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[Federal Register Volume 76, Number 142 (Monday, July 25, 2011)]
[Rules and Regulations]
[Pages 44262-44265]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2011-18777]

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COMMODITY FUTURES TRADING COMMISSION

17 CFR Parts 1 and 4

RIN 3038-AD11

Removing Any Reference to or Reliance on Credit Ratings in 

Commission Regulations; Proposing Alternatives to the Use of Credit 

Ratings

AGENCY: Commodity Futures Trading Commission.

ACTION: Final rule.

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SUMMARY: The Commodity Futures Trading Commission (``Commission'' or 

``CFTC'') is adopting a final rule that amends existing CFTC 

regulations in order to implement new statutory provisions enacted by 

Title IX of the Dodd-Frank Wall Street Reform and Consumer Protection 

Act (``Dodd-Frank Act''). The rule amendments set forth herein apply to 

futures commission merchants (``FCMs''), derivatives clearing 

organizations (``DCOs''), and commodity pool operators (``CPOs''). The 

rule amendments implement the new statutory framework that requires 

agencies to replace any reference to or reliance on credit ratings in 

their regulations with an appropriate alternative standard.

DATES: This rule is effective September 23, 2011.

FOR FURTHER INFORMATION CONTACT: Ward P. Griffin, Counsel, Office of 

General Counsel, Commodity Futures Trading Commission, Three Lafayette 

Centre, 1155 21st Street, NW, Washington, DC 20581. Telephone: 202-418-

5425. E-mail: wgriffin@cftc.gov.

SUPPLEMENTARY INFORMATION: 

I. Background

    On July 21, 2010, President Obama signed into law the Dodd-Frank 

Act.\1\ In relevant part, Title IX of the Dodd-Frank Act directs 

Federal agencies to take certain actions concerning any reference to--

or requirement of reliance on--credit ratings in each agency's 

respective regulations. Specifically, section 939A of the Dodd-Frank 

Act requires agencies to take three actions by July 21, 2011, the one-

year anniversary of the enactment of the Dodd-Frank Act. First, section 

939A(a) directs each Federal agency to review ``any regulation issued 

by such agency that requires the use of an assessment of the credit-

worthiness of a security or money market instrument [and] any 

references to or requirements in such regulations regarding credit 

ratings.'' Second, section 939A(b) requires that each Federal agency 

``modify any such regulations identified by the review conducted under 

subsection (a) to remove any reference to or requirement of reliance on 

credit ratings and to substitute in such regulations such standard of 

credit-worthiness as each respective agency shall determine as 

appropriate for such regulations.'' To the extent feasible, Federal 

agencies should ``seek to establish * * * uniform standards of credit-

worthiness for use by each such agency.'' And third, section 939A(c) 

directs each Federal agency to report to Congress ``a description of 

any modification of any regulation such agency made pursuant to 

subsection (b).''

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    \1\ Dodd-Frank Wall Street Reform and Consumer Protection Act, 

Pub. L. 111-203, 124 Stat. 1376 (2010). The text of the Dodd-Frank 

Act may be accessed at http://www.cftc.gov/LawRegulation/OTCDERIVATIVES/index.htm.

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    Subsequent to the enactment of the Dodd-Frank Act, the Commission 

reviewed its regulations and identified instances in which credit 

ratings were referred to or relied upon.\2\ The identified regulations 

could be categorized into two groups: (1) those that rely on ratings to 

limit how Commission registrants may invest or deposit customer funds; 

and (2) those that require disclosing a credit rating to describe an 

investment's characteristics. In keeping with its efforts to comply 

fully with both the spirit and letter of the Dodd-Frank Act, the 

Commission proposed to amend all of the identified regulations that 

rely on credit ratings regarding financial instruments.

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    \2\ Commission regulations that are referenced herein are found 

at 17 CFR Ch. 1 (2010). They are accessible on the Commission's Web 

site at http://www.cftc.gov.

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    On November 2, 2010, the Commission published in the Federal 

Register proposed amendments to certain of its existing regulations 

(the ``Proposing Release'') in response to the directives set forth in 

section 939A of the Dodd-Frank Act.\3\ Specifically, the Commission 

addressed two regulations in the Proposing Release: (1) Regulation 

1.49, which places qualifications on the types of depositories where 

FCMs and DCOs might place customer funds; and (2) Regulation 4.24, 

wherein credit ratings are used to help disclose the characteristics of 

an investment.\4\

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    \3\ 75 FR 67254, Nov. 2, 2010.

    \4\ Separately, the Commission issued Notices of Proposed 

Rulemaking that addressed references to credit ratings in Commission 

Regulations 1.25 and 30.7, and in Appendix A to Part 40. See 

``Investment of Customer Funds and Funds Held in an Account for 

Foreign Futures and Foreign Options Transactions,'' 75 FR 67642, 

Nov. 3, 2010 (proposing amendments to Regulations 1.25 and 30.7); 

``Provisions Common to Registered Entities,'' 75 FR 67282, Nov. 2, 

2010 (proposing to delete the current Appendix A of Part 40). The 

amendments proposed in those Notices are not addressed herein and 

may be subject to future Commission rulemaking.

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    Regulation 1.49, which mirrors Regulation 30.7,\5\ requires that an 

acceptable foreign depository must either: (1) Have in excess of $1 

billion of regulatory capital; or (2) issue commercial paper or a long-

term debt instrument that is rated in one of the two highest rating 

categories by at least one nationally recognized statistical rating 

organization (``NRSRO''). In the Proposing Release, the Commission 

proposed to remove all ratings requirements from Regulation 1.49. The 

Commission based its proposal on its views regarding the uncertain 

reliability of ratings as currently administered, particularly in light 

of the significant weaknesses of the ratings industry that were 

revealed in recent years. The Commission noted the poor past 

performance of credit ratings in gauging the safety of certain types of 

investments, and its view that credit ratings are not necessary to 

gauge the future ability of certain types of investments to preserve 

customer funds. The proposal was intended to align Regulation 1.49 with 

proposed Regulations 1.25 and 30.7, and to greater simplify the 

regulatory treatment of the investment of customer funds.

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    \5\ See 68 FR 5545, 5548, Feb. 4, 2003 (noting the Commission's 

view that consistency between Regulations 1.49 and 30.7 on this 

issue is ``appropriate''). In a separate release, the Commission has 

proposed amendments to Regulation 30.7 that are similar to the 

amendments to Regulation 1.49 addressed herein. See supra note 4.

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    With respect to the proposed amendment of Regulation 1.49, the 

Commission requested comment on: (1) Whether relying on a minimum 

capital requirement of $1 billion dollars in regulatory capital is an 

adequate alternative standard to the current Regulation 1.49; and (2) 

whether another standard or measure of solvency and credit-worthiness 

should be used as an appropriate, additional test of a bank's safety, 

such as a leverage ratio or a capital adequacy ratio requirement 

consistent with or similar to those in the Basel III accords. The 

Commission also stated that it would welcome any other comments on the 

proposal.

[[Page 44263]]

    In addition to the proposed amendment to Regulation 1.49, the 

Proposing Release also proposed to amend Regulation 4.24. Regulation 

4.24 requires CPOs to disclose the characteristics of the commodity and 

other interests that the pool will trade, including, if applicable, 

their investment rating. In order to comply fully with the spirit and 

letter of the Dodd-Frank Act, the Commission proposed removing the 

references to ratings in Regulation 4.24 and replacing that reference 

with the phrase ``credit-worthiness.'' In the Proposing Release, the 

Commission expressly noted that CPOs may still choose to reference an 

investment rating to describe the credit-worthiness of an investment in 

its disclosures. However, the Commission noted that the CPO as 

appropriate should make an independent assessment of the credit-

worthiness of those investments.

    The Commission requested comment on its proposed amendment of 

Regulation 4.24, particularly with respect to what effect the removal 

of the credit ratings reference in Regulation 4.24 might have on the 

ability of investors and others to understand the disclosures of CPOs 

regarding the characteristics of a commodity pool. The Commission also 

requested comment on the ability of CPOs to make independent 

assessments of the credit-worthiness of their pool's investments.

II. Comments on the Proposing Release

    In response to the Proposing Release, the Commission received three 

comments, two of which were not responsive to the issues presented in 

the Notice. The other commenter forwarded a letter originally submitted 

in response to an advance notice of proposed rulemaking issued by the 

Federal banking agencies.\6\ The commenter discussed issues and options 

surrounding the implementation of section 939A of the Dodd-Frank Act, 

and offered analytical services to refine alternatives to credit 

ratings. However, the commenter did not raise any factual or policy 

concern relating to the rule amendments proposed by the Commission in 

the Proposing Release.

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    \6\ See ``Advance Notice of Proposed Rulemaking Regarding 

Alternatives to the Use of Credit Ratings in the Risk-Based Capital 

Guidelines of the Federal Banking Agencies,'' 75 FR 52283, Aug. 25, 

2010.

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    After considering the comments received in response to the 

Proposing Release, the Commission has determined to amend Regulations 

1.49 and 4.24 as proposed. Section 939A of the Dodd-Frank Act directs 

each Federal agency, including the Commission, ``to remove any 

reference to or requirement of reliance on credit ratings and to 

substitute in such regulations such standard of credit-worthiness as 

each respective agency shall determine as appropriate for such 

regulations.'' As acknowledged in the Proposing Release, the Commission 

proposed the amendments to Regulations 1.49 and 4.24, in part, to 

facilitate ``its efforts to fully comply with both the spirit and 

letter of the Dodd-Frank Act.'' The amendments set forth herein are 

narrowly tailored to accomplish that task, while maintaining the 

commitment to the protection of customer funds that the Commission 

continually has promoted over the years.

III. Consideration of Costs and Benefits Under Section 15(A) of the 

Commodity Exchange Act (``CEA'')

    Section 15(a) of the CEA requires the Commission to consider the 

costs and benefits of its actions before issuing a rulemaking under the 

Act. Section 15(a) further specifies that the costs and benefits shall 

be evaluated in light of the five broad areas of market and public 

concern: (1) Protection of market participants and the public; (2) 

efficiency, competitiveness and financial integrity of futures markets; 

(3) price discovery; (4) sound risk management practices; and (5) other 

public interest considerations.\7\ The Commission may in its discretion 

give greater weight to any one of the five enumerated areas and could 

in its discretion determine that, notwithstanding its costs, a 

particular rule is necessary or appropriate to protect the public 

interest or to effectuate any of the provisions or accomplish any of 

the purposes of the Act.

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    \7\ The rule amends the qualifications required of non-U.S. 

depositories in which customer funds may be held and alters the 

disclosures that CPOs must provide to their customers. Given the 

characteristics of the rule and its anticipated effect, the 

Commission does not believe that the rule will impact the efficiency 

or competitiveness of futures markets, or have any effect on price 

discovery.

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    Although the Commission specifically requested public comment on 

appropriate alternatives to the rule language contained in the 

Proposing Release,\8\ the Commission received no such comments, nor did 

the Commission receive any substantive comments on the costs and 

benefits related to the rule. Section 939A instructs the Commission to 

implement the removal of any references to or reliance on credit 

ratings in its rules and regulations.

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    \8\ See 75 FR 67254, 67256, Nov. 2, 2010.

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    Because of the statutory requirement to remove the reference to 

credit ratings from Regulation 1.49, investments in foreign 

depositories that have less than $1 billion in regulatory capital, but 

that previously were eligible depositories in reliance upon their 

credit ratings, may no longer be eligible depositories for customer 

funds. The consequences of this regulatory action may impose 

transaction costs associated with transferring customer funds, if 

necessary, to another depositor if a foreign depository is no longer 

eligible. Costs also may be borne by foreign banks or trusts that will 

no longer be eligible to receive deposits of customer funds under 

Regulation 1.49, given the resultant loss of business.

    However, the amendments to Regulation 1.49 reflect the statutory 

mandate set forth under section 939A of the Dodd-Frank Act. The 

Commission acknowledged in the Proposing Release the uncertain 

reliability of ratings as currently administered, the poor past 

performance of credit ratings in gauging the safety of certain types of 

investments, and the Commission's view that credit ratings are not 

necessary to gauge the future ability of certain types of investments 

to preserve customer funds. Although the Commission specifically 

``request[ed] comment on whether there is another standard or measure 

of solvency and creditworthiness that might be used as an appropriate, 

additional test of a bank's safety,'' \9\ the Commission received no 

comments offering an appropriate alternative to the amendments to 

Regulation 1.49 that were contained in the Proposing Release. In light 

of the uncertain reliability of ratings and their poor past 

performance, the Commission believes that the elimination of references 

to credit ratings in Regulation 1.49 will enhance the protection of 

market participants and the public, as well as enhance sound risk 

management practices, by requiring that if customer funds are held in a 

non-U.S. bank or trust company, the non-U.S. bank or trust company have 

more than $1 billion of regulatory capital. The capital standard will 

afford greater protection of customer funds. Such protections will, in 

turn, promote the financial integrity of futures markets by reducing 

the likelihood of loss, relative to the status quo.

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    \9\ Id.

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    Similarly, the statutory requirement to modify Regulation 4.24 has 

the potential benefit of reducing risk in the financial system by 

placing more responsibility on CPOs to fully understand the credit-

[[Page 44264]]

worthiness of investments. CPOs will be required to make an independent 

assessment, as appropriate, of the credit-worthiness of investments in 

their portfolio rather than relying solely on credit ratings, though 

CPOs will not be prohibited from relying on credit ratings, as 

appropriate. Customers of CPOs may benefit from improved disclosure of 

the credit-worthiness of the investments in which funds are placed. In 

light of the specific issues identified by the Commission concerning 

the reliance of credit ratings, as discussed in greater detail supra, 

the Commission believes that the rule will enhance the protection of 

market participants and the public, promote the financial integrity of 

futures markets, and enhance sound risk management practices. Costs may 

be imposed on CPOs in improving their ability to make independent 

assessments of credit-worthiness. Although CPOs will not be prohibited 

from relying on credit ratings under Regulation 4.24, circumstances may 

require a CPO to engage in further assessments of the credit-worthiness 

of the investments in which funds are placed, as appropriate, beyond 

merely citing the ratings of those investments by a NRSRO. However, 

notwithstanding its costs, this rule is necessary and appropriate to 

protect the public interest, and effectuates the mandate prescribed in 

section 939A of the Dodd-Frank Act.

IV. Related Matters

A. Regulatory Flexibility Act

    The Regulatory Flexibility Act (``RFA'') requires Federal agencies, 

in promulgating rules, to consider the impact of those rules on small 

businesses, and whether the rules will have a significant economic 

impact on a substantial number of small entities.\10\ The rule 

amendments proposed herein will affect FCMs, DCOs, and CPOs. The 

Commission previously has established certain definitions of ``small 

entities'' to be used by the Commission in evaluating the impact of its 

regulations on small entities in accordance with the RFA, and has 

determined that registered FCMs,\11\ DCOs,\12\ and CPOs \13\ are not 

small entities for the purpose of the RFA. Accordingly, as set forth in 

the Proposing Release,\14\ the Chairman, on behalf of the Commission 

and pursuant to 5 U.S.C. 605(b), certifies that the proposed rules will 

not have a significant economic impact on a substantial number of small 

entities.

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    \10\ 5 U.S.C. 601 et seq.

    \11\ 47 FR 18618, 18619, Apr. 30, 1982.

    \12\ 66 FR 45604, 45609, Aug. 29, 2001.

    \13\ 47 FR at 18619-20.

    \14\ See 75 FR 67254, 67256, Nov. 2, 2010.

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B. Paperwork Reduction Act

    The Paperwork Reduction Act (``PRA'') \15\ imposes certain 

requirements on Federal agencies (including the Commission) in 

connection with their conducting or sponsoring any collection of 

information as defined by the PRA. These rule amendments do not require 

a new collection of information on the part of any entities subject to 

the rule amendments. Accordingly, for purposes of the PRA, the 

Commission certifies that these rule amendments will not impose any new 

reporting or recordkeeping requirements.

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    \15\ 44 U.S.C. 3501 et seq.

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List of Subjects

17 CFR Part 1

    Brokers, Commodity futures, Consumer protection.

17 CFR Part 4

    Advertising, Commodity futures, Commodity pool operators, Commodity 

trading advisors, Consumer protection, Disclosure, Principals, 

Reporting and recordkeeping requirements.

    For the reasons stated in this release, the Commission hereby 

amends 17 CFR parts 1 and 4 as follows:

PART 1--GENERAL REGULATIONS UNDER THE COMMODITY EXCHANGE ACT

0

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

    Authority: 7 U.S.C. 1a, 2, 5, 6, 6a, 6b, 6c, 6d, 6e, 6f, 6g, 6h, 

6i, 6k, 6m, 6n, 6o, 6p, 7, 7a, 7b, 8, 9, 12, 12a, 12c, 13a, 13a-1, 

16, 16a, 19, 21, 23, and 24, as amended by the Dodd-Frank Wall 

Street Reform and Consumer Protection Act, Pub. L. 111-203, 124 

Stat. 1376 (2010), and the Commodity Futures Modernization Act of 

2000, Appendix E of Pub. L. 106-554, 114 Stat. 2763 (2000).

0

2. Section 1.49 is amended by revising paragraph (d)(3) to read as 

follows:

Sec.  1.49  Denomination of customer funds and location of 

depositories.

* * * * *

    (d) * * *

    (3) A depository, if located outside the United States, must be:

    (i) A bank or trust company that has in excess of $1 billion of 

regulatory capital;

    (ii) A futures commission merchant that is registered as such with 

the Commission; or

    (iii) A derivatives clearing organization.

* * * * *

PART 4--COMMODITY POOL OPERATORS AND COMMODITY TRADING ADVISORS

0

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

    Authority: 7 U.S.C. 1a, 2, 4, 6(c), 6b, 6c, 6l, 6m, 6n, 6o, 12a 

and 23, as amended by the Dodd-Frank Wall Street Reform and Consumer 

Protection Act, Pub. L. 111-203, 124 Stat. 1376 (2010).

0

4. Section 4.24 is amended by revising paragraph (h)(1)(i) to read as 

follows:

Sec.  4.24  General disclosures required.

* * * * *

    (h) * * *

    (1) * * *

    (i) The approximate percentage of the pool's assets that will be 

used to trade commodity interests, securities and other types of 

interests, categorized by type of commodity or market sector, type of 

security (debt, equity, preferred equity), whether traded or listed on 

a regulated exchange market, maturity ranges and credit-worthiness, as 

applicable;

* * * * *

    By the Commodity Futures Trading Commission.

    Dated: July 20, 2011.

David A. Stawick,

Secretary.

Appendices to Removing Any Reference to or Reliance on Credit Ratings 

in Commission Regulations; Proposing Alternatives to the Use of Credit 

Ratings--Commission Voting Summary and Statements of Commissioners

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

Federal Regulations.

Appendix 1--Commission Voting Summary

    On this matter, Chairman Gensler and Commissioners Dunn, 

Sommers, Chilton and O'Malia voted in the affirmative; no 

Commissioner voted in the negative.

Appendix 2--Statement of Chairman Gary Gensler

    I support the final rulemaking to remove references to credit 

ratings within the CFTC's regulations. Under Title IX of the Dodd-

Frank Wall Street Reform and Consumer Protection Act, Congress 

required the Commission to review credit rating references in our 

existing regulations and remove reliance upon them. The rule removes 

them from Regulation 1.49, which limits the types of non-U.S. banks 

in which futures commission merchants and derivatives clearing 

organizations may place customer funds. The rule also removes them 

from Regulation 4.24, which requires commodity pool operators to 

disclose to their customers where they are putting customer

[[Page 44265]]

money. Other references included in Regulations 1.25 and 30.7 will 

be taken up when the Commission considers the proposed rulemaking 

related to investment of customer funds.

[FR Doc. 2011-18777 Filed 7-22-11; 8:45 am]

BILLING CODE 6351-01-P
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