[Federal Register Volume 65, Number 121 (Thursday, June 22, 2000)]
[Proposed Rules]
[Pages 39027-39033]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 00-14916]


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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.

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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 
<a href="/cdn-cgi/l/email-protection#2152444253445540535861424755420f464e57"><span class="__cf_email__" data-cfemail="cebdabadbcabbaafbcb78eada8baade0a9a1b8">[email protected]</span></a>. 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 e-mail [<a href="/cdn-cgi/l/email-protection#17475665747f7e636d727b577471637439707861"><span class="__cf_email__" data-cfemail="3f6f7e4d5c57564b455a537f5c594b5c11585049">[email protected]</span></a>], 
[<a href="/cdn-cgi/l/email-protection#4a0b192f232c2f383e0a292c3e29642d253c"><span class="__cf_email__" data-cfemail="98d9cbfdf1fefdeaecd8fbfeecfbb6fff7ee">[email protected]</span></a>], or [<a href="/cdn-cgi/l/email-protection#216d665344464e535861424755420f464e57"><span class="__cf_email__" data-cfemail="3a767d485f5d5548437a595c4e59145d554c">[email protected]</span></a>].

SUPPLEMENTARY INFORMATION:

[[Page 39028]]

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\
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    \1\ See the Report of the President's Working Group on Financial 
Markets, Over the Counter Derivatives Markets and the Commodity 
Exchange Act (Nov. 1999).
    \2\ The 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.
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    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.
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    \3\ See footnote 1, above.
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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.
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    \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.
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    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

[[Page 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.
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    \6\ Section 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. para. 20,534.
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    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--
    <bullet> 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;
    <bullet> 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;
    <bullet> Enhancing the quality, usefulness, and clarity of the 
information to be collected; and
    <bullet> 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).


Sec. 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 Sec. 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 Sec. 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 Sec. 39.5 of this part.


Sec. 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;

[[Page 39030]]

    (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 
information-sharing arrangements.
    (c) Transactions not specified in Sec. 39.1(b)(1) of this part may 
also be cleared by a recognized clearing organization.


Sec. 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.


Sec. 39.4  Procedures for Recognition.

    (a) Recognition by certification. A clearing organization that 
cleared for at least one nondormant contract within the meaning of 
Sec. 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 Sec. 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

[[Page 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 Sec. 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 Sec. 39.4(b)(3) shall be 
submitted to the Commission pursuant to Sec. 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.


Sec. 39.5  Enforceability.

    In accordance with the proviso in Sec. 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 Secs. 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.


Sec. 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 Sec. 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 cross-margining programs would 
provide for clear,

[[Page 39032]]

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

[[Page 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


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