed Sec.  39.13(g)(4) 
to afford recognition to this technique. OCC requested that the 
Commission acknowledge that its STANS methodology meets the 
requirements of proposed Sec.  39.13(g)(4), noting that STANS currently 
relies on over 20 million separate correlations. OCC stated that it 
would be impractical to attempt to document or even articulate the 
``theoretical basis'' for all of these correlations even though it 
believes that they would be supportable on a theoretical level, and 
further believes that its systems for determining and reviewing the 
validity of the correlations it uses are sufficient to ensure that OCC 
does not allow unjustified margin offsets. NYPC requested that the 
Commission clarify that Sec.  39.13(g)(4) would not be applicable to 
margin models that calculate initial margin requirements at the account 
level, including NYPC's historical VaR-based margin model.
    The Commission intends Sec.  39.13(g)(4) to apply to portfolio-
based margin models as well as product-based margin models. For some 
products, DCOs establish defined spread margin rates, pursuant to a 
product-based margin methodology. Typically, this occurs where there is 
a bilateral correlation, e.g., a March-June calendar spread or a 
correlation between two related products.\121\ For other products, 
there may be multilateral correlations for which margin is calculated 
on a portfolio basis, pursuant to a portfolio-based margin methodology. 
In the latter instance, there is not a defined margin amount or margin 
reduction for a defined portfolio that remains the same over time. 
Instead, margin is recalculated each day for each individual portfolio.
---------------------------------------------------------------------------

    \121\ A defined spread margin rate may also apply to three 
related products, e.g., the Chicago Board of Trade's soybean crush 
spread with respect to soybeans, soybean oil and soybean meal.
---------------------------------------------------------------------------

    Therefore, the Commission is adopting Sec.  39.13(g)(4), with 
several modifications, in order to clarify that margin reductions 
calculated on a portfolio basis are also permissible if they meet the 
standards of the regulation. First, the Commission is changing the 
heading of the provision from ``[s]pread margins'' to ``[s]pread and 
portfolio margins.'' The Commission is also removing the parenthetical 
``(spread margins)'' after the clause in Sec.  39.13(g)(4)(i) that 
states ``[a] derivatives clearing organization may allow reductions in 
initial margin requirements for related positions.'' Finally, the 
Commission is changing the reference to ``spread margins'' in Sec.  
39.13(g)(4)(ii) to ``margin reductions.'' These changes are designed to 
make it clear that Sec.  39.13(g)(4) applies to reductions in initial 
margin requirements for related positions, whether a DCO uses a 
product-based margin model or a portfolio-based margin model.
    Better Markets and Mr. Greenberger commented that Sec.  39.13(g)(4) 
must require that the relationship between positions be calculated 
using the same standards (with respect to volatility and liquidity 
requirements) that are applied to the calculation of initial margin for 
the individual positions. The Commission agrees with Better Markets and 
Mr. Greenberger and, as discussed above, spread and portfolio margins 
would also be subject to a 99 percent coverage standard.
f. Price Data--Sec.  39.13(g)(5)
    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.
    Interactive Data Corporation expressed its belief that the concept 
of ``sound valuation models'' should be expanded further with 
additional prescriptive guidance in four key dimensions, including: (1) 
Leveraging greater trade transparency; (2) using multiple sources; (3) 
mitigating conflicts of interest; and (4) sourcing of independent price 
data.
    The Commission does not believe that it is necessary to be more 
specific or prescriptive with respect to this requirement, and is 
adopting Sec.  39.13(g)(5) as proposed. As the Commission noted in the 
notice of proposed rulemaking, the nature of the applicable valuation 
models would necessarily depend on the particular products and the 
available sources of any relevant pricing data.
g. Daily Review and Back Tests--Sec. Sec.  39.13(g)(6) and (g)(7)
    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 defined ``back test'' in Sec.  39.2, 
adopted herein, 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.''
    For purposes of proposed Sec.  39.13(g)(7)(i) and (ii), the 
introductory paragraph of proposed Sec.  39.13(g)(7) would require 
that, in conducting back tests, a DCO 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 percent confidence level or a longer time period. The 
applicable time period

[[Page 69373]]

was separately specified for the back tests required by proposed Sec.  
39.13(g)(7)(iii), as discussed below.
    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 requested 
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 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. In the notice of 
proposed rulemaking, the Commission noted that, since the composition 
of such accounts and swap portfolios may change on a daily basis, it 
was anticipated 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 also requested 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.
    Several commenters addressed the appropriate frequency of back 
tests and/or the appropriate historic time period for the analysis of 
price change data. FIA commented that initial margin requirements 
should be back tested monthly. MGEX stated that it was not opposed to a 
monthly back testing requirement with respect to proposed Sec.  
39.13(g)(7)(iii) based on its understanding that the Commission 
intended that the DCO must look at its clearing member's net account 
and not each underlying customer account with the exception of 
swaps.\122\
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    \122\ MGEX correctly understands that the Commission's reference 
to ``each account held by a clearing member at the DCO, by origin, 
house and customer'' in proposed Sec.  39.13(g)(7)(iii) was not 
intended to apply to individual accounts by beneficial owner, 
although proposed Sec.  39.13(g)(7)(iii) would require monthly back 
tests with respect to initial margin requirements for each swap 
portfolio, by beneficial owner.
---------------------------------------------------------------------------

    LCH took the position that back tests should be conducted at least 
on a daily basis for all products cleared by a DCO. However, LCH argued 
that such back tests should be conducted at the portfolio level because 
margining techniques appropriate for swaps, such as LCH's PAIRS 
methodology, do not allow for the disaggregation of initial margin and 
spread margin requirements at a product level. LCH also commented that, 
for back tests to be statistically meaningful, the applicable historic 
time period should be a minimum of one calendar year.
    KCC stated that it may be appropriate for the Commission to further 
define ``significant market volatility,'' for purposes of proposed 
Sec.  39.13(g)(7)(i),\123\ but that, more generally, any back-testing 
requirements should be based on a discretionary, risk-based 
determination by the DCO. In addition, KCC expressed its belief that 
the back testing period should be subject to the discretion of the DCO 
in light of then-current market conditions, i.e., imposing a specific 
back-testing period may inappropriately reflect an exaggerated or 
understated level of market volatility.
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    \123\ The Commission believes that each DCO should determine 
what ``significant volatility'' means based upon the volatility 
patterns of each individual product or swap portfolio that it 
clears.
---------------------------------------------------------------------------

    NOCC took the position that products, customers or spread credits 
should reach a specified volume or risk exposure level before being 
required to be back tested with the proposed frequencies so long as the 
DCO can demonstrate that it is meeting the core principle objectives 
underlying proposed Sec.  39.13(f).
    NYPC requested that the Commission clarify that proposed Sec. Sec.  
39.13(g)(6) and (g)(7)(i)-(ii) would not be applicable to margin models 
that calculate initial margin requirements at the account level, 
including NYPC's historical VaR-based margin model. OCC also stated its 
belief that it would not be subject to the requirement for daily review 
in proposed Sec.  39.13(g)(7)(i), as it does not margin on a product 
basis, but noted that it does conduct daily back testing on all 
accounts, i.e., on a portfolio basis.
    The Commission is adopting Sec.  39.13(g)(6), eliminating the 
language stating ``for each product (that is margined on a product 
basis),'' in order to correct a potential inconsistency between the 
text of the rule and the notice of proposed rulemaking. In the notice 
of proposed rulemaking, the Commission stated that ``[d]aily review and 
periodic back testing are essential to enable a DCO to provide adequate 
coverage of the DCO's risk exposures to its clearing members.'' As 
proposed, Sec.  39.13(g)(6) would only require a DCO to determine the 
adequacy of its initial margin requirements, on a daily basis, for 
products that were margined on a product basis. The adequacy of a DCO's 
initial margin requirements for futures and options on futures products 
margined on a portfolio basis, and for swap portfolios, would not have 
been subject to such daily review. The Commission believes that such a 
result is untenable, as one of the most rudimentary steps in risk 
management is to conduct daily review of margin coverage, i.e., to 
determine whether any margin breaches have occurred. Moreover, the 
Commission believes that the change will not impose any burden because 
it believes that all DCOs currently conduct some form of daily review 
of the adequacy of their initial margin requirements, whether they use 
a product-based or a portfolio-based margin methodology.
    The Commission is adopting Sec.  39.13(g)(7)(i) with modifications 
that require a DCO to conduct back tests, on a daily basis, to test the 
adequacy of its initial margin requirements with respect to products or 
swap portfolios that are experiencing significant market volatility: 
(a) For that product if the DCO uses a product-based margin 
methodology; (b) for each spread involving that product if there is a 
defined spread margin rate; (c) for each account held by a clearing 
member at the DCO that contains a significant position \124\ in that 
product, by house origin and by each customer origin; and (d) for each 
such swap portfolio, including any portfolio containing futures and/or 
options and held in a commingled account pursuant to Sec.  
39.15(b)(2),\125\ by beneficial owner.
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    \124\ The Commission has not defined a ``significant position,'' 
leaving that determination to the discretion of each DCO, as the 
size of a position that would be a ``significant position'' may vary 
depending on the nature of the particular product or the composition 
of the particular account.
    \125\ See discussion of the addition of the same language to 
Sec.  39.13(g)(2)(iii)(D), in section IV.D.6.c.(3), above.
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    Similarly, the Commission is adopting Sec.  39.13(g)(7)(ii) with 
modifications that

[[Page 69374]]

require a DCO to conduct back tests, on at least a monthly basis: (a) 
For each product for which the DCO uses a product-based margin 
methodology; (b) for each spread for which there is a defined spread 
margin rate; (c) for each account held by a clearing member at the DCO, 
by house origin and by each customer origin; and (d) for each swap 
portfolio, including any portfolio containing futures and/or options 
and held in a commingled account pursuant to Sec.  39.15(b)(2),\126\ by 
beneficial owner. As adopted, Sec.  39.13(g)(7) no longer contains a 
paragraph (iii) as paragraph (ii) now describes all monthly back 
testing requirements.
---------------------------------------------------------------------------

    \126\ Id.
---------------------------------------------------------------------------

    As originally proposed, Sec.  39.13(g)(7) would only require daily 
back testing for products that were experiencing significant market 
volatility if the DCO used a product-based margin methodology, and for 
spreads involving that product if there was a defined spread margin 
rate. It would not require daily back testing for each account, by 
customer origin and house origin, that contained a significant position 
in that product, whether the DCO used a product-based or a portfolio-
based margin methodology, or for each swap portfolio that was 
experiencing significant market volatility. As with respect to Sec.  
39.13(g)(6), there was a potential inconsistency in the treatment of 
different positions. There is no reasonable basis to require daily back 
tests solely with respect to products that are experiencing significant 
market volatility for which the DCO uses a product-based margin 
methodology and spreads involving such products if there is a defined 
spread margin rate, and not to require daily back tests with respect to 
accounts, by customer origin and house origin, which contain 
significant positions in those products simply because the DCO uses a 
portfolio-based margin methodology. Similarly, there is no 
justification for requiring daily back tests with respect to products 
that are experiencing significant market volatility and not requiring 
daily back tests with respect to swap portfolios that are experiencing 
significant market volatility. A DCO should be required to conduct 
daily back tests when the instruments that it clears are subject to 
significant market volatility, whether the DCO bases its initial margin 
requirements on a product-based or a portfolio-based margin 
methodology, and whether those instruments are futures, options on 
futures, or swaps.
    Although OCC stated that it currently conducts daily back tests on 
all accounts on a portfolio basis, and LCH expressed its view that back 
tests should be conducted on a daily basis for all products and swap 
portfolios cleared by a DCO, the Commission has determined to permit a 
DCO to conduct back tests on at least a monthly basis when significant 
market volatility is not present. FIA and MGEX supported monthly back 
testing. Apart from KCC's contention that back testing should be 
subject to the discretion of the DCO, and NOCC's suggestion that DCOs 
should be able to obtain an exemption from the proposed frequencies for 
products, customers and spread credits that have not reached a 
specified volume or risk exposure level,\127\ none of the commenters 
indicated that back tests should be conducted less frequently than 
monthly. Moreover, a particular DCO would be able to exercise its 
discretion to conduct back tests on a more frequent basis than that 
required by the Commission's regulation.
---------------------------------------------------------------------------

    \127\ The Commission does not believe that it is appropriate to 
adopt a regulation establishing an exemption process with respect to 
back testing requirements based on volume or risk exposure or 
otherwise.
---------------------------------------------------------------------------

    The Commission has not proposed and is not adopting LCH's 
suggestion that the applicable historic time period for the price 
change data used for back testing should be a minimum of one calendar 
year. However, the Commission is removing the proposed language from 
the introductory paragraph of Sec.  39.13(g)(7) regarding the time 
periods for historical price changes that must be used in the required 
back tests and is revising the introductory paragraph to require a DCO 
to use an appropriate time period but not less than the previous 30 
days for all of the back tests required by Sec. Sec.  39.13(g)(7)(i) 
and (ii).
h. Customer Margin
(1) Gross Margin for Customer Accounts --Sec.  39.13(g)(8)(i)
    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 and would prohibit a 
DCO from netting positions of different customers against one another. 
The proposed regulation would permit a DCO to collect initial margin 
for its clearing members' house accounts on a net basis.
    Better Markets and LCH (with a suggested exception described below) 
supported proposed Sec.  39.13(g)(8)(i).\128\ CME, KCC, OCC, ICE, NYPC, 
FIA, and the Commodity Markets Council (CMC) argued against the 
adoption of proposed Sec.  39.13(g)(8)(i).
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    \128\ LCH also expressed its belief that a DCO should also 
collect margin from all affiliated legal entities within a house 
account on a gross basis unless there is legal certainty of the 
DCO's right to offset risks across the affiliates in the event of 
the default of the group or one or more of its affiliated legal 
entities. The Commission has not proposed and is not adopting such a 
requirement. However, although Sec.  39.13(g)(8)(i) permits a DCO to 
collect initial margin for its clearing members' house accounts on a 
net basis, it does not require it to do so, and a DCO could 
determine to collect house margin in the manner suggested by LCH.
---------------------------------------------------------------------------

    KCC and ICE pointed out that DCOs that perform net margining have 
not had any clearing member defaults or customer losses, including 
during the 2008 financial crisis.
    Various commenters opposed the proposal based on the potential 
extent and costs of operational and technology changes that would need 
to be made by clearing members and DCOs: (1) To convert net margining 
systems to gross margining systems, and (2) to permit clearing members 
to provide individual customer position information to DCOs, and DCOs 
to receive individual customer position information and calculate the 
margin required for each individual customer account (CME, KCC, ICE, 
NYPC, and CMC).
    OCC stated that the only means by which it could calculate margin 
requirements on a customer-by-customer basis within a clearing member's 
omnibus futures customers' account would be to create subaccounts for 
each customer. CME, NYPC, KCC, and FIA commented that DCOs do not 
currently receive position-level information for each individual 
customer of their clearing members. CME and FIA expressed concern about 
the costs associated with clearing members having to provide individual 
customer position information, and CME indicated that DCOs would incur 
costs in processing the information received from clearing members in 
order to calculate margin requirements on individual customer accounts 
on a daily basis. NYPC also stated that the adoption of proposed Sec.  
39.13(g)(8)(i) would require it to make significant changes to its 
systems.\129\
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    \129\ See further discussion of these costs in section VII, 
below. NYPC also commented that given the necessary technology 
builds, it would need more than three years to come into compliance 
with proposed Sec. Sec.  39.13(g)(8)(i) and 39.13(h)(2). The 
Commission believes that the modifications to Sec.  39.13(g)(8)(i), 
discussed in this section, would minimize any technology changes 
that would be necessary in order to comply with Sec.  
39.13(g)(8)(i).
---------------------------------------------------------------------------

    KCC stated that managing gross customer margin at the DCO level

[[Page 69375]]

would require a DCO to assume the role of a back-office account 
management service, requiring continuous updates from each clearing 
member regarding customer positions. KCC further noted that DCOs would 
be required to adjust the timing deadlines for margin payments, DCOs' 
ability to track margin requirements closely with market movements 
would be decreased, and DCOs may face difficulty in relaying variation 
margin payment information to their settlement banks quickly.
    ICE noted that converting to a gross margining system would be a 
major operational change for clearing firms and DCOs that use net 
margining. However, ICE also stated that most DCOs currently use gross 
margining, including ICE Trust (now ICE Clear Credit LLC) and ICE Clear 
U.S., although ICE Clear Europe uses net margining. In particular, ICE 
stated that gross margining would require reengineering of firms' end-
of-day processing. According to ICE, changes would need to be made to 
such DCOs' margining technology, data submission/input mechanism and 
margin reporting specifications, and clearing firms or their service 
providers would need to implement software updates. ICE noted that 
changes to position reporting, reconciliation and margining methodology 
are challenging technology changes for clearing members and their 
third-party software vendors and typically take at least six to nine 
months to complete. However, ICE indicated that an implementation 
period of at least 12 months would allow DCOs that currently use net 
margining, and their clearing members, to adequately test and implement 
the systems necessary for gross margining.
    CME, KCC, and CMC all argued that requiring clearing members to 
report gross customer positions by beneficial owner to DCOs is not 
necessary in order to accomplish reasonable and adequate ``modified'' 
gross margining. Specifically, CME and KCC urged the Commission to 
permit a version of gross margining of customer accounts that would 
only require clearing members to report gross customer positions to 
DCOs (not by beneficial owner) and that would allow clearing firms to 
submit positions as spreadable for those accounts that have recognized 
calendar spreads or spreads between correlated products. However, CME 
further represented that ``[t]his version of gross margining will 
sometimes lead to less than aggregate gross margins as a result of 
optimal spreading that occasionally occurs between accounts. 
Nevertheless, it approximates aggregate gross margins without imposing 
significant costs on the industry.''
    In light of the various concerns raised by CME, KCC, ICE, NYPC, and 
CMC regarding the operational and technology changes that would be 
needed and related costs of requiring a DCO to obtain individual 
customer position information from its clearing members and to use such 
information to calculate the margin requirements for each individual 
customer, the Commission is modifying Sec.  39.13(g)(8)(i). In 
particular, the Commission is adding a provision, which states that 
``[f]or purposes of calculating the gross initial margin requirement 
for each clearing member's customer account(s), to the extent not 
inconsistent with other Commission regulations, a derivatives clearing 
organization may require its clearing members to report the gross 
positions of each individual customer to the derivatives clearing 
organization, or it may permit each clearing member to report the sum 
of the gross positions of its customers to the derivatives clearing 
organization.'' \130\
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    \130\ The Commission is including the phrase ``to the extent not 
inconsistent with other Commission regulations'' because, in a 
separate rulemaking, the Commission has proposed regulations that 
would require FCM clearing members to provide daily information 
identifying the positions of individual cleared swaps customers to 
the relevant DCO and that would require such DCOs to calculate the 
amount of collateral required for each cleared swaps customer of 
such clearing members on a daily basis. If these regulations are 
adopted, they will supersede the provisions of Sec.  39.13(g)(8)(i) 
to the extent that they are inconsistent with such provisions, with 
respect to cleared swaps. See 76 FR 33818 (June 9, 2011) (Protection 
of Cleared Swaps Customer Contracts and Collateral; Conforming 
Amendments to the Commodity Broker Bankruptcy Provisions).
    The Commission is also making a conforming amendment by 
inserting ``and may not permit its clearing members to'' in the 
sentence that now reads as follows (added text in italics): ``A 
derivatives clearing organization may not, and may not permit its 
clearing members to, net positions of different customers against 
one another.''.
---------------------------------------------------------------------------

    Thus, the Commission is providing a DCO with the discretion to 
either calculate customer gross margin requirements based on individual 
customer position information that it obtains from its clearing members 
or based on the sum of the gross positions of all of a clearing 
member's customers that the clearing member provides to the DCO, 
without forwarding individual customer position information to the DCO. 
In either case, the customer gross margin requirement determined by a 
DCO must equal ``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.'' The customer gross margin collected by a DCO may not 
be subject to ``spreading that occasionally occurs between accounts'' 
that may lead to ``less than aggregate gross margins,'' as described by 
CME.
    CME commented that proposed Sec.  39.13(g)(8)(i) was unclear 
regarding how DCOs would be expected to treat customer omnibus accounts 
of non-clearing FCMs and foreign brokers for which the clearing firm 
carrying the account generally does not know the identities of 
individual customers within the omnibus accounts. Under current 
industry practice, omnibus accounts report gross positions to their 
clearing members and clearing members collect margins on a gross basis 
for positions held in omnibus accounts.\131\ The Commission does not 
intend to alter this current practice by adopting Sec.  39.13(g)(8)(i). 
Therefore, the Commission is adding a provision, which states that 
``[f]or purposes of this paragraph, a derivatives clearing organization 
may rely, and may permit its clearing members to rely, upon the sum of 
the gross positions reported to the clearing members by each domestic 
or foreign omnibus account that they carry, without obtaining 
information identifying the positions of each individual customer 
underlying such omnibus accounts.''
---------------------------------------------------------------------------

    \131\ See, e.g., Margins Handbook, http://www.nfa.futures.org/NFA-compliance/publication-library/margins-handbook.pdf, at 34; CME 
Rule 930.J.; ICE Futures U.S. Inc. Rule 5.04; and CBOE Futures 
Exchange, LLC Rule 516.
---------------------------------------------------------------------------

    The Commission believes that giving a DCO the option of permitting 
its clearing members to provide the sum of their customers' gross 
positions to a DCO, without the need to provide individual customer 
position information to the DCO, allows DCOs to provide their clearing 
members with a much less costly alternative to requiring clearing 
members to provide individual customer position information to the DCO, 
and requiring the DCO to calculate the gross margin requirement for 
each customer of each clearing member.
    The Commission recognizes that Sec.  39.13(g)(8)(i), even as 
modified, will require DCOs and their clearing members to incur certain 
costs. However, the Commission continues to believe, as stated in the 
notice of proposed rulemaking, that gross margining of customer 
accounts will: (a) More appropriately address the risks posed to a DCO 
by its clearing members' customers than net margining; (b) will 
increase the financial resources available to a DCO in the event of a

[[Page 69376]]

customer default; \132\ and (c) with respect to cleared swaps, will 
support the requirement in Sec.  39.13(g)(2)(iii) that a DCO must 
margin each swap portfolio at a minimum 99 percent confidence level.
---------------------------------------------------------------------------

    \132\ ICE commented that the Commission's rationale for gross 
margining, i.e., that it would increase the financial resources 
available to a DCO in the event of a customer default, is based upon 
the mutualization of customer risk to protect the DCO. ICE stated 
its belief that this rationale conflicts with the reasoning behind 
the proposal that DCOs individually segregate cleared swaps customer 
funds to protect such customers from fellow customer risk. The 
Commission notes, however, that gross margining is not only 
consistent with, but will be instrumental in achieving, complete 
legal segregation for cleared swaps accounts. See 76 FR 33818 (June 
9, 2011) (Protection of Cleared Swaps Customer Contracts and 
Collateral; Conforming Amendments to the Commodity Broker Bankruptcy 
Provisions).
---------------------------------------------------------------------------

    The Commission believes that the clearing of swaps will increase 
the risk that DCOs face. Gross margining will maximize the amount of 
money DCOs hold. Because a DCO may not have access to customer initial 
margin collected by and held at an FCM if the DCO collects initial 
margin on a net basis, if the FCM defaults, the Commission believes 
that holding gross initial margin at a DCO is the safest mechanism by 
which DCOs can protect themselves from increased risk. If a DCO is 
unable to obtain customer margin in the event of default, there is 
significant risk of contagion. Consequently, if more margin is held at 
the DCO, the potential risk that the failure of one clearing member 
will propagate throughout the financial system to other clearing 
members and other entities is decreased.\133\
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    \133\ As pointed out in the CPSS-IOSCO Consultative Report, 
under certain circumstances gross margining may also increase the 
portability of customer positions in an FCM insolvency. That is, a 
gross margining requirement would increase the likelihood that there 
will be sufficient collateral on deposit in support of a customer 
position to enable the DCO to transfer it to a solvent FCM. See 
CPSS-IOSCO Consultative Report, Principle 14: Segregation and 
Portability, Explanatory Notes 3.14.6 and 3.14.8, at 67-68.
---------------------------------------------------------------------------

    CME and KCC commented that proposed Sec.  39.13(g)(8)(i) would 
require clearing members to ``pass-through'' the margin deposits that 
they receive from their customers to the DCO, thus requiring clearing 
members to apply to their customers the DCO's standards for acceptable 
collateral as well as the DCO's concentration limits with respect to 
collateral types. CME indicated that this would add pressure with 
respect to the available collateral pool, and argued that the 
Commission should not impose such additional and costly constraints on 
market participants in the absence of significant and demonstrable 
benefits. The Commission notes that, although as a business matter 
clearing members may determine to ``pass-through'' the margin deposits 
that they receive from their customers to the relevant DCO, proposed 
Sec.  39.13(g)(8)(i) does not require that a clearing member only 
accept from its customers those types of margin assets that are 
acceptable for the clearing member to deposit with the DCO.
    KCC requested that the Commission clarify whether the requirement 
to collect gross customer margin imposes an obligation on the DCO to 
determine the defaulting customer accounts in a customer default 
situation (which would be costly and burdensome) and stated that having 
the total customer gross margin available to the DCO in the event of a 
customer default is a prudent risk management technique. The Commission 
notes that Commission rules currently permit a DCO to commingle the 
initial margin with respect to all of a clearing member's customers in 
a single customer origin account at the DCO and to apply the entire 
customer origin account to cover losses with respect to a customer 
default, whether the DCO collects initial margin on a net basis or on a 
gross basis. The Commission does not intend Sec.  39.13(g)(8)(i), by 
its terms, to alter this approach.
    In a separate rulemaking, however, the Commission has proposed to 
require DCOs to legally segregate customer funds and assets margining 
swap positions that are held by a clearing member at the DCO in a 
commingled cleared swaps customer account.\134\ In addition, European 
Union legislation, although not yet finalized, would require central 
counterparties to provide individual customer segregation in certain 
circumstances.\135\ As previously noted, gross margining will be 
instrumental if individual customer segregation is adopted. OCC 
requested that the Commission restrict the applicability of proposed 
Sec.  39.13(g)(8)(i) to futures customer accounts at both the clearing 
level and the FCM level, to make it clear that it does not intend to 
impose these margin requirements on accounts that are restricted to 
securities products (with respect to an entity that is both a DCO and 
an SEC-regulated clearing agency). OCC is correct that Sec.  
39.13(g)(8)(i) applies only to customer and house accounts, cleared by 
a DCO, which contain futures, options on futures, and/or swap positions 
that are subject to the jurisdiction of the Commission. It does not 
apply to accounts that only contain securities products that are 
subject to the jurisdiction of the SEC.
---------------------------------------------------------------------------

    \134\ See 76 FR 33818 (June 9, 2011) (Protection of Cleared 
Swaps Customer Contracts and Collateral; Conforming Amendments to 
the Commodity Broker Bankruptcy Provisions).
    \135\ See Financial markets: OTC derivatives, central 
counterparties and trade repositories (amend. Directive 98/26/EC), 
COD/2010/0250 (June 7, 2011), available at http://www.europarl.europa.eu/oeil/FindByProcnum.do?lang=en&procnum=COD/2010/0250.
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    LCH requested that the Commission allow DCOs operating from non-
U.S. jurisdictions to offer ``net omnibus'' account structures for 
associated entities operating under the same group or umbrella 
structure to customers outside the U.S. The treatment of customers is 
outside the scope of this rulemaking. However, to the extent a DCO is 
clearing products subject to the Commission's jurisdiction, this rule 
would apply at the clearing level regardless of the location of the DCO 
or the customer.
    The Commission is adopting Sec.  39.13(g)(8)(i) with the 
modifications described above. The Commission recognizes that DCOs that 
currently use net margining, or that use a ``modified'' version of 
gross margining, as well as their clearing members and their service 
providers, will need time to make the necessary operational and 
technology enhancements that will facilitate gross margining, as 
described herein. Therefore, the Commission is adopting an effective 
date that is 12 months after the publication of final Sec.  
39.13(g)(8)(i) in the Federal Register.
(2) End-of-Day Position Reporting--Sec.  39.19(c)(1)(iv)
    Proposed Sec.  39.19(c)(1)(iv) would require each DCO to report to 
the Commission, on a daily basis, the end-of-day positions for each 
clearing member, by customer origin and house origin; and for customer 
origin, separately, the gross positions of each beneficial owner.\136\
---------------------------------------------------------------------------

    \136\ As originally proposed, Sec.  39.19(c)(1)(iv) would 
require each DCO to report to the Commission, on a daily basis, the 
end-of-day positions for each clearing member, by customer origin 
and house origin. See 75 FR 78185 (Dec. 15, 2010) (Information 
Management). The preamble in the notice of proposed rulemaking (76 
FR 3698 (Jan. 20, 2011) (Risk Management)), described a proposed 
amendment to proposed Sec.  39.19(c)(1)(iv) to add ``and for 
customer origin, separately, the gross positions of each beneficial 
owner.'' However, this clause was inadvertently omitted from the 
language of the regulation in the notice of proposed rulemaking. 
Therefore, the Commission subsequently issued a correction at 76 FR 
16588 (Mar. 24, 2011) (Risk Management Requirements for Derivatives 
Clearing Organizations; Correction).
---------------------------------------------------------------------------

    As noted by KCC and CMC, the Commission currently receives certain 
information about the ownership and control of reportable positions 
through its large trader reporting program, under Parts 15 through 21 
of the Commission's

[[Page 69377]]

regulations. Commission staff reviews the effectiveness of this program 
on a regular basis, and will continue to adopt enhancements where 
appropriate.\137\ The large trader reporting system, however, does not 
currently apply to many swaps that are, or may be, cleared. The 
Commission may need information about large swap positions to assess 
the risk profile of a DCO or a clearing FCM.
---------------------------------------------------------------------------

    \137\ For example, the Commission recently adopted final rules 
on Large Trader Reporting for Physical Commodity Swaps at 76 FR 
43851 (July 22, 2011).
---------------------------------------------------------------------------

    CME, KCC, MGEX, FIA, and CMC commented that clearing members do not 
generally have information identifying the underlying customers in 
customer omnibus accounts carried on behalf of non-clearing member 
FCMs, foreign brokers, hedge funds or commodity pools, and therefore 
clearing members cannot reasonably be expected to report such 
information to DCOs, and DCOs cannot reasonably be expected to report 
such information to the Commission. The Commission notes that a DCO may 
be able to obtain such information under its own rules. For example, 
CME Rule 960 requires a clearing member to immediately disclose the 
identities and positions of the beneficial owners of any omnibus 
account to CME upon its request.
    MGEX expressed its concern that the significant costs resulting 
from compliance with a requirement for the routine daily reporting of 
all gross customer positions by beneficial owner could lead to further 
consolidation in the industry at the FCM, clearing member, and DCO 
levels.
    The Commission is not adopting the proposed requirement in Sec.  
39.19(c)(1)(iv) that a DCO provide daily reports to the Commission of 
the gross positions of each beneficial owner within each clearing 
member's customer origin account. However, the Commission is adopting 
Sec.  39.19(c)(5)(iii),\138\ which requires a DCO to provide this 
information to the Commission upon the Commission's request, in the 
format and manner, and within the time, specified by the Commission.
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    \138\ See further discussion of Sec.  39.19, adopted herein, in 
section IV.J, below.
---------------------------------------------------------------------------

    For example, the Commission could request that a DCO provide 
information about customer positions by beneficial owner, on a case-by-
case basis, with respect to a particular clearing member, customer, or 
product. Moreover, the Commission could request that such information 
be provided for a particular day, month, or until further notice by the 
Commission. In recent years, the Commission has worked cooperatively 
with several DCOs to obtain information about cleared swap positions. 
The Commission notes that any potential costs should be substantially 
reduced by the modified requirement that a DCO provide information to 
the Commission identifying the positions of beneficial owners of 
customer accounts only upon Commission request and not on a daily 
basis.
(3) Customer Initial Margin Requirements--Sec.  39.13(g)(8)(ii)
    Proposed Sec.  39.13(g)(8)(ii) would require a DCO to require its 
clearing members to collect customer initial margin \139\ from their 
customers for non-hedge positions at a level that is greater than 100 
percent of the DCO's initial margin requirements \140\ with respect to 
each product and swap portfolio. 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. However, under the proposed regulation, the 
Commission could review such percentage levels and require different 
percentage levels if the Commission deemed the levels insufficient to 
protect the financial integrity of the clearing members or the DCO in 
accordance with Core Principle D.\141\
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    \139\ The term ``customer initial margin'' is now defined in 
Sec.  1.3(kkk), adopted herein.
    \140\ A DCO's initial margin requirements are also referred to 
herein as ``clearing initial margin'' requirements. ``Clearing 
initial margin'' is defined as ``initial margin posted by a clearing 
member with a [DCO]'' in Sec.  1.3(jjj), adopted herein.
    \141\ Section 5b(c)(2)(D)(iii) of the CEA, 7 U.S.C. 7a-
1(c)(2)(D)(iii).
---------------------------------------------------------------------------

    OCC stated its view that exchanges, which have historically set 
customer level margin requirements, should continue to do so, rather 
than DCOs, noting that clearing organizations would ordinarily have no 
means to enforce customer level margin requirements.
    KCC stated that it generally supports the concept that clearing 
members should collect customer initial margin at a level above that of 
DCO initial margin, but requested that the Commission clarify the 
circumstances in which it may deem the ratio of customer initial margin 
to DCO initial margin insufficient to protect the DCO. Although the 
FHLBanks opposed the proposal, they recommended that if the Commission 
were to adopt it, the Commission should provide additional guidance 
and/or establish criteria for DCOs with respect to setting the required 
amount of excess margin. MGEX noted that although it currently 
maintains a 130 percent requirement, this is a decision that should be 
left to each DCO and its clearing members to determine. Because the 
circumstances for each DCO or the nature of its clearing members vary, 
it would be difficult to provide the general clarification or criteria 
that KCC and the FHLBanks are seeking, because such a determination 
would need to be made on a case-by-case basis.
    MFA argued that a requirement that a DCO must require its clearing 
members to collect customer initial margin at a level that is greater 
than the DCO's initial margin requirements would be inappropriate 
because DCOs do not have information about individual customers' 
creditworthiness and such a requirement would impair market liquidity 
by limiting the trading activity of certain market participants, 
resulting in greater market concentration. Citadel and the FHLBanks 
made similar comments.
    ICE stated that FCMs are best able to determine how much to charge 
above the initial margin requirement because they have complete 
visibility into their customers' positions, and the Commission should 
not place this requirement on a DCO, but should address this with FCMs 
through another set of rules. FIA opposed the proposed rule stating 
that the amount of excess margin, if any, that an FCM may require from 
its customers is a credit decision that should be made by each FCM 
based on its analysis of the creditworthiness of the particular 
customer, including the nature of the customer's trading activity and 
its record of meeting margin calls.
    Currently DCMs require their FCM members to impose customer initial 
margin requirements that are a specified percentage higher than the 
DCO's initial margin requirements, generally in the neighborhood of 125 
percent to 140 percent, as determined by the DCM. DCMs generally permit 
FCM members to impose customer initial margin requirements for hedge 
positions that are equal to the applicable maintenance margin 
requirements (which are generally the same as the applicable clearing 
initial margin requirements). This rule simply shifts the 
responsibility for establishing customer initial margin requirements 
from DCMs to DCOs.
    DCOs have greater expertise in risk management and a direct 
financial stake in whether their clearing members' customers, and 
consequently their clearing members, are able to meet their margin 
obligations. Moreover, it is anticipated that some DCOs will clear 
fungible swaps that may be listed on multiple SEFs. SEFs may or may not

[[Page 69378]]

impose customer initial margin requirements on their members for 
cleared swaps. Requirements set by DCOs may be less susceptible to 
pressure to being lowered for competitive reasons. Finally, DCOs will 
be the only self-regulatory organizations that will be in a position to 
set customer initial margin requirements for swaps that are executed 
bilaterally, and voluntarily cleared. Moreover, DCOs will have the 
opportunity to review whether their clearing members are collecting 
customer initial margin, as required by the DCO, during their reviews 
of the risk management policies, procedures, and practices of their 
clearing members, pursuant to Sec.  39.13(h)(5).\142\
---------------------------------------------------------------------------

    \142\ See discussion of Sec.  39.13(h)(5), adopted herein, in 
section IV.D.7.e, below.
---------------------------------------------------------------------------

    Section 39.13(g)(8)(ii) permits a DCO to exercise its discretion in 
determining the appropriate percentage by which the customer initial 
margin for a particular product or swap portfolio should exceed the 
clearing initial margin,\143\ as DCMs do today with respect to futures 
and options. This percentage should be based on the nature and 
volatility patterns of the particular product or swap portfolio, and 
the DCO's related evaluation of the potential risks posed by customers 
in general to their clearing members and, in turn, the potential risks 
posed by such clearing members in general to the DCO, rather than the 
creditworthiness of particular customers. Consequently, a DCO will 
retain the flexibility to establish an appropriate percentage for 
customer initial margin that applies to each product that it clears, 
which will apply to all of its clearing FCMs and all of their 
customers. However, as is also the case today, such clearing FCMs would 
remain free to exercise their discretion to determine whether they will 
collect additional margin over and above that amount either from all of 
their customers, or from particular customers based on such customers' 
risk profiles.\144\
---------------------------------------------------------------------------

    \143\ OCC commented that its STANS margin system calculates 
margin based on all positions in an account and not on a position-
by-position basis; therefore it would not be able to furnish 
clearing members with a number representing the initial margin on a 
particular position without conducting subaccounting for each 
customer. OCC also noted that since STANS requirements are data-
driven on a month-to-month, and even a day-to-day, basis they can 
vary in ways that cannot be readily predicted. The Commission is 
adopting Sec.  39.13(g)(8)(i) herein, which requires a DCO to 
collect initial margin on a gross basis for its clearing members' 
customer accounts. Therefore, a clearing member (or the DCO) will be 
required to determine the initial margin that must be posted with 
the DCO with respect to each customer's positions. Even if that 
amount changes from day to day as a result of the application of a 
portfolio-based margin system, a DCO could require that its clearing 
members collect customer initial margin in an amount that is a given 
percentage in excess of 100 percent of the daily clearing initial 
margin requirement with respect to each customer.
    \144\ See, e.g., CME Rule 8G930.E (``IRS Clearing members may 
call for additional performance bond at their discretion.'') 
(available at http://www.cmegroup.com/rulebook/CME/I/8G/) and 
International Derivatives Clearinghouse, LLC Rule 614(g) (``A 
Clearing Member may call, at any time, for [margin] above and beyond 
the minimums required by the Clearinghouse.'') (available at http://www.idch.com/pdfs/idch/20100901rulebook.pdf).
---------------------------------------------------------------------------

    The Commission continues to believe that requiring a DCO to require 
its clearing members to collect customer initial margin in a percentage 
higher than 100 percent of the clearing initial margin, for non-hedge 
positions, provides a valuable cushion of readily available customer 
margin. Citadel stated that the market's extensive experience in a 
range of cleared markets demonstrates preparedness for the regular 
exchange of margin between clearing members and their customers for 
cleared OTC derivatives, even where margin calls occur more frequently 
than once daily, and that frequent exchange of margin is also current 
market practice for uncleared trades. However, the maintenance of 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 
such frequent margin calls to their customers. In addition, many 
clearing members choose to deposit excess margin with their DCOs to 
provide their own cushion, which may in some instances obviate the need 
to transfer funds to the DCO on a daily basis in order to meet 
variation margin requirements.
    ISDA, FIA, and the FHLBanks commented that if the Commission were 
to adopt proposed Sec.  39.13(g)(8)(ii), it should clarify the meaning 
of ``non-hedge positions.'' The FHLBanks also stated that the 
Commission should provide guidance regarding how the determination as 
to whether a position is a hedge or a non-hedge position would be made, 
whether by the DCO, the clearing member, or the customer, and expressed 
the belief that a clearing member's customers should be responsible for 
determining and certifying, to their clearing members or DCOs, whether 
their swap positions are ``hedge'' or ``non-hedge'' positions.
    Several commenters have argued that there is no basis for 
distinguishing between hedge positions and non-hedge positions in 
determining whether such positions should be subject to customer 
initial margin requirements in excess of clearing initial margin 
requirements.\145\ LCH stated that it does not believe that a DCO or a 
clearing member should distinguish in any way between a customer's 
hedge and non-hedge positions because: (1) if the two parts of the 
hedge are carried by the same clearing member within the same DCO, such 
hedges would in any event implicitly be recognized by the DCO's risk 
calculations and the provision would be unnecessary; and (2) if one or 
the other leg of the hedge is uncleared, or is carried by a different 
clearing member, or by the same or another clearing member at another 
DCO, no recognition of the offsetting hedge should be allowed either by 
the DCO(s) or by the clearing member(s), as neither party would have 
the economic benefit of the hedged transaction. The Commission notes 
that the categorization of a position as a hedge for purposes of this 
regulation does not affect the margin collected by the DCO; it only 
affects the additional increment that the clearing member collects from 
its customer.
---------------------------------------------------------------------------

    \145\ MFA stated that it would be highly burdensome to 
distinguish between hedge and non-hedge positions for purposes of 
the application of differentiated margining, especially in a 
portfolio margining context. As noted in n. 143, above, a DCO that 
uses a portfolio-based margin model could require that its clearing 
members collect customer initial margin in an amount that is a given 
percentage in excess of 100 percent of the daily clearing initial 
margin requirement with respect to each customer. If all of a 
particular customer's positions were hedge positions, the DCO could 
permit the clearing member to collect customer initial margin in an 
amount that equals the amount of clearing initial margin with 
respect to that customer's positions. It is only in those 
circumstances where a hedger may also engage in speculative trading 
that it may be difficult to distinguish between positions for 
purposes of the application of differentiated margining in a 
portfolio margining context.
---------------------------------------------------------------------------

    Freddie Mac indicated that the Commission should consider 
eliminating the proposed requirement for increased customer initial 
margin for ``non-hedge positions,'' noting that customers with non-
hedge positions are not inherently riskier or more likely to miss 
margin calls than customers with ``hedge positions.''
    As previously noted, DCMs have historically drawn a distinction 
between hedge positions and non-hedge positions in setting customer 
initial margin requirements, and the Commission believes that it is 
reasonable to assume that hedgers may present less risk than 
speculators, in that losses on their derivatives positions should be 
offset by gains on the positions whose risks they are hedging. The 
relevant consideration is the relative risks posed by hedgers versus 
non-hedgers, rather than the

[[Page 69379]]

creditworthiness of particular customers.
    Freddie Mac recommended that, if the Commission does not eliminate 
the distinction between hedge and non-hedge positions, the Commission 
should clarify that, for purposes of Sec.  39.13(g)(8)(ii): (1) ``hedge 
positions'' would include all swaps that hedge or mitigate any form of 
a customer's business risks; (2) such swaps may qualify as ``hedge 
positions'' regardless of whether they qualify as ``bona fide hedging 
transactions'' under the CEA and Sec.  1.3(z) or qualify as hedges 
under applicable accounting standards; and (3) such swaps may qualify 
as ``hedge positions'' regardless of the nature of the entity that 
holds such positions (e.g., whether it is a financial entity or a non-
financial entity). Freddie Mac indicated that such treatment would be 
consistent with Commission proposals for defining hedging for purposes 
of other Dodd-Frank Act rules, including the definition of a ``major-
swap participant'' \146\ and rules relating to the availability of the 
end-user exception to mandatory clearing.\147\
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    \146\ See 75 FR 80174 (Dec. 21, 2010) (Further Definition of 
``Swap Dealer,'' ``Security-Based Swap Dealer,'' ``Major Swap 
Participant,'' ``Major Security-Based Swap Participant'' and 
``Eligible Contract Participant'').
    \147\ See 75 FR 80747 (Dec. 23, 2010) (End-User Exception to 
Mandatory Clearing).
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    The Commission intends to interpret ``hedge positions,'' for 
purposes of Sec.  39.13(g)(8)(ii), as referring to those that meet 
either the definition set forth in Sec.  1.3(z), or the definition set 
forth in Sec.  1.3(ttt), when, and in the form in which, it is 
ultimately adopted.\148\ The Commission also believes that, as is 
currently the practice, it would be the customer's responsibility to 
identify its positions as hedge positions to its clearing FCM.
---------------------------------------------------------------------------

    \148\ The Commission has proposed a definition of ``hedging or 
mitigating commercial risk,'' to be codified at Sec.  1.3(ttt), for 
the purposes of the definition of ``Major Swap Participant,'' 75 FR 
at 80214-80215 (Further Definition of ``Swap Dealer,'' ``Security-
Based Swap Dealer,'' ``Major Swap Participant,'' ``Major Security-
Based Swap Participant'' and ``Eligible Contract Participant'').
---------------------------------------------------------------------------

    The Commission is adopting Sec.  39.13(g)(8)(ii) as proposed.
(4) Withdrawal of Customer Initial Margin--Sec.  39.13(g)(8)(iii)
    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 swap 
portfolios in the customer's account, which were cleared by the DCO.
    LCH agreed with the underlying requirement, but stated that it 
should be imposed in rules that directly apply to clearing members 
rather than in rules applicable to DCOs. KCC also supported the concept 
but noted that DCM rules already require customers to maintain minimum 
margin levels and that these restrictions are generally tested by a 
clearing member's risk department and the clearing member's self-
regulatory organization during examinations. KCC further noted that 
DCOs do not have full access to information regarding each customer's 
financial condition. MGEX took the position that the Commission \149\ 
or a clearing member's designated self-regulatory organization (DSRO) 
should monitor compliance with such a requirement rather than the DCO, 
indicating that it would not be economically feasible for the DCO to do 
so.
---------------------------------------------------------------------------

    \149\ The Commission does not believe that it would be practical 
for the Commission to review each clearing member of each DCO to 
determine whether the clearing member is prohibiting its customers 
from making impermissible withdrawals from their accounts.
---------------------------------------------------------------------------

    As noted in the notice of proposed rulemaking, the requirement 
stated in Sec.  39.13(g)(8)(iii) is consistent with the definition of 
``Margin Funds Available for Disbursement'' in the Margins Handbook 
prepared by the JAC.\150\ Therefore, DSROs currently review FCMs to 
determine whether they are appropriately prohibiting their customers 
from withdrawing funds from their futures accounts unless the net 
liquidating value plus the margin deposits remaining in such customers' 
accounts after the withdrawal would be sufficient to meet the customer 
initial margin requirements with respect to such accounts. However, it 
is unclear to what extent this requirement would apply to cleared swaps 
accounts when such swaps are executed on a DCM which participates in 
the JAC. Moreover, clearing members which only clear swaps that are 
executed on a SEF will not be subject to the requirements set forth in 
the Margins Handbook or subject to review by a DSRO.
---------------------------------------------------------------------------

    \150\ See http://www.nfa.futures.org/NFA-compliance/publication-library/margins-handbook.pdf, at 45.
---------------------------------------------------------------------------

    The Commission anticipates that, at a minimum, DCOs will be able to 
review whether their clearing members are ensuring that customers do 
not make withdrawals from their accounts unless the specified 
conditions are met, when they conduct reviews of their clearing 
members' risk management policies, procedures, and practices pursuant 
to Sec.  39.13(h)(5).\151\
---------------------------------------------------------------------------

    \151\ See discussion of Sec.  39.13(h)(5), adopted herein, in 
section IV.D.7.e, below.
---------------------------------------------------------------------------

    The Commission is adopting Sec.  39.13(g)(8)(iii) as proposed.
i. Time Deadlines--Sec.  39.13(g)(9)
    Proposed Sec.  39.13(g)(9) would require a DCO to establish and 
enforce time deadlines for initial and variation margin payments.
    LCH submitted a comment letter indicating that it agrees with the 
proposal, but stated that it should apply only to a DCO's clearing 
members since a DCO has no direct relationship with clients of its 
clearing members. Consistent with its original intent, the Commission 
is adopting Sec.  39.13(g)(9) with a modification to make it clear that 
it only applies to time deadlines for initial and variation margin 
payments to a DCO by its clearing members.
7. Other Risk Control Mechanisms
a. Risk Limits--Sec.  39.13(h)(1)(i)
    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 Commission believes that an FCM 
engages in excess risk-taking if it, or its customers, take on 
positions that require financial resources that exceed this threshold. 
The DCO would have reasonable discretion in determining: (1) the method 
of computing risk exposure; (2) the applicable threshold(s); and (3) 
the applicable financial resources, provided however, that the ratio of 
exposure to capital would have to remain the same across all capital 
levels. For example, if a DCO set limits under which margin could not 
exceed 200 percent of capital, the limit for a $100 million clearing 
member would be $200 million and the limit for a $200 million clearing 
member would be $400 million. 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

[[Page 69380]]

exposure at the clearing member. The Commission could review the amount 
of additional initial margin and require a different amount, as 
appropriate.
    J.P. Morgan and Alice Corporation supported the proposal to require 
DCOs to establish risk-based position limits for their clearing 
members. J.P. Morgan indicated that in setting such position limits 
applicable to any one clearing member, a DCO should consider its 
overall exposure to clearing members in the aggregate. The Commission 
agrees that this would be prudent and expects that DCOs would take into 
consideration the aggregate exposure in establishing individual levels. 
J.P. Morgan further took the position that DCOs should monitor 
exposures against these limits on a real time basis. As discussed in 
section IV.D.4, above, Sec.  39.13(e)(2) requires a DCO to monitor its 
credit exposure to each clearing member periodically during each 
business day.
    FIA stated that it generally agrees with the proposed requirement 
that ``the ratio of exposure to capital must remain the same across all 
capital levels'' but indicated that the rule should make clear that, in 
computing the ratio of exposure to capital, a clearing member's capital 
should be calculated net of all risk exposures and potential assessment 
obligations at other clearing organizations of which it is a clearing 
member. The Commission agrees that it would be appropriate for a DCO to 
consider a clearing member's exposures to other clearing organizations, 
to the extent that it is able to obtain such information, in 
determining a clearing member's applicable financial resources for the 
purpose of setting appropriate risk limits.
    CME argued that a requirement that DCOs impose risk limits for 
every clearing member would be overly prescriptive and unnecessary, 
provided that a DCO collects adequate margin, its stress-test results 
regarding the clearing member's exposures are acceptable, and it 
employs concentration margining (whereby the DCO would set a level of 
risk at which it would begin to charge higher margins based on 
indicative stress-test levels). In other words, CME suggested that risk 
limits may be unnecessary if a DCO sets a level of risk at which it 
would begin to charge higher margins based on stress test results with 
respect to a clearing member. However, Sec.  39.13(h)(1)(ii) would 
allow a DCO to permit a clearing member to exceed an established risk 
limit provided that the DCO required the clearing member to post 
additional margin. Although CME's proposed approach is worded slightly 
differently, the effect would be the same as that of Sec.  
39.13(h)(1)(ii), i.e., a clearing member could only exceed a defined 
risk level if it posted additional margin.
    MGEX indicated that the proposed rule requiring DCOs to impose risk 
limits on each clearing member might not be practical, adding 
additional cost with little benefit, noting that DCOs currently address 
credit and default risk via margins and security deposits on a daily 
basis and conduct risk reviews. Rather, according to MGEX, a DCO should 
be looking for risk signs and focusing on those that are most relevant. 
The Commission believes that the establishment of risk limits for 
clearing members would impose little additional cost on DCOs since DCOs 
are already required to monitor their clearing members' capital levels 
and their own financial resources, as well as the trading activity of 
their clearing members. On the other hand, the Commission believes that 
the establishment of such risk limits would add significant risk 
management benefits to the benefits already conferred by margins, 
security deposits, and reviews of clearing members' risk management 
policies and procedures.
    The Commission is adopting Sec.  39.13(h)(i) as proposed, except 
for a technical revision that replaces the phrase ``by customer orgin 
and house origin'' with ``by house origin and by each customer 
origin,'' which conforms the language with other provisions of part 39. 
OCC requested that the Commission clarify that proposed Sec.  
39.13(h)(i) would not apply to securities accounts of broker-dealers 
that are not FCMs and do no futures business. The Commission does not 
intend for Sec.  39.13(h)(i) to apply to such accounts. The Commission 
is also adopting Sec.  39.13(h)(ii) as proposed.
b. Large Trader Reports--Sec.  39.13(h)(2)
    Proposed Sec.  39.13(h)(2) would require a DCO to obtain from its 
clearing members, copies of all reports that such clearing members are 
required to file with the Commission pursuant to part 17 of the 
Commission's regulations, i.e., large trader reports. Large trader 
reports are necessary for stress testing to ensure that FCMs and their 
customers have not taken on too much risk. 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 would 
therefore be required to file such reports on behalf of clearing 
members pursuant to Sec.  17.00(i).
    Proposed Sec.  39.13(h)(2) would further require a DCO to review 
the large trader reports that it receives 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 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 those actions specified in 
proposed Sec.  39.13(h)(6).\152\
---------------------------------------------------------------------------

    \152\ See discussion of Sec.  39.13(h)(6), adopted herein, in 
section IV.D.7.f, below.
---------------------------------------------------------------------------

    FIA supported the proposal to require DCOs to obtain copies of all 
large trader reports that are filed with the Commission. MGEX commented 
that the Commission should provide large trader reports to each DCO 
rather than imposing a requirement that would require clearing members 
to make redundant filings. KCC argued that the proposed requirement 
that DCOs obtain large trader reports from clearing members is 
duplicative because a DCO receives large trader information from the 
exchange.\153\
---------------------------------------------------------------------------

    \153\ KCC further noted that, in its case, the exchange in turn 
receives the relevant large trader reports from the Commission.
---------------------------------------------------------------------------

    MGEX recommended that the Commission perform the review of large 
trader reports itself or permit a clearing member's DSRO to perform 
such review instead of DCOs.
    NYPC recommended that the Commission not adopt proposed Sec.  
39.13(h)(2) because the Commission has expended considerable resources 
to modify its own internal programs and processes in order to glean 
potentially relevant financial and risk management information from the 
large trader data that it receives from clearing members and DCMs, and 
even if DCOs had comparable financial and human resources that they 
could deploy for such a purpose, the information that they would obtain 
would frequently be fragmented and inconclusive, given that--unlike the 
Commission--no single DCO will ever have access to information relating 
to the futures, option and swap positions that are cleared by other 
DCOs or to uncleared swaps. NYPC further argued that given the 
necessary technology builds, it would need more than three years to 
come into compliance with proposed Sec. Sec.  39.13(g)(8)(i) and 
39.13(h)(2).
    OCC indicated that it should be the role of a clearing member's 
DSRO to require that an FCM submit sufficient information to permit the 
DSRO to identify customer accounts that could potentially cause a 
clearing member to

[[Page 69381]]

default, and that if DCOs were required to perform all tasks required 
by the proposed rules alone, they would be required to build new 
surveillance systems and significantly increase their surveillance 
staff.
    In response to suggestions that the Commission should conduct the 
required review of large trader reports, the Commission notes that it 
does review large trader reports for financial, market, and risk 
surveillance purposes. However, the Commission believes that DCOs 
should also have an obligation to review large trader reports for those 
large traders whose trades they clear, for their own risk surveillance 
purposes, even though as noted by NYPC, they may not have access to 
information relating to positions cleared by other DCOs or to uncleared 
swaps. Moreover, Sec.  39.13(h)(2) requires a DCO to review such large 
trader reports with a view toward taking any necessary additional 
actions with respect to such large traders' clearing members in order 
to address risks posed by such large traders to the DCO.
    In addition, it would not be feasible for a clearing member's DSRO 
to review large trader reports. DSRO designations apply to FCMs that 
are members of multiple DCMs. Therefore, clearing members that only 
trade for their own accounts do not have a DSRO. Clearing members that 
solely clear SEF-executed trades also will not have DSROs. Moreover, 
risk management ultimately is the responsibility of each DCO. A DSRO 
would not be in a position to analyze the daily risk of the overall 
portfolio of each large trader at a particular DCO, nor to take any 
additional actions to address such risks at a particular DCO.
    KCC stated that it is the clearing member's obligation to determine 
the financial fitness of large trader customers, in that clearing 
members have better, more direct information regarding the credit 
quality of the customer and the exposures of the customer under 
positions the customer may hold outside the DCO. KCC stated its belief 
that imposing a duplicative requirement on DCOs would achieve little 
risk management benefit at a high cost. The Commission agrees that 
clearing members must determine the financial capacity of their 
customers and they may have information which a particular DCO may not 
have regarding positions that they may clear for their customers on 
other DCOs.\154\ However, this does not obviate the need for each 
relevant DCO to ascertain the risks that the large trader poses to that 
DCO based on the information which the DCO is able to obtain through 
large trader reports.
---------------------------------------------------------------------------

    \154\ The Commission is modifying the language in proposed Sec.  
39.13(h)(2), which would have referred to ``positions at all 
clearing members carrying accounts for each such large trader'' by 
revising it to read as follows: ``futures, options, and swaps 
cleared by the [DCO] which are held by all clearing members carrying 
accounts for each such large trader.'' This will make it clear that 
the Commission is not attempting to require a DCO to review a large 
trader's positions that were cleared by another DCO, as it would not 
typically have access to information about such positions. The 
technical change from ``positions'' to ``futures, options, and 
swaps'' conforms the language with other provisions of part 39.
---------------------------------------------------------------------------

    ISDA noted that while the expansion of oversight required by 
proposed Sec. Sec.  39.13(h)(2) and Sec.  39.13(h)(3) \155\ may provide 
benefits, many DCOs do not currently have the systems or infrastructure 
to monitor or assess non-clearing member risk.\156\
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    \155\ See discussion of Sec.  39.13(h)(3), adopted herein, in 
section IV.D.7.c, below.
    \156\ ISDA also stated that further clarity regarding how the 
Commission intends to apply the large trader definition to swaps is 
needed. The Commission notes that it has begun this process by 
adopting final rules for Large Trader Reporting for Physical 
Commodity Swaps, in a new part 20, at 76 FR 43851 (July 22, 2011). 
Since these large trader reporting rules were adopted subsequent to 
the Commission's proposal of Sec.  39.13(h)(2), the Commission is 
modifying Sec.  39.13(h)(2) to refer to reports required to be filed 
with the Commission by, or on behalf of, clearing members pursuant 
to parts 17 and 20 of this chapter.
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    In response to ISDA's comment, as well as other comments that in 
order to comply with Sec.  39.13(h)(2), DCOs would need technology 
builds (NYPC), new surveillance systems and additional surveillance 
staff (OCC), and that there would be a high cost (KCC), the Commission 
notes that some DCOs already receive and review large trader reports 
for risk surveillance purposes on a daily basis. In fact, KCC stated in 
its comment letter that ``KCC would also remind the Commission that DCO 
compliance staff review the reportable position files that they receive 
on a daily basis to ascertain large trader risks that [clearing 
members] face.'' In addition, at least five years ago, Commission staff 
began recommending that DCOs do so, if they had not already been doing 
so, in DCO reviews that Commission staff has conducted to determine 
whether such DCOs were in compliance with relevant core principles 
under the CEA.
    The Commission is modifying Sec.  39.13(h)(2) to require a DCO to 
obtain large trader reports either from its clearing members or from a 
DCM or a SEF for which it clears, which are required to be filed with 
the Commission by, or on behalf of, such clearing members. However, the 
Commission does not believe that it is practical or appropriate for a 
DCO to rely on the Commission to provide large trader reports to the 
DCO.
    The Commission is adopting Sec.  39.13(h)(2) with the modifications 
described above.
c. Stress Tests--Sec.  39.13(h)(3)
    Proposed Sec.  39.13(h)(3) would require a DCO to conduct certain 
daily and weekly stress tests. The Commission has defined a ``stress 
test'' in Sec.  39.2, adopted herein, as ``a test that compares the 
impact of potential extreme price moves, changes in option volatility, 
and/or changes 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.'' \157\
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    \157\ See further discussion of Sec.  39.2 in section III.B, 
above.
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    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 the stress tests. However, 
the Commission could review the methodology and require any appropriate 
changes. The Commission requested 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.
    Several commenters addressed daily stress testing. FIA recommended 
that all of the proposed stress tests should be conducted on a daily 
basis. LCH stated its belief that stress testing requirements should 
not be extended to cover large traders that are clients of clearing

[[Page 69382]]

members but that the proposed weekly stress tests should be conducted 
daily. OCC stated that it did not see a sufficient benefit to justify 
the increased DCO resources that would be required to undertake daily 
stress tests on each large trader,\158\ noting that the costs would be 
passed on to clearing members and their customers. MGEX indicated that 
a requirement for daily stress testing of large traders seems excessive 
since the data may be dated even after one day and may not be more 
relevant than doing an average stress test over a weekly or monthly 
period. MGEX also expressed the view that the value of stress testing 
large traders is diminished if they have accounts with different 
clearing members.
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    \158\ As noted above, proposed Sec.  39.13(h)(3)(i) would not 
require daily stress tests on each large trader, but only with 
respect to those large traders who pose significant risk to a 
clearing member or the DCO in the event of default.
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    As stated above, proposed Sec.  39.13(h)(3)(i) would require a DCO 
to include positions at all clearing members carrying accounts for the 
large trader in the required stress tests. The Commission is making the 
same change to Sec.  39.13(h)(3)(i) that it is making to Sec.  
39.13(h)(2) by replacing the reference to ``positions at all clearing 
members carrying accounts for each such large trader'' with ``futures, 
options, and swaps cleared by the derivatives clearing organization, 
which are held by all clearing members carrying accounts for each such 
large trader.''
    KCC stated its belief that the frequency of stress testing should 
be left to the discretion of the DCO and should be risk-based in light 
of prevailing market conditions. NOCC indicated that products, 
customers or spread credits should reach a specified volume or risk 
exposure level before being required to be stress tested with the 
proposed frequencies so long as the DCO can demonstrate that it is 
meeting the core principle objectives underlying proposed Sec.  
39.13(f).\159\
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    \159\ NOCC made a similar comment with respect to the frequency 
of back testing, which is discussed in section IV.D.6.g,, above. The 
Commission does not believe that it is appropriate to adopt a 
regulation establishing an exemption process with respect to stress 
testing requirements based on volume or risk exposure or otherwise.
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    The Commission believes that it is appropriate to specify the 
minimum frequency of stress tests as set forth in Sec.  39.13(h)(3). As 
noted above, several commenters supported certain daily stress testing 
requirements. With the exception of KCC's and NOCC's comments, no 
commenters suggested that stress tests should be conducted less 
frequently than weekly.
    LCH recommended that the Commission prescribe that the stress 
scenarios used by the DCO in its testing should be adapted for current 
market conditions such that price or market shifts should not be 
translated literally, but rather proportionally. The Commission 
believes that Sec.  39.13(h)(3) should explicitly permit DCOs to 
exercise reasonable discretion in determining the methodology to be 
used in conducting the required stress tests. The Commission would 
recognize the approach suggested by LCH to be an appropriate element of 
a DCO's stress testing methodology, but does not believe that it is 
necessary to adopt such a prescriptive requirement.
    OCC indicated that for regulatory reasons associated with OCC's 
status as a dual SEC/Commission registrant, OCC's system does not 
consolidate all positions into a single ``customer origin'' and ``house 
origin'' for each clearing member, but rather permits multiple account 
types, including a firm (proprietary) account that incorporates both 
securities and futures positions, a securities customers' account, a 
regular futures customer segregated funds account subject to Section 4d 
of the CEA, separate segregated funds accounts for cross-margining 
arrangements as provided in various Commission orders approving such 
arrangements, and others. OCC further stated that because of the 
mathematical properties of the risk measures that it uses, its 
unconsolidated account level stress testing is more rigorous than if 
such stress testing were conducted at the level of each origin as a 
whole and argued that it makes sense to aggregate positions for stress 
testing in the same manner as they would be aggregated or netted for 
liquidation purposes. Therefore, OCC requested that the Commission 
clarify that this method of stress testing at the unconsolidated 
account level based on appropriate historical data would meet the 
requirements of proposed Sec.  39.13(h)(3)(ii). The Commission agrees 
with OCC that it would be appropriate for a DCO to conduct the stress 
tests required by Sec.  39.13(h)(3)(ii) with respect to separate house 
origin and customer origin accounts such as the house account that 
incorporates both securities and futures positions identified by 
OCC,\160\ separate customer accounts subject to Sections 4d(a) and 
4d(f) of the CEA, respectively, or cross-margining accounts.
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    \160\ A DCO that is dually-registered as a securities clearing 
agency would not be subject to the stress testing requirements of 
Sec.  39.13(h)(3)(ii) with respect to an account that only contains 
securities positions. However, such a DCO would be subject to the 
requirements of Sec.  39.13(h)(3)(ii) with respect to any relevant 
account that contains positions in instruments regulated by the 
Commission, even if that account also contains securities positions. 
In this regard, the Commission is revising Sec.  39.13(h)(3)(ii) to 
refer to ``each clearing member account, by house origin and by each 
customer origin, and each swap portfolio, including any portfolio 
containing futures and/or options and held in a commingled account 
pursuant to Sec.  39.15(b)(2) of this part, * * *''
---------------------------------------------------------------------------

    OCC also argued that while the requirement of conducting stress 
tests under ``extreme but plausible'' market conditions may be 
appropriate for determining the adequacy of a clearing organization's 
resources for withstanding the default of its largest participant, it 
would be inappropriate for measuring the adequacy of an individual 
clearing member's margin deposits. In particular, OCC expressed its 
belief that stress testing the positions, including margin assets, in 
clearing member accounts on a daily basis to ensure a positive 
liquidating value at more than a 99 percent confidence level is 
adequate and appropriate and that DCOs should have the ability to cover 
for more extreme market conditions through the use of additional 
financial resources, including clearing fund deposits.
    A stress test, as defined by the Commission, is not designed to 
measure the adequacy of a clearing member's margin deposits or to 
ensure that margin assets in clearing members' accounts meet a 99 
percent confidence level. Rather, these are the functions of the daily 
review and back testing required by Sec. Sec.  39.13(g)(6) and (g)(7), 
adopted herein.\161\ Stress tests address the adequacy of the 
applicable financial resources to cover losses resulting from potential 
extreme price moves, changes in option volatility, and/or changes in 
other inputs that affect the value of a position. In other words, if 
margin deposits would be sufficient to cover losses 99 percent of the 
time, stress tests would determine whether other financial resources 
would be available and sufficient to cover losses the remaining 1 
percent of the time. Such other financial resources could include the 
capital of the clearing member or the DCO, or a DCO's guaranty fund.
---------------------------------------------------------------------------

    \161\ See discussion of Sec. Sec.  39.13(g)(6) and (g)(7) in 
section IV.D.6.g, above.
---------------------------------------------------------------------------

    The Commission is adopting Sec.  39.13(h)(3) with the modifications 
described above.
d. Portfolio Compression--Sec.  39.13(h)(4)
    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

[[Page 69383]]

exercises are appropriate for those swaps that it clears. The 
Commission requested comment regarding whether such exercises should be 
offered monthly, quarterly, or on another frequency. In addition, the 
Commission requested comment regarding whether the frequency of such 
exercises should vary for different categories of swaps.
    Proposed Sec.  39.13(h)(4)(ii) would mandate that a DCO 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 was 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 members 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).
    CME commended the Commission for recognizing the importance of 
portfolio compression exercises as an important risk management tool. 
CME further suggested that the Commission refrain from prescribing the 
frequency of such exercises, stating its belief that each DCO is best 
positioned to determine the optimal frequency of portfolio compression 
exercises for the swaps that it clears, based on the unique 
characteristics of the particular products and markets. On the other 
hand, the FHLBanks stated that the Commission should specify how often 
portfolio compression exercises are to take place. The Commission 
agrees with CME and is retaining the language that simply refers to ``a 
regular basis.''
    ISDA requested that the Commission clarify the meaning of 
``multilateral portfolio compression'' in these proposals. ISDA stated 
that if the Commission is referring to position netting, then it agrees 
that a DCO must offer such exercises. However, ISDA indicated that if 
it refers to the provision of multilateral portfolio compression 
services such as those currently provided by entities such as 
TriOptima, DCOs should not be required to build such duplicative 
services, which would be likely to delay their roll-out of 
comprehensive clearing services. The Commission agrees that a DCO 
should not be required to incur the expense of building its own 
multilateral compression services. Therefore, the Commission is 
modifying the requirement to make it clear that although a DCO may 
develop its own portfolio compression services if it chooses, it is 
only required to make such exercises available to its clearing members 
if applicable portfolio compression services have been developed by a 
third party for those swaps that it clears.\162\
---------------------------------------------------------------------------

    \162\ This also addresses the FHLBanks' comment that the 
Commission should specify what types of swaps are to be included in 
portfolio compression exercises.
---------------------------------------------------------------------------

    The FHLBanks urged the Commission to further define ``reasonably 
likely to increase risk exposure to a clearing member'' to include the 
risk exposures of a clearing member's customers, and also stated their 
view that a clearing member's customers must have the ability to ``opt-
out'' of portfolio compression requirements to the extent that those 
customers' swap positions need to be retained for hedge accounting and 
other business purposes. In particular, the FHLBanks expressed their 
concern that the proposal's ambiguities would cause the internal risk 
management strategies of entities that are not swap dealers or major 
swap participants to be adversely affected, noting that portfolio 
compression could potentially jeopardize hedge accounting treatment for 
customers' swap transactions and disrupt anticipated cash flows.
    LCH stated that it strongly supports the use of compression 
services and believes that they should be encouraged by the Commission 
to the greatest extent possible, but it would not necessarily always be 
appropriate for a DCO to require its clearing members to participate in 
all such exercises. First, LCH noted that a DCO's clearing members may 
not always be subject to the Commission's supervision and may not be 
required to engage in such compression activities; therefore imposing 
such a requirement on the DCO may discourage such firms from becoming 
clearing members of that DCO and thereby have the perverse effect of 
discouraging such firms from clearing. Second, LCH stated that a 
clearing member may have legitimate reasons for not participating in 
such compression exercises at all times, or for not submitting all 
eligible swaps to such exercises. Therefore, LCH took the position that 
the use of compression services should be encouraged but should not be 
compulsory, and suggested that the Commission eliminate Sec.  39.13 
(h)(4)(ii) in its entirety. For the reasons stated by LCH and the 
FHLBanks, the Commission is modifying Sec.  39.13(h)(4) to provide that 
participation in compression exercises by clearing members and their 
customers would be voluntary.
e. Clearing Members' Risk Management Policies and Procedures--Sec.  
39.13(h)(5)
    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 would be required to adopt rules that: 
(a) require its clearing members to maintain current written risk 
management policies and procedures (proposed Sec.  39.13(h)(5)(i)(A)); 
(b) ensure that the DCO 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 (proposed 
Sec.  39.13(h)(5)(i)(B)); 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 (proposed Sec.  39.13(h)(5)(i)(C)).
    In addition, proposed Sec.  39.13(h)(5)(ii) would require a DCO to 
review the risk management policies, procedures, and practices of each 
of its clearing members on a periodic basis and document such reviews. 
The Commission invited 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 requested 
comment regarding whether it 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 invited 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.
    ISDA and FIA supported the proposed requirement in Sec.  
39.13(h)(5)(i)(A) that clearing members must have written risk 
management policies and procedures. FIA also recommended that clearing 
members should be required to have adequate staff and systems to 
monitor customer risk on a real-time or near-real time basis and to 
routinely test their risk management procedures under theoretical 
stress scenarios.
    NGX stated that the requirement that clearing members have and 
follow risk management policies is a sensible requirement in the 
context of the

[[Page 69384]]

typical, intermediated clearinghouse.However, NGX argued that such 
requirements should not apply to a non-intermediated DCO such as NGX, 
where clearing participants are commercial end users, trading and 
clearing for their own accounts, and none of the clearing participants 
are exposed to the default risk of any other clearing participant or to 
that of fellow customers of a clearing participant.
    The Commission believes that it is appropriate for a DCO to require 
all of its clearing members to maintain written risk management 
policies and procedures, regardless of whether such clearing members 
have customer business or are exclusively self-clearing. As noted 
above, the Commission believes that written policies are a crucial 
component of any risk management framework. Moreover, Sec.  
39.13(h)(5)(i)(A) does not specify the nature or extent of the required 
written risk management policies and procedures, which could vary as 
appropriate to a particular type of clearing member, subject to the 
requirements of any other applicable Commission regulations.\163\
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    \163\ For example, in a separate rulemaking, proposed Sec.  
23.600 would set forth detailed requirements for the risk management 
programs of swap dealers and major swap participants, and would 
require such entities to maintain written procedures and policies 
describing their Risk Management Programs. See 75 FR 71397 (Nov. 23, 
2010) (Regulations Establishing and Governing the Duties of Swap 
Dealers and Major Swap Participants). Such swap dealers and major 
swap participants may or may not be clearing members.
---------------------------------------------------------------------------

    The Commission has not proposed and is not adopting the additional 
requirements suggested by FIA, described above, as part of this 
rulemaking. However, the Commission has proposed additional 
requirements with respect to clearing members' risk management policies 
and procedures in a separate rulemaking applicable directly to clearing 
members.\164\
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    \164\ See 76 FR 45724 (Aug. 1, 2011) (Clearing Member Risk 
Management). In that rulemaking, the Commission has proposed to 
require FCMs, swap dealers, and major swap participants, each of 
which are clearing members, to adopt certain specified risk 
management procedures, including written procedures to comply with 
the proposed requirements.
---------------------------------------------------------------------------

    With respect to the proposed requirement in Sec.  39.13(h)(5)(i)(C) 
that a DCO must have rules requiring its clearing members to make 
information regarding their risk management policies, procedures, and 
practices available to the Commission, MGEX stated that the Commission 
should seek access to a clearing member's risk management policies and 
processes directly and a DCO should not act as an unnecessary conduit 
between the Commission and clearing members. The Commission notes that 
even if it were to propose a regulation to impose such a requirement 
directly on clearing members in the future, it does not preclude the 
Commission from requiring DCOs to impose this requirement on their 
clearing members at this time.\165\
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    \165\ In another context, e.g., a DCM has adopted a rule that 
requires the operator of a DCM-approved delivery facility to '' * * 
* make such reports, keep such records and permit such facility 
visitation as the Exchange, the Commodity Futures Trading Commission 
or any other applicable government agency may require * * * .'' See 
CBOT Rule 703.A.
---------------------------------------------------------------------------

    LCH stated that it concurs with the provisions of proposed Sec.  
39.13(h)(5) but suggested that the Commission limit the requirements 
under proposed paragraph (h)(5)(C) so that they would be applicable 
only to those clearing members that are subject to the Commission's 
oversight and not to all clearing members of a DCO regardless of the 
jurisdiction in which they operate. The Commission notes that risk 
management practices of clearing members of registered DCOs, to the 
extent that such clearing members are clearing products subject to the 
Commission's oversight, are of importance to the Commission in its 
capacity as the regulator of the DCO. For purposes of risk management 
oversight, there is no basis for differentiating among clearing members 
because of their registration status or domicile. Although the 
Commission does not directly supervise non-registrants, the Commission 
has previously adopted rules that apply to clearing members, whether or 
not they are Commission registrants, e.g., Sec. Sec.  1.35(b) and (c) 
(recordkeeping requirements), and Part 17 of the Commission's 
regulations (reporting requirements). Section 39.13(h)(5)(C) is 
consistent with the Commission's approach with respect to such other 
rules, and is an appropriate component of the regulatory framework for 
DCO risk management.
    With regard to the proposed requirement in Sec.  39.13(h)(5)(ii) 
that a DCO must review the risk management policies, procedures, and 
practices of each of its clearing members on a periodic basis, FIA 
stated that all clearing members should be subject to on-site audits at 
least annually. NGX suggested that if the Commission requires non-
intermediated DCOs to require their members to have written risk 
management policies, the Commission should provide guidance that a non-
intermediated DCO would not be required to conduct on-site audits of 
clearing participants and that the DCO would meet its obligations to 
review the policies of such clearing participants if it does so only on 
a for-cause basis.
    The Commission is adopting Sec.  39.13(h)(5)(ii) as proposed, 
without prescribing the specific frequency, depth, or methodology of 
such reviews, and without specifying when an on-site audit may or may 
not be appropriate. The Commission believes that such a review is 
important to ensure that each clearing member's risk management 
framework is sufficient and properly implemented. The Commission also 
believes that a DCO should be permitted to exercise reasonable 
discretion with respect to each of these matters, based upon the 
nature, risk profiles, or other regulatory supervision of particular 
clearing members. The requirement that such reviews must be conducted 
on a ``periodic basis'' means that reviews must be conducted routinely 
and, therefore, the requirement would not permit a DCO to only conduct 
such reviews on a for-cause basis.
    A number of commenters noted that many clearing members are 
clearing members of multiple DCOs and thus could be subject to multiple 
duplicative risk reviews. CME, OCC, MGEX, ICE, and NYPC indicated that 
this would be burdensome for such clearing members. For example, MGEX 
noted ``the burden a clearing member may be faced with due to 
duplication of efforts and associated costs.'' KCC indicated that such 
duplicative reviews would achieve little with great expenditure of 
resources.
    OCC and NYPC also expressed their concerns about the costs to DCOs. 
In particular, OCC noted that requiring DCOs to conduct such reviews 
would impose a very high cost on a DCO that is not integrated with a 
DCM. NYPC noted its concern that the Commission may be underestimating 
the immensity of conducting such reviews in that a clearing member's 
risk management plan will not address solely the risks associated with 
clearing membership, but will be integrated and cover the broad 
spectrum of risks, including market, credit, liquidity, capital, and 
operational risk, that are associated with the entirety of the clearing 
member's securities, banking and futures business, much of which may 
have nothing to do with business through the DCO.
    In order to address NYPC's specific concern, the Commission is 
modifying Sec.  39.13(h)(5)(i)(A) to add the qualifier ``which address 
the risks that such clearing members may pose to the derivatives 
clearing organization'' after ``risk management policies and 
procedures'' and is adding the same qualifier in Sec.  39.13(h)(5)(ii) 
after ``risk

[[Page 69385]]

management policies, procedures, and practices of each of its clearing 
members.''
    To reduce the potential burden of duplicative risk reviews of 
clearing members that are clearing members of multiple DCOs, CME and 
NYPC urged the Commission to give each DCO reasonable discretion 
regarding the frequency, scope, or manner in which it conducts risk 
reviews of its clearing members, taking into account various factors 
including other regulatory supervision, or review by a governmental 
entity or self-regulatory organization, of particular firms. Other 
commenters variously suggested that risk reviews should be conducted by 
the Commission (OCC and MGEX), by the clearing member's DSRO or a 
similar DCO industry group (KCC, OCC, ICE, and MGEX), or by NFA (OCC).
    The Commission notes that the current DSRO system is not a viable 
option for reviewing clearing members' risk management policies, 
procedures and practices. Because DSROs are only responsible for 
conducting examinations of DCM-member FCMs' compliance with financial 
requirements, clearing members that only engage in house trading do not 
have a DSRO, nor will clearing members that solely clear SEF-executed 
trades. Moreover, such examinations do not address all of the risk 
issues which would concern a particular DCO. Furthermore, even if the 
current DSRO system were expanded to include DCOs, or a similar 
industry group composed of DCOs were formed, it would be impractical to 
allocate the responsibility to one DCO to analyze the risk management 
policies, procedures and practices of a common clearing member, on 
behalf of all relevant DCOs, when each DCO may impose different risk 
management requirements on its clearing members and each DCO may have 
differing margin methodologies that call for different risk management 
responses from clearing members.
    The Commission does not believe that it should assume the sole 
oversight of the risk management policies, procedures, and practices of 
clearing members of DCOs. The Commission conducts risk surveillance 
with respect to both DCOs and clearing members; however, this cannot 
replace a DCO's obligation to ensure that its clearing members are 
appropriately managing the risks that such clearing members pose to 
that particular DCO. Similarly, it does not appear that NFA would be an 
efficient alternative. The Commission recognizes that certain DCMs have 
entered into regulatory services agreements with NFA, and that NFA has 
thereby assumed certain audit responsibilities with respect to FCMs 
that are members of those DCMs. However, a DCO remains in the best 
position to review the risk management policies, procedures, and 
practices of its clearing members in the context of their obligations 
to that particular DCO.
    The Commission is adopting Sec.  39.13(h)(5) with the modifications 
described above.
f. Additional Authority--Sec.  39.13(h)(6)
    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 could 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.
    KCC stated that it generally supports the concept that DCOs should 
impose heightened risk management requirements on clearing members as 
their risk profiles change and requested that the Commission clarify 
whether each of the potential heightened risk management requirements 
enumerated in proposed Sec.  39.13(h)(6)(i)-(vii) must be explicitly 
delineated in DCO rules or in the DCO's clearing membership agreement. 
The Commission believes that a DCO must have the authority and ability 
to take appropriate additional actions with respect to particular 
clearing members, as described in Sec.  39.13(h)(6), but how the DCO 
asserts such authority, whether by rule or contractual agreement, 
should be left to the discretion of the DCO.
    J.P. Morgan expressed the view that higher margin multipliers 
should be adopted for members who present a higher risk profile as a 
result of excessive concentration of risk cleared, reduced 
creditworthiness, or other factors affecting a particular member, and 
that such margin multipliers should be documented in risk management 
policies applicable to all members.
    J.P. Morgan's concern that margin multipliers should be applied to 
clearing members with a higher risk profile, is addressed in Sec.  
39.13(h)(1), adopted herein and discussed in section IV.D.7.a, above, 
which requires a DCO to impose risk limits on each clearing member.
    The Commission is adopting Sec.  39.13(h)(6) as proposed.

E. Core Principle E--Settlement Procedures--Sec.  39.14

    Core Principle E,\166\ as amended by the Dodd-Frank Act, requires a 
DCO to: (1) Complete money settlements on a timely basis, but not less 
frequently than once each business day; (2) 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); (3) ensure that money settlements are 
final when effected; (4) maintain an accurate record of the flow of 
funds associated with money settlements; (5) possess the ability to 
comply with the terms and conditions of any permitted netting or offset 
arrangement with another clearing organization; (6) establish rules 
that clearly state each obligation of the DCO with respect to physical 
deliveries; and (7) ensure that it identifies and manages each risk 
arising from any of its obligations with respect to physical 
deliveries. The Commission proposed Sec.  39.14 to establish 
requirements that a DCO would have to meet in order to comply with Core 
Principle E.\167\
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    \166\ Section 5b(c)(2)(E) of the CEA, 7 U.S.C. 7a-1(c)(2)(E) 
(Core Principle E).
    \167\ Without addressing any specific aspect of proposed Sec.  
39.14, LCH commented that it agrees with the Commission's proposals 
for settlement procedures.
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1. Definitions--Sec.  39.14(a)
    ``Settlement'' was 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'' 
was 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].''
    ISDA and FIA commented that posting of variation margin on swaps 
should not be viewed as ``settling'' the present value of the trade and 
noted that price alignment interest would still be paid on variation 
margin. ISDA stated that, similarly, initial margin is not ``paid'' by 
a clearing member to a DCO

[[Page 69386]]

but is often posted with a security interest granted by the clearing 
member. FIA also commented that the deposit and withdrawal of initial 
margin is not properly defined as a settlement.
    NGX stated that, with the exception of a relatively small power 
contract, its clearing model does not require daily variation margin 
payments and collections from its clearing participants; rather, it 
holds collateral (initial margin) in an account at a depository bank 
rather than in a settlement account, and additional collateral may be 
called for as required. Therefore, NGX stated that it would be clearer 
when applied to the NGX model, to use the term ``payment and receipt'' 
rather than the term ``deposit'' when referring to initial margin.
    The Commission proposed a broad definition of ``settlement'' in 
Sec.  39.14(a)(1) to encompass all cash flows between clearing members 
and a DCO. The Commission recognizes that accounts that are used for 
the payment and receipt of variation margin are frequently called 
settlement accounts, while accounts that are used for the deposit and 
withdrawal of initial margin may be called deposit accounts, or custody 
accounts, if the initial margin deposited therein is in the form of 
securities. The definition of ``settlement bank'' in Sec.  39.14(a)(2) 
was intended to encompass any bank that a DCO uses for settlements, as 
defined in Sec.  39.14(a)(1), whether the relevant accounts are called 
settlement accounts, deposit accounts, or custody accounts. In order to 
avoid confusion, the Commission is modifying Sec.  39.14(a)(2) to 
define a settlement bank simply 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 any settlement described in paragraph (a)(1) 
above.'' The Commission is adopting Sec.  39.14(a)(1) as proposed, 
except for a non-substantive change, which replaces each reference to 
``futures, options, and swap positions'' with ``futures, options, and 
swaps.''
2. Daily Settlements--Sec.  39.14(b)
    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.
    CME expressed its support for intra-day settlements. LCH suggested 
that a DCO must measure its credit exposures ``several times each 
business day,'' and should be obliged to recalculate initial and 
variation margin requirements more than once each business day. J.P. 
Morgan stated that intraday margin calls should be made with greater 
frequency for clearing members who have a higher risk profile.
    The Commission does not believe that it is necessary to adopt a 
requirement that all DCOs recalculate initial and variation margin 
requirements more than once each business day or an explicit 
requirement for intraday margin calls for clearing members with a 
higher risk profile. The Commission believes that it has struck the 
appropriate balance in Sec.  39.14(b), by requiring a DCO to conduct 
daily settlements, while permitting a DCO to exercise its discretion 
regarding whether it will conduct routine intraday settlements, or 
whether it will settle positions on an intraday basis only when certain 
thresholds are breached \168\ or in times of extreme market volatility. 
This approach is also generally consistent with proposed international 
standards.\169\ A particular DCO could determine to conduct routine 
intraday settlements, as some have done, or to conduct intraday 
settlements for particular clearing members based on their risk 
profiles.
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    \168\ E.g., a DCO could establish thresholds that relate to the 
extent of market volatility, or with respect to a particular 
clearing member, the extent of losses that it has suffered on a 
particular day or whether it has reached a risk limit established by 
the DCO pursuant to Sec.  39.13(h)(1)(i), which is discussed in 
section IV.D.7.a, above.
    \169\ See CPSS-IOSCO Consultative Report, Principle 6: Margin, 
Key Consideration 4, at 40; EMIR, Article 39, paragraph 3, at 46.
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    NEM, NGX, and NOCC all requested that the Commission afford 
recognition to a clearing model that does not require daily variation 
margin payments and collections but permits accrual accounting with 
respect to certain energy products.
    NEM noted that most Retail Energy Marketers (REMs) \170\ use an 
accrual accounting practice that recognizes revenues and costs after 
energy delivery to their retail customers and that clearing solutions 
that require daily cash settlements would either complicate their 
accounting practices or significantly impact REM cash flows.
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    \170\ NEM stated that REMs ``sell electricity and natural gas to 
consumers as a competitive alternative to the local utility'' and 
``often purchase wholesale physical natural gas and electricity on a 
spot (delivery) month (day) basis and also purchase swaps to lock in 
prices for any consumers who want a long-term fixed price 
contract.''
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    NGX stated that its clearing model generally does not require daily 
variation margin payments and collections, and that settlement on its 
energy contracts \171\ occurs only on a monthly basis, after clearing 
participant obligations have been netted, consistent with practices in 
the cash market and with the end-user nature of the vast majority of 
NGX clearing participants. NGX noted that, therefore, the type of daily 
settlement risk that proposed Sec.  39.14 addresses is not present in 
the NGX model and the degree of risk in the monthly settlement process 
is reduced.
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    \171\ NGX stated that it ``operates a trading and clearing 
system for energy products that provides electronic trading, central 
counterparty clearing and data services to the North American 
natural gas, electricity and oil markets.''
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    Although NOCC supported adoption of proposed Sec.  39.14(b) for 
traditional futures and cleared swaps, it indicated that it intends to 
develop a clearinghouse that will seek registration as a DCO to clear 
energy products, including commercial forward contracts that it 
believes will be outside the scope of regulation as futures contracts 
or as swaps under the CEA, as well as financial forwards that it 
believes will fall within the definition of swaps under the CEA. NOCC 
stated that while gains and losses on the commercial forward contracts 
and financial forwards that it intends to clear are calculated daily, 
they are accrued throughout the delivery period and following the 
delivery period, and are not cash settled until final payment occurs 
approximately three weeks after the month in which the commodity is 
delivered. NOCC proposed that the Commission adopt a rule that would 
permit exemptions for alternative risk management frameworks, which 
would provide NOCC with the ability to demonstrate to the Commission 
that daily accrual settlement of variation margin is a sound practice 
appropriately tailored to the unique characteristics of the cash energy 
markets and market participants for which NOCC is seeking to provide 
the benefits of clearing.
    The Commission has not proposed and is not adopting a rule 
permitting exemptions for alternative risk management frameworks. 
However, a particular DCO may petition the Commission for an exemption 
if it believes that it can demonstrate that the daily accrual of gains 
and losses provides the same protection to the DCO as would daily 
variation margin payments and collections. Therefore, the Commission is 
adding a clause to Sec.  39.14(b) that states ``[e]xcept as otherwise 
provided by Commission order'' prior to the requirement that a DCO 
``shall effect a settlement with each clearing member at least once 
each business day.''

[[Page 69387]]

3. Settlement Banks--Sec.  39.14(c)
    The introductory paragraph of proposed Sec.  39.14(c) would require 
a DCO to 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.
    OCC commented that it would not be possible for a DCO to 
``eliminate'' all exposure to settlement bank risks and that the 
Commission had not provided any guidance as to what it means to 
``strictly limit'' such exposure. The Commission notes that the 
language in the introductory paragraph of proposed Sec.  39.14(c), 
which would require a DCO to ``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 * * *,'' is virtually identical to the 
statutory language in Core Principle E.\172\ The Commission is adopting 
the introductory paragraph of Sec.  39.14(c) with two modifications. 
First, in response to OCC's comment, the Commission is adding the words 
``as follows:'' at the end of the sentence, in order to clarify that a 
DCO that complies with Sec.  39.14(c)(1), (2), and (3), discussed 
below, will be deemed to have ``employ[ed] settlement arrangements that 
eliminate or strictly limit its exposure to settlement bank risks'' 
within the meaning of Sec.  39.14(c). The Commission is also inserting 
parentheses around the letter ``s'' in the word ``banks'' in order to 
clarify that the Commission is not intending to require that a DCO must 
have more than one settlement bank in all circumstances. However, a DCO 
will need to have more than one settlement bank to the extent that it 
is reasonably necessary in order to eliminate or strictly limit the 
DCO's exposures to settlement bank risks, pursuant to Sec.  
39.14(c)(3), as further discussed below.
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    \172\ See Section 5b(c)(2)(E)(ii) of the CEA, 7 U.S.C. 7a-
1(c)(2)(E)(ii).
---------------------------------------------------------------------------

4. Criteria for Acceptable Settlement Banks--Sec. Sec.  39.14(c)(1) and 
(c)(2)
    Proposed Sec.  39.14(c)(1) would require a DCO to have documented 
criteria with respect to those banks that are acceptable settlement 
banks for the DCO and its clearing members, including criteria 
addressing the capitalization, creditworthiness, access to liquidity, 
operational reliability, and regulation or supervision of such banks. 
Proposed Sec.  39.14(c)(2) would require a DCO to monitor each approved 
settlement bank on an ongoing basis to ensure that such bank continues 
to meet the criteria established pursuant to Sec.  39.14(c)(1). 
Proposed Sec. Sec.  39.14(c)(1) and (c)(2) are consistent with 
international recommendations.\173\
---------------------------------------------------------------------------

    \173\ See CPSS-IOSCO Consultative Report, Principle 9: Money 
Settlements, Key Consideration 3, at 54.
---------------------------------------------------------------------------

    NYPC agreed with the proposed requirement that DCOs must articulate 
the standards that they apply to the selection of settlement banks.
    OCC indicated that a DCO may have to deviate from its written 
policies on the selection of clearing banks during a major market 
disruption, as those settlement banks that are the best options 
available at the time may not meet the technical criteria set forth in 
a DCO's written policies. The Commission agrees with OCC that a DCO may 
have to deviate from its written policies during a major market 
disruption. However, whether the Commission would permit a DCO to do so 
would need to be addressed in the context of the particular major 
market disruption, e.g., based on an analysis of whether all available 
settlement banks no longer meet such written criteria.
    MGEX commented that the Federal Reserve and other banking 
authorities are in the best position to review a bank's financial 
condition. NYPC recommended that the Commission modify the proposed 
rule to reflect the fact that the only criteria that are likely to be 
susceptible to observation by a DCO are a bank's operational 
reliability, regulatory capital, and the rating of its parent bank 
holding company. The Commission agrees that the Federal Reserve and 
other banking authorities may be in the best position to review a 
bank's financial condition and that there is certain information about 
settlement banks to which a DCO will not have regular access. 
Nonetheless, a DCO has a responsibility to undertake reasonable efforts 
to ensure that its settlement bank(s) continue to meet the criteria 
established by the DCO. A DCO may be able to obtain pertinent 
information from public sources, and it should be able to request and 
obtain information from an approved settlement bank, which demonstrates 
whether the bank continues to meet the criteria established by the DCO.
    The Commission is adopting Sec.  39.14(c)(1) with a modification 
that replaces the language that states: ``with respect to those banks 
that are acceptable settlement banks for the derivatives clearing 
organization and its clearing members'' with ``that must be met by any 
settlement bank used by the derivatives clearing organization or its 
clearing members.'' In addition, the Commission is inserting 
parentheses around the letter ``s'' in the word ``banks.'' Consistent 
with the modification to the introductory paragraph of Sec.  39.14(c) 
described above, these modifications also clarify that there may be 
circumstances in which it may be appropriate for a DCO to use a single 
settlement bank. The Commission is adopting Sec.  39.14(c)(2) as 
proposed.
5. Monitoring and Addressing Exposure to Settlement Banks--Sec.  
39.14(c)(3)
    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 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.\174\ 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 if any such 
actions are reasonably necessary in order to eliminate or strictly 
limit such exposures.
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    \174\ Some DCOs have their own settlement accounts at each 
settlement bank used by their clearing members, in which case a 
clearing member's settlement bank is also the DCO's settlement bank, 
and transfers between a clearing member's settlement account and a 
DCO's settlement account are made internally. Other DCOs permit 
their clearing members to use settlement banks at which such DCOs do 
not have their own settlement accounts, and settlement transfers are 
made between a clearing member's settlement bank and the DCO's 
settlement bank. In either event, the settlement bank with the 
largest share of settlement activity will always be a bank at which 
the DCO maintains a settlement account, as all settlement activity 
will involve the DCO.
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    OCC commented that the requirement that a DCO monitor its clearing 
members' exposure to the settlement banks used by such clearing members 
could result in a massive duplication of effort and would be very 
burdensome for the DCO. Therefore, OCC suggested that clearing members 
or their primary regulators should be responsible for monitoring 
clearing members' exposure to their settlement banks.
    The Commission does not agree with OCC that proposed Sec.  
39.14(c)(3) could result in a massive duplication of effort. The focus 
of the monitoring required by Sec.  39.14(c)(3) is on a DCO's exposures 
and its clearing members' potential losses insofar as they may create 
exposures for the DCO. Therefore, each

[[Page 69388]]

DCO must conduct the required monitoring as each DCO's exposures are 
unique to that DCO. In addition, this provision of Sec.  39.14(c)(3) is 
consistent with proposed international standards.\175\
---------------------------------------------------------------------------

    \175\ See CPSS-IOSCO Consultative Report, Principle 9: Money 
Settlements, Explanatory Note, 3.9.5, at 56.
---------------------------------------------------------------------------

    NYPC commented that since initial and variation margin requirements 
fluctuate daily, proposed Sec.  39.14(c)(3) would require DCOs to 
monitor their exposures to all settlement banks and not merely the 
largest. The Commission agrees with NYPC. 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,'' 
which means that a DCO must conduct such monitoring with respect to all 
such settlement banks. The reference to ``the settlement bank with the 
largest share of settlement activity'' was made in the context of 
requiring a DCO to assess the potential impact of the failure of such 
bank.
    CME and OCC requested that the Commission clarify that a DCO would 
only be required to take any of the actions specified in proposed Sec.  
39.14(c)(3)(i)-(iv), if the specific action were reasonably necessary 
in order to eliminate or strictly limit exposures to settlement banks, 
and that a DCO would not be required to take all of the specified 
actions in all cases. CME supported this interpretation and OCC stated 
its belief that these requirements would be reasonable if the final 
rule were expressly limited in this manner. The Commission is modifying 
Sec.  39.14(c)(3)(i)-(iv) to clarify the Commission's intent to 
obligate a DCO to employ any one or more of the actions specified in 
(i) through (iv), only if any one or more of such actions is reasonably 
necessary in order to eliminate or strictly limit such exposures.
    CME, ICE, MGEX, and KCC variously commented that prescribing 
concentration limits and requiring that a DCO and its clearing members 
maintain multiple settlement banks would impose significant expenses on 
the DCO, its clearing members, and their customers. CME, MGEX, and NYPC 
stated their belief that it would be difficult to comply with this 
regulation given the limited number of banks that are qualified and 
willing to serve as settlement banks.\176\ CME also commented that the 
meaning of ``concentration limits'' is unclear, and stated its belief 
that it would be unwise to impose artificial limits on the number of 
clearing members or the size of clearing member accounts at a 
particular settlement bank.
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    \176\ CME also expressed concern that, as drafted, the proposed 
regulation appears to require a DCO to approve at least two more 
settlement banks, because of the reference to ``settlement banks'' 
in the plural.
---------------------------------------------------------------------------

    ICE took the position that hard concentration limits could increase 
systemic risk because a DCO would need to distribute funds across 
multiple banks. ICE indicated that as settlement funds increased, 
highly rated banks would eventually be consumed by the concentration 
limits and DCOs may have to open accounts with lower rated banks. ICE 
further commented that concentration limits could act as a constraint 
on customer choice, in that if one bank had a large number of 
settlement customers, there would be natural concentration of 
settlement flows, and the DCO could have to direct customers not to use 
their chosen bank.
    NYPC also questioned whether current settlement banks would be 
willing to continue to act in that role if the Commission required a 
DCO and some of its clearing members to transfer their business to 
other banks. NYPC stated that this would leave the existing settlement 
banks with an expensive infrastructure supported by fewer client 
accounts.
    MGEX stated its belief that requiring a DCO to oversee clearing 
members' banks and establishing credit or concentration limits would be 
intrusive and suggested that the final rule should provide DCOs with 
flexibility.
    The Commission notes that proposed Sec.  39.14(c)(3)(iii) would 
require a DCO to impose concentration limits with respect to its own or 
its clearing members' settlement banks if such action were reasonably 
necessary in order to eliminate or strictly limit its exposures to such 
settlement banks. Section 39.14(c)(3) would provide a DCO with other 
possible options for addressing such exposures. For example, a DCO 
could open an account at an additional settlement bank pursuant to 
Sec.  39.14(c)(3)(i), or approve an additional settlement bank for use 
by its clearing members pursuant to Sec.  39.14(c)(3)(ii), without 
imposing concentration limits, if doing so would mean that such limits 
would not be reasonably necessary. In addition, proposed Sec.  
39.14(c)(3)(iv) would allow a DCO to take other appropriate actions, 
which could obviate the potential need for concentration limits.
    KCC commented that identifying multiple settlement banks for use by 
clearing members could increase a DCO's operational risk by fragmenting 
the DCO's margin pool. KCC suggested that there is no need for multiple 
settlement banks because there would be little effect on the operations 
of a DCO if a non-systemically significant settlement bank failed. KCC 
noted that the Federal Deposit Insurance Corporation generally 
facilitates the transfer of the accounts and operations of a failed 
bank to a successor institution or a bridge bank with little or no 
disruption to depositors at the failed bank. KCC further stated that a 
DCO's settlement account is essentially a pass-through account and DCOs 
generally do not maintain large, long-term balances in the account. 
According to KCC, even if a DCO held significant guaranty funds or 
security deposits at a settlement bank, such assets would likely be 
held in a trust or custody account, which would be unavailable to 
creditors of the failed institution and would generally be available to 
the DCO within a short period of time following the insolvency of the 
settlement bank. KCC also noted that a requirement that DCOs identify 
additional settlement banks for use by clearing members would cause a 
significant rise in bank service fees for DCOs and clearing members.
    NGX noted that proposed Sec.  39.14(c) generally refers to 
settlement banks, in the plural, assuming that all DCOs will maintain 
accounts with at least two settlement banks. NGX questioned the benefit 
of requiring all DCOs, regardless of size, to use multiple settlement 
banks. According to NGX, settlement risk varies across DCOs, and the 
type of daily settlement risk the proposed rule addresses is not 
present at a DCO like NGX, which does not engage in daily variation 
margin payments and collections from its clearing participants. NGX 
stated that the rule should take account of the level of settlement 
activity because requiring a DCO with a relatively small need for 
settlement services to divide the flow of funds may cause the DCO to be 
less attractive, bear higher costs, and be less competitive with larger 
DCOs, while having a negligible impact on systemic risk.\177\ NGX also 
commented that the rule could result in increased operational risk at a 
DCO like NGX with complex contract settlement and delivery that 
requires a settlement bank to have specialized expertise and to 
maintain specialized processes and operational capabilities. NGX 
requested that the Commission provide the flexibility to permit a DCO 
to

[[Page 69389]]

demonstrate that the use of a single settlement bank is appropriate 
from both a policy and a financial perspective.
---------------------------------------------------------------------------

    \177\ However, NGX stated that where a DCO has daily settlements 
or monthly settlements in a greater amount, requiring more than one 
settlement bank may materially reduce systemic risk without adverse 
effects.
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    As noted above, the Commission does not intend to require a DCO to 
use more than one settlement bank if the particular DCO otherwise 
employs settlement arrangements that eliminate or strictly limit its 
exposure to settlement bank risks. The Commission understands that the 
number of banks that are willing to serve settlement functions might be 
limited, particularly for smaller DCOs. The Commission further 
understands that it might be costly for some DCOs that currently only 
have one settlement bank to use an additional settlement bank. However, 
pursuant to Sec.  39.14(c)(3), a DCO would be required to have a second 
settlement bank, if it were reasonably necessary in order to eliminate 
or strictly limit the DCO's exposures to settlement bank risks.
    The Commission is modifying Sec. Sec.  39.14(c)(3)(i) and (ii) to 
refer to ``one or more'' additional settlement banks, so that it will 
be clear that a DCO would not necessarily be required to maintain 
settlement accounts with more than one additional settlement bank or to 
approve more than one additional settlement bank that its clearing 
members could choose to use, under the specified circumstances. In 
addition, the Commission is modifying Sec.  39.14(c)(3)(iii) to 
similarly clarify that a DCO may only be required to impose 
concentration limits with respect to ``one or more'' of its own or its 
clearing members' settlement banks, under the specified circumstances. 
The Commission is also modifying Sec.  39.14(c)(3)(ii) by replacing 
``for use by its clearing members'' with ``that its clearing members 
could choose to use'' to make it clear that the Commission is not 
suggesting that a single clearing member might be required to use more 
than one settlement bank.\178\
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    \178\ For example, it appears that CME may have interpreted 
proposed Sec.  39.14(c)(3)(ii) in this unintended manner, since it 
stated that ``we do not believe the CFTC should require clearing 
members to have accounts at multiple settlement banks, which may 
prove to be an impossible (and/or extremely costly) requirement to 
satisfy.'' It appears that KCC may also have interpreted proposed 
Sec.  39.14(c)(3)(ii) in this manner, in light of its comment that a 
requirement that DCOs identify additional settlement banks for use 
by clearing members would cause a significant rise in bank service 
fees for DCOs and clearing members. There is no reason that 
providing greater choice to clearing members regarding which single 
settlement bank they could elect to use would cause a rise in bank 
service fees for clearing members.
---------------------------------------------------------------------------

    The Commission is adopting Sec.  39.14(c)(3) with the modifications 
described above.
6. Settlement Finality--Sec.  39.14(d)
    Proposed Sec.  39.14(d) would require a DCO to 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 must state clearly when settlement fund transfers 
would occur and a DCO was required to routinely confirm that its 
settlement banks were effecting fund transfers as and when required by 
those legal agreements.
    ISDA and FIA requested that the rule allow for the correction of 
errors.\179\ The Commission agrees with ISDA and FIA that settlement 
finality should not preclude the correction of errors, and is adding a 
clause to Sec.  39.14(d) that explicitly provides that a DCO's legal 
agreements with its settlement banks may provide for the correction of 
errors.
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    \179\ ISDA also requested that the Commission clarify how the 
proposed requirement would be compatible with the fact that title 
transfer of initial margin may not occur when it is posted to a DCO. 
Title transfer is not a necessary element of settlement finality. 
Although in some jurisdictions a clearing member may need to 
transfer title to margin collateral to a DCO in order for the DCO to 
effectively exert control over such collateral, in other 
jurisdictions a clearing member may transfer margin collateral to a 
DCO and grant a security interest to the DCO without transfer of 
title.
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    In addition, the Commission is adding the modifier ``no later 
than'' before ``when the derivatives clearing organization's accounts 
are debited or credited'' in recognition of the fact that a DCO's legal 
agreements with its settlement banks may provide for settlement 
finality prior to the time when the DCO's accounts are debited or 
credited, e.g., upon the bank's acceptance of a settlement instruction.
    KCC commented that a DCO can never effectively ensure that 
settlement payments are irrevocable, given the existence of a legal 
risk that a settlement payment may be deemed to be an inappropriate 
transfer pursuant to applicable bankruptcy law. Therefore, KCC urged 
the Commission to eliminate the requirement or to restate the rule as a 
requirement to monitor operational risks related to settlement 
finality. The Commission does not believe that it is appropriate to do 
so. Core Principle E requires a DCO to ``ensure that money settlements 
are final when effected.'' \180\ In addition, Section 546(e) of the 
U.S. Bankruptcy Code \181\ provides that a bankruptcy trustee may not 
avoid a transfer that is a margin payment or a settlement payment made 
to a DCO by a clearing member, or made to a clearing member by a DCO 
(with the exception of fraudulent transfers). However, the Commission 
is modifying Sec.  39.14(d) to state that ``[a DCO] shall ensure that 
settlements are final when effected by ensuring that it has entered 
into legal agreements that state that settlement fund transfers are 
irrevocable and unconditional * * *'' (added text in italics).
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    \180\ See Section 5b(c)(2)(E)(iii) of the CEA, 7 U.S.C. 7a-
1(c)(2)(E)(iii).
    \181\ 11 U.S.C. 546(e).
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    The Commission is adopting Sec.  39.14(d) with the modifications 
described above.
7. Recordkeeping--Sec.  39.14(e)
    Proposed Sec.  39.14(e) would require a DCO to maintain an accurate 
record of the flow of funds associated with each settlement.
    KCC expressed its general support of the concept of maintaining 
accurate records of settlement fund flows, but stated that it may be 
prudent for the Commission to further clarify the extent to which the 
additional recordkeeping applies to cross-margining and netting 
arrangements that a DCO may have in place with certain clearing members 
and their customers. The language in Sec.  39.14(e) is virtually 
identical to the Core Principle E language, which the Dodd-Frank Act 
added to the CEA.\182\ Moreover, this language is similar to the 
language that had been contained in Core Principle E prior to its 
amendment by the Dodd-Frank Act.\183\
    Therefore, proposed Sec.  39.14(e) would not impose any additional 
recordkeeping requirements. The Commission believes that the 
requirement that a DCO must maintain an accurate record of the flow of 
funds associated with each settlement would necessarily require the 
maintenance of an accurate record with respect to any cross-margining 
or netting arrangements, without the need to separately address such 
arrangements. The Commission is adopting Sec.  39.14(e) as proposed.
---------------------------------------------------------------------------

    \182\ See Section 5b(c)(2)(E)(iv) of the CEA, 7 U.S.C. 7a-
1(c)(2)(E)(iv).
    \183\ Prior to amendment by the Dodd Frank Act, Core Principle E 
provided, in part, that a [DCO] applicant shall have the ability to 
``* * * [m]aintain an adequate record of the flow of funds 
associated with each transaction that the applicant clears. * * *''
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8. Netting Arrangements--Sec.  39.14(f)
    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.\184\

[[Page 69390]]

The Commission did not receive any comment letters discussing Sec.  
39.14(f) and is adopting Sec.  39.14(f) as proposed.
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    \184\ See Section 5b(c)(2)(E)(v) of the CEA, 7 U.S.C. 7a-
1(c)(2)(E)(v).
---------------------------------------------------------------------------

9. Physical Delivery--Sec.  39.14(g)
    Proposed Sec.  39.14(g) 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.
    KCC commented that it generally supports the concept of proposed 
Sec.  39.14(g), but requested that the Commission clarify that a DCO 
may be deemed to have satisfied its obligation to establish rules 
relating to physical deliveries if the rules of the exchange that lists 
the cleared contracts clearly delineates such physical delivery 
obligations. The Commission notes that the rules referenced in Sec.  
39.14(g) must be enforceable by and against the DCO. If a DCO were 
integrated with a DCM and the DCM's rules were enforceable by and 
against the DCO, then it may be that the DCM's rules would satisfy the 
requirements of Sec.  39.14(g). However, such compliance would need to 
be determined on a case-by-case basis. The Commission is adopting Sec.  
39.14(g) as proposed, except for a technical revision that replaces 
``contracts, agreements and transactions'' with ``products'' to ensure 
consistency with other provisions in part 39.

F. Core Principle F--Treatment of Funds--Sec.  39.15

    Core Principle F, \185\ as amended by the Dodd-Frank Act, requires 
a DCO to: (i) Establish standards and procedures that are designed to 
protect and ensure the safety of its clearing members' funds and 
assets; (ii) 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 (iii) only invest such funds and assets in instruments 
with minimal credit, market, and liquidity risks. The Commission 
proposed Sec.  39.15 to establish requirements that a DCO would have to 
meet in order to comply with Core Principle F.
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    \185\ Section 5b(c)(2)(F) of the CEA, 7 U.S.C. 7a-1(c)(2)(F) 
(Core Principle F).
---------------------------------------------------------------------------

1. Required Standards and Procedures--Sec.  39.15(a)
    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.\186\ The Commission did not receive any comments on proposed 
Sec.  39.15(a) and is adopting the provision as proposed.
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    \186\ 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.
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2. Segregation--Sec.  39.15(b)(1)
    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.
    LCH suggested that the Commission clarify the meaning of 
``segregated'' and limit the segregation requirement to the funds of 
clearing members' clients. LCH also urged the Commission to limit these 
requirements to client business cleared by the DCO under the FCM 
clearing structure, noting that a DCO based outside the United States 
may offer client clearing services through alternative structures and 
that it did not believe it would be appropriate for clients clearing 
under these non-U.S. structures to be subject to the segregation 
requirements of Section 4d of the CEA, but rather to the requirements 
set out by the DCO's home or other regulators.
    FIA recommended that the proposed rule be revised to make clear 
that a DCO should keep margin posted by clearing members to support 
proprietary positions separate from the DCO's own assets, noting that 
although proprietary funds held at a DCO are not subject to the 
segregation provisions of the CEA, it is essential that these funds are 
protected in the event of the default of the DCO. The Commission has 
not proposed and is not adopting FIA's suggestion that the Commission 
expand the applicability of Sec.  39.15(b)(1) in this manner.
    BlackRock and FHLBanks expressed their views on specific 
segregation models. The Commission has proposed rules in a separate 
rulemaking regarding the segregation of cleared swaps customer 
contracts and collateral, and the Commission will address BlackRock's 
and FHLBanks' comments in connection with the final rulemaking for that 
proposal.\187\
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    \187\ See 76 FR 33818 (June 9, 2011) (Protection of Cleared 
Swaps Customer Contracts and Collateral; Conforming Amendments to 
the Commodity Broker Bankruptcy Provisions).
---------------------------------------------------------------------------

    The comments submitted by LCH, FIA, BlackRock, and FHLBanks all 
address the substance or applicability of segregation requirements. 
Proposed Sec.  39.15(b)(1) would not have imposed any additional 
substantive segregation requirements upon a DCO. It would simply 
require a DCO to comply with the substantive segregation requirements 
of the CEA and other Commission regulations or orders, which are 
currently applicable or which may become applicable in the future. In 
particular, Sec.  39.15(b)(1) is not intended to extend the 
extraterritorial reach of existing segregation requirements beyond that 
which may already exist in such requirements. However, in order to 
clarify the Commission's intent in this regard, the Commission has 
added ``applicable'' before ``segregation requirements'' in Sec.  
39.15(b)(1). In addition, the Commission wishes to clarify that its 
current segregation requirements apply to a non-U.S. based DCO with 
respect to clearing members that are registered as FCMs, whether they 
are clearing business for U.S. based customers or non-U.S. based 
customers. Such requirements do not apply with respect to clearing 
members that are non-U.S. based and that are not registered as FCMs, 
nor required to be registered as FCMs.
    The Commission is adopting Sec.  39.15(b)(1) with the modification 
described above.
3. Commingling of Futures, Options on Futures, and Swap Positions--
Sec.  39.15(b)(2)
    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 swaps account), pursuant to DCO rules that have been approved 
by the Commission under Sec.  40.5 of the Commission's regulations. The 
DCO's rule filing \188\ 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

[[Page 69391]]

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 
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; (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.\189\
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    \188\ The DCO's rule filing would also need to comply with the 
procedural requirements of Sec.  40.5(a).
    \189\ As noted in the Commission's notice of proposed rulemaking 
regarding the protection of cleared swaps customer contracts and 
collateral, 76 FR at 33818 (June 9, 2011) (Protection of Cleared 
Swaps Customer Contracts and Collateral; Conforming Amendments to 
the Commodity Broker Bankruptcy Provisions), if the complete legal 
segregation model is adopted for cleared swaps, a DCO could more 
easily justify the approval of rules or the issuance of a 4d order 
allowing the commingling of futures, options, and swaps, since the 
impact of any different risk from the product being brought into the 
portfolio would be limited to the customer who chooses to trade that 
product. In such case, the Commission may still wish to obtain and 
review all of the information specified in proposed Sec.  
39.15(b)(2)(i), although its specific concerns may be minimized. 
However, if the complete legal segregation model is adopted for 
cleared swaps, and after the Commission obtains experience with 
respect to considering requests to commingle futures, options, and 
swaps under Sec.  39.15(b)(2) in an environment where that margin 
model applies, the Commission may revisit its ongoing need for all 
of the information listed in Sec.  39.15(b)(2)(i).
---------------------------------------------------------------------------

    Proposed Sec.  39.15(b)(2)(ii) would address 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. Proposed Sec.  39.15(b)(2)(ii) would incorporate the informational 
requirements of proposed Sec.  39.15(b)(2)(i), but would require a DCO 
to file a petition with the Commission for an order pursuant to Section 
4d(a) of the CEA, permitting the DCO and its clearing members to 
commingle customer positions in futures, options on futures, and swaps 
in a futures account (4d order).
    Proposed Sec.  39.15(b)(2)(iii)(A) would provide that the 
Commission may request additional information in support of a rule 
submission and that it may approve the rules in accordance with Sec.  
40.5.\190\ Proposed Sec.  39.15(b)(2)(iii)(B) would provide that the 
Commission could request additional information in support of a 
petition and that it could issue a 4d order in its discretion.
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    \190\ A rule 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 44793-44794 (Provisions Common to Registered Entities; 
final rule).
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    As noted in the notice of proposed rulemaking, 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 4d(a) or 4d(f) account, as 
applicable).
    The Commission requested 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 requested 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 requested 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.
    In some instances, commenters addressed topics that are more 
properly considered by the Commission in connection with a separate 
rulemaking,\191\ that relate to substantive requirements that the 
Commission might impose as a condition of approving a rule or granting 
an order under Sec.  39.15(b)(2),\192\ or that relate to other 
provisions adopted herein.\193\ The Commission is not addressing those 
comments in its discussion of Sec.  39.15(b)(2) because they are not 
within the scope of the proposal.
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    \191\ E.g., CME and FIA raised operational concerns in the event 
the Commission adopts a different segregation regime for each type 
of customer account. Those comments will be considered in connection 
with the Commission's proposal regarding the appropriate segregation 
regime for cleared swaps accounts. See 76 FR 33818 (June 9, 2011) 
(Protection of Cleared Swaps Customer Contracts and Collateral; 
Conforming Amendments to the Commodity Broker Bankruptcy 
Provisions).
    \192\ E.g., LCH suggested additional factors that the Commission 
should consider before a DCO or its clearing members should be able 
to commingle, and offer offsets between, futures, options on 
futures, and swaps, including: (a) clients must hold their futures, 
options, and swaps under the same account structure and within the 
same legal entity, and (b) the DCO must margin the futures, options, 
and swaps using the same margin model; and ELX expressed the view 
that in order for a customer to gain the portfolio margining 
benefits of commingling futures, options, and swaps executed on a 
SEF, it would be necessary for a customer to clear its futures, 
options, and swaps through the same DCO.
    \193\ LCH stated that all offset assumptions in the DCO's margin 
calculations must, at a minimum, be replicated in the DCO's stress 
testing and must be recalibrated frequently. The Commission notes 
that permitted spread and portfolio margins are addressed in Sec.  
39.13(g)(4), discussed in section IV.D.6.e, above, and back testing 
of such spread and portfolio margins is addressed in Sec.  
39.13(g)(7), discussed in section IV.D.6.g, above.
---------------------------------------------------------------------------

    CME, FIA, and MFA expressed their general support for the adoption 
of rules that would allow commingling of customer positions in futures, 
options on futures, and cleared swaps. In particular, CME indicated 
that such commingling could achieve important benefits with respect to 
greater capital efficiency which would result from margin reductions 
for correlated positions, and that adoption of a regulation permitting 
such commingling would be consistent with the public interest, in 
accordance with Section 4(c) of the CEA. CME further stated that 
``[h]aving positions in a single account can also enhance risk 
management practices and systemic risk containment by allowing the 
customer's portfolio to

[[Page 69392]]

be handled in a coordinated fashion in a transfer or liquidation 
scenario.''
    CME stated its belief that it would be logical to apply the same 
methodology (rule submission or petition for an order) with respect to 
the futures account and the cleared swaps account, and that a rule 
submission would be the most efficient and optimal approach. The 
Commission is retaining the proposed distinction whereby the Commission 
may permit futures to be commingled in a Section 4d(f) cleared swaps 
account subject to a rule approval process, and may permit cleared 
swaps to be commingled in a Section 4d(a) futures account subject to a 
4d order. In the latter instance, the 4d petition process would provide 
additional procedural protections in that: (1) Review of a 4d petition 
by the Commission is not subject to the time limits that apply to a 
request for rule approval under Sec.  40.5; and (2) the Commission may 
impose conditions in a 4d order, as appropriate. The Commission has 
determined that, at this time, it is appropriate to provide these 
additional procedural protections before exposing futures customers to 
the risks of swaps that may be commingled in a futures account. As also 
noted in other contexts in this notice of final rulemaking, DCOs have 
greater experience in clearing futures. Swaps will expose DCOs to risks 
that can differ in their nature and magnitude. However, as the 
Commission and the industry gain more experience with cleared swaps, 
the Commission may revisit this issue in the future.
    The Commission is adopting CME's suggestion that it revise Sec.  
39.15(b)(2)(i)(L) to remove the reference to obtaining daily position 
data ``from each beneficial owner.'' Therefore, Sec.  
39.15(b)(2)(i)(L), as modified, requires a DCO to submit ``[a] 
description of the arrangements for obtaining daily position data with 
respect to futures, options on futures, and swaps in the account,'' 
without specifying the level of detail or the source of the daily 
position data that the DCO must obtain. As noted by CME, the Commission 
could request additional information from the DCO, in support of its 
request for rule approval or petition for a 4d order, pursuant to Sec.  
39.15(b)(2)(iii).
    The Commission is also making conforming changes to Sec.  
39.15(b)(2), to replace a reference to ``cleared swap account'' with 
``cleared swaps account'' to achieve consistency with the terminology 
in another Commission rulemaking; \194\ is revising the references to 
``futures, options on futures, and swap positions'' and ``futures, 
options on futures, and swaps'' to read ``futures, options, and 
swaps;'' \195\ is replacing a reference to ``contract'' with 
``product;'' and is correcting the references to Sec.  39.15(b)(2)(i) 
and (ii) in Sec.  39.15(b)(iii)(A) and (B), respectively.
---------------------------------------------------------------------------

    \194\ See 76 FR 33818 (June 9, 2011) (Protection of Cleared 
Swaps Customer Contracts and Collateral; Conforming Amendments to 
the Commodity Broker Bankruptcy Provisions).
    \195\ This conforming terminology, which appears elsewhere in 
part 39, streamlines the rule text without changing the meaning of 
the provision. The scope of part 39 covers only those products 
subject to the Commission's oversight and would not include, for 
example, options on securities. Refinements in the definitions of 
products subject to Commission oversight will be addressed in the 
future.
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    The Commission is adopting Sec.  39.15(b)(2) with the modifications 
described above.
4. Holding of Funds and Assets--Sec.  39.15(c)
    The introductory paragraph of proposed Sec.  39.15(c) would require 
that a DCO 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. The Commission did not 
receive any comment letters discussing the introductory paragraph of 
proposed Sec.  39.15(c) and is adopting the provision as proposed.
5. Types of Assets--Sec.  39.15(c)(1)
    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, and prohibit a DCO from accepting letters of 
credit as initial margin.
    LCH agreed with the provisions of proposed Sec.  39.15(c), but 
added that the rules might more properly require that a DCO must be 
able to convert any funds and assets held promptly into cash, and 
should prove that it is able to do so on an ongoing basis. J.P. Morgan 
stated that it is necessary for DCOs to maintain sufficient liquidity, 
and that this could be achieved by requiring that clearing members post 
a minimum amount of liquid (cash and qualifying government securities) 
margin, among other things.\196\
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    \196\ J.P. Morgan also suggested that DCOs could maintain 
liquidity by requiring clearing members to make guarantee fund 
contributions or by requiring clearing members to participate in a 
liquidity facility. The Commission has not proposed and is not 
adopting such requirements.
---------------------------------------------------------------------------

    The Commission believes that the standard of ``minimal credit, 
market, and liquidity risks'' is sufficient and that it is not 
necessary to modify the language of the regulation to include an 
explicit requirement that a DCO must be able to convert funds and 
assets promptly into cash or to require that clearing members must post 
a minimum amount of cash and qualifying government securities. 
Moreover, the requirement that a DCO shall limit the assets that it 
accepts as initial margin to those that have ``minimal credit, market, 
and liquidity risks'' is consistent with international 
recommendations.\197\
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    \197\ See CPSS-IOSCO Consultative Report, Principle 5: 
Collateral, at 37.
---------------------------------------------------------------------------

    OCC expressed its belief that the proposal places an excessive 
focus on the types of assets that may be used as margin and that the 
Commission's central focus should be on whether a DCO's procedures and 
risk management systems are sufficient to provide a high degree of 
assurance that a portfolio, including margin assets, can be liquidated 
with a positive liquidation value. OCC further noted its concern that 
some of the collateral that it currently accepts as initial margin, 
including less-liquid stocks and long-dated Treasury securities, would 
no longer be permitted under the proposed rule. OCC explained that its 
``collateral in margins'' or ``CIM'' program looks at each type of 
collateral as an asset with specific risk characteristics rather than 
as a fixed value, and it recognizes both positive and negative 
correlations with other assets and liabilities in a particular account.
    As an example, OCC stated that even though XYZ stock may be less 
liquid than other stocks, it may have a greater value than a more 
liquid stock when it is used as margin for a short position in XYZ call 
options. Therefore, OCC urged the Commission not to impose a standard 
of ``minimal credit, market, and liquidity risk,'' or not to adopt an 
interpretation of such a standard in a manner that would reduce the 
opportunities for diversification of collateral and use of assets that 
may have specific risk-reducing properties in a particular portfolio. 
In particular, OCC stated that ``[w]here a DCO is capable of reflecting 
the risk of certain assets in its margin model, we see no reason why 
less liquid instruments or instruments with higher than average credit 
or market risks should not be acceptable for initial margin.''
    The Commission agrees that a DCO should be permitted to accept 
assets as initial margin if such assets have specific risk-reducing 
properties in a particular portfolio and the DCO's margin model is 
capable of appropriately reflecting the risk of those

[[Page 69393]]

assets. Accordingly, although the Commission is retaining the standard 
of minimal credit, market, and liquidity risk, it is revising the 
provision to add the following: ``A [DCO] may take into account the 
specific risk-reducing properties that particular assets have in a 
particular portfolio.'' As illustrated by OCC, an asset that would not 
generally be acceptable could be acceptable for use in connection with 
a particular portfolio.
    Freddie Mac requested that the Commission clarify that DCOs may 
accept collateral types beyond those specified as permitted investments 
under Sec.  1.25. Section 39.15(c) does not prohibit a DCO from 
accepting collateral types that are not specified as permitted 
investments under Sec.  1.25. The Commission believes that it is 
appropriate to permit DCOs to retain the flexibility to accept a 
broader range of assets that meet the general requirement of ``minimal 
credit, market, and liquidity risks'' than those which are appropriate 
investments for funds received from clearing members.
    Several comment letters specifically discussed the proposal to 
prohibit the use of letters of credit as initial margin. The commenters 
disagreed with the Commission's proposed requirement that a DCO may not 
accept letters of credit for this purpose. CME stated that letters of 
credit provide an absolute assurance of payment and, therefore, the 
issuing bank must honor the demand even in circumstances where the DCO 
(the beneficiary) breached its duty to the clearing member and even if 
the clearing member is unable to reimburse the bank for its payment. 
CME also stated that it was not aware of any instances in the cleared 
derivatives industry in which a beneficiary of a letter of credit 
posted as collateral had sought to draw upon the letter of credit and 
had not been promptly paid by the issuer. CME noted that letters of 
credit have been especially useful for clearing members to post as 
collateral for late-day margin calls. ICE and NOCC similarly commented 
that letters of credit should be permitted to serve as non-cash 
collateral. NGX indicated that letters of credit are consistent with 
Section 4s(e)(3)(D) of the CEA, which provides that the financial 
regulators shall establish comparable capital requirements and minimum 
initial and variation margin requirements, including the use of non-
cash collateral, for swap dealers.\198\
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    \198\ The Commission notes that the minimum initial and 
variation margin requirements referenced in Section 4s(e)(3)(D) of 
the CEA, 7 U.S.C. 6s(e)(3)(D), apply to uncleared swaps.
    NGX also stated its view that in a non-intermediated model, such 
as that operated by NGX, the DCO is familiar with its clearing 
participants, and can exercise a degree of discretion in accepting 
letters of credit without the same risk management challenges that 
may be faced by an intermediated DCO.
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    Many commenters suggested that letters of credit should be 
acceptable if they are subject to appropriate conditions. OCC 
recommended that the Commission should allow letters of credit as long 
as a DCO sets criteria with respect to issuers, diversifies 
concentration of risk among issuers, and limits the proportion of a 
clearing member's margin requirement that can be represented by letters 
of credit. In addition, OCC stated that it would be appropriate for the 
Commission to prohibit a DCO from accepting a letter of credit from a 
clearing member if the letter of credit is issued by an institution 
affiliated with the clearing member.
    Similarly, FIA suggested that a DCO should be permitted to accept 
letters of credit on a case-by-case basis subject to the credit quality 
of the bank and appropriate limits on the percentage of a clearing 
member's margin requirements that can be met by letters of credit. FIA 
also indicated that DCOs should limit the aggregate value of letters of 
credit that may be issued by any one bank.
    FHLBanks wrote that ``a hard and fast prohibition against letters 
of credit is inappropriate because it fails to take into account that a 
letter of credit issued by a highly creditworthy entity could contain 
terms that would make the letter of credit just as liquid as a funded 
asset.'' \199\
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    \199\ The FHLBanks further noted that the prohibition on letters 
of credit may unnecessarily constrain certain end-users from 
clearing swaps because they may be precluded from pledging other 
assets, e.g., by loan covenants.
---------------------------------------------------------------------------

    CME stated that it only accepts letters of credit that comply with 
its specified terms and conditions, including payment within one hour 
of notification of a draw, from issuers that it has reviewed and 
approved and that meet its criteria for issuing banks. CME further 
noted that it conducts periodic reviews of approved banks and uses caps 
and concentration limits in connection with letters of credit.
    NGX stated that it has accepted letters of credit that comply with 
its requirements regarding timing and acceptable institutions, for many 
years, and has successfully drawn on such letters of credit.
    Several commenters warned of the potential risks associated with 
prohibiting letters of credit, including higher costs for clearing 
members and their customers (OCC), the placement of U.S. DCOs at a 
disadvantage to foreign clearing houses (ICE),\200\ and increased 
systemic risk as a result of decreased voluntary clearing (NOCC).
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    \200\ ICE noted that the CPSS-IOSCO Consultative Report did not 
prohibit any type of collateral.
---------------------------------------------------------------------------

    The Commission acknowledges that DCOs have historically been 
permitted to exercise their discretion regarding whether and to what 
extent they would accept letters of credit for initial margin for 
futures and options. Certain DCOs have accepted such letters of credit 
without incident and continue to do so. On the other hand, as stated in 
the notice of proposed rulemaking, letters of credit are unfunded 
financial resources with respect to which funds might be not be 
available when they are most needed by the DCO. Moreover, the initial 
margin of a defaulting clearing member would typically be the first 
asset tapped to cure the clearing member's default. Taking into account 
both the strong track record of letters of credit in connection with 
cleared futures and options on futures and the potentially greater 
risks of cleared swaps, the Commission is modifying the provision to 
permit DCOs to accept letters of credit as initial margin for futures 
and options on futures. However, the Commission has determined to 
maintain an additional safeguard for swaps at this time by prohibiting 
a DCO from accepting letters of credit as initial margin for swaps. In 
cases where futures and swaps are margined together, the Commission has 
determined that letters of credit may not be accepted. The Commission 
will monitor developments in this area and may revisit this issue in 
the future.
    The Commission is adopting Sec.  39.15(c)(1), redesignated as Sec.  
39.13(g)(10),\201\ with the modification described above.
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    \201\ Redesignation of this provision and several other 
provisions proposed as part of Sec.  39.15 is a non-substantive 
change that moves the provisions to the risk management rules for 
margin requirements. As a risk management rule, the provision 
implements Core Principle D, Section 5b(c)(2)(D)(iii) of the CEA, 
which provides that ``Each [DCO], through margin requirements and 
other risk control mechanisms, shall limit the exposure of the [DCO] 
to potential losses from defaults by members and participants of the 
[DCO].''
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6. Valuation and Haircuts--Sec. Sec.  39.15(c)(2) and 39.15(c)(3)
    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. 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

[[Page 69394]]

initial margin obligations and to evaluate the appropriateness of its 
haircuts on at least a quarterly basis.
    OCC commented that if a DCO can only accept instruments with 
minimal risk, then haircuts should either not be required at all or 
should be very small. The Commission notes that, as defined in Sec.  
39.15(c)(3), haircuts are ``appropriate reductions in value to reflect 
market and credit risk.'' This is a flexible standard that would allow 
a DCO to determine the extent of the haircut based on the extent of the 
risk posed by the instrument deposited as initial margin.
    OCC further stated that proposed Sec.  39.15(c)(3) is ambiguous 
regarding what OCC would be required to test on a quarterly basis. OCC 
explained that its STANS margin methodology does not apply fixed 
haircuts to securities deposited as collateral, but rather treats 
collateral as part of a clearing member's overall portfolio, revisiting 
each ``haircut'' or valuation on a security-by-security, account-by-
account, and day-by-day basis. Thus, OCC stated that it checks the 
adequacy of its haircuts through back testing and not through a 
periodic review.
    The general language of Sec.  39.15(c)(3), requiring a DCO to 
``apply appropriate reductions in value to reflect market and credit 
risk * * * to the assets that it accepts in satisfaction of initial 
margin obligations'' and to ``evaluate the appropriateness of such 
haircuts on at least a quarterly basis,'' is broad enough to encompass 
the method of daily valuation and back testing described by OCC.
    The Commission is adopting Sec.  39.15(c)(2), redesignated as Sec.  
39.13(g)(11), as proposed. The Commission is adopting a technical 
revision to Sec.  39.15(c)(3), redesignated as Sec.  39.13(g)(12), by 
adding a reference to ``liquidity'' risk to conform the terminology 
used to describe haircuts (proposed as ``appropriate reductions in 
value to reflect market and credit risk'') with the terminology used in 
Sec.  39.13(g)(10), which refers to assets that have ``minimal credit, 
market, and liquidity risks.'' \202\ The Commission is also making a 
non-substantive revision to replace the phrase ``including in stressed 
market conditions'' with ``taking into consideration stressed market 
conditions.''
---------------------------------------------------------------------------

    \202\ Credit, market, and liquidity risks are concepts that are 
not mutually exclusive, and this articulation of the types of risks 
to be evaluated by a DCO appears in the CEA (Core Principle F, 
Treatment of Funds (requiring that ``[f]unds and assets invested by 
a [DCO] shall be held in instruments with minimal credit, market, 
and liquidity risks''), and ``minimal credit, market, and liquidity 
risks'' is set forth as the standard for assets acceptable for a 
guaranty fund (Sec.  39.11(e)(3)(i)), and as the standard for assets 
acceptable as initial margin (Sec.  39.13(g)(10)).
---------------------------------------------------------------------------

7. Concentration Limits--Sec.  39.15(c)(4)
    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. The proposed 
regulation also would require a DCO to evaluate the appropriateness of 
its concentration limits, on at least a monthly basis.
    OCC indicated that the proposed rule was not clear regarding 
whether it would be sufficient to impose concentration charges rather 
than imposing concentration limits, but argued that if the margin 
system adequately penalizes concentration of risk, it does not believe 
that fixed concentration limits are required. The Commission agrees 
that concentration charges, rather than concentration limits, may be 
appropriate in certain circumstances, and is modifying the provision to 
permit a DCO to apply ``appropriate limitations or charges on the 
concentration of assets posted as initial margin'' and to ``evaluate 
the appropriateness of any such concentration limits or charges, on at 
least a monthly basis.'' The inclusion of concentration charges as an 
acceptable alternative to concentration limits is consistent with 
international recommendations.\203\
---------------------------------------------------------------------------

    \203\ See CPSS-IOSCO Consultative Report, Principle 5: 
Collateral, Explanatory Note 3.5.4, at 38.
---------------------------------------------------------------------------

    CME stated its view that the Commission should not prescribe the 
frequency of a DCO's reviews of its concentration limits and it urged 
the Commission to revise Sec.  39.15(c)(4) to replace ``on at least a 
monthly basis'' with ``on a regular basis.'' The Commission believes 
that it is appropriate to require a DCO to evaluate the appropriateness 
of its concentration limits (or charges) on at least a monthly basis 
and notes that Sec.  39.15(c)(4) provides a DCO with the discretion to 
determine the nature of such evaluation.
    The Commission is adopting Sec.  39.15(c)(4), redesignated as Sec.  
39.13(g)(13), with the modifications described above.
8. Pledged Assets--Sec.  39.15(c)(5)
    Under proposed Sec.  39.15(c)(5), if a DCO were to permit its 
clearing members to pledge assets for initial margin while retaining 
such assets in accounts in the names of such clearing members, the DCO 
would have to ensure that the assets are unencumbered and that the 
pledge has been validly created and validly perfected in the relevant 
jurisdiction. The Commission did not receive any comments discussing 
proposed Sec.  39.15(c)(5) and is adopting the provision, redesignated 
as Sec.  39.13(g)(14), as proposed.
9. Permitted Investments--Sec.  39.15(d)
    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 and that any investment of 
customer funds or assets by a DCO must comply with Sec.  1.25 of the 
Commission's regulations. Moreover, the proposed regulation would apply 
the limitations contained in Sec.  1.25 to all customer funds and 
assets, whether they are 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 cleared swaps customers subject to 
the segregation requirements of Section 4d(f) of the CEA.
    The Commission did not receive any comment letters discussing 
proposed Sec.  39.15(d). The Commission is adopting the provision, 
redesignated as Sec.  39.15(e), as proposed.
10. Transfer of Customer Positions--Sec.  39.15(d)
    The Commission proposed regulations addressing the processing, 
clearing, and transfer of customer positions by swap dealers (SDs), 
major swap participants (MSPs), FCMs, SEFs, DCMs, and DCOs.\204\ 
Proposed Sec.  39.15(d) would require a DCO to have rules providing 
that, upon the request of a customer and subject to the consent of the 
receiving clearing member, the DCO would promptly transfer all or a 
portion of such customer's portfolio of positions and related funds 
from the carrying clearing member of the DCO to another clearing member 
of the DCO, without requiring the close-out and rebooking of the 
positions prior to the requested transfer.
---------------------------------------------------------------------------

    \204\ 76 FR 13101 (March 10, 2011) (Straight-Through 
Processing).
---------------------------------------------------------------------------

    MFA, Citadel, and FHLBanks supported the proposal. MFA and Citadel 
suggested that the Commission clarify that associated margin should 
transfer simultaneously with the transferred positions.
    LCH also suggested that the section should be revised to require 
that the transfer of positions and related funds be effected 
simultaneously. LCH believes that absent such a provision, a

[[Page 69395]]

DCO could be understood to be required to transfer either the positions 
or the funds, but not both, and such an obligation would expose the DCO 
to risk during the customer transfer.
    FIA agreed with the Commission that a customer should not be 
required to close-out and re-book positions as a condition of 
transferring such positions, and that a clearing member should not 
unnecessarily interfere with a customer's request to transfer 
positions. However, FIA noted that a DCO will not have the immediate 
ability to determine which positions carried in a clearing member's 
omnibus account belong to a particular customer. FIA suggested that a 
DCO's rules provide that the customer submit its request to transfer 
its positions to the clearing member carrying the positions, not to the 
DCO. FIA also suggested that the Commission revise the proposed rule to 
confirm that a clearing member is required to transfer a customer's 
positions only after that customer has met all contractual obligations, 
including outstanding margin calls and any additional margin required 
to support any remaining positions.
    OCC also noted that a customer will not ask a DCO directly to 
transfer a customer position. Like FIA, OCC believes that any such 
transfer must be subject to all legitimate conditions or restrictions 
established by the DCO in connection with its clearing of swaps.
    CME stated that it fully supports the concept of applying the same 
standards to transfer of customer cleared swaps as have historically 
been applied to transfer of customer futures. It noted that a customer 
request to transfer its account is made not to a DCO but to the FCM 
that carries the customer's account.
    ISDA commented that any transfer rule must provide that a party 
seeking transfer not be in default to its existing clearing member. 
ISDA believes that the transfer rule must take into account any cross-
cleared or cross-margined transactions and in the case where only a 
portion of a customer's portfolio is transferred, clearing members must 
have the ability to condition the transfer on the posting of additional 
margin by the customer.
    KCC commented that this rule is not necessary because KCC has never 
required a futures position to be closed out and re-booked prior to 
transfer from the carrying clearing member to another clearing member, 
nor would KCC require a wheat calendar swap to be closed out and re-
booked prior to transfer. The Commission notes that such a requirement 
has been imposed by other clearinghouses in connection with swaps.
    In response to concerns raised by commenters, the Commission is 
revising Sec.  39.15(d) to read as set forth in the regulatory text of 
this final rule.
    The language making it explicit that positions and margin be 
transferred at the same time is responsive to the comments of MFA, 
Citadel, and LCH and consistent with prudent risk management 
procedures. The language clarifying that a customer transfer 
instruction would go to a clearing member and not directly to the DCO 
is responsive to the comments of FIA, OCC, and CME. The requirement 
that a customer may not be in default is responsive to the comments of 
FIA and ISDA and consistent with the statement in the notice of 
proposed rulemaking that transfers should be subject to contractual 
requirements. The requirement that positions at both clearing members 
will have appropriate margin is responsive to the comments of MFA, 
Citadel, and ISDA and consistent with the statement in the notice of 
proposed rulemaking that transfers should be subject to contractual 
requirements.

G. Core Principle G--Default Rules and Procedures--Sec.  39.16

    Core Principle G,\205\ as amended by the Dodd-Frank Act, 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. The 
Commission proposed Sec.  39.16 to establish requirements that a DCO 
would have to meet in order to comply with Core Principle G.
---------------------------------------------------------------------------

    \205\ Section 5b(c)(2)(G) of the CEA, 7 U.S.C. 7a-1(c)(2)(G) 
(Core Principle G).
---------------------------------------------------------------------------

1. General--Sec.  39.16(a)
    Proposed Sec.  39.16(a) would require a DCO 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.
    The Commission did not receive any comment letters discussing 
proposed Sec.  39.16(a), although LCH stated that it concurs with all 
the provisions set out under proposed Sec.  39.16. The Commission is 
adopting Sec.  39.16(a) as proposed.
2. Default Management Plan--Sec.  39.16(b)
    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 also would 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.
    OCC agreed with the proposal for annual testing of a DCO's default 
management plan, while ISDA stated that such tests should be conducted 
at least on a semi-annual basis. FIA indicated that the default 
management plan should be subject to frequent, periodic testing. The 
Commission believes that it is appropriate and sufficient to require at 
least annual testing of a DCO's default management plan. A particular 
DCO could determine to test its plan on a semi-annual or other periodic 
basis, in its discretion.
    ISDA expressed its view that regulators should review and sign off 
on the default management plans of DCOs. KCC requested that the 
Commission clarify that the default management plan concepts in 
proposed Sec.  39.16(b) may be satisfied by annual testing of the DCO's 
existing set of default rules and procedures. The Commission does not 
believe that it is necessary to adopt an explicit requirement that the 
Commission review and approve a DCO's default management plan. However, 
Commission staff will review a DCO's default management plan in the 
context of the Commission's ongoing DCO review program, including a 
determination of whether a DCO's ``existing set of default rules and 
procedures'' meet the requirements of Sec.  39.16(b).
    The Commission is making a technical revision to Sec.  39.16(b), 
removing the parentheticals and substituting the word ``products'' for 
the word ``contracts.'' The sentence now reads: ``Such plan shall 
address any differences in procedures with respect

[[Page 69396]]

to highly liquid products and less liquid products.''
3. Default Procedures--Sec.  39.16(c)(1)
    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.
    The Commission did not receive any comment letters discussing 
proposed Sec.  39.16(c)(1) and is adopting Sec.  39.16(c)(1) as 
proposed.
4. Default Rules--Sec.  39.16(c)(2)
    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 would specifically provide that any 
allocation would have to be proportional to the size of the 
participating or accepting clearing member's positions at the DCO.
    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. 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.\206\ 
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.
---------------------------------------------------------------------------

    \206\ This is consistent with the segregation requirements of 
Section 4d of the CEA and Sec.  1.20 of the Commission's 
regulations.
---------------------------------------------------------------------------

    The Commission did not receive any comment letters discussing 
proposed Sec.  39.16(c)(2)(i), (ii) or (iii). The Commission is 
adopting Sec.  39.16(c)(2)(i) as proposed. The Commission is making 
technical revisions to Sec. Sec.  39.16(c)(2)(ii), (iii), (v) and (vi), 
as well as Sec.  39.16(d)(3), by replacing each use of the word 
``proprietary'' with ``house.''
    As discussed above in connection with participant eligibility 
requirements under Sec.  39.12,\207\ the Commission is revising Sec.  
39.16(c)(2)(iii) to require a DCO that imposes obligations on its 
clearing members to participate in auctions or to accept allocations of 
a defaulting clearing member's positions, to permit its clearing 
members to outsource these obligations to qualified third parties, 
subject to appropriate safeguards imposed by the DCO. The Commission 
believes that it is important to permit outsourcing, while recognizing 
that it is essential to limit participation only to qualified third 
parties. Accordingly, a DCO's rules may impose appropriate terms and 
conditions on outsourcing arrangements, addressing, for example, the 
necessary qualifications to be eligible to act in the clearing member's 
place and conflicts of interest issues. Thus, for example, a clearing 
member could hire a qualified third party to act as its agent in an 
auction. The Commission cautions, however, that any DCO imposing terms 
and conditions that could indirectly deny fair and open access and 
therefore are not ``appropriate,'' i.e., not supported by sound risk 
management policies, may run afoul of Core Principle C and Sec.  39.12.
---------------------------------------------------------------------------

    \207\ See discussion in section IV.C.1.i, above.
---------------------------------------------------------------------------

    The Commission is also making two additional technical revisions to 
Sec.  39.16(c)(2)(iii). First, the Commission is replacing ``a 
defaulting clearing member's positions'' with ``the customer or house 
positions of the defaulting clearing member,'' to correct an oversight 
in the proposed language. Second, the Commission is revising Sec.  
39.16(c)(2)(iii)(A) to provide that any allocation shall be 
``[p]roportional to the size of the participating or accepting clearing 
member's positions in the same product class at the derivatives 
clearing organization'' (added text in italics) to clarify the 
Commission's intent.
    With respect to proposed Sec.  39.16(c)(2)(iv), OCC agreed that it 
would be appropriate to require DCOs to adopt rules that would define 
the sequence in which the funds and assets of a defaulting clearing 
member and the financial resources maintained by the DCO would be 
applied in the event of a default.
    Freddie Mac expressed concern with the broad discretion that would 
be given to DCOs to determine the sequence in which financial resources 
would be applied in the event of a clearing member default, and 
recommended that DCOs should be required to place non-customer 
resources (e.g., clearing member guaranty funds and their own capital) 
ahead of non-defaulting customer collateral in the risk waterfall. In 
particular, Freddie Mac indicated that if the Commission does not 
require individual segregation of customer collateral, it should 
require DCOs to place non-defaulting customers at the bottom of the 
risk waterfall. Freddie Mac stated that the Commission should defer 
adoption of proposed Sec.  39.16(c) until after adoption of rules 
relating to customer segregation.
    The Commission is adopting Sec.  39.16(c)(2)(iv) to require that a 
DCO adopt rules that identify the sequence of its default waterfall, as 
proposed, without imposing any substantive requirements with respect to 
such sequence, as suggested by Freddie Mac. The Commission is 
addressing the issue of the application of the collateral of non-
defaulting swaps customers in a separate pending rulemaking,\208\ but 
does not believe that it is appropriate to defer the adoption of 
proposed Sec.  39.16(c) until that rulemaking is complete.
---------------------------------------------------------------------------

    \208\ See 76 FR 33818 (June 9, 2011) (Protection of Cleared 
Swaps Customer Contracts and Collateral; Conforming Amendments to 
the Commodity Broker Bankruptcy Provisions).
---------------------------------------------------------------------------

    The Commission is making a technical revision to Sec.  
39.16(c)(2)(iv) by inserting ``and its customers'' after ``the funds 
and assets of the defaulting clearing member'' to correct an oversight 
in the proposed language.
    ISDA commented that proposed Sec.  39.16(c)(2)(v), which would 
require a DCO to adopt ``[a] provision that customer margin posted by a 
defaulting clearing member shall not be applied in the event of a 
proprietary default'' should be revised to replace the words ``in the 
event of'' with ``to cover losses in respect of''; otherwise, ISDA 
believed that customer margin would not be able to be applied even to 
cover customer losses. The Commission agrees with ISDA and is modifying 
Sec.  39.16(c)(2)(v) by replacing ``in the event of'' with ``to cover 
losses with respect to'' and has made a similar modification to Sec.  
39.16(c)(2)(vi).
    CME recommended that the Commission replace ``proprietary

[[Page 69397]]

margins posted by a defaulting clearing member'' in Sec.  
39.16(c)(2)(vi) with ``proprietary margins, positions and any other 
assets in the account of the defaulting clearing member.'' CME argued 
that the Commission's proposed reference to ``proprietary margins 
posted by a defaulting clearing member'' is too narrow in scope, since 
in the event of a clearing member default (whether originating in the 
customer origin or the house origin), a DCO would likely liquidate 
positions in the defaulting clearing member's house account and then 
apply excess funds and not just proprietary margins to cure the 
default. The Commission agrees that ``proprietary margins posted by a 
defaulting clearing member'' is too narrow and is replacing the phrase 
in Sec.  39.16(c)(2)(vi) with ``house funds and assets of a defaulting 
clearing member.'' The Commission believes that ``house funds and 
assets'' is broad enough to include ``proprietary margins, positions 
and any other assets,'' as suggested by CME, and is consistent with the 
language in Sec.  39.16(c)(2)(iv) and Sec.  39.15. The Commission is 
similarly replacing ``customer margin posted by a defaulting clearing 
member'' in Sec.  39.16(c)(2)(v) with ``the funds and assets of a 
defaulting clearing member's customers'' and is replacing ``customer 
margin'' in Sec.  39.16(c)(2)(vi) with ``customer funds and assets.''
    ISDA commented that proposed Sec.  39.16(c)(2)(vi) should be 
revised to insert the word ``excess'' immediately before the words 
``proprietary margins'' to make it clear that proprietary margin is to 
be applied first to cover proprietary losses, noting that the use of 
proprietary margin to cover customer losses ahead of proprietary losses 
would hasten the mutualization of losses among clearing members, which 
would likely result in higher margin levels being imposed with respect 
to customer positions in order to avoid that outcome. The Commission 
agrees with ISDA and is modifying Sec.  39.16(c)(2)(vi) by inserting 
``excess'' before ``house funds and assets of a defaulting clearing 
member,'' as suggested by ISDA.
    The Commission is adopting Sec.  39.16(c)(2) with the modifications 
described above.
5. Publication of Default Rules--Sec.  39.16(c)(3)
    Proposed Sec.  39.16(c)(3) would require that a DCO must make its 
default rules publicly available, and would cross-reference Sec.  
39.21, adopted herein, which also addresses this requirement.\209\
---------------------------------------------------------------------------

    \209\ See discussion of Sec.  39.21 in section IV.L, below.
---------------------------------------------------------------------------

    The Commission did not receive any comment letters discussing 
proposed Sec.  39.16(c)(3) and is adopting Sec.  39.16(c)(3) as 
proposed.
6. Insolvency of a Clearing Member--Sec.  39.16(d)
    Proposed Sec.  39.16(d)(1) would require a DCO to adopt rules that 
require a clearing member to provide prompt notice to the DCO if the 
clearing member becomes the subject of a bankruptcy petition, a 
receivership proceeding, or an equivalent proceeding, e.g., a foreign 
liquidation proceeding. Proposed Sec.  39.13(d)(2) would require a DCO 
to review the clearing member's continuing eligibility for clearing 
membership, upon receipt of 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, upon receipt of such notice.
    CME recommended that, in order to preserve a DCO's right to take 
appropriate steps before a clearing member files for, or is placed 
into, bankruptcy, the Commission should amend proposed Sec. Sec.  
39.16(d)(2) and (3) to require DCOs to take appropriate actions ``no 
later than upon receipt'' of notice that the clearing member is the 
subject of a bankruptcy petition or similar proceeding. The Commission 
is adopting Sec.  39.16(d) with the modifications to Sec. Sec.  
39.16(d)(2) and (3) suggested by CME. In addition, the Commission is 
making a technical revision to Sec.  39.16(d)(3) by replacing the 
phrase ``with respect to such clearing member or its positions'' with 
the phrase ``with respect to such clearing member or its house or 
customer positions.'' This revision eliminates possible ambiguity in 
the reference to ``its positions,'' which was intended to reflect 
current industry practice and include both house and customer 
positions, not just house positions.

H. Core Principle H--Rule Enforcement--Sec.  39.17

    Core Principle H,\210\ as amended by the Dodd-Frank Act, requires a 
DCO to maintain adequate arrangements and resources for the effective 
monitoring and enforcement of compliance with its rules and resolution 
of disputes. It also requires a DCO to have the authority and ability 
to discipline, limit, suspend, or terminate the activities of a member 
or participant due to a violation by the member or participant of any 
rule of the DCO. It further requires that a DCO report to the 
Commission regarding rule enforcement activities and sanctions imposed 
against clearing members.
---------------------------------------------------------------------------

    \210\ Section 5b(c)(2)(H) of the CEA, 7 U.S.C. 7a-1(c)(2)(H).
---------------------------------------------------------------------------

    Proposed Sec.  39.17 would codify these requirements, adding a 
provision that would require a DCO to report to the Commission in 
accordance with proposed Sec.  39.19(c)(4)(xiii). As proposed, Sec.  
39.19(c)(4)(xiii) would require a DCO to report the initiation of a 
rule enforcement action against a clearing member or the imposition of 
sanctions against a clearing member, no later than two business days 
after the DCO takes such action. As discussed in connection with rules 
implementing Core Principle J (Reporting), the Commission is adopting 
that reporting requirement with a modification that only requires a DCO 
to report sanctions imposed against a clearing member.\211\
---------------------------------------------------------------------------

    \211\ See discussion of rule enforcement reporting in section 
IV.J.5.j, below.
---------------------------------------------------------------------------

    The Commission received no comments on proposed Sec.  39.17. The 
Commission is adopting Sec.  39.17 as proposed, but with a change to 
the cross-reference to Sec.  39.19(c)(4)(xiii) in Sec.  39.17(a)(3) to 
reflect the redesignation of that provision as Sec.  
39.19(c)(4)(xi).\212\
---------------------------------------------------------------------------

    \212\ See id. (The Commission is adopting Sec.  
39.19(c)(4)(xiii) as a renumbered Sec.  39.19(c)(4)(xi)).
---------------------------------------------------------------------------

I. Core Principle I--System Safeguards--Sec.  39.18

    Core Principle I,\213\ as amended by the Dodd-Frank Act, requires a 
DCO to establish and maintain a program of risk analysis and oversight 
that identifies and minimizes 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 that the emergency procedures, back-up 
facilities, and disaster recovery plans that a DCO is obligated to 
establish and maintain specifically allow for the timely recovery and 
resumption of the DCO's operations and the fulfillment of each 
obligation and responsibility of the DCO. Finally, Core Principle I 
requires that a DCO periodically conduct tests to verify that the DCO's 
back-up resources are sufficient to ensure daily processing, clearing, 
and settlement.
---------------------------------------------------------------------------

    \213\ Section 5b(c)(2)(I) of the CEA, 7 U.S.C. 7a-1(c)(2)(I).
---------------------------------------------------------------------------

    Proposed Sec.  39.18 would codify the obligations contained in Core 
Principle I and delineate the minimum requirements that a DCO would be 
required to satisfy in order to comply with Core Principle I. Proposed 
Sec.  39.18 also would define the terms ``relevant

[[Page 69398]]

area,'' ``recovery time objective,'' and ``wide-scale disruption'' for 
purposes of that section.
    The Commission received one general comment from LCH. LCH generally 
``concurred with all the provisions set out under proposed rule 
39.18,'' but urged the Commission to align these provisions with the 
CPSS-IOSCO standards, and to phase in such standards.
    As discussed below, the Commission received comments on proposed 
Sec. Sec.  39.18 (h), (j), and (k), and proposed Sec.  39.30(a).
    The Commission did not receive any comments specifically related to 
the definitions contained in proposed Sec.  39.18(a); proposed 
Sec. Sec.  39.18(b),(c) and (d), which would address the required 
program of risk analysis and oversight; proposed Sec.  39.18(e), which 
would require a DCO to have a business continuity and disaster recovery 
(BC-DR) plan and resources sufficient to enable the DCO to resume daily 
processing, clearing and settlement no later than the next business day 
following a disruption; proposed Sec.  39.18(f), which would address 
outsourcing by a DCO of resources required to meet its responsibilities 
with respect to business continuity and disaster recovery plans; 
proposed Sec.  39.18(g), which would delineate certain exceptional 
events upon the occurrence of which a DCO would be obligated to notify 
promptly the Commission's Division of Clearing and Risk; proposed Sec.  
39.18(h)(1), which would require a DCO to provide timely advance notice 
to the Division of Clearing and Risk of certain planned changes to 
automated systems; or proposed Sec.  39.18(i), which would set forth 
certain records that a DCO would be required to maintain. The 
Commission is adopting each of these provisions as proposed, except 
that the Commission is replacing ``contracts'' with ``products'' in 
Sec.  39.18(a) and is adding ``of the derivatives clearing 
organization's'' before ``own and outsourced resources'' in Sec.  
39.18(f)(2)(ii) for clarification.
1. Notice of Changes to Program of Risk Analysis and Oversight--Sec.  
39.18(h)(2)
    Proposed Sec.  39.18(h)(2) would require a DCO to give Division of 
Clearing and Risk staff ``timely advance notice'' of ``planned changes 
to the DCO's program of risk analysis and oversight.'' CME commented 
that this is an ``extraordinarily broad requirement'' and urged the 
Commission to ``appropriately consider[] context and relative risks.''
    The Commission is adopting Sec.  39.18(h)(2) as proposed. The 
provision merely requires that DCOs submit such notice as part of their 
planning process. The Commission expects that staff will evaluate 
compliance with this provision, as with all other provisions, giving 
appropriate consideration to context and relative risks.
2. Testing--Sec.  39.18(j)
    Proposed Sec.  39.18(j) would set forth the requirements for the 
testing that a DCO must conduct of its automated systems and BC-DR 
plans. Proposed Sec.  39.18(j)(1) would require that DCOs conduct 
regular, periodic, and objective testing and review of (i) their 
automated systems, to ensure that such systems are reliable, secure, 
and have adequate scalable capacity, and (ii) their BC-DR capabilities, 
to ensure that the DCO's backup resources meet the standards set forth 
in proposed Sec.  39.18(e). Proposed Sec.  39.18(j)(2) would require 
that these tests ``be conducted by qualified, independent professionals 
* * * [who] may be independent contractors or employees [of the DCO] 
but shall not be persons responsible for development or operation of 
the capabilities being tested.'' Proposed Sec.  39.18(j)(3) would 
require that reports setting forth the protocols for, and the results 
of, such tests ``be communicated to, and reviewed by, senior management 
of the [DCO]'' and that ``[p]rotocols of tests which result in few or 
no exceptions shall be subject to more searching review.''
    ICE, OCC, and MGEX objected to the obligation that the testing 
required by Sec.  39.18(j) be performed by ``qualified, independent 
professionals.'' ICE contended that the proper standard should be to 
have qualified, independent professionals review, rather than conduct 
testing of, systems or capabilities. Similarly, OCC suggested that the 
testing could be overseen, rather than conducted, by an independent 
professional. MGEX objected more generally to the requirement that 
tests of its BC-DR capabilities be performed by ``independent 
professionals'' and expressly objected to the proposal's prohibition on 
the use of any employees who participated in the development or the 
operation of the systems or capabilities being tested to fulfill this 
role. MGEX argued that such persons are the most qualified persons to 
run the tests. KCC requested that a DCO's CRO or other similar official 
qualify as an `independent professional' for purposes of the testing 
rule.
    The Commission is adopting Sec.  39.18(j) as proposed. The 
Commission notes that the obligation that the required testing of 
automated systems and BC-DR capabilities be performed by qualified, 
independent professionals is consistent with the Commission's 
historical practice of requiring independent testing of systems where 
appropriate.\214\
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    \214\ For example, paragraph (a)(2) of the application guidance 
to Core Principle 9 (prior to amendment by the Dodd-Frank Act) for 
contract markets noted that ``Any program of independent testing and 
review of [an automated] system should be performed by a qualified, 
independent professional.'' 17 CFR part 38, appendix B at Core 
Principle 9, paragraph (a)(2).
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    The Commission recognizes that persons charged with developing or 
operating a system are frequently called upon to test that system. The 
Commission believes, however, that the active involvement and direction 
of qualified, independent professionals in the testing process is 
needed to ensure objective and accurate results.
    MGEX's requested approach would result in tests being conducted 
only by persons with an inherent conflict of interest (because negative 
results of the tests might call into question the work of those who 
developed or operate the systems) and, separately, would deny the DCO 
the benefit of an independent analysis of the workings of the system. 
Accordingly, while some testing of a DCO's automated systems and BC-DR 
capabilities may be conducted by persons who design or operate such 
system or capabilities, the Commission has decided to retain the 
requirement that the objective testing performed to satisfy Sec.  
39.18(j) must be conducted by qualified, independent persons, as 
defined therein. While a DCO's CRO may appropriately serve this 
function if he or she has the appropriate training and experience to be 
``qualified'' in this context, and the appropriate role in the 
organization to be ``independent,'' the Commission does not believe it 
would be advisable to determine that the person serving in such a role 
is necessarily qualified and independent.
3. Coordination of BC-DR Plans With Members and Providers of Essential 
Services--Sec.  39.18(k)
    Proposed Sec.  39.18(k) would require that a DCO to the extent 
practicable: (1) Coordinate its BC-DR 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 BC-DR 
plans and the plans of its clearing members; and (3) ensure that its 
BC-DR plan takes into account the plans of its providers

[[Page 69399]]

of essential services, including telecommunications, power, and water.
    MGEX proposed that industry-sponsored events should suffice to 
satisfy the requirement that a DCO must coordinate its BC-DR plan with 
those of its members. Similarly, KCC requested that the Commission 
clarify that coordination would be deemed to be satisfied if the DCO 
reviews the BC-DR plans of its clearing members and essential service 
providers and subsequently provides to such parties the DCO's own BC-DR 
plan. KCC stated that it does not believe that coordination should 
involve extensive efforts at achieving specific consistency between the 
procedures of each party, as each has a distinct business model that 
faces varying operational risks.
    NYPC objected to the requirement contained in proposed Sec.  
39.18(k)(3). NYPC noted that its business continuity plan (BCP) would 
be invoked any time a service provider ceases to provide an essential 
service, regardless of whether that service provider has invoked its 
own BCP, and thus such information would not necessarily give DCOs any 
additional insight into their own BCP. Similarly, CME noted that, while 
it obtains representations that its major vendors have disaster 
recovery plans, CME does not control, or generally have access to, the 
details of the proprietary plans of those service providers.
    The Commission is adopting Sec.  39.18(k) as proposed. With respect 
to the requirements of Sec. Sec.  39.18(k)(1) and (2), the Commission 
recognizes that participation in industry-sponsored events, such as the 
annual testing conducted by FIA, serves as an important assessment of 
the connectivity between the systems of DCOs and their members 
(including backup sites), but such participation would not, in and of 
itself, satisfy the requirements of these regulations. The level of 
participation of a particular DCO in a particular industry test is left 
to the discretion of the DCO, and different DCOs may participate in 
such tests to different extents. Moreover, while such industry-
sponsored events may be helpful, it is the responsibility of each DCO--
not that of an industry organization--to ensure that the functionality 
of clearing will be maintained between the DCO and its members. The 
Commission believes that a DCO will best be able to meet its 
responsibilities reliably in a wide-area disaster that affects a DCO 
and its clearing members if the DCO has actively worked together with 
those clearing members to coordinate their plans and has obtained some 
evidence that such plans will appropriately mesh when implemented.
    While it is true that a DCO should have backup arrangements that 
promptly can be engaged to address a failure of essential services, it 
is likely that most DCOs will prepare for a temporary, rather than an 
indefinite, loss of such services. Among the benefits provided by 
coordination of a DCO's BCP with that of providers of essential 
services is an insight into the period of time for which the DCO should 
be prepared to provide such services itself.
    The Commission recognizes that a service provider may reasonably be 
reluctant to provide sensitive details of its own BCP, such as the 
precise location of backup facilities, and notes that the proposed 
requirement is prefaced with the limitation that a DCO is required to 
obtain this information only ``to the extent practicable.'' 
Nonetheless, merely obtaining a representation that states that a 
service provider has a backup plan--with no detail as to the Recovery 
Time Objective (RTO) of that service provider, and no insight into how 
that service provider's BCP might affect the BCP of the DCO--would 
likely be insufficient.
4. Recovery Time Objective--Sec.  39.18(a)
    Proposed Sec.  39.18(a) would define an RTO as the 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 a wide-
scale disruption, and defines a wide-scale disruption as an event that 
causes a severe disruption or destruction of transportation, 
telecommunications, power, water or other critical infrastructure 
components in a relevant area, or an event that results in an 
evacuation or unavailability of the population in a relevant area. 
Proposed Sec.  39.18(e)(3) would require that a DCO have an RTO of the 
next business day, while proposed Sec.  39.30(a) would require that a 
SIDCO have an RTO of two hours.
    ICE noted that proposed Sec.  39.18(a) does not specify a minimum 
time that a wide-scale disruption must be accommodated, and that costs 
would be higher if the unavailability of staff in the relevant area 
that must be accommodated is the total loss of personnel. ICE suggested 
that one week would allow relocation of personnel outside the affected 
area.
    The Commission is adopting Sec. Sec.  39.18(a) and 39.18(e)(3) as 
proposed. However, as discussed above in connection with the financial 
resources requirements, the Commission believes that it would be 
premature to take action regarding Sec.  39.30 at this time. The 
Commission will consider the proposals relating to SIDCOs together in 
the future.

J. Core Principle J--Reporting Requirements--Sec.  39.19

    Core Principle J,\215\ as amended by the Dodd-Frank Act, requires a 
DCO to provide the Commission with all information that the Commission 
determines to be necessary to conduct oversight of the DCO. The 
Commission proposed Sec.  39.19 to establish requirements that a DCO 
would have to meet in order to comply with Core Principle J. Under 
proposed Sec.  39.19, certain reports would have to be made by a DCO to 
the Commission: (1) On a periodic basis (daily, quarterly, or 
annually), (2) where the reporting requirement is triggered by the 
occurrence of a significant event; and (3) upon request by the 
Commission. Section 39.19(a) states the general requirement of Core 
Principle J. The Commission did not receive any comment letters 
discussing Sec.  39.19(a) and is adopting the provision as proposed.
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    \215\ Section 5b(c)(2)(J) of the CEA, 7 U.S.C. 7a-1(c)(2)(J).
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1. Submission of Reports--Sec.  39.19(b)
    The Commission proposed Sec.  39.19(b) to establish procedural 
requirements for electronic submission of reports and determination of 
time zones applicable to filing deadlines. The Commission received no 
comments and is adopting Sec. Sec.  39.19(b)(1) and (2) as proposed. 
For purposes of clarification, the Commission is also adopting Sec.  
39.19(b)(3) to provide a definition of ``business day'' as ``the 
intraday period of time starting at the business hour of 8:15 a.m. and 
ending at the business hour of 4:45 p.m., on all days except Saturdays, 
Sundays, and Federal holidays.'' This is consistent with the definition 
of ``business day'' set forth in Sec.  40.1(a).\216\
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    \216\ See 76 FR at 44790 (July 27, 2011) (Provisions Common to 
Registered Entities; final rule).
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2. Daily Reporting--Sec.  39.19(c)(1)
    Proposed Sec.  39.19(c)(1) would require a DCO to submit daily 
reports with certain initial margin and variation margin data as well 
as other cash flows for each clearing member. More specifically, Sec.  
39.19(c)(1)(i) would require a DCO to report both the initial margin 
requirement for each clearing member, by customer origin and house 
origin, and the initial margin on deposit for each clearing member, by 
origin.

[[Page 69400]]

Proposed Sec.  39.19(c)(1)(ii) would require a DCO to report the daily 
variation margin collected and paid by the DCO, listing the mark-to-
market amount collected from or paid to each clearing member, by 
origin.\217\
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    \217\ This requirement would apply to options transactions only 
to the extent a DCO uses futures-style margining for options.
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    Proposed Sec.  39.19(c)(1)(iii) would require a DCO to report all 
other cash flows relating to clearing and settlement including, but not 
limited to, option premiums and payments related to swaps such as 
coupon amounts, collected from or paid to each clearing member, by 
origin. Proposed Sec.  39.19(c)(1)(iv) would require a DCO to report 
the end-of-day positions for each clearing member, by customer origin 
and house origin.
    In addition, as discussed in section IV.D.6.h.(2), above, in 
connection with the Commission's proposal to require DCOs to collect 
initial margin for customer accounts on a gross basis under proposed 
Sec.  39.13(g)(8)(i), the Commission further proposed an addition to 
proposed Sec.  39.19(c)(1)(iv) that would also require DCOs to report, 
for each clearing member's customer account, the end-of-day positions 
of each beneficial owner. The Commission is adopting Sec.  39.19(c)(1) 
with two modifications. First, the Commission is not requiring 
reporting of customer positions by beneficial owner, except upon 
Commission request.\218\ Second, as discussed below, the Commission is 
renumbering the paragraphs in Sec.  39.19(c)(1) and adding a new 
paragraph (ii) to clarify the applicability of the daily reporting 
requirements to FCM/BDs. In addition, the Commission is replacing ``by 
customer origin and house origin'' with ``by house origin and by each 
customer origin''; and is replacing ``options on futures positions'' 
with ``options positions.''
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    \218\ See further discussion of reports of beneficial ownership 
in section IV.D.6.h.(2), above.
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    MGEX and KCC commented that while such information is available to 
them,\219\ they are concerned that if the Commission mandates a 
specific form of delivery, the cost to DCOs will be significantly 
higher than expected. MGEX referred to its recent experience with the 
Trade Capture Reporting initiative conversion to the Commission's new 
FIXML standards, which was more costly and time consuming than 
expected. KCC commented that all of the data proposed to be reported to 
the Commission is already made readily available to the Commission in 
varying degrees, and there is little need for the Commission to require 
the increasing level of detailed information in specified formats. In 
addition, MGEX expressed concern with the Commission's potential data 
storage capacity limitations. MGEX concluded that the combination of 
these two factors suggest that the burden of the daily reporting 
requirements on DCOs and the Commission outweigh the value of these 
reports.
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    \219\ MGEX noted that it is already ``internally performing 
these tasks'' in reference to the several daily reporting 
requirements. KCC has also noted that it already submits trading 
activity and positions by each clearing member by origin on a daily 
basis in file formats prescribed by the Commission.
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    MGEX suggested that requiring such data on an as-needed, rather 
than a daily, basis would limit the burden on DCOs and the Commission 
while ensuring relevancy as to the data being requested. KCC asked that 
the Commission reconsider the amount and detail of information 
necessary for its oversight role. While CME supported the proposed 
reporting requirement, it suggested that the Commission work with DCOs 
to determine the form and manner of delivery.
    As mentioned in the notice of proposed rulemaking, many DCOs 
already provide the Commission with much of the data required under 
this provision. The Commission recognizes that the daily reporting 
requirements may place an additional burden on a DCO, particularly if 
the DCO must employ a specific form of delivery that it does not 
already have in place. However, establishment of an automated reporting 
system is a one-time cost, and a uniform reporting format for all DCOs 
is necessary to facilitate the Commission's ability to receive data 
promptly and quickly disseminate it within the agency.\220\
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    \220\ The Commission notes that its staff is in the process of 
developing a plan for uniform submission of DCO reports.
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    The overall purpose of receiving the daily data is to enable 
Commission staff to analyze the data on a regular basis so that it can 
detect certain trends or unusual activity on a timely basis. Receiving 
such data less frequently would significantly reduce its usefulness. 
While there may be initial costs for DCOs to set up the reporting 
systems, there should be little cost to DCOs on a continuing 
basis.\221\ Finally, MGEX's suggestion to require such data on an as-
needed basis does not further the objective of enhanced risk 
surveillance, given that the purpose of gathering the data is to 
identify and address potential problems at the earliest possible time.
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    \221\ See further discussion of the costs and benefits of the 
reporting requirements in section VII.J, below.
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    OCC expressed concern that the reporting requirements make no 
accommodation for clearing members that are FCM/BDs, with respect to 
their securities positions. In response to OCC's comment, the 
Commission is adding a new paragraph (ii) to Sec.  39.19(c)(1) to 
clarify the limited applicability of the daily reporting requirements 
to securities positions. The final rule provides that ``The report 
shall contain the information required by paragraph (c)(1)(i) of this 
section for (A) all futures positions, and options on futures 
positions, as applicable; (B) all swaps positions; and (C) all 
securities positions that are held in a customer account subject to 
Section 4d of the Act or are subject to a cross-margining agreement.''
3. Quarterly Reporting--Sec.  39.19(c)(2)
    The Commission is adopting Sec.  39.19(c)(2), requirements for 
quarterly reporting of financial resources, as proposed.\222\
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    \222\ See further discussion of the quarterly reporting 
requirement under Sec.  39.11(f) in section IV.B.10, above.
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4. Annual Reporting--Sec.  39.19(c)(3)
    Proposed Sec.  39.19(c)(3) would require a DCO to submit a report 
of the CCO and an audited financial statement annually, as required by 
Sec.  39.10(c). The Commission received no comments on proposed Sec.  
39.19(c)(3), and the Commission is adopting Sec.  39.19(c)(3) as 
proposed.
    The Commission notes that in a separate proposed rulemaking 
implementing Core Principle O (Governance Fitness Standards), it 
proposed a new Sec.  39.24(b)(4) which would require annual 
verification that directors, members of the disciplinary panel and 
disciplinary committee, clearing members, persons with direct access, 
and certain affiliates of a DCO, satisfy applicable fitness 
standards.\223\ In connection with this, the Commission subsequently 
proposed to cross-reference this annual reporting obligation as a 
renumbered Sec.  39.19(c)(3)(iii). At such time as the Commission may 
adopt the verification requirement as a final rule, Sec.  39.19(c)(3) 
will be amended accordingly.
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    \223\ See 76 FR at 736 (Jan. 6, 2011) (Governance).
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5. Event-Specific Reporting--Sec.  39.19(c)(4)
a. Decrease in Financial Resources--Sec.  39.19(c)(4)(i)
    Under proposed Sec.  39.19(c)(4)(i), a DCO would be required to 
report to the

[[Page 69401]]

Commission a 10 percent decrease in the total value of the financial 
resources required to be maintained by the DCO under Sec.  39.11(a), 
either from the last quarterly report. or from the value as of the 
close of the previous business day. Such notification would alert the 
Commission of potential strain on the DCO's financial resources, either 
gradual or precipitous.
    The Commission invited comments regarding possible alternatives as 
to what would be considered a significant drop in the value of 
financial resources. Although many commenters opposed using the 10 
percent threshold as a barometer for a ``significant'' decrease, no 
commenter questioned the Commission's objective in obtaining this type 
of information in a timely manner.
    MGEX commented that 10 percent is an arbitrary threshold and it is 
not uncommon for financial resources to fluctuate by 10 percent even in 
a stable market. Similarly, OCC and KCC stated that the threshold is 
arbitrary and would most likely be crossed on a frequent basis during 
the ordinary course of business.\224\ In addition, KCC suggested that 
this requirement is duplicative, as a material drop in financial 
resources would already be required to be reported by the proposed 
requirement to report all material adverse changes (Material Adverse 
Change Reporting Requirement).\225\
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    \224\ KCC mentioned that changes in the level of excess 
permanent margin deposited by clearing members, changes in the 
minimum margin requirements on contracts or in the level of the 
guarantee pool requirements, and changes in the level of assessments 
that can be levied against clearing members in the event of a 
default, could cause financial resources to drop more than 10 
percent within the ordinary course of business. OCC stated it would 
cross the 10 percent threshold on an almost monthly basis, i.e., the 
day after monthly expirations occur.
    \225\ See discussion of proposed Sec.  39.19(c)(4)(xiv) 
(finalized as Sec.  39.19(c)(4)(xii)) in section IV.J.5.k, below.
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    OCC, Better Markets, and Mr. Barnard were also concerned about the 
types of financial resources to consider when calculating a decrease. 
OCC suggested it is counterproductive to report a decrease in financial 
resources as a result of a decrease in margin requirements, which is a 
sign of risk reduction. Similarly, Better Markets suggested that 
coincidental increases in margin-based financial resources, which could 
fluctuate substantially, could offset decreases by more important 
financial resources. In addition, Mr. Barnard raised concerns 
regarding: (1) Grouping all types of financial resources together for 
purposes of calculating decreases, and (2) whether only requiring a 
report of a decrease in financial resources is sufficient.
    Several commenters proposed using a different threshold: (1) OCC 
suggested 25 percent; (2) MGEX suggested allowing a DCO to determine 
what constitutes a material decrease or, as an alternative, adopting a 
threshold of 30 percent over a five-day period and 25 percent when 
compared to the previous quarter; and (3) Better Markets suggested 
adopting a threshold of 5 percent of non-margin-based financial 
resources. NYPC recommended taking an approach similar to the FCM 
``early warning'' reporting requirement.\226\
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    \226\ Section 1.12(b)(2) requires an FCM to give 24 hours notice 
to the Commission if it ``knows or should have known'' that its 
adjusted net capital is at any time less than 110 percent of the 
amount required by the Commission's net capital rule.
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    To compensate for an upwards adjustment of the financial resources 
requirement, Better Markets suggested also requiring a report if the 
ratio of financial resources to minimum required levels decreases to 1 
to 1. Mr. Barnard suggested splitting financial resources into two 
groups: (1) The more ``robust'' financial resources (a DCO's own 
capital and guaranty fund), and (2) market or risk-related items 
(margins); and requiring a report for a decrease in either amount or a 
decrease in the total of both amounts. Mr. Barnard also suggested 
requiring a DCO to report a calculation of its ``solvency ratio'' 
(available financial resources/financial resources requirements) and a 
5 percent or more drop in such ratio.
    In response to commenters' objections to setting the level at 10 
percent, the Commission is setting the reporting threshold at a level 
of 25 percent for both the daily and quarterly financial resources 
decreases. As noted, OCC suggested 25 percent while MGEX suggested 25 
percent for the quarterly and 30 percent for a report covering any 5-
day period. MGEX did not explain why there should be a distinction 
between the percentage decrease triggering the quarterly and shorter-
term reports. The Commission believes that a 25 percent level addresses 
the commenters' concerns about ``noise'' while providing the Commission 
with notification of material decreases.
    The Commission is not excluding certain financial resources from 
the decrease calculation as suggested by several commenters. Although 
there are certain financial resources that may fluctuate in the 
ordinary course of business, the Commission believes that setting the 
reporting threshold level higher should resolve many of these issues 
because fewer fluctuations that occur in the ordinary course of 
business would trigger the higher 25 percent threshold. Additionally, 
the purpose of the financial resources requirement in Core Principle B 
and as codified in the Commission's regulations is to ensure that a DCO 
has adequate resources to cover the default of the clearing member with 
the largest exposure. Financial resources are looked at in the 
aggregate. Thus, fluctuations during the ordinary course of business, 
even coincidental decreases in financial resources, all reflect the 
financial health of the DCO at that time.
    The Commission is not replacing the financial resources percentage 
decrease reporting requirement with a requirement similar to the FCM 
``early warning'' reporting requirement, as suggested by NYPC. While 
FCMs do have an ``early warning'' reporting requirement, this is only 
in addition to an FCM's requirement to also report decreases of 20 
percent pursuant to Sec.  1.12(g)(1).\227\ In fact, even with the new 
financial resources reporting requirement for DCOs, DCOs still have a 
lesser reporting requirement than FCMs in this regard: DCOs are only 
required to report 25 percent decreases, while FCMs are required to 
report 20 percent decreases in addition to reporting decreases below 
certain thresholds (the ``early warning'' requirement).
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    \227\ Section 1.12(g)(1) requires an FCM to provide written 
notice within two business days of a substantial reduction in 
capital as compared to that last reported in a financial report if 
there is a reduction in net capital of 20 percent or more.
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    The Commission is adopting the modified Sec.  39.19(c)(4)(i) 
reporting requirement described herein. The Commission does not 
consider it to be duplicative of the Material Adverse Change Reporting 
Requirement, or the quarterly financial resource reporting requirement 
under Sec.  39.11(f), as suggested by KCC. Each reporting requirement, 
including the financial resources reporting requirement, relates to 
specific circumstances that the Commission has determined to be 
material and which, based on its experience in conducting financial 
risk surveillance, the Commission believes warrants notification. The 
Material Adverse Change Reporting Requirement is intended to cover more 
unusual changes that are not readily identifiable in advance but would 
nonetheless be of interest to Commission staff in conducting its 
oversight of a DCO. The Commission is also not requiring the solvency 
ratio decrease reporting requirement suggested by Mr. Barnard. The 
Commission believes that receiving reports regarding financial 
resources decreases will serve the purpose of alerting the Commission 
to possible financial distress at a DCO, without

[[Page 69402]]

unnecessarily burdening a DCO with additional reporting requirements.
    NYPC pointed out that the proposed rule language referring to a 
decrease in the ``total value of financial resources'' could be read to 
refer to the total combined default and operating resources. It also 
raised a question as to whether the reference to financial resources 
``required to be maintained * * * under Sec.  39.11(a)'' referred to 
the minimum amount ``required'' or if it was intended to encompass all 
financial resources ``available to satisfy'' the requirements.
    The Commission intends the reporting requirement in Sec.  
39.19(c)(4)(i) to refer only to financial resources available to cover 
a default in accordance with Sec.  39.11(a)(1). A significant change in 
the amount of financial resources available to meet operating expenses 
is addressed by Sec.  39.19(c)(4)(iv).\228\ In response to the 
interpretive issues raised by NYPC, the Commission is revising the 
language in Sec.  39.19(c)(4)(i) to clarify that the decrease in 
financial resources refers to a decrease in resources ``available to 
satisfy the requirements under Sec.  39.11(a)(1)'' so it is clear that 
the reporting requirement applies only to default resources and refers 
to those resources available to the DCO to satisfy the default resource 
requirements, even if the amount of those resources exceeds the minimum 
amount that is required by Sec.  39.11(a)(1).\229\
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    \228\ See discussion of Sec.  39.19(c)(4)(iv) in section 
IV.J.5.d, below.
    \229\ As a technical matter, ICE Clear sought clarification in 
the rule text regarding the reference to Sec.  39.11(a), pointing 
out that Sec.  39.11(a) sets the standard for financial resources 
and Sec.  39.11(b) lists the financial resources available to 
satisfy those standards. ICE Clear recommended that Sec.  
39.19(c)(4)(i) be revised to refer to both Sec. Sec.  39.11(a) and 
(b). The Commission declines to include a reference to Sec.  
39.11(b) as the purpose of the cross-reference is to incorporate by 
reference the standard, not the means for satisfying the standard.
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    The Commission notes that it should be apprised when a DCO 
experiences a 25 percent decrease in the value of its default resources 
from the value as of the close of the previous business day, even if 
their value has increased substantially since the last quarterly 
report. Such a change could signal a significant change in a DCO's risk 
profile and early reporting will enable the Commission to take 
appropriate measures to facilitate proper risk management at the DCO.
b. Decrease in Ownership Equity--Sec.  39.19(c)(4)(ii)
    Proposed Sec.  39.19(c)(4)(ii) would require a DCO to report an 
expected 20 percent decrease in ownership equity two business days 
prior to the event (or two business days following the event, if the 
DCO does not and reasonably should not have known prior to the event). 
Such report must include pro forma financial statements (or current 
financial statements) reflecting the anticipated condition of the DCO 
following the decrease (or current condition). The report is intended 
to alert the Commission of major planned events that would 
significantly affect ownership equity, most of which are events of 
which the DCO would have advance knowledge, such as a reinvestment of 
capital, dividend payment, or a major acquisition.
    Better Markets commented that a decrease in ownership equity is an 
extraordinary event which would warrant notification for even a 5 
percent decrease, the threshold the SEC uses for triggering reporting 
of acquisition of beneficial ownership of a class of shares. While a 
decrease in ownership equity can have a significant effect on the 
financial resources of a DCO, the Commission determined that 20 percent 
is a level that would represent a significant decrease and yet would 
not occur on a frequent basis. The Commission believes that setting the 
threshold lower than 20 percent would unnecessarily increase the 
potential burden on DCOs as well as on the Commission, which could then 
be responsible for reviewing a larger number of reports.
    Better Markets also suggested that five business days advance 
notice is more appropriate and would not pose a significant burden for 
DCOs. While changing the requirement to five business days does not 
itself pose an additional burden on a DCO, the Commission is adopting 
the two-day notification requirement, as proposed. The Commission has 
determined that requiring the report two days prior to such an event is 
sufficient for its purposes in reviewing the transaction, particularly 
given the confidential nature of such a transaction.
    OCC expressed concern that it would be problematic to provide the 
necessary financial statements within the time frame required; OCC 
stated that it runs financial statements on a monthly basis, thus it 
would not have them readily available within two days. Rather, OCC 
suggested keeping the notification time frame at two days, but allowing 
up to 30 days, or when the financial statements are ready, whichever 
occurs first, to provide the financial statements. The Commission is 
adopting the two-day requirement, as proposed. A 20 percent decrease in 
ownership equity is generally a major, planned event and the Commission 
believes it would be highly unusual for a DCO not to have financial 
statements prepared in connection with such a transaction.
    The Commission is adopting Sec.  39.19(c)(4)(ii) as proposed.
c. Six-Month Liquid Asset Test--Sec.  39.19(c)(4)(iii)
    Proposed Sec.  39.19(c)(4)(iii) would require immediate notice of a 
deficit in the six months of liquid assets required by Sec.  
39.11(e)(2). CME expressed concern with other ``immediate notice'' 
events,\230\ stating that this would require a DCO to immediately 
notify the Commission, in the specific form and manner requested, even 
before the DCO attends to the situation and gathers all the relevant 
information. CME recommended only requiring ``prompt'' notice, which 
would require the DCO to notify the Commission ``quickly and 
expeditiously,'' while allowing the DCO to first attend to the 
situation at hand and ensure that the information reported to the 
Commission is correct and accurate. CME also suggested ``prompt'' 
notice for the Material Adverse Change Reporting Requirement.
---------------------------------------------------------------------------

    \230\ CME referred to the immediate notice required under 
proposed Sec. Sec.  39.19(c)(4)(v)-(ix).
---------------------------------------------------------------------------

    The Commission is adopting the rule as proposed and retaining the 
``immediate'' reporting requirement for both Sec.  39.19(c)(4)(iii) and 
the Material Adverse Change Reporting Requirement.\231\ While the 
Commission appreciates that in such situations a DCO would be busy 
attending to the matter at hand, the burden to contact the Commission 
is minimal. The Commission does not specify a particular form or manner 
of delivery, so as to minimize the burden on the DCO. Moreover, the 
Commission is concerned that using a time frame of ``prompt'' would 
leave too much open to interpretation by the DCO and could lead to 
untimely notices.
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    \231\ See further discussion of the Material Adverse Change 
Reporting Requirement in section IV.J.5.k, below.
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d. Change in Working Capital (Current Assets)--Sec.  39.19(c)(4)(iv)
    Proposed Sec.  39.19(c)(4)(iv) would require a DCO to report to the 
Commission no later than two business days after working capital is 
negative. The report must include a current balance sheet of the DCO. 
Better Markets commented that allowing a DCO two days to report 
negative working capital is too much time, given the potential gravity 
of the situation, and that anything less than a requirement of 
immediate notification is ``simply indefensible.''

[[Page 69403]]

    As with the ownership equity decrease reporting requirement, OCC 
commented that it is problematic to submit a balance sheet in two 
business days. OCC suggested keeping the notification requirement at 
two days, but allowing up to 30 days (or sooner if ready) to provide a 
balance sheet.
    The Commission is adopting Sec.  39.19(c)(4)(iv) as proposed, 
except that it is revising certain terminology to clarify the intended 
meaning of the term ``working capital.'' While the Commission agrees 
that negative working capital is a serious matter, immediate reporting 
is not necessary to further the Commission's purpose in obtaining this 
information. The Commission is allowing up to two days for notification 
because immediate notification would require a DCO to put in place a 
potentially expensive system to allow for real-time tracking of working 
capital. Nonetheless, a DCO is expected to have a general knowledge of 
the level of its working capital at all times. By allowing two days for 
notification, a DCO will have time to compute whether working capital 
is negative if it has reason to believe that this may be the case, 
without being required to implement a real-time notification system. 
Thus, the purpose of the two business days is actually to give a DCO 
time to become aware of its obligation to report, not to allow the DCO 
to wait two days after it becomes aware of the situation.
    The Commission is also requiring the DCO to submit a balance sheet 
within two business days of the DCO experiencing negative working 
capital. Given that a DCO would be expected to update its balance sheet 
upon realizing that it has negative working capital, the Commission 
does not believe this requirement imposes an additional burden on the 
DCO.
    As ``working capital'' is not a defined term, the Commission is 
substituting the term ``current assets'' for ``working capital'' for 
purposes of clarification. Thus, ``negative working capital'' now 
refers to a situation when current liabilities exceed current assets. 
Section 39.19(c)(4)(iv) now reads as follows: ``Change in current 
assets. No later than two business days after current liabilities 
exceed current assets; the notice shall include a balance sheet that 
reflects the derivatives clearing organization's current assets and 
current liabilities and an explanation as to the reason for the 
negative balance.''
e. Intraday Initial Margin Calls--Sec.  39.19(c)(4)(v)
    Proposed Sec.  39.19(c)(4)(v) would require a DCO to report to the 
Commission any intraday margin call to a clearing member, no later than 
one hour following the margin call. Several commenters stated that the 
requirement is unnecessary and a burden on DCOs, while other commenters 
requested certain modifications to the proposal.
    The Commission is not adopting the intraday margin call reporting 
requirement in proposed Sec.  39.19(c)(4)(v). While such information 
could provide early notice of potential problems at a DCO, the 
Commission has concluded that the requirement would be overly 
burdensome to DCOs given the amount of work commenters indicated it 
would entail. In addition, the Commission will still receive much of 
the same information as part of each DCO's daily reporting under Sec.  
39.19(c)(1), and unusual intraday initial margin calls that reflect a 
material adverse change will still be reported under the Material 
Adverse Change Reporting Requirement.
f. Issues Related to Clearing Members--Sec. Sec.  39.19(c)(4)(vi)-(ix)
    Proposed Sec. Sec.  39.19(c)(4)(vi)-(ix) would require a DCO to 
report the following issues related to clearing members: (1) A delay in 
collection of initial margin; (2) a request to clearing members to 
reduce positions; (3) a determination by the DCO to transfer or 
liquidate a clearing member position; and (4) a default of a clearing 
member. The Commission received comments suggesting that these 
reporting requirements are unnecessary or, at the very least, require 
some modification. KCC suggested not adopting these requirements 
altogether, because notification of these events would still be 
required under the Material Adverse Change Reporting Requirement.
    The Commission has concluded that delays in the collection of 
initial margin are not necessarily signs of a financial problem at 
either the DCO or its clearing members. The Commission therefore is not 
adopting the requirement to report such delays under proposed Sec.  
39.19(c)(4)(vi). Nonetheless, if a delay is evidence of a material 
adverse change in the financial condition of a clearing member, it 
would still have to be reported under the Material Adverse Change 
Reporting Requirement.
    The Commission is adopting the remainder of these reporting 
requirements as proposed. However, it is redesignating proposed 
Sec. Sec.  39.19(c)(4)(vii)-(ix) as Sec. Sec.  39.19(c)(4)(v)-(vii). 
These reporting requirements relate to events that occur infrequently 
but can be of significance to the Commission's risk surveillance 
program even if they do not rise to the level of having ``a material 
adverse financial impact'' on the DCO or represent ``a material adverse 
change in the financial condition of any clearing member'' under the 
Material Adverse Change Reporting Requirement. Thus, with respect to 
these reports, the Commission is not relying on the Material Adverse 
Change Reporting Requirement as suggested by KCC.
    In connection with these proposed requirements, the Commission also 
proposed removing Sec.  1.12(f)(1) in light of the fact that its 
requirements were substantially similar to those being proposed as 
Sec.  39.19(c)(4)(viii). The Commission did not receive any comments on 
this proposal and is removing Sec.  1.12(f)(1) as proposed.
g. Change in Ownership or Corporate or Organizational Structure--Sec.  
39.19(c)(4)(x)
    Proposed Sec.  39.19(c)(4)(x) would require a DCO to report certain 
changes in ownership or corporate or organizational structure. In 
general, such reports must be submitted to the Commission three months 
in advance of the anticipated change. With the exception of the change 
discussed below, the Commission is adopting Sec.  39.19(c)(4)(x) as 
proposed, redesignated as Sec.  39.19(c)(4)(viii).
    Proposed Sec.  39.19(c)(4)(x)(A)(2) (redesignated as Sec.  
39.19(c)(4)(viii)(A)(2)) would require a DCO to report the creation of 
a new subsidiary, or the elimination of a current subsidiary, of the 
DCO or its parent company. CME commented that the creation or 
elimination of a separate subsidiary of the DCO's parent company would 
not serve the Commission's purpose of conducting effective oversight of 
the DCO or enhance the Commission's ability to conduct timely analysis 
of a DCO's activities. CME added that the plans of a DCO's parent 
company to create (or eliminate) a subsidiary may be highly 
confidential.\232\ CME urged the Commission to eliminate such reporting 
requirement, asserting that ``the value of this information to the 
[Commission] is questionable, and the burdens associated with providing 
it may be substantial.'' CME did not provide any explanation as to why 
the burden of reporting might be substantial.
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    \232\ MGEX also commented on the highly confidential nature of 
changes in ownership, corporate or organizational structure. The 
Commission believes MGEX's concerns are addressed by the 
Commission's procedures for nonpublic records and confidential 
treatment requests set forth in Part 145 of the Commission's 
regulations.
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    While information about corporate changes that potentially impact a 
DCO's

[[Page 69404]]

financial standing or operations is helpful to the Commission in its 
oversight of a DCO, to avoid creating an unintended burden on DCOs and 
Commission staff, particularly where a DCO is part of a complex 
corporate structure, the Commission is modifying Sec.  
39.19(c)(4)(viii)(A)(2) to eliminate the requirement to report a change 
in subsidiaries of the DCO's parent company. Thus, Sec.  
39.19(c)(4)(viii)(A) now requires only that a DCO report ``[a]ny 
anticipated change in the ownership or corporate or organizational 
structure of the [DCO] or its parent(s) that would: * * * (2) Create a 
new subsidiary or eliminate a current subsidiary of the [DCO]. * * * 
\233\
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    \233\ As proposed, the provision referred to the DCO's ``parent 
company.'' The Commission is adopting a technical amendment to refer 
to the ``parent(s)'' to clarify that there could be more than one 
parent, such as in the case of a DCO owned by a joint venture, and 
the parent need not have any particular corporate form. For purposes 
of these reporting requirements, a ``parent'' is a direct parent, 
not an entity further up the chain of ownership.
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h. Change in Key Personnel--Sec.  39.19(c)(4)(xi)
    Proposed Sec.  39.19(c)(4)(xi) would require a DCO to report the 
departure or addition of any person who qualifies as ``key personnel,'' 
as defined in Sec.  39.2, no later than two business days following the 
change. KCC suggested requiring a report ``within a reasonable period 
of time.'' The Commission notes that key personnel are not likely to 
change often, and KCC did not provide any explanation as to why the two 
business day notification period is inappropriate. The Commission is 
adopting Sec.  39.19(c)(4)(xi) as proposed, but redesignated as Sec.  
39.19(c)(4)(ix).
i. Change in Credit Facility Funding Arrangement--Sec.  
39.19(c)(4)(xii)
    Proposed Sec.  39.19(c)(4)(xii) would require a DCO to report no 
later than one business day after a DCO changes an existing credit 
facility funding arrangement, is notified that such arrangement has 
changed, or knows or reasonably should have known that the arrangement 
will change. KCC commented that this requirement is duplicative: such 
reports would already be required by the Material Adverse Change 
Reporting Requirement. CME had no objection to the requirement to 
report such changes, but opposed the requirement to notify the 
Commission when it knows that the arrangement will change in the 
future, stating that it serves little purpose to notify the Commission 
without knowing what will change. CME suggested that the requirement 
should be to report to the Commission after the terms have changed. 
Conversely, Better Markets opposed several components of the proposed 
rule, asserting that it is ``too narrow and too loose,'' allowing one 
business day is too long, and the standard of reporting when the DCO 
``knows or reasonably should have known'' is insufficient. Better 
Markets suggested expanding the reporting requirement to cover 
alternative sources of liquidity such as access to commercial paper and 
repurchase agreement markets. It also suggested requiring such a report 
(i) immediately, and (ii) when ``there is a reasonable likelihood that 
the arrangement may change.''
    The Commission is modifying the rule as suggested by CME by 
removing the following: ``or knows or reasonably should have known that 
the arrangement will change.'' Thus, a DCO is required to report a 
change in a credit facility funding arrangement no later than one 
business day after it changes the arrangement or is notified that such 
arrangement has changed. The provision is also being redesignated as 
Sec.  39.19(c)(4)(x). The Commission is not adopting KCC's suggestion 
to rely on the Material Adverse Change Reporting Requirement because a 
change in a credit facility funding arrangement would be of specific 
interest to the Commission in its conduct of DCO oversight, but such a 
change is not likely to rise to the level of being a material adverse 
change. The Commission also is declining to adopt Better Markets' 
recommendations because they would result in the filing of multiple 
reports, many of limited usefulness, which, on balance, would place an 
unnecessary burden on DCOs and Commission staff. Nonetheless, the 
Commission notes that unusual market conditions such as those that 
might limit a DCO's access to commercial paper or ability to enter into 
repurchase agreements, thereby adversely affecting the DCO's liquidity, 
could constitute a material adverse change that would have to be 
reported under the Material Adverse Change Reporting Requirement.
j. Rule Enforcement--Sec.  39.19(c)(4)(xiii)
    Proposed Sec.  39.19(c)(4)(xiii) would require a DCO to report the 
initiation of a rule enforcement action against a clearing member or 
the imposition of sanctions against a clearing member, no later than 
two business days after the DCO takes such action. Several commenters 
observed that this would result in multiple reports with little useful 
information. They further noted that the DCO would otherwise inform the 
Commission about serious financial issues, as a matter of current 
practice and pursuant to the Material Adverse Change Reporting 
Requirement. MGEX recommended that the Commission not adopt the rule 
enforcement reporting requirement. OCC and CME recommended that the 
Commission not adopt the enforcement reporting requirement as proposed.
    MGEX commented that requiring notification of the initiation of 
rule enforcement is unnecessary and premature, noting that many 
investigations are unrelated to financial risk and many are routine. 
OCC made a similar comment. MGEX expressed concern about the harm such 
a report could cause to a clearing member's reputation by notifying the 
Commission before there has been any determination of any guilt. MGEX 
also noted that the Commission is already routinely informed or is 
aware of ongoing or potential actions.
    OCC stated that the proposed enforcement reports would serve no 
purpose because if there were serious financial issues, the DCO would 
already have been in regular contact with the Commission long before 
the DCO reached the stage of initiating a rule enforcement action. 
Thus, OCC believes these reports would not serve as an effective early 
warning sign. OCC further opposed this reporting requirement because a 
clearing member could appeal a decision after a sanction is imposed. 
OCC recommended notification to the Commission within 30 days after a 
final decision on a disciplinary matter.
    CME believes it is unclear when the notification requirement would 
be triggered, and that there are situations when it is unclear when an 
enforcement action is considered to be initiated.
    The Commission is adopting the rule with modifications. While the 
Commission considers information about enforcement actions to be useful 
in its oversight of a DCO's rule enforcement program under Core 
Principle H, and more broadly in its oversight of a DCO's overall risk 
management program, the Commission has concluded that the requirement, 
as proposed, could result in the reporting of many events that are not 
material to the Commission's oversight of a DCO.\234\ The Commission 
recognizes that many enforcement actions may be based on relatively 
minor offenses and are

[[Page 69405]]

unlikely to have a significant impact on a DCO's ability to manage risk 
related to the provision of clearing and settlement services.
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    \234\ Core Principle H provides in relevant part that ``each 
derivatives clearing organization shall * * * (iii) report to the 
Commission regarding rule enforcement activities and sanctions 
imposed against members and participants. * * * '' See also 
discussion of Sec.  39.17 in section IV.H, above.
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    Therefore, the Commission is adopting the regulation with a 
modification such that it would only require the reporting of sanctions 
against clearing members, no later than two business days after the DCO 
takes such action, and would not require the reporting of the 
initiation of rule enforcement actions. The Commission is also 
redesignating the provision as Sec.  39.19(c)(4)(xi). The Commission 
notes that events or circumstances that rise to the level of having a 
material adverse impact on a DCO's ability to comply with the 
requirements of Part 39, or relate to a material adverse change in the 
financial condition of any clearing member, whether or not they form 
the basis of an enforcement action, will have to be formally reported 
under Sec.  39.19(c)(4)(xii)(B) or (C), respectively.
    Last, OCC requested clarification as to whether the rule 
enforcement reporting requirement applies to DCO enforcement activities 
involving a clearing member that is only registered as a BD. The 
Commission confirms that the requirement to report the imposition of 
sanctions against clearing members does not apply to a DCO's clearing 
members that are registered as BDs only and engaged solely in 
securities-based transactions. However, insofar as such a clearing 
member's actions might have a material adverse impact on the DCO's 
ability to comply with the requirements of Part 39 or would constitute 
a material adverse change in the financial condition of a clearing 
member, the DCO would be required to submit a Material Adverse Change 
Report, as discussed below.
k. Financial Condition and Events (Material Adverse Change Reporting 
Requirement)--Sec.  39.19(c)(4)(xiv)
    Proposed Sec.  39.19(c)(4)(xiv) would require a DCO to immediately 
notify the Commission after the DCO knows or reasonably should have 
known of certain material adverse changes, i.e., the institution of any 
legal proceedings which may have a material adverse financial impact on 
the DCO; any event, circumstance or situation that materially impedes 
the DCO's ability to comply with part 39 of the Commission's 
regulations and is not otherwise required to be reported; or a material 
adverse change in the financial condition of any clearing member that 
is not otherwise required to be reported.\235\ CME and OCC are opposed 
to this ``catch-all'' requirement. In particular, CME is concerned that 
the requirement is too broad and thus would include a reporting 
requirement for anything that is technically in violation of Part 39, 
e.g., even if the DCO's email or Web site goes down temporarily. OCC 
also commented that the requirement is unnecessary because the 
Commission will be receiving adequate reporting as a result of other 
reporting requirements in Part 39 and the reporting requirements for 
FCMs. Alternatively, CME suggested requiring ``prompt'' notice, rather 
than ``immediate'' notice.
---------------------------------------------------------------------------

    \235\ Because of the potential impact on a DCO of an adverse 
change in the financial condition of a clearing member, this 
reporting requirement would apply to ``any'' clearing member, 
including one that is solely a BD engaging in securities activities.
---------------------------------------------------------------------------

    The Commission is adopting Sec.  39.19(c)(4)(xiv) as proposed, but 
redesignated as Sec.  39.19(c)(4)(xii). CME's concerns are unwarranted 
as the reporting requirement would only require reporting incidents 
that could have a material adverse effect on the DCO. A Web site 
temporarily going down would not necessarily be expected to have a 
``material'' adverse effect on the DCO. However, if it did have a 
material adverse impact, the Commission would expect it to be reported. 
The Commission recognizes that it is requiring a DCO to exercise its 
discretion in the first instance to determine what events trigger this 
reporting requirement, but the Commission considers this to be an 
appropriate responsibility for a DCO.
    Moreover, while the Commission will be getting information as a 
result of other Part 39 and FCM reporting requirements, there may be 
certain conditions or events that could materially impact a DCO that 
the Commission could not anticipate, yet about which it would still be 
important for the Commission to be notified. This is especially 
important in light of the Commission's decision not to adopt certain 
proposed reporting requirements, as discussed above.
    The Commission is also keeping the timing of the reporting 
requirement as ``immediate'' rather than ``prompt,'' as these are 
material changes for which immediate notification is essential and for 
which the more ambiguous ``prompt'' is not appropriate.\236\
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    \236\ See discussion of timing requirements in section IV.J.5.c, 
above.
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l. Financial Statements Material Inadequacies--Sec.  39.19(c)(4)(xv)
    Proposed Sec.  39.19(c)(4)(xv) would require a DCO to report 
material inadequacies in its financial statements. The Commission 
received no comments on this requirement, and the Commission is 
adopting Sec.  39.19(c)(4)(xv) as proposed (redesignated as Sec.  
39.19(c)(4)(xiii)), with the exception of a technical revision to add a 
reference to ``in a financial statement'' so that the language now 
reads ``If a derivatives clearing organization discovers or is notified 
by an independent public accountant of the existence of any material 
inadequacy in a financial statement, such derivatives clearing 
organization shall give notice. * * *'' \237\
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    \237\ The Commission is also making a technical non-substantive 
change by substituting the word ``shall'' for the word ``must'' to 
conform this provision with other provisions in Sec.  39.19.
---------------------------------------------------------------------------

m. Action of Board of Directors or Risk Management Committee--Sec.  
39.19(c)(4)(xvi)
    In a separate proposed rulemaking that would implement Core 
Principle P (Conflicts of Interest), the Commission proposed Sec.  
39.25(b), which would require a DCO to report when the board of 
directors of a DCO rejects a recommendation or supersedes an action of 
the DCO's Risk Management Committee, or when the Risk Management 
Committee rejects a recommendation or supersedes an action of its 
subcommittee.\238\ In connection with this, the Commission subsequently 
proposed to cross reference this reporting obligation in proposed Sec.  
39.19(c)(4)(xvi). At such time as the Commission may adopt the 
reporting requirement in Sec.  39.25(b) as a final rule, Sec.  
39.19(c)(4) will be amended accordingly.
---------------------------------------------------------------------------

    \238\ See 76 FR at 736 (Jan. 6, 2011) (Governance).
---------------------------------------------------------------------------

n. Election of Board of Directors--Sec.  39.19(c)(4)(xvii)
    In a separate proposed rulemaking that would implement Core 
Principles P (Conflicts of Interest) and Q (Composition of Governing 
Boards), the Commission proposed Sec.  40.9(b)(1)(iii), which would 
require a DCO to report certain information to the Commission after 
each election of its board of directors.\239\ In connection with this, 
the Commission subsequently proposed to cross-reference this reporting 
obligation in proposed Sec.  39.19(c)(4)(xvii). At such time as the 
Commission may adopt the reporting requirement in Sec.  40.9(b)(1)(iii) 
as a final rule, Sec.  39.19(c)(4) will be amended accordingly.
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    \239\ Id.
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o. System Safeguards--Sec.  39.19(c)(4)(xviii)
    Proposed Sec.  39.19(c)(4)(xviii) would require a DCO to report 
certain exceptional events and planned changes as required by Sec.  
39.18(g) and Sec.  39.18(h),

[[Page 69406]]

respectively. The Commission received no comments on this reporting 
requirement, and the Commission is adopting Sec.  39.19(c)(4)(xviii), 
redesignated as Sec.  39.19(c)(4)(xvi), as proposed.\240\
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    \240\ See discussion of system safeguards reporting in section 
IV.I, above.
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K. Core Principle K--Recordkeeping--Sec.  39.20

    Core Principle K,\241\ as amended by the Dodd-Frank Act, requires a 
DCO to maintain records of all activities related to the business of 
the DCO as a DCO, in a form and manner that is acceptable to the 
Commission and for a period of not less than 5 years. The Commission 
proposed Sec.  39.20 to establish requirements that a DCO would have to 
meet in order to comply with Core Principle K.
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    \241\ Section 5b(c)(2)(K) of the CEA, 7 U.S.C. 7a-1(c)(2)(K).
---------------------------------------------------------------------------

    Under proposed Sec.  39.20(b), a DCO would have to maintain records 
of all activities related to its business as a DCO ``for a period of 
not less than 5 years,'' except for swap data that must be maintained 
in accordance with the SDR rules in part 45 of the Commission's 
regulations. Mr. Barnard expressed the view that limiting record 
retention to five years is insufficient and records should be required 
to be kept indefinitely.
    The Commission is adopting Sec.  39.20 as proposed. The Commission 
believes that codifying the statutory minimum requirement of five years 
is appropriate, noting that a five-year minimum is consistent with 
other Commission recordkeeping requirements.\242\ In addition, the 
exception for swap data recordkeeping addresses situations where the 
Commission has previously determined that a five-year minimum may not 
be sufficient.\243\
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    \242\ See, e.g., Sec.  1.31 of the Commission's regulations.
    \243\ See 75 FR 76574 (Dec. 8, 2010) (Swap Data Recordkeeping 
and Reporting Requirements).
---------------------------------------------------------------------------

L. Core Principle L--Public Information--Sec.  39.21

    Core Principle L,\244\ as amended by the Dodd-Frank Act, requires a 
DCO to provide market participants sufficient information to enable the 
market participants to identify and evaluate accurately the risks and 
costs associated with using the DCO's services. More specifically, a 
DCO is required to make available to market participants information 
concerning the rules and operating and default procedures governing its 
clearing and settlement systems and also to disclose publicly and to 
the Commission the terms and conditions of each contract, agreement, 
and transaction cleared and settled by the DCO, each clearing and other 
fee charged to members,\245\ the DCO's margin-setting methodology, 
daily settlement prices, and other matters relevant to participation in 
the DCO's clearing and settlement activities.
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    \244\ Section 5b(c)(2)(L) of the CEA, 7 U.S.C. 7a-1(c)(2)(L).
    \245\ The statutory language refers to fees charged to ``members 
and participants,'' and the Commission interprets this phrase to 
mean fees charged to ``clearing members.''
---------------------------------------------------------------------------

    Proposed Sec.  39.21 would require a DCO to provide market 
participants with sufficient information to enable the market 
participants to identify and evaluate accurately the risks and costs 
associated with using the services of the DCO. In particular, proposed 
Sec. Sec.  39.21(c)(2), (3) and (4) would require a DCO to disclose 
publicly and to the Commission information concerning its margin-
setting methodology and the size and composition of the financial 
resource package available in the event of a clearing member default.
    KCC, MGEX, and NGX variously commented that DCO fees and charges, 
margin methodology and financial resource information are confidential 
and should not be required to be publicly disclosed for the following 
reasons: (1) It is intellectual property, (2) there is no correlation 
between the availability of such information and the decision whether 
to invest in or trade with a DCO, and (3) privately held companies (or 
non-intermediated DCOs in the case of NGX) should not have to disclose 
such information. MGEX also suggested that making margin methodology 
information available to the public could lead to market manipulation 
by those who might attempt to influence the margin level. MGEX 
suggested that the rule should only require making the financial 
resource package information available upon request by a clearing 
member that has signed the DCO's confidentiality agreement. Conversely, 
Better Markets believes that Sec.  39.21 does not go far enough and 
that many of the DCO reports required by Sec.  39.19 should also be 
required to be disclosed to the public, as the Dodd-Frank Act requires 
that market participants and the public be informed of the risks and 
other potential consequences of transacting with a DCO.\246\ Similarly, 
Mr. Barnard suggested requiring public disclosure of all items of 
public interest, including event-specific reports under Sec.  
39.19(c)(4), except for those that would expose business-specific 
confidential issues.
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    \246\ In particular, Better Markets stated that, at a minimum, a 
DCO should be required to publicly disclose (i) the adequacy of its 
financial resources, measured by the required level of financial 
resources under Commission rules, and (ii) to the extent they must 
be reported to the Commission, a reduction in financial resources, 
decrease in ownership equity, or change in ownership or corporate 
structure.
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    The Commission is adopting Sec.  39.21 as proposed, except for 
proposed Sec.  39.21(c)(7), which would require the public disclosure 
of information related to governance and conflicts of interest in 
accordance with provisions that were proposed in a separate rulemaking. 
At such time as the Commission adopts those provisions, Sec.  39.21 
will be amended accordingly. The requirement to publicly disclose 
clearing and other fees charged by the DCO, margin methodology and 
financial resources information comes directly from Core Principle L. 
Moreover, the Commission believes that concerns regarding the 
confidential nature of this information are unfounded because such 
information would seem to be fundamental to a clearing member or 
potential clearing member's assessment of the strengths and weaknesses 
of a DCO. This does not necessarily require disclosure of proprietary 
information; certain DCOs, e.g., CME, already disclose this type of 
information on their Web sites.
    The Commission is not revising the rule to incorporate Better 
Markets' or Mr. Barnard's proposals. From a practical standpoint, some 
of the information Better Markets and Mr. Barnard have requested to be 
publicly disclosed is otherwise going to be public information, 
particularly if the DCO is a public company, and thus subject to SEC 
filing requirements. Regardless, the Commission does not interpret Core 
Principle L as requiring disclosure of all of the financial workings of 
a DCO.

M. Core Principle M--Information Sharing--Sec.  39.22

    Core Principle M,\247\ as amended by the Dodd-Frank Act, requires a 
DCO to enter into and abide by the terms of each appropriate and 
applicable domestic and international information-sharing agreement and 
to use relevant information obtained under such agreements in carrying 
out its risk management program. The Commission proposed Sec.  39.22 to 
codify the statutory requirement.
---------------------------------------------------------------------------

    \247\ Section 5b(c)(2)(M) of the CEA, 7 U.S.C. 7a-1(c)(2)(M).
---------------------------------------------------------------------------

    Proposed Sec.  39.22 would require a DCO to enter into certain 
information-sharing agreements and use relevant information obtained 
from those

[[Page 69407]]

agreements in carrying out the risk management program of the DCO. MGEX 
is opposed to sharing confidential information such as proprietary 
intellectual property. MGEX also asked for further clarity to be able 
to comment further on this requirement.
    The Commission is adopting Sec.  39.22 as proposed. The provision 
purposely lacks specific details to allow each DCO the discretion to 
make its own determination as to which information-sharing agreements 
are necessary and appropriate, including taking into account 
confidentiality concerns. DCOs may seek further guidance from 
Commission staff if they have specific questions about existing or 
potential information-sharing arrangements.

N. Core Principle N--Antitrust Considerations--Sec.  39.23

    Core Principle N,\248\ as amended by the Dodd-Frank Act, conforms 
the standard for DCOs with the standard applied to DCMs under Core 
Principle 19.\249\ Proposed Sec.  39.23 would codify Core Principle N. 
CME commented that the proposed regulation is adequate, and the 
Commission is adopting the rule as proposed.
---------------------------------------------------------------------------

    \248\ Section 5b(c)(2)(N) of the CEA, 7 U.S.C. 7a-1(c)(2)(N).
    \249\ See Section 5(d)(19) of the CEA, 7 U.S.C. 7(d)(19) (DCM 
Core Principle 19).
---------------------------------------------------------------------------

O. Core Principle R--Legal Risk--Sec.  39.27

    Section 725(c) of the Dodd-Frank Act sets forth a new Core 
Principle R (Legal Risk).\250\ Core Principle R requires a DCO to have 
a well-founded, transparent, and enforceable legal framework for each 
aspect of the DCO's activities. Proposed Sec.  39.27 would set forth 
the required elements of such a legal framework. The Commission 
solicited comment as to the legal risks addressed in proposed Sec.  
39.27 and whether the rule should address additional legal risks.
---------------------------------------------------------------------------

    \250\ Section 5b(c)(2)(R) of the CEA, 7 U.S.C. 7a-1(c)(2)(R).
---------------------------------------------------------------------------

    CME commented that proposed Sec.  39.27(c)(1), which would require 
a DCO that provides clearing services outside the United States to 
identify and address all conflict of law issues, should only require a 
DCO to identify and address any ``material'' conflict of law issues. 
The Commission agrees with CME that a DCO should not be burdened to 
identify non-material conflict of law issues and has revised Sec.  
39.27(c)(1) to provide that such a DCO must identify and address ``any 
material conflict of law issues.'' The Commission is otherwise adopting 
the rule as proposed.

P. Special Enforcement Authority for 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 \251\ 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. Proposed Sec.  
39.31 would codify this special authority. The Commission did not 
receive any comments on this provision. Nevertheless, as discussed 
above in connection with the proposals relating to SIDCO financial 
resources and system safeguards for SIDCOs, the Commission is not 
finalizing the rules relating to SIDCOs at this time. The Commission 
expects to consider all the proposals relating to SIDCOs together in 
the future.
---------------------------------------------------------------------------

    \251\ 12 U.S.C. 1818.
---------------------------------------------------------------------------

V. Part 140 Amendments--Delegations of Authority

    Under Sec.  140.94, the Commission delegates the authority to 
perform certain functions that are reserved to the Commission to the 
Director of the Division of Clearing and Risk. In connection with the 
regulations the Commission is adopting herein, as well as previously 
adopted Sec.  39.5, the Commission is amending Sec.  140.94 to delegate 
authority to perform certain functions to the Director of the Division 
of Clearing and Risk, as discussed below.
    With respect to DCO applications, under Sec.  140.94(a)(6), the 
Commission is delegating authority to determine whether a DCO 
application is materially complete under Sec.  39.3(a)(2), and to 
request that an applicant submit supplemental information in order for 
the Commission to process a DCO application under Sec.  39.3(a)(3).
    In addition to the authority delegated to the Director of the 
Division of Clearing and Risk in connection with the Commission's final 
rulemaking for Sec.  39.5,\252\ Sec.  140.94(a)(7) delegates authority 
to request specific additional information as part of a DCO's swap 
submission under Sec.  39.5(b)(3)(ix).
---------------------------------------------------------------------------

    \252\ The Commission has already delegated authority to the 
Director of the Division of Clearing and Risk to: (1) consolidate 
multiple swap submissions from one DCO or subdivide a submission as 
appropriate for review under Sec.  39.5(b)(2); and request 
information from a DCO to assist the Commission's review of a 
clearing requirement that has been stayed under Sec.  39.5(d)(3). 
See 76 FR at 44474 (July 26, 2011) (Process for Review of Swaps for 
Mandatory Clearing; final rule).
---------------------------------------------------------------------------

    Section 140.94(a)(8) delegates authority to grant an extension of 
time for a DCO to file its annual compliance report under Sec.  
39.10(c)(4)(iv).
    With respect to financial resources requirements for DCOs, Sec.  
140.94(a)(9) delegates authority to: (1) determine whether a particular 
financial resource may be used to satisfy the requirements of Sec.  
39.11(a)(1) under Sec.  39.11(b)(1)(vi); (2) determine whether a 
particular financial resource may be used to satisfy the requirements 
of Sec.  39.11(a)(2) under Sec.  39.11(b)(2)(ii); (3) review the 
methodology used to compute the requirements of Sec.  39.11(a)(1) and 
require changes as appropriate under Sec.  39.11(c)(1); (4) review the 
methodology used to compute the requirements of Sec.  39.11(a)(2) and 
require changes as appropriate under Sec.  39.11(c)(2); (5) request 
financial reporting from a DCO (in addition to the quarterly reports) 
under Sec.  39.11(f)(1); and (6) grant an extension of time for a DCO 
to file its quarterly financial report under Sec.  39.11(f)(4).
    Section 140.94(a)(10) delegates authority to request the periodic 
financial reports of a DCO's clearing members that are not FCMs under 
Sec.  39.12(a)(5)(i)(B).
    With respect to risk management requirements, Sec.  140.94(a)(11) 
delegates authority to: (1) Review percentage levels for customer 
initial margin requirements and require different percentage levels if 
levels are deemed insufficient under Sec.  39.13(g)(8)(ii); (2) review 
methods, thresholds, and financial resources and require the 
application of different methods, thresholds, and financial resources 
as appropriate (relating to risk limits on clearing members) under 
Sec.  39.13(h)(1)(i)(C); (3) review the amount of additional initial 
margin required of a clearing member permitted to exceed its risk 
threshold and require a different amount as appropriate under Sec.  
39.13(h)(1)(ii); (4) review the selection of accounts and methodology 
used in daily stress testing of large trader positions and require 
changes as appropriate under Sec.  39.13(h)(3)(i); (5) review 
methodology for weekly stress testing of clearing member accounts and 
swap portfolios and require changes as appropriate under Sec.  
39.13(h)(3)(ii); and (6) request clearing member information and 
documents regarding their risk management policies, procedures, and 
practices under Sec.  39.13(h)(5)(i)(A).
    With respect to rule submissions and 4d petitions relating to the 
commingling of futures, options on futures, and cleared swaps in a 
cleared swaps

[[Page 69408]]

account or futures account, respectively, Sec.  140.94(a)(12) delegates 
authority to request additional information in support of a rule 
submission, under Sec.  39.15(b)(2)(iii)(A), and to request additional 
information in support of a 4d petition, under Sec.  
39.15(b)(2)(iii)(B).
    With respect to DCO reporting requirements, Sec.  140.94(a)(13) 
delegates authority to: (1) Grant an extension of time for filing of 
reports required to be filed annually under Sec.  39.19(c)(3)(iv); (2) 
request that a DCO file information related to its business as a 
clearing organization, including information relating to trade and 
clearing details, under Sec.  39.19(c)(5)(i); (3) request that a DCO 
file a written demonstration that the DCO is in compliance with one or 
more core principles and relevant rule provisions under Sec.  
39.19(c)(5)(ii); and (4) request that a DCO file, for each clearing 
member, by customer origin, the end-of day positions for each 
beneficial owner under Sec.  39.19(c)(5)(iii).
    Finally, Sec.  140.94(a)(14) delegates authority to permit a DCO to 
refrain from publishing on its Web site information that is otherwise 
required to be published under Sec.  39.21(d).

VI. Effective Dates

    For purposes of publication in the Code of Federal Regulations, all 
of the rules adopted herein will have an effective date of 60 days 
after publication in the Federal Register. The Commission received a 
number of comments, however, that discussed a DCO's need for time to 
develop appropriate systems and procedures to come into compliance with 
some of the rules. The Commission is extending the date by which DCOs 
must come into compliance for certain rules as follows:
    DCOs must comply with the following rules 180 days after 
publication in the Federal Register: Financial resources--Sec.  39.11; 
participant and product eligibility--Sec.  39.12; risk management--
Sec.  39.13 (except gross margin--Sec.  39.13(g)(8)(i)); and settlement 
procedures--Sec.  39.14.
    DCOs must comply with the following rules 1 year after publication 
in the Federal Register: chief compliance officer--Sec.  39.10(c); 
gross margin--Sec.  39.13(g)(8)(i); system safeguards--Sec.  39.18; 
reporting--Sec.  39.19; and recordkeeping--Sec.  39.20.

VII. Section 4(c)

    Proposed Sec. Sec.  39.15(b)(2)(i) and 39.15(b)(2)(ii) would 
establish procedures for permitting futures and options on futures to 
be carried in a cleared swaps account (subject to Section 4d(f) of the 
CEA), and for cleared swaps to be carried in a futures account (subject 
to Section 4d(a) of the CEA), respectively. In connection with 
proposing those rules, the Commission proposed to grant an exemption 
under Section 4(c) of the CEA and requested comment on its proposed 
exemption.\253\
---------------------------------------------------------------------------

    \253\ See 76 FR at 3715-3716 (Jan. 20, 2011) (Risk Management).
---------------------------------------------------------------------------

    Section 4(c) of the CEA provides that, in order to promote 
responsible 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.\254\
---------------------------------------------------------------------------

    \254\ 7 U.S.C. 6(c).
---------------------------------------------------------------------------

    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 swaps 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.
    Under the proposed exemption, a 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 swaps account 
subject to Section 4d(f) of the CEA, instead of a futures account; and 
similarly, a 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 swaps 
account. For the reasons discussed below, the Commission has determined 
to grant the exemption under Section 4(c) of the CEA.
    In the notice of proposed rulemaking, the Commission expressed its 
view 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. 
However, the Commission solicited public comment on whether the 
proposed regulations would satisfy the requirements for exemption under 
Section 4(c) of the CEA.
    The Commission received one comment. CME supported the Commission's 
conclusion, agreeing that in appropriate circumstances, the commingling 
of customer positions in futures, options on futures, and cleared swaps 
could achieve important benefits with respect to greater capital 
efficiency resulting from margin reductions for correlated positions. 
CME believes that adoption of a regulation permitting such commingling 
would be consistent with the public interest, adding that ``[h]aving 
positions in a single account can also enhance risk management 
practices and systemic risk containment by allowing the customer's 
portfolio to be handled in a coordinated fashion in a transfer or 
liquidation scenario.''
    In light of the foregoing, the Commission finds that permitting the 
commingling of positions pursuant to Sec. Sec.  39.15(b)(2)(i) and 
39.15(b)(2)(ii) will promote responsible economic and financial 
innovation and fair competition, and is consistent with the ``public 
interest,'' as that term is used in Section 4(c) of the CEA.

VIII. Considerations of Costs and Benefits

    Section 15(a) of the CEA requires the Commission to ``consider the 
costs and benefits'' of its actions before promulgating a 
regulation.\255\ In particular, these costs and benefits must 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. In conducting its evaluation, the Commission 
may, in its discretion, give greater weight to any one of the five 
enumerated areas and it may determine that, notwithstanding

[[Page 69409]]

costs, a particular rule is necessary to protect the public interest or 
to effectuate any of the provisions or to accomplish any of the 
purposes of the CEA.\256\
---------------------------------------------------------------------------

    \255\ 7 U.S.C. 19(a).
    \256\ See, e.g., Fisherman's Doc Co-op., Inc v. Brown, 75 F.3d 
164 (4th Cir. 1996); Center for Auto Safety v. Peck, 751 F.2d 1336 
(D.C. Cir. 1985) (noting that an agency has discretion to weigh 
factors in undertaking cost-benefit analysis). Section 3 of the CEA 
states the purposes of the Act:
    It is the purpose of this Act to serve the public interests 
described in subsection (a) through a system of effective self-
regulation of trading facilities, clearing systems, market 
participants and market professionals under the oversight of the 
Commission. To foster these public interests, it is further the 
purpose of this Act to deter and prevent price manipulation or any 
other disruptions to market integrity; to ensure the financial 
integrity of all transactions subject to this Act and the avoidance 
of systemic risk; to protect all market participants from fraudulent 
or other abusive sales practices and misuses of customer assets; and 
to promote responsible innovation and fair competition among boards 
of trade, other markets and market participants.
---------------------------------------------------------------------------

    In the following discussion, the Commission presents its 
considerations of the costs and benefits of the final rulemaking in 
light of the comments it received, other relevant data and information, 
and the five broad areas of market and public concern as required by 
section 15(a) of the CEA.

A. Background

    A derivatives clearing organization (DCO) is an entity registered 
with the Commission through which derivatives transactions are cleared 
and settled. A DCO acts as a central counterparty, serving principally 
to ensure performance of the contractual obligations of the original 
counterparties to derivatives transactions and to manage and mitigate 
counterparty risk and systemic risk in the markets they serve. This is 
accomplished by interposing the DCO between the counterparties so that 
the DCO becomes the buyer to every seller and the seller to every 
buyer. Upon novation by the original parties to a transaction, the 
contractual obligations of the original parties to one another are 
extinguished and replaced by a pair of equal and opposite transactions 
between the DCO and the counterparties or their agents.
    The DCO's role as central counterparty potentially exposes the DCO 
itself to risk from every user whose transactions are cleared through 
the DCO. Conversely, if a DCO itself fails or suffers a risk of 
failure, the consequences for the market at large are likely to be 
serious and widespread. Effective risk management, therefore, is 
critical to the functioning of a marketplace in which swaps are cleared 
through DCOs.
    Clearing members are the entities that deal directly with DCOs. 
They may be acting on their own behalf or as agents. DCOs establish 
rules and risk management requirements for their clearing members, 
which typically include specified levels of financial resources, 
operational capacity, and risk management capability; deposit of risk-
based initial margin and payment of daily variation margin sized to 
cover current and potential losses of the member; and contribution to a 
guaranty fund that can be used in the event of a clearing member 
default. These requirements lower systemic risk by reducing the 
likelihood of a clearing member default and, in the event a clearing 
member default does occur, reducing the likelihood that it will result 
in the default of other market participants.
    Additionally, unlike bilateral derivatives transactions where 
parties do not know the exposures their counterparties have to other 
market participants, as a result of the multilateral nature of 
centralized clearing, DCOs have a real-time, more complete picture of 
each clearing member's risk exposure to multiple parties. Thus the DCO 
can more effectively and quickly identify developing risk exposures for 
individual clearing members and better manage these risks if clearing 
members become distressed.

B. General Comments and Considerations

    The Dodd-Frank Act is intended to facilitate stability in the 
financial system of the United States by reducing risk, increasing 
transparency, and promoting market integrity. To accomplish these 
objectives, among other things, the Dodd-Frank Act provides for the 
mandatory clearing of certain swaps by DCOs and explicitly authorizes 
the Commission to promulgate rules to establish appropriate standards 
for DCOs in carrying out their risk mitigation function. Regulatory 
standards for DCOs will serve to assure market participants that credit 
and other risks associated with cleared swap transactions are being 
appropriately managed by DCOs. This, in turn, can promote the use of 
cleared swaps. Regulatory standards also can foster market confidence 
in the integrity of the derivatives clearing system.
    In this final rulemaking, the Commission is adopting regulations to 
implement 15 DCO core principles: A (Compliance), B (Financial 
Resources), C (Participant and Product Eligibility), D (Risk 
Management), E (Settlement Procedures), F (Treatment of Funds), G 
(Default Rules and Procedures), H (Rule Enforcement), I (System 
Safeguards), J (Reporting), K (Recordkeeping), L (Public Information), 
M (Information Sharing), N (Antitrust Considerations), and R (Legal 
Risk). In addition, the Commission is adopting regulations to implement 
the Chief Compliance Officer provisions of Section 725 of the Dodd-
Frank Act, and to update the regulatory framework for DCOs to reflect 
standards and practices that have evolved over the past decade since 
the enactment of the CFMA.
    This rulemaking process has generated an extensive record, which is 
discussed at length throughout this notice as it relates to the 
substantive provisions in the final rules. A number of commenters 
expressed the view that there would be significant costs associated 
with implementing and complying with proposed rules. The Commission 
also received comments from KCC, CME, and OCC who stated generally that 
the cost-benefit analysis presented in the proposed rulemakings was 
insufficient. The Commission has carefully considered alternatives 
suggested by commenters, and in a number of instances, for reasons 
discussed in detail above, has adopted such alternatives or 
modifications to the proposed rules where, in the Commission's 
judgment, the alternative or modified standard accomplishes the same 
regulatory objective in a more cost-effective manner.
    The Commission invited comments on the comprehensive or 
``systemic'' costs and benefits of the proposed rules. MFA and Better 
Markets addressed this issue stating that the Commission's cost-benefit 
analyses presented in the notices of proposed rulemaking may have 
understated the benefits of the proposed rules.\257\ MFA commented that 
the costs to market participants would be substantial if the Commission 
does not adopt the proposed regulations. Better Markets commented that 
the only reasonable way to consider costs and benefits of any of the 
Commission's rule proposals under Dodd-Frank is to view them as a 
whole. According to Better Markets:

    \257\ See Letter from Better Markets dated June 3, 2011; Letter 
from MFA dated March 21, 2011 (comment file for 76 FR 3698 (Risk 
Management)).

    It is undeniable that the Proposed Rules are intended and 
designed to work as a system. Costing-out individual components of 
the Proposed Rules inevitably double counts costs which are 
applicable to multiple individual rules. It also prevents the 
consideration of the full range of benefits that arise from the 
system as a whole that provides for greater stability, reduces

[[Page 69410]]

systemic risk and protects taxpayers and the public treasury from 
---------------------------------------------------------------------------
future bailouts.

    Better Markets believes that the benefits must include the avoided 
risk of a new financial crisis and the best measure of this benefit is 
the cost of the 2008 financial crisis, which is still accumulating. It 
cited Andrew G. Haldane, Executive Director, Financial Stability of the 
Bank of England, who estimated that the worldwide cost of the crisis in 
terms of lost output was between $60 trillion and $200 trillion, 
depending primarily on the long term persistence of the effects.
    The Commission agrees with Better Markets that the DCO rules 
operate in an integrated, systemic manner to ensure that the risks 
associated with cleared swap transactions are being appropriately 
managed or addressed by DCOs. When implemented in their entirety, these 
rules have the potential to significantly change not only the aggregate 
risk profile of the entire derivatives clearing industry, but also the 
allocation of risks among DCOs, clearing firms, and market 
participants. The final rules require DCOs to admit firms as clearing 
members that may differ substantially from existing members with 
respect to size, risk profiles, specializations, and risk management 
abilities. The rules also help create an environment in which DCOs will 
compete for the business of clearing trades of different sizes, and of 
many different derivatives products--both futures and swaps. In a 
potentially much more diverse range of both participants and products, 
these final rules will allow, and in some cases require, DCOs to make 
use of a number of risk management tools, including, among others, 
periodic valuation of financial resources; a potentially more rigorous 
design for margins; stress testing and back testing for financial 
resources and margin, respectively; and additional rules and procedures 
designed to allow for management of events associated with a clearing 
member defaulting on its obligations to the DCO. These rules help 
reduce the potential for DCO default, and the potential follow-on 
effects on financial markets as a whole. In addition, the daily, 
quarterly, annual, and event-specific reporting requirements for DCOs 
enhance the tools available to the Commission in conducting its 
financial risk surveillance in connection with derivatives clearing by 
DCOs.
    Certain of the regulations promulgated in this final rulemaking 
merely codify the requirements of the CEA, as amended by the Dodd-Frank 
Act, e.g., Sec. Sec.  39.10(a) and (b) (compliance with core 
principles); 39.17 (rule enforcement); 39.22 (information sharing); and 
39.23 (antitrust considerations). For such provisions, the Commission 
has not considered alternatives to the statute's prescribed 
requirements, even though a DCO may incur costs to comply with these 
provisions. As these requirements are imposed by the Dodd-Frank Act, 
any associated costs and benefits are the result of statutory 
directives, as previously determined by the Congress, that govern DCO 
activities independent of the Commission's regulations. By its terms, 
CEA Section 15(a) requires the Commission to consider and evaluate the 
prospective costs and benefits of regulations and orders of the 
Commission prior to their issuance; it does not require the Commission 
to evaluate the costs and benefits of the actions or mandates of the 
Congress.
    In its notice of proposed rulemaking, the Commission requested data 
or other information in connection with its cost-benefit 
considerations. The Commission received only a few comments providing 
quantitative information on the costs of the proposed rules. It 
received two comments on the benefits of the proposed rules.
    The Commission invited but did not receive public comments specific 
to, or related to, its consideration of costs and benefits for proposed 
Sec. Sec.  1.3, 39.1, 39.2, 39.4, 39.9, 39.16, 39.18, 39.20, 39.21, and 
39.27. However, the Commission received comments on substantive 
provisions of those proposed rules and such comments are addressed 
above.
    The following discussion summarizes the Commission's consideration 
of the costs and benefits of the final rules pursuant to CEA Section 
15(a).

C. Form DCO--Sec.  39.3(a)(2)

    Section 5b(c)(1) of the CEA provides that ``[a] person desiring to 
register as a derivatives clearing organization shall submit to the 
Commission an application in such form and containing such information 
as the Commission may require for the purpose of making the 
determinations required for approval under paragraph (2).'' Paragraph 
(2), which sets forth the 18 core principles applicable to DCOs, 
further provides in paragraph (i) that ``[t]o be registered and to 
maintain registration as a derivatives clearing organization, a 
derivatives clearing organization shall comply with each core principle 
described in this paragraph and any requirement that the Commission may 
impose by rule or regulation pursuant to section 8a(5) [of the CEA].'' 
Accordingly, the standard for approval of DCO registration is the 
applicant's ability to satisfy the DCO core principles.
    Proposed Sec.  39.3(a)(2) would require that any person seeking to 
register as a DCO submit a completed Form DCO, which would be provided 
as an appendix to part 39 of the Commission's regulations. The Form 
DCO, composed of a cover sheet and list of exhibits, would replace the 
general guidance contained in Appendix A to Part 39, ``Application 
Guidance and Compliance With Core Principles'' (Guidance), which was 
adopted by the Commission in 2001. In accordance with Section 5b(c) of 
the Act, the Form DCO is designed to elicit a demonstration that an 
applicant can satisfy each of the DCO core principles. Toward this end, 
the Form DCO requires submission of extensive information about an 
applicant's intended operations. This information has been required of 
applicants under the previous Guidance, and the use of the Form DCO 
does not represent a departure in substance from the Commission's 
practices over the past decade.
    Rather, as explained in the proposed rulemaking, the Form DCO was 
designed to standardize and clarify the information that the Commission 
has required from DCO applicants in the past, in an effort to 
facilitate a more streamlined and efficient application process. The 
Commission has learned from experience that the general guidance 
contained in the previous Appendix A did 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 the Commission requires to conclude 
that the applicant has demonstrated its ability to comply with the core 
principles.
    The Commission did not receive comments specifically with respect 
to its cost-benefit analysis of proposed Sec.  39.3(a)(2) or to its 
Paperwork Reduction Act estimate that the cost of preparing a completed 
application would be $100,000. The Commission notes that applicants for 
DCO registration will incur direct costs associated with the 
preparation of the completed Form DCO. However, because the Form DCO to 
a large extent captures information that has already been required by 
the Commission under the Guidance or, with respect to new core 
principles, captures information that tracks the statutory

[[Page 69411]]

requirements,\258\ the use of the Form DCO will not impose greater 
costs than have been imposed in the past. In fact, by providing greater 
clarity as to what is expected from an applicant and by reducing the 
need for Commission staff to request, and the applicant to provide, 
supplementary information, the Form DCO should reduce costs for 
applicants.
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    \258\ Exhibits O, P, and Q, relating to the requirements of Core 
Principles O (Governance Fitness Standards), P (Conflicts of 
Interest), and Q (Composition of Governing Boards), respectively.
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    As discussed in more detail in this notice of final rulemaking, the 
Commission received two comment letters that addressed the proposed 
Form DCO.\259\ The comments did not oppose the concept of the Form DCO. 
The comments were directed at the large amount of information required 
and the necessity of submitting certain specific information. One of 
the comment letters focused on the use of the Form DCO for amending an 
existing DCO registration, and the Commission has provided a 
clarification to address that commenter's concerns. The Commission has 
determined to adopt the final Form DCO largely as proposed, but it has 
modified several of the exhibits in response to specific comments.
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    \259\ See discussion in Section III.C.1, above.
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    The Commission has evaluated the costs and benefits of the required 
use of Form DCO, under Sec.  39.3(a)(2), in light of the specific 
considerations identified in Section 15(a) of the CEA as follows:
 1. Protection of Market Participants and the Public
Costs
    Applicants currently incur costs in demonstrating compliance with 
the core principles. As described above, based on the staff's 
experience in processing DCO applications over the last ten years, the 
Commission believes that use of the Form DCO will not increase, and 
often may decrease, the time and expense associated with applying for 
registration as a DCO for future applicants.
Benefits
    The Commission expects that use of the Form DCO will promote the 
protection of market participants and the public. Given the critical 
role that DCOs play in providing financial integrity to the markets for 
which they clear--which now include swaps as well as futures markets--
it is essential that the Commission conduct a comprehensive and 
thorough review of all DCO applications. Such review is essential for 
the protection of market participants and the public insofar as it 
serves to limit the performance of DCO functions to only those entities 
that have provided adequate demonstration that they are capable of 
satisfying the core principles.
2. Efficiency, Competitiveness, and Financial Integrity
Costs
    As noted, the Commission believes that use of the Form DCO will not 
increase, and often may decrease, the time and expense associated with 
applying for registration as a DCO for future applicants.
Benefits
    The Commission expects that use of the Form DCO will promote 
efficiency, competitiveness, and financial integrity. As discussed 
above, the CEA requires that prospective DCO registrants submit an 
application and comply with the core principles. In connection with 
these requirements, in 2001, the Commission adopted the Guidance to 
assist applicants in preparing application materials. However, the 
Commission's experience with protracted reviews of draft applications 
and materially incomplete final submissions has indicated a need for 
streamlining the application process.
    By requiring the use of Form DCO, the Commission is promoting 
increased efficiency by providing greater clarity to applicants before 
they undertake the application process, thereby facilitating the 
submission of a materially complete final application in the first 
instance. This will also reduce the need for submission of supplemental 
materials and consultation between applicants and the Commission staff. 
The result will be more cost effective and expeditious review and 
approval of applications. This will benefit applicants as well as free 
Commission staff to handle other regulatory matters.
    In addition, use of the Form DCO makes available to the public the 
Commission's informational requirements so that all prospective 
applicants have a heightened understanding of what is involved in the 
preparation and processing of an application. It promotes greater 
transparency in the process and will enhance competition among DCOs by 
making it easier for qualified applicants to undertake and navigate the 
application process in a timely manner.
    The Form DCO is designed to address an applicant's ability to 
comply with the core principles. Compliance with the core principles is 
essential to ensure the financial integrity of the derivatives clearing 
process and of derivatives markets, generally. In particular, the 
required information in Form DCO Exhibits B (financial resources), D 
(risk management), E (settlement procedures), F (treatment of funds), G 
(default rules and procedures) and I (system safeguards) elicits 
important information supporting the applicant's ability to operate a 
financially sound clearing organization that can provide reliable 
clearing and settlement services and appropriately manage the risks 
associated with its role as a central counterparty.
3. Price Discovery
    The Commission does not anticipate that use of the Form DCO will 
impact the price discovery process.
4. Sound Risk Management Practices
Costs
    As noted, the Commission believes that use of the Form DCO will not 
increase, and often may decrease, the time and expense associated with 
applying for registration as a DCO for future applicants.
Benefits
    The Commission expects that use of the Form DCO will promote sound 
risk management practices. Use of the Form DCO will reinforce sound 
risk management by requiring an applicant to examine its proposed risk 
management program through the preparation of a series of detailed 
exhibits. The submission of exhibits relating to risk management also 
make it easier for Commission staff to analyze and evaluate an 
applicant's ability to comply with Core Principle D (risk management, 
which includes monitoring and addressing credit exposure through margin 
requirements and other risk control mechanisms). Sound risk management 
practices are required by the CEA and Commission regulations, and are 
essential to the effective functioning of a DCO.
5. Other Public Interest Considerations
Costs
    As noted, the Commission believes that use of the Form DCO will not 
increase, and often may decrease, the time and expense associated with 
applying for registration as a DCO for future applicants.
Benefits
    There are considerable benefits to the public in standardizing and 
streamlining the DCO application process in terms of more efficient use 
of Commission resources and more cost-effective and transparent 
requirements for applicants. DCOs play a key role in

[[Page 69412]]

supporting the financial integrity of derivatives markets, and this 
role takes on even greater significance with the Dodd-Frank 
requirements for swaps clearing. A coherent and comprehensive approach 
to DCO registration is needed to ensure that only qualified applicants 
will be approved and that they are capable of satisfying the 
requirements of the core principles and Commission regulations.

D. Chief Compliance Officer--Sec.  39.10(c)

    Section 725(b) of the Dodd-Frank Act added a new paragraph (i) to 
Section 5b of the CEA to require each DCO to designate an individual as 
its CCO, responsible for the DCO's compliance with the CEA and 
Commission regulations and the filing of an annual compliance report.
    The provisions regarding the CCO in proposed Sec.  39.10(c) would 
largely codify Section 5b(i) of the CEA. There are certain provisions, 
however, that effectuate or implement the statutory requirements. For 
example, the proposed rules would require that the CCO have the 
appropriate background and skills for the position and not be 
disqualified from registration under Sections 8a(2) or 8a(3) of the 
CEA; meet with the board of directors or the senior officer at least 
once a year to discuss the DCO's compliance program; and perform duties 
including establishing a code of ethics. In addition, with respect to 
the annual report, the proposed rules would set forth certain content 
requirements (e.g., discussing areas for compliance program improvement 
and listing any material changes to compliance policies and procedures 
since the last annual report) and procedural requirements (e.g., 
submitting the annual report to the board of directors or senior 
officer prior to submitting the report to the Commission, and 
submitting the annual report not more than 90 days after the end of the 
DCO's fiscal year unless the Commission grants an extension of time.)
    As discussed in detail above, the Commission received a number of 
comments that supported the proposed rules for CCOs and the annual 
compliance report, and other comments that suggested alternatives or 
refinements to the Commission's proposed rules. Commenters did not 
provide any quantitative data regarding the costs to either DCOs or 
market participants and the public. The Commission addressed those 
comments above and, where appropriate, the final rules reflect 
commenters' suggestions.
    One commenter, MGEX, expressed concerns that relate to the 
Commission's implementation of the compliance framework established by 
Congress. MGEX stated that the regulations regarding organizational 
structure and reporting lines seem ``excessive and beyond what was 
contemplated by the passage of the Dodd-Frank Act.'' It also believes 
that the regulations do not ``guarantee improved market protection, 
which is one of the main goals of the Dodd-Frank Act.''
    The Commission does not agree with MGEX that the rules exceed what 
was contemplated by Congress. To a great extent the rules codify the 
relevant provisions of the CEA, as amended, and it was Congress, not 
the Commission, that specified the compliance framework that the 
Commission is now implementing. The additional requirements set forth 
by the rules are designed to increase the CCO's effectiveness and 
ensure that the annual report is a useful compliance and oversight 
tool.
    MGEX also commented that ``the rules will impose a cost and burden 
on the market that will be passed along to the market participants 
which decreases the overall efficiency and risk mitigation.'' MGEX did 
not provide any details to support its conclusion.
    The Commission disagrees with MGEX that the Commission's rules will 
impose such a significant burden on the market and market participants. 
The principal costs of the CCO requirement result from the statutory 
provisions of the CEA which, as amended by the Dodd-Frank Act, requires 
each DCO to designate a CCO and submit an annual compliance report. 
Although the Commission's rules would impose certain additional costs 
in order to implement this statutory requirement, these additional 
costs are not expected to significantly increase costs to the DCO or 
market participants. For example, a DCO may incur higher costs to the 
extent that it needs to pay a higher salary to a person who has the 
qualifications set forth in the rule to perform the statutory and 
regulatory duties of the CCO.\260\ The Commission believes that such 
costs are appropriate because it has determined that a CCO should have 
these qualifications to be effective, and notes that the standards are 
general enough to provide reasonable discretion to the DCO in its 
designation of a CCO.\261\ Similarly, a DCO may have to incur higher 
costs in terms of staff time to prepare an annual report that contains 
the information required by Sec.  39.10(c)(3), as opposed to a less 
comprehensive annual report. However, the Commission believes that the 
annual report must contain adequate information if it is to be useful 
to the DCO and the Commission. The Commission does not anticipate that 
these costs of hiring a qualified CCO, or of preparing a more detailed 
annual report, will be significantly higher than the costs to the DCO 
imposed by the basic statutory requirements for the CCO.\262\
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    \260\ The Commission believes that even in the absence of this 
specific rule many DCOs would employ well-qualified persons to 
perform the responsibilities of the statutorily-required CCO. In 
such circumstances this rule would not result in any additional 
costs for a DCO.
    \261\ As noted in section IV.A.3, above, the rules do not 
require that the person designated as the CCO hold that position, 
exclusively. A CCO may have dual responsibilities so long as the CCO 
can effectively carry out his or her duties as the CCO. Accordingly, 
depending on the skills and background of the personnel within a 
particular DCO, a DCO may be able to use an existing staff member to 
perform the duties of the CCO.
    \262\ In light of the variations that exist today among DCO 
compliance programs, including the qualifications of DCO compliance 
personnel, the Commission does not believe it is feasible to 
quantify the incremental costs associated with Sec.  39.10(c).
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    For purposes of the Paperwork Reduction Act, the notice of proposed 
rulemaking estimated the cost of preparing the annual report to be 
$8000 to $9000 per year. The Commission received no comments on this 
estimate. The Commission received comments that the annual report 
should be more limited than proposed. The Commission notes that those 
comments did not suggest limiting the annual report to achieve a more 
favorable cost-benefit ratio, and the Commission addressed those 
comments above.
    The Commission has evaluated the costs and benefits of Sec.  
39.10(c) in light of the specific considerations identified in Section 
15(a) of the CEA as follows:
1. Protection of Market Participants and the Public
Costs
    As discussed above, there are likely to be direct costs to DCOs in 
connection with designating a qualified CCO and annually preparing a 
comprehensive compliance report. To the extent that the Commission's 
regulations impose more specific or supplemental requirements when 
compared to those requirements explicitly imposed by Section 5b(i) of 
the CEA, those incremental costs are not likely to be significant. 
While it is possible that those incremental costs will be passed along 
to clearing members and market participants in the form of increased 
clearing fees, the size of those incremental costs, when spread across 
recipients of clearing services, are likely to be negligible.

[[Page 69413]]

Benefits
    The Commission believes that the CCO rules will protect market 
participants and the public by promoting compliance with the core 
principles and Commission regulations through the designation and 
effective functioning of the CCO, and the establishment of a framework 
for preparation of a meaningful annual review of a DCO's compliance 
program. While there may be incremental costs associated with 
imposition of the Commission's regulatory standards, those costs may be 
mitigated by the countervailing benefits of an effective compliance 
program that fosters financial integrity of the clearing process and 
responsible risk management practices to protect the public from the 
adverse consequences that would result from a DCO failure.
    The annual compliance report, in particular, will help the DCO and 
the Commission to assess whether the DCO has mechanisms in place to 
adequately address compliance issues and whether the DCO remains in 
compliance with the core principles and the Commission's regulations. 
Such compliance will protect market participants and the public.
2. Efficiency, Competitiveness, and Financial Integrity
Costs
    The Commission believes that designation of a qualified CCO who 
will effectively perform required duties, including the preparation of 
an annual compliance report, will not increase costs and is likely to 
lead to reduction of costs, in terms of the efficiency, 
competitiveness, and financial integrity of the derivatives markets.
Benefits
    Clearing is a critical component of the efficient, competitive, and 
financially sound functioning of derivatives markets. The financial 
integrity of these markets, in particular, is achieved through layers 
of protection. Requirements for an effective DCO compliance program 
will add a new layer of protection to ensure that the DCO remains 
compliant with the CEA and Commission regulations, especially relating 
to Core Principles B (financial resources), D (risk management), E 
(settlement procedures), F (treatment of funds), G (default rules and 
procedures), I (system safeguards), and N (antitrust considerations).
    An effective CCO will provide benefits to DCOs and the markets they 
serve by implementing measures that enhance the safety and efficiency 
of DCOs and reduce systemic risk. Reliable and financially sound DCOs 
are essential for the stability of the derivatives markets they serve, 
and for the greater public which benefits from a sound financial 
system.
3. Price Discovery
    The Commission does not anticipate that Sec.  39.10(c) will impact 
the price discovery process.
4. Sound Risk Management Practices
Costs
    The Commission does not believe that the CCO provisions will impose 
costs in terms of sound risk management practices. To the contrary, the 
Commission perceives there to be benefits that will result from its CCO 
implementing regulations.
Benefits
    The regulatory provisions that interpret or implement the statutory 
requirements for the CCO and annual report serve to enhance the 
standards for a DCO's compliance program which will necessarily 
emphasize risk management compliance because of its significance to the 
overall purpose and functioning of the DCO. Compliance with Core 
Principle D (risk management) and related regulations encompasses, 
among other things, measurement and monitoring of credit exposures to 
clearing members, implementation of effective risk-based margin 
methodologies, and appropriate calculation and back testing of margin 
levels. It is the responsibility of the CCO to ensure that the DCO is 
compliant with Core Principle D and the regulations thereunder, and is 
otherwise engaged in appropriate risk management activities in 
accordance with the DCO's own rules, policies and procedures.
5. Other Public Interest Considerations
    The Commission does not believe that the rule will have a material 
effect on public interest considerations other than those identified 
above.

E. Financial Resources--Sec.  39.11

    Section 5b(c)(2)(B) of the CEA, Core Principle B, as amended by the 
Dodd-Frank Act, requires a DCO to possess financial resources that, at 
a minimum, exceed the total amount that would enable the DCO to meet 
its financial obligations to its clearing members notwithstanding a 
default by the clearing member creating the largest financial exposure 
for the DCO in extreme but plausible market conditions, and to cover 
its operating costs for a period of one year, calculated on a rolling 
basis.
    Proposed Sec.  39.11 would codify these requirements and set forth 
additional standards for the types of financial resources that are 
acceptable (Sec.  39.11(b)); computation of the amount of financial 
resources required to satisfy the statutory default and operational 
resources requirements (Sec.  39.11(c)); valuation of financial 
resources (Sec.  39.11(d)); liquidity of financial resources (Sec.  
39.11(e)); and quarterly reporting of financial resources (Sec.  
39.11(f)).\263\
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    \263\ The Commission also proposed Sec.  39.29 which would apply 
certain stricter requirements to SIDCOs. As discussed above, the 
Commission is not taking action on those proposed rules as part of 
this final rulemaking.
---------------------------------------------------------------------------

    As discussed in more detail above, the Commission received comment 
letters requesting further clarity as to the proposed requirements. The 
Commission also received comment letters that discussed how the 
proposed rules might impose costs or burdens on DCOs.\264\ Two 
commenters objected to the requirement that DCOs must monitor ``on a 
continual basis'' a clearing member's ability to meet potential 
assessments, which one of the commenters characterized as ``overly 
burdensome and difficult to administer.'' Regarding the proposed 
restrictions on the use of assessment powers, another commenter stated 
that the inclusion of assessment powers as a financial resource is 
necessary for it to meet its obligations in the event of a default. Two 
commenters recommended that the Commission permit letters of credit to 
be considered in the financial resources computation. Finally, several 
DCOs urged the Commission to allow U.S. Treasuries, in addition to 
cash, as a financial resource sufficient to meet the proposed financial 
resource liquidity requirement.
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    \264\ See discussion in Section IV.B, above.
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    As discussed above, in proposing that a DCO ``monitor, on a 
continual basis, the financial and operational capacity of its clearing 
members to meet potential assessments,'' the Commission did not intend 
to require real-time monitoring of clearing members. Rather, the 
purpose of the provision was to require a DCO to monitor often enough 
to enable it to become aware of any potential problems in a timely 
manner. The Commission has modified Sec.  39.11(d)(2)(ii) to remove the 
``continual basis'' standard, leaving the DCO to exercise its 
discretion in determining the appropriate frequency of periodic reviews 
or more frequent reviews as circumstances warrant in connection with 
particular clearing members.
    The Commission is permitting DCOs to include potential clearing 
member

[[Page 69414]]

assessments in calculating default financial resources, as proposed, 
subject to the limitations of Sec.  39.11(d)(2)(iii) (30 percent 
haircut) and Sec.  39.11(d)(2)(iv) (DCO may count the value of 
assessments, after the haircut, to meet up to 20 percent of its default 
resources requirement). The comments on this proposal were varied. Some 
commenters stated that the Commission had proposed an appropriate, 
balanced approach; others stated that the limitations on assessments 
were too strict; and still others stated that the Commission should not 
permit assessments to count at all.
    It is the Commission's view that, in light of recent market events 
and as a general matter, it is not prudent to permit a DCO to rely on 
letters of credit. However, for the reasons discussed above, the 
Commission would consider permitting letters of credit to be included 
as a DCO financial resource on a very limited case-by-case basis.
    Finally, the Commission is revising Sec.  39.11(e)(1) so that, in 
addition to cash, a DCO may use U.S. Treasury obligations and high 
quality, liquid, general obligations of a sovereign nation to satisfy 
financial resource liquidity requirements. This revised standard 
reflects the current practices of U.S. and foreign-based DCOs.
    The Commission has evaluated the costs and benefits of Sec.  39.11 
in light of the specific considerations identified in Section 15(a) of 
the CEA as follows:
1. Protection of Market Participants and the Public
Costs
    The regulations require DCOs to take specific actions to ensure 
that they are able to meet the statutory requirements for covering 
default and operating expenses. These actions include monthly stress 
testing to calculate what those financial obligations are, and 
quarterly reporting to the Commission to demonstrate the adequacy of 
financial resources in terms of dollar amount and liquidity. DCOs will 
incur direct costs related to staffing and technology programming to 
calculate, monitor, and report financial resources.
    Existing DCOs will have already implemented certain practices and 
systems for tracking and managing financial resources in order to 
comply with Core Principle B, as originally enacted in 2000. Given the 
staffing and operational differences among DCOs, the Commission is 
unable to accurately estimate or quantify the additional costs DCOs may 
incur to comply with the new financial resource rules.\265\ Moreover, 
the cost-effects of new cleared products and new market participants 
clearing those products are too speculative and uncertain for the 
Commission to be able to quantify or estimate at this time. Such costs 
or benefits will depend upon a number of variables that are not 
estimable or quantifiable at this time, such as the nature and number 
of the new products that become subject to clearing, the nature and 
number of market participants that enter into transactions involving 
such products, and the resulting costs or benefits to such market 
participants from the clearing of such products.
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    \265\ Commenters did not provide the Commission with 
quantitative data regarding such costs.
---------------------------------------------------------------------------

    As to costs associated with restrictions the Commission is imposing 
on the types and valuation of financial resources that may be counted 
as financial resources for purposes of satisfying Core Principle B, 
those too will vary among DCOs. For example, for DCOs that do not 
include potential clearing member assessments in their calculations of 
financial resources, the limitations on assessments will not result in 
increased costs. For DCOs that to any extent rely on potential 
assessments, the new limitations might require revisions to their 
default management plans, an increase in guaranty fund requirements, or 
an infusion of additional capital. The same would apply to letters of 
credit that cannot be considered to be financial resources for purposes 
of complying with Core Principle B, absent relief. Again, because of 
the range of circumstances of different DCOs, it is not feasible to 
estimate or quantify the costs of the safeguards imposed by the 
Commission's financial resource rules.
Benefits
    The financial resource rules establish uniform standards that 
further the goals of avoiding market disruptions and financial losses 
to market participants and the general public, and avoiding systemic 
problems that could arise from a DCO's failure to maintain adequate 
default or operating resources. While it is not possible to estimate or 
quantify the benefits to market participants and the public in 
facilitating the financial soundness of a DCO, the Commission believes 
that a DCO failure, regardless of the size of the DCO, could adversely 
affect the financial markets, market participants, and the public.
2. Efficiency, Competitiveness, and Financial Integrity
Costs
    As discussed in connection with factor 1 above, quantification or 
estimation of these costs and benefits is not readily feasible. For 
some DCOs, the financial resource rules will have little or no direct 
or indirect impact. For others, the impact may be more substantial. 
Although there may be disparate impact among DCOs, overall the rules 
are not expected to impose significant costs in terms of efficiency, 
competitiveness, or financial integrity of derivatives markets.
Benefits
    The regulations promote financial strength and stability, thereby 
fostering efficiency and a greater ability to compete in the broader 
financial markets. The regulations promote competition by preventing 
DCOs that lack adequate financial safeguards from expanding in ways 
that may ultimately harm the broader financial market. The regulations 
promote efficiency insofar as DCOs that operate with adequate financial 
resources are less likely to fail. The regulations are designed to 
ensure that DCOs can meet their financial obligations to market 
participants, thus contributing to the financial integrity of the 
derivatives markets as a whole.
    As highlighted by recent events in the global financial markets, 
maintaining sufficient financial resources is a critical aspect of any 
financial entity's risk management system, and ultimately contributes 
to the goal of stability in the broader financial markets. Therefore, 
the Commission believes it is prudent to include financial resources 
requirements for entities applying to become or operating as DCOs. 
Finally, Congress has determined that a DCO must comply with Core 
Principle B to achieve the purposes of the CEA and the Commission has 
determined that Sec.  39.11 sets forth the minimum standards for a DCO 
to do so.
3. Price Discovery
    The Commission does not believe that this rule will have a material 
effect on price discovery.
4. Sound Risk Management Practices
Costs
    Adequate financial resources are a corollary to strong risk 
management. To the extent that the financial resource rules result in 
additional costs, these costs are associated with implementing the 
practices and procedures that are necessary to ensure a DCO has 
adequate financial resources.

[[Page 69415]]

Benefits
    The regulations, by setting specific standards with respect to how 
DCOs should assess, monitor, and report the adequacy of their financial 
resources, contribute to DCOs' maintenance of sound risk management 
practices and further the goal of minimizing systemic risk. The 
reporting requirements, in particular, will enable the Commission to 
conduct more thorough and meaningful oversight of DCOs that will 
contribute to improved risk management by DCOs overall.
5. Other Public Interest Considerations
Costs
    The Commission has not identified any public interest 
considerations that would be negatively affected by the provisions of 
the financial resource rules that effectuate or implement the statutory 
requirements of Core Principle B (financial resources).
Benefits
    The benefits to the public of a DCO maintaining adequate financial 
resources are discussed above.

F. Participant and Product Eligibility--Sec.  39.12

Participant Eligibility
    Section 5b(c)(2)(C) of the CEA, Core Principle C, as amended by the 
Dodd-Frank Act, requires each DCO to establish appropriate admission 
and continuing eligibility standards for members of, and participants 
in, the DCO, 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.
    As discussed above, the Commission crafted the provisions of 
proposed Sec.  39.12(a) and related rules to establish a regulatory 
framework that accomplishes two goals: (1) to provide for fair and open 
access, while (2) limiting risk to the DCO and its clearing members. 
The provisions in Sec.  39.12(a)(1) provide for fair and open access in 
a number of ways. A DCO is prohibited from adopting restrictive 
clearing member standards if less restrictive requirements that would 
not materially increase risk to the DCO or clearing members could be 
adopted (Sec.  39.12(a)(1)(i)); a DCO must allow all market 
participants who satisfy participation requirements to become clearing 
members (Sec.  39.12(a)(1)(ii)); the standards must be non-
discriminatory (Sec.  39.12(a)(1)(iii)); and they may not require 
clearing members to be swap dealers (Sec.  39.12(a)(1)(iv)), or 
clearing members to maintain a swap portfolio of any particular size or 
meet a swap transaction volume threshold (Sec.  39.12(a)(1)(v)).
    Section 39.12(a)(2) facilitates greater participation by requiring 
that capital requirements for clearing members be based on objective, 
transparent, and commonly accepted standards that appropriately match 
capital to risk (Sec.  39.12(a)(2)(i)); and by setting the minimum 
capital requirement at not more than $50 million (Sec.  
39.12(a)(2)(ii)).
    A number of commenters supported the proposed rules. They asserted 
that increased access to clearing would stimulate competition and 
diversify risk. A number of other commenters opposed aspects of the 
proposed rules, particularly the $50 million capital standard. They 
argued that these provisions could increase risk by providing access to 
firms with insufficient financial resources or operational capacity.
    The Commission did not receive any comments that quantified the 
costs associated with the proposed participation rules. Instead, 
commenters focused on qualitative considerations, including how the 
proposed rules would affect market participants, market risk, 
efficiency, competitiveness, the financial integrity of futures 
markets, and price discovery.
    The Commission is adopting these provisions essentially as 
proposed.
    The Commission has evaluated the costs and benefits of the proposed 
regulations in light of the specific considerations identified in 
Section 15(a) of the CEA, as follows:
1. Protection of Market Participants and the Public
Costs
    The participant eligibility rules may result in costs beyond those 
incurred in the normal course of operating a DCO or clearing firm, but 
such potential costs are, at this time, speculative in nature and 
impossible to estimate or quantify. By providing access to clearing to 
additional firms, the rules could impose costs on DCOs, other clearing 
members, or customers if a firm admitted to clearing membership in a 
DCO pursuant to these rules failed to meet its obligations. Any such 
costs depend upon a number of factors that are not presently knowable, 
quantifiable, or estimable.
    It is not possible to estimate or quantify these costs in a 
reliable way for a number of reasons. The historical record prior to 
the enactment of the Dodd-Frank Act with respect to the operation of 
clearing organizations provides little guidance as to the costs that 
may be incurred in the future in the unlikely event of a default at a 
DCO. Defaults at DCOs are very rare and the circumstances of each one 
are unique. Moreover, the Dodd-Frank Act and implementing regulations 
will alter the landscape significantly. Existing DCOs and FCMs will be 
clearing new products. New DCOs and FCMs will enter the market. 
Mandatory clearing will bring new products and participants to DCOs and 
FCMs. The interaction of all these factors creates a wide range of 
uncertainty as to the nature of the potential consequences of a default 
under the new regulatory regime. In sum, the Commission believes that 
the possible future circumstances leading to and potential resulting 
consequences of a DCO default are too speculative and uncertain to be 
able to quantify or estimate the resulting costs to DCOs, clearing 
members, or market participants with any precision or degree of 
magnitude.
    Whatever these potential costs, the Commission believes that the 
participant eligibility rules will reduce the risk that clearing 
members will in fact incur such costs. First, increased access to 
clearing membership should reduce concentration at any one clearing 
member and diversify risk. Second, the rules contain risk management 
provisions specifically designed to minimize the likelihood and extent 
of defaults. The provisions in Sec.  39.12(a)(2) set forth requirements 
that mandate DCOs: Require that all clearing members have sufficient 
financial resources to meet obligations arising from participation in 
the DCO (Sec.  39.12(a)(2)(i)); establish capital requirements that are 
scalable so that they are proportional to the risks posed by clearing 
members (Sec.  39.12(a)(2)(ii)); require that clearing members have 
adequate operational capacity to meet obligations arising from 
participation in the DCO (Sec.  39.12(a)(3)); verify the compliance of 
each clearing member with the requirements of the DCO (Sec.  
39.12(a)(4)); satisfy certain reporting requirements (Sec.  
39.12(a)(5)); and have the ability to enforce participation 
requirements (Sec.  39.12(a)(6)).
    For reasons similar to those described above, it is also not 
feasible to quantify or estimate this reduction in costs with any 
confidence. Based on its judgment and experience with the regulation 
and operation of clearing organizations, the

[[Page 69416]]

Commission believes that these rules will lower the risk that clearing 
members will in fact incur such costs. However, the possible future 
circumstances leading to and potential resulting consequences of a 
future default are too speculative and uncertain to quantify or 
estimate, either under the current regulatory regime or under the rules 
being adopted by the Commission.
Benefits
    Greater access to clearing should benefit market participants by 
increasing competition among clearing members. Allowing more firms to 
clear should increase competition among clearing firms on both price 
and service which should, in turn, reduce costs to market participants. 
Further, the safeguards in Sec.  39.12(a)(2) will benefit DCOs, 
clearing members, and market participants by reducing risk. Reductions 
in risk also benefit the general public by decreasing the probability 
of a systemic failure.
    For the reasons described above in connection with costs, it is 
also impractical to quantify or estimate these benefits associated with 
reductions in risk to clearing members, market participants, and the 
public.
2. Efficiency, Competitiveness, and Financial Integrity
Costs
    The considerations under this factor are very similar to the 
considerations under the previous factor with respect to participant 
eligibility requirements. Quantification or estimation of these costs 
and benefits is not feasible for the reasons set forth under the first 
factor. The potential increase in risk of default resulting from open 
access is mitigated by the decrease in risk resulting from 
diversification of risk, increased competition, and the safeguards set 
forth in Sec.  39.12(a)(2).
Benefits
    By opening access the rules should increase competition among 
clearing members thereby resulting in increased efficiency in the 
provision of clearing services. The safeguards in the rules such as the 
requirement that DCOs impose risk limits on clearing members will 
enhance the financial integrity of the DCO and its clearing members.
3. Price Discovery
Costs
    The Commission has not identified any way in which the rules will 
impair price discovery.
Benefits
    Increased competition among clearing members could bring more 
participants into the markets which could result in more competitive 
pricing and enhanced price discovery.
4. Sound Risk Management Practices
Costs
    According to some commenters, the open access rules could hinder 
sound risk management practices by admitting clearing members unable to 
participate in the default management process. Other commenters assert 
that the rules provide appropriate protections and will facilitate 
sound risk management practices. The Commission believes that the open 
access rules, when coupled with the default management rules discussed 
below, will not impair sound risk management practices. Under the 
rules, clearing members will be required to demonstrate that they have 
operational capacity to carry out their responsibilities as well as 
sufficient financial resources to meet their obligations.
Benefits
    As explained above, the provisions in Sec.  39.12(a)(2) require 
that DCOs establish a risk management framework with respect to their 
members. In addition, open access should lead to diversification of 
risk at DCOs and allow additional firms to assist in the resolution of 
any defaults.
5. Other Public Interest Considerations
Costs
    The Commission has not identified any other public interest 
considerations that would be negatively affected by the potential costs 
of the eligibility requirements.
Benefits
    The CEA, as amended by the Dodd-Frank Act, requires DCOs to allow 
for open access and, therefore, broader participation. The Commission 
believes that greater participation in clearing could increase 
liquidity in the markets. This could help prevent price manipulation or 
other anti-competitive practices because it will be harder to organize 
concerted efforts to achieve such ends. Finally, Congress has 
determined that a DCO must comply with Core Principle C to achieve the 
purposes of the CEA and the Commission has determined that Sec.  
39.12(a) sets forth the minimum standards for a DCO to comply with the 
CEA's participation requirements.
Product Eligibility
    Core Principle C also requires a DCO to establish ``appropriate 
standards for determining the eligibility of agreements, contracts, or 
transactions submitted to the [DCO] for clearing.'' Section 39.12(b) 
implements this provision.
    Proposed Sec.  39.12(b)(1) would require a DCO to establish 
requirements for determining product eligibility taking into account 
the DCO's ability to manage risks associated with the product. Proposed 
Sec. Sec.  39.12(b)(2) and (b)(3) would codify section 2(h)(1)(B) of 
the CEA. Proposed Sec.  39.12(b)(4) would prohibit a DCO from requiring 
an executing party to be a clearing member in order for the product to 
be eligible for clearing. Proposed Sec.  39.12(b)(5) would require a 
DCO to select contract units for clearing purposes that maximize 
liquidity, facilitate transparency, promote open access, and allow for 
effective risk management. Proposed Sec.  39.12(b)(6) would require 
novation upon acceptance of a swap. Finally, proposed Sec.  39.12(b)(8) 
would require a DCO to confirm the terms of a swap at the time the swap 
is accepted for clearing.\266\
---------------------------------------------------------------------------

    \266\ Proposed Sec.  39.12(b)(7) will be addressed in a separate 
rulemaking.
---------------------------------------------------------------------------

    The Commission did not receive any comments directly addressing 
cost-benefit considerations. The Commission did receive several 
comments on substantive provisions that bear on those considerations. 
One commenter suggested that Sec.  39.12(b)(4) may be an impediment to 
the development of new DCOs. Several commenters suggested that it would 
be impractical or inappropriate for a DCO to establish unit sizes for 
clearing that differ from the unit size at execution (Sec.  
39.12(b)(5)).
    The Commission also received several comments requesting 
clarification of certain provisions. As discussed above, the Commission 
has made changes to these rules that are responsive to the comments.
    The Commission is adopting Sec.  39.12(b) largely as proposed with 
several clarifying amendments as discussed above.
    The Commission has evaluated the costs and benefits of Sec.  
39.12(b) in light of the specific considerations identified in Section 
15(a) of the CEA, as follows:
1. Protection of Market Participants and the Public
Costs
    The Commission has not identified any new costs arising out of 
Sec. Sec.  39.12(b)(1), 39.12(b)(6), or

[[Page 69417]]

39.12(b)(8). DCOs currently perform risk analysis before accepting new 
products for clearing, currently novate trades upon acceptance, and 
currently issue confirmations to clearing members.
    As noted, one commenter suggested that prohibiting a DCO from 
requiring one of the original executing parties to be a clearing member 
in order for a contract to be eligible for clearing may be an 
impediment to the development of new DCOs. The Commission believes 
that, to the contrary, such restrictions on product eligibility for 
clearing increase overall costs for market participants, and that 
prohibiting such restrictions will lead to lower overall costs. Such 
restrictions deny the availability and benefits of clearing to non-
clearing members. Open access will enable non-clearing members to 
obtain the benefits of clearing and increase competition in clearing 
and trading, thereby increasing liquidity, and reducing costs.
    The commenters who questioned the unit size provision did not 
elaborate on the costs. It is not feasible to quantify these costs for 
a number of reasons. The rule provides DCOs with significant 
flexibility in selecting unit sizes. Different DCOs may select 
different sizes for the same or similar products. Numerous SEFs will 
also be making judgments concerning unit size which will influence the 
decisions of DCOs and traders. Some products will be subject to 
mandatory clearing and others to voluntary clearing. The unpredictable 
interaction of these variables creates a wide range of uncertainty as 
to the nature of the consequences of the selection of unit sizes by 
DCOs. Similar considerations apply to the other provisions of Sec.  
39.12(b). In sum, the Commission believes that the possible future 
circumstances leading to, and the potential resulting consequences of, 
the implementation of Sec.  39.12(b) are too speculative and uncertain 
to be able to quantify or estimate resulting costs with any precision 
or degree of magnitude.
Benefits
    The Commission believes that Sec.  39.12(b) will protect market 
participants and the public in many ways. First, these provisions are 
likely to facilitate the standardization of swaps, thereby eliminating 
differences between the terms of a swap as cleared at the DCO level and 
as carried at the customer level. Any such outstanding 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 still has a bilateral position opposite its counterparty. The 
customer is still exposed to the credit risk of the counterparty and 
the position would not be able to be offset against other positions at 
the DCO. Similarly, from a systemic perspective, any differences in 
terms between the trades would eliminate the possibility of 
multilateral offset and thereby diminish liquidity.
    Second, Sec.  39.12(b) can promote liquidity by permitting more 
parties to trade the product and by permitting more clearing members to 
clear the product. Third, it can enhance risk management by enabling a 
DCO, in the event of a default, to have more potential counterparties 
for liquidation.
    Fourth, these provisions will 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 economically equivalent within the DCO and may 
be offset with each other.
    Fifth, clearing will eliminate the need for a counterparty to 
ascertain the credit-worthiness of each of its counterparties. This 
will promote liquidity, competition, and financial integrity to the 
benefit of all market participants.
2. Efficiency, Competitiveness, and Financial Integrity
Costs
    The Commission has not identified any ways in which the proposals 
would reduce efficiency, competitiveness, or financial integrity.
Benefits
    The rules should increase participation by clearing members, which 
should increase competition among clearing members to provide services 
to customers. In addition, the rules will lead to standardization of 
products. Finally, the rules will allow for more clearing through 
novation, which should result in increased open interest and liquidity. 
In turn, this should lead to more competitive and efficient markets. As 
noted above, smaller units can promote liquidity and encourage 
prospective clearing members to bid on positions and enable them to 
accept a forced allocation in the event of a clearing member's default. 
This facilitates open access, and at same time promotes risk management 
by enabling a DCO, in the event of a default, to be able to rely on 
more potential counterparties for liquidation.
3. Price Discovery
Costs
    The Commission has not identified any ways in which the rules would 
reduce price discovery.
Benefits
    As discussed above, the rules will increase competition, which 
should enhance price discovery by bringing more participants into the 
markets. In addition, standardization means that prices observed on 
different trades are more directly comparable, which can improve price 
discovery.
4. Sound Risk Management Practices
Costs
    The Commission has not identified any ways in which the rules would 
impair sound risk management practices.
Benefits
    The rules require DCOs to establish appropriate standards for 
determining the eligibility of contracts submitted to the DCO for 
clearing taking into account the DCO's ability to manage risks 
associated with the product. Such standards are a sound risk management 
practice.
5. Other Public Interest Considerations
Costs
    The Commission has not identified any ways in which the rules would 
harm any other public interest considerations.
Benefits
    As discussed above, open access, increased competition, greater 
liquidity, improved price discovery, and greater financial integrity 
are all benefits of the rules. All these factors will benefit the 
general public, which may not participate in these markets directly but 
may feel their impact on the larger economy.

G. Risk Management--Sec.  39.13

In General
    Core Principle D,\267\ as amended by the Dodd-Frank Act, 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

[[Page 69418]]

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 non-defaulting clearing members would not be exposed to losses 
that non-defaulting clearing members cannot anticipate or control. 
Finally, Core Principle D provides that a DCO must require margin from 
each clearing member 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.
---------------------------------------------------------------------------

    \267\ Section 5b(c)(2)(D) of the CEA; 7 U.S.C. 7a-1(c)(2)(D).
---------------------------------------------------------------------------

    The Commission proposed Sec.  39.13 to establish requirements that 
a DCO would have to meet in order to comply with Core Principle D. For 
a number of provisions of proposed Sec.  39.13, the Commission did not 
receive any comments on the associated costs or on cost-benefit 
analysis. The Commission discussed in the notice of proposed rulemaking 
and above why it believes a DCO must satisfy each of those provisions 
to be in compliance with the Core Principle D and why it is appropriate 
for market participants to incur any costs associated with implementing 
each of those provisions. The Commission also addressed comments that 
suggested alternative standards, frameworks, or procedures. Where 
appropriate, the Commission revised the proposed rules. To avoid 
repetition, the Commission incorporates by reference the above 
discussion of Sec.  39.13.
    Commenters raised concerns about the costs of Sec. Sec.  
39.13(g)(2)(ii) (minimum liquidation time), 39.13(g)(2)(iii) (margin 
confidence level), 39.13(g)(8)(i) (gross margin), 39.13(h)(1)(i) (risk 
limits), 39.13(h)(2) (large trader reports), and 39.13(h)(5)(ii) 
(clearing member risk review) or the Commission's cost-benefit analysis 
relating to these rules. The Commission's consideration of the costs 
and benefits associated with these rules is discussed in greater detail 
below.
Minimum Liquidation Time
    As proposed, Sec.  39.13(g)(2)(ii) would require a DCO to use a 
liquidation time that is a minimum of five business days for cleared 
swaps that are not executed on a DCM, and 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.
    Numerous commenters objected to the proposed difference in 
requirements that would subject swaps that were either executed 
bilaterally or executed on a SEF to a minimum five-day liquidation 
time, while permitting equivalent swaps that were executed on a DCM to 
be subject to a minimum one-day liquidation time. The Commission did 
not receive any comments that quantified the costs of this rule.
    As to the actual periods proposed, commenters variously contended 
that a liquidation time of five business days may be excessive for some 
swaps, a one-day liquidation period is too short, a one-day liquidation 
period is appropriate for swaps executed on a DCM or a SEF, and a two-
day liquidation period is appropriate for cleared swaps.
    Some commenters encouraged the Commission to permit a DCO to 
determine the appropriate liquidation time for all products that it 
clears based on the unique characteristics and liquidity of each 
relevant product or portfolio. Two commenters recommended that if the 
Commission were to mandate minimum liquidation times in the final 
rules, it should allow DCOs to apply for exemptions for specific groups 
of swaps if market conditions prove that such minimum liquidation times 
are excessive.
    Upon consideration of the comments, the Commission is adopting 
Sec.  39.13(g)(2)(ii) with a number of modifications. First, the final 
rule requires a DCO to use the same liquidation time for a product 
whether it is executed on a DCM, a SEF, or bilaterally. Second, the 
final rule provides that the minimum liquidation time for swaps based 
on certain physical commodities, i.e., agricultural commodities, 
energy, and metals, as well as futures and options, is one day. For all 
other swaps, the minimum liquidation time is five days. Third, to 
provide further flexibility, the Commission is adding a provision 
specifying that, by order, the Commission may provide for a different 
minimum liquidation time for particular products or portfolios.
    The Commission has evaluated the costs and benefits of the proposed 
regulations in light of the specific considerations identified in 
Section 15(a) of the CEA, as follows:
1. Protection of Market Participants and the Public
Costs
    The Commission anticipates that using only one criterion--i.e., the 
characteristic of the commodity underlying a swap--to determine 
liquidation time could result in less-than-optimal margin calculations. 
For some products, a five-day minimum may prove to be excessive and tie 
up more funds than are strictly necessary for risk management purposes. 
For other products, a one-day or even a five-day period may be 
insufficient and expose a DCO and market participants to additional 
risk.
    The Commission believes that it is not feasible to estimate or 
quantify these costs reliably. In addition to the liquidation time 
frame, the margin requirements for a particular instrument depend upon 
a variety of characteristics of the instrument and the markets in which 
it is traded, including the risk characteristics of the instrument, its 
historical price volatility, and liquidity in the relevant market. 
Determining such margin requirements does not solely depend upon such 
quantitative factors, but also requires expert judgment as to the 
extent to which such characteristics and data may be an accurate 
predictor of future market behavior with respect to such instruments, 
and applying such judgment to the quantitative results. Thousands of 
different swap products may be subject to clearing. Determining the 
risk characteristics, price volatility, and market liquidity of even a 
sample for purposes of determining a liquidation time specifically for 
such instrument would be a formidable task for the Commission to 
undertake and any results would be subject to a range of uncertainty. 
Reliable data is not readily available for many swaps that prior to the 
Dodd-Frank Act were executed in unregulated markets.
    Given the amount of uncertainty in estimating margin requirements 
using either a five-day liquidation time or a one-day liquidation time, 
the amount of uncertainty in estimating the cost of using one rather 
than the other is compounded. For all the reasons stated in the 
previous paragraph, the possible range within which the size of the 
difference would fall is very large. In sum, in the absence of a 
reasonably feasible and reliable methodology at the present time for 
the Commission to use in calculating the appropriate margin 
requirements for swaps with either five-day or one-day liquidation 
times,\268\ the

[[Page 69419]]

Commission believes that possible future circumstances surrounding 
margin levels are too speculative and uncertain to be able to quantify 
or estimate the resulting costs to DCOs, clearing members, or the 
public from the rule with any precision or degree of magnitude.
---------------------------------------------------------------------------

    \268\ The Commission notes that ``[t]he existence of significant 
outstanding notional exposures, trading liquidity, and adequate 
pricing data'' is one of the factors the Commission must consider in 
reviewing whether a swap or group or class of swaps is subject to 
the mandatory clearing requirement in CEA Section 2(h)(1). See 
Section 2(h)(2)(D) of the CEA. To enable the Commission to make this 
determination, the Commission requires DCOs that submit swaps to the 
Commission for a mandatory clearing determination to submit data and 
other information that would enable the Commission to effectively 
consider this factor. See Sec.  39.5(b)(3)(ii)(A), 76 FR at 44473 
(July 26, 2011) (Process for Review of Swaps for Mandatory Clearing; 
final rule). Not only is this type of information needed for the 
Commission to consider the statutory factors and make the 
determinations as to which swaps should be subject to mandatory 
clearing, but it also would be needed to calculate appropriate 
margin amounts for such swaps, were the Commission to attempt such 
calculations.
---------------------------------------------------------------------------

    Moreover, any potential costs of this rule may be mitigated by the 
provision that allows DCOs to request, or the Commission on its own 
initiative to make, a determination that the liquidation time for a 
particular contract is too long or too short. As markets evolve, it may 
become appropriate to ease the requirement for certain swaps subject to 
the five-day minimum. Conversely, analysis may reveal that for other 
products or portfolios the five-day or one-day minimum is insufficient. 
This procedure could serve to reduce costs that may arise from 
application of the rule.
Benefits
    A minimum liquidation time is a standard input in value-at-risk 
models used by DCOs to compute a confidence interval to estimate their 
risk. The value-at-risk confidence interval protects DCOs, their 
clearing members, market participants, and the public by fixing the 
probability that a default will occur and the position cannot be 
liquidated in time.
    The five-day/one-day distinction for different types of swaps is 
based on the ease of liquidation of different product groups and is 
consistent with existing requirements that reflect the risk assessments 
DCOs have made over the course of their experience clearing these types 
of swaps. Several DCOs have determined that these are the appropriate 
standards for these instruments and apply it to their margin 
requirements. The Commission believes that this is a reasonable and 
prudent judgment.
    A minimum standard is designed to prevent DCOs from competing by 
offering lower margin requirements than other DCOs and, as a result, 
taking on more risk than is prudent. In addition, the Commission is 
concerned that a DCO may misjudge the appropriate liquidation time 
frame because of limited experience with clearing and managing the 
risks of financial swaps. A minimum liquidation time frame should 
prevent DCOs from taking on too much risk.
    While it is not possible to estimate or quantify the benefits to 
market participants and the public in facilitating the financial 
soundness of DCOs, the Commission believes that a DCO failure, 
regardless of the size of the DCO, could adversely affect the financial 
markets, market participants, and the public. This rule will diminish 
the chances that such a failure will occur.
2. Efficiency, Competitiveness, and Financial Integrity
Costs
    The considerations under this factor are similar to the 
considerations under the first factor.
Benefits
    The rule will promote efficiency, competitiveness and financial 
integrity by establishing a minimum standard for all DCOs. While a DCO 
will still have considerable latitude in setting risk-based margin 
levels, the Commission has determined that establishing a minimum 
liquidation time will provide legal certainty for an evolving 
marketplace, will offer a practical means for assuring that the 
thousands of different swaps that are going to be cleared subject to 
the Commission's oversight will have prudent minimum margin 
requirements, and will help prevent a potential ``race to the bottom'' 
by competing DCOs. Competition among DCOs will be channeled to other 
areas such as level of service.
    The Commission believes that default by a clearing member could 
have a significant, adverse effect on market participants or the 
public. Market participants may have to incur the costs of making up 
any shortfall in margin through guaranty fund deposits and/or 
assessments, and any costs associated with participation in an auction 
or allocation of the positions of a defaulting clearing member. In a 
worst case scenario, a default by a clearing member may undermine the 
financial integrity of the DCO, which could have serious and widespread 
consequences for the U.S. financial markets. This rule protects market 
participants and the public from bearing these costs by requiring a DCO 
to follow certain minimum standards in establishing margin 
requirements.
3. Price Discovery
    The Commission does not believe that this rule will have a material 
effect on price discovery.
4. Sound Risk Management Practices
Costs
    Because the rule simply establishes minimums, it will not hinder 
the exercise of sound risk management practices. The rule specifically 
requires DCOs to use longer liquidation times if appropriate for 
particular products.
Benefits
    As discussed under the first two factors, the rule will foster 
sound risk management practices.
5. Other Public Interest Considerations
    The Commission has not identified any costs or benefits beyond 
those discussed under the first factor.
Margin Confidence Level
    As proposed, Sec.  39.13(g)(2)(iii) would require a DCO's initial 
margin models to meet an established confidence level of at least 99% 
based on data from an appropriate historical period.
    A number of commenters stated that each DCO should have discretion 
to establish confidence levels based on the particular characteristics 
of the products and portfolios it clears and their underlying markets. 
However, a number of other commenters stated that a 99% confidence 
level was the proper minimum.
    The Commission is adopting the rule as proposed.
    The Commission has evaluated the costs and benefits of the proposed 
regulation in light of the specific considerations identified in 
Section 15(a) of the CEA, as follows:
1. Protection of Market Participants and the Public
Costs
    A 99% confidence level will require that more money be held as 
margin as compared to a lower confidence level. There is an opportunity 
cost to clearing members holding this money as margin.
    The Commission believes that it is not feasible to estimate or 
quantify this cost reliably. In addition to the confidence level, the 
margin requirements for a particular instrument depend upon a variety 
of characteristics of the instrument and the markets in which it is 
traded, including the risk characteristics of the instrument, its 
historical price volatility, and liquidity in the relevant market. 
Determining such margin requirements does not solely depend upon such 
quantitative

[[Page 69420]]

factors, but also requires expert judgment as to the extent to which 
such characteristics and data may be an accurate predictor of future 
market behavior with respect to such instruments, and applying such 
judgment to the quantitative results. Thousands of different swap 
products may be subject to clearing. Determining the risk 
characteristics, price volatility, and market liquidity of even a 
sample for purposes of determining a confidence level specifically for 
such instrument would be a formidable task for the Commission to 
undertake and any results would be subject to a range of uncertainty. 
Reliable data is not readily available for many swaps that prior to the 
Dodd-Frank Act were executed in unregulated markets. In sum, in the 
absence of a reasonably feasible and reliable methodology at the 
present time for the Commission to use in calculating the margin 
requirements for swaps,\269\ the Commission believes that possible 
future circumstances surrounding margin levels are too speculative and 
uncertain to be able to quantify or estimate the resulting costs to 
DCOs, clearing members, or the public from the rule with any precision 
or degree of magnitude.
---------------------------------------------------------------------------

    \269\ Id.
---------------------------------------------------------------------------

Benefits
    A minimum confidence level is essential to protect market 
participants and the public. A minimum confidence level will prevent 
DCOs from competing with respect to how much risk they are willing to 
take on or from misjudging the amount of risk they would take on if 
they operated under lower standards. In addition, it will provide 
assurance to market participants that every DCO has sufficient margin 
to effectively manage a default.
    Some DCOs currently apply the 99 percent standard. Others use 95-99 
percent for some contracts depending on facts and circumstances. 
International standards currently recommend 99 percent.\270\ In view of 
the increased risk that DCOs will face as a result of clearing swaps, 
the Commission believes that protection of market participants and the 
public dictates that the minimum standard on this key risk management 
element should be set in accordance with current best practices among 
DCOs and international standards.
---------------------------------------------------------------------------

    \270\ See CPSS-IOSCO Consultative Report, Principle 6: Margin, 
Key Consideration 3, at 40; EMIR, Article 39, paragraph 1, at 46.
---------------------------------------------------------------------------

2. Efficiency, Competitiveness, and Financial Integrity
Costs
    The considerations under this factor are very similar to the 
considerations under the first factor.
Benefits
    The rule will promote efficiency, competitiveness and financial 
integrity by establishing a minimum standard for all DCOs. While a DCO 
will still have considerable latitude in setting risk-based margin 
levels, the Commission has determined that establishing a minimum 
confidence level will provide legal certainty for an evolving 
marketplace, will offer a practical means for assuring that the 
thousands of different swaps that are going to be cleared subject to 
the Commission's oversight will have prudent minimum margin 
requirements, and will prevent a potential ``race to the bottom'' by 
competing DCOs. As noted above, the Commission is adopting a 99% 
standard in order to conform to current best practices among DCOs as 
well as international standards. Competition among DCOs will be 
channeled to other areas such as level of service.
    The Commission believes that default by a clearing member could 
have a significant, adverse effect on market participants and the 
public. Market participants may have to incur the costs of making up 
any shortfall in margin through guaranty fund deposits and/or 
assessments, and any costs associated with participation in an auction 
or allocation of the positions of a defaulting clearing member. In a 
worst case scenario, a default by a clearing member may undermine the 
financial integrity of the DCO, which could have significant negative 
consequences for the financial stability of U.S. financial markets. As 
highlighted by recent events in the global financial markets, the 
ability to manage the risks associated with clearing is critical to the 
goal of stability in the broader financial markets. This rule protects 
market participants and the public from bearing these costs by 
requiring a DCO to follow certain minimum standards in establishing 
margin requirements.
3. Price Discovery
    The Commission does not believe that this rule will have a material 
effect on price discovery.
4. Sound Risk Management Practices
Costs
    Because the rule simply establishes minimums, it will not hinder 
the exercise of sound risk management practices. The rule specifically 
requires DCOs to use higher confidence levels if appropriate for 
particular products.
Benefits
    As discussed under the first two factors, the rule will foster 
sound risk management practices.
5. Other Public Interest Considerations
    The Commission does not believe that the rule will have a material 
effect on public interest considerations other than those identified 
above.
Gross Margin
    As proposed, Sec.  39.13(g)(8)(i) would require a DCO to collect 
initial margin on a gross basis for customer accounts.
    Two commenters supported the proposal. Several commenters stated 
that the provision of individual customer position information to DCOs 
may entail significant, costly, and time-consuming changes to systems 
infrastructure at the clearing member level and the DCO level.
    In light of the various concerns regarding the operational and 
technology changes that would be needed and related costs of requiring 
a DCO to obtain individual customer position information from its 
clearing members and to use such information to calculate the margin 
requirements for each individual customer, the Commission is modifying 
Sec.  39.13(g)(8)(i). As amended, the rule provides a DCO with the 
discretion to either calculate customer gross margin requirements based 
on individual customer position information that it obtains from its 
clearing members or based on the sum of the gross positions of all of a 
clearing member's customers that the clearing member provides to the 
DCO, without forwarding individual customer position information to the 
DCO.
    The Commission has evaluated the costs and benefits of the proposed 
regulation in light of the specific considerations identified in 
Section 15(a) of the CEA, as follows:
1. Protection of Market Participants and the Public
Costs
    Three kinds of costs could result from a change from net to gross 
margining, for those DCOs that currently use net margining.\271\ First, 
gross margining could change the loss that customers of a clearing 
member may face in the event

[[Page 69421]]

of default by a fellow customer of that clearing member. Under net 
margining, a greater portion of customer margin is held at the clearing 
member and thereby insulated from the DCO, so that non-defaulting 
customers face lower risk of losing their margin deposits to the DCO if 
a fellow customer defaults. Gross margining gives a DCO access to the 
margin deposits of non-defaulting customers of a defaulting FCM.\272\ 
In this sense, gross margining could shift a portion of the default 
risk from the DCO to fellow customers.\273\
---------------------------------------------------------------------------

    \271\ As discussed in section IV.D.6.h.(1), above, certain DCOs 
already use a version of gross margining, in which case the costs of 
complying with Sec.  39.13(g)(8)(i) would be considerably less.
    \272\ Offsetting this effect is the potential for a failing FCM 
to misappropriate customer funds. That potential is greater under 
net margining.
    \273\ The Commission has proposed rules that would not permit 
this in the case of swaps. See 76 FR 33818 (June 9, 2011) 
(Protection of Cleared Swaps Customer Contracts and Collateral; 
Conforming Amendments to the Commodity Broker Bankruptcy 
Provisions).
---------------------------------------------------------------------------

    It is not possible to estimate or quantify these costs--which would 
only arise in the event of a default of a customer--in a reliable way 
for a number of reasons. The historical record prior to the enactment 
of the Dodd-Frank Act with respect to the operation of clearing 
organizations provides little guidance as to the costs that may be 
incurred in the future in the unlikely event of a default at a DCO. 
Defaults at DCOs are very rare and the circumstances of each one are 
unique. Moreover, the Dodd-Frank Act and implementing regulations will 
alter the landscape significantly. Existing DCOs and FCMs will be 
clearing new products. New DCOs and FCMs will enter the market. 
Mandatory clearing will bring new products and participants to DCOs and 
FCMs. The interaction of all these factors creates a wide range of 
uncertainty as to the nature of the potential consequences of a default 
under the new regulatory regime. In sum, the Commission believes that 
the possible future circumstances leading to and potential resulting 
consequences of a future default are too speculative and uncertain to 
be able to quantify or estimate the resulting costs to clearing members 
with any precision or degree of magnitude.
    Second, because gross margining means that more customer margin is 
held at the DCO, rather than the FCM, gross margining also means that 
any return on this margin (e.g., interest earned) is earned by the DCO, 
rather than the FCM. This is largely a transfer between those parties. 
If there is no offsetting change in other terms of the relationship 
between customers, FCMs and DCOs, gross margining leads to a cost for 
FCMs and a benefit to DCOs from this change.
    Third, gross margining could result in changes in operating costs 
for DCOs and clearing members. Gross margining could require the DCO to 
possess more detailed information about customer positions. The 
provision of individual customer position information to DCOs may 
entail significant, costly, and time-consuming changes to systems 
infrastructure at the clearing firm level and the DCO level. For 
example, NYPC stated that its preliminary cost estimate for compliance 
with the customer gross margin and large trader report requirements 
contained in proposed Sec. Sec.  39.13(g)(8)(i) and 39.13(h)(2) was 
approximately 128,650 hours and $14.5 million.
    In order to reduce the potential costs, the Commission has revised 
Sec.  39.13(g)(8)(i) to allow a DCO to permit an FCM to provide the DCO 
with the sum of the gross positions of all of its customers so that the 
DCO may calculate the applicable gross margin requirement based on that 
sum. Under this scenario, a DCO will not have to establish a framework 
to receive each customer's position information and calculate the 
initial margin requirement applicable to each customer's positions. The 
Commission believes this alternative framework will be significantly 
less expensive for market participants. Whether a DCO chooses to make 
the calculation based on individual customer position information or 
the sum of customers' gross positions submitted by the clearing member, 
the clearing member's customer gross margin requirement will be the 
same.
    NYPC also commented that such implementation costs could 
significantly deter new clearinghouses like NYPC from launching. 
However, NYPC did not provide an estimate for the costs of a new 
clearinghouse system capable of gross margining in relation to the cost 
of retrofitting an existing net margin system. The Commission believes 
that retrofitting an existing system may be more expensive than 
implementing a new system from scratch, and that it is unclear whether 
additional implementation costs would deter any new clearinghouses.
Benefits
    The Commission believes that the clearing of swaps will increase 
the risk that DCOs face. Gross margining will increase the amount of 
money that DCOs hold. Under gross margining, the amount of margin at 
the DCO more accurately approximates the risks posed to a DCO by its 
clearing members' customers than net margining and increases the 
financial resources available to a DCO in the event of a customer 
default.
    A DCO may not be able to collect initial customer margin from an 
FCM if the FCM defaults. This could have a serious adverse impact on 
the financial stability of a DCO, non-defaulting customers, and 
potentially wider markets. In this regard, a significant customer 
default leading to an FCM default could strain a DCO's financial 
resources, causing it to exhaust the initial margin available to cover 
the default and forcing other clearing members and/or the DCO to incur 
related costs. In the worst case, an FCM default resulting from a large 
customer default could cause a DCO to fail if its financial resources 
are inadequate to cover the losses it incurs as a result of the 
default. Gross margining provides the DCO with a larger financial 
cushion that can be tapped in the event of a default. Initial margin is 
the DCO's first ``line of defense'' in managing a default, and a larger 
initial margin held at the DCO will help compensate for the DCO's 
inability to collect additional margin from a defaulting clearing 
member. This rule protects market participants and the public from 
bearing these costs by requiring a DCO to hold additional margin.
2. Efficiency, Competitiveness, and Financial Integrity
Costs
    The considerations under this factor are very similar to the 
considerations under the first factor.
Benefits
    The rule promotes efficiency, competitiveness, and financial 
integrity by providing that the amount of margin at the DCO more 
accurately approximates the risks posed to a DCO by its clearing 
members' customers and by increasing the financial resources available 
to a DCO in the event of a customer default.
3. Price Discovery
    The Commission does not believe that this rule will have a material 
effect on price discovery.
4. Sound Risk Management Practices
    The considerations relating to sound risk management practices are 
very similar to the considerations under the first factor.
5. Other Public Interest Considerations
    The Commission does not believe that the rule will have a material 
effect on

[[Page 69422]]

public interest considerations other than those identified above.
Risk Limits
    As 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.
    Several commenters supported the rule as an appropriate risk 
management procedure. Two commenters suggested that the rule is overly 
prescriptive. The Commission did not receive any comments that 
quantified the costs of this rule.
    The Commission is adopting Sec.  39.13(h)(i) as proposed.
    The Commission has evaluated the costs and benefits of the proposed 
regulation in light of the specific considerations identified in 
Section 15(a) of the CEA, as follows:
1. Protection of Market Participants and the Public
Costs
    Some DCOs already set limits and will not incur any costs. Others 
will incur the costs of calculating limits for each clearing member. 
Such costs will be incremental because all DCOs currently have 
procedures for monitoring clearing member risk and may already have 
informal triggers or alerts in place. For clearing members, the rule 
would impose opportunity costs to the extent the limits constrain their 
activities.
    Under the rule each DCO would have discretion to set limits for 
each clearing member. It would be pure conjecture for the Commission to 
estimate what levels DCOs would set for their clearing members and how 
much that would constrain such clearing members. Each DCO would rely on 
the informed judgment of its risk management committee and/or risk 
management staff to assess the risks and resources of each clearing 
member and arrive at the applicable limits for each one. Estimating the 
extent to which this would constrain clearing members is even more 
speculative. That would entail a guess as to the risk appetite of each 
clearing member. In sum, the Commission believes that possible future 
circumstances surrounding risk limits are too speculative and uncertain 
to be able to quantify or estimate the resulting costs to DCOs, 
clearing members, or the public with any precision or degree of 
magnitude.
Benefits
    The rule will benefit market participants by reducing the ability 
of clearing members and their customers to assume excessive risks. This 
will diminish the chances of default with all the attendant 
consequences previously discussed.
2. Efficiency, Competitiveness, and Financial Integrity
Costs
    The considerations under this factor are very similar to the 
considerations under the first factor.
Benefits
    Because the rule provides DCOs the discretion to tailor the limits 
for each clearing member in accordance with the DCO's assessment of the 
risk that the clearing member poses, it will foster efficiency and 
competitiveness in the markets. Because it will decrease the chance of 
default it will foster financial integrity.
    The Commission believes that default by a clearing member could 
have a significant, adverse effect on market participants or the 
public. Market participants may have to incur the costs of making up 
any shortfall in margin through guaranty fund deposits and/or 
assessments, and any costs associated with participation in an auction 
or allocation of the positions of a defaulting clearing member. In a 
worst case scenario, a default by a clearing member may undermine the 
financial integrity of the DCO, which could have serious and widespread 
consequences for the stability of U.S. financial markets. This rule 
protects market participants and the public from bearing these costs by 
requiring a DCO to analyze the risk posed by each clearing member and 
impose appropriate limits.
3. Price Discovery
    The Commission does not believe that this rule will have a material 
effect on price discovery.
4. Sound Risk Management Practices
Costs
    The considerations under this factor are very similar to the 
considerations under the first factor.
Benefits
    Risk limits are a sound risk management practice currently employed 
by several DCOs. The rule will extend the practice across all DCOs.
5. Other Public Interest Considerations
    The Commission does not believe that the rule will have a material 
effect on public interest considerations other than those identified 
above.
Large Trader Reports
    As proposed, Sec.  39.13(h)(2) would require a DCO to obtain from 
its clearing members, copies of all reports that such clearing members 
are required to file with the Commission pursuant to part 17 of the 
Commission's regulations, i.e., large trader reports. Proposed Sec.  
39.13(h)(2) would further require a DCO to review the large trader 
reports that it receives from its clearing members on a daily basis to 
ascertain the risk of the overall portfolio of each large trader.
    One commenter supported the proposal. One commenter argued that the 
proposed requirement that DCOs obtain large trader reports from 
clearing members is duplicative because a DCO receives large trader 
information from the exchange. One commenter stated that a DCO would 
need new technology to implement the rule. One commenter stated that a 
DCO would need additional surveillance staff.
    The Commission is modifying Sec.  39.13(h)(2) to require a DCO to 
obtain large trader reports either from its clearing members or from a 
DCM or a SEF for which it clears.
    The Commission has evaluated the costs and benefits of the proposed 
regulations in light of the specific considerations identified in 
Section 15(a) of the CEA, as follows:
1. Protection of Market Participants and the Public
Costs
    The Commission notes that some DCOs already receive large trader 
reports from DCMs and review large trader reports for risk surveillance 
purposes on a daily basis. For them, this rule imposes no additional 
cost. For other DCOs, the receipt and analysis of large trader 
information may entail significant, costly, and time-consuming changes 
to systems infrastructure. Clearing members could also incur costs to 
provide large trader reports to DCOs. For example, NYPC stated that its 
preliminary cost estimate for compliance with the customer gross margin 
and large trader report requirements contained in proposed Sec. Sec.  
39.13(g)(8)(i) and 39.13(h)(2) was approximately 128,650 hours and 
$14.5 million.
    In order to reduce costs, the Commission modified Sec.  39.13(h)(2) 
to permit a DCO to obtain large trader reports either from its clearing 
members or from a DCM or a SEF for which it clears. The latter approach 
would

[[Page 69423]]

eliminate duplicative reporting for clearing members and would 
significantly reduce costs for DCOs by enabling them to obtain the data 
from a single source.
Benefits
    Currently, at some DCOs, the receipt and analysis of large trader 
reports is an integral part of their risk management programs. 
Extension of this practice to all DCOs would benefit market 
participants and the public. Proactive analysis of this information 
allows DCOs to identify and to address incipient problems in customer 
accounts before they get out of hand. In particular, large trader 
reports are an essential part of a rigorous risk management system 
because they provide information that is required for stress testing.
    A default by a clearing member could have a significant, adverse 
effect on market participants or the public. Market participants may 
have to incur the costs of making up any shortfall in margin through 
guaranty fund deposits and/or assessments, and any costs associated 
with participation in an auction or allocation of the positions of a 
defaulting clearing member. In a worst case scenario, a default by a 
clearing member may undermine the financial integrity of the DCO, which 
could have serious and widespread consequences for the stability of 
U.S. financial markets. This rule protects market participants and the 
public by requiring a DCO to analyze the potential risks at an earlier 
stage.
2. Efficiency, Competitiveness, and Financial Integrity
    The considerations under this factor are very similar to the 
considerations under the first factor.
3. Price Discovery
    The Commission does not believe that this rule will have a material 
effect on price discovery.
4. Sound Risk Management Practices
    The considerations under this factor are very similar to the 
considerations under the first factor.
5. Other Public Interest Considerations
    The Commission does not believe that the rule will have a material 
effect on public interest considerations other than those identified 
above.
Clearing Member Risk Review
    As proposed, Sec.  39.13(h)(5)(ii) would require each DCO to review 
the risk management policies, procedures, and practices of each of its 
clearing members on a periodic basis.
    Several commenters asserted that the review would be burdensome for 
such clearing members. The Commission did not receive any comments that 
quantified the costs of this rule.
    The Commission is adopting the rule with two modifications. These 
changes clarify that a DCO's review need only cover those procedures of 
a clearing member which address the risks that such clearing member may 
pose to the DCO.
    The Commission has evaluated the costs and benefits of Sec.  
39.13(h)(5)(ii) in light of the specific considerations identified in 
Section 15(a) of the CEA, as follows:
1. Protection of Market Participants and the Public
Costs
    Those DCOs that currently conduct risk reviews of their clearing 
members are not likely to incur any additional costs as a result of the 
rule.\274\ Those DCOs that do not currently have such a program will 
incur costs to build on existing procedures for reviewing applicants 
for clearing membership in order to develop programs for ongoing review 
of clearing members. Clearing members will incur costs in working with 
the DCOs that review them. Commission staff intends to work with the 
DCOs to develop arrangements designed to avoid duplicative efforts 
without compromising the requirement that each DCO maintain an 
understanding of the risks of each of its clearing members.
---------------------------------------------------------------------------

    \274\ To the extent that some DCOs would conduct risk reviews in 
the absence of a rule, the incremental benefits of the rule are 
reduced. Even for these DCOs, however, a rule provides the market 
with the benefit of greater certainty that risk reviews of members 
will be continued in the future.
---------------------------------------------------------------------------

    In recognition that each DCO has a unique product mix and set of 
rules, the rule does not prescribe the specific frequency, depth, or 
methodology of such reviews, nor does it specify when an on-site audit 
may or may not be appropriate. Nevertheless, based on the Commission's 
experience overseeing DCOs that currently conduct risk reviews of 
clearing members, the Commission estimates the approximate costs of 
this rule as follows.\275\
---------------------------------------------------------------------------

    \275\ Figures used in the estimate are based on the judgment of 
Commission staff with experience overseeing DCO reviews of clearing 
member risk.
---------------------------------------------------------------------------

    The Commission estimates that a risk review by a large DCO 
typically would require on the order of 100 person-hours of work by a 
supervisor and several risk analysts. This includes preparation, an on-
site visit, and drafting the report. The Commission also estimates that 
a large DCO would perform, on average, 40 risk reviews a year, although 
the number would vary depending on the number of clearing members a 
particular DCO has, and other circumstances. The Commission estimates 
compensation costs on the order of $150 an hour for risk analysts, and 
$250 an hour for a supervisor. Based on these estimates, the Commission 
estimates that the annual cost to a large DCO would be roughly on the 
order of $700,000.\276\ Costs for particular DCOs are likely to vary 
from this amount based on the size of the DCO, the DCO's management and 
compensation practices, and the DCO's exercise of the flexibility 
allowed by the rule provision. In light of the potential consequences 
of risk management failures by clearing members discussed below, and of 
the Commission's judgment that DCOs are the market participants in the 
best position to review clearing member risk management programs, the 
Commission believes that the benefits of this provision would justify 
the costs even if costs proved to be substantially larger than the 
Commission's estimate.
---------------------------------------------------------------------------

    \276\ For example, 20 hours supervisor time per review x $250/hr 
plus 80 hours analyst time per review x $150/hr = $17,000 x 40 
reviews = $680,000.
---------------------------------------------------------------------------

Benefits
    Rigorous risk management programs at clearing members benefit 
market participants by providing safeguards to prevent default. 
Clearing members are at the front line of risk management. The 
Commission believes that risk reviews are important to ensure that each 
clearing member's risk management framework is sufficient and properly 
implemented. The Commission believes that a clearing member's DCO 
should undertake the review because that DCO is in the best position to 
review the risk management policies, procedures, and practices of its 
clearing members in the context of the clearing members' obligations 
under the DCO's rules.
2. Efficiency, Competitiveness, and Financial Integrity
Costs
    The considerations under this factor are very similar to the 
considerations under the first factor.
Benefits
    Ensuring that each clearing member has proper risk management 
procedures for each DCO at which it clears will promote efficiency and 
competitiveness in the clearing process by ensuring that the clearing 
member is in compliance

[[Page 69424]]

with each such DCO's rules and encouraging the exercise of best 
practices. The rule will foster financial integrity for the reasons set 
forth under the first factor.
    The Commission believes that default by a clearing member could 
have a significant, adverse effect on market participants and the 
public. Market participants may have to incur the costs of making up 
any shortfall in margin through guaranty fund deposits and/or 
assessments, and any costs associated with participation in an auction 
or allocation of the positions of a defaulting clearing member. In a 
worst case scenario, a default by an FCM may undermine the financial 
integrity of the DCO, which could have serious and widespread 
consequences for the stability of U.S. financial markets. This rule 
protects market participants and the public from bearing these costs by 
requiring a DCO to periodically review the risk management procedures 
of each of its clearing members.
3. Price Discovery
    The Commission does not believe that this rule will have a material 
effect on price discovery.
4. Sound Risk Management Practices
    The considerations under this factor are similar to the 
considerations under the first factor.
5. Other Public Interest Considerations
    The Commission does not believe that the rule will have a material 
effect on public interest considerations other than those identified 
above.

H. Settlement Procedures--Sec.  39.14(c)(3)

    Section 5b(c)(2)(E) of the CEA, Core Principle E, as amended by the 
Dodd-Frank Act, requires a DCO to: (1) complete money settlements on a 
timely basis, but not less frequently than once each business day; (2) 
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); (3) ensure that 
money settlements are final when effected; (4) maintain an accurate 
record of the flow of funds associated with money settlements; (5) 
possess the ability to comply with the terms and conditions of any 
permitted netting or offset arrangement with another clearing 
organization; (6) establish rules that clearly state each obligation of 
the DCO with respect to physical deliveries; and (7) ensure that it 
identifies and manages each risk arising from any of its obligations 
with respect to physical deliveries.
    The Commission proposed Sec.  39.14 to implement Core Principle E. 
With the exception of proposed Sec.  39.14(c), the commenters did not 
address the costs of the proposed rule or the Commission's 
consideration of costs and benefits.
    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 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.'' It would further require that a DCO (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 
reasonably necessary in order to eliminate or strictly limit such 
exposures.
    As discussed above, several commenters expressed concern that these 
provisions would impose costly requirements that are unnecessary or 
could have unintended adverse consequences. In this regard, one 
commenter claimed that the requirement to monitor clearing members' 
exposure to their settlement banks could result in a duplication of 
effort that would be burdensome for a DCO. Commenters also stated that 
there are a limited number of banks that are qualified and willing to 
serve as settlement banks; as such, it may be difficult for smaller 
DCOs to maintain more than one settlement bank given the associated 
costs. Further, commenters stated that imposing concentration limits 
could increase systemic risk because a DCO would need to distribute 
funds across multiple banks and as settlement funds increased, highly 
rated banks would eventually reach the applicable concentration limit, 
potentially forcing DCOs to open accounts with lower rated banks.
    None of the commenters provided quantitative data or information to 
support their assertions as to the potential costs and burdens of 
compliance with Sec.  39.14(c)(3), and none addressed the benefits of 
the rule.
    As discussed above, the Commission believes that there are risks 
associated with a DCO concentrating all its funds in a single 
settlement bank. Bank failure in such a circumstance could have adverse 
consequences for the DCO, its clearing members, and their customers. 
However, the Commission also acknowledges the concerns expressed by 
commenters, particularly given the settlement practices and procedures 
that DCOs currently maintain in the absence of such a regulation.
    Accordingly, the Commission is modifying Sec.  39.14(c)(3) to 
eliminate any implied requirement that all DCOs must maintain 
settlement accounts at more than one bank, and is retaining the 
requirement that a DCO monitor exposure to its settlement bank(s) and 
those of its clearing members, including an ongoing assessment of the 
effect to the DCO of a failure of the settlement bank that has the 
largest share of settlement activity. It is also clarifying its intent 
to qualify the need to take actions set forth in Sec.  39.14(c)(3)(i)-
(iv) (such as imposing concentration limits) ``to the extent that any 
such action or actions are reasonably necessary in order to eliminate 
or strictly limit such exposures.'' Thus, the Commission is providing 
DCOs with more flexibility than would have been provided under the 
proposed rule which, in turn, should reduce the costs associated with 
compliance.
    The Commission has evaluated the costs and benefits of Sec.  
39.14(c)(3) in light of the specific considerations identified in 
Section 15(a) of the CEA, as follows:
 1. Protection of Market Participants and the Public
Costs
    A DCO's monitoring of its exposure to its settlement bank(s) and 
those of its clearing members is a sound business practice in which a 
DCO should be engaged notwithstanding the rule. Nevertheless, the 
Commission believes the rule will require commitment of DCO staff 
resources, the costs of which could be passed along to clearing members 
and market participants as part of the DCO's clearing fees. Such costs 
could vary significantly across DCOs given differences in operational 
and risk management procedures, settlement arrangements, and fee 
pricing practices. Given these circumstances, the Commission is unable 
to quantify the costs attributable to the Commission's rule, and no 
commenter provided an estimate. As a general matter, however, the 
Commission is mindful that the measures set forth in Sec.  
39.14(c)(3)(i)-(iv), specifically the requirement that DCOs take 
actions that are ``reasonably necessary in order to eliminate or 
strictly limit'' exposure to settlement banks, could cause DCOs to 
incur costs. Such costs could include, for example, the costs of 
establishing an account at an additional settlement bank, which would 
entail evaluating the bank to ensure that it meets the DCO's

[[Page 69425]]

criteria for a settlement bank, reviewing account agreements, and 
establishing connectivity to the bank. There may also be fees charged 
by a bank for standby services if the bank is not used as the primary 
settlement bank, or there may be other account-related fees. The 
Commission is unable to ascertain the specific amount of any such costs 
for DCOs because of the varying nature of settlement bank arrangements 
across DCOs.
Benefits
    Use of multiple settlement banks by DCOs, as well as imposition of 
concentration limits and other safeguards provided for in Sec.  
39.14(c)(3)(i)-(iv), when reasonably necessary, could help insulate the 
DCO and its members from the risk of default by a settlement bank. This 
in turn could provide market participants and the public with greater 
protection from disruption of markets, as well as the clearing and 
settlement system.
    Affording a DCO flexibility in managing its settlement bank 
arrangements and, to a lesser degree, those of its clearing members, 
benefits market participants and the public by reducing the costs and 
potential inefficiencies associated with maintaining settlement 
arrangements with multiple settlement banks when that might not yield a 
concomitant benefit in the form of risk reduction. The rule sets forth 
general standards while permitting each DCO to tailor its settlement 
bank arrangements to its unique circumstances and risk tolerances.
2. Efficiency, Competitiveness, and Financial Integrity
Costs
    Quantification or estimation of costs to efficiency, 
competitiveness, and financial integrity of markets are not readily 
ascertainable, and no commenter provided an estimate.
Benefits
    The rule permits DCOs to obtain settlement services from a single 
bank if the size and needs of the DCO, as well as the availability of 
suitable settlement bank services, makes the use of more than one 
settlement bank cost-prohibitive and it is not reasonably necessary to 
have more than one settlement bank in order to eliminate or strictly 
limit the DCO's exposures. More efficient use of DCO resources can 
result in enhanced efficiency and financial integrity of the markets 
for which the DCO clears. Particularly for smaller DCOs, it may not be 
practical to obtain settlement services from more than one settlement 
bank because of the costs of evaluating a bank's suitability to perform 
settlement functions, reviewing account agreements, and establishing 
connectivity to the bank. There also may be account-related fees 
charged by a bank, including fees for standby services, if the bank is 
used as a back-up settlement bank and not the primary settlement bank.
3. Price Discovery
    The Commission has not identified any ways in which Sec.  
39.14(c)(3) could affect price discovery.
4. Sound Risk Management Practices
Costs
    The Commission has not identified any ways in which Sec.  
39.14(c)(3) could impair sound risk management practices.
Benefits
    The Commission regards an effective settlement framework as a sound 
risk management practice because it reduces the risks associated with a 
bank's potential failure to make timely settlement. The requirements 
that a DCO monitor risk exposures to settlement banks and address 
diversification concerns, as reasonably necessary, are important 
adjuncts to a DCO's overall risk management practices.
5. Other Public Interest Considerations.
    The Commission has not identified any other costs or benefits that 
should be taken into account.

I. Treatment of Funds--Sec.  39.15

    Core Principle F, as amended by the Dodd-Frank Act, requires a DCO 
to: (i) Establish standards and procedures that are designed to protect 
and ensure the safety of its clearing members' funds and assets; (ii) 
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 (iii) 
only invest such funds and assets in instruments with minimal credit, 
market, and liquidity risks.\277\
---------------------------------------------------------------------------

    \277\ Section 5b(c)(2)(F) of the CEA; 7 U.S.C. 7a-1(c)(2)(F) 
(Core Principle F).
---------------------------------------------------------------------------

    Proposed Sec.  39.15 would establish minimum standards for DCO 
compliance with Core Principle F. Among other things, it would set 
forth standards for the types of assets that could be accepted as 
initial margin. In this regard, 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 risk. It would further 
specify that a DCO may not accept letters of credit as initial margin.
    The Commission received comments on substantive aspects of the 
proposed rules, and it has addressed those comments above. The 
Commission also received several comments on potential costs associated 
with the proposed Sec.  39.15(c)(1) prohibition on the acceptance of 
letters of credit as initial margin.\278\ CME asserted that the 
prohibition is unnecessary because letters of credit provide an 
absolute assurance of payment and, therefore, the issuing bank must 
honor the demand even in circumstances where the beneficiary is unable 
to reimburse the bank for its payment. Other commenters suggested that 
letters of credit should be acceptable if they are subject to 
appropriate conditions. Finally, several commenters warned of the 
potential risks associated with prohibiting letters of credit, 
including higher costs for clearing members and their customers, the 
potential placement of U.S. DCOs at a disadvantage as compared to 
foreign clearing houses, and increased systemic risk as a result of 
decreased voluntary clearing.
---------------------------------------------------------------------------

    \278\ The Commission notes that proposed 39.15(c)(1) regarding 
types of assets that can be accepted as initial margin has been 
redesignated as Sec.  39.13(g)(10) under the risk management rules.
---------------------------------------------------------------------------

    Taking into account both the strong track record of letters of 
credit in connection with cleared futures and options on futures and 
the potentially greater risks of cleared swaps, the Commission has 
determined to modify the rule to permit letters of credit in connection 
with cleared futures and options on futures but to retain the 
prohibition on letters of credit as initial margin for swaps. Certain 
DCOs have accepted letters of credit as initial margin for futures and 
options on futures for a number of years without incident and continue 
to do so. On the other hand, letters of credit are only a promise by a 
bank to pay, not an asset that can be sold. The Commission is concerned 
that the potential losses that swap market participants could incur may 
be of a greater magnitude than potential losses with respect to futures 
and options. Initial margin is the first financial resource that a DCO 
will apply in the event of a clearing member default. If a DCO were to 
need to draw on a letter of credit posted by a clearing member whose 
customers had suffered such losses, the larger the amount that it would 
need to draw, the greater the risk that the issuing bank may be unable 
to pay under the terms of the letter of credit. Accordingly, the 
Commission is modifying the proposal as described.

[[Page 69426]]

    The Commission has evaluated the costs and benefits of Sec.  
39.13(g)(10) in light of the specific considerations identified in 
Section 15(a) of the CEA, as follows:
1. Protection of Market Participants and the Public
Costs
    The prohibition on accepting letters of credit as initial margin 
for swaps may impose higher costs for clearing members because they 
will have to deposit cash or other assets that have minimal credit, 
market, and liquidity risk for those products. This could increase 
costs for market participants and decrease capital efficiency. It may 
also place U.S. DCOs at a disadvantage to those foreign clearing houses 
that permit letters of credit to be used as initial margin for swaps. 
The Commission notes, however, that in response to the comments it has 
modified the rule to permit letters of credit for futures. Therefore, 
futures market participants will not incur any costs as a result of 
this provision.
    It is not possible to estimate or quantify these costs for a number 
of reasons. The Dodd-Frank Act and implementing regulations will 
significantly affect the manner in which swaps are developed, traded, 
executed, and cleared. Existing DCOs and FCMs will be clearing new 
products. New DCOs and FCMs will enter the market. Mandatory clearing 
will bring new products and participants to DCOs and FCMs. The 
interaction of all these factors creates a wide range of uncertainty as 
to which products will be cleared, what their margin requirements will 
be, and the extent to which clearing members would post letters of 
credit as margin if permitted. Under these circumstances, the potential 
opportunity costs that may arise from the deposit of cash or other 
assets rather than letters of credit depends on a variety of future 
circumstances and actions of market participants that cannot be known 
or predicted at the present time. In sum, the Commission believes that 
the possible future circumstances involving the posting of letters of 
credit as margin is too speculative and uncertain to be able to 
quantify or estimate the resulting costs to clearing members with any 
precision or degree of magnitude.
Benefits
    One of the primary functions of a DCO is to guarantee financial 
performance, which includes performing daily variation settlement. 
Daily pays are made in cash, and to the extent a DCO relies on margin 
deposits to meet its end-of-day obligations, it must have access to 
sufficient cash or highly liquid assets. Similarly, initial margin may 
be tapped by a DCO in the event of a clearing member default. By 
limiting the use of letters of credit, the DCO will avoid the 
possibility that a letter of credit would be dishonored when presented 
to the issuing bank.
    Thus, requiring initial margin in the form of assets that can be 
immediately sold provides greater financial protection to the DCO, 
clearing members, and market participants.
2. Efficiency, Competitiveness, and Financial Integrity
Costs
    As noted above, there could be competitive disadvantages to DCOs if 
foreign competitors do not impose similar restrictions on initial 
margin deposits. In addition, the prospect of increased costs may 
reduce voluntary clearing of swaps, which would be inconsistent with 
the goals of the Dodd-Frank Act and could potentially lead to systemic 
risk.
Benefits
    A DCO can be more efficient in facilitating payments if it has 
readily available liquid assets as opposed to a conditional obligation 
that must be presented for payment. Holding actual assets provides 
greater assurance of financial integrity to the clearing process, as 
the DCO will not have to bear the costs of possible default on the part 
of the issuing bank. Even an irrevocable letter of credit can be 
dishonored, with the DCO's only recourse being a lawsuit.
3. Price Discovery
    The Commission does not believe this rule will have a material 
effect on price discovery.
4. Sound Risk Management Practices
Costs
    The Commission does not believe this rule will have a material 
adverse impact on sound risk management practices.
Benefits
    The Commission expects that prohibiting the use of letters of 
credit as initial margin for swaps could serve to strengthen a DCO's 
risk management program. It eliminates the risk of funds not being 
available if a letter of credit were to be dishonored, which could have 
a significant impact because initial margin is the first financial 
resource to be tapped in the event of a clearing member default.
5. Other Public Considerations
    The Commission does not believe this rule will have a material 
impact on public interest considerations other than those discussed 
above.

J. Reporting--Sec.  39.19

    Core Principle J,\279\ as amended by the Dodd-Frank Act, requires a 
DCO to provide the Commission with all information that the Commission 
determines to be necessary to conduct oversight of the DCO.
---------------------------------------------------------------------------

    \279\ Section 5b(c)(2)(J) of the CEA, 7 U.S.C. 7a-1(c)(2)(J).
---------------------------------------------------------------------------

    The Commission proposed Sec.  39.19 to establish minimum 
requirements that a DCO would have to meet in order to comply with Core 
Principle J. Under proposed Sec.  39.19, certain reports would have to 
be made by a DCO to the Commission (1) On a periodic basis (daily, 
quarterly, or annually); (2) where the reporting requirement is 
triggered by the occurrence of a significant event; and (3) upon 
request by the Commission.
    The rules would require DCOs to provide information that the 
Commission has determined is necessary to conduct oversight of DCOs. 
The proposed reporting regime would assist the Commission in monitoring 
the financial strength and operational capabilities of a DCO and in 
evaluating whether a DCO's risk management practices are effective. The 
required reports also would assist the Commission in taking prompt 
action as necessary to identify incipient problems and address them at 
an early stage. A self-reporting program of this type enhances the 
Commission's ability to conduct oversight given its limited resources 
which do not permit routine on-site surveillance of DCOs.
    The proposed rules would require submission of information 
electronically and in a form and manner prescribed by the Commission. 
These general procedural standards would provide flexibility to the 
Commission in establishing and updating uniform format and delivery 
protocols that would assist the Commission in conducting timely review 
of submissions. In this regard, the transmission of information using a 
uniform format would enable Commission staff to sort and interpret data 
without the need to convert the data into a format that provides the 
necessary functionality, e.g., it would be designed to provide the 
Commission with the ability to compare data across DCOs when necessary.
    A number of commenters discussed costs associated with proposed 
Sec.  39.19

[[Page 69427]]

in the form of comments on the substantive provisions of the proposed 
rule. For example, a number of commenters discussed whether alternative 
reporting requirements might better inform the Commission of potential 
risks. Some commenters questioned the need for certain information and 
some commenters questioned the feasibility of the reporting 
requirements. The Commission has addressed those comments above.
    The Commission also received comments that directly addressed two 
areas of the Commission's cost-benefit analysis of proposed Sec.  
39.19: (1) The cost of preparing and submitting daily and annual 
audited financial reports; and (2) the cost of reporting a 10 percent 
decrease in financial resources. Those comments are discussed in detail 
below.
a. Cost of Preparing and Submitting Daily and Annual Reports
    Proposed Sec.  39.19(c) would require a DCO to submit various 
periodic reports for the purposes of risk surveillance and oversight of 
the DCO's compliance with the core principles and Commission 
regulations. In the notice of proposed rulemaking, the Commission 
observed that the information that would be reported was information 
readily available to a DCO and which, in certain instances, was already 
being reported to the Commission. The Commission requested data or 
other information that could quantify or qualify costs.
    Only NYPC provided an estimate of the fixed cost of implementing an 
automated system for daily reporting. In a comment letter submitted by 
NYPC, the cost was estimated at $582,000.
    In a follow-up phone conversation with representatives of NYPC, 
Commission staff discussed the basis for NYPC's estimate that 
implementing an automated system for daily reporting would cost 
$582,000. Staff was told that NYPC already provides certain daily 
reports to the Commission, but that the additional data that it would 
have to report under the proposal (not including the proposed gross 
margin data or large trader data) would necessitate implementing an 
automated system. NYPC representatives confirmed that the estimate was 
for a one-time cost, not the cost of generating and transmitting the 
actual daily reports. NYPC also confirmed that the cost of generating 
and transmitting the actual daily reports would be minimal.
    The Commission was able to estimate the costs of providing reports 
and presented this information in the Paperwork Reduction Act 
discussion. It estimated that daily reporting could require a DCO to 
expend up to $8,280 per year, and an annual report could require a DCO 
to expend up to $482,110 per year.
    KCC and MGEX commented that the variable cost for daily reporting 
could be significantly more than the Commission's estimates if the 
Commission were to require a costly format and method of delivery. MGEX 
also commented that the Commission may have underestimated the cost of 
providing the annual report (audited financial report under Sec.  
39.19(c)(3)(ii)), and that the Commission's estimate is ``extremely 
excessive, particularly when most of [the annual reporting requirements 
do] not appear to be required by the Dodd-Frank Act.'' Finally, MGEX 
believes that the proposed rules will not guarantee increased market 
participation or improve legitimate risk management and hedging 
activity, and the additional costs will create barriers to entry and 
decrease DCO competition.
    Although KCC and MGEX commented that the costs of preparing the 
reports may be greater than the Commission's estimates, neither DCO 
provided an alternative estimate. Nor did they suggest alternative 
reporting requirements that would achieve the purposes of the CEA with 
a more favorable cost-benefit ratio. As to the estimated costs of the 
required format and method of delivery, the Commission notes that it 
based its estimate on the cost of using the SHAMIS system. The 
Commission has no basis for concluding that the cost of using an 
alternative system would be less substantial and it received no 
comments on this.
    The Commission believes that the costs that DCOs will incur to 
implement a system to provide such information to the Commission are 
necessary and justified. As explained above, the Commission has 
determined that the information required in the reports is necessary 
for the Commission to conduct adequate oversight of DCOs, particularly 
given its limited ability to conduct on-site reviews.
b. Reporting a 10 Percent Decrease in Financial Resources
    Under proposed Sec.  39.19(c)(4)(i), a DCO would be required to 
report a decrease of 10 percent in the total value of its financial 
resources either from (1) the value reported in the DCO's last 
quarterly report or (2) from the value as of the close of the previous 
business day. This would allow the Commission to more quickly identify 
and address financial problems at the DCO. As discussed above, the 
Commission raised the reporting threshold from 10 percent to 25 percent 
in response to comments that a higher percentage might yield more 
meaningful results. In addition, the higher threshold is likely to 
reduce the number of reports that might be submitted under this 
requirement.
    NYPC commented that compliance with the proposed reporting 
requirement would necessitate an expenditure of approximately 15,000 
hours and $1.7 million. NYPC explained that this estimate reflects 
implementing a system that would track default resources and working 
capital, combined. After talking with Commission staff, NYPC submitted 
a comment letter that provided a preliminary estimate of approximately 
4,600 hours and $566,000 for designing, building, and testing a 
reporting system for a decline in default resources only.
    Based on NYPC's initial comment letter, the Commission believes 
that the material costs associated with Sec.  39.19(c)(4)(i) are the 
initial investments made by a DCO to develop and implement a system 
(automated or not) to alert the DCO that the valuation threshold has 
been met. As discussed above, it is important for the Commission to be 
apprised of a 25% reduction in default resources because it could 
indicate that the DCO's financial resources are strained and corrective 
action may be needed.
    The Commission has evaluated the costs and benefits of Sec.  39.19 
in light of the specific considerations identified in Section 15(a) of 
the CEA as follows:
1. Protection of Market Participants and the Public
Costs
    Section 39.19 requires DCOs to provide information that the 
Commission has determined is necessary for oversight of DCOs and to 
provide that information in a time frame, format, and delivery method 
that will enable effective use of the information. To the extent that 
DCOs do not already have an infrastructure for preparing and 
transmitting reports, they will incur one-time costs to put such a 
framework in place.
Benefits
    The comprehensive regulatory reporting program will enhance 
protection of market participants and the public by promoting more in-
depth and effective oversight by the Commission. The reports will 
assist the Commission's Risk Surveillance staff in monitoring clearing 
house risk and evaluating DCOs' management and mitigation of that risk. 
In addition, the

[[Page 69428]]

information will assist the Commission to identify incipient problems 
and address them at an early stage.
2. Efficiency, Competitiveness, and Financial Integrity
Costs
    The Commission does not believe that the reporting requirements 
will adversely impact efficiency, competitiveness, or the financial 
integrity of derivatives markets.
Benefits
    The reporting requirements will protect the financial integrity of 
derivatives markets because they will support effective and timely 
oversight of DCOs. This will help to minimize the risk of default and 
the impact default would have on the markets.
3. Price Discovery
    The Commission does not believe that Sec.  39.19 will have a 
material impact on price discovery.
4. Sound Risk Management Practices
Costs
    The Commission does not believe that the reporting requirements 
will adversely impact sound risk management practices.
Benefits
    The reporting requirements are expected to enhance sound risk 
management practices because the Commission will be able to more 
effectively evaluate a DCO's risk management practices on an on-going 
basis. The Commission staff can build a knowledge base that will 
support prompt action if there are adverse changes in trends or 
financial profiles.
5. Other Public Interest Considerations
    The Commission does not believe this rule will have a material 
impact on public interest considerations other than those discussed 
above. Effective oversight of DCOs will enhance the safety and 
efficiency of DCOs and reduce systemic risk. Safe and reliable DCOs are 
essential not only for the stability of the derivatives markets they 
serve but also the public which relies on the prices formed in these 
markets for all manner of commerce.

IX. 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.\280\ 
The rules adopted herein will affect only DCOs). 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.\281\ The Commission has 
previously determined that DCOs are not small entities for the purpose 
of the RFA.\282\ Accordingly, the Chairman, on behalf of the 
Commission, hereby certifies pursuant to 5 U.S.C. 605(b) that these 
rules will not have a significant economic impact on a substantial 
number of small entities. The Chairman made the same certification in 
the proposed rulemakings, and the Commission did not receive any 
comments on the RFA in relation to any of those rulemakings.
---------------------------------------------------------------------------

    \280\ 5 U.S.C. 601 et seq.
    \281\ 47 FR 18618 (Apr. 30, 1982).
    \282\ See 66 FR 45604, at 45609 (Aug. 29, 2001) (New Regulatory 
Framework for Clearing Organizations).
---------------------------------------------------------------------------

B. Paperwork Reduction Act

    The Commission may not conduct or sponsor, and a registered entity 
is not required to respond to, a collection of information unless it 
displays a currently valid Office of Management and Budget (OMB) 
control number. The Commission's adoption of Sec. Sec.  39.3 (DCO 
registration application requirements), 39.10 (annual compliance report 
and recordkeeping), 39.11 (financial resources quarterly report), 39.14 
(settlement recordkeeping), 39.18 (system safeguards reporting and 
recordkeeping), 39.19 (periodic and event-specific reporting), and 
39.20 (general recordkeeping), imposes new information collection 
requirements on registered entities within the meaning of the Paperwork 
Reduction Act.\283\
---------------------------------------------------------------------------

    \283\ 44 U.S.C. 3501 et seq.
---------------------------------------------------------------------------

    Accordingly, the Commission requested and OMB assigned control 
numbers for the required collections of information. The Commission has 
submitted this notice of final rulemaking along with supporting 
documentation for OMB's review in accordance with 44 U.S.C. 3507(d) and 
5 CFR 1320.11. The titles for these collections of information are 
``Financial Resources Requirements for Derivatives Clearing 
Organizations, OMB control number 3038-0066,'' ``Information Management 
Requirements for Derivatives Clearing Organizations, OMB control number 
3038-0069,'' ``General Regulations and Derivatives Clearing 
Organizations, OMB control number 3038-0081,'' and ``Risk Management 
Requirements for Derivatives Clearing Organizations, OMB control number 
3038-0076.'' Many of the responses to this new collection of 
information are mandatory.
    The Commission protects proprietary information according to the 
Freedom of Information Act and 17 CFR part 145, ``Commission Records 
and Information.'' In addition, Section 8(a)(1) of the CEA strictly 
prohibits the Commission, unless specifically authorized by the Act, 
from making public ``data and information that would separately 
disclose the business transactions or market positions of any person 
and trade secrets or names of customers.'' 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.
    The regulations require each respondent to file certain information 
with the Commission and to maintain certain records.\284\ The 
Commission received comments from NYPC and MGEX regarding the estimated 
costs of preparing and submitting daily reports. It also received 
comments from MGEX regarding costs associated with annual reports and 
the proposed rules in general.
---------------------------------------------------------------------------

    \284\ See 75 FR at 63119 (Oct. 14, 2010) (Financial Resources) 
(requirement to file quarterly reports); see also discussion of the 
financial resources reporting requirements in section IV.B.10, 
above.
    See 75 FR at 77583-77584 (Dec. 13, 2010) (General Regulations) 
(proposed requirements: (i) For the CCO to submit an annual report 
to the Commission; (ii) to retain a copy of the policies and 
procedures adopted in furtherance of compliance with the CEA; (iii) 
to retain copies of materials, including written reports provided to 
the board of directors in connection with the board's review of the 
annual report; and (iv) to retain any records relevant to the annual 
report, including, but not limited to, work papers and other 
documents that form the basis of the report, and memoranda, 
correspondence, other documents, and records that are (a) created, 
sent or received in connection with the annual report and (b) 
contain conclusions, opinions, analyses, or financial data related 
to the annual report); see also discussion of Sec.  39.10 in section 
IV.A, above.
    See 75 FR at 78193 (Dec. 15, 2010) (Information Management) 
(proposed requirements to file specified information with the 
Commission (i) periodically, on a daily, quarterly, and annual 
basis; (ii) as specified events occur; and (iii) upon Commission 
request); see also discussion of reporting requirements in section 
IV.J, above.
    See 75 FR at 78196 (Dec. 15, 2010) (Information Management) 
(proposed requirement 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); see also discussion of recordkeeping 
requirements in section IV.K, above.
---------------------------------------------------------------------------

    NYPC and MGEX commented that the costs associated with the rules in 
the Information Management proposed rulemaking would be higher than the

[[Page 69429]]

Commission estimated.\285\ With respect to daily reporting, NYPC 
commented that designing, building, and testing the application 
necessary to automate the process of producing daily reports would 
require approximately 5,200 hours and cost $582,000.\286\ MGEX 
commented that the cost to a DCO could be significantly more than the 
estimated cost if the Commission were to require a costly format and 
method of delivery.
---------------------------------------------------------------------------

    \285\ See 75 FR at 78193 (Dec. 15, 2010) (Information 
Management). In the Paperwork Reduction Act discussion, the 
Commission estimated that daily reporting would result in an 
aggregated cost of $8,280 initially (12 respondents x $690) and 
$16,800 per annum (12 respondents x $1,400). Annual reporting would 
result in an aggregated cost of $5,785,320 per annum (12 respondents 
x $482,110).
    \286\ In a follow-up phone conversation with representatives of 
NYPC, Commission staff discussed the basis for NYPC's estimate that 
implementing an automated system for daily reporting would cost 
$582,000. Commission staff was told that NYPC already provides 
certain daily reports to the Commission's Risk Surveillance Group, 
but that the additional data that it would have to report under the 
Information Management NPRM (not including the gross margin data or 
large trader data) would necessitate implementing an automated 
system. NYPC representatives confirmed that the estimate was for a 
one-time cost, not the cost of generating and transmitting the 
actual daily reports. NYPC also confirmed that the cost of 
generating and transmitting the actual daily reports would be 
minimal.
---------------------------------------------------------------------------

    With respect to annual reporting, MGEX commented that the 
Commission may have underestimated the associated costs because the 
Commission did not address the costs of building reporting methods, 
forms, programs, or the allocation of labor resources. In addition, 
MGEX believes that the estimated costs associated with the annual 
report are ``extremely excessive, particularly when most of [the annual 
report requirements do] not appear to be required by the Dodd-Frank 
Act.'' MGEX further commented that the proposed rules will not 
guarantee increased market participation or improve legitimate risk 
management and hedging activity, and the additional costs would create 
barriers to entry and decreased DCO competition.
    Finally, with respect to the estimated costs identified in the Risk 
Management notice of proposed rulemaking,\287\ MGEX noted that the 
Commission had estimated the total hours for the proposed collection of 
information to be 50 hours per year per respondent for the additional 
reporting requirements at an annual cost of $500 per respondent (50 
hours x $10). MGEX stated its belief that these estimates, both in 
hours and cost, are extremely low, and that it did not appear that the 
Commission had accounted for the costs to implement a system; collect, 
forward and format data; monitor and enforce compliance; and document 
compliance with the proposed rulemaking. MGEX noted that the costs are 
not limited to reporting to the Commission for many of the proposed 
rules, and that reporting may be the least expensive facet. MGEX 
specifically identified reporting the gross position of each beneficial 
owner as a requirement for which the Commission did not provide any 
cost estimates.
---------------------------------------------------------------------------

    \287\ See 76 FR at 3716-3717 (Jan. 20, 2011) (Risk Management).
---------------------------------------------------------------------------

    Although MGEX commented that the costs of the proposed requirements 
may be greater than the costs the Commission set forth in the 
Information Management and Risk Management proposed rulemakings, and 
that the Commission did not estimate the costs of building reporting 
methods, forms, programs, or the allocation of labor resources, MGEX 
did not provide an estimate of these costs. Nor did MGEX suggest 
alternative reporting requirements that would achieve the purposes of 
the CEA with a more favorable cost-benefit ratio.
    As to the estimated costs of the required format and method of 
delivery, the Commission notes that the estimates of these costs were 
based on the cost of using the SHAMIS system. There was no basis for 
concluding that the cost of using an alternative system would be more 
substantial and the Commission received no comment to that effect. 
Moreover, Core Principle J requires a DCO to provide reports to the 
Commission, and all DCOs will have to bear these costs in order to 
comply with Core Principle J. Core Principle J requires each DCO ``to 
provide to the Commission all information that the Commission 
determines to be necessary to conduct oversight of the [DCO].'' As 
discussed above and in the Information Management proposed rulemaking, 
the Commission believes that the daily and annual reporting 
requirements provide the Commission with information that is important 
to its oversight of a DCO to ensure the DCO is in compliance with the 
core principles. This can lead to increased market participation and 
improve legitimate risk management and hedging activity. Accordingly, 
the Commission believes the collection of information related to the 
reporting rules is necessary to achieve the purposes of the CEA, 
particularly in light of the Dodd-Frank Act clearing mandate for 
swaps.\288\
---------------------------------------------------------------------------

    \288\ See further discussion of the costs and benefits 
associated with the reporting requirements in section VII.J, above.
---------------------------------------------------------------------------

    The Commission has considered the comments of NYPC and MGEX but is 
declining to revise the estimated costs. The Commission believes that 
its original estimates remain appropriate for PRA purposes.

List of Subjects

17 CFR Part 1

    Brokers, Commodity futures, Consumer protection, Definitions, 
Swaps.

17 CFR Part 21

    Brokers, Commodity futures, Reporting and recordkeeping 
requirements.

17 CFR Part 39

    Definitions, Commodity futures, Reporting and recordkeeping 
requirements, Swaps, Business and industry, Participant and product 
eligibility, Risk management, Settlement procedures, Treatment of 
funds, Default rules and procedures, System safeguards, Enforcement 
authority, Application form.

17 CFR Part 140

    Authority delegations (Government agencies), Conflict of interests, 
Organization and functions (Government agencies).

    For the reasons stated in the preamble, amend 17 CFR parts 1, 21, 
39, and 140 as follows:

PART 1--GENERAL REGULATIONS UNDER THE COMMODITY EXCHANGE ACT

0
1. The authority citation for part 1 is revised to read as follows:

    Authority: 7 U.S.C. 1a, 2, 5, 6, 6a, 6b, 6c, 6d, 6e, 6f, 6g, 6h, 
6i, 6j, 6k, 6l, 6m, 6n, 6o, 6p, 7, 7a, 7b, 8, 9, 12, 12a, 12c, 13a, 
13a-1, 16, 16a, 19, 21, 23, and 24, as amended by Pub. L. 111-203, 
124 Stat. 1376.

0
2. Amend Sec.  1.3 to revise paragraphs (c) and (d), remove and reserve 
paragraph (k), and add paragraphs (aaa), (bbb), (ccc), (ddd), (eee), 
and (fff) to read as follows:

Sec.  1.3  Definitions.

* * * * *
    (c) Clearing member. This term means 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.
    (d) Clearing organization or derivatives clearing organization. 
This term means a clearinghouse, clearing association, clearing 
corporation, or similar entity, facility, system, or

[[Page 69430]]

organization that, with respect to an agreement, contract, or 
transaction--
    (1) Enables each party to the agreement, contract, or transaction 
to substitute, through novation or otherwise, the credit of the 
derivatives clearing organization for the credit of the parties;
    (2) Arranges or provides, on a multilateral basis, for the 
settlement or netting of obligations resulting from such agreements, 
contracts, or transactions executed by participants in the derivatives 
clearing organization; or
    (3) Otherwise provides clearing services or arrangements that 
mutualize or transfer among participants in the derivatives clearing 
organization the credit risk arising from such agreements, contracts, 
or transactions executed by the participants.
    (4) Exclusions. The terms clearing organization and derivatives 
clearing organization do not include an entity, facility, system, or 
organization solely because it arranges or provides for--
    (i) Settlement, netting, or novation of obligations resulting from 
agreements, contracts or transactions, on a bilateral basis and without 
a central counterparty;
    (ii) Settlement or netting of cash payments through an interbank 
payment system; or
    (iii) Settlement, netting, or novation of obligations resulting 
from a sale of a commodity in a transaction in the spot market for the 
commodity.
* * * * *
    (k) [Reserved]
* * * * *
    (aaa) Clearing initial margin. This term means initial margin 
posted by a clearing member with a derivatives clearing organization.
    (bbb) Customer initial margin. This term means initial margin 
posted by a customer with a futures commission merchant, or by a non-
clearing member futures commission merchant with a clearing member.
    (ccc) Initial margin. This term means 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.
    (ddd) Margin call. This term means a request from a futures 
commission merchant to a customer to post customer initial margin; or a 
request by a derivatives clearing organization to a clearing member to 
post clearing initial margin or variation margin.
    (eee) Spread margin. This term means reduced initial margin that 
takes into account correlations between certain related positions held 
in a single account.
    (fff) Variation margin. This term means 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.

0
3. Amend Sec.  1.12 to remove and reserve paragraph (f)(1).

PART 21--SPECIAL CALLS

0
4. The authority citation for part 21 is revised to read as follows:

    Authority: 7 U.S.C. 1a, 2, 2a, 4, 6a, 6c, 6f, 6g, 6i, 6k, 6m, 
6n, 7, 7a, 12a, 19 and 21, as amended by Pub. L. 111-203, 124 Stat. 
1376; 5 U.S.C. 552 and 552(b), unless otherwise noted.

0
5. Redesignate Sec.  21.04 as Sec.  21.05.
0
6. Add a new Sec.  21.04 to read as follows:

Sec.  21.04  Special calls for information on customer accounts or 
related cleared positions.

    Upon special call by the Commission, each futures commission 
merchant, clearing member or foreign broker shall provide information 
to the Commission concerning customer accounts or related positions 
cleared on a derivatives clearing organization in the format and manner 
and within the time provided by the Commission in the special call.

0
7. Add Sec.  21.06 to read as follows:

Sec.  21.06  Delegation of authority to the Director of the Division of 
Clearing and Risk.

    The Commission hereby delegates, until the Commission orders 
otherwise, the special call authority set forth in Sec.  21.04 to the 
Director of the Division of Clearing and Risk to be exercised by such 
Director or by such other employee or employees of such Director as 
designated from time to time by the Director. The Director of the 
Division of Clearing and Risk may submit to the Commission for its 
consideration any matter which has been delegated in this section. 
Nothing in this section shall be deemed to prohibit the Commission, at 
its election, from exercising the authority delegated in this section 
to the Director.

PART 39--DERIVATIVES CLEARING ORGANIZATIONS

0
8. Revise part 39 to read as follows:
Subpart A--General Provisions Applicable to Derivatives Clearing 
Organizations
Sec.
39.1 Scope.
39.2 Definitions.
39.3 Procedures for registration.
39.4 Procedures for implementing derivatives clearing organization 
rules and clearing new products.
39.5 Submission of swaps for Commission determination regarding 
clearing requirements.
39.6 [Reserved]
39.7 Enforceability.
39.8 Fraud in connection with the clearing of transactions on a 
derivatives clearing organization.
Subpart B--Compliance With Core Principles
39.9 Scope.
39.10 Compliance with core principles.
39.11 Financial resources.
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 Rule enforcement.
39.18 System safeguards.
39.19 Reporting.
39.20 Recordkeeping.
39.21 Public information.
39.22 Information sharing.
39.23 Antitrust considerations.
39.24 [Reserved]
39.25 [Reserved]
39.26 [Reserved]
39.27 Legal risk considerations.

Appendix A to Part 39--Form DCO Derivatives Clearing Organization 
Application for Registrations

    Authority: 7 U.S.C. 7a-1 as amended by Pub. L. 111-203, 124 
Stat. 1376.

Subpart A--General Provisions Applicable to Derivatives Clearing 
Organizations

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 applies to register as such with the 
Commission pursuant to section 5b(b) or otherwise.

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.
    Customer means a person trading in any commodity named in the 
definition of commodity in section 1a(9) of the Act or in Sec.  1.3 of 
this chapter, or in any swap as defined in section 1a(47) of the Act or 
in Sec.  1.3 of this chapter; Provided, however, an owner or holder of 
a house

[[Page 69431]]

account as defined in this section shall not be deemed to be a customer 
within the meaning of section 4d of the Act, the regulations that 
implement sections 4d and 4f of the Act and Sec.  1.35, and such an 
owner or holder of such a house account shall otherwise be deemed to be 
a customer within the meaning of the Act and Sec. Sec.  1.37 and 1.46 
of this chapter and all other sections of these rules, regulations, and 
orders which do not implement sections 4d and 4f of the Act.
    Customer account or customer origin means a clearing member account 
held on behalf of customers, as that term is defined in this section, 
and which is subject to section 4d(a) or section 4d(f) of the Act.
    House account or house origin means a clearing member account which 
is not subject to section 4d(a) or 4d(f) of the Act.
    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 potential 
extreme price moves, changes in option volatility, and/or changes 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, which has been designated by 
the Financial Stability Oversight Council to be systemically important 
and for which the Commission acts as the Supervisory Agency pursuant to 
section 803(8) of the Dodd-Frank Wall Street Reform and Consumer 
Protection Act.

Sec.  39.3  Procedures for registration.

    (a) Application procedures. (1) An organization desiring to be 
registered as a derivatives clearing organization shall file 
electronically an application for registration with the Secretary of 
the Commission in the format and manner specified by the Commission. 
The Commission will review the application for registration as a 
derivatives clearing organization pursuant to the 180-day timeframe and 
procedures specified in section 6(a) of the Act. The Commission may 
approve or deny the application or, if deemed appropriate, register the 
applicant as a derivatives clearing organization subject to conditions.
    (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 the appendix to this part 39 (application). An 
applicant, when filing a Form DCO for purposes of amending its pending 
application or requesting an amendment to an existing registration, is 
only required to submit exhibits and updated information that are 
relevant to the requested amendment and are necessary to demonstrate 
compliance with the core principles affected by the requested 
amendment. 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 format and manner specified 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 Risk 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 designation 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 Risk 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 format and manner specified 
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.
    (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

[[Page 69432]]

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 format and manner specified 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.
    (f) Request for transfer of registration and open interest. (1) In 
anticipation of a corporate change that will result in the transfer of 
all or substantially all of a derivatives clearing organization's 
assets to another legal entity, the derivatives clearing organization 
shall submit a request for approval to transfer the derivatives 
clearing organization's registration and positions comprising open 
interest for clearing and settlement.
    (2) Timing of submission and other procedural requirements. (i) The 
request shall be submitted no later than three months prior to the 
anticipated corporate change, or as otherwise permitted under Sec.  
39.19(c)(4)(viii)(C) of this part.
    (ii) The derivatives clearing organization shall submit a request 
for transfer by filing electronically such a request with the Secretary 
of the Commission in the format and manner specified by the Commission.
    (iii) The derivatives clearing organization shall submit a 
confirmation of change report pursuant to Sec.  39.19(c)(4)(viii)(D) of 
this part.
    (3) Required information. The request shall include the following:
    (i) The underlying agreement that governs the corporate change;
    (ii) A narrative description of the corporate change, including the 
reason for the change and its impact on the derivatives clearing 
organization's financial resources, governance, and operations, and its 
impact on the rights and obligations of clearing members and market 
participants holding the positions that comprise the derivatives 
clearing organization's open interest;
    (iii) A discussion of the transferee's ability to comply with the 
Act, including the core principles applicable to derivatives clearing 
organizations, and the Commission's regulations thereunder;
    (iv) The governing documents of the transferee, including but not 
limited to articles of incorporation and bylaws;
    (v) The transferee's rules marked to show changes from the current 
rules of the derivatives clearing organization;
    (vi) A list of products for which the derivatives clearing 
organization requests transfer of open interest;
    (vii) A representation by the derivatives clearing organization 
that it is in compliance with the Act, including the core principles 
applicable to derivatives clearing organizations, and the Commission's 
regulations thereunder; and
    (viii) A representation by the transferee that it understands that 
the derivatives clearing organization is a regulated entity that must 
comply with the Act, including the core principles applicable to 
derivatives clearing organizations, and the Commission's regulations 
thereunder, in order to maintain its registration as a derivatives 
clearing organization; and further, that the transferee will continue 
to comply with all self-regulatory requirements applicable to a 
derivatives clearing organization under the Act and the Commission's 
regulations thereunder.
    (4) Commission determination. The Commission will review a request 
as soon as practicable, and based on the Commission's determination as 
to the transferee's ability to continue to operate the derivatives 
clearing organization in compliance with the Act and the Commission's 
regulations thereunder, such request will be approved or denied 
pursuant to a Commission order.

Sec.  39.4  Procedures for implementing derivatives clearing 
organization rules and clearing new products.

    (a) Request for approval of rules. An applicant for registration, 
or a registered derivatives clearing organization, may request, 
pursuant to the procedures of Sec.  40.5 of this chapter, that the 
Commission approve any or all of its rules and subsequent amendments 
thereto, including operational rules, prior to their implementation or, 
notwithstanding the provisions of section 5c(c)(2) of the Act, at any 
time thereafter, under the procedures of Sec.  40.5 of this chapter. A 
derivatives clearing organization may label as, ``Approved by the 
Commission,'' only those rules that have been so approved.
    (b) Self-certification of rules. Proposed new or amended rules of a 
derivatives clearing organization not voluntarily submitted for prior 
Commission approval pursuant to paragraph (a) of this section must be 
submitted to the Commission with a certification that the proposed new 
rule or rule amendment complies with the Act and rules thereunder 
pursuant to the procedures of Sec.  40.6 of this chapter.
    (c) Acceptance of new products for clearing. (1) A dormant 
derivatives clearing organization within the meaning of Sec.  40.1 of 
this chapter may not accept for clearing a new product until its 
registration as a derivatives clearing organization is reinstated under 
the procedures of Sec.  39.3 of this part; provided however, that an 
application for reinstatement may rely upon previously submitted 
materials that still pertain to, and accurately describe, current 
conditions.
    (2) A derivatives clearing organization that accepts for clearing a 
new product that is a swap shall comply with the requirements of Sec.  
39.5 of this part.
    (d) Orders regarding competition. An applicant for registration or 
a registered derivatives clearing organization may request that the 
Commission issue an order concerning whether a rule or practice of the 
organization is the least anticompetitive means of achieving the 
objectives, purposes, and policies of the Act.
    (e) Holding securities in a futures portfolio margining account. A 
derivatives clearing organization seeking to provide a portfolio 
margining program under which securities would be held in a futures 
account as defined in Sec.  1.3(vv) of this chapter, shall submit rules 
to implement such portfolio margining program for Commission approval 
in accordance with Sec.  40.5 of this chapter. Concurrent with the 
submission of such rules for Commission approval, the derivatives 
clearing organization shall petition the Commission for an order under 
section 4d of the Act.

Sec.  39.5  Review of swaps for Commission determination on clearing 
requirement.

    (a) Eligibility to clear swaps. (1) A derivatives clearing 
organization shall be presumed eligible to accept for clearing any swap 
that is within a group, category, type, or class of swaps that the 
derivatives clearing organization already clears. Such presumption of 
eligibility, however, is subject to review by the Commission.
    (2) A derivatives clearing organization that wishes to accept for 
clearing any swap that is not within a group, category, type, or class 
of swaps that the derivatives clearing organization already clears 
shall request a determination by the Commission of the derivatives 
clearing organization's eligibility to clear such a swap before 
accepting the swap for clearing. The request, which shall be filed 
electronically with the Secretary of the Commission, shall address the 
derivatives clearing

[[Page 69433]]

organization's ability, if it accepts the swap for clearing, to 
maintain compliance with section 5b(c)(2) of the Act, specifically:
    (i) The sufficiency of the derivatives clearing organization's 
financial resources; and
    (ii) The derivative clearing organization's ability to manage the 
risks associated with clearing the swap, especially if the Commission 
determines that the swap is required to be cleared.
    (b) Swap submissions. (1) A derivatives clearing organization shall 
submit to the Commission each swap, or any group, category, type, or 
class of swaps that it plans to accept for clearing. The derivatives 
clearing organization making the submission must be eligible under 
paragraph (a) of this section to accept for clearing the submitted 
swap, or group, category, type, or class of swaps.
    (2) A derivatives clearing organization shall submit swaps to the 
Commission, to the extent reasonable and practicable to do so, by 
group, category, type, or class of swaps. The Commission may in its 
reasonable discretion consolidate multiple submissions from one 
derivatives clearing organization or subdivide a derivatives clearing 
organization's submission as appropriate for review.
    (3) The submission shall be filed electronically with the Secretary 
of the Commission and shall include:
    (i) A statement that the derivatives clearing organization is 
eligible to accept the swap, or group, category, type, or class of 
swaps for clearing and describes the extent to which, if the Commission 
were to determine that the swap, or group, category, type, or class of 
swaps is required to be cleared, the derivatives clearing organization 
will be able to maintain compliance with section 5b(c)(2) of the Act;
    (ii) A statement that includes, but is not limited to, information 
that will assist the Commission in making a quantitative and 
qualitative assessment of the following factors:
    (A) The existence of significant outstanding notional exposures, 
trading liquidity, and adequate pricing data;
    (B) The availability of rule framework, capacity, operational 
expertise and resources, and credit support infrastructure to clear the 
contract on terms that are consistent with the material terms and 
trading conventions on which the contract is then traded;
    (C) The effect on the mitigation of systemic risk, taking into 
account the size of the market for such contract and the resources of 
the derivatives clearing organization available to clear the contract;
    (D) The effect on competition, including appropriate fees and 
charges applied to clearing; and
    (E) The existence of reasonable legal certainty in the event of the 
insolvency of the relevant derivatives clearing organization or one or 
more of its clearing members with regard to the treatment of customer 
and swap counterparty positions, funds, and property;
    (iii) Product specifications, including copies of any standardized 
legal documentation, generally accepted contract terms, standard 
practices for managing any life cycle events associated with the swap, 
and the extent to which the swap is electronically confirmable;
    (iv) Participant eligibility standards, if different from the 
derivatives clearing organization's general participant eligibility 
standards;
    (v) Pricing sources, models, and procedures, demonstrating an 
ability to obtain sufficient price data to measure credit exposures in 
a timely and accurate manner, including any agreements with clearing 
members to provide price data and copies of executed agreements with 
third-party price vendors, and information about any price reference 
index used, such as the name of the index, the source that calculates 
it, the methodology used to calculate the price reference index and how 
often it is calculated, and when and where it is published publicly;
    (vi) Risk management procedures, including measurement and 
monitoring of credit exposures, initial and variation margin 
methodology, methodologies for stress testing and back testing, 
settlement procedures, and default management procedures;
    (vii) Applicable rules, manuals, policies, or procedures;
    (viii) A description of the manner in which the derivatives 
clearing organization has provided notice of the submission to its 
members and a summary of any views on the submission expressed by the 
members (a copy of the notice to members shall be included with the 
submission); and
    (ix) Any additional information specifically requested by the 
Commission.
    (4) The Commission must have received the submission by the open of 
business on the business day preceding the acceptance of the swap, or 
group, category, type, or class of swaps for clearing.
    (5) The submission will be made available to the public and posted 
on the Commission Web site for a 30-day public comment period. A 
derivatives clearing organization that wishes to request confidential 
treatment for portions of its submission may do so in accordance with 
the procedures set out in Sec.  145.9(d) of this chapter.
    (6) The Commission will review the submission and determine whether 
the swap, or group, category, type, or class of swaps described in the 
submission is required to be cleared. The Commission will make its 
determination not later than 90 days after a complete submission has 
been received, unless the submitting derivatives clearing organization 
agrees to an extension. The determination of when such submission is 
complete shall be at the sole discretion of the Commission. In making a 
determination that a clearing requirement shall apply, the Commission 
may impose such terms and conditions to the clearing requirement as the 
Commission determines to be appropriate.
    (c) Commission-initiated reviews. (1) The Commission, on an ongoing 
basis, will review swaps that have not been accepted for clearing by a 
derivatives clearing organization to make a determination as to whether 
the swaps should be required to be cleared. In undertaking such 
reviews, the Commission will use information obtained pursuant to 
Commission regulations from swap data repositories, swap dealers, and 
major swap participants, and any other available information.
    (2) Notice regarding any determination made under paragraph (c)(1) 
of this section will be made available to the public and posted on the 
Commission Web site for a 30-day public comment period.
    (3) If no derivatives clearing organization has accepted for 
clearing a particular swap, group, category, type, or class of swaps 
that the Commission finds would otherwise be subject to a clearing 
requirement, the Commission will:
    (i) Investigate the relevant facts and circumstances;
    (ii) Within 30 days of the completion of its investigation, issue a 
public report containing the results of the investigation; and
    (iii) Take such actions as the Commission determines to be 
necessary and in the public interest, which may include requiring the 
retaining of adequate margin or capital by parties to the swap, group, 
category, type, or class of swaps.
    (d) Stay of clearing requirement. (1) After making a determination 
that a swap, or group, category, type, or class of swaps is required to 
be cleared, the Commission, on application of a counterparty to a swap 
or on its own

[[Page 69434]]

initiative, may stay the clearing requirement until the Commission 
completes a review of the terms of the swap, or group, category, type, 
or class of swaps and the clearing arrangement.
    (2) A counterparty to a swap that wishes to apply for a stay of the 
clearing requirement for that swap shall submit a written request to 
the Secretary of the Commission that includes:
    (i) The identity and contact information of the counterparty to the 
swap;
    (ii) The terms of the swap subject to the clearing requirement;
    (iii) The name of the derivatives clearing organization clearing 
the swap;
    (iv) A description of the clearing arrangement; and
    (v) A statement explaining why the swap should not be subject to a 
clearing requirement.
    (3) A derivatives clearing organization that has accepted for 
clearing a swap, or group, category, type, or class of swaps that is 
subject to a stay of the clearing requirement shall provide any 
information requested by the Commission in the course of its review.
    (4) The Commission will complete its review not later than 90 days 
after issuance of the stay, unless the derivatives clearing 
organization that clears the swap, or group, category, type, or class 
of swaps agrees to an extension.
    (5) Upon completion of its review, the Commission may:
    (i) Determine, subject to any terms and conditions as the 
Commission determines to be appropriate, that the swap, or group, 
category, type, or class of swaps must be cleared; or
    (ii) Determine that the clearing requirement will not apply to the 
swap, or group, category, type, or class of swaps, but clearing may 
continue on a non-mandatory basis.

Sec.  39.6  [Reserved]

Sec.  39.7  Enforceability.

    An agreement, contract or transaction submitted to a derivatives 
clearing organization for clearing shall not be void, voidable, subject 
to rescission, or otherwise invalidated or rendered unenforceable as a 
result of:
    (a) A violation by the derivatives clearing organization of the 
provisions of the Act or of Commission regulations; or
    (b) Any Commission proceeding to alter or supplement a rule under 
section 8a(7) of the Act, to declare an emergency under section 8a(9) 
of the Act, or any other proceeding the effect of which is to alter, 
supplement, or require a derivatives clearing organization to adopt a 
specific rule or procedure, or to take or refrain from taking a 
specific action.

Sec.  39.8  Fraud in connection with the clearing of transactions on a 
derivatives clearing organization.

    It shall be unlawful for any person, directly or indirectly, in or 
in connection with the clearing of transactions by a derivatives 
clearing organization:
    (a) To cheat or defraud or attempt to cheat or defraud any person;
    (b) Willfully to make or cause to be made to any person any false 
report or statement or cause to be entered for any person any false 
record; or
    (c) Willfully to deceive or attempt to deceive any person by any 
means whatsoever.

Subpart B--Compliance with Core Principles

Sec.  39.9  Scope.

    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  Compliance with core principles.

    (a) To be registered and to maintain registration as a derivatives 
clearing organization, a derivatives clearing organization shall comply 
with each core principle set forth in section 5b(c)(2) of the Act and 
any requirement that the Commission may impose by rule or regulation 
pursuant to section 8a(5) of the Act; and
    (b) Subject to any rule or regulation prescribed by the Commission, 
a registered derivatives clearing organization shall have reasonable 
discretion in establishing the manner by which it complies with each 
core principle.
    (c) Chief compliance officer--(1) Designation. Each derivatives 
clearing organization shall establish the position of chief compliance 
officer, designate an individual to serve as the chief compliance 
officer, and provide the chief compliance officer with the full 
responsibility and authority to develop and enforce, in consultation 
with the board of directors or the senior officer, appropriate 
compliance policies and procedures, to fulfill the duties set forth in 
the Act and Commission regulations.
    (i) The individual designated to serve as chief compliance officer 
shall have the background and skills appropriate for fulfilling the 
responsibilities of the position. No individual who would be 
disqualified from registration under sections 8a(2) or 8a(3) of the Act 
may serve as a chief compliance officer.
    (ii) The chief compliance officer shall report to the board of 
directors or the senior officer of the derivatives clearing 
organization. The board of directors or the senior officer shall 
approve the compensation of the chief compliance officer.
    (iii) The chief compliance officer shall meet with the board of 
directors or the senior officer at least once a year.
    (iv) A change in the designation of the individual serving as the 
chief compliance officer of the derivatives clearing organization shall 
be reported to the Commission in accordance with the requirements of 
Sec.  39.19(c)(4)(ix) of this part.
    (2) Chief compliance officer duties. The chief compliance officer's 
duties shall include, but are not limited to:
    (i) Reviewing the derivatives clearing organization's compliance 
with the core principles set forth in section 5b of the Act, and the 
Commission's regulations thereunder;
    (ii) In consultation with the board of directors or the senior 
officer, resolving any conflicts of interest that may arise;
    (iii) Establishing and administering written policies and 
procedures reasonably designed to prevent violation of the Act;
    (iv) Taking reasonable steps to ensure compliance with the Act and 
Commission regulations relating to agreements, contracts, or 
transactions, and with Commission regulations prescribed under section 
5b of the Act;
    (v) Establishing procedures for the remediation of noncompliance 
issues identified by the chief compliance officer through any 
compliance office review, look-back, internal or external audit 
finding, self-reported error, or validated complaint; and
    (vi) Establishing and following appropriate procedures for the 
handling, management response, remediation, retesting, and closing of 
noncompliance issues.
    (3) Annual report. The chief compliance officer shall, not less 
than annually, prepare and sign a written report that covers the most 
recently completed fiscal year of the derivatives clearing 
organization, and provide the annual report to the board of directors 
or the senior officer. The annual report shall, at a minimum:
    (i) Contain a description of the derivatives clearing 
organization's

[[Page 69435]]

written policies and procedures, including the code of ethics and 
conflict of interest policies;
    (ii) Review each core principle and applicable Commission 
regulation, and with respect to each:
    (A) Identify the compliance policies and procedures that are 
designed to ensure compliance with the core principle;
    (B) Provide an assessment as to the effectiveness of these policies 
and procedures;
    (C) Discuss areas for improvement, and recommend potential or 
prospective changes or improvements to the derivatives clearing 
organization's compliance program and resources allocated to 
compliance;
    (iii) List any material changes to compliance policies and 
procedures since the last annual report;
    (iv) Describe the financial, managerial, and operational resources 
set aside for compliance with the Act and Commission regulations; and
    (v) Describe any material compliance matters, including incidents 
of noncompliance, since the date of the last annual report and describe 
the corresponding action taken.
    (4) Submission of annual report to the Commission. (i) Prior to 
submitting the annual report to the Commission, the chief compliance 
officer shall provide the annual report to the board of directors or 
the senior officer of the derivatives clearing organization for review. 
Submission of the report to the board of directors or the senior 
officer shall be recorded in the board minutes or otherwise, as 
evidence of compliance with this requirement.
    (ii) The annual report shall be submitted electronically to the 
Secretary of the Commission in the format and manner specified by the 
Commission not more than 90 days after the end of the derivatives 
clearing organization's fiscal year, concurrently with submission of 
the fiscal year-end audited financial statement that is required to be 
furnished to the Commission pursuant to Sec.  39.19(c)(3)(ii) of this 
part. The report shall include a certification by the chief compliance 
officer that, to the best of his or her knowledge and reasonable 
belief, and under penalty of law, the annual report is accurate and 
complete.
    (iii) The derivatives clearing organization shall promptly submit 
an amended annual report if material errors or omissions in the report 
are identified after submission. An amendment must contain the 
certification required under paragraph (c)(4)(ii) of this section.
    (iv) A derivatives clearing organization may request from the 
Commission an extension of time to submit its annual report in 
accordance with Sec.  39.19(c)(3) of this part.
    (5) Recordkeeping. (i) The derivatives clearing organization shall 
maintain:
    (A) A copy of all compliance policies and procedures and all other 
policies and procedures adopted in furtherance of compliance with the 
Act and Commission regulations;
    (B) Copies of materials, including written reports provided to the 
board of directors or the senior officer in connection with the review 
of the annual report under paragraph (c)(4)(i) of this section; and
    (C) Any records relevant to the annual report, including, but not 
limited to, work papers and other documents that form the basis of the 
report, and memoranda, correspondence, other documents, and records 
that are created, sent, or received in connection with the annual 
report and contain conclusions, opinions, analyses, or financial data 
related to the annual report.
    (ii) The derivatives clearing organization shall maintain records 
in accordance with Sec.  1.31 of this chapter and Sec.  39.20 of this 
part.

Sec.  39.11  Financial resources.

    (a) General. A derivatives clearing organization shall maintain 
financial resources sufficient to cover its exposures with a high 
degree of confidence and to enable it to perform its functions in 
compliance with the core principles set out in section 5b of the Act. A 
derivatives clearing organization shall identify and adequately manage 
its general business risks and hold sufficient liquid resources to 
cover potential business losses that are not related to clearing 
members' defaults, so that the derivatives clearing organization can 
continue to provide services as an ongoing concern. Financial resources 
shall be considered sufficient if their value, at a minimum, exceeds 
the total amount that would:
    (1) Enable the derivatives clearing organization to meet its 
financial obligations to its clearing members notwithstanding a default 
by the clearing member creating the largest financial exposure for the 
derivatives clearing organization in extreme but plausible market 
conditions; Provided that if a clearing member controls another 
clearing member or is under common control with another clearing 
member, the affiliated clearing members shall be deemed to be a single 
clearing member for purposes of this provision; and
    (2) Enable the derivatives clearing organization to cover its 
operating costs for a period of at least one year, calculated on a 
rolling basis.
    (b) Types of financial resources. (1) Financial resources available 
to satisfy the requirements of paragraph (a)(1) of this section may 
include:
    (i) Margin to the extent permitted under parts 1, 22, and 190 of 
this chapter and under the rules of the derivatives clearing 
organization;
    (ii) The derivatives clearing organization's own capital;
    (iii) Guaranty fund deposits;
    (iv) Default insurance;
    (v) Potential assessments for additional guaranty fund 
contributions, if permitted by the derivatives clearing organization's 
rules; and
    (vi) Any other financial resource deemed acceptable by the 
Commission.
    (2) Financial resources available to satisfy the requirements of 
paragraph (a)(2) of this section may include:
    (i) The derivatives clearing organization's own capital; and
    (ii) Any other financial resource deemed acceptable by the 
Commission.
    (3) A financial resource may be allocated, in whole or in part, to 
satisfy the requirements of either paragraph (a)(1) or paragraph (a)(2) 
of this section, but not both paragraphs, and only to the extent the 
use of such financial resource is not otherwise limited by the Act, 
Commission regulations, the derivatives clearing organization's rules, 
or any contractual arrangements to which the derivatives clearing 
organization is a party.
    (c) Computation of financial resources requirement. (1) A 
derivatives clearing organization shall, on a monthly basis, perform 
stress testing that will allow it to make a reasonable calculation of 
the financial resources needed to meet the requirements of paragraph 
(a)(1) of this section. The derivatives clearing organization shall 
have reasonable discretion in determining the methodology used to 
compute such requirements, provided that the methodology must take into 
account both historical data and hypothetical scenarios. The Commission 
may review the methodology and require changes as appropriate.
    (2) A derivatives clearing organization shall, on a monthly basis, 
make a reasonable calculation of its projected operating costs over a 
12-month period in order to determine the amount needed to meet the 
requirements of paragraph (a)(2) of this section. The derivatives 
clearing organization shall have reasonable discretion in determining 
the methodology used to compute such projected operating costs. The 
Commission may review the

[[Page 69436]]

methodology and require changes as appropriate.
    (d) Valuation of financial resources. (1) At appropriate intervals, 
but not less than monthly, a derivatives clearing organization shall 
compute the current market value of each financial resource used to 
meet its obligations under paragraph (a) of this section. Reductions in 
value to reflect credit, market, and liquidity risks (haircuts) shall 
be applied as appropriate and evaluated on a monthly basis.
    (2) If assessments for additional guaranty fund contributions are 
permitted by the derivatives clearing organization's rules, in 
calculating the financial resources available to meet its obligations 
under paragraph (a)(1) of this section:
    (i) The derivatives clearing organization shall have rules 
requiring that its clearing members have the ability to meet an 
assessment within the time frame of a normal end-of-day variation 
settlement cycle;
    (ii) The derivatives clearing organization shall monitor the 
financial and operational capacity of its clearing members to meet 
potential assessments;
    (iii) The derivatives clearing organization shall apply a 30 
percent haircut to the value of potential assessments, and
    (iv) The derivatives clearing organization shall only count the 
value of assessments, after the haircut, to meet up to 20 percent of 
those obligations.
    (e) Liquidity of financial resources. (1) (i) The derivatives 
clearing organization shall effectively measure, monitor, and manage 
its liquidity risks, maintaining sufficient liquid resources such that 
it can, at a minimum, fulfill its cash obligations when due. The 
derivatives clearing organization shall hold assets in a manner where 
the risk of loss or of delay in its access to them is minimized.
    (ii) The financial resources allocated by the derivatives clearing 
organization to meet the requirements of paragraph (a)(1) of this 
section shall be sufficiently liquid to enable the derivatives clearing 
organization to fulfill its obligations as a central counterparty 
during a one-day settlement cycle. The derivatives clearing 
organization shall maintain cash, U.S. Treasury obligations, or high 
quality, liquid, general obligations of a sovereign nation, in an 
amount greater than or equal to an amount calculated as follows:
    (A) Calculate the average daily settlement pay for each clearing 
member over the last fiscal quarter;
    (B) Calculate the sum of those average daily settlement pays; and
    (C) Using that sum, calculate the average of its clearing members' 
average pays.
    (iii) The derivatives clearing organization may take into account a 
committed line of credit or similar facility for the purpose of meeting 
the remainder of the requirement under paragraph (e)(1)(ii) of this 
section.
    (2) The financial resources allocated by the derivatives clearing 
organization to meet the requirements of paragraph (a)(2) of this 
section must include unencumbered, liquid financial assets (i.e., cash 
and/or highly liquid securities) equal to at least six months' 
operating costs. If any portion of such financial resources is not 
sufficiently liquid, the derivatives clearing organization may take 
into account a committed line of credit or similar facility for the 
purpose of meeting this requirement.
    (3)(i) Assets in a guaranty fund shall have minimal credit, market, 
and liquidity risks and shall be readily accessible on a same-day 
basis;
    (ii) Cash balances shall be invested or placed in safekeeping in a 
manner that bears little or no principal risk; and
    (iii) Letters of credit shall not be a permissible asset for a 
guaranty fund.
    (f) Reporting requirements.
    (1) Each fiscal quarter, or at any time upon Commission request, a 
derivatives clearing organization shall:
    (i) Report to the Commission;
    (A) The amount of financial resources necessary to meet the 
requirements of paragraph (a);
    (B) The value of each financial resource available, computed in 
accordance with the requirements of paragraph (d) of this section; and
    (C) The manner in which the derivatives clearing organization meets 
the liquidity requirements of paragraph (e) of this section;
    (ii) Provide the Commission with a financial statement, including 
the balance sheet, income statement, and statement of cash flows, of 
the derivatives clearing organization or of its parent company; and
    (iii) Report to the Commission the value of each individual 
clearing member's guaranty fund deposit, if the derivatives clearing 
organization reports having guaranty funds deposits as a financial 
resource available to satisfy the requirements of paragraph (a)(1) of 
this section.
    (2) The calculations required by this paragraph shall be made as of 
the last business day of the derivatives clearing organization's fiscal 
quarter.
    (3) The derivatives clearing organization shall provide the 
Commission with:
    (i) Sufficient documentation explaining the methodology used to 
compute its financial resources requirements under paragraph (a) of 
this section,
    (ii) Sufficient documentation explaining the basis for its 
determinations regarding the valuation and liquidity requirements set 
forth in paragraphs (d) and (e) of this section, and
    (iii) Copies of any agreements establishing or amending a credit 
facility, insurance coverage, or other arrangement evidencing or 
otherwise supporting the derivatives clearing organization's 
conclusions.
    (4) The report shall be filed not later than 17 business days after 
the end of the derivatives clearing organization's fiscal quarter, or 
at such later time as the Commission may permit, in its discretion, 
upon request by the derivatives clearing organization.

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 achieve 
the same objective and 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 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.

[[Page 69437]]

    (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. A derivatives clearing organization may permit such 
financial resources to include, without limitation, 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.  240.15c3-1of this title, for broker-dealers, or any similar 
risk adjusted capital calculation for all other 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 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 non-futures commission 
merchants, to provide to the derivatives clearing organization periodic 
financial reports that contain any financial information that the 
derivatives clearing organization determines is necessary to assess 
whether participation requirements are being met on an ongoing basis.
    (A) A derivatives clearing organization shall require clearing 
members that are futures commission merchants to provide the financial 
reports that are specified in Sec.  1.10 of this chapter to the 
derivatives clearing organization.
    (B) A derivatives clearing organization shall require clearing 
members that are not futures commission merchants to make the periodic 
financial reports provided pursuant to paragraph (a)(5)(i) of this 
section available to the Commission upon the Commission's request or, 
in lieu of imposing this requirement, a derivatives clearing 
organization may provide such financial reports directly to 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, 
liquidating, transferring, auctioning, and/or allocating 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 unusual risk characteristics of a 
product.
    (2) A derivatives clearing organization shall adopt rules providing 
that all swaps with the same terms and conditions, as defined by 
product specifications established under derivatives clearing 
organization rules, 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.
    (3) A derivatives clearing organization shall provide for non-
discriminatory clearing of a swap executed bilaterally or on or subject 
to the rules of an unaffiliated swap execution facility or designated 
contract market.
    (4) A derivatives clearing organization shall not require that one 
of the original executing parties be a clearing member in order for a 
product to be eligible for clearing.
    (5) A derivatives clearing organization shall select product unit 
sizes and other terms and conditions that maximize liquidity, 
facilitate transparency in pricing, promote open access, and allow for 
effective risk management. To the extent appropriate to further these 
objectives, a derivatives clearing organization shall select product 
units for clearing purposes that are smaller than the product units in 
which trades submitted for clearing were executed.
    (6) 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 an equal and opposite swap 
between the derivatives clearing organization and each clearing member 
acting as principal for a house trade or acting as agent for a customer 
trade;
    (iii) All terms of a cleared swap must conform to product 
specifications 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.
    (7) [Reserved]
    (8) Confirmation. A derivatives clearing organization shall provide 
each

[[Page 69438]]

clearing member carrying a cleared swap with a definitive written 
record of the terms of the transaction which shall legally supersede 
any previous agreement and serve as a confirmation of the swap. The 
confirmation of all terms of the transaction shall take place at the 
same time as the swap is accepted for clearing.

Sec.  39.13  Risk management.

    (a) 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 house and customer 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 non-defaulting clearing members cannot anticipate or control.
    (g) Margin requirements. (1) General. 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 unusual characteristics of, or risks associated with, particular 
products or portfolios, including but not limited to jump-to-default 
risk or similar jump risk.
    (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) A minimum liquidation time that is one day for futures and 
options;
    (B) A minimum liquidation time that is one day for swaps on 
agricultural commodities, energy commodities, and metals;
    (C) A minimum liquidation time that is five days for all other 
swaps; or
    (D) Such longer liquidation time as is appropriate based on the 
specific characteristics of a particular product or portfolio; provided 
further that the Commission, by order, may establish shorter or longer 
liquidation times for 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 
percent, based on data from an appropriate historic time period, for:
    (A) Each product for which the derivatives clearing organization 
uses a product-based margin methodology;
    (B) Each spread within or between products for which there is a 
defined spread margin rate;
    (C) Each account held by a clearing member at the derivatives 
clearing organization, by house origin and by each customer origin; and
    (D) Each swap portfolio, including any portfolio containing futures 
and/or options and held in a commingled account pursuant to Sec.  
39.15(b)(2) of this part, 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. Such qualified and independent 
parties may be independent contractors or employees of the derivatives 
clearing organization, but shall not be persons responsible for 
development or operation of the systems and models being tested.
    (4) Spread and portfolio margins. (i) A derivatives clearing 
organization may allow reductions in initial margin requirements for 
related positions 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 
margin reductions 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.
    (7) Back tests. A derivatives clearing organization shall conduct 
back tests, as defined in Sec.  39.2 of this part, using an appropriate 
time period but not less than the previous 30 days, as follows:
    (i) On a daily basis, a derivatives clearing organization shall 
conduct back

[[Page 69439]]

tests with respect to products or swap portfolios that are experiencing 
significant market volatility, to test the adequacy of its initial 
margin requirements, as follows:
    (A) For that product if the derivatives clearing organization uses 
a product-based margin methodology;
    (B) For each spread involving that product if there is a defined 
spread margin rate;
    (C) For each account held by a clearing member at the derivatives 
clearing organization that contains a significant position in that 
product, by house origin and by each customer origin; and
    (D) For each such swap portfolio, including any portfolio 
containing futures and/or options and held in a commingled account 
pursuant to Sec.  39.15(b)(2) of this part, by beneficial owner.
    (ii) On at least a monthly basis, a derivatives clearing 
organization shall conduct back tests to test the adequacy of its 
initial margin requirements, as follows:
    (A) For each product for which the derivatives clearing 
organization uses a product-based margin methodology;
    (B) For each spread for which there is a defined spread margin 
rate;
    (C) For each account held by a clearing member at the derivatives 
clearing organization, by house origin and by each customer origin; and
    (D) For each swap portfolio, including any portfolio containing 
futures and/or options and held in a commingled account pursuant to 
Sec.  39.15(b)(2) of this part, by beneficial owner.
    (8) Customer margin. (i) Gross margin. (A) A derivatives clearing 
organization shall collect initial margin on a gross basis for each 
clearing member's customer account(s) 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.
    (B) For purposes of calculating the gross initial margin 
requirement for each clearing member's customer account(s), to the 
extent not inconsistent with other Commission regulations, a 
derivatives clearing organization may require its clearing members to 
report the gross positions of each individual customer to the 
derivatives clearing organization, or it may permit each clearing 
member to report the sum of the gross positions of its customers to the 
derivatives clearing organization.
    (C) For purposes of this paragraph (g)(8), a derivatives clearing 
organization may rely, and may permit its clearing members to rely, 
upon the sum of the gross positions reported to the clearing members by 
each domestic or foreign omnibus account that they carry, without 
obtaining information identifying the positions of each individual 
customer underlying such omnibus accounts.
    (D) A derivatives clearing organization may not, and may not permit 
its clearing members to, net positions of different customers against 
one another.
    (E) 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 
percent 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 by its clearing 
members.
    (10) Types of assets. A derivatives clearing organization shall 
limit the assets it accepts as initial margin to those that have 
minimal credit, market, and liquidity risks. A derivatives clearing 
organization may take into account the specific risk-reducing 
properties that particular assets have in a particular portfolio. A 
derivatives clearing organization may accept letters of credit as 
initial margin for futures and options on futures but shall not accept 
letters of credit as initial margin for swaps.
    (11) Valuation. A derivatives clearing organization shall use 
prudent valuation practices to value assets posted as initial margin on 
a daily basis.
    (12) Haircuts. A derivatives clearing organization shall apply 
appropriate reductions in value to reflect credit, market, and 
liquidity risks (haircuts), to the assets that it accepts in 
satisfaction of initial margin obligations, taking into consideration 
stressed market conditions, and shall evaluate the appropriateness of 
such haircuts on at least a quarterly basis.
    (13) Concentration limits or charges. A derivatives clearing 
organization shall apply appropriate limitations or charges 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 or charges, on at least a monthly 
basis.
    (14) 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.
    (h) Other risk control mechanisms-- (1) Risk limits. (i) A 
derivatives clearing organization shall impose risk limits on each 
clearing member, by house origin and by each customer 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.

[[Page 69440]]

    (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 
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 or from a relevant designated contract 
market or swap execution facility, copies of all reports that are 
required to be filed with the Commission by, or on behalf of, such 
clearing members pursuant to parts 17 and 20 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 futures, options, and swaps cleared by the 
derivatives clearing organization, which are held by 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 futures, options, and swaps cleared by the 
derivatives clearing organization, which are held by 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 house origin and by each customer origin, and each 
swap portfolio, including any portfolio containing futures and/or 
options and held in a commingled account pursuant to Sec.  39.15(b)(2) 
of this part, 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. A derivatives clearing organization 
shall make portfolio compression exercises available, on a regular and 
voluntary basis, for its clearing members that clear swaps, to the 
extent that such exercises are appropriate for those swaps that it 
clears; provided, however, a derivatives clearing organization is not 
required to develop its own portfolio compression services, and is only 
required to make such portfolio compression exercises available, if 
applicable portfolio compression services have been developed by a 
third party.
    (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, which address the risks that such 
clearing members may pose to the derivatives clearing organization;
    (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, which address the risks that such clearing members may pose to 
the derivatives clearing organization, 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 swaps;
    (ii) Payment and receipt of option premiums;
    (iii) Deposit and withdrawal of initial margin for futures, 
options, and swaps;
    (iv) All payments due in final settlement of futures, options, and 
swaps 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 any settlement described in paragraph 
(a)(1) above.
    (b) Daily settlements. Except as otherwise provided by Commission 
order, 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 bank(s) to effect settlements with 
its clearing members, as follows:
    (1) A derivatives clearing organization shall have documented 
criteria that must be met by any settlement bank used by the 
derivatives clearing organization or its clearing members, including 
criteria addressing the capitalization, creditworthiness, access to 
liquidity, operational reliability, and regulation or supervision of 
such bank(s).
    (2) A derivatives clearing organization shall monitor each approved 
settlement

[[Page 69441]]

bank on an ongoing basis to ensure that such bank continues to meet the 
criteria established pursuant to paragraph (c)(1) of this section.
    (3) A derivatives clearing organization shall monitor the full 
range and concentration of its exposures to its own and its clearing 
members' settlement bank(s) 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 take any one or more of 
the following actions, to the extent that any such action or actions 
are reasonably necessary in order to eliminate or strictly limit such 
exposures:
    (i) Maintain settlement accounts at one or more additional 
settlement banks; and/or
    (ii) Approve one or more additional settlement banks that its 
clearing members could choose to use; and/or
    (iii) Impose concentration limits with respect to one or more of 
its own or its clearing members' settlement banks; and/or
    (iv) Take any other appropriate actions.
    (d) Settlement finality. A derivatives clearing organization shall 
ensure that settlements are final when effected by ensuring that it has 
entered into legal agreements that state that settlement fund transfers 
are irrevocable and unconditional no later than when the derivatives 
clearing organization's accounts are debited or credited; provided, 
however, a derivatives clearing organization's legal agreements with 
its settlement banks may provide for the correction of errors. 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 products 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 applicable 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, and swaps. (i) Cleared swaps 
account. In order for a derivatives clearing organization and its 
clearing members to commingle customer positions in futures, options, 
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) Identification of the futures, options, and swaps that would be 
commingled, including product specifications or the criteria that would 
be used to define eligible futures, options, and swaps;
    (B) Analysis of the risk characteristics of the eligible products;
    (C) Identification of whether the swaps would be executed 
bilaterally and/or executed on a designated contract market and/or a 
swap execution facility;
    (D) Analysis of the liquidity of the respective markets for the 
futures, options, 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, and swaps in a timely 
manner, without compromising the financial integrity of the account, 
and, as appropriate, proposed means for addressing insufficient 
liquidity;
    (E) 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, 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, and swaps that 
would be commingled;
    (I) A description and analysis of the margin methodology that would 
be applied to the commingled futures, options, 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, 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, or swaps in the 
account; and
    (L) A description of the arrangements for obtaining daily position 
data with respect to futures, options, 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, 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)(2)(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

[[Page 69442]]

petition filed under paragraph (b)(2)(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 of loss or of 
delay in the access by the derivatives clearing organization to such 
funds and assets.
    (d) Transfer of customer positions. A derivatives clearing 
organization shall have rules providing that the derivatives clearing 
organization will promptly transfer all or a portion of a customer's 
portfolio of positions and related funds at the same time from the 
carrying clearing member of the derivatives clearing organization to 
another clearing member of the derivatives clearing organization, 
without requiring the close-out and re-booking of the positions prior 
to the requested transfer, subject to the following conditions:
    (1) The customer has instructed the carrying clearing member to 
make the transfer;
    (2) The customer is not currently in default to the carrying 
clearing member;
    (3) The transferred positions will have appropriate margin at the 
receiving clearing member;
    (4) Any remaining positions will have appropriate margin at the 
carrying clearing member; and
    (5) The receiving clearing member has consented to the transfer.
    (e) 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 
chapter, 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) 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 a derivatives 
clearing organization may have 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 products 
and less liquid products. A derivatives clearing organization shall 
conduct and document a test of its default management plan at least on 
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 house 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 the customer or house positions of the 
defaulting clearing member, provided that:
    (A) The derivatives clearing organization shall permit a clearing 
member to outsource to a qualified third party, authority to act in the 
clearing member's place in any auction, subject to appropriate 
safeguards imposed by the derivatives clearing organization;
    (B) The derivatives clearing organization shall permit a clearing 
member to outsource to a qualified third party, authority to act in the 
clearing member's place in any allocations, subject to appropriate 
safeguards imposed by the derivatives clearing organization; and
    (C) Any allocation shall be proportional to the size of the 
participating or accepting clearing member's positions in the same 
product class at the derivatives clearing organization;
    (iv) The sequence in which the funds and assets of the defaulting 
clearing member and its customers and the financial resources 
maintained by the derivatives clearing organization would be applied in 
the event of a default;
    (v) A provision that the funds and assets of a defaulting clearing 
member's customers shall not be applied to cover losses with respect to 
a house default;
    (vi) A provision that the excess house funds and assets of a 
defaulting clearing member shall be applied to cover losses with 
respect to a customer default, if the relevant customer funds and 
assets are 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) No later than upon receipt of such notice, a derivatives 
clearing organization shall review the continuing eligibility of the 
clearing member for clearing membership; and
    (3) No later than 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 house or 
customer positions, including but not limited to liquidation or 
transfer of positions, suspension, or revocation of clearing 
membership.

Sec.  39.17  Rule enforcement.

    (a) General. Each derivatives clearing organization shall:
    (1) Maintain adequate arrangements and resources for the effective 
monitoring and enforcement of compliance with the rules of the 
derivatives clearing organization and the resolution of disputes;
    (2) Have the authority and ability to discipline, limit, suspend, 
or terminate the activities of a clearing member due to a violation by 
the clearing member of any rule of the derivatives clearing 
organization; and
    (3) Report to the Commission regarding rule enforcement activities 
and sanctions imposed against clearing members as provided in paragraph 
(a) (2) of this section, in accordance with Sec.  39.19(c)(4)(xi) of 
this part.
    (b) Authority to enforce rules. The board of directors of the 
derivatives clearing organization may delegate responsibility for 
compliance with the requirements of paragraph (a) of this

[[Page 69443]]

section to the risk management committee, unless the responsibilities 
are otherwise required to be carried out by the chief compliance 
officer pursuant to the Act or this part.

Sec.  39.18  System safeguards.

    (a) Definitions. For purposes of this section:
    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 products, after those capabilities 
become temporarily inoperable for any reason up to or including a wide-
scale disruption.
    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 clearing and settlement of existing and new products. 
The term ``relevant area'' also includes communities economically 
integrated with, adjacent to, or within normal commuting distance of 
that metropolitan or other geographic area.
    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) General--(1) Program of risk analysis. Each derivatives 
clearing organization shall establish and 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) of this section 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) of this section 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 
section shall include all of the derivatives clearing organization's 
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 Risk 
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 Risk 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

[[Page 69444]]

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.

Sec.  39.19  Reporting.

    (a) General. Each derivatives clearing organization shall provide 
to the Commission the information specified in this section and any 
other information that the Commission deems necessary to conduct its 
oversight of a derivatives clearing organization.
    (b) Submission of reports. (1) Unless otherwise specified by the 
Commission or its designee, each derivatives clearing organization 
shall submit the information required by this section to the Commission 
electronically and in a format and manner specified by the Commission.
    (2) Time zones. Unless otherwise specified by the Commission or its 
designee, any stated time in this section is Central time for 
information concerning derivatives clearing organizations located in 
that time zone, and Eastern time for information concerning all other 
derivatives clearing organizations.
    (3) Unless otherwise specified by the Commission or its designee, 
business day means the intraday period of time starting at the business 
hour of 8:15 a.m. and ending at the business hour of 4:45 p.m., on all 
days except Saturdays, Sundays, and Federal holidays.
    (c) Reporting requirements. Each registered derivatives clearing 
organization shall provide to the Commission or other person as may be 
required or permitted by this paragraph the information specified 
below:
    (1) Daily reporting. (i) A report containing the information 
specified by this paragraph (c)(1), which shall be compiled as of the 
end of each trading day and shall be submitted to the Commission by 10 
a.m. on the following business day:
    (A) Initial margin requirements and initial margin on deposit for 
each clearing member, by house origin and by each customer origin;
    (B) Daily variation margin, separately listing the mark-to-market 
amount collected from or paid to each clearing member, by house origin 
and by each customer origin;
    (C) All other daily cash flows relating to clearing and settlement 
including, but not limited to, option premiums and payments related to 
swaps such as coupon amounts, collected from or paid to each clearing 
member, by house origin and by each customer origin; and
    (D) End-of-day positions for each clearing member, by house origin 
and by each customer origin.
    (ii) The report shall contain the information required by paragraph 
(c)(1)(i) of this section for:
    (A) All futures positions, and options positions, as applicable;
    (B) All swaps positions; and
    (C) All securities positions that are held in a customer account 
subject to section 4d of the Act or are subject to a cross-margining 
agreement.
    (2) Quarterly reporting. A report of the derivatives clearing 
organization's financial resources as required by Sec.  39.11(f) of 
this part; provided that, additional reports may be required by 
paragraph (c)(4)(i) of this section or Sec.  39.11(f) of this part.
    (3) Annual reporting--(i) Annual report of chief compliance 
officer. The annual report of the chief compliance officer required by 
Sec.  39.10 of this part.
    (ii) Audited financial statements. Audited year-end financial 
statements of the derivatives clearing organization or, if there are no 
financial statements available for the derivatives clearing 
organization itself, the consolidated audited year-end financial 
statements of the derivatives clearing organization's parent company.
    (iii) [Reserved]
    (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 a 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) Event-specific reporting--(i) Decrease in financial resources. 
If there is a decrease of 25 percent in the total value of the 
financial resources available to satisfy the requirements under Sec.  
39.11(a)(1) of this part, either from the last quarterly report 
submitted under Sec.  39.11(f) of this part or from the value as of the 
close of the previous business day, the derivatives clearing 
organization shall report such decrease to the Commission no later than 
one business day following the day the 25 percent threshold was 
reached. The report shall include:
    (A) The total value of the financial resources:
    (1) As of the close of business the day the 25 percent threshold 
was reached, and
    (2) If reporting a decrease in value from the previous business 
day, the total value of the financial resources immediately prior to 
the 25 percent decline;
    (B) A breakdown of the value of each financial resource reported in 
each of paragraphs (c)(4)(i)(A)(1) and (2) of this section, calculated 
in accordance with the requirements of Sec.  39.11(d) of this part, 
including the value of each individual clearing member's guaranty fund 
deposit if the derivatives clearing organization reports guaranty fund 
deposits as a financial resource; and
    (C) A detailed explanation for the decrease.
    (ii) Decrease in ownership equity. No later than two business days 
prior to an event which the derivatives clearing organization knows or 
reasonably should know will cause a decrease of 20 percent or more in 
ownership equity from the last reported ownership equity balance as 
reported on a quarterly or audited financial statement required to be 
submitted by paragraph (c)(2) or (c)(3)(ii), respectively, of this 
section; but in any event no later than two business days after such 
decrease in ownership equity for events that caused the decrease about 
which the derivatives clearing organization did not know and reasonably 
could not have

[[Page 69445]]

known prior to the event. The report shall include:
    (A) Pro forma financial statements reflecting the derivatives 
clearing organization's estimated future financial condition following 
the anticipated decrease for reports submitted prior to the anticipated 
decrease and current financial statements for reports submitted after 
such a decrease; and
    (B) Details describing the reason for the anticipated decrease or 
decrease in the balance.
    (iii) Six-month liquid asset requirement. Immediate notice when a 
derivatives clearing organization knows or reasonably should know of a 
deficit in the six-month liquid asset requirement of Sec.  39.11(e)(2).
    (iv) Change in current assets. No later than two business days 
after current liabilities exceed current assets; the notice shall 
include a balance sheet that reflects the derivatives clearing 
organization's current assets and current liabilities and an 
explanation as to the reason for the negative balance.
    (v) Request to clearing member to reduce its positions. Immediate 
notice, of a derivatives clearing organization's request to a clearing 
member to reduce its positions because the derivatives clearing 
organization has determined that the clearing member has exceeded its 
exposure limit, has failed to meet an initial or variation margin call, 
or has failed to fulfill any other financial obligation to the 
derivatives clearing organization. The notice shall include:
    (A) The name of the clearing member;
    (B) The time the clearing member was contacted;
    (C) The number of positions by which the derivatives clearing 
organization requested the reduction;
    (D) All products that are the subject of the request; and
    (E) The reason for the request.
    (vi) Determination to transfer or liquidate positions. Immediate 
notice, of a determination that any position a derivatives clearing 
organization carries for one of its clearing members must be liquidated 
immediately or transferred immediately, or that the trading of any 
account of a clearing member shall be only for the purpose of 
liquidation because that clearing member has failed to meet an initial 
or variation margin call or has failed to fulfill any other financial 
obligation to the derivatives clearing organization. The notice shall 
include:
    (A) The name of the clearing member;
    (B) The time the clearing member was contacted;
    (C) The products that are subject to the determination;
    (D) The number of positions that are subject to the determination; 
and
    (E) The reason for the determination.
    (vii) Default of a clearing member. Immediate notice, upon the 
default of a clearing member. An event of default shall be determined 
in accordance with the rules of the derivatives clearing organization. 
The notice of default shall include:
    (A) The name of the clearing member;
    (B) The products the clearing member defaulted upon;
    (C) The number of positions the clearing member defaulted upon; and
    (D) The amount of the financial obligation.
    (viii) Change in ownership or corporate or organizational 
structure. (A) Reporting requirement. Any anticipated change in the 
ownership or corporate or organizational structure of the derivatives 
clearing organization or its parent(s) that would:
    (1) Result in at least a 10 percent change of ownership of the 
derivatives clearing organization,
    (2) Create a new subsidiary or eliminate a current subsidiary of 
the derivatives clearing organization, or
    (3) Result in the transfer of all or substantially all of the 
assets of the derivatives clearing organization, including its 
registration as a derivatives clearing organization to another legal 
entity.
    (B) Required information. The report shall include: a chart 
outlining the new ownership or corporate or organizational structure; a 
brief description of the purpose and impact of the change; and any 
relevant agreements effecting the change and corporate documents such 
as articles of incorporation and bylaws. With respect to a corporate 
change for which a derivatives clearing organization submits a request 
for approval to transfer its derivatives clearing organization 
registration and open interest under Sec.  39.3(f) of this part, the 
informational requirements of this paragraph (c)(4)(viii)(B) shall be 
satisfied by the derivatives clearing organization's compliance with 
Sec.  39.3(f)(3).
    (C) Time of report. The report shall be submitted to the Commission 
no later than three months prior to the anticipated change; provided 
that the derivatives clearing organization may report the anticipated 
change to the Commission later than three months prior to the 
anticipated change if the derivatives clearing organization does not 
know and reasonably could not have known of the anticipated change 
three months prior to the anticipated change. In such event, the 
derivatives clearing organization shall immediately report such change 
to the Commission as soon as it knows of such change.
    (D) Confirmation of change report. The derivatives clearing 
organization shall report to the Commission the consummation of the 
change no later than two business days following the effective date of 
the change.
    (ix) Change in key personnel. No later than two business days 
following the departure, or addition of persons who are key personnel 
as defined in Sec.  39.1(b), a report that includes, as applicable, the 
name of the person who will assume the duties of the position on a 
temporary basis until a permanent replacement fills the position.
    (x) Change in credit facility funding arrangement. No later than 
one business day after a derivatives clearing organization changes an 
existing credit facility funding arrangement it may have in place, or 
is notified that such arrangement has changed, including but not 
limited to a change in lender, change in the size of the facility, 
change in expiration date, or any other material changes or conditions.
    (xi) Sanctions. Notice of action taken, no later than two business 
days after the derivatives clearing organization imposes sanctions 
against a clearing member.
    (xii) Financial condition and events. Immediate notice after the 
derivatives clearing organization knows or reasonably should have known 
of:
    (A) The institution of any legal proceedings which may have a 
material adverse financial impact on the derivatives clearing 
organization;
    (B) Any event, circumstance or situation that materially impedes 
the derivatives clearing organization's ability to comply with this 
part and is not otherwise required to be reported under this section; 
or
    (C) A material adverse change in the financial condition of any 
clearing member that is not otherwise required to be reported under 
this section.
    (xiii) Financial statements material inadequacies. If a derivatives 
clearing organization discovers or is notified by an independent public 
accountant of the existence of any material inadequacy in a financial 
statement, such derivatives clearing organization shall give notice of 
such material inadequacy within 24 hours, and within 48 hours after 
giving such notice file a written report stating what steps have been 
and are being taken to correct the material inadequacy.
    (xiv) [Reserved]
    (xv) [Reserved]
    (xvi) System safeguards. A report of:

[[Page 69446]]

    (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.
    (5) Requested reporting. (i) Upon request by the Commission, a 
derivatives clearing organization shall file with the Commission such 
information related to its business as a clearing organization, 
including information relating to trade and clearing details, in the 
format and manner specified, and within the time provided, by the 
Commission in the request.
    (ii) Upon request by the Commission, a derivatives clearing 
organization shall file with the Commission a written demonstration, 
containing such supporting data, information and documents, that the 
derivatives clearing organization is in compliance with one or more 
core principles and relevant provisions of this part, in the format and 
manner specified, and within the time provided, by the Commission in 
the request.
    (iii) Upon request by the Commission, a derivatives clearing 
organization shall file with the Commission, for each customer origin 
of each clearing member, the end-of-day gross positions of each 
beneficial owner, in the format and manner specified, and within the 
time provided, by the Commission in the request. Nothing in this 
paragraph shall affect the obligation of a derivatives clearing 
organization to comply with the daily reporting requirements of 
paragraph (c)(1) of this section.

Sec.  39.20  Recordkeeping.

    (a) Requirement to maintain information. Each derivatives clearing 
organization shall maintain records of all activities related to its 
business as a derivatives clearing organization. Such records shall 
include, but are not limited to, records of:
    (1) All cleared transactions, including swaps;
    (2) All information necessary to record allocation of bunched 
orders for cleared swaps;
    (3) All information required to be created, generated, or reported 
under this part 39, including but not limited to the results of and 
methodology used for all tests, reviews, and calculations in connection 
with setting and evaluating margin levels, determining the value and 
adequacy of financial resources, and establishing settlement prices;
    (4) All rules and procedures required to be submitted pursuant to 
this part 39 and part 40 of this chapter, including all proposed 
changes in rules, procedures or operations subject to Sec.  40.10 of 
this chapter; and
    (5) Any data or documentation required by the Commission or by the 
derivatives clearing organization to be submitted to the derivatives 
clearing organization by its clearing members, or by any other person 
in connection with the derivatives clearing organization's clearing and 
settlement activities.
    (b) Form and manner of maintaining information. (1) General. The 
records required to be maintained by this chapter shall be maintained 
in accordance with the provisions of Sec.  1.31 of this chapter, for a 
period of not less than 5 years, except as provided in paragraph (b)(2) 
of this section.
    (2) Exception for swap data. Each derivatives clearing organization 
that clears swaps must maintain swap data in accordance with the 
requirements of part 45 of this chapter.

Sec.  39.21  Public information.

    (a) General. Each derivatives clearing organization shall provide 
to market participants sufficient information to enable the market 
participants to identify and evaluate accurately the risks and costs 
associated with using the services of the derivatives clearing 
organization. In furtherance of this objective, each derivatives 
clearing organization shall have clear and comprehensive rules and 
procedures.
    (b) Availability of information. Each derivatives clearing 
organization shall make information concerning the rules and the 
operating and default procedures governing the clearing and settlement 
systems of the derivatives clearing organization available to market 
participants.
    (c) Public disclosure. Each derivatives clearing organization shall 
disclose publicly and to the Commission information concerning:
    (1) The terms and conditions of each contract, agreement, and 
transaction cleared and settled by the derivatives clearing 
organization;
    (2) Each clearing and other fee that the derivatives clearing 
organization charges its clearing members;
    (3) The margin-setting methodology;
    (4) The size and composition of the financial resource package 
available in the event of a clearing member default;
    (5) Daily settlement prices, volume, and open interest for each 
contract, agreement, or transaction cleared or settled by the 
derivatives clearing organization;
    (6) The derivatives clearing organization's rules and procedures 
for defaults in accordance with Sec.  39.16 of this part; and
    (7) Any other matter that is relevant to participation in the 
clearing and settlement activities of the derivatives clearing 
organization.
    (d) Publication of information. The derivatives clearing 
organization shall make its rulebook, a list of all current clearing 
members, and the information listed in paragraph (c) of this section 
readily available to the general public, in a timely manner, by posting 
such information on the derivatives clearing organization's Web site, 
unless otherwise permitted by the Commission. The information required 
in paragraph (c)(5) of this section shall be made available to the 
public no later than the business day following the day to which the 
information pertains.

Sec.  39.22  Information sharing.

    Each derivatives clearing organization shall enter into, and abide 
by the terms of, each appropriate and applicable domestic and 
international information-sharing agreement, and shall use relevant 
information obtained from each such agreement in carrying out the risk 
management program of the derivatives clearing organization.

Sec.  39.23  Antitrust considerations.

    Unless necessary or appropriate to achieve the purposes of the Act, 
a derivatives clearing organization shall not adopt any rule or take 
any action that results in any unreasonable restraint of trade, or 
impose any material anticompetitive burden.

Sec.  39.24  [Reserved]

Sec.  39.25  [Reserved]

Sec.  39.26  [Reserved]

Sec.  39.27  Legal risk considerations.

    (a) Legal authorization. A derivatives clearing organization shall 
be duly organized, legally authorized to conduct business, and remain 
in good standing at all times in the relevant jurisdictions. If the 
derivatives clearing organization provides clearing services outside 
the United States, it shall be duly organized to conduct business and 
remain in good standing at all times in the relevant jurisdictions, and 
be authorized by the appropriate foreign licensing authority.
    (b) Legal framework. A derivatives clearing organization shall 
operate pursuant to a well-founded, transparent, and enforceable legal 
framework that addresses each aspect of the activities of the 
derivatives clearing organization. As applicable, the framework shall 
provide for:
    (1) The derivatives clearing organization to act as a counterparty, 
including novation;
    (2) Netting arrangements;
    (3) The derivatives clearing organization's interest in collateral;

[[Page 69447]]

    (4) The steps that a derivatives clearing organization would 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 (no later than when a derivatives 
clearing organization's accounts are debited and credited); and
    (6) Other significant aspects of the derivatives clearing 
organization's operations, risk management procedures, and related 
requirements.
    (c) Conflict of laws. If a derivatives clearing organization 
provides clearing services outside the United States:
    (1) The derivatives clearing organization shall identify and 
address any material conflict of law issues. The derivatives clearing 
organization's contractual agreements shall specify a choice of law.
    (2) The derivatives clearing organization shall be able to 
demonstrate the enforceability of its choice of law in relevant 
jurisdictions and that its rules, procedures, and contracts are 
enforceable in all relevant jurisdictions.

Appendix to Part 39--Form DCO Derivatives Clearing Organization 
Application for Registrations

BILLING CODE 6351-01-P

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BILLING CODE 6351-01-C

PART 140--ORGANIZATION, FUNCTIONS, AND PROCEDURES OF THE COMMISSION

0
9. The authority citation for part 140 continues to read as follows:

    Authority:  7 U.S.C. 2 and 12a.

0
10. Amend Sec.  140.94 by revising the section heading and paragraph 
(a)(5), redesignating paragraph (a)(6) as paragraph (a)(7), revise 
newly redesignated paragraph (a)(7), and add new paragraphs (a)(6) and 
(a)(8) through (a)(14) to read as follows:

Sec.  140.94  Delegation of authority to the Director of the Division 
of Clearing and Risk.

    (a) * * *
    (5) All functions reserved to the Commission in Sec.  5.14 of this 
chapter;
    (6) All functions reserved to the Commission in Sec. Sec.  
39.3(a)(2) and (a)(3) of this chapter;
    (7) All functions reserved to the Commission in Sec. Sec.  
39.5(b)(2), (b)(3)(ix), and (d)(3) of this chapter;
    (8) All functions reserved to the Commission in Sec.  
39.10(c)(4)(iv) of this chapter;
    (9) All functions reserved to the Commission in Sec. Sec.  
39.11(b)(1)(vi), (b)(2)(ii), (c)(1), (c)(2), (f)(1) and (f)(4) of this 
chapter;
    (10) All functions reserved to the Commission in Sec.  
39.12(a)(5)(i)(B) of this chapter;
    (11) All functions reserved to the Commission in Sec. Sec.  
39.13(g)(8)(ii), (h)(1)(i)(C), (h)(1)(ii), (h)(3)(i), (h)(3)(ii), and 
(h)(5)(i)(A) of this chapter;
    (12) The authority to request additional information in support of 
a rule submission under Sec.  39.15(b)(2)(iii)(A) of this chapter and 
in support of a petition pursuant to section 4d of the Act under Sec.  
39.15(b)(2)(iii)(B) of this chapter;
    (13) All functions reserved to the Commission in Sec. Sec.  
39.19(c)(3)(iv), (c)(5)(i), (c)(5)(ii), and (c)(5)(iii) of this 
chapter; and
    (14) All functions reserved to the Commission in Sec.  39.21(d) of 
this chapter.

    Issued in Washington, DC, on October 18, 2011, by the 
Commission.
David A. Stawick,
Secretary of the Commission.

Appendices to Derivatives Clearing Organization General Provisions and 
Core Principles--Commission Voting Summary and Statements of 
Commissioners

    Note:  The following appendices will not appear in the Code of 
Federal Regulations

[[Page 69473]]

Appendix 1--Commission Voting Summary

    On this matter, Chairman Gensler and Commissioners Dunn and Chilton 
voted in the affirmative; Commissioners Sommers and O'Malia voted in 
the negative.

Appendix 2--Statement of Chairman Gary Gensler

    I support the final rulemaking on core principles for derivatives 
clearing organizations (DCOs). Centralized clearing has been a feature 
of the U.S. futures markets since the late-19th century. Clearinghouses 
have functioned both in clear skies and during stormy times--through 
the Great Depression, numerous bank failures, two world wars, and the 
2008 financial crisis--to lower risk to the economy. Importantly, 
centralized clearing protects banks and their customers from the risk 
of either party failing.
    When customers don't clear their transactions, they take on their 
dealer's credit risk. We have seen over many decades, however, that 
banks do fail. Centralized clearing protects all market participants by 
requiring daily mark to market valuations and requiring collateral to 
be posted by both parties so that both the swap dealer and its 
customers are protected if either fails. It lowers the 
interconnectedness between financial entities that helped spread risk 
throughout the economy when banks began to fail in 2008.
    Today's rulemaking will establish certain regulatory requirements 
for DCOs to implement important core principles that were revised by 
the Dodd-Frank Act. We recognize the need for very robust risk 
management standards, particularly as more swaps are moved into central 
clearinghouses. We have incorporated the newest draft Committee on 
Payment and Settlement Systems (CPSS)-International Organization of 
Securities Commissions (IOSCO) standards for central counterparties 
into our final rules.
    First, the financial resources and risk management requirements 
will strengthen financial integrity and enhance legal certainty for 
clearinghouses. We're adopting a requirement that DCOs collect initial 
margin on a gross basis for its clearing member's customer accounts For 
interest rates and financial index swaps, such as credit default swaps, 
we are maintaining, as proposed, a minimum margin for a five-day 
liquidation period. This is consistent with current market practice, 
and many commenters recommended this as a minimum. For the clearing of 
physical commodity swaps, such as on energy, metals and agricultural 
products, we are requiring margin that is risk-based but consistent 
with current market practice--a minimum of one day. Maintaining a 
minimum five day liquidation period for interest rates and credit 
default swaps is appropriate not only as it is consistent with current 
market practice, but also as these markets are the most systemically 
relevant for the interconnected financial system. History shows that, 
in 2008, it took five days after the failure of Lehman Brothers for the 
clearinghouse to transfer Lehman's interest rate swaps positions to 
other clearing members. These financial resource requirements, and 
particularly the margin requirements, are critical for safety and 
soundness as more swaps are moved into central clearing.
    Second, the rulemaking implements the Dodd-Frank Act's requirement 
for open access to DCOs. The participant eligibility requirements 
promote fair and open access to clearing. Importantly, the rule 
addresses how a futures commission merchant can become a member of a 
DCO. The rule promotes more inclusiveness while allowing DCO to scale a 
member's participation and risk based upon its capital. This improves 
competition that will benefit end-users of swaps, while protecting 
DCOs' ability manage risk.
    Third, the reporting requirements will ensure that the Commission 
has the information it needs to monitor DCO compliance with the 
Commodity Exchange Act and Commission regulations.
    Fourth, the rules formalize the DCO application procedures to bring 
about greater uniformity and transparency in the application process 
and facilitate greater efficiency and consistency in processing 
applications.
    These reforms will both lower risk in the financial system and 
strengthen the market by making many of the processes more efficient 
and consistent.

Appendix 3--Statement of Commissioner Jill Sommers

    The final rules adopted by the Commission today for derivatives 
clearing organizations (DCOs) will implement a key component of the 
Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) 
to facilitate centralized clearing of both exchange-traded and over-
the-counter swaps. While I fully support the centralized clearing of 
swaps, I reluctantly cannot support the final DCO rules.
    In my opinion, the rules are needlessly prescriptive, internally 
inconsistent, and depart from the Commission's time-tested principles-
based oversight regime, with little to no explanation of the costs and 
benefits of doing so, or even a rationale other than an overarching 
belief that prescriptive rules will increase legal certainty and 
prevent a race to the bottom by competing clearinghouses. A few 
examples will illustrate my point.
    Rule 39.11(a)(1) requires a DCO to maintain sufficient financial 
resources to cover a default by its largest clearing member. Rule 
39.11(a)(2) requires a DCO to maintain sufficient financial resources 
to cover its operating costs for a period of at least one year. Rules 
39.11(b)(1) and (b)(2) list the types of financial resources deemed 
sufficiently liquid to meet the requirements of Rules 39.11(a)(1) and 
(a)(2). The preamble to the rules states that letters of credit are not 
an acceptable financial resource for purposes of Rules 39.11(a)(1) or 
(a)(2), but may be allowed on a case-by-case basis. Letters of credit 
are also banned for purposes of Rule 39.11(e)(1) (cash obligations), 
and Rule 39.11(e)(3) (guaranty fund obligations), neither of which 
allow for a case-by-case determination. When it comes to initial 
margin, letters of credit are allowed for futures and options without 
qualification, but banned for swaps.
    These distinctions, in my opinion, are not legally or factually 
justifiable. The ability to draw on safe, liquid assets is critical in 
all of the situations described above. We should treat letters of 
credit the same way unless there is a compelling reason not to. This is 
especially true given the fact that banning their use as initial margin 
for swaps will have the perverse, unintended consequence of 
disincentivizing voluntary clearing by commercial end-users who support 
their swaps positions using letters of credit--a result that is 
directly at odds with the goals of Dodd-Frank.
    Another example can be found in Rule 39.13(g)(2)(ii), which 
establishes a one-day minimum liquidation time for calculating initial 
margin for futures and options, a one-day minimum liquidation time for 
swaps on agricultural, metal, and energy commodities, and a five-day 
minimum liquidation time for all other swaps. In the cost-benefit 
analysis, the Commission states that ``using only one criterion--i.e., 
the characteristic of the commodity underlying a swap--to determine 
liquidation time could result in less-than-optimal margin 
calculations.'' The Commission goes on to describe the complex nature 
of calculating appropriate margin levels, which includes the ability to 
assess quantitative factors such as the risk characteristics of the 
instrument traded,

[[Page 69474]]

its historical price volatility and liquidity in the relevant market, 
as well as ``expert judgment as to the extent to which such 
characteristics and data may be an accurate predictor of future market 
behavior with respect to such instruments, and [the application of] 
such judgment to the quantitative results.'' We then explain that the 
Commission is not capable of determining the risk characteristics, 
price volatility and market liquidity of even a sample of swaps for 
purposes of determining an appropriate liquidation time for specific 
swaps.
    In the face of our admitted inability to determine appropriate 
liquidation times for particular swaps, we are picking a one-day time 
for some, based on the underlying commodity, and a five-day time for 
all others, even though this ``could result in less-than-optimal margin 
calculations.'' This defies common sense.
    The only reason we give for eliminating the long-standing 
discretion of the acknowledged experts, i.e., the DCOs, to determine 
the appropriate liquidation times for the transactions they clear is to 
prevent a feared race to the bottom by DCOs who will compete to clear 
swaps in the future. We acknowledge, however, that DCOs have used 
reasonable and prudent judgment in establishing liquidation times in 
the past, including DCOs that currently compete in the swaps clearing 
space. The Commission gives no reason for its belief that there may be 
a race to the bottom if we do not establish this less than ideal 
methodology. Nor does the Commission acknowledge the existence of other 
safeguards in the rules that give us strong tools for policing a 
potential race to the bottom.
    With the passage of Dodd-Frank, Congress gave the Commission broad 
authority to regulate swap transactions, swap markets and swap market 
participants. I do not believe, however, that Congress intended for the 
Commission to strip DCOs of the flexibility to determine the manner in 
which they comply with core principles, as we have done with these 
rules. Our registered DCOs have a strong track record of prudent risk 
management, including during the financial crisis, and there is no 
reason to believe they will not continue to use their expert judgment 
in a responsible fashion. Moreover, unnecessary and inflexible rules, 
such as these, will prevent DCOs from quickly adapting to changing 
market conditions for no apparent benefit. I therefore dissent.

Appendix 4--Statement of Commissioner Scott O'Malia

    Today, the Commission approved a final rulemaking on the operation 
of derivatives clearing organizations (each, a ``DCO'').\289\ Of the 
Dodd-Frank rulemakings that the Commission has so far undertaken, this 
rulemaking is among the most important. I have been a strong proponent 
of clearing. In the aftermath of the Enron crisis, I witnessed first-
hand how the creation of ClearPort ameliorated counterparty credit 
fears in the energy merchant markets and restored liquidity to those 
markets. I am certain that clearing will similarly benefit the swaps 
market,\290\ particularly by significantly expanding execution on 
electronic platforms, thereby increasing price transparency and 
discovery. Moreover, as we have seen in the 2008 financial crisis, 
clearing has the potential to mitigate systemic risk, by ensuring that 
swap counterparties--not hardworking American taxpayers--post 
collateral to support their exposures.
---------------------------------------------------------------------------

    \289\ Derivatives Clearing Organizations (to be codified at 17 
CFR pts. 1, 21, 39, and 140), available at: http://www.cftc.gov/PressRoom/Events/opaevent_cftcdoddfrank101811 (the ``DCO Final 
Rule'').
    \290\ See Kathryn Chen et al., An Analysis of CDS Transactions: 
Implications for Public Reporting, Federal Reserve Bank of New York 
Staff Report no. 517 (September 2011), available at: http://www.newyorkfed.org/research/staff_reports/sr517.pdf (stating that 
``[c]learing-eligible products within our sample traded on more days 
and had more intraday transactions than non-clearing eligible 
products'').
---------------------------------------------------------------------------

    The main goal of this final rulemaking is to ensure that clearing 
contributes to the integrity of the United States financial system by, 
among other things, allowing entities other than the largest dealer 
banks to offer clearing services to commercial and financial end-users. 
I fully support this goal. However, in an attempt to achieve this goal, 
this rulemaking abandons the principles-based regulatory regime which 
permitted DCOs to perform so admirably in the 2008 financial crisis. 
Instead, the final rulemaking sets forth a series of prescriptive 
requirements. I disagree with this approach. DCO risk management poses 
complex and multidimensional challenges. One DCO may have a 
significantly different risk profile than another. Consequently, each 
DCO must have sufficient discretion to match requirements to risks. The 
role of the Commission is to oversee the exercise of such discretion, 
not to prevent such exercise.\291\
---------------------------------------------------------------------------

    \291\ See section 3(b) of the Commodity Exchange Act (CEA), 7 
U.S.C. 5(b) (stating that ``[i]t is the purpose of this Act to serve 
the public interests * * * through a system of effective self-
regulation of trading facilities, clearing systems, market 
participants and market professionals under the oversight of the 
Commission.'').
---------------------------------------------------------------------------

    Additionally, I am mindful of the cost of clearing and want to 
ensure that such cost does not constitute a barrier to entry. Certain 
provisions in this final rulemaking may impose substantial costs 
without corresponding benefits. Such provisions may discourage market 
participants from executing transactions subject to mandatory clearing, 
even if they need such transactions to prudently hedge risks, or from 
clearing on a voluntary basis. By creating perverse incentives to keep 
risk outside of the regulatory framework, and to leave it within our 
commercial and financial enterprises, the DCO rules undermine a 
fundamental purpose of the Dodd-Frank Act--namely, the expansion of 
clearing.
    I will elaborate on each concern in turn.

Participant Eligibility: One-Size Does Not Fit All

    This final rulemaking prohibits a DCO from requiring more than $50 
million in capital from any entity seeking to become a swaps clearing 
member. This number makes a great headline, mainly because it is so 
low. It also sends an unequivocal message to DCOs that have clearing 
members that are primarily dealer banks. However, in adopting and 
interpreting this requirement, the Commission may unwisely limit the 
range of legitimate actions that DCOs can take to manage their 
counterparty risks. By imposing such limitations, the Commission is 
introducing costs to clearing that it fails to detail and explore.
    Let me be plain. I oppose anticompetitive behavior. However, an 
entity with $50 million in capitalization may not be an appropriate 
clearing member for every DCO. The $50 million threshold prevents DCOs 
from engaging in anticompetitive behavior but also prohibits DCOs from 
taking legitimate, risk-reducing actions. Instead of adopting this 
prescriptive requirement, the Commission should have provided 
principles-based guidance to DCOs on the other components of fair and 
open access, such as the standard for less restrictive participation 
requirements.\292\ By taking a more principles-based approach, the 
Commission could have been in greater accord with international 
regulators, one of which explicitly cautioned against the $50 million 
threshold.\293\
---------------------------------------------------------------------------

    \292\ The DCO Final Rule, supra note 289, at 387-388 (to be 
codified at 17 CFR 39.12(a)(1)).
    \293\ See letter, dated March 21, 2011, from the United Kingdom 
Financial Services Authority (``FSA''), available at http://comments.cftc.gov/PublicComments/CommentList.aspx?id=957 (stating 
that ``whilst capital thresholds or other participation eligibility 
threshold limitations may be a potential tool to help ensure fair 
and open access to [central counterparties (``CCPs'')], to impose 
them on clearing arrangements for products that have complex or 
unique characteristics could lead to increased risk to the system in 
the short to medium term.'')

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[[Page 69475]]

Basis for the $50 Million?
    How did the Commission determine that the $50 million threshold is 
appropriate? It is not really evident from the notice of proposed 
rulemaking.\294\ In the final rulemaking, the Commission states that 
the $50 million threshold was derived from the fact that most 
registered futures commission merchants (``FCMs'') that are currently 
DCO clearing members have at least $50 million in capital.\295\
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    \294\ See Risk Management Requirements for Derivatives Clearing 
Organizations, 76 FR 3698, 3791 (Jan. 20, 2011).
    \295\ See the DCO Final Rule, supra note 289, at 83 to 84 
(further stating that ``of 126 FCMs, 63 currently have capital above 
$50 million and most FCMs with capital below that amount are not 
clearing members.'').
---------------------------------------------------------------------------

    The final rulemaking, however, does not answer a number of 
questions that are crucial to determining whether the $50 million 
threshold is appropriate for all swap transactions. These questions 
include, without limitation: What types of products do the referenced 
FCMs currently clear? Are there differences between the capital 
distributions of FCMs that clear different products? If so, what are 
such differences?
    The answers to these questions are important because FCMs may need 
different amounts of capital to support their exposures to different 
products. Assume, for example, that the average capitalization of FCMs 
clearing agricultural futures is $50 million. Further assume that an 
FCM has $50 million in capital, and is seeking to become a clearing 
member. The Commission may reasonably conclude that such FCM would have 
the resources to clear agricultural futures. It may also reasonably 
conclude that such FCM would have the resources to clear agricultural 
swaps that have the same terms and conditions as agricultural futures. 
The Commission cannot reasonably conclude, however, that such FCM would 
have the resources to clear credit default swaps.
    By not setting forth the answers to questions such as these, the 
final rulemaking creates the impression that the $50 million threshold 
is arbitrary, and renders vulnerable its conclusion that the threshold 
``captures firms that the Commission believes have the financial, 
operational, and staffing resources to participate in clearing swaps 
without posing an unacceptable level of risk to a DCO.'' \296\
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    \296\ Id. at 83.
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Anticompetitive behavior? Or legitimate, risk-reducing action?
    The final rulemaking recognizes that DCOs may increase capital 
requirements for legitimate, risk-reducing reasons. In fact, the final 
rulemaking requires a DCO to ``set forth capital requirements that * * 
* appropriately match capital to risk.'' \297\ Further, the final 
rulemaking mandates DCOs to ``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.'' \298\ The final rulemaking states that a DCO ``may permit 
such financial resources to include, without limitation, a clearing 
member's capital.'' \299\
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    \297\ Id. at 388 (to be codified at 17 CFR 39.12(a)(2)(ii)) 
(further stating that ``[c]apital requirements shall be scalable to 
risks posed by clearing members''.).
    \298\ Id. (to be codified at 17 CFR 39.12(a)(2)(i)).
    \299\ Id. Additionally, the notice of proposed rulemaking 
states: ``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. 
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.'' 
76 FR at 3701.
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    The final rulemaking, however, provides little insight on how the 
Commission intends to differentiate between (i) a required risk-based 
increase in capital requirements and (ii) an illegitimate attempt to 
circumvent the $50 million threshold to squash competition. To use an 
example grounded in reality--ICE Clear Credit recently lowered its 
minimum capital requirement for clearing members to $100 million. 
However, it added a requirement that clearing members hold excess net 
capital equal to 5 percent of their segregated customer funds. Upon 
learning about the additional requirement, at least two existing FCMs 
complained that it violates fair and open access.\300\ The final 
rulemaking gives very little guidance on the criteria that the 
Commission will apply in adjudicating a dispute such as this. The 
preamble to the final rulemaking simply states: ``A DCO may not * * * 
[enact] some additional financial requirement that effectively renders 
the $50 million threshold meaningless for some potential clearing 
members.'' It further states that such a requirement would violate the 
other components of fair and open access, such as ``Sec.  
39.12(a)(1)(i) (less restrictive alternatives), or Sec.  
39.12(a)(1)(iii) (exclusion of certain types of firms).'' \301\ This 
vague statement provides no legal certainty or bright lines for DCOs 
and potential clearing members to follow.
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    \300\ See Matthew Leising, ``ICE Clear Credit's Member Rules Too 
Exclusive, Small Firms Say,'' Bloomberg, Aug. 9, 2011, available at: 
http://www.bloomberg.com/news/2011-08-09/ice-clear-credit-s-member-rules-too-exclusive-small-firms-say.html.
    \301\ The DCO Final Rule, supra note 289, at 85-86.
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    If I were running a DCO, I would be extremely confused. On the one 
hand, the final rulemaking requires me to match capital requirements to 
risk. On the other hand, the preamble suggests that I cannot increase 
capital requirements (or any other financial requirement), if that 
would prohibit some entities with $50 million in capitalization from 
becoming clearing members. How should I resolve this conundrum?
Hidden Costs
    If a DCO took a narrow interpretation of the reference to financial 
requirements in the preamble, then it has only one alternative: (i) 
Admit any entity with $50 million in capital as a clearing member and 
(ii) impose strict risk limits.\302\ How strict could such limits be? 
To lend some context to this $50 million threshold, a recent report 
from the staff of the Federal Reserve Bank of New York observed that 
$50 million tended to be the notional value of one single transaction 
in a credit default swap index with relatively high liquidity.\303\
---------------------------------------------------------------------------

    \302\ The final rulemaking requires DCOs to impose risk limits 
on clearing members. See id. at 399 to 400 (to be codified at 17 CFR 
39.13(h)(1)).
    \303\ See supra note.
---------------------------------------------------------------------------

    Assuming that the Commission does not require the DCO to increase 
its risk limits,\304\ where does this situation leave the DCO? The DCO 
would need to incur the cost of (i) evaluating applications from all 
entities with $50 million in capital, (ii) operationally connecting to 
such entities, and (iii) potentially defending itself against claims 
from such entities that the risk limits or financial requirements are 
too stringent. The DCO may pass on such costs to clearing members, 
which may pass on such costs to commercial and financial end-users. In 
the meantime, such entities, when admitted, may be unable to clear any 
significant volume

[[Page 69476]]

of transactions, for themselves or for customers, especially in asset 
classes such as credit default swaps. Under this scenario, rather than 
leading to fair and open access, the $50 million threshold may actually 
impede access to clearing by commercial and financial end-users, 
because the threshold would increase their costs without introducing 
meaningful competition among FCMs offering clearing services.
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    \304\ See the DCO Final Rule, supra note 289, at 399 to 400 (to 
be codified at 17 CFR 39.13(h)(1)(i)(C)) (stating that ``[t]he 
Commission may review such methods, thresholds, and financial 
resources and require the application of different methods, 
thresholds, or financial resources, as appropriate.'').
---------------------------------------------------------------------------

    If, on the other hand, a DCO took a more aggressive interpretation 
of the reference to financial requirements in the preamble, then it may 
have other alternatives to mitigate risks that admitting an entity with 
$50 million in capital may introduce. For example, it may increase 
margin requirements. It may also increase guaranty fund contributions 
for all clearing members, in proportion to their clearing activity. In 
other words, a DCO may increase the overall cost of clearing in order 
to compensate for the risks of having lesser capitalized new clearing 
members.
    What are the potential effects of such increases? It is difficult 
to determine from our cost-benefit analysis. The analysis does not 
identify increases in margin or guaranty fund contributions as 
potential costs, much less attempt to quantify such costs.\305\ 
However, if the increases in costs are significant, and if such 
increases apply to a wide range of clearing members (because the DCO 
fears being accused of unjustified discrimination),\306\ then such 
increases would most definitely influence whether commercial and 
financial entities voluntarily clear or even enter into hedges in the 
first place.
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    \305\ Interestingly, the preamble notes that at least two 
commenters agreed that a DCO may legitimately use such increases to 
moderate the risk of a member with only $50 million in capital. 
Specifically, the preamble states: ``Newedge commented that the 
proposed rule should not increase risk to a DCO because a DCO can 
mitigate risk by, among other things, imposing position limits, 
stricter margin requirements, or stricter default deposit 
requirements on lesser capitalized clearing members.'' The preamble 
also states: ``J.P. Morgan, however, commented that a cap on a 
member's minimum capital requirement would not impact the systemic 
stability of a DCO as long as * * * DCOs hold a sufficient amount of 
margin and funded default guarantee funds.'' Id. at 80 to 82. It is 
therefore unclear why the cost-benefit analysis did not address the 
potential for such increases.
    \306\ See id. at 387 (to be codified at 17 CFR 39.12(a)(1)(iii)) 
(stating that ``[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.'' The regulation contains no further detail regarding what 
type of demonstration would be sufficient.).
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Principles-Based Regulation Is a Better Solution
    I propose a simple solution that would have addressed the confusion 
and hidden costs resulting from the $50 million threshold. The 
Commission should have eliminated the threshold. The threshold adds no 
value to the other components of fair and open access.\307\ Given that 
the final rulemaking rightfully requires a DCO to properly manage its 
risks, one or more DCOs would inevitably impose some sort of financial 
requirement that would prevent entities with $50 million (or more) in 
capital from directly participating in clearing. At that point, the 
Commission would not be able to opine on such a requirement without 
looking to the other components of fair and open access. As a result, 
it would have served the Commission well to have focused in the first 
instance on setting forth principles-based guidance on such 
components.\308\ Moreover, principles-based guidance would have brought 
the Commission into greater accord with certain international 
regulators,\309\ current international standards on CCP 
regulation,\310\ as well as the proposed revisions to such 
standards.\311\
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    \307\ In legal parlance, the $50 million threshold is neither 
necessary nor sufficient to determining whether a DCO has violated 
fair and open access. The threshold is not necessary because a DCO 
can set an even lower minimum capital requirement and still violate 
fair and open access if another requirement ``excludes or limits 
clearing membership of certain types of market participants.'' Id. 
(to be codified at 17 CFR 39.12(a)(1)(iii)). The threshold is not 
sufficient because, even if the DCO accepts all entities with $50 
million in capital as clearing members, the Commission may still 
hold that DCO violated fair and open access if it imposes ``some 
additional financial requirement that effectively renders the $50 
million threshold meaningless.'' Id. at 85-86.
    \308\ In such guidance, the Commission could have detailed the 
information that a DCO would need to provide in order to demonstrate 
that it could not adopt a less restrictive participation requirement 
without materially increasing its own risk. The Commission could 
have also discussed the weight that DCOs should accord to a 
particular level of capitalization, depending on whether the 
relevant clearing member (i) engages in businesses other than the 
intermediation of futures or swaps, or (ii) participates at multiple 
DCOs rather than one DCO.
    \309\ See supra note. I note that the Commission and FSA share 
jurisdiction over three DCOs clearing swaps--namely, LCH.Clearnet 
Limited, ICE Clear Europe Limited, and CME Clearing Europe. How the 
Commission and FSA will resolve conflicting regulation remains to be 
seen.
    \310\ See Bank for International Settlements' Committee on 
Payment and Settlement Systems and Technical Committee of the 
International Organization of Securities Commissions (``CPSS-
IOSCO''), ``Recommendations for Central Counterparties,'' CPSS 
Publ'n No. 64 (November 2004), available at: http://www.bis.org/publ/cpss64.pdf (the ``CPSS-IOSCO Recommendations''). Section 4.2.2 
of the CPSS-IOSCO Recommendations state: ``To reduce the likelihood 
of a participant's default and to ensure timely performance by the 
participant, a CCP should establish rigorous financial requirements 
for participation. Participants are typically required to meet 
minimum capital standards. Some CCPs impose more stringent capital 
requirements if exposures of or carried by a participant are large 
or if the participant is a clearing participant. Capital 
requirements for participation may also take account of the types of 
products cleared by a CCP. In addition to capital requirements, some 
CCPs impose standards such as a minimum credit rating or parental 
guarantees.''
    \311\ See CPSS-IOSCO, ``Principles for financial market 
infrastructures: Consultative report,'' CPSS Publ'n No. 94 (March 
2011), available at: http://www.bis.org/publ/cpss94.pdf (the ``CPSS-
IOSCO Consultation''). The CPSS-IOSCO Consultation, which CPSS-IOSCO 
has not adopted as final, does not set forth any requirement or 
suggestion that resembles the $50 million threshold. Instead, the 
Consultation, like the Recommendations, emphasizes the importance of 
``risk-based'' CCP participation criteria that are not unduly 
discriminatory. Specifically, Section 3.16.6 of the CPSS-IOSCO 
Consultation states: ``Participation requirements based solely on a 
participant's size are typically insufficiently related to risk and 
deserve careful scrutiny.'' Whereas the Consultation may have 
intended to comment on restrictively high CCP participation 
requirements, the same logic applies to restrictively low CCP 
participation requirements. Neither are risk-based.
---------------------------------------------------------------------------

Costs Without Benefits: Minimum Liquidation Time Requirements

    I have consistently highlighted that our rulemakings are 
interconnected and that the Commission has an obligation to analyze the 
cost impact across rulemakings. In this instance, I am concerned about 
the relationship between this final rulemaking and our proposal 
interpreting core principle 9 for designated contract markets (DCMs), 
which may be finalized in the future.\312\ Although this relationship 
may result in significant costs for the market, this final rulemaking 
fails to disclose such costs.
---------------------------------------------------------------------------

    \312\ See Core Principles and Other Requirements for Designated 
Contract Markets, 75 FR 80572 (Dec. 22, 2010).
---------------------------------------------------------------------------

    Specifically, this final rulemaking requires a DCO to calculate 
margin using different minimum liquidation times for different 
products. A DCO must calculate margin for (i) futures based on a one-
day minimum liquidation time, (ii) agricultural, energy, and metals 
swaps based on a one-day minimum liquidation time, and (iii) all other 
swaps based on a five-day minimum liquidation time.\313\
---------------------------------------------------------------------------

    \313\ See the DCO Core Principles, supra note 289, at 393-394 
(to be codified at 17 CFR 39.13(g)(2)(ii)).
---------------------------------------------------------------------------

No Policy Basis for Minimum Liquidation Times
    As a preliminary matter, this final rulemaking creates the 
impression that these requirements are arbitrary, like the $50 million 
threshold. Although the final rulemaking characterizes these 
requirements as ``prudent,'' it sets forth

[[Page 69477]]

no justification for this characterization.\314\ According to the final 
rulemaking, DCOs should consider at least five factors in establishing 
minimum liquidation times for its products, including trading volume, 
open interest, and predictable relationships with highly liquid 
products.\315\ In setting forth such factors, the Commission is holding 
DCOs to a higher standard than it holds itself. The final rulemaking 
presents no evidence that the Commission considered any of the five 
factors in determining minimum liquidation times.\316\
---------------------------------------------------------------------------

    \314\ See id. at 126-127.
    \315\ According to the final rulemaking, such factors are: ``(i) 
Average daily trading volume in a product; (ii) average daily open 
interest in a product; (iii) concentration of open interest; (iv) 
availability of a predictable basis relationship with a highly 
liquid product; and (v) availability of multiple market participants 
in related markets to take on positions in the market in question.'' 
Id. at 129.
    \316\ Instead of considering the five factors, the Commission 
appears to have simply codified the minimum liquidations times that 
certain DCOs currently use for swaps. For example, the Commission 
justifies setting a minimum liquidation time of five days for swaps 
referencing non-physical commodities as follows: ``The longer 
liquidation time, currently five days for credit default swaps at 
ICE Clear Credit LLC and CME, and for interest rate swaps at LCH and 
CME, is based on their assessment of the higher risk associated with 
these products.'' Id. at 127-128. Given that this justification 
appears to focus on credit default swaps and interest rate swaps, it 
is unclear how the Commission concluded that a five-day minimum 
liquidation time is appropriate for swaps that reference financial 
commodities but are neither credit default swaps nor interest rate 
swaps.
---------------------------------------------------------------------------

Negative Implications for Competition
    More importantly, when these requirements are juxtaposed against 
our proposal interpreting DCM core principle 9, the potential of these 
requirements to disrupt already established futures markets becomes 
apparent. In the proposal, which is entitled Core Principles and Other 
Requirements for Designated Contract Markets, the Commission proposed, 
in a departure from previous interpretations of DCM core principle 9, 
to prohibit a DCM from listing any contract for trading unless an 
average of 85 percent or greater of the total volume of such contract 
is traded on the centralized market, as calculated over a twelve (12) 
month period.\317\ If the Commission finalizes such proposal, then DCMs 
may need to delist hundreds of futures contracts.\318\ Financial 
contracts may be affected, along with contracts in agricultural 
commodities, energy commodities, and metals.
---------------------------------------------------------------------------

    \317\ 75 FR at 80616.
    \318\ According to information that I have received from one 
DCM, the proposal would force conversion of 628 futures and options 
contracts to swap contracts. Moreover, according to the Off-Market 
Volume Study (May-2010 through July-2010) prepared by Commission 
staff, the proposal would force conversion of approximately 493 
futures and options contracts. See Off-Market Volume Study, 
available at: http://www.cftc.gov/LawRegulation/DoddFrankAct/Rulemakings/DF_12_DCMRules/index.htm.
---------------------------------------------------------------------------

    According to the proposal, DCMs may convert delisted futures 
contracts to swap contracts.\319\ However, if the futures contracts 
reference financial commodities, then this final rulemaking would 
require that a DCO margin such swap contracts using a minimum 
liquidation time of five days instead of one day for futures. If 
nothing substantive about the contracts change other than their 
characterization (i.e., futures to swaps), then how can the Commission 
justify such a substantial increase in minimum liquidation time and 
margin? An increase of this magnitude may well result in a chilling of 
activity in the affected contracts. Such chilling would be an example 
of the type of market disruption that the CEA was intended to avoid.
---------------------------------------------------------------------------

    \319\ See 75 FR at 80589-90.
---------------------------------------------------------------------------

    I believe this has severe implications for competition. As 
commenters to the DCM proposal noted, market participants generally 
execute new futures contracts outside the DCM centralized market until 
the contracts attract sufficient liquidity. Attracting such liquidity 
may take years.\320\ Let us assume that an established DCM already 
lists a commercially viable futures contract on a financial commodity 
that meets the 85 percent threshold. Even without the DCM proposal and 
this final rulemaking, a DCM seeking to compete by listing a futures 
contract with the same terms and conditions already faces an uphill 
battle. Now with the DCM proposal, the competitor DCM would have to 
also face the constant threat of being required to convert the futures 
contract into a swap contract.
---------------------------------------------------------------------------

    \320\ See letter, dated February 22, 2011, from NYSE Liffe U.S., 
available at: http://comments.cftc.gov/PublicComments/ViewComment.aspx?id=27910&SearchText=. See also letter, dated 
February 22, 2011, from ELX Futures, L.P., available at: http://comments.cftc.gov/PublicComments/ViewComment.aspx?id=27873&SearchText=. See further letter, dated 
February 22, 2011, from Eris Exchange, LLC, available at: http://comments.cftc.gov/PublicComments/ViewComment.aspx?id=27853&SearchText=.
---------------------------------------------------------------------------

    With this final rulemaking, the competitor DCM (or a competitor 
swap execution facility (SEF)) faces the additional threat that, by 
virtue of such conversion, the contract would be margined using a five-
day minimum liquidation time. In contrast, the incumbent futures 
contract--which may have the same terms and conditions as the new 
``swap'' contract--would still be margined using a one-day minimum 
liquidation time. It is difficult to imagine a DCM (or a competitor 
SEF) willing to compete given the twin Swords of Damocles that it would 
need to confront. By dissuading such competition, this final rulemaking 
and the DCM proposal undermine the ``responsible innovation and fair 
competition among boards of trade'' that the CEA was intended to 
promote.\321\
---------------------------------------------------------------------------

    \321\ See section 3(b) of the CEA, 7 U.S.C. 5(b).
---------------------------------------------------------------------------

    Some may argue that this final rulemaking would not have the 
negative effects that I articulated because it explicitly permits the 
Commission to establish, either sua sponte or upon DCO petition, longer 
or shorter liquidation times for particular products or 
portfolios.\322\ I would argue that requiring market participants, 
during the pendency of such a petition, to pay margin calculated using 
a five-day minimum liquidation time would likely cause a substantial 
number of market participants to withdraw from the market, thereby 
chilling activity--perhaps irrevocably--in the contract. I would 
further argue that the additional cost that (i) a DCM would incur to 
persuade a DCO to file a petition with the Commission and (ii) a DCM or 
DCO would incur to prepare such a petition, when coupled with the 
possibility that the Commission may deny such petition, would likely 
deter a DCM from seeking to compete with an incumbent futures contract. 
After all, the Commission may take a long time to consider any DCO 
petition. For example, the Commission took approximately two years to 
approve a petition to reduce the minimum liquidation time for certain 
contracts on the Dubai Mercantile Exchange from two days to one 
day.\323\ Thus, this power to petition the Commission for relief may be 
of little value to offset the likely stifling of competition.
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    \322\ See the DCO Final Rule, supra note 289, at 394 (to be 
codified at 17 CFR 39.13(g)(2)(ii)(D)).
    \323\ The petition is available at: http://www.cftc.gov/PressRoom/PressReleases/pr5724-09. The petition was filed on July 
28, 2009. The Commission issued an order granting the petition on 
September 16, 2011. The order does not appear on the Commission Web 
site.
---------------------------------------------------------------------------

Return to Principles-Based Regulation
    What should the Commission have done to avoid market disruption and 
a curtailment in competition? Again, the Commission should have 
retained a principles-based regime, and should have permitted each DCO 
to determine the appropriate minimum liquidation time for its products, 
using the five factors articulated above. Determining

[[Page 69478]]

appropriate margin requirements involves quantitative and qualitative 
expertise. Such expertise resides in the DCOs and not in the 
Commission. In its cost-benefit analysis, the final rulemaking admits 
as much.\324\ Returning to a principles-based regime would have also 
better aligned with current international standards on CCP 
regulation,\325\ as well as the revisions to such standards.\326\
---------------------------------------------------------------------------

    \324\ See the DCO Final Rule, supra note 289, at 315-316 
(stating that ``[i]n addition to the liquidation time frame, the 
margin requirements for a particular instrument depend upon a 
variety of characteristics of the instrument and the markets in 
which it is traded, including the risk characteristics of the 
instrument, its historical price volatility, and liquidity in the 
relevant market. Determining such margin requirements does not 
solely depend upon such quantitative factors, but also requires 
expert judgment as to the extent to which such characteristics and 
data may be an accurate predictor of future market behavior with 
respect to such instruments, and applying such judgment to the 
quantitative results * * * Determining the risk characteristics, 
price volatility, and market liquidity of even a sample for purposes 
of determining a liquidation time specifically for such instrument 
would be a formidable task for the Commission to undertake and any 
results would be subject to a range of uncertainty.'').
    \325\ See supra note 310. With respect to minimum liquidation 
times, Section 4.4.3 of the CPSS-IOSCO Recommendations simply state: 
``Margin requirements impose opportunity costs on CCP participants. 
So, a CCP needs to strike a balance between greater protection for 
itself and higher opportunity costs for its participants. For this 
reason, margin requirements are not designed to cover price risk in 
all market conditions. Nonetheless, a CCP should estimate the 
interval between the last margin collection before default and the 
liquidation of positions in a particular product, and hold 
sufficient margin to cover potential losses over that interval in 
normal market conditions.''
    \326\ See also supra note 311. Like the CPSS-IOSCO 
Recommendations, the CPSS-IOSCO Consultation also advocates a 
principles-based model for estimating minimum liquidation times. 
Section 3.6.7 of the CPSS-IOSCO Consultation states: ``A CCP should 
select an appropriate close-out period for each product cleared by 
the CCP, and document the close-out periods and related analysis for 
each product type. A CCP should base its close-out period upon 
historical price and liquidity data when developing its initial 
margin methodology. Historical data should include the worst events 
that occurred in the selected time period for the product cleared as 
well as simulated data projections that would capture potential 
events outside of the historical data. In certain instances, a CCP 
may need to determine margin levels using a shorter historical 
period to reflect better new or current volatility in the market. 
Conversely, a CCP may need to determine margin levels based on a 
longer period in order to reflect past volatility. The close-out 
period should be set based on anticipated close-out times in 
stressed market conditions. Close-out periods should be set on a 
product-specific basis, as less-liquid products might require 
significantly longer close-out periods. A CCP should also consider 
and address position concentrations, which can lengthen close-out 
timeframes and add to price volatility during close outs.''
---------------------------------------------------------------------------

The ``Race to the Bottom'' Argument Simply Cannot Withstand Scrutiny
    Some may argue that, by not imposing minimum liquidation times, the 
Commission may enable a ``race to the bottom,'' where DCOs would 
compete by offering the lowest margin. As a conceptual matter, given 
that the Commission has not demonstrated that the minimum liquidation 
times that it has decided to mandate are ``prudent,'' it cannot 
demonstrate that the one-day or five-day period would prevent a ``race 
to the bottom.'' \327\ As an empirical matter, the Commission must have 
decided that DCOs currently competing to clear interest rate swaps and 
credit default swaps have not entered into a ``race to the bottom,'' 
because the final rulemaking codifies the existing five-day minimum 
liquidation time that such competing DCOs voluntarily adopted.\328\
---------------------------------------------------------------------------

    \327\ The Commission acknowledged as much in its cost-benefit 
analysis. The analysis states: ``The Commission anticipates that 
using only one criterion--i.e., the characteristic of the commodity 
underlying a swap--to determine liquidation time could result in 
less-than-optimal margin calculations. For some products, a five-day 
minimum may prove to be excessive and tie up more funds than are 
strictly necessary for risk management purposes. For other products, 
a one-day or even a five-day period may be insufficient and expose a 
DCO and market participants to additional risk.'' The DCO Final 
Rule, supra note 289, at 315.
    \328\ Id. at 127 to 128 (stating `` * * * the final rule 
provides that the minimum liquidation time for swaps based on 
certain physical commodities, i.e., agricultural commodities, 
energy, and metals, is one day. For all other swaps, the minimum 
liquidation time is five days. This distinction is based on the 
differing risk characteristics of these product groups and is 
consistent with existing requirements that reflect the risk 
assessments DCOs have made over the course of their experience 
clearing these types of swaps. The longer liquidation time, 
currently five days for credit default swaps at ICE Clear Credit, 
LLC, and CME, and for interest rate swaps at LCH and CME, is based 
on their assessment of the higher risk associated with these 
products.'').
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    Finally, the Commission has more effective tools to prevent any 
``race to the bottom.'' First, this final rulemaking requires a DCO to 
determine the adequacy of its initial margin requirements on a daily 
basis.\329\ Second, this final rulemaking requires a DCO to conduct 
back testing of its initial margin requirements on a daily or monthly 
basis.\330\ Third, this final rulemaking requires a DCO to stress test 
its default resources at least once a month, and to report to the 
Commission the results of such stress testing at least once every 
fiscal quarter.\331\ Fourth, the Commission has the ability to 
independently back test and stress test DCO initial margin 
requirements.\332\ Consequently, the Commission would be able to detect 
any ``race to the bottom'' that would cause any DCO to have 
insufficient initial margin to cover its risks.
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    \329\ Id. at 396 (to be codified at 17 CFR 39.13(g)(6)).
    \330\ Id. at 396-397 (to be codified at 17 CFR 39.13(g)(7)).
    \331\ Id. at 383-387 (to be codified at 17 CFR 39.11(c)(1) and 
(f)).
    \332\ See United States Commodity Futures Trading Commission, 
International Monetary Fund--Financial Sector Assessment Program: 
Self-Assessment of IOSCO Objectives and Principles of Securities 
Regulation, August 2009, available at: http://www.treasury.gov/resource-center/international/standards-codes/Documents/Securities%20CFTC%20Self%20Assessment%208-28-09.pdf (the ``FSAP 
Assessment'') (describing the capabilities of the Risk Surveillance 
Group within the Division of Clearing and Risk (formerly known as 
the Division of Clearing and Intermediary Oversight): ``After 
identifying traders or FCMs at risk, the RSG estimates the magnitude 
of the risk. The SRM system enables RSG staff to calculate the 
current performance bond requirement for any trader or FCM. This 
amount is generally designed to cover approximately 99% of potential 
one-day moves * * * SRM also enables RSG staff to conduct stress 
tests. RSG staff can determine how much a position would lose in a 
variety of circumstances such as extreme market moves. This is a 
particularly important tool with respect to option positions. As 
noted, the non-linear nature of options means that the loss 
resulting from a given price change may be many multiples greater 
for an option position than for a futures position in the same 
market. Moreover, the complexity of option positions can result in 
situations where the greatest loss does not correspond to the most 
extreme price move.'').
    The FSAP Assessment also describes the ability of the RSG to 
check DCO stress testing of its default resources: ``The RSG 
compares the risk posed by the largest clearing member to a DCO's 
financial resource package. The RSG analyzes not only the size of 
the DCO package but also its composition. In the event of a default, 
a DCO must have access to sufficient liquidity to meet its 
obligations as a central counterparty on very short notice.''
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Cost-Benefit Analysis: We Can Do Better

    I have always emphasized that the Commission must engage in more 
rigorous cost-benefit analyses of its rulemakings. At various points in 
my speeches and writings, I have urged the Commission to (i) focus on 
the economic effects of its rulemakings, both cumulative and 
incremental, (ii) quantify the costs and benefits of its rulemakings, 
both cumulative and incremental, and (iii) better justify the choice of 
a prescriptive requirement when a less-costly and equally effective 
principles-based alternative is available. Only by engaging in more 
rigorous cost-benefit analyses would the Commission fulfill the 
mandates of two Executive Orders \333\ and render our rulemakings less 
vulnerable to legal challenge.\334\
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    \333\ See Exec. Order No. 13,563, 76 Fed. Reg. 3821 (Jan. 21, 
2011); Exec. Order No. 13,579, 76 Fed. Reg. 41,587 (July 14, 2011).
    \334\ See, e.g., Business Roundtable and the United States 
Chamber of Commerce vs. SEC, No. 10-1305, 2011 U.S. App. LEXIS 14988 
(July 22, 2011).
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    I have read the cost-benefit analysis in this final rulemaking with 
great interest. I can confirm that such analysis is longer than 
previous analyses. Unfortunately, increased length does not ensure an 
improvement in analysis and content.

[[Page 69479]]

    Although I have numerous concerns with the cost-benefit analysis, 
my primary concern relates to its failure to attempt meaningful 
quantification. In multiple places in the cost-benefit analysis, the 
Commission concludes that the costs of a particular requirement are 
difficult or impossible to estimate. In certain instances, the 
statement may be accurate. If the Commission truly cannot quantify the 
costs in those instances, then that fact alone should cause the 
Commission to proceed with caution if it is going to abandon the 
existing principles-based regime. In other instances, however, I find 
the statement to be puzzling, given the capabilities and expertise of 
the Risk Surveillance Group (``RSG'') and the DCO Review Group 
(``DRG'') in our Division of Clearing and Risk (formerly known as the 
Division of Clearing and Intermediary Oversight).
    I would like to highlight two such instances where the Commission 
has not utilized its own data to quantify the costs associated with its 
policy decisions. First, with respect to the minimum liquidation time 
requirements, the Commission states that ``it is not feasible to 
estimate or quantify these costs reliably.'' The Commission justifies 
such conclusion by stating that (i) ``reliable data is not available 
for many swaps that prior to the Dodd-Frank Act were executed in 
unregulated markets,'' and (ii) it would be too difficult for the 
Commission to estimate margin using either a one-day or five-day 
minimum liquidation time for any particular product.\335\ Whereas these 
statements may be accurate for certain swaps, they are not accurate for 
futures contracts currently listed on a DCM that will be converted to 
swap contracts under the pending DCM proposal. However potentially 
incomplete, the Off-Market Volume Study (May 2010 through July 2010) 
accompanying the DCM proposal entitled Core Principles and Other 
Requirements for Designated Contract Markets \336\ demonstrates that 
the Commission has the ability to identify at least a sample of the 
futures contracts that may be potentially converted to swap contracts. 
It is true that the DCO usually impounds the minimum liquidation time 
in the risk arrays that it uses to calculate margin, and the RSG cannot 
change such risk arrays easily. However, the RSG can ask the DCO to 
provide the assumptions underlying the risk arrays, including the 
minimum liquidation time (usually one day). Then the RSG can modify 
such assumptions to estimate margin calculations using a five-day 
minimum liquidation time.\337\ Would these calculations be imperfect? 
Yes. However, any attempt, even an imperfect one, undertaken by the 
Commission to understand the cost of our rulemakings or to justify our 
policy decisions is better than no attempt at all.
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    \335\ See the DCO Final Rule, supra note 289, at 315-316.
    \336\ See supra note 318. The Off-Market Volume Survey does not 
include contracts listed on new DCMs, such as NYSE Liffe U.S., ELX 
Futures, L.P., or Eris Exchange, LLC. However, the existence of such 
survey is proof that the Commission has the ability to identify 
contracts that DCM core principle 9 may affect.
    \337\ See supra note 332. See pages 252 to 268 of the FSAP 
Assessment for a full description of the capabilities of the RSG.
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    Another instance that I would like to highlight pertains to letters 
of credit. This final rulemaking prohibits DCOs from accepting letters 
of credit as (i) initial margin for swaps contracts (but not futures 
contracts) or (ii) as guarantee fund contributions. In the cost-benefit 
analysis, the Commission states that, ``it is not possible to estimate 
or quantify [the] cost'' of the prohibition.\338\ In response to 
questions from me and certain of my colleagues, however, the DRG 
prepared a memorandum on the use of letters of credit as initial 
margin. Although this memorandum is non-public, it is part of the 
administrative record for this final rulemaking. This memorandum 
details, among other things: (i) the number and identity of certain 
DCOs accepting and/or holding letters of credit as initial margin; (ii) 
the percentage of total initial margin on deposit across all DCOs that 
letters of credit constitute; and (iii) the potential disproportionate 
impact on energy and agricultural end-users of disallowing letters of 
credit. Whereas the memorandum may focus on the use of letters of 
credit as initial margin for futures contracts, the Commission proposal 
for DCM core principle 9 may force conversion of numerous energy and 
agricultural futures contracts into swaps contracts. Yet, the cost-
benefit analysis contains none of the information in the memorandum, 
even in aggregate and anonymous form. In the interests of transparency, 
the Commission should have found a way to share this information with 
the public.
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    \338\ The DCO Final Rule, supra note 289, at 344.
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    The Commission (or its predecessor) has regulated the futures 
markets since the 1930s. The Commission has overseen DCOs clearing 
swaps since at least 2001. We can do better than this. If the 
Commission needs to re-propose a rulemaking to provide quantitative 
estimates of its costs and benefits, so be it. Given the foundational 
nature of this rulemaking, as well as other rulemakings that are 
forthcoming, it is more important for the Commission to achieve the 
most reasonable balance between costs and benefits, rather than to 
finish the rulemaking fast.

International Coordination: We Must Do Better.

    In closing, I would mention my strong desire for the Commission to 
ensure that its policies do not create disadvantages for United States 
businesses and that our rules comport with international standards. It 
is becoming increasingly clear that the schedule for financial reform 
is converging among the G-20 nations. It is less clear that the 
substantive policies underlying financial reform are experiencing the 
same convergence. We must be more cognizant of the effects of such lack 
of convergence on dually-registered entities, and the incentives 
created by such divergence for regulatory arbitrage.
    This final rulemaking illustrates the inconsistent approach that 
the Commission has taken towards international coordination to date. 
First, although the final rulemaking notes that the CPSS-IOSCO 
Recommendations embody the current international standards on CCP 
regulation, the final rulemaking does not attempt to comport with the 
CPSS-IOSCO Recommendations.\339\ Instead, the final rulemaking attempts 
to comport with the CPSS-IOSCO Consultation, which has not been 
finalized.\340\ In general, both the CPSS-IOSCO Recommendations and the 
CPSS-IOSCO Consultation are less prescriptive than the final 
rulemaking.
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    \339\ See supra note 310.
    \340\ See supra note 311.
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    Second, while the final rulemaking does note the rare instance 
where its prescriptive requirements comport with the CPSS-IOSCO 
Consultation,\341\ it does not reveal where its prescriptive 
requirements depart from the CPSS-IOSCO Consultation. For example, as I 
stated above, the CPSS-IOSCO Consultation actually sets forth 
principles-based considerations for participant eligibility and margin 
calculation.
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    \341\ See, e.g., id. at 132 (stating that requiring DCOs to 
calibrate margin to cover price movements at a 99 percent confidence 
interval accords with Principle 6 of the CPSS-IOSCO Consultation).
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    Finally, the final rulemaking states that the Commission will 
review a number of its provisions after CPSS and IOSCO finish their 
work, which is likely to occur in 2012. Whereas I support such a 
review, the statement begs the following questions: What legal 
certainty are these regulations offering

[[Page 69480]]

DCOs, clearing members, and market participants if the Commission 
changes such regulations in 2012? Also, what are the implications of 
requiring DCOs to incur costs to comport with prescriptive requirements 
now when the Commission might change such requirements next year? If 
changes are foreseeable, shouldn't the Commission adopt a phasing or 
delayed implementation plan to allow the international coordination 
process to reach completion before our rules and their costs become 
effective? If, in the alternative, the Commission will not be 
influenced by international standards, what are the costs of such non-
convergence?
    As we are finalizing foundational rulemakings, we can no longer 
rely on an inconsistent approach. We need to produce a more coherent 
plan for international coordination.

Conclusion

    Due to the above concerns, I respectfully dissent from the decision 
of the Commission to approve this final rulemaking for publication in 
the Federal Register.
[FR Doc. 2011-27536 Filed 11-7-11; 8:45 am]
BILLING CODE 6351-01-P
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