Federal Register / Vol. 65, No. 121 / Thursday, June 22, 2000 / Proposed Rules 39027

facility (mixed panel): Provided,

however, that the list of qualified

organizations provided by a

Commission registrant that is a floor

broker need not include a registered

futures association unless a registered

futures association has been authorized

to act as a decision-maker in such

matters.

(ii) The customer shall, within fortyfive days after receipt of such list, notify

the opposing party of the organization

selected. A customer’s failure to provide

such notice shall give the opposing

party the right to select an organization

from the list.

(6) Fees. The agreement must

acknowledge that the Commission

registrant will pay any incremental fees

that may be assessed by a qualified

forum for provision of a mixed panel,

unless the arbitrators in a particular

proceeding determine that the customer

has acted in bad faith in initiating or

conducting that proceeding.

(7) Cautionary Language. The

agreement must include the following

language printed in large boldface type:

THREE FORUMS EXIST FOR THE

RESOLUTION OF COMMODITY

DISPUTES: CIVIL COURT

LITIGATION, REPARATIONS AT THE

COMMODITY FUTURES TRADING

COMMISSION (CFTC) AND

ARBITRATION CONDUCTED BY A

SELF-REGULATORY OR OTHER

PRIVATE ORGANIZATION.

THE CFTC RECOGNIZES THAT THE

OPPORTUNITY TO SETTLE DISPUTES

BY ARBITRATION MAY IN SOME

CASES PROVIDE MANY BENEFITS TO

CUSTOMERS, INCLUDING THE

ABILITY TO OBTAIN AN

EXPEDITIOUS AND FINAL

RESOLUTION OF DISPUTES

WITHOUT INCURRING

SUBSTANTIAL COSTS. THE CFTC

REQUIRES, HOWEVER, THAT EACH

CUSTOMER INDIVIDUALLY

EXAMINE THE RELATIVE MERITS OF

ARBITRATION AND THAT YOUR

CONSENT TO THIS ARBITRATION

AGREEMENT BE VOLUNTARY.

BY SIGNING THIS AGREEMENT,

YOU: (1) MAY BE WAIVING YOUR

RIGHT TO SUE IN A COURT OF LAW;

AND (2) ARE AGREEING TO BE

BOUND BY ARBITRATION OF ANY

CLAIMS OR COUNTERCLAIMS

WHICH YOU OR [NAME] MAY

SUBMIT TO ARBITRATION UNDER

THIS AGREEMENT. YOU ARE NOT,

HOWEVER, WAIVING YOUR RIGHT

TO ELECT INSTEAD TO PETITION

THE CFTC TO INSTITUTE

REPARATIONS PROCEEDINGS

UNDER SECTION 14 OF THE

COMMODITY EXCHANGE ACT WITH

RESPECT TO ANY DISPUTE THAT

MAY BE ARBITRATED PURSUANT

TO THIS AGREEMENT. IN THE EVENT

A DISPUTE ARISES, YOU WILL BE

NOTIFIED IF [NAME] INTENDS TO

SUBMIT THE DISPUTE TO

ARBITRATION. IF YOU BELIEVE A

VIOLATION OF THE COMMODITY

EXCHANGE ACT IS INVOLVED AND

IF YOU PREFER TO REQUEST A

SECTION 14 ‘‘REPARATIONS’’

PROCEEDING BEFORE THE CFTC,

YOU WILL HAVE 45 DAYS FROM THE

DATE OF SUCH NOTICE IN WHICH

TO MAKE THAT ELECTION.

YOU NEED NOT SIGN THIS

AGREEMENT TO OPEN OR

MAINTAIN AN ACCOUNT WITH

[NAME]. SEE 17 CFR 166.5.

(d) Enforceability. A dispute

settlement procedure may require

parties utilizing such procedure to

agree, under applicable state law,

submission agreement or otherwise, to

be bound by an award rendered in the

procedure, provided that the agreement

to submit the claim or grievance to the

procedure was made in accordance with

paragraph (c) of this section or that the

agreement to submit the claim or

grievance was made after the claim or

grievance arose. Any award so rendered

shall be enforceable in accordance with

applicable law.

(e) Time limits for submission of

claims. The dispute settlement

procedure established by a contract

market, recognized futures exchange or

derivatives transaction facility shall not

include any unreasonably short

limitation period foreclosing submission

of customers’ claims or grievances or

counterclaims.

(f) Counterclaims. A procedure

established by a contract market,

recognized futures exchanges or

derivatives transaction facility under the

Act for the settlement of customers’

claims or grievances against a member

or employee thereof may permit the

submission of a counterclaim in the

procedure by a person against whom a

claim or grievance is brought. The

contract market, recognized futures

exchanges or derivatives transaction

facility may permit such a counterclaim

where the counterclaim arises out of the

transaction or occurrence that is the

subject of the customer’s claim or

grievance and does not require for

adjudication the presence of essential

witnesses, parties or third persons over

whom the contract market, recognized

futures exchanges or derivatives

transaction facility does not have

jurisdiction. Other counterclaims are

permissible only if the customer agrees

to the submission after the counterclaim

has arisen, and if the aggregate monetary

value of the counterclaim is capable of

calculation.

Issued in Washington, DC on June 8, 2000,

by the Commission.

Jean A. Webb,

Secretary of the Commission.

[FR Doc. 00–14915 Filed 6–21–00; 8:45 am]

BILLING CODE 6351–01–U

COMMODITY FUTURES TRADING

COMMISSION

17 CFR Part 39

RIN 3038–AB57

A New Regulatory Framework for

Clearing Organizations

AGENCY: Commodity Futures Trading

Commission.

ACTION: Proposed Rulemaking.

SUMMARY: The Commodity Futures

Trading Commission (Commission) is

proposing a new Part 39 of its rules that

would apply to clearing organizations,

as defined in the proposed rules. This

proposal, centered on broad, flexible,

core principles, is part of an initiative

described in separate companion

releases published in this edition of the

Federal Register proposing a new

regulatory framework applicable to

multilateral transaction execution

facilities and market intermediaries, in

addition to clearing organizations.

These notices propose far-reaching and

fundamental changes to modernize

Federal regulation of commodity futures

and option markets.

DATE: Comments must be received by

August 7, 2000.

ADDRESSES: Comments should be sent to

the Commodity Futures Trading

Commission, Three Lafayette Centre,

1155 21st Street, NW, Washington, DC

20581, attention: Office of the

Secretariat. Comments may be sent by

facsimile transmission to (202) 418–

5521 or, by e-mail to secretary@cftc.gov.

Reference should be made to ‘‘clearing

organizations reinvention.’’

FOR FURTHER INFORMATION CONTACT: Paul

M. Architzel, Chief Counsel, Division of

Economic Analysis, Alan L. Seifert,

Deputy Director, Division of Trading

and Markets, or Lois J. Gregory, Special

Counsel, Division of Trading and

Markets, Commodity Futures Trading

Commission, Three Lafayette Centre,

1155 21st Street, NW, Washington, DC

20581. Telephone (202) 418–5260 or email [PArchitzel@cftc.gov],

[ASeifert@cftc.gov], or

[LGregory@cftc.gov].

SUPPLEMENTARY INFORMATION:

39028 Federal Register / Vol. 65, No. 121 / Thursday, June 22, 2000 / Proposed Rules

1See the Report of the President’s Working Group

on Financial Markets, Over the Counter Derivatives

Markets and the Commodity Exchange Act (Nov.

1999).

2The Commission is aware of the standards set

forth in the Bank of International Settlements’ 1993

Lamfalussy Report on multilateral netting systems,

the recommendations with respect to clearing and

settlement of securities transactions of the Group of

Thirty, a private sector group representing leading

banking and securities firms from around the world,

and the recommendations of the President’s

Working Group in response to the market break of

October, 1987. Currently existing clearing

organizations for U.S. futures and options

exchanges meet or exceed these standards and

recommendations as a result of the Commission’s

review of these entities’ rules and procedures and

the Commission’s ongoing oversight program. These

standards and recommendations, along with others,

were taken into account in formulation proposed

part 39.

3See footnote 1, above.

4 Indeed, the benefits of clearing noted above

could be enhanced were RCOs to clear both cash

market and derivative instruments. In this regard,

the Commission seeks comment on what obstacles,

if any, exist to combining such clearing functions

in an RCO, whether such obstacles are specific to

particular commodities and what steps can be taken

to address them.

5 12 U.S.C. 611 et seq. An Edge Act corporation

is an organization chartered by the Federal Reserve

to engage in international banking operations. The

Federal Reserve Board acts upon applications by

U.S. and foreign banking organizations to establish

Edge Act corporations. It also examines Edge Act

corporations and their subsidiaries. The Edge Act

corporation gets its name from Senator Walter Edge

of New Jersey, the sponsor of the original legislation

to permit formation of such organization.

6Section 6 of the Act is applicable to clearing

organizations as well as contract markets.

Commission Regulation 1.41(a)(3) defines the term

‘‘contract market’’ to include a clearing organization

that clears trades for a contract market. The

authority of the Commission to define and treat a

clearing organization as a contract market for

purposes of the Act and the Commission’s

regulations was upheld in Board of Trade Clearing

Corporation v. U.S., (DCDC Jan 11, 1978), ’77–’80

CCH Dec. ¶ 20,534.

I. Background

The Commission is proposing a new

Part 39 regulatory framework that would

apply to clearing organizations (i.e.,

entities that perform a credit

enhancement function by becoming a

universal counterparty to market

participants or by operating a facility for

the netting of obligations and

payments). This proposal, centered on

broad, flexible, core principles, is part of

an initiative described in separate

companion releases published in this

edition of the Federal Register

proposing a new regulatory framework

applicable to multilateral transaction

execution facilities and to market

intermediaries.

Clearing organizations perform

valuable functions in exchange-traded

futures and option markets. They serve

to mitigate counterparty credit risk,

facilitate the netting and offsetting of

contractual obligations, and decrease

systemic risk. The development of

similar clearing facilities for the clearing

of over-the-counter derivatives should

be encouraged.1 However, the

performance of these functions may

raise concerns regarding concentration

of financial and credit risk in a single

entity. Accordingly, clearing

organizations should be subject to

regulatory oversight to ensure that such

facilities are capitalized sufficiently and

that they establish and implement a risk

management program that is designed to

control the credit concentration risk

associated with centralized clearing.

The Commission notes that it currently

oversees the clearing organizations that

are associated or affiliated with U.S.

futures and option exchanges.2

The Commission is proposing to

require, pursuant to proposed part 39 of

its regulations, that certain transactions

be cleared only by recognized clearing

organizations (RCOs). An entity may

become recognized by the Commission

by effectively demonstrating that it

satisfies core principles covering, among

other areas, financial resources, risk

management, treatment of client funds

and settlement procedures. U.S. clearing

organizations that currently perform

clearing services for transactions

executed on domestic futures and

option exchanges generally satisfy the

core principles and, thus, would not be

required to make any additional

showing or change their method of

operation. Consistent with

recommendations made in the

President’s Working Group report, 3 the

Commission recognizes that the form

and degree of regulatory oversight

imposed upon a clearing organization

should be consistent with the types of

instruments and markets for which it

clears and the class of market

participants for whom it clears. Part 39

would specify entities other than and in

addition to RCOs that could serve as

clearing organizations for transactions

executed pursuant to part 35 of the

Commission’s regulations or effected on

an exempt multilateral transaction

execution facility under part 36 of the

Commission’s regulations. These

entities may be: (1) A securities clearing

agency regulated by the Securities and

Exchange Commission (SEC); (2) a

clearing system organized as, among

other things, a bank, and subject to the

jurisdiction of the Board of Governors of

the Federal Reserve System; or (3) a

foreign clearing organization that

demonstrates to the Commission that it:

(a) Is subject to home country regulation

and oversight comparable to the

standards set forth by the Commission

for recognition of clearing organizations

under part 39; and (b) is a party to and

abides by appropriate and adequate

information-sharing agreements.

II. The Proposed Rules

Proposed part 39 rules would require

that every transaction effected on a

designated contract market, recognized

futures exchange or derivatives

transaction facility, if cleared, be cleared

by an RCO. RCOs also would be

authorized to clear transactions that are

exempt under part 35 or part 36. RCOs

would not be required by part 39 to be

affiliated with any of the foregoing

entities. Moreover, nothing in the

Commission’s rules prohibits an RCO

from clearing any other type of cash

market or derivative instrument.4 In

addition to RCOs, the following entities

also are authorized to clear transactions

exempt under part 35 or part 36 of the

Commission’s rules: (1) Securities

clearing agencies subject to the

supervisory jurisdiction of the SEC; (2)

clearing systems organized as a bank,

bank subsidiary, bank affiliate, or Edge

Act corporation; 5 or (3) foreign clearing

organizations that demonstrate to the

Commission that they are: (i) Subject to

home country regulation and oversight

comparable to the standards set forth by

the Commission for recognition of

clearing organizations under part 39;

and (ii) parties to appropriate and

adequate information-sharing

agreements. The Commission would

defer to oversight by the clearing

organization’s primary regulator in

connection with the clearance of such

exempt transactions.

To be recognized as an RCO, an entity

must have already been clearing

nondormant contracts on a U.S.-

designated contract market as of January

1, 2000, or must apply to the

Commission for recognition as an RCO

under part 39. An application would

address how the core principles would

be satisfied by the applicant’s proposed

rules, procedures, and framework for

operation by addressing the matters set

forth in the guidance provided to

applicants in the appendix to part 39.

A clearing organization seeking

recognition would be deemed

recognized sixty days after the

Commission received the application,

unless it appeared that the applicant

and/or its rules or procedures might

violate a specific provision of the

Commodity Exchange Act (Act), or the

Commission’s regulations or the form

and content requirements of part 39. In

that event, the Commission could notify

the applicant that the Commission

would review the proposal under the

procedures of section 6 of the Act.6 An

Federal Register / Vol. 65, No. 121 / Thursday, June 22, 2000 / Proposed Rules 39029

entity seeking recognition as an RCO

may request that the Commission

approve its initial set of rules under

section 5a(a)(12)(A) of the Act and

Commission regulations thereunder.

Part 39 rules would provide that, after

an entity was recognized as an RCO, it

would submit new rules and rule

amendments to the Commission

pursuant to proposed amended

Commission regulation 1.41. An RCO

also could request the Commission to

approve new rules or rule amendments

under section 5a(a)(12)(A) of the Act

and Commission regulation 1.41. An

RCO also could request the Commission

to issue an order considering whether

the RCO, in adopting and implementing

a rule, endeavored to take the least

anticompetitive means of achieving the

objective, purposes, and policies of the

Act.

The fraud and manipulation

provisions of the Act would apply with

respect to transactions cleared by an

RCO.

III. Related Matters

A. Regulatory Flexibility Act

The Regulatory Flexibility Act

(‘‘RFA’’), 5 U.S.C. 601–611, requires that

agencies, in proposing regulations,

consider the impact of those regulations

on small entities. Information of the

type that would be required under the

proposed rule does not involve any

small organizations.

B. Paperwork Reduction Act

Part 39 contains information

collection requirements. As required by

the Paperwork Reduction Act of 1995

(44 U.S.C. 3507(d)), the Commission has

submitted a copy of this part to the

Office of Management and Budget

(‘‘OMB’’) for its review.

Collection of Information

Submissions of Applicants for

Recognition as Recognized Clearing

Organizations, OMB Control Number

3038–XXXX.

The burden associated with the

proposed new part is estimated to be

2,000 hours which will result from new

submission requirements for first-time

applicants for recognition as Recognized

Clearing Organizations.

The estimated burden of the proposed

new part was calculated as follows:

Estimated number of respondents: 10.

Reports Annually by each respondent:

1.

Total Annual Responses: 10.

Estimated Average Number of Hours

Per Response: 200.

Estimated Total Number of Hours of

Annual Burden in Fiscal Year: 2,000.

Organizations and individuals

desiring to submit comments on the

information collection requirements

should direct them to the Office of

Information and Regulatory Affairs,

OMB, Room 10235 New Executive

Office Building, Washington, DC 20503,

Attention: Desk Officer for the

Commodity Futures Trading

Commission.

The Commission considers comments

by the public on this proposed

collection of information in—

• Evaluating whether the proposed

collection of information is necessary

for the proper performance of the

functions of the Commission, including

whether the information will have a

practical use;

• Evaluating the accuracy of the

Commission’s estimate of the burden of

the proposed collection of information,

including the validity of the

methodology and assumptions used;

• Enhancing the quality, usefulness,

and clarity of the information to be

collected; and

• Minimizing the burden of collection

of information on those who are to

respond, including through the use of

appropriate automated electronic,

mechanical, or other technological

collection techniques or other forms of

information technology, e.g., permitting

electronic submission of responses.

OMB is required to make a decision

concerning the collection of information

contained in these proposed regulations

between 30 and 60 days after

publication of this document in the

Federal Register. A comment to OMB is

best assured of having its full effect if

OMB receives it within 30 days of

publication. This does not affect the

deadline for the public to comment to

the Commission on the proposed

regulations.

Copies of the information collection

submission to OMB are available from

the CFTC Clearance Officer, 1155 21st

Street, NW, Washington, DC 20581,

(202) 418–5160.

List of Subjects in 17 CFR Part 39

Clearing, Clearing organizations,

Commodity futures, Consumer

protection.

In consideration of the foregoing, and

pursuant to the authority contained in

Sections 2, 6(c), 7a, and 12a(5) of the

U.S.C., the Commission proposes to

amend Chapter I of Title 17 of the Code

of Federal Regulations by adding Part 39

to read as follows:

PART 39—RECOGNIZED CLEARING

ORGANIZATIONS

Sec.

39.1 Definitions and Scope.

39.2 Permitted Clearing.

39.3 Conditions for Recognition as a

Recognized Clearing Organization

39.4 Procedures for Recognition.

39.5 Enforceability.

39.6 Fraud and Manipulation in Connection

with transactions cleared by a

Recognized Clearing Organizations.

Appendix A to Part 39—Application

Guidance

Authority: 7 U.S.C. 2, 6(c), 7a, 12a(5).

§ 39.1 Definitions and Scope.

(a) Definitions. For purposes of this

part:

(1) Clearing organization means a

person, entity or association thereof,

which performs a credit enhancement

function in connection with

transactions executed on a designated

contract market or pursuant to parts 35–

38 of this chapter by becoming a

universal counterparty to market

participants or by operating a facility for

the netting of obligations and payments

of such transactions; but does not

include those netting arrangements

specified in § 35.2(d)(1) and (d)(2), nor

does it include an entity that is a single

counterparty offering to enter into, or

entering into, bilateral transactions with

multiple counterparties.

(b) Scope. (1) This section applies to

all cleared transactions effected on or

through a designated contract market, a

recognized futures exchange under part

38 of this chapter, a derivatives

transaction facility under part 37 of this

chapter, an exempt multilateral

transaction execution facility under part

36 of this chapter, and to exempt

bilateral transactions under part 35 of

this chapter.

(2) A clearing organization that has

been recognized by the Commission

under § 39.3 of this part shall be deemed

to be a contract market for purposes of

the Act, and Commission rules

thereunder; provided, however, a

recognized clearing organization shall

be exempt from all provisions of the Act

and Commission regulations thereunder

except as reserved in § 39.5 of this part.

§ 39.2 Permitted clearing.

(a) Any transaction effected on a

designated contract market, recognized

futures exchange, or derivatives

transaction facility, if cleared, shall be

cleared by a recognized clearing

organization.

(b) A transaction effected pursuant to

Part 35 or Part 36 of this chapter, if

cleared, shall be cleared by any of the

following authorized clearing

organizations:

(1) A recognized clearing organization

under this part;

39030 Federal Register / Vol. 65, No. 121 / Thursday, June 22, 2000 / Proposed Rules

(2) A securities clearing agency

subject to the supervisory jurisdiction of

the Securities and Exchange

Commission;

(3) A clearing system organized as a

bank, bank subsidiary, affiliate of a

bank, or Edge Act corporation

established under the Federal Reserve

Act authorized to engage in

international banking or financial

activities, and subject to the jurisdiction

of the Federal Reserve or Comptroller of

the Currency; or

(4) A foreign clearing organization

that demonstrates to the Commission

that it:

(i) Is subject to home country

regulation and oversight comparable to

the standards set forth by the

Commission for recognition of clearing

organizations under this part; and

(ii) Is a party to and abides by

appropriate and adequate informationsharing arrangements.

(c) Transactions not specified in

§ 39.1(b)(1) of this part may also be

cleared by a recognized clearing

organization.

§ 39.3 Conditions for Recognition as a

Recognized Clearing Organization.

To be recognized by the Commission

under this part 39 as a recognized

clearing organization, an entity:

(a) Need not be affiliated with a

designated contract market or

recognized futures exchange under part

38 of this chapter, derivatives

transaction facility under part 37 of this

chapter or exempt multilateral

transaction execution facility under part

36 of this chapter;

(b) Must have rules and procedures

relating to its governance and the

operation of its clearing function; and

(c) Must initially, and on a continuing

basis, meet and adhere to the following

fourteen core principles:

(1) Financial resources: Adequate

capital resources to fulfill its guarantee

function without interruption in various

market conditions.

(2) Participant and product eligibility:

Appropriate admission and continuing

eligibility standards for members or

participants of the organization and

defined criteria for instruments it will

accept for clearing.

(3) Risk management: Ability to

manage the risks associated with

carrying out its guarantee function

through the use of appropriate tools and

procedures.

(4) Settlement procedures: Ability to

complete settlements on a timely basis

under varying circumstances, to

maintain an adequate record of the flow

of funds associated with each

transaction it clears, and to comply with

the terms and conditions of any

permitted netting or offset arrangements

with other clearing organizations.

(5) Treatment of client funds:

Adequate standards and procedures

designed to protect and ensure the

safety of client funds.

(6) Default rules and procedures:

Rules and procedures designed to allow

for efficient, fair, and safe management

of events when members or participants

become insolvent or otherwise default

on their obligations to the clearing

organization.

(7) Rule enforcement: Adequate

arrangements and resources for the

effective monitoring and enforcement of

compliance with its rules and for

resolution of disputes.

(8) System safeguards: An adequate

program of oversight and risk analysis to

ensure that its automated systems

function properly and have adequate

capacity, security, and emergency and

disaster recovery procedures.

(9) Governance: Have fitness

standards for owners or operators with

greater than ten percent interest or an

affiliate of such an owner, and for

members of the governing board, and

have a means to address conflicts of

interest in making decisions.

(10) Reporting: Provision to the

Commission of all information

necessary for the Commission to

conduct its oversight function of the

clearing organization’s activities.

(11) Recordkeeping: Maintain full

books and records of all activities

related to business as a recognized

clearing organization in a form and

manner acceptable to the Commission

for a period of five years.

(12) Public information: Public

disclosure of information concerning

the rules and operating procedures

governing its clearing and settlement

systems, including default procedures.

(13) Information sharing: Enter into

and abide by the terms of all appropriate

and applicable domestic and

international information-sharing

agreements and use relevant

information obtained from such

agreements in carrying out the clearing

organization’s risk management

program.

(14) Competition: Endeavor to avoid

unreasonable restraints of trade or

imposing any burden on competition

not necessary or appropriate in

furtherance of the objectives of the Act

or the regulations thereunder.

§ 39.4 Procedures for Recognition.

(a) Recognition by certification. A

clearing organization that cleared for at

least one nondormant contract within

the meaning of § 5.4 of this chapter on

January 1, 2000, will be recognized by

the Commission as a recognized clearing

organization upon receipt by the

Commission at its Washington, DC,

headquarters of a copy of the clearing

organization’s rules and a certification

by the clearing organization that it

meets the conditions for recognition

under this part.

(b) Recognition by application. A

clearing organization shall be

recognized by the Commission as a

recognized clearing organization sixty

days after receipt by the Commission of

an application for recognition unless

notified otherwise during that period, if:

(1) The application demonstrates that

the applicant satisfies the conditions for

recognition under this part;

(2) The submission is labeled as being

submitted pursuant to this part;

(3) The submission includes a copy of

the applicant’s rules and a brief

explanation of how the rules satisfy

each of the conditions for recognition

under § 39.3 of this part;

(4) The applicant does not amend or

supplement the application for

recognition, except as requested by the

Commission or for correction of

typographical errors, renumbering or

other nonsubstantive revisions, during

that period; and

(5) The applicant has not instructed

the Commission in writing during the

review period to review the application

pursuant to procedures under section 6

of the Act.

(6) Attached to this part as Appendix

A is guidance to applicants concerning

how the core principles set forth above

could be satisfied.

(c) Termination of Part 39 Review.

During the sixty-day period for review

pursuant to paragraph (b) of this section,

the Commission shall notify the

applicant seeking recognition that the

Commission is terminating review

under this section and will review the

proposal under the procedures of

section 6 of the Act, if it appears that the

application fails to meet the conditions

for recognition under this part. This

termination notification will state the

nature of the issues raised and the

specific condition of recognition that

the application appears to violate, is

contrary to or fails to meet. Within ten

days of receipt of this termination

notification, the applicant seeking

recognition may request that the

Commission render a decision whether

to recognize the clearing organization or

to institute a proceeding to disapprove

the proposed submission under

procedures specified in section 6 of the

Act by notifying the Commission that

the applicant seeking recognition views

Federal Register / Vol. 65, No. 121 / Thursday, June 22, 2000 / Proposed Rules 39031

its submission as complete and final as

submitted.

(d) Delegation of Authority. (1) The

Commission hereby delegates, until it

orders otherwise, to the Director of the

Division of Trading and Markets or the

Director’s delegatee, with the

concurrence of the General Counsel or

the General Counsel’s delegatee,

authority to notify an entity seeking

recognition under paragraph (b) of this

section that review under those

procedures is being terminated.

(2) The Director of the Division of

Trading and Markets may submit to the

Commission for its consideration any

matter which has been delegated in this

paragraph.

(3) Nothing in the paragraph prohibits

the Commission, at its election, from

exercising the authority delegated in

paragraph (d)(1) of this section.

(e) Request for Commission Approval

of Rules. (1) An applicant for

recognition as a recognized clearing

organization may request that the

Commission approve any or all of its

rules and subsequent amendments

thereto, at the time of recognition or

thereafter, under section 5a(a)(12) of the

Act and § 1.41 of this chapter. The

recognized clearing organization may

label such rules as having been

approved by the Commission. In

addition, rules of the recognized

clearing organization not submitted

pursuant to § 39.4(b)(3) shall be

submitted to the Commission pursuant

to § 1.41 of this chapter.

(2) An applicant seeking recognition

as a recognized clearing organization

may request that the Commission

consider under the provisions of section

15 of the Act any of the entity’s rules or

policies at the time of recognition or

thereafter.

(f) Request for withdrawal of

recognition. A recognized clearing

organization may withdraw from

Commission recognition by filing with

the Commission at its Washington, DC,

headquarters such a request.

Withdrawal from recognition 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 clearing organization was

recognized by the Commission.

§ 39.5 Enforceability.

In accordance with the proviso in

§ 39.1(b)(2), sections 1a, 2(a)(1), 4, 4b,

4c, 4d, 4g, 4i, 4o, 5(7), the rule

disapproval procedures of sections

5a(a)(12), 5b, 6, 6b, 6c, 8(a), 8(c), 8a(6),

8a(7), 8a(9), 8c(a), 8c(b), 8(c)(c), 8(c)(d),

9(a), 9(f), 20 and 22 of the Act and

§§ 1.3, 1.20, 1.24, 1.25, 1.26, 1.27 1.31,

1.38, 1.41, 33.10, parts 15–21, part 39,

and part 190 of this chapter continue to

apply.

§ 39.6 Fraud and Manipulation in

Connection with transactions cleared by a

Recognized Clearing Organization.

It shall be unlawful for any person,

directly or indirectly, in or in

connection with any transaction cleared

by a recognized clearing organization:

(a) To cheat or defraud or attempt to

cheat or defraud any other person;

(b) Willfully to make or cause to be

made to any other person any false

report or statement thereof or cause to

be entered for any person any false

record thereof; or

(c) Willfully to deceive or attempt to

deceive any other person by any means

whatsoever.

Appendix A to Part 39—Application

Guidance

This appendix provides guidance to

applicants for recognition as recognized

clearing organizations in connection with

satisfying each of the core principles of

§ 39.4. In addressing the core principles,

applicants should address the matters set

forth below.

Core Principle 1—Financial Resources.

Adequate Capital Resources to Fulfill the

Guarantee Function Without Interruption in

Various Market Conditions

In addressing core principle 1, applicants

should describe or otherwise document:

1. The amount of resources dedicated to

supporting the clearing function:

a. The amount of resources available to the

clearing organization and the sufficiency of

those resources such that no break in clearing

operations would occur in a variety of market

conditions; and

b. The level of member/participant default

such resources could support as

demonstrated through use of a hypothetical

default scenario that explains assumptions

and variables factored into the illustration.

2. The nature of resources dedicated to

supporting the clearing function:

a. The type of the resources, including

their liquidity, and how they could be

accessed and applied by the clearing

organization without delay; and

b. Any legal or operational impediments or

conditions to access.

Core Principle 2—Participant and Product

Eligibility. Appropriate Admission and

Continuing Eligibility Standards for Members

or Participants of the Organization and

Defined Criteria for Instruments it Will

Accept for Clearing

In addressing core principle 2, applicants

should describe or otherwise document:

1. Member/participant admission criteria:

a. How admission standards for its clearing

members would contribute to the soundness

and integrity of operations; and

b. Matters such as whether these criteria

would be in the form of organization rules

that apply to all clearing members, whether

different levels of membership would relate

to different levels of net worth, income, and

creditworthiness of members, and whether

margin levels, position limits and other

controls would vary in accordance with these

levels.

2. Member/participant continuing

eligibility criteria:

a. A program for monitoring the financial

status of its members; and

b. Whether/how the clearing organization

would be able to change continuing

eligibility criteria in accordance with changes

in a member’s financial status.

3. Criteria for instruments acceptable for

clearing:

a. How the clearing organization would

establish specific criteria for the types of

derivatives it will clear; and

b. How those criteria take into account the

different risks inherent in clearing different

derivatives and how they affect maintenance

of assets to support the guarantee function in

varying risk environments.

4. Clearing function for each instrument:

a. The clearing function for each

instrument the organization undertakes to

clear; and

b. How different functions would be made

known to participants.

Core Principle 3—Risk Management. Ability

to Manage the Risks Associated With

Carrying Out the Guarantee Function

Through the Use of Appropriate Tools and

Procedures

In addressing core principle 3, applicants

should describe or otherwise document:

1. Use of risk analysis tools and

procedures:

a. How the adequacy of the overall level of

financial resources would be tested on an

ongoing periodic basis in a variety of market

conditions; and

b. How the organization would use specific

risk management tools including stress

testing and value at risk calculations.

2. Use of collateral:

a. How appropriate forms and levels of

collateral would be established and collected;

b. How amounts would be adequate to

secure prudentially obligations arising from

clearing transactions and performing as

central counterparty;

c. Why particular margin levels would be

appropriate for a contract cleared and the

clearing member clearing the contract;

d. The appropriateness of required or

allowed forms of margin given the liquidity

and related requirements of the clearing

organization;

e. How the clearing organization would

ensure appropriate valuation of open

positions and valuation of collateral assets;

and

f. The proposed margin collection schedule

and how it would synchronize with changes

in the value of market positions and

collateral values.

3. Use of credit limits:

If and how systems would be implemented

that would prevent members and other

market participants from exceeding

appropriate credit limits; and

4. Appropriate use of cross margin

reduction programs:

How collateral assets subject to crossmargining programs would provide for clear,

39032 Federal Register / Vol. 65, No. 121 / Thursday, June 22, 2000 / Proposed Rules

fair, and efficient loss-sharing arrangements

in the event of a program participant default.

Core Principle 4—Settlement Procedures.

Ability To Complete Settlements on a Timely

Basis Under Varying Circumstances, To

Maintain an Adequate Record of the Flow of

Funds Associated With Each Transaction it

Clears, and To Comply With the Terms and

Conditions of Any Permitted Netting or Offset

Arrangements With Other Clearing

Organizations

In addressing core principle 4, applicants

should describe or otherwise document:

1. Settlement timeframe:

a. Procedures for completing settlements

on a timely basis during times of normal

operating conditions; and

b. Procedures for completing settlements

on a timely basis in varying market

circumstances including during a period

when a significant participant or member has

defaulted.

2. Recordkeeping:

a. The nature and quality of the

information collected concerning the flow of

funds involved in clearing and settlement;

and

b. How the flow of funds associated with

each cleared transaction would be recorded,

maintained and easily accessed.

3. Appropriate interfaces with other

clearing organizations:

How compliance with the terms and

conditions of any permitted netting or offset

arrangements with other clearing

organizations would be met, including,

among others, common banking or common

clearing programs.

Core Principle 5—Treatment of Client Funds.

Standards and Procedures Designed To

Protect and Ensure the Safety of Client Funds

In addressing core principle 5, applicants

should describe or otherwise document:

1. Safe custody:

a. The safekeeping of client funds, whether

in accounts, in depositories, or with

custodians, and how it would meet industry

standards of safety;

b. Any written terms regarding the legal

status of the funds and the specific

conditions or prerequisites for movement of

the funds; and

c. How the deposit of client funds in

accounts in depositories or with custodians

would also ensure adequate diversification of

concentration of risk.

2. Segregation between customer and

proprietary funds:

a. Requirements for segregation and

requiring members or participants that clear

trades executed on behalf of customers to

segregate customer accounts and funds; and

b. Requirements or restrictions regarding

commingling customer with proprietary

funds, obligating customer funds for any

purpose other than to purchase, clear, and

settle the products the clearing organization

is clearing, and any other aspects of customer

fund segregation.

3. Investment standards:

How customer funds would be invested to

meet high standards of safety and the

proposed recordkeeping regarding all details

of such investments.

Core Principle 6—Default Rules and

Procedures. Rules and Procedures Designed

To Allow for Efficient, Fair, and Safe

Management of Events When Members or

Participants Become Insolvent or Otherwise

Default on Their Obligations to the Clearing

Organization

In addressing core principle 6, applicants

should describe or otherwise document:

1. Definition of default:

a. The definition of default and how it

would be established and enforced; and

b. How it would address failure to meet

margin requirements, the insolvent financial

condition of a member or participant, failure

to comply with certain rules, failure to

maintain eligibility standards, actions taken

by other regulatory bodies, or other events.

2. Remedial action:

The authority pursuant to which, and how,

the clearing organization would take

appropriate action in the event of the default

of a member which may include, among

other things, closing out positions, replacing

positions, set-off, and applying margin;

3. Process to address shortfalls:

Procedures for the prompt, fair, and safe

application of Clearing Organization and/or

member financial resources to eliminate any

monetary shortfall resulting from a default.

4. Customer priority rule:

Rules and procedures regarding priority of

customer accounts over proprietary accounts

of intermediary members or participants and

where applicable, in the context of other

programs, such as specialized margin

reduction programs like cross-margining or

trading links with other exchanges.

Core Principle 7—Rule Enforcement.

Adequate Arrangements and Resources for

the Effective Monitoring and Enforcement of

Compliance With its Rules and for Resolution

of Disputes

In addressing core principle 7, applicants

should describe or otherwise document:

1. Surveillance:

Arrangements and resources for the

effective monitoring of compliance with rules

including any clearing practice and financial

surveillance programs.

2. Enforcement:

a. Arrangements and resources for effective

enforcement of rules and authority and

ability to discipline and limit or suspend a

member’s or participant’s activities; and

b. Authority and ability to terminate a

member’s or participant’s activities pursuant

to clear and fair standards.

3. Dispute resolution:

Arrangements and resources for resolution

of disputes between customers and members,

and between members.

Core Principle 8—System Safeguards. An

Adequate Program of Oversight and Risk

Analysis to Ensure That Its Automated

Systems Function Properly and have

Adequate Capacity, Security, and Emergency

and Disaster Recovery Procedures

In addressing core principle 8, applicants

should describe or otherwise document:

1. Oversight/risk analysis program:

a. Any program of oversight and risk

analysis and whether it addresses

appropriate principles for the oversight of

automated systems to ensure that its clearing

system functions properly and has adequate

capacity and security;

b. Emergency procedures and a plan for

disaster recovery; and

c. Periodic testing of back-up facilities and

ability to ensure daily processing, clearing,

and settlement of transactions.

2. Appropriate periodic objective system

reviews/testing:

a. Any program for the periodic objective

testing and review of the system; and

b. Confirmation that such testing and

review would be performed by an

independent third-party professional that is a

certified member of the Information Systems

Audit and Control Association with an

appropriate level of experience in the

industry.

Core Principle 9—Governance. Have Fitness

Standards for Owners or Operators With

Greater Than Ten Percent Interest, or an

Affiliate of Such an Owner, and for Members

of the Governing Board, and Have a Means

to Address Conflicts of Interest in Making

Decisions

In addressing core principle 9, applicants

should describe or otherwise document:

1. Appropriate standards for fitness for

clearing organization owners, operators,

affiliates of owners or operators, and

members of the governing board based on

disqualification standards under section

8a(2) of the Act.

2. Collection and verification of

information supporting compliance with

standards:

a. Verification information could be

registration information or certification of

fitness or affidavit of fitness by outside

counsel based on other verified information.

3. Methods to ascertain presence of

conflicts of interest and methods of making

decisions in that event.

Core Principle 10—Reporting. Provision to

the Commission of all Information Necessary

for the Commission to Conduct its Oversight

Function of the Recognized Clearing

Organization’s Activities

In addressing core principle 10, applicants

should describe or otherwise document:

1. Information necessary for the

Commission to perform its oversight

activities of the recognized clearing

organization’s activities:

a. All information available to or generated

by the clearing organization that will be

made available to the Commission as

appropriate to enable the Commission to

perform properly its oversight function,

including counterparties and their positions,

stress test results, internal governance, legal

proceedings, and other clearing activities;

b. The types of information which are not

believed to be necessary to provide to the

Commission and why; and

c. The information the organization intends

to make routinely available to members/

participants or the general public.

2. Provision of information:

a. The manner in which all relevant

information will be provided to the

Commission whether by electronic or other

means; and

Federal Register / Vol. 65, No. 121 / Thursday, June 22, 2000 / Proposed Rules 39033

b. The means by which any information

will be made available to members/

participants and/or the general public.

Core Principle 11—Recordkeeping.

Maintaining Complete Books and Records of

all Activities Related to Business as a

Recognized Clearing Organization in a Form

and Manner Acceptable to the Commission

for a Period of Five Years

In addressing core principle 11, applicants

should describe or otherwise document:

1. Maintaining records of all activities

related to the function of a clearing

organization:

a. The different activities related to the

function of the clearing organization for

which the organization intends to keep books

or records; and

b. Any activity related to the function of a

clearing organization for which the

organization does not intend to keep books

or records and why this is not viewed as

necessary.

2. Maintenance of full books and records

in a form and manner acceptable to the

Commission:

3. How the entity would satisfy the

requirements of Commission Regulation 1.31

including:

a. What ‘‘complete’’ would encompass

with respect to each type of book or record

that would be maintained;

b. How books or records would be

compiled and maintained with respect to

each type of activity for which such books or

records would be kept;

c. Confirmation that books and records

would be open to inspection by any

representative of the Commission or of the

U.S. Department of Justice;

d. How long books and records would be

readily available and how they would be

made readily available during the first two

years; and

e. How long books and records would

ultimately be maintained (and confirmation

that, in any event, they would be maintained

for at least five years).

Core Principle 12—Public Information.

Disclosure of Information Concerning the

Rules and Operating Procedures Governing

its Clearing and Settlement Systems,

Including Default Procedures

In addressing core principle 12, applicants

should describe or otherwise document:

1. Disclosure of information regarding rules

and operating procedures governing clearing

and settlement systems:

a. Which rules and operating procedures

governing clearing and settlement systems

should be disclosed to the public, to whom

they would be disclosed, and how they

would be disclosed;

b. What other information would be

available regarding the operation, purpose

and effect of rules;

c. How member/participants may become

familiar with such procedures before

participating in operations; and

d. How member/participants will be

informed of their specific rights and

obligations preceding a default and upon a

default, and of the specific rights, options

and obligations of the clearing organization

preceding and upon the participant’s default.

Core Principle 13—Information Sharing.

Entering Into and Abiding by the Terms of all

Appropriate and Applicable Domestic and

International Information-Sharing

Agreements and Using Relevant Information

Obtained from such Agreements in Carrying

out the Recognized Clearing Organization’s

Risk Management Program

In addressing core principle 13, applicants

should describe or otherwise document:

1. Becoming a party to applicable

appropriate domestic and international

information-sharing agreements and

arrangements:

a. The utility of entering into various types

of information-sharing arrangements;

b. The different types of domestic and

international information-sharing

arrangements, both formal and informal,

which the clearing organization views as

appropriate and applicable to its operations;

and

c. The specific information-sharing

agreements or other arrangements to which

the clearing organization would become a

party and how it would abide by the terms

of these agreements.

2. Using information obtained from

information-sharing arrangements in carrying

out risk management and surveillance

programs:

a. How information obtained from any

information-sharing arrangements would be

used to further the objectives of the clearing

organization’s risk management program and

any of its surveillance programs including

financial surveillance and continuing

eligibility of its members/participants;

b. How accurate information is expected to

be obtained and the mechanisms or

procedures which would make timely use

and application of all information; and

c. The types of information expected to be

shared and how that information would be

shared.

Core Principle 14—Competition. Endeavoring

to Avoid Unreasonable Restraints of Trade or

Imposing Any Burden on Competition not

Necessary or Appropriate in Furtherance of

the Objectives of the Act or the Regulations

Thereunder

In addressing core principle 14, applicants

should describe or otherwise document:

1. Avoiding unreasonable restraints of

trade:

a. Terms and conditions of access and

provision of services;

b. Any contracts or agreements to which

the organization is a party which contain any

noncompete clauses or limitations on future

activity which may compete with the

interests of either party to the contract.

2. Avoiding burdening competition:

a. Any practice of the clearing organization

that may appear to affect the competitiveness

of any other entity or the practice of any

entity that may appear to affect the

competitive ability of the clearing

organization; and

b. The extent to which the entity has

endeavored to adopt a rule or practice that

is the least anticompetitive means of

achieving the objective, purposes and

policies of the Act.

Issued in Washington, D.C. on June 8,

2000, by the Commission.

Jean A. Webb,

Secretary of the Commission.

[FR Doc. 00–14916 Filed 6–21–00; 8:45 am]

BILLING CODE 6351–01–U

COMMODITY FUTURES TRADING

COMMISSION

17 CFR Part 35

RIN 3038–AB58

Exemption for Bilateral Transactions

AGENCY: Commodity Futures Trading

Commission.

ACTION: Proposed Rulemaking.

SUMMARY: The Commodity Futures

Trading Commission (Commission or

CFTC) is proposing to clarify the

operation of the current swaps

exemption, 17 CFR Part 35. In addition,

in a companion notice of proposed

rulemaking on clearing, the Commission

is proposing rules clarifying that

transactions under its Part 35 swaps

exemption can be cleared. The

Commission, in companion releases

published in this edition of the Federal

Register, also is proposing a new

regulatory framework to apply to

multilateral transaction execution

facilities, to market intermediaries and

to clearing organizations. This new

framework establishes a number of new

market categories, including a category

of exempt multilateral transaction

execution facility. Nothing in these

releases, however, would affect the

continued vitality of the Commission’s

exemption for swaps transactions under

Part 35 of its rules, or any of its other

existing exemptions, policy statements

or interpretations.

DATES: Comments must be received by

August 7, 2000.

ADDRESSES: Comments should be sent to

the Commodity Futures Trading

Commission, Three Lafayette Centre,

1125 21st Street, NW., Washington, DC

20581, attention: Office of the

Secretariat. Comments may be sent by

facsimile transmission to (202) 418–

5521 or, by e-mail to secretary@cftc.gov.

Reference should be made to

‘‘Exemption for Bilateral Transactions.’’

FOR FURTHER INFORMATION CONTACT: Paul

M. Architzel, Chief Counsel, Division of

Economic Analysis, Commodity Futures

Trading Commission, Three Lafayette

Centre, 1125 21st Street, NW,

Washington, DC 20581. Telephone:

(202) 418–5260. E-mail:

[PArchitzel@cftc.gov].

SUPPLEMENTARY INFORMATION: