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[Federal Register: April 6, 2010 (Volume 75, Number 65)]
[Rules and Regulations]               
[Page 17297-17303]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr06ap10-4]                         

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COMMODITY FUTURES TRADING COMMISSION

17 CFR Part 190

RIN 3038-AC94

 
Account Class

AGENCY: Commodity Futures Trading Commission.

ACTION: Final rules.

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SUMMARY: The Commodity Futures Trading Commission (the ``Commission'') 
is amending its regulations (the ``Regulations'') \1\ to create a sixth 
and separate ``account class,'' \2\ applicable only to the bankruptcy 
of a commodity broker that is a futures commission merchant (``FCM''), 
for positions in cleared over-the-counter (``OTC'') derivatives (and 
money, securities, and/or other property margining, guaranteeing, or 
securing such positions).
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    \1\ The regulations of the Commission can be found at 17 CFR 
Chapter 1.
    \2\ In general, the concept of ``account class'' governs the 
manner in which the trustee calculates the net equity (i.e., claims 
against the estate) and the allowed net equity (i.e., pro rata share 
of the estate) for each customer of a commodity broker in 
bankruptcy.
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    Further, the Commission is amending the Regulations to codify the 
appropriate allocation, in a bankruptcy of any commodity broker, of 
positions in commodity contracts of one account class (and the money, 
securities, and/or other property margining, guaranteeing, or securing 
such positions), which, pursuant to an order issued by the Commission 
under Section 4d of the Commodity Exchange Act (the ``Act''),\3\ are 
commingled with positions in commodity contracts of the futures account 
class (and the money, securities, and/or other property margining, 
guaranteeing, or securing such positions).
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    \3\ The Act can be found at 7 U.S.C. 1-23.

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DATES: Effective Date: The final rules are effective as of May 6, 2010.

FOR FURTHER INFORMATION CONTACT: Robert B. Wasserman, Associate 
Director, Division of Clearing and Intermediary Oversight, 202-418-
5092, rwasserman@cftc.gov; or Nancy Schnabel, Special Counsel, Division 
of Clearing and Intermediary Oversight, 202-418-5344, 
nschnabel@cftc.gov; Commodity Futures Trading Commission, Three 
Lafayette Centre, 1155 21st Street, NW., Washington, DC 20581.

SUPPLEMENTARY INFORMATION: 

I. Background

    On August 13, 2009, the Commission published a Notice of Proposed 
Rulemaking, which contained the following three proposals (the 
``Notice'').\4\ First, the Notice proposed amending Regulation 
190.01(a), as well as adding new Regulation 190.01(oo), to create a 
sixth and separate account class, applicable only to the bankruptcy of 
a commodity broker that is an FCM, for positions in ``cleared OTC 
derivatives'' (and money, securities, and/or other property margining, 
guaranteeing, or securing such positions).\5\ Second, the Notice 
proposed further amending Regulation 190.01(a) to codify the 
appropriate allocation, in a bankruptcy of any commodity broker, of 
positions in commodity contracts of one account class (and relevant 
collateral), which, pursuant to an order issued by the Commission under 
Section 4d of the Act \6\ (a ``Section 4d Order''), are commingled with 
positions in commodity contracts of the futures account class (and 
relevant collateral). Third, the Notice proposed making certain 
conforming amendments to Regulation 190.07(b)(2)(viii) and Form 4 
(Proof of Claim) in Appendix A to Regulation Part 190 (Bankruptcy 
Forms).
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    \4\ 74 FR 40794 (August 13, 2009).
    \5\ The Notice proposed defining ``cleared OTC derivatives'' as:
    Positions in commodity contracts that have not been entered into 
or traded on a contract market (as such term is defined in Sec.  
1.3(h) of this chapter) or on a derivatives transaction execution 
facility (within the meaning of Section 5a of the Act), but which 
nevertheless are submitted by a commodity broker that is a futures 
commission merchant (as such term is defined in Sec.  1.3(p) of this 
chapter) for clearing by a clearing organization (as such term is 
defined in this section), along with the money, securities, and/or 
other property margining, guaranteeing, or securing such positions, 
which are required to be segregated, in accordance with a rule, 
regulation, or order issued by the Commission, or which are required 
to be held in a separate account for cleared OTC derivatives only, 
in accordance with the rules or bylaws of a clearing organization 
(as such term is defined in this section).
    Id. at 40799.
    \6\ 7 U.S.C. 6d.
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    Although, as mentioned above, the Notice proposed creating a new 
account class for positions in cleared OTC derivatives (and relevant 
collateral), the Notice declined to propose substantive requirements, 
applicable prior to the bankruptcy of a commodity broker that is an 
FCM, for the treatment of such positions (and relevant collateral). 
Rather, the Notice stated that ``the Commission proposes to define 
`cleared OTC derivatives' in such a manner as to specify the sources 
from which such substantive requirements may

[[Page 17298]]

originate.'' \7\ According to the Notice, the rules or bylaws of a DCO 
constitute one such source.
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    \7\ 74 FR at 40796.
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    The public comment period on the Notice ended on September 14, 
2009. The Commission received four comments \8\ during the comment 
period: (i) One from an alternative investment industry trade 
association; \9\ (ii) one from a futures industry trade association; 
\10\ (iii) one from the holding company of four designated contract 
markets (each, a ``DCM'') and three DCOs; \11\ and (iv) one from a 
DCM.\12\
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    \8\ For purposes of this release, a comment letter is referenced 
by (i) its author, (ii) its file number (as shown in the comment 
file associated with the Notice on the Commission's Web site), and 
(iii) the page (if applicable). The comment file associated with the 
Notice is available at http://www.cftc.gov/lawandregulation/federalregister/federalregistercomments/2009/09-009.html.
    \9\ The Managed Funds Association (representing the global 
alternative investment industry) (``MFA'') (CL01).
    \10\ The Futures Industry Association (representing the 
commodity futures and options industry) (``FIA'') (CL02).
    \11\ The CME Group, Inc. (the holding company for: (i) The 
Chicago Mercantile Exchange Inc. (``CME'') and CME Clearing, a 
division of CME; (ii) the Board of Trade of the City of Chicago, 
Inc. and its clearing house; (iii) the New York Mercantile Exchange, 
Inc. and its clearing house; and (iv) the Commodity Exchange, Inc.) 
(``The CME Group'') (CL03).
    \12\ ELX Futures, L.P. (``ELX'') (CL04).
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    Collectively, the comments raise the following five concerns with 
the Notice:
     The Commission may not have authority to promulgate the 
proposed amendments in the Notice;
     The Commission should make the proposed account class for 
cleared OTC derivatives applicable to the bankruptcy of a commodity 
broker that is a DCO, not simply to the bankruptcy of a commodity 
broker that is an FCM;
     The Commission should change the definition of cleared OTC 
derivatives in the Notice to better comport with the definition of 
``cleared-only contracts'' \13\ in the Interpretative Statement that 
the Commission issued on September 26, 2008 (the ``Statement on Cleared 
OTC Derivatives''); \14\
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    \13\ In the Statement on Cleared OTC Derivatives, the Commission 
defined ``cleared-only contracts'' as those contracts that 
``although not executed or traded on a Designated Contract Market or 
a Derivatives Transaction Execution Facility, are subsequently 
submitted for clearing through a Futures Commission Merchant * * * 
to a Derivatives Clearing Organization.'' 73 FR 65514 (November 4, 
2008).
    \14\ Id.
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     The Commission should establish objective standards for 
issuing Section 4d Orders; and
     The Commission should specify substantive requirements 
with respect to the treatment of positions in cleared OTC derivatives 
(and money, securities, and/or other property margining, guaranteeing, 
or securing such positions), if a DCO requires such positions (and 
relevant collateral) to be held in a separate account for cleared OTC 
derivatives.
    The Commission will address below each of the five concerns in 
turn.

II. Concern That the Commission Does Not Have Authority To Promulgate 
the Proposed Amendments in the Notice

A. Rationale for Concern

    Two commenters stated that certain participants in the OTC 
derivatives markets have questioned the authority of the Commission to 
promulgate the proposed amendments in the Notice. In support of their 
respective statements, both commenters referenced the Report to the 
Supervisors of the Major OTC Derivatives Dealers on the Proposals of 
Centralized CDS Clearing Solutions for the Segregation and Portability 
of Customer CDS Positions and Related Margin, dated June 30, 2009 (the 
``Segregation and Portability Report'').\15\ One commenter quotes from 
a portion of the Segregation and Portability Report, which states that 
there exists a ``not insignificant'' risk that a court administering 
the bankruptcy of a commodity broker would disagree with the Statement 
on Cleared OTC Derivatives.\16\ In the Statement on Cleared OTC 
Derivatives, the Commission determined (i) that cleared-only contracts 
constituted ``commodity contracts'' \17\ within the meaning of 
Subchapter IV of Chapter 7 of the Bankruptcy Code (``Subchapter 
IV''),\18\ and (ii) that, therefore, customer positions in cleared-only 
contracts that, pursuant to a Section 4d Order, are commingled with 
customer positions in futures contracts should be afforded all 
protections available under Subchapter IV and Regulation Part 190 in 
the event of the bankruptcy of a commodity broker that is an FCM. For 
the reasons explained below, the Commission does not believe that the 
commenters' concerns are well founded.
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    \15\ The Segregation and Portability Report is available at 
http://www.newyorkfed.org/newsevents/news/markets/2009/an090713.html.
    According to the MFA, the Segregation and Portability Report 
states that ``there is uncertainty as to the proposition that 
cleared OTC derivatives contracts constitute `commodity contracts', 
thereby receiving account class protections under the [Act] and the 
Bankruptcy Code.'' See MFA CL01 at 3.
    According to the FIA, the Segregation and Portability Report 
``concludes that there are reasonable arguments that cleared OTC 
derivatives may be viewed as `commodity contracts' for purposes of 
Subchapter IV and Part 190. However, `the risk of a contrary 
conclusion is not insignificant.' [Emphasis supplied.]'' See FIA 
CL02 at 6.
    \16\ Id. The FIA also quotes from another portion of the 
Segregation and Portability Report, which states:
    We believe there is a significant possibility (in a worst-case 
scenario) that the proposition that cleared [credit default swap] 
contracts constitute ``commodity contracts'' within the meaning of 
the Bankruptcy Code may be challenged * * * In addition, we also 
believe that any challenge to the proposition that [credit default 
swaps] constitute ``commodity contracts'' would likely result in 
significant delay for customers seeking the return of margin through 
the insolvent FCM.
    Id.
    To properly contextualize these expressed concerns, the 
Commission makes two observations.
    First, while the Segregation and Portability Report repeatedly 
makes portentous statements concerning the ``not insignificant'' 
risk that a court might find that cleared-only contracts (as the 
Statement on Cleared OTC Derivatives defines such term) are not 
commodity contracts, the Segregation and Portability Report cites 
neither to statutory language nor to case law that might be relied 
upon to support such a conclusion. Indeed, the Report fails to 
specify any analytical basis for its concerns.
    Second, the Segregation and Portability Report's discussion of 
timing concerns in this context is somewhat incongruous, given that 
the report contains the following description of its own scope:
    We do not principally focus on timing issues in this Report--
e.g., when customers will be able to recover their margin. Although 
we note certain instances in which timing concerns may be 
particularly relevant, our primary focus is on whether customers 
will be able to recover their margin. Timing issues are critical to 
the analysis of any CCP's customer protection framework. However, we 
do not focus on them in this Report because of their inherently 
complex and unpredictable nature.
    See the Segregation and Portability Report at 3. In any event, 
the prosaic observation that the conclusions of the Statement on 
Cleared OTC Derivatives may be the subject of a challenge, and that 
such a challenge might take time to resolve, provides no reason for 
rejecting the proposals contained in the Notice that are based on 
those conclusions.
    \17\ 11 U.S.C. 761(4)(A).
    \18\ 11 U.S.C. Chapter 7, Subchapter IV.
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B. ``Commodity Contract'' Definition

    In both the Statement on Cleared OTC Derivatives and the Notice, 
the Commission relied on clear statutory authority that the Commodity 
Futures Modernization Act of 2000 (the ``CFMA'') \19\ introduced in the 
Act and in Subchapter IV to conclude that cleared OTC derivatives are 
``commodity contracts'' within the meaning of Section 761(4)(A) of the 
Bankruptcy Code.\20\ The CFMA created the opportunity for OTC 
derivatives to be cleared.\21\ The CFMA also extended Subchapter IV to 
cleared OTC derivatives. Section 761(4)(A) of the Bankruptcy Code 
defines ``commodity contract,'' with respect to an FCM, as a ``contract 
for the purchase or sale of a commodity for future delivery on, or 
subject to the rules of, a contract market

[[Page 17299]]

or board of trade.'' \22\ Section 112(c)(6) of the CFMA amended the 
definition of ``contract market'' in Section 761(7) of the Bankruptcy 
Code to include reference to a ``registered entity.'' \23\ It also 
amended Section 761(8) of the Bankruptcy Code to incorporate by 
reference the definition of ``registered entity'' in the Act.\24\ 
Section 1a(29) of the Act defines a ``registered entity'' to include 
``(iii) a derivatives clearing organization registered under Section 5b 
* * *''.\25\
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    \19\ Appendix E of Public Law 106-554, 114 Stat. 2763 (2000).
    \20\ See supra note 17.
    \21\ See, e.g., Sections 2(d), (e), and (g) of the Act (7 U.S.C. 
2(d), (e), (g)).
    \22\ See supra note 17.
    \23\ 11 U.S.C. 761(7).
    \24\ 11 U.S.C. 761(8).
    \25\ 7 U.S.C. 1a(29).
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    Therefore, the Commission believes that the CFMA permitted cleared 
OTC derivatives, which are subject to the rules of a DCO, to become 
``commodity contracts,'' with respect to an FCM, within the meaning of 
Section 761(4) of the Bankruptcy Code.\26\ The Commission further 
believes that a court administering the bankruptcy of an FCM would 
consider the abovementioned CFMA interpretation to be a ``reasonable'' 
``construction of a statutory scheme'' that the Commission has been 
``entrusted to administer'' under Chevron U.S.A. Inc. v. Natural 
Resources Defense Council, Inc., et al., 467 U.S. 837, 844 (1984).\27\ 
Indeed, the Segregation and Portability Report states: ``Ultimately, we 
believe a court is likely to conclude that [credit default swaps] are 
`commodity contracts' (on account of which [credit default swap] 
clearing customers are `customers' within the meaning of the Bankruptcy 
Code) * * *''.\28\
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    \26\ See supra note 17.
    \27\ As mentioned above, ``account class'' governs the manner in 
which the trustee calculates the net equity (i.e., claims against 
the estate) and the allowed net equity (i.e., pro rata share of the 
estate) for each customer of a commodity broker in bankruptcy. As 
the NPRM states, ``[t]he Commission is empowered by Section 20 of 
the Commodity Exchange Act * * * (i) to define the `net equity' of a 
customer of a commodity broker in bankruptcy, and (ii) to prescribe, 
by rule or regulation, the procedures for calculating such `net 
equity.' '' See 74 FR at 40795. The Commission is exercising its 
powers under Section 20 of the Act in determining whether cleared 
OTC derivatives could, with respect to an FCM that is a commodity 
broker, constitute a sixth and separate account class. The plain 
language of the Bankruptcy Code recognizes the authority of the 
Commission to make such determination. For example, Section 761(17) 
of the Bankruptcy Code subjects the definition of ``net equity,'' in 
the case of a commodity broker, to such ``rules and regulations as 
the Commission promulgates under the Act.'' Moreover, the 
legislative history of the 1978 amendments to the Bankruptcy Code 
supports the authority of the Commission. Cf. H.R. Rep. No. 95-595 
(1977) (stating that ``a final distinction [between Subchapter III 
of Title 7 of the Bankruptcy Code (11 U.S.C., Title 7, Subchapter 
III) and Subchapter IV] concerns the creation of a rule-making power 
in the Commodity Futures Trading Commission to carry out the 
provisions * * * The bill contains such a rule-making power with 
respect to * * * net equity * * * The rule-making power was 
requested by the CFTC and is appropriate in light of the germinal 
state of regulation in this area'').
    \28\ The Segregation and Portability Report does note that 
``this outcome is not at all certain.'' See the Segregation and 
Portability Report at 35. However, the Segregation and Portability 
Report also observes that, in the event that a court administering 
the bankruptcy of a commodity broker disagrees with the 
determination of the Commission that cleared-only contracts (as the 
Statement on Cleared OTC Derivatives defines such term) constitute 
``commodity contracts'' under Subchapter IV, ``if the [commodity 
broker] segregates assets solely for the cleared [credit default 
swap] customers, then the cleared [credit default swap] customers' 
interest in those assets may be superior to any interest of the 
commodities customers or unsecured creditors of the [commodity 
broker] * * *''. See the Segregation and Portability Report at 37. 
Therefore, the Segregation and Portability Report appears to imply 
that the creation, in the event of the bankruptcy of a commodity 
broker that is an FCM, of a separate account class for customer 
positions in cleared OTC derivatives (and money, securities, and/or 
other property margining, guaranteeing, or securing such positions), 
as the Notice proposed, may benefit customers, even if a court does 
not accord such positions (and relevant collateral) full protection 
under Subchapter IV and Regulation Part 190.
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C. Support for Legislative Changes

    One commenter notes that the Commission proposed to Congress on 
August 17, 2009 certain amendments to the Bankruptcy Code that would 
achieve the same effect as the amendments proposed in the Notice. The 
commenter then speculated that the Commission may have been motivated 
to make such proposal because it believed that it otherwise lacks 
authority to promulgate the proposed amendments in the Notice.\29\ Such 
speculation is mistaken. As stated above, the Commission believes that 
cleared OTC derivatives are ``commodity contracts'' within the meaning 
of Section 761(4)(A) of the Bankruptcy Code.\30\ The commenter 
references proposals that Chairman Gary Gensler made to Congress. These 
proposals included the abovementioned amendments to the Bankruptcy Code 
in order to clarify the status of swaps, in the context of the 
improvements to regulation of over-the-counter derivatives markets that 
the Administration proposed \31\ and other, more extensive changes to 
the Bankruptcy Code. The proposal that Congress make explicit what the 
CFMA left implicit does not mean that the interpretation of the 
existing statute that the Commission has advanced is not 
reasonable.\32\
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    \29\ As mentioned above, according to the FIA, the Segregation 
and Portability Report ``concludes that there are reasonable 
arguments that cleared OTC derivatives may be viewed as `commodity 
contracts' for purposes of Subchapter IV and Part 190. However, `the 
risk of a contrary conclusion is not insignificant.' [Emphasis 
supplied.]'' The FIA then further observes:
    The Commission may have reached the same conclusion. In its 
August 17, 2009 recommendations to Congress, the Commission has 
proposed amendments to the Bankruptcy Code that amend the definition 
of a ``contract market'' to remove the reference to ``registered 
entity,'' which is currently the Commission's basis for finding that 
cleared-only derivatives contracts are ``commodity contracts'' under 
the Bankruptcy Code. Instead, the Commission recommends that the 
definition of a ``commodity contract'' be amended to include a 
``swap that is submitted to a derivatives clearing organization for 
clearing'' by a ``swap clearer'' (as defined). The broad definition 
of a ``swap'' in the Bankruptcy Code would encompass all cleared OTC 
derivatives contracts.
    See FIA CL02 at 6-7.
    \30\ See supra note 17.
    \31\ Such proposals are available at http://financialstability.gov/docs/regulatoryreform/titleVII.pdf.
    \32\ See United States v. Sepulveda, 115 F.3d 882, 885 (11th 
Cir. 1997) (quoting Hawkins v. United States, 30 F.3d 1077, 1082 
(9th Cir. 1994)) (stating that ``Congress may, however, `amend a 
statute to clarify existing law * * *' Thus, an amendment to a 
statute does not necessarily indicate that the unamended statute 
meant the opposite.'' See also Wesson v. United States, 48 F.3d 894, 
900-901 (5th Cir. 1995); Fowler v. Unified School District No. 259, 
Sedgwick County, Kansas, 128 F.3d 1431 (10th Cir. 1997)).
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III. Recommendation That the Commission Extend the Application of the 
Proposed Account Class for Cleared OTC Derivatives

    One commenter recommends that the Commission extend the application 
of the account class for cleared OTC derivatives, as proposed in the 
Notice, to the bankruptcy of a commodity broker that is a DCO, rather 
than limit such application to the bankruptcy of a commodity broker 
that is an FCM. That commenter argues that the absence of such an 
extension would cause confusion, in the event of a DCO bankruptcy, 
regarding the treatment of the money, securities, and/or other property 
that the DCO holds to margin, guarantee, or secure positions in cleared 
OTC derivatives belonging to customers of DCO members.\33\
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    \33\ Specifically, The CME Group states:
    If, as proposed by the Commission, an FCM were to utilize a 
separate account for customers' cleared OTC derivatives in the 
absence of a 4d order, the DCO must also maintain a similar account 
for holding such positions and their accompanying margins. If the 
cleared OTC derivatives account class will not apply in the unlikely 
event of a DCO bankruptcy, then it is unclear what account class 
would apply to the funds in the DCO's separate account for those OTC 
derivatives that it clears on behalf of its clearing FCMs' 
customers.
    See The CME Group CL03 at 3.
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    While sympathetic to these arguments, the Commission continues to 
believe that a DCO bankruptcy would be sui generis.\34\ Therefore, the

[[Page 17300]]

Commission believes that the best approach, at present, would be to 
limit the application of the account class for cleared OTC derivatives 
to the bankruptcy of a commodity broker that is an FCM.
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    \34\ The proposing release to Regulation Part 190 states:
    The Commission is proposing that all open commodity contracts, 
even those in a deliverable position, be liquidated in the event of 
a clearing organization bankruptcy because it would be highly 
unlikely that an exchange could maintain a properly functioning 
futures market in the event of the collapse of its clearing 
organization. The Commission has proposed no other rules with 
respect to the operation of clearing organization debtors * * * 
Because the bankruptcy of a clearing organization would be unique, 
the Commission is not proposing a general rule in this regard. The 
potential for disruption of the Markets, and of the nation's economy 
as a whole, in the case of a clearing organization bankruptcy, 
together with the desirability of the Commission's active 
participation in developing a means of meeting such an emergency, 
has disposed the Commission to take a case-by-case approach with 
respect to clearing organizations.
    See 46 FR 57535, 57545 (November 24, 1981).
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IV. Recommendation That the Commission Change the Proposed Definition 
of Cleared OTC Derivatives

    One commenter recommends that the Commission change the definition 
of cleared OTC derivatives, as proposed in the Notice,\35\ to better 
comport with the definition of cleared-only contracts in the Statement 
on Cleared OTC Derivatives.\36\ Specifically, the commenter notes that 
the definition of cleared OTC derivatives proposed in the Notice 
appears to require that an FCM actually submit a contract for clearing. 
In contrast, the definition of cleared-only contracts in the Statement 
on Cleared OTC Derivatives only requires that a contract is submitted 
through an FCM for clearing.\37\ The commenter states that, if the 
Commission adopts the recommendation, the Commission would render 
patent that it ``does not intend to prohibit clearing FCMs from 
authorizing their customers to directly enter their transactions into 
the clearing system, in order to meet the definition of cleared OTC 
derivatives, as long as the transactions are cleared through an FCM.'' 
\38\ The Commission agrees with this commenter, and has modified, in 
this release, the definition of cleared OTC derivatives proposed in the 
Notice in accordance with the recommendation from this commenter.
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    \35\ See supra note 5.
    \36\ See supra note 13.
    \37\ See The CME Group CL03 at 5.
    \38\ Id.
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    Another commenter poses two questions about the definition of 
cleared OTC derivatives proposed in the Notice.\39\ All such questions 
appear related to whether the Commission may deem a contract listed for 
trading on a contract market (as Regulation 1.3(h) defines such term) 
to have been executed OTC, if such contract fails to reach a certain 
liquidity threshold on the contract market. The Commission believes 
that the definition of cleared OTC derivatives, as proposed in the 
Notice (i.e., proposed Regulation 190.01(oo)), plainly limits such term 
to contracts that ``have not been entered into or traded on a contract 
market (as such term is defined in Sec.  1.3(h) of this chapter) * * 
*.'' Regulation 1.3(h), in turn, defines ``contract market'' in terms 
of a board of trade's designation as a DCM, not in terms of the 
liquidity of any particular contract.
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    \39\ Specifically, ELX asks:
     ``What constitutes a `cleared only' contract? If an OTC 
derivative is offered for exchange trading (thus losing the moniker 
OTC derivative) but fails to trade, or trades fewer than 100 
contracts per day, is it considered cleared only?''
     ``How much time will a contract be given to reach a 
liquidity threshold before being deemed `cleared only' and required 
to be placed in a new account class?''
    See ELX CL04 at 2.
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V. Recommendations That the Commission Establish Objective Standards 
for Section 4d Orders

    Two commenters recommend that the Commission propose objective 
standards for determining which cleared OTC derivatives would be 
eligible for a Section 4d Order.\40\ The first commenter states that 
``it would be beneficial to DCOs and the Commission if the Commission 
were to adopt standards that would define the requirements that must be 
met for a cleared OTC derivative to qualify for 4d treatment.'' \41\ In 
contrast, the second commenter states that the Commission must propose 
such objective standards ``[i]n order to assure that `cleared OTC 
derivatives' customers receive the benefits intended'' by the proposed 
rules contained in the Notice.\42\ The second commenter contends that, 
without such standards, customers with positions (and money, 
securities, and/or other property margining, guaranteeing, or securing 
such positions) in the account class for cleared OTC derivatives may 
argue, in the bankruptcy of a commodity broker that is an FCM, that: 
(i) Such positions share certain characteristics with positions in the 
futures account class; and (ii) thus such customers ``should have 
access to the same pool of assets, i.e., the futures account.'' \43\
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    \40\ A Section 4d Order would permit positions in a cleared OTC 
derivative (and relevant collateral) to be included in the futures 
account class rather than another account class (e.g., the account 
class for cleared OTC derivatives).
    \41\ See The CME Group CL03 at 7.
    \42\ See FIA CL02 at 3.
    \43\ Id. at 3-5.
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    The proposed regulations contained in the Notice (i.e., the 
proposed amendment to Regulation 190.01(a)) unambiguously state that 
``positions in commodity contracts of one account class (and the money, 
securities, and/or other property margining, guaranteeing, or securing 
such positions)'' would be treated, in the bankruptcy of any commodity 
broker, ``as being held in the futures account class'' only if, 
``pursuant to a Commission order,'' such positions are ``commingled 
with positions in commodity contracts of the futures account class (and 
the money, securities, and/or other property margining, guaranteeing, 
or securing such positions).'' \44\ Pursuant to that plain language, in 
the bankruptcy of a commodity broker, the decisive factor as to whether 
a position in a cleared OTC derivative contract (and relevant 
collateral) would be treated as belonging to the futures account class 
is whether the Commission has issued a Section 4d Order covering such 
contract, not whether the Commission should have or could have issued 
such a Section 4d Order.\45\
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    \44\ 74 FR at 40798-99.
    \45\ To enhance clarity on this point, the reference in the 
definition of cleared OTC derivatives, as proposed in the Notice, to 
positions (and relevant collateral) that are ``segregated * * * in 
accordance with a rule, regulation, or order issued by the 
Commission,'' see id. at 40799, has been changed in this release to 
a reference to positions (and relevant collateral) that are 
``segregated or set aside * * * in accordance with a rule, 
regulation, or order issued by the Commission.'' Also, Regulation 
190.01(a), as proposed in the Notice, has been changed to include 
the following emphasized language: ``Provided, further, that, if 
positions in commodity contracts that would otherwise belong to one 
account class (and the money, securities, and/or other property 
margining, guaranteeing, or securing such positions), are, pursuant 
to a Commission order, commingled with positions in commodity 
contracts of the futures account class (and the money, securities, 
and/or other property margining, guaranteeing, or securing such 
positions), then the former positions (and the relevant money, 
securities, and/or other property) shall be treated, for purposes of 
this part, as being held in an account of the futures account 
class.''
    In making the abovementioned changes, the Commission intends to 
remove any possible doubt that:
     OTC derivatives subject to a Section 4d Order 
(including from inception) are ``cleared OTC derivatives'' within 
the meaning of Regulation 190.01(oo), but that such derivatives 
shall be treated, pursuant to Regulation 190.01(a), as belonging to 
the futures account class and not the cleared OTC derivative account 
class; and
     OTC derivatives not subject to a Section 4d Order may 
become ``cleared OTC derivatives'' within the meaning of Regulation 
190.01(oo), but that such derivatives shall be treated, pursuant to 
Regulation 190.01(a), as belonging to the cleared OTC derivative 
account class and not the futures account class.
---------------------------------------------------------------------------

    It is outside the purview of this release to propose objective 
standards for determining which cleared OTC derivative contracts would 
be eligible

[[Page 17301]]

for a Section 4d Order. For the abovementioned reasons, such standards 
are not necessary to effectuate the purposes of the proposed rules 
contained in the Notice (including the proposed amendment to Regulation 
190.01(a)).\46\
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    \46\ As the Notice states: ``The Commission is proposing [to 
create an account class for cleared OTC derivatives] at this time 
because of increased interest among DCOs in clearing OTC 
derivatives, and the need to enhance certainty regarding the 
treatment of cleared OTC derivatives in the bankruptcy of a 
commodity broker in bankruptcy.'' 74 FR at 40796.
---------------------------------------------------------------------------

    A third commenter poses questions pertaining to the operation of 
the futures account class after the Commission establishes a separate 
account class for cleared OTC derivatives.\47\ In answer to such 
questions, the Commission makes the following three observations. 
First, the Commission will continue to review petitions for Section 4d 
Orders and will approve such petitions in appropriate cases. Second, 
the only effect of this release on contracts (and relevant collateral) 
that, pursuant to a previously issued Section 4d Order, are permitted 
to be commingled with contracts (and relevant collateral) of the 
futures account class, is to codify the Statement on Cleared OTC 
Derivatives and the Interpretative Statement that the Commission issued 
on November 30, 2004 (the ``Statement on Commingling Foreign Futures 
Positions''),\48\ which, in each case, provides that such contracts 
(and relevant collateral) are to be treated as part of the futures 
account class. This release does not in any way vitiate any previously 
issued Section 4d Order. Finally, in the absence of an appropriate 
order, the Commission does not intend to permit positions in the 
futures account class and positions in the separate account class for 
cleared OTC derivatives to be margined as a single portfolio.
---------------------------------------------------------------------------

    \47\ Specifically, ELX asks:
     ``[W]hether the DCO will be permitted to cross margin 
the new account class envisioned by the Proposed Rules against 
related products in different account classes * * *''
     ``Will 4d exemptions still be granted after the new 
account class is created?''
     ``What will be the status of previously granted 4d 
exemptions, and will they be grandfathered or required to be 
transferred into the new account class?''
    ELX CL04 at 2.
    \48\ The Statement on Cleared OTC Derivatives can be found at 73 
FR 65514 (November 4, 2008). The Statement on Commingling Foreign 
Futures Positions can be found at 69 FR 69510 (November 30, 2004).
---------------------------------------------------------------------------

VI. Recommendation That the Commission Establish Rules for the 
Treatment of Positions in Cleared OTC Derivatives (and Relevant 
Collateral)

    In the Notice, the Commission stated that it ``[did] not intend to 
specify substantive requirements for the treatment of cleared OTC 
derivatives (and the money, securities, and/or other property 
margining, guaranteeing, or securing such derivatives). Rather, the 
Commission propose[d] to define `cleared OTC derivatives' in such a 
manner as to specify the sources from which such substantive 
requirements may originate.'' As the Notice indicates, a DCO rule or 
bylaw constitutes one possible source for such substantive 
requirements. Because different DCOs may adopt different substantive 
requirements, such DCOs may afford varying levels of protection to 
positions in cleared OTC derivatives (and relevant collateral).\49\
---------------------------------------------------------------------------

    \49\ As The CME Group accurately observed, the proposed 
definition of ``cleared OTC derivatives'' in the Notice would 
permit, for example, ``one DCO [to] model its rule on the 
requirements for 4d segregated accounts which limit the instruments 
in which such funds may be invested to those set forth in Regulation 
1.25,'' and ``another DCO [to] use Regulation 30.7 requirements as 
its guide, and choose not to specify permissible investments.'' The 
CME Group CL03 at 6.
---------------------------------------------------------------------------

    Two commenters disagree with such approach. They recommend that the 
Commission specify substantive requirements with respect to the 
treatment of positions in cleared OTC derivatives (and relevant 
collateral), if the DCO requires such positions (and relevant 
collateral) to be held in a separate account for cleared OTC 
derivatives.\50\ One commenter observes:
---------------------------------------------------------------------------

    \50\ FIA states: ``In adopting these standards, the Commission 
should also provide guidance regarding the treatment of funds 
deposited to margin `cleared OTC derivatives.' '' FIA CL02 at 4.
    In addition, The CME Group states:
    Given that the Commission's goal is to ensure that customers 
clearing OTC derivatives receive bankruptcy protection, and in the 
interest of providing consistency in the safeguards for OTC customer 
positions and margins, the Commission should define the minimum 
requirements that must apply to cleared OTC derivatives accounts for 
transactions that are cleared through any DCO with respect to those 
areas that the Commission has already addressed for 4d accounts, 
including permitted investments, recordkeeping, and acknowledgement 
letters. The CME Group CL03 at 6-7.

    Depending on how much the requirements for cleared OTC 
derivatives accounts vary among DCOs, FCMs could find themselves in 
the position of having to maintain multiple cleared OTC derivatives 
accounts with respect to different DCOs. Moreover, under the 
Commission proposal, all cleared OTC derivatives accounts are 
considered to be part of the same account class, even if the 
accounts relate to multiple DCOs with varying requirements for such 
accounts. Therefore, the available funds in the cleared OTC 
derivatives account class could be diluted for customers of a 
bankrupt FCM who hold OTC derivatives cleared by a DCO with more 
stringent requirements because the account class also contains the 
margins of customers who hold OTC derivatives cleared by a DCO with 
less stringent requirements.\51\
---------------------------------------------------------------------------

    \51\ See The CME Group CL03 at 6.

    The Commission does not disagree with the recommendations of the 
two commenters, and has directed staff to recommend for the 
Commission's consideration proposals that would impose substantive 
requirements with respect to the treatment of positions in cleared OTC 
derivatives (and relevant collateral).
    The Commission has decided to promulgate the final rules contained 
in this release, without waiting to propose the abovementioned 
requirements, because the Commission believes that it is important, in 
light of recent market events (including disruptions in global credit 
markets), to enhance certainty, as soon as possible, with respect to 
the protections available under Subchapter IV and Regulation Part 190 
to positions in cleared OTC derivatives (and relevant collateral), 
however the FCM and the DCO treat such collateral. Moreover, the 
Commission believes that it is important to enhance certainty, as soon 
as possible, regarding the treatment, in a bankruptcy of any commodity 
broker, of customers with positions (and relevant collateral) subject 
to a Section 4d Order. Therefore, for the avoidance of doubt, the 
Commission clarifies that, after the final rules become effective, a 
position in an OTC derivative (and relevant collateral) that a customer 
clears through an FCM with a DCO, which position (and collateral) is 
not subject to a Section 4d Order, would be considered part of the 
cleared OTC derivative account class, as soon as, but only after, a DCO 
rule or bylaw that requires such positions (and relevant collateral) to 
be held in a separate account for cleared OTC derivatives becomes 
effective, either through self-certification or approval by the 
Commission.\52\ Such rule or bylaw need not specify any particular 
treatment of such positions (and relevant collateral) at this time in 
order for such positions to be considered within the OTC derivative 
account class.
---------------------------------------------------------------------------

    \52\ See Regulations 40.5 and 40.6 (17 CFR 40.5, 40.6).

---------------------------------------------------------------------------

[[Page 17302]]

VII. Related Matters

A. Regulatory Flexibility Act

    The Regulatory Flexibility Act (``RFA'') \53\ requires Federal 
agencies, in promulgating regulations, to consider the impact of those 
regulations on small businesses. The final rules promulgated in this 
release will affect only FCMs and DCOs. The Commission has previously 
established certain definitions of ``small entities'' to be used by the 
Commission in evaluating the impact of its regulations in accordance 
with the RFA.\54\ The Commission has previously determined that FCMs 
\55\ and DCOs \56\ are not small entities for the purpose of the RFA. 
Accordingly, pursuant to 5 U.S.C. 605(b), the Chairman, on behalf of 
the Commission, certifies that the final rules promulgated herein will 
not have a significant impact on a substantial number of small 
entities.
---------------------------------------------------------------------------

    \53\ 5 U.S.C. 601 et seq.
    \54\ 47 FR 18618 (April 30, 1982).
    \55\ Id. at 18619.
    \56\ 66 FR 45604, 45609 (August 29, 2001).
---------------------------------------------------------------------------

B. Paperwork Reduction Act

    The Paperwork Reduction Act of 1995 (``PRA'') \57\ imposes certain 
requirements on Federal agencies in connection with their conducting or 
sponsoring any ``collection of information'' as defined by the PRA. The 
final rules promulgated in this release do not require the new 
collection of information on the part of DCOs or FCMs. Accordingly, for 
purposes of the PRA, the Commission certifies that the final rules 
promulgated in this release would not impose any new reporting or 
recordkeeping requirements.
---------------------------------------------------------------------------

    \57\ 44 U.S.C. 3501-3520.
---------------------------------------------------------------------------

C. Cost-Benefit Analysis

    Section 15(a) of the Act requires that the Commission, before 
promulgating a regulation under the Act or issuing an order, consider 
the costs and benefits of its action. By its terms, Section 15(a) of 
the Act does not require the Commission to quantify the costs and 
benefits of a new regulation or determine whether the benefits of the 
regulation outweigh its costs. Rather, Section 15(a) of the Act simply 
requires the Commission to ``consider the costs and benefits'' of its 
action.
    Section 15(a) of the Act further specifies that costs and benefits 
shall be evaluated in light of the following considerations: (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. Accordingly, the Commission could, in its 
discretion, give greater weight to any one of the five considerations 
and could determine that, notwithstanding its costs, a particular 
regulation was necessary or appropriate to protect the public interest 
or to effectuate any of the provisions or to accomplish any of the 
purposes of the Act.
    The Commission has evaluated the costs and benefits of the final 
rules promulgated in this release in light of (i) the comments that it 
has received on the Notice and (ii) the specific considerations 
identified in Section 15(a) of the Act, as follows:
1. Protection of Market Participants and the Public
    The final rules promulgated in this release would benefit FCMs and 
DCOs, as well as customers of the futures and options markets, by 
providing greater certainty, (i) in a bankruptcy of a commodity broker 
that is an FCM, regarding the treatment of cleared OTC derivatives, and 
(ii) in a bankruptcy of any commodity broker, regarding the allocation 
of positions in commodity contracts (and relevant money, securities, 
and/or other property) of one account class that are commingled in an 
FCM or DCO account, pursuant to a Section 4d Order, with positions in 
commodity contracts (and relevant money, securities, and/or other 
property) of the futures account class.
2. Efficiency and Competition
    The final rules promulgated in this release are not expected to 
have an effect on efficiency or competition.
3. Financial Integrity of Futures Markets and Price Discovery
    The final rules promulgated in this release would enhance the 
protection, in the bankruptcy of a commodity broker that is an FCM, of 
customers with positions in cleared OTC derivatives by providing an 
account class in which to hold such positions (and relevant money, 
securities, and/or other property). Further, the final rules would 
enhance certainty regarding the treatment, in a bankruptcy of any 
commodity broker, of customers with positions (and relevant money, 
securities, and/or other property) subject to a Section 4d Order, by 
removing concerns regarding whether the Statement on Cleared OTC 
Derivatives, as well as the Statement on Commingling Foreign Futures 
Positions, would be limited to the specific factual patterns addressed 
therein. Thus, the final rules would contribute to the financial 
integrity of the futures and options markets as a whole.
4. Sound Risk Management Practices
    The final rules promulgated in this release would reinforce the 
sound risk management practices already required of FCMs and DCOs, by 
(i) providing an account class, in the bankruptcy of a commodity broker 
that is an FCM, in which to hold positions in cleared OTC derivatives 
(and relevant money, securities, and/or other property), and (ii) 
providing certainty to FCMs and DCOs regarding the allocation between 
account classes, in a bankruptcy of any commodity broker, of customer 
positions (and relevant money, securities, and/or other property) 
subject to a Section 4d Order.
5. Other Public Considerations
    Recent market events, including disruptions in global credit 
markets, render it prudent to enhance certainty regarding the treatment 
of customer positions (and relevant money, securities, and/or other 
property) in a commodity broker bankruptcy.
    Accordingly, after considering the five factors enumerated in the 
Act, the Commission has determined to promulgate the final rules as set 
forth below.

List of Subjects in 17 CFR Part 190

    Bankruptcy, Brokers, Commodity futures.

0
For the reasons stated in the preamble, the Commission hereby amends 17 
CFR part 190 as follows:

PART 190--BANKRUPTCY

0
1. The authority citation for part 190 continues to read as follows:

    Authority:  7 U.S.C. 1a, 2, 4a, 6c, 6d, 6g, 7a, 12, 19, and 24, 
and 11 U.S.C. 362, 546, 548, 556, and 761-766, unless otherwise 
noted.

0
2. In Sec.  190.01, revise paragraph (a) and add paragraph (oo) to read 
as follows:


Sec.  190.01  Definitions.

* * * * *
    (a) Account class means each of the following types of customer 
accounts which must be recognized as a separate class of account by the 
trustee: futures accounts, foreign futures accounts, leverage accounts, 
commodity option accounts, delivery accounts as defined in Sec.  
190.05(a)(2), and, only with respect to the bankruptcy of a commodity 
broker that is a futures commission merchant, cleared OTC derivatives 
accounts; Provided, however, That to the extent that the equity 
balance, as defined in Sec.  190.07, of a customer in a

[[Page 17303]]

commodity option, as defined in Sec.  1.3(hh) of this chapter, may be 
commingled with the equity balance of such customer in any domestic 
commodity futures contract pursuant to regulations under the Act, the 
aggregate shall be treated for purposes of this part as being held in a 
futures account; Provided, further, that, if positions in commodity 
contracts that would otherwise belong to one account class (and the 
money, securities, and/or other property margining, guaranteeing, or 
securing such positions), are, pursuant to a Commission order, 
commingled with positions in commodity contracts of the futures account 
class (and the money, securities, and/or other property margining, 
guaranteeing, or securing such positions), then the former positions 
(and the relevant money, securities, and/or other property) shall be 
treated, for purposes of this part, as being held in an account of the 
futures account class.
* * * * *
    (oo) Cleared OTC derivatives shall mean positions in commodity 
contracts that have not been entered into or traded on a contract 
market (as such term is defined in Sec.  1.3(h) of this chapter) or on 
a derivatives transaction execution facility (within the meaning of 
Section 5a of the Act), but which nevertheless are submitted through a 
commodity broker that is a futures commission merchant (as such term is 
defined in Sec.  1.3(p) of this chapter) for clearing by a clearing 
organization (as such term is defined in this section), along with the 
money, securities, and/or other property margining, guaranteeing, or 
securing such positions, which are required to be segregated or set 
aside, in accordance with a rule, regulation, or order issued by the 
Commission, or which are required to be held in a separate account for 
cleared OTC derivatives only, in accordance with the rules or bylaws of 
a clearing organization (as such term is defined in this section).

0
4. In Sec.  190.07, revise paragraph (b)(2)(viii) to read as follows:


Sec.  190.07  Calculation of allowed net equity.

    (b) * * *
    (2) * * *
    (viii) Subject to paragraph (b)(2)(ix) of this section, the futures 
accounts, leverage accounts, options accounts, foreign futures 
accounts, and cleared OTC derivatives accounts of the same person shall 
not be deemed to be held in separate capacities: Provided, however, 
That such accounts may be aggregated only in accordance with paragraph 
(b)(3) of this section.
* * * * *

0
5. Amend ``bankruptcy appendix form 4--proof of claim'' in Appendix A 
to Part 190 by revising paragraph a in section III to read as follows:

Appendix A to Part 190--Bankruptcy Forms

* * * * *
bankruptcy appendix form 4--proof of claim
* * * * *
    III. * * *
    a. Whether the account is a futures, foreign futures, leverage, 
option (if an option account, specify whether exchange-traded or 
dealer), ``delivery'' account, or, only with respect to a bankruptcy 
of a commodity broker that is a futures commission merchant, a 
cleared OTC derivatives account. A ``delivery'' account is one which 
contains only documents of title, commodities, cash, or other 
property identified to the claimant and deposited for the purposes 
of making or taking delivery on a commodity underlying a commodity 
contract or for payment of the strike price upon exercise of an 
option.

    Issued in Washington, DC, on March 31, 2010, by the Commission.
David A. Stawick,
Secretary of the Commission.
[FR Doc. 2010-7742 Filed 4-5-10; 8:45 am]
BILLING CODE P
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