78020 Federal Register / Vol. 65, No. 240 / Wednesday, December 13, 2000 / Rules and Regulations

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 exchange, 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

exchange, 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 exchange, or derivatives

transaction facility does not have

jurisdiction. Other counterclaims arising

out of a transaction subject to the Act

and rules promulgated thereunder for

which the customer utilizes the services

of the registrant may be permissible

where the customer and the registrant

have agreed in advance to require that

all such submissions be included in the

proceeding, and if the aggregate

monetary value of the counterclaim is

capable of calculation.

(g) Institutional customers. (1) A

person who is an ‘‘institutional

customer’’ as defined in § 1.3(g) of this

chapter may negotiate any term of an

agreement or understanding with a

Commission registrant in which the

institutional customer agrees, prior to

the time a claim or grievance arises, to

submit such claim or grievance to any

settlement procedure, except that

signing the agreement must not be made

a condition for the institutional

customer to use the services offered by

the registrant.

(2) If the agreement is contained as a

clause or clauses of a broader

agreement, the institutional customer

must separately endorse the clause or

clauses containing the agreement;

Provided, however, a futures

commission merchant or introducing

broker may obtain such endorsement as

provided in § 1.55(d) of this chapter.

Issued in Washington, D.C. on November

21, 2000 by the Commission.

Jean A. Webb,

Secretary of the Commission.

[FR Doc. 00–30268 Filed 12–12–00; 8:45 am]

BILLING CODE 6351–01–P

COMMODITY FUTURES TRADING

COMMISSION

17 CFR Part 39

RIN 3038–AB57

A New Regulatory Framework for

Clearing Organizations

AGENCY: Commodity Futures Trading

Commission.

ACTION: Final rulemaking.

SUMMARY: The Commodity Futures

Trading Commission (Commission or

CFTC) is promulgating a new regulatory

framework to apply to clearing

organizations. These regulations for

clearing organizations are part of an

initiative that would also establish a

new regulatory framework for

multilateral transaction execution

facilities (MTEF) and market

intermediaries. The final new

framework in its entirety is

simultaneously announced today in

companion releases. The new

framework, including these regulations

are centered on broad, flexible, core

principles and are designed to ‘‘promote

innovation, maintain U.S.

competitiveness, and at the same time

reduce systemic risk and protect

customers.’’ The Commission has

fashioned these regulations so that it

can fairly and efficiently carry out the

important duty of overseeing clearing

organizations in a changing, dynamic

industry pursuant to a transparent

codified framework.

EFFECTIVE DATE: February 12, 2001.

FOR FURTHER INFORMATION CONTACT:

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 PArchitzel@cftc.gov,

ASeifert@cftc.gov, or LGregory@cftc.gov.

SUPPLEMENTARY INFORMATION: 

Federal Register / Vol. 65, No. 240 / Wednesday, December 13, 2000 / Rules and Regulations 78021

1See Over-the-Counter Derivatives Markets and

the Commodity Exchange Act, Report of the

President’s Working Group, November 1999.

2 In addition to RCOs, certain other enumerated

entities also are authorized to clear transactions

exempt under Parts 35 and 36. These include a

clearing agency or system regulated by the

Securities and Exchange Commission (SEC), the

Federal Reserve, or the Comptroller of the Currency,

and certain foreign clearing organizations.

3Further, nothing in Part 39 prohibits an entity

that clears only exempt transactions from applying

to the Commission for RCO status. An entity may

want to apply for recognition as an RCO for its own

business purposes.

4 In this and three companion Notices of Final

Rulemaking which are being published in this

edition of the Federal Register, comment letters

(CL) are referenced by file number, letter number

and page. These letters are available through the

Commission’s internet web site. Comments filed in

response to the notice of proposed rulemaking on

clearing organizations are contained in file No. 23.

Comments filed predominantly in response to the

notice of proposed rulemaking on Parts 36–38, but

which also had comments on clearing

organizations, are contained in file No. 21. Those

commenting upon Part 39 include: Board of Trade

Clearing Corporation (BOTCC); California Power

Exchange; Chicago Board of Trade; Chicago

Mercantile Exchange (CME); Federal Reserve Bank

of Chicago (FRB of Chicago); Financial Markets

Lawyers Group; Futures Industry Association (FIA);

Global TeleExchange; Government Securities

Clearing Corporation (GSCC); New York

Independent System Operator; JP Morgan; Kiodex,

Inc.; Mercatus Center at George Mason University;

New York Clearing Corporation (NYCC); New York

Mercantile Exchange; Options Clearing Corporation

(OCC); Oxy Energy Services, Inc.; PetroCosm

Corporation; Securities Industry Association; and

Cleary, Gottlieb, Steen & Hamilton, on behalf of a

coalition of investment banks consisting of Chase

Manhattan Bank, Citigroup Inc., Credit Suisse First

Boston Inc., Goldman Sachs & Co., Merrill Lynch

& Co. Inc., and Morgan Stanley Dean Witter & Co.

(Coalition).

I. Background

On June 22, 2000, the Commission

published for comment proposed new

Part 39, a regulatory framework for the

oversight of clearing organizations. 65

FR 39027. Part 39 is part of an initiative

that would also establish a new

regulatory framework for MTEFs and

market intermediaries. The final new

framework in its entirety is

simultaneously announced today in

companion releases. The new

framework, including Part 39, is

centered on broad, flexible, core

principles and is designed to ‘‘promote

innovation, maintain U.S.

competitiveness, and at the same time

reduce systemic risk and protect

customers.’’ 65 FR 38986.

The futures and option markets are

undergoing changes in market structure

and technology. Clearing organizations

for these markets perform valuable

functions by mitigating counterparty

risk, facilitating the netting and

offsetting of contractual obligations, and

decreasing systemic risk. Clearing

organizations should be subject to

continuing regulatory oversight to

ensure that they have sufficient

financial resources and that they

establish and implement prudential risk

management programs designed to

control concentration risks associated

with centralized clearing.1 The

Commission has fashioned new Part 39

so that it can fairly and efficiently carry

out the important duty of overseeing

clearing organizations in a changing,

dynamic industry pursuant to a

transparent codified framework.

Part 39 requires that transactions

effected on recognized futures

exchanges (RFEs) under Part 38 and

derivatives transaction facilities (DTFs)

under Part 37 be cleared only by

clearing organizations that have been

recognized by the Commission under

Part 39—recognized clearing

organizations (RCOs). RCOs are also

permitted to clear transactions that are

exempt under Part 35—Exemption of

Bilateral Agreements and Part 36—

Exemption of Transactions on

Multilateral Transaction Execution

Facilities.2 In addition, nothing in Part

39 prohibits an RCO from clearing any

other type of instrument such as cash or

forward delivery contracts.3

Current futures clearing organizations

may self-certify and automatically

qualify as RCOs under Part 39. New

entities could apply for RCO status by

demonstrating that their rules,

procedures, and operations would be

consistent with the 13 broad and

flexible core principles set forth in Part

39. Appendix A to Part 39 would

provide guidance to applicant RCOs as

to how to make such a demonstration.

Certain provisions of Part 39 and

Appendix A have been modified from

their proposed versions in light of

comments received from participants in

the industry. These modifications, as

discussed herein, provide additional

clarity and are consistent with the new

regulatory framework’s goal of

promoting innovation and maintaining

U.S. competitiveness, while also

reducing systemic risk and protecting

customers.

II. Overview

The Commission received comment

letters on Part 39 from a number of

SROs and other interested entities.4

Commenters overwhelmingly supported

the Part 39 requirement that all

transactions executed on a designated

contract market, an RFE, or a DTF, if

cleared, be cleared by an RCO.

Commenters also supported the

proposition that nothing in Part 39

prohibits RCOs from clearing

transactions other than those effected

pursuant to Parts 35–38. Other

comments concerned the definition of

clearing organization, the jurisdiction of

the Commission, the applicable

provisions of the Commodity Exchange

Act (Act) and regulations, and the

guidance in Appendix A to Part 39. In

response to the comments, the

Commission has made changes to the

definition of clearing organization and

changes that clarify the jurisdiction of

the Commission under Part 39. Other

changes to Part 39 limit the applicability

of sections of the Act and the

regulations, and address the illustrative

purpose of the guidance in Appendix A.

III. Discussion

A. Purpose

The Part 39 core principles reflect

standards that the Commission takes

into account in overseeing the clearing

of futures and option contracts without

imposing new regulatory requirements.

Certain commenters contended that Part

39 as proposed would impose a new

regulatory framework on entities already

successfully regulated, and that the

Commission had not fully articulated

why Part 39 was being imposed at this

time. See, e.g., CL 21–51 at 11 and CL

23–40 at 2.

The Commission currently oversees

the clearing organizations that are

associated or affiliated with U.S. futures

and option exchanges. As a practical

matter, the Commission generally has

regulated clearing organizations in

connection with its oversight of contract

markets which heretofore have had

close affiliations with their clearing

organizations. Among other things, the

Commission has reviewed clearing

organization rules, audited clearing

organizations for compliance with the

Commission’s segregation,

recordkeeping, and customer funds

investment rules, monitored the clearing

process in times of major market moves

to identify potential systemic risks, and

conducted oversight of the liquidation

of positions and transfer of customer

accounts in cases where clearing

members encounter financial difficulty.

The Commission’s oversight of

clearing organizations also has been

guided by standards not expressly set

forth in the Act or the Commission’s

regulations for contract markets. For

example, the Commission has taken into

account, among other standards and

procedures, the standards set forth in

the Bank for International Settlements’

(BIS) 1993 Lamfalussy Report on

multilateral netting systems and other

BIS reports, the recommendations with

respect to clearing and settlement of

78022 Federal Register / Vol. 65, No. 240 / Wednesday, December 13, 2000 / Rules and Regulations

5The definition continues to exclude those

netting arrangements specified in § 35.2 (d)(1) and

(d)(2) and an entity that is a single counterparty

offering to enter into, or entering into, bilateral

transactions with multiple counterparties.

6 It also includes, where applicable, the

scheduling or netting of physical delivery

obligations and related bookkeeping functions such

as those performed by operators of physical

delivery points for certain energy-related products.

See CL 21–56 at 2.

7Transactions pursuant to Part 34 are not

included in 39.2 or otherwise referred to in Part 39

as these instruments have consistently been subject

to other regulatory schemes, whether under the

jurisdiction of the SEC as securities, or regulated

pursuant to federal banking laws as depository

instruments.

8An analogy can be drawn to the interest the

Commission has in assessing risk presented to

futures commission merchants (FCMs) by their nonfutures activities. Thus, for example, the

Commission’s net capital rule has provisions

relating to the capital treatment of securities and

securities transactions of the Group of

Thirty, and the recommendations of the

President’s Working Group in response

to the market break of October 1987.

Part 39’s core principles reflect these

various standards and existing futures

clearing organizations currently meet

these standards. Thus, Part 39

represents the Commission’s intention

to put into a logical and coherent

regulatory form the same principles that

the Commission now applies to clearing

organizations. This approach is a

natural accompaniment to the new

regulatory framework.

Recently, there has been an increase

in the number of new electronic markets

that do not have their own clearing

capacity. This trend has resulted in an

increase in the opportunity for clearing

organizations independent of

transaction facilities to clear for

multiple markets, which in turn

magnifies the importance of clearing in

the management of systemic risk.

Clearing organizations unaffiliated with

the transaction facilities for which they

clear necessarily will have rules,

procedures, and practices separate and

independent from the transaction

facilities. Thus, the Commission will

oversee the clearing function pursuant

to a framework separate from, but

related to, the framework for the

oversight of the transaction facilities.

B. Definition of Clearing Organization

In its final Part 39 rules, the

Commission has clarified the definition

of ‘‘clearing organization’’ to mean, with

respect to transactions executed on a

designated contract market or pursuant

to Parts 35–38, a person that provides

credit enhancement to its members or

participants in connection with netting

and/or settling the payments and

payment obligations of such members or

participants, by becoming a universal

counterparty to such members or

participants, or otherwise.5 Providing

credit enhancement in connection with,

or as a byproduct of, providing

settlement services is the critical

attribute of a clearing organization.

Some of the comments raised

concerns about the proposed definition

in that they stated certain activities

should not constitute the activity of

clearing. See, e.g., BOTCC CL 21–20 at

10. These activities include the netting

of payment obligations and entitlements

and the performance of trade processing

services such as trade comparison,

margin calculation, and reporting

services.6 In response to these

comments, the revised definition

captures only organizations whose

services enhance the credit of the

members or participants that are parties

to the contracts cleared by the

organization.

One method of credit enhancement is

to be the counterparty to every cleared

transaction. The clearing organization

substitutes itself for each original

counterparty and becomes legally bound

to every party to a transaction. This is

known as legal novation. However, a

clearing organization can provide credit

enhancement in ways other than strict

legal novation. It can agree with its

members and participants that it will be

legally bound to guarantee payment

flows associated with transactions in

connection with or as a byproduct of the

provision of netting services, that is, the

netting of all payment obligations and

entitlements. A clearing organization

also could provide credit enhancement

in any legal agreement to guarantee

payment flows in connection with other

settlement services.

The provision of one or more clearing

services absent credit enhancement,

however, will not, as a general matter,

constitute the activity of clearing for

purposes of Part 39. Therefore, for

purposes of Part 39, the term ‘‘clearing

organization’’ does not encompass the

sole provision of netting services in the

absence of any type of credit

enhancement.

C. Scope of Part 39

The language of the scope provision,

§ 39.1, the enforceability provision,

§ 39.5, and the antifraud provision,

§ 39.6, in their final form, all apply to

an RCO’s clearing of transactions

effected pursuant to the enumerated

parts. The final language of § 39.2

clarifies:

(1) what must be cleared by an RCO

(any transaction effected on a contract

market or pursuant to Parts 37 and 38

that is cleared);

(2) that the clearing of transactions by

an RCO is regulated under Part 39;

(3) that transactions effected pursuant

to Parts 35 or 36 may be cleared by an

RCO or by other authorized clearing

organizations;7

(4) that the clearing of transactions

effected pursuant to Parts 35 or 36 by an

RCO is regulated under Part 39;

(5) that the clearing of transactions

effected pursuant to Parts 35 or 36 by

authorized clearing organizations other

than an RCO is not regulated under Part

39; and

(6) that transactions not specified in

39.1(a) may also be cleared by an RCO.

The changes to the scope,

enforceability and antifraud provisions

address commenters’ concerns that: (1)

proposed Part 39 could be interpreted to

apply the Act and the Commission’s

regulations to transactions outside the

appropriate scope of Part 39, such as

cash products or other products beyond

the authority of the Act, see, e.g., CME

CL 21–51 at 9–10; (2) it may appear as

if the Commission is attempting to

expand its jurisdiction to include any

over-the-counter transaction that is

submitted to an RCO for clearing, id.; (3)

the new part should clarify that

transactions effected pursuant to Parts

35 or 36 do not become subject to the

jurisdiction of the Commission simply

because they are submitted to a Part 39

clearing organization and that clearing

does not, by itself, make an exempt

transaction subject to the Act, see

BOTCC CLs 21–6 at 4 and 21–20 at 8;

and (4) the effect of § 39.6 would not be

the assertion of the Commission’s

enforcement authority over otherwiseexempt transactions simply because

those transactions are submitted to

clearing. As proposed, § 39.6 prohibited

fraud in connection with any

transaction cleared by an RCO. The final

section prohibits fraud in connection

with the activity of clearing. See BOTCC

CL 21–6 at 4, FRB of Chicago CL 23–25

at 7 and GSCC CL 23–19 at 4.

As discussed, the final Part 39 rules

address these comments. The

Commission is not hereby asserting

jurisdiction over transactions in cash

and other products not subject to the

Act. Commission oversight of an RCO

under Part 39 addresses the clearing

process only and does not include

regulation or oversight of the

transactions or the traders. The

Commission, however, notes that it

must monitor for the potential that

clearing of cash and other products not

subject to the Act could adversely affect

the viability, risk exposure, and

management of the entity as an RCO.8

Federal Register / Vol. 65, No. 240 / Wednesday, December 13, 2000 / Rules and Regulations 78023

other non-futures inventory held by an FCM in the

normal course of its business. See Commission

Regulation 1.17. See also Commission Regulations

1.14 and 1.15 that assess risk to a registered FCM

from affiliates in its holding company system.

9Over-the-Counter Derivatives Markets and the

Commodity Exchange Act, Report of the President’s

Working Group, November 1999. The group, whose

members were signatories to the report, includes

the Secretary of the Treasury, the Chairman of the

Board of Governors of the Federal Reserve System,

the Chairman of the Securities and Exchange

Commission, and the Chairman of the Commodity

Futures Trading Commission.

10Specifically, the Commission has removed the

reference to exempt securities and indexes thereof

previously included in proposed Rule 36.2(b)(4)

and has amended final Rule 36.2(b)(1) to make clear

that eligible debt instruments do not include such

exempt securities.

11Although § 39.4(a) allows only nondormant

entities, as defined, to self-certify, the Commission

is prepared to accept the certification of the

Intermarket Clearing Corporation (ICC) under this

provision. ICC is a wholly-owned subsidiary of the

Options Clearing Corporation. Commission staff is

familiar with ICC’s rules and operations. ICC has

maintained its clearing systems, rules, and banking

and other arrangements in place and remains fully

prepared operationally to clear transactions in

futures contracts in accordance with its rules.

D. Treatment as Contract Market

As proposed, § 39.1(b)(2) provided

that an RCO would be deemed to be a

contract market for purposes of the Act

and the regulations, but would be

exempt from all such provisions except

as reserved in § 39.5. In its final rules,

the Commission has combined the

language of proposed § 39.1(b)(2) with

proposed § 39.5. Section 39.5 now

provides that an RCO is deemed to be

a contract market to the extent it clears

transactions specified in § 39.1(a) (the

scope provision), but is exempt from all

provisions of the Act and regulations

except, as applicable, certain

enumerated sections of the Act and the

Commission’s regulations which would

continue to apply.

Combining the separate provisions

and amending the resulting § 39.5 as

indicated, limits the purpose for which

RCOs are deemed to be contract markets

and addresses commenters’ concern that

the provision would subject clearing

organizations to provisions of the Act

and the Commission’s regulations that

do not now apply. See, e.g., BOTCC CL

21–6 at 4. Pursuant to the final rule, an

RCO is deemed to be a contract market

only to the extent it clears those

transactions specified in § 39.1(a).

Further, even though an RCO is deemed

to be a contract market to this limited

extent, § 39.5 exempts it from all

provisions of the Act and regulations,

except the sections enumerated, and

only to the extent those enumerated

sections are applicable to the activity of

clearing § 39.1(a) transactions.

In reserving the sections of the Act

and the regulations enumerated in

§ 39.5, the Commission is not asserting

that any of those sections or regulations

would be applicable to an RCO under

any particular circumstances. The

Commission only seeks, conservatively,

to reserve those sections of the Act and

regulations that may need to be applied

to an RCO in order to achieve

compliance with the core principles set

forth in Part 39. The reservations in

§ 39.5 of Sections 4b and 4o of the Act

and Rule 33.10 will subject RCOs to the

same standard with respect to fraud and

manipulation in connection with the

clearing of transactions to which

clearing organizations are currently

subject. See FIA CL 23–26 at 5.

Reservation of the enumerated sections

of the Act or regulations, including

specifically Section 4i of the Act and

Rule 1.38(a), will not render RCOs

responsible for the enforcement of any

new or additional regulatory

requirements, nor increase the liability

of clearing organizations under Section

22 of the Act. See BOTCC CLs 21–20 at

7 and 21–6 at 4.

E. Competitive Issues

Commenters strongly agreed with the

requirement in § 39.2 that all

transactions effected on a contract

market, RFE, or DTF, if cleared, must be

cleared by an RCO. For example, the

CME expressed its agreement with the

result that a clearing organization that

either is governed by another regulator,

or has no regulator, is prohibited from

clearing such products. CL 21–51 at 10.

However, many commenters raised

concerns regarding the effect of Part 39

on the ability of RCOs to compete with

other types of clearing organizations.

The commenters stated that allowing

clearing organizations other than RCOs,

including clearing organizations

regulated by the SEC, to clear

transactions effected pursuant to Parts

35 or 36, will give clearing organizations

other than RCOs the ability to clear the

full spectrum of financial transactions—

cash, securities, options, futures (if

traded on an exempt MTEF) and other

derivatives. They further stated that the

SEC, however, will not allow an RCO

that is not also registered as a clearing

agency with the SEC to clear

transactions in securities. Id.

Commenters thought the proposal grants

an unfair exemption to securities

clearinghouses, banks, bank affiliates,

and foreign clearinghouses from the

substantive requirements that otherwise

would apply to RCOs. CLs 21–6 at 5,

21–20 at 5, 23–26 at 7, and 21–36 at 6.

In authorizing particular clearing

organizations in addition to RCOs to

clear transactions pursuant to Parts 35

and 36, the Commission is adopting the

unanimous recommendations made in

the report of the President’s Working

Group.9 The Commission notes that it

has made revisions elsewhere in its new

regulatory framework (i.e., the final

rules under Parts 35–38) that lessen the

impact of these concerns in some

instances. Under final rules adopted by

the Commission in response to

comments made by the U.S. Department

of the Treasury, transactions based on

U.S. government securities are not

eligible for trading on exempt MTEFs.10

Under part 39, only RCOs can clear

transactions effected on DTFs or RFEs.

F. Application of Core Principles and

Appendix A

1. General

RCO applicants must demonstrate

compliance with each of the core

principles of Part 39 as a condition of

recognition. These principles will not

subject RCOs to any regulatory

requirement not now applicable to

futures clearing organizations under the

Commission’s current oversight. Each of

the core principles must be addressed,

but the guidance in Appendix A to Part

39 is intended only to be illustrative of

the types of matters an applicant may

address in order to satisfactorily

demonstrate that it meets the core

principles.

The final appendix clarifies the

purpose of the guidance in response to

commenters’ concerns regarding the

level of specificity in Appendix A.

Commenters were concerned that the

guidance would take on the force of law,

applicants would have to affirmatively

demonstrate compliance with each

provision, and clearing organizations

would be subject to far greater

regulatory compliance burdens than

before. See, e.g., FIA CL 23–26 at 4 and

BOTCC CL 21–20 at 10. Appendix A

expressly makes clear that it is neither

a checklist of issues that an applicant is

required to address nor an exclusive list

of matters from which an applicant can

choose applicable components to

address. Rather, the appendix provides

detailed non-binding guidance that

applicants can use as a tool in

demonstrating satisfaction of the core

principles.

In order to become recognized under

Part 39, current futures clearing

organizations need only submit a

certification that their rules, procedures

and operations fulfill the conditions for

recognition under Part 39.11 All of the

current futures clearing organizations

could become recognized in this

78024 Federal Register / Vol. 65, No. 240 / Wednesday, December 13, 2000 / Rules and Regulations

manner. They are not required to

address affirmatively any of the separate

core principles (and none of the

suggested guidance in Appendix A).

2. The Core Principles

The final rules contain changes that

address commenters’ views concerning

the wording and applicability of

particular core principles. Commenters

requested that Core Principle 2, which

deals with participant and product

eligibility, be revised to eliminate

product eligibility criteria for

instruments that an RCO will accept for

clearing. Commenters contended that

this requirement was impractical, would

require an extraordinary degree of

prognostication and would best be dealt

with on a case-by-case basis by an RCO,

considering all relevant circumstances.

BOTCC CL 21–20 at 13. The

Commission has revised the final core

principle and the accompanying

appendix guidance accordingly.

Several commenters thought that Core

Principle 7 on enforcement

inappropriately required arrangements

and resources for resolution of disputes

and encouraged the Commission to

eliminate it from the principle. See, e.g.,

NYCC CL 23–40 at 4 and GSCC 23–19

at 4. The Commission has considered

the commenters’ concerns that this

requirement would impose a new and

inappropriate burden on RCOs, but has

determined to retain it in the core

principle with the added qualification

of ‘‘as applicable.’’ The Commission

does not wish to rule out the possible

appropriateness of some form of dispute

resolution at RCOs as the industry

continues to evolve. By qualifying the

item with its applicability, RCO

applicants can choose to address

whether and why they do or do not have

a dispute resolution program in

demonstrating that they will be able to

effectively enforce their rules.

The final version of the other core

principles contains modifications that

serve to increase their intended breadth

and flexibility. For example, Core

Principle 1, which deals with financial

resources, as proposed, required

adequate capital resources to fulfill its

guarantee function without interruption

in various market conditions. At the

suggestion of one of the commenters,

the final version of Core Principle 1

requires adequate financial resources to

fulfill its guarantee function without

interruption in reasonably foreseeable

market conditions. See Coalition CL 23–

41 at 24. In addition, Core Principle 14

concerning competition has been

revised. The Commission does not want

to inadvertently impose duties on an

applicant that differ in form or degree

from the antitrust statutes and court

decisions construing federal antitrust

laws. See BOTCC CL 21–20 at 13. Thus,

final Core Principle 14 simply requires

RCOs to operate in a manner consistent

with the public interest to be protected

by the antitrust laws. This language

comes directly from Section 15 of the

Act which the Commission has reserved

in § 39.5. The requirements of Section

15 remain the responsibility of the

Commission and the Commission

intends to apply Section 15 to antitrust

issues in the same manner as previously

applied.

Core Principle 12 regarding public

disclosure of certain operating

procedures of an RCO was not revised

in response to concerns regarding

confidentiality. An RCO, however, will

not be required under this core

principle to disclose trade secrets.

3. The Guidance in Appendix A

Commenters also expressed opinions

about the applicability and wording of

particular proposed guidance in

Appendix A. Many of these concerns

are addressed by language in the final

appendix that states the guidance is

only illustrative of the types of matters

an applicant may address in order to

demonstrate that it meets the core

principles and is not intended to be a

mandatory checklist of issues to

address. If particular guidance does not

apply to an RCO applicant, it may either

not address it or explain why it does not

apply. Applicants also are strongly

encouraged to address relevant matters

other than those contained in the

guidance suggested in the appendix if

doing so would assist the applicant in

demonstrating compliance with a

particular core principle.

The Commission has modified certain

of the guidance in response to

commenters’ concerns regarding the

appropriateness or applicability of

particular guidance language. In

response to comments that the

Commission does not have the authority

to review the setting of levels of margin,

the Commission revised guidance

regarding the determination of

appropriate margin levels for a cleared

contract and the clearing member

clearing the contract. See, e.g., FIA CL

23–26 at 4. The final version of this

guidance suggests that an applicant may

describe the process by which it would

determine appropriate margin levels for

an instrument that it clears and its

clearing members. This information is

highly relevant and could be used by an

applicant for RCO status to assist in

demonstrating that it meets the third

core principle concerning the ability to

manage risks associated with carrying

out the guarantee function.

Several comments addressed the

appropriateness of the proposed

guidance under Core Principle 6

concerning default rules and

procedures. The guidance suggested that

applicants describe rules and

procedures regarding priority of

customer accounts over proprietary

accounts and, where applicable, in the

context of other programs such as

specialized margin reduction programs

like cross-margining. Commenters

argued that given the successful

operation of cross-margining programs,

it is inappropriate for the accounts of

cross-margining participants to be

subordinated to the accounts of market

participants not participating in crossmargining programs. OCC CL 23–23 at

2, 3. The Commission has considered

this argument and although it

recognizes that cross-margining

programs have been successful and can

operate to reduce risks, including risk of

participant default, it has determined to

retain this guidance in the final

Appendix A. The guidance is

appropriate in that it only suggests that

an applicant RCO that is proposing or

contemplating being a party to a margin

reduction program such as crossmargining address in its application

whether and why a priority rule would

or would not be present in any

particular margin reduction program. It

does not require such a priority rule.

This information will provide relevant

and useful information to the

Commission in assessing the applicant’s

overall compliance with all aspects of

Core Principle 6.

The Commission modified other

guidance under various core principles

in response to comments received. For

example, the final guidance under Core

Principle 8 dealing with system

safeguards suggests that an applicant

may confirm that system testing and

review has been performed by a

qualified independent professional, and

not specifically by a member of the

Information Systems Audit and Control

Association. A professional that is a

certified member of the Information

Systems Audit and Control Association

experienced in the industry, however, is

referred to as an example of an

acceptable party to carry out such

testing and review. See CL 21–20 at 10.

In addition, the Commission has

modified the guidance for Core

Principle 9 relating to governance to

note that an RCO, consistent with

longstanding Commission policy, may

not limit liability for violation of the Act

or Commission rules, fraud, or wanton

or willful misconduct. This requirement

Federal Register / Vol. 65, No. 240 / Wednesday, December 13, 2000 / Rules and Regulations 78025

currently applies to designated contract

markets.

G. Other Comments

Certain commenters suggested that

the Commission restrict the length of

time that a proposed RCO rule could be

stayed under Commission Regulation

1.41. See e.g., CL 21–20 at 12. The

Commission anticipates that it only will

impose a stay of an RCO rule in limited

and potentially egregious situations. In

fact, the Commission would only be

able to stay a proposed rule incident to

disapproval proceedings and the stay

determination would not be delegable to

Commission staff. Since a rule only

would be stayed incident to a

disapproval proceeding, the length of

any stay would not be indeterminate in

any event.

Certain commenters raised questions

as to whether bankruptcy provisions

that are currently applicable to

transactions conducted on a contract

market could also be applicable to all

transactions cleared by an RCO. See,

e.g., CL 21–65 at 23. Part 39 reserves the

applicability of Part 190 to the activity

of clearing § 39.1(a) transactions, if

applicable. Part 190 in conjunction with

the commodity broker liquidation

provisions of Subchapter IV of Chapter

7, Title 11 of the Federal Bankruptcy

Code, apply to an insolvency when the

insolvent party is a ‘‘commodity broker’’

(typically an FCM or clearing

organization that has any futures

accounts), as defined under Title 11. If

an RCO does not have open futures

accounts it would not be covered by

SubChapter IV.

IV. Section 4(c) Findings

These final rules are being

promulgated under Section 4(c) of the

Act, which grants the Commission

broad exemptive authority. Section 4(c)

of the Act provides that, in order to

promote responsible economic or

financial innovation and fair

competition, the Commission may by

rule, regulation or order, exempt any

class of agreements, contracts or

transactions, including any person or

class of persons offering, entering into,

rendering advice or rendering other

services with respect to, the agreement,

contract, or transaction, from the

contract market designation requirement

of Section 4(a) of the Act, or any other

provision of the Act other than Section

2(a)(1)(B), if the Commission determines

that the exemption would be consistent

with the public interest. Furthermore,

Section 4(c)(2) of the Act provides that

the Commission may not grant an

exemption from the contract market

designation requirement of Section 4(a)

of the Act unless the Commission also

finds that: (i) the contract market

designation requirement should not be

applied to the agreement, contract, or

transaction for which the exemption is

requested and the exemption would be

consistent with the public interest and

the purposes of the Act; (ii) the

exempted transaction will be entered

into solely between ‘‘appropriate

persons’’; and (iii) the agreement,

contract, or transaction in questions will

not have a material adverse effect on the

ability of the Commission or any

contract market to discharge its

regulatory or self-regulatory duties

under the Act.

As explained above, Part 39 is part of

a new regulatory framework. The new

framework is intended to promote

innovation and competition in the

trading of derivatives and to permit the

markets the flexibility to respond to

technological and structural changes.

Specifically, Part 39 replaces

Commission regulation of clearing

organizations through the current more

formal designation and regulation of

contract markets. It provides for a

streamlined procedure for clearing

organizations to obtain recognition by

meeting broad, non-prescriptive core

principles. It permits recognized

clearing organizations the flexibility to

clear regulated, exempt, and

unregulated transactions. It also

authorizes clearing organizations

regulated by other regulatory bodies to

clear certain transactions. The core

principle approach set forth in Part 39

strikes an appropriate balance between

applying necessary regulatory

protections to the critical market

functions of clearing and facilitating the

development of varied clearing

mechanisms and structures.

Accordingly, the Commission believes

that Part 39 is consistent with the public

interest, is consistent with the purposes

of the Act, will be applicable only to

appropriate persons, and would have no

adverse effect on the regulatory or selfregulatory responsibilities imposed by

the Act.

V. Related Matters

A. Regulatory Flexibility Act

The Regulatory Flexibility Act (RFA),

5 U.S.C. 601 et seq., requires that

agencies, in promulgating rules,

consider the impact of those regulations

on small entities. The rules adopted

herein would affect certain clearing

organizations. The Commission has

stated that it is appropriate to evaluate

within the context of a particular rule

whether some or all of affected entities

should be considered small entities and,

if so, to analyze the economic impact on

them of any rule. In this regard, the

rules being adopted herein would not

require any current futures clearing

organization to change any aspect of its

operation or take any action other than

to submit a certification. The rules being

adopted replace regulation of clearing

organizations through the formal

designation and regulation of contract

markets with a streamlined procedure

for clearing organizations, regardless of

size, to obtain recognition by meeting

broad, non-prescriptive core principles.

Accordingly, the Chairman, on behalf of

the Commission, hereby certifies,

pursuant to 5 U.S.C. 605(b), that the

action taken herein will not have a

significant economic impact on a

substantial number of small entities. In

this regard, the Commission notes that

it did not receive any comments

regarding the RFA implications of Part

39.

B. Paperwork Reduction Act

Part 39 contains information

collection requirements. As required by

the Paperwork Reduction Act of 1995,

44 U.S.C. 3501 et seq., the Commission

submitted a copy of this part to the

Office of Management and Budget

(OMB) for its review. See 44 U.S.C.

§ 3507(d). No comments were received

in response to the Commission’s

invitation in the proposing release to

comment on any potential paperwork

burden associated with this regulation.

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 hereby amends

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 Scope and definitions.

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 in connection with the clearing

of transactions by a recognized clearing

organization.

Appendix A to Part 39—Application

Guidance

Authority: 7 U.S.C. 2, 6(c), 6d(2), 6g, 7a,

12a(5).

78026 Federal Register / Vol. 65, No. 240 / Wednesday, December 13, 2000 / Rules and Regulations

§ 39.1 Scope and definitions.

(a) Scope. The provisions of this part

39 apply to a recognized clearing

organization that clears 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.

(b) Definitions. For purposes of this

part:

(1) Clearing organization means a

person that provides a credit

enhancement function with respect to

transactions executed on a designated

contract market or pursuant to Parts 35

through 38 of this chapter in connection

with netting and/or settling the

payments and payment obligations of

such members or participants, by

becoming a universal counterparty to

such members or participants, or

otherwise; 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.

(2) Recognized clearing organization

means a clearing organization that has

been recognized by the Commission

under § 39.3.

§ 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. The clearing of

transactions by a recognized clearing

organization shall be governed by the

provisions of this part.

(b) A transaction effected pursuant to

part 35 or part 36 of this chapter, if

cleared, shall meet the requirements of

§ 35.2(c) or § 36.2(c) of this chapter, as

applicable, if the transaction is cleared

by one of the following authorized

clearing organizations:

(1) A recognized clearing

organization;

(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) The clearing of transactions

effected pursuant to part 35 or part 36

of this chapter by a recognized clearing

organization shall be governed by the

provisions of this part. The provisions

of this part shall not apply to the

clearing of transactions effected

pursuant to part 35 or part 36 by an

authorized clearing organization other

than a recognized clearing organization.

(d) Nothing in this part prohibits

clearing by a recognized clearing

organization of transactions not

specified in § 39.1(a).

§ 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 to the

operation of its clearing function; and

(c) Must initially, and on a continuing

basis, meet and adhere to the following

core principles:

(1) Financial resources: Have

adequate financial resources to fulfill its

guarantee function without interruption

in reasonably foreseeable market

conditions.

(2) Participant eligibility: Have

appropriate admission and continuing

eligibility standards for members or

participants of the organization.

(3) Risk management: Have the ability

to manage the risks associated with

carrying out its guarantee function

through the use of tools and procedures

appropriate under the circumstances.

(4) Settlement procedures: Have the

ability to complete settlements on a

timely basis under varying

circumstances, to maintain an adequate

record of the flow of funds associated

with the transactions it clears, and, to

the extent applicable, to comply with

the terms and conditions of any netting

or offset arrangements with other

clearing organizations.

(5) Treatment of member and

participant funds: Have adequate

procedures designed to protect the

safety of member and participant, and as

applicable, customer funds held by the

clearing organization.

(6) Default rules and procedures:

Have rules and procedures designed to

allow for the effective and fair

management of events when members

or participants become insolvent or

otherwise default on their obligations to

the clearing organization.

(7) Rule enforcement: Have

arrangements and resources for the

effective monitoring and enforcement of

compliance with its rules and, as

applicable, for resolution of disputes.

(8) System safeguards: Have a

program of testing, oversight, and risk

analysis to ensure that its automated

systems function properly and have

adequate capacity, security, emergency,

and disaster recovery procedures.

(9) Governance: Have appropriate

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 a

means to address conflicts of interest in

making decisions.

(10) Reporting: Provide all

information requested by the

Commission for it to conduct its

oversight function of the clearing

organization’s activities.

(11) Recordkeeping: Keep full books

and records of all activities relating to

its business as a recognized clearing

organization in a form and manner

acceptable to the Commission for a

period of five years, during the first two

of which the books and records are

readily available, and which shall be

open to inspection by any representative

of the Commission or the U.S.

Department of Justice.

(12) Public information: Publicly

disclose information concerning the

rules and operating procedures

governing its clearing and settlement

systems, including default procedures.

(13) Information sharing: Participate

in domestic and international

information-sharing agreements as

appropriate and use information

obtained from such agreements in

carrying out the clearing organization’s

risk management program.

(14) Competition: Operate in a manner

consistent with the public interest to be

protected by the antitrust laws.

§ 39.4 Procedures for recognition.

(a) Recognition by certification. A

clearing organization that cleared for at

least one nondormant contract market

Federal Register / Vol. 65, No. 240 / Wednesday, December 13, 2000 / Rules and Regulations 78027

within the meaning of § 5.3 of this

chapter on February 12, 2001, 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 current

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, to the extent

that compliance with the conditions of

recognition is not self-evident, a brief

explanation of how the rules satisfy

each of the conditions for recognition

under § 39.3;

(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) Appendix A to this part is

guidance to applicants concerning how

the core principles set forth in this

paragraph (b) 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

its submission as complete and final as

submitted.

(d) Delegation of authority. (1) The

Commission hereby delegates 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.

(2) Rules of a recognized clearing

organization that have not been

submitted pursuant to paragraph (a) or

(b)(3) of this section shall be submitted

to the Commission pursuant to § 1.41 of

this chapter.

(3) 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.

To the extent it clears transactions

specified in § 39.1(a), a recognized

clearing organization shall be deemed to

be a contract market for purposes of the

Act and the Commission rules

thereunder; provided, however, a

recognized clearing organization shall

be exempt from all provisions of the Act

and Commission regulations except, as

applicable, sections 1a, 2(a)(1), 4, 4b, 4c,

4d, 4g, 4i, 4o, 5(6), 5(7), 5a(a)(1),

5a(a)(2), 5a(a)(8), 5a(a)(9), the rule

disapproval procedures of section

5a(a)(12), 5a(a)(16), 5a(a)(17), 6(a), 6(c)

to the extent it prohibits manipulation

of the market price of any commodity in

interstate commerce or for future

delivery on or subject to the rules of any

contract market, 8a(7), 8a(9), 8c(a),

8c(b), 8c(c), 8c(d), 9(a), 9(f), 14, 15, 20

and 22 of the Act and §§ 1.3, 1.20, 1.24,

1.25, 1.26, 1.27, 1.29, 1.31, 1.36, 1.38,

1.41, parts 15 through 21, § 33.10, this

part 39, and part 190 of this chapter,

which continue to apply.

§ 39.6 Fraud in connection with the

clearing of transactions by a recognized

clearing organization.

It shall be unlawful for any person,

directly or indirectly, in or in

connection with the clearing of any

transaction specified in § 39.1(a) 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. This appendix is only illustrative of

the types of matters an applicant may

address, as applicable, in order to

demonstrate satisfactorily that it meets the

core principles and is not intended to be a

mandatory checklist of issues to address.

Core Principle 1—Financial Resources. Have

adequate financial resources to fulfill its

guarantee function without interruption in

reasonably foreseeable market conditions.

In addressing core principle 1, applicants

may 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 to assure 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 hypothetical

default scenarios that explain assumptions

and variables factored into the illustrations.

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

78028 Federal Register / Vol. 65, No. 240 / Wednesday, December 13, 2000 / Rules and Regulations

accessed and applied by the clearing

organization promptly; and

b. Any legal or operational impediments or

conditions to access.

Core Principle 2—Participant Eligibility.

Have appropriate admission and continuing

eligibility standards for members or

participants of the organization.

In addressing core principle 2, applicants

may 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 and how the clearing

organization would be able to change

continuing eligibility criteria in accordance

with changes in a member’s financial status.

3. The clearing function for each

instrument the organization undertakes to

clear.

Core Principle 3—Risk Management. Have

the ability to manage the risks associated

with carrying out its guarantee function

through the use of tools and procedures

appropriate under the circumstances.

In addressing core principle 3, applicants

may 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 such as 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 a

central counterparty;

c. The process for determining appropriate

margin levels for an instrument cleared and

for clearing members;

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

value open positions and collateral assets;

and

f. The proposed margin collection schedule

and how it would relate to 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 credit limits.

4. Use of cross-margin programs: How

collateral assets subject to cross-margining

programs would provide, where applicable,

for clear, fair, and efficient loss-sharing

arrangements in the event of a program

participant default.

Core Principle 4—Settlement Procedures.

Have the ability to complete settlements on

a timely basis under varying circumstances,

to maintain an adequate record of the flow

of funds associated with the transactions it

clears, and, to the extent applicable, to

comply with the terms and conditions of any

netting or offset arrangements with other

clearing organizations.

In addressing core principle 4, applicants

may 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 such information would be

recorded, maintained and accessed.

3. Interfaces with other clearing

organizations: How compliance with the

terms and conditions of 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 Member and

Participant Funds. Have adequate

procedures designed to protect the safety of

member and participant, and as applicable,

customer funds held by the clearing

organization.

In addressing core principle 5, applicants

may describe or otherwise document:

1. Safe custody:

a. The safekeeping of 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. The extent to which the deposit of funds

in accounts in depositories or with

custodians would limit concentration of risk.

2. Segregation between customer and

proprietary funds: 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, or which are subject

to cross-margin or similar agreements, and

any other aspects of customer fund

segregation.

3. Investment standards: How customer

funds would be invested consistent with high

standards of safety and associated

recordkeeping regarding the details of such

investments.

Core Principle 6—Default Rules and

Procedures. Have rules and procedures

designed to allow for the effective and fair

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

may describe or otherwise document:

1. Definition of default:

a. The definition of default and how it

would be established and enforced; and

b. How the applicant 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

may 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 application of clearing

organization and/or member financial

resources to address monetary shortfalls

resulting from a default.

4. Customer priority rule: Rules and

procedures regarding priority of customer

accounts over proprietary accounts of

defaulting members or participants and,

where applicable, in the context of

specialized margin reduction programs such

as cross-margining or trading links with other

exchanges.

Core Principle 7—Rule Enforcement. Have

arrangements and resources for the effective

monitoring and enforcement of compliance

with its rules and, as applicable, for

resolution of disputes.

In addressing core principle 7, applicants

may describe or otherwise document:

1. Surveillance: Arrangements and

resources for the effective monitoring of

compliance with rules relating to clearing

practices and financial surveillance.

2. Enforcement: 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 pursuant to clear and fair

standards.

3. Dispute resolution: Where applicable,

arrangements and resources for resolution of

disputes between customers and members,

and between members.

Core Principle 8—System Safeguards. Have

a program of testing, oversight and risk

analysis to ensure that its automated systems

function properly and have adequate

capacity, security, emergency, and disaster

recovery procedures.

In addressing core principle 8, applicants

may describe or otherwise document:

1. Oversight/risk analysis program:

a. Whether a program addresses

appropriate principles for the oversight of

automated systems to ensure that its clearing

systems function properly and have adequate

capacity and security;

Federal Register / Vol. 65, No. 240 / Wednesday, December 13, 2000 / Rules and Regulations 78029

b. Emergency procedures and a plan for

disaster recovery; and

c. Periodic testing of back-up facilities and

ability to provide timely 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, including

tests conducted and results; and

b. Confirmation that such testing and

review would be performed or assessed by a

qualified independent professional. A

professional that is a certified member of the

Information Systems Audit and Control

Association experienced in the industry is an

example of an acceptable party to carry out

such testing and review.

Core Principle 9—Governance. Have

appropriate 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 a

means to address conflicts of interest in

making decisions.

In addressing core principle 9, applicants

may describe or otherwise document:

1. 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 and

a history of serious disciplinary offenses,

such as those which would be disqualifying

under § 1.63 of this chapter.

2. Collection and verification of

information supporting compliance with

standards: 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.

4. A recognized clearing organization may

not limit its liability or the liability of any of

its officers, directors, employees, licensors,

contractors and/or affiliates where such

liability arises from such person’s violation

of the Act or Commission rules, fraud, or

wanton or willful misconduct.

Core Principle 10—Reporting. Provide all

information requested by the Commission

for it to conduct its oversight function of the

clearing organization’s activities.

In addressing core principle 10, applicants

may describe or otherwise document:

1. Information necessary for the

Commission to perform its oversight

activities of the recognized clearing

organization’s activities:

a. Information available to or generated by

the clearing organization that will be made

available to the Commission, upon request

and/or 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

b. The manner in which any information

will be made available to members/

participants and/or the general public.

Core Principle 11—Recordkeeping. Keep full

books and records of all activities relating to

its business as a recognized clearing

organization in a form and manner

acceptable to the Commission for a period of

five years, during the first two of which the

books and records are readily available, and

which shall be open to inspection by any

representative of the Commission or the U.S.

Department of Justice.

In addressing core principle 11, applicants

may describe or otherwise document:

1. Maintenance of records related to the

function of a clearing organization in a form

and manner acceptable to the Commission:

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. How the entity would satisfy the

requirements of § 1.31 of this chapter

including:

a. What ‘‘full’’ or ‘‘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 be

maintained (and confirmation that, in any

event, they would be maintained for at least

five years).

Core Principle 12—Public Information.

Publicly disclose information concerning the

rules and operating procedures governing its

clearing and settlement systems, including

default procedures.

In addressing core principle 12, applicants

may describe or otherwise document:

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.

Participate in domestic and international

information-sharing agreements as

appropriate, and use information obtained

from such agreements in carrying out the

clearing organization’s risk management

program.

In addressing core principle 13, applicants

may describe or otherwise document:

1. Applicable appropriate domestic and

international information-sharing agreements

and arrangements including 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.

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. Operate in

a manner consistent with the public interest

to be protected by the antitrust laws.

Pursuant to Core Principle 14, an entity

seeking recognition as a recognized clearing

organization may request the Commission

consider under the provisions of section 15

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

at the time of application for recognition or

thereafter. The Commission intends to apply

section 15 of the Act to its consideration of

issues under this core principle in a manner

consistent with that previously applied to

contract markets.

Issued in Washington, D.C., this 21st day

of November, 2000, by the Commission.

Jean A. Webb,

Secretary of the Commission.

[This statement will not appear in the Code

of Federal Regulations.]

Concurrence of Commissioner Thomas J.

Erickson Regarding Final Rules for a New

Regulatory Framework for Clearing

Organizations

I concur with the adoption of the final

rules relating to clearing organizations.

Increasingly, clearing is being de-coupled

from the exchange. More electronic

78030 Federal Register / Vol. 65, No. 240 / Wednesday, December 13, 2000 / Rules and Regulations

1See Final Rules for a New Regulatory

Framework for Clearing Organizations, p.12.

1 65 FR 39033 (June 22, 2000).

2Recognizing the importance of the OTC

derivatives markets, the chairmen of the Senate and

House Agriculture Committees requested that the

PWG conduct a study of OTC derivatives markets.

After studying the existing regulatory framework of

OTC derivatives, recent innovations, and the

potential for future developments, the PWG on

November 9, 1999, reported to Congress its

recommendations. See Over-the-Counter

Derivatives Markets and the Commodity Exchange

Act, Report of the President’s Working Group on

Financial Markets (PWG Report). The PWG Report

focused on promoting innovation, competition,

efficiency, and transparency in OTC derivatives

markets and in reducing systemic risk.

3See Our Estimates of Global Size Market (visited

Oct. 10, 2000), http://www.swapsmonitor.com.

4 In addition to these 31, a significant number of

letters commenting on aspects of the regulatory

framework in companion notices were also

submitted to the Commission. In this and three

companion Notices of Final Rulemaking which are

being published in this edition of the Federal

Register, comment letters (CLs) are referenced by

file number, letter number and page. Comments

filed in response to the notice of proposed

exchanges are choosing to contract with new

or existing clearing organizations for this

aspect of traditional exchange activity. From

what the Commission heard at the public

hearing on the proposed framework, this

trend is expected to continue and accelerate.

Accordingly, this proposal represents a first

step toward providing clearing organizations

with the flexibility they will need to adapt

to this new environment.

Nevertheless, I am sympathetic to the

concerns of domestic clearing organizations

regarding competition, jurisdiction and

scope. Specifically, the final rule’s treatment

of securities clearinghouses, banks, bank

affiliates, and foreign clearinghouses with

regard to the requirements of Part 39 would

appear to subject futures clearinghouses to a

significant competitive disadvantage. The

Commission’s final rules justify this

approach with little more than the

observation that it is consistent with the

‘‘unanimous recommendations of the

President’s Working Group.’’ 1 Much more

needs to be done so that one segment of the

industry is not disproportionately affected

and unfairly hamstrung by these regulations.

Therefore, while I support the final rules to

the extent they represent the Commission’s

willingness to meet the evolving marketplace

with innovative approaches, I do so with the

caveat that Part 39 will clearly need the

Commission’s full attention in order to

ensure that the Commission is not picking

winners and losers. At a minimum, since

these reforms follow so closely the

recommendations of the President’s Working

Group, I hope that the members of the PWG

will respond swiftly to today’s action by

making parallel changes to their own

regulatory schemes implementing the PWG’s

recommendations.

Date: November 20, 2000.

Thomas J. Erickson,

Commissioner.

[FR Doc. 00–30269 Filed 12–12–00; 8:45 am]

BILLING CODE 6351–01–P

COMMODITY FUTURES TRADING

COMMISSION

17 CFR Part 35

RIN 3038–AB58

Exemption for Bilateral Transactions

AGENCY: Commodity Futures Trading

Commission.

ACTION: Final rules.

SUMMARY: The Commodity Futures

Trading Commission (Commission or

CFTC) is adopting final rules to clarify

the operation of the current swaps

exemption. In addition, in a companion

notice of final rulemaking published in

this edition of the Federal Register, the

Commission is adopting rules that

provide for the clearing of transactions

under the revised exemption. The

Commission, in other companion

releases, also is adopting a new

regulatory framework to apply to

multilateral transaction execution

facilities and to market intermediaries.

This new framework establishes a

number of new market categories,

including a category of exempt

multilateral transaction execution

facility. Nothing in these releases,

however, affects the continued vitality

of the Commission’s exemption for

swaps transactions in effect before

December 13, 2000, or any of its other

existing exemptions, policy statements

or interpretations.

EFFECTIVE DATE: February 12, 2001.

FOR FURTHER INFORMATION CONTACT: Paul

M. Architzel, Chief Counsel, or Nancy E.

Yanofsky, Assistant Chief Counsel,

Division of Economic Analysis,

Commodity Futures Trading

Commission, Three Lafayette Centre,

1155 21st Street, NW., Washington, DC

20581. Telephone: (202) 418–5260. Email: PArchitzel@cftc.gov or

NYanofsky@cftc.gov.

SUPPLEMENTARY INFORMATION:

I. The Proposed Rules

On June 22, 2000, the Commission

published proposed amendments to its

part 35 swaps exemption to expand and

to clarify its operation, including the

availability of clearing for these

transactions.1 These amendments were

proposed in order to provide greater

legal certainty to the over-the-counter

(OTC) markets and to reduce systemic

risk. The President’s Working Group on

Financial Markets (PWG) 2 and the

chairmen of the Commission’s

Congressional oversight committees

encouraged the Commission in this

undertaking.

The Commission proposed the

amendments to part 35 in light of the

changes that have occurred in the OTC

markets since the Commission adopted

its Swaps Policy Statement in 1989, and

its subsequent part 35 swaps exemption

in 1993. In the intervening years, the

OTC derivatives markets have

experienced dramatic and sustained

growth. During this period, OTC

financial derivatives have developed

into global markets having outstanding

contracts with a total notional value of

over $90 trillion.3 OTC derivatives have

transformed finance, increasing the

range of financial products available for

managing risk.

The Commission proposed making

several changes to part 35. First, the

Commission proposed deleting specific

reference to ‘‘swaps’’ within the

exemption itself. Instead, the rule would

refer to a ‘‘contract, agreement or

transaction’’ that meets the requisite

exemptive conditions. Moreover, as

suggested by the PWG Report, the

Commission proposed to delete the

requirement that exempt transactions

not be fungible or standardized and to

make clear that insofar as such exempt

transactions may be cleared,

creditworthiness of the counterparty is

not a condition of the exemption. PWG

Report at 17. In addition, the

Commission proposed, through an

exemption from the private right of

action provision of section 22 of the Act,

that transactions entered into in reliance

on the part 35 swaps exemption would

not be subject to a claim for rescission

solely due to a violation of the

exemption’s requirements. See id. at 18.

In proposing the rules, the

Commission affirmed the continuing

vitality of the exemptive relief that it

had previously granted to transactions

in the OTC market, including the part

35 exemption, the Policy Statement

Concerning Swap Transactions (54 FR

30694 (July 21, 1989)) (Swaps Policy

Statement), the Statutory Interpretation

Concerning Forward Transactions (55

FR 39188 (Sept. 25, 1990)) (Energy

Interpretation), and the Exemption for

Certain Contracts Involving Energy

Products (58 FR 21286 (April 20, 1993))

(Energy Exemption). Moreover, in

recognition of its continuing vitality and

to assist the public in locating it, the

Commission proposed publishing the

Swaps Policy Statement as Appendix A

to part 35.

II. Comments Received

The Commission received 31

comment letters on the proposed

rulemaking.4 The commenters included