69334 Federal Register / Vol. 76, No. 216 / Tuesday, November 8, 2011 / Rules and Regulations 

1See Dodd-Frank Wall Street Reform and 

Consumer Protection Act, Public Law 111–203, 124 

Stat. 1376 (2010). The text of the Dodd-Frank Act 

may be accessed at http://www.cftc.gov/ 

LawRegulation/OTCDERIVATIVES/index.htm. 

2Pursuant to Section 701 of the Dodd-Frank Act, 

Title VII may be cited as the ‘‘Wall Street 

Transparency and Accountability Act of 2010.’’ 

3 7 U.S.C. 1 et seq. 

4See Commodity Futures Modernization Act of 

2000, Public Law 106–554, 114 Stat. 2763 (2000). 

5See 66 FR 45604 (Aug. 29, 2001) (adopting 17 

CFR part 39, app. A). 

6Section 8a(5) of the CEA authorizes the 

Commission to promulgate such regulations ‘‘as, in 

the judgment of the Commission, are reasonably 

necessary to effectuate any of the provisions or to 

accomplish any of the purposes of [the CEA].’’ 7 

U.S.C. 12a(5). 

COMMODITY FUTURES TRADING 

COMMISSION 

17 CFR Parts 1, 21, 39, and 140 

RIN 3038–AC98 

Derivatives Clearing Organization 

General Provisions and Core 

Principles 

AGENCY: Commodity Futures Trading 

Commission. 

ACTION: Final rule. 

SUMMARY: The Commodity Futures 

Trading Commission (Commission) is 

adopting final regulations to implement 

certain provisions of Title VII and Title 

VIII of the Dodd-Frank Wall Street 

Reform and Consumer Protection Act 

(Dodd-Frank Act) governing derivatives 

clearing organization (DCO) activities. 

More specifically, the regulations 

establish the regulatory standards for 

compliance with DCO Core Principles A 

(Compliance), B (Financial Resources), 

C (Participant and Product Eligibility), D 

(Risk Management), E (Settlement 

Procedures), F (Treatment of Funds), G 

(Default Rules and Procedures), H (Rule 

Enforcement), I (System Safeguards), J 

(Reporting), K (Recordkeeping), L 

(Public Information), M (Information 

Sharing), N (Antitrust Considerations), 

and R (Legal Risk) set forth in Section 

5b of the Commodity Exchange Act 

(CEA). The Commission also is updating 

and adding related definitions; adopting 

implementing rules for DCO chief 

compliance officers (CCOs); revising 

procedures for DCO applications 

including the required use of a new 

Form DCO; adopting procedural rules 

applicable to the transfer of a DCO 

registration; and adding requirements 

for approval of DCO rules establishing a 

portfolio margining program for 

customer accounts carried by a futures 

commission merchant (FCM) that is also 

registered as a securities broker-dealer 

(FCM/BD). In addition, the Commission 

is adopting certain technical 

amendments to parts 21 and 39, and is 

adopting certain delegation provisions 

under part 140. 

DATES: The rules will become effective 

January 9, 2012. DCOs must comply 

with §§ 39.11; 39.12; 39.13 (except for 

39.13(g)(8)(i)); and 39.14 by May 7, 

2012; with §§ 39.10(c); 39.13(g)(8)(i); 

39.18; 39.19; and 39.20 by November 8, 

2012; and all other provisions of these 

rules by January 9, 2012. 

FOR FURTHER INFORMATION CONTACT: 

Phyllis P. Dietz, Deputy Director, (202) 

418–5449, pdietz@cftc.gov; John C. 

Lawton, Deputy Director, (202) 418– 

5480, jlawton@cftc.gov; Robert B. 

Wasserman, Chief Counsel, (202) 418– 

5092, rwasserman@cftc.gov; Eileen A. 

Donovan, Associate Director, (202) 418– 

5096, edonovan@cftc.gov; Jonathan 

Lave, Special Counsel, (202) 418–5983, 

jlave@cftc.gov, Division of Clearing and 

Risk; and Jacob Preiserowicz, Special 

Counsel, (202) 418–5432, 

jpreiserowicz@cftc.gov, Division of 

Swap Dealer and Intermediary 

Oversight, Commodity Futures Trading 

Commission, Three Lafayette Centre, 

1155 21st Street NW., Washington, DC 

20581; and Julie A. Mohr, Deputy 

Director, (312) 596–0568, 

jmohr@cftc.gov; and Anne C. Polaski, 

Special Counsel, (312) 596–0575, 

apolaski@cftc.gov, Division of Clearing 

and Risk, Commodity Futures Trading 

Commission, 525 West Monroe Street, 

Chicago, Illinois 60661. 

SUPPLEMENTARY INFORMATION: 

Table of Contents 

I. Background 

A. Title VII of the Dodd-Frank Act 

B. Title VIII of the Dodd-Frank Act 

C. Regulatory Framework for DCOs 

II. Part 1 Amendments—Definitions 

III. Part 39 Amendments—General Provisions 

A. Scope 

B. Definitions 

C. Procedures for Registration 

D. Procedures for Implementing DCO Rules 

and Clearing New Products 

E. Reorganization of Part 39 

F. Technical Amendments 

IV. Part 39 Amendments—Core Principles 

A. Compliance with Core Principles 

B. Financial Resources 

C. Participant and Product Eligibility 

D. Risk Management 

E. Settlement Procedures 

F. Treatment of Funds 

G. Default Rules and Procedures 

H. Rule Enforcement 

I. System Safeguards 

J. Reporting 

K. Recordkeeping 

L. Public Information 

M. Information Sharing 

N. Antitrust Considerations 

O. Legal Risk Considerations 

P. Special Enforcement Authority for 

SIDCOs 

V. Part 140 Amendments—Delegations of 

Authority 

VI. Effective Dates 

VII. Section 4(c) 

VIII. Consideration of Costs and Benefits 

IX. Related Matters 

A. Regulatory Flexibility Act 

B. Paperwork Reduction Act 

I. Background 

A. Title VII of the Dodd-Frank Act 

On July 21, 2010, President Obama 

signed the Dodd-Frank Act.1 Title VII of 

the Dodd-Frank Act 2 amended the 

CEA 3 to establish a comprehensive 

statutory framework to reduce risk, 

increase transparency, and promote 

market integrity within the financial 

system by, among other things: (1) 

Providing for the registration and 

comprehensive regulation of swap 

dealers and major swap participants; (2) 

imposing clearing and trade execution 

requirements on standardized derivative 

products; (3) creating rigorous 

recordkeeping and real-time reporting 

regimes; and (4) enhancing the 

Commission’s rulemaking and 

enforcement authorities with respect to 

all registered entities and intermediaries 

subject to the Commission’s oversight. 

Section 725(c) of the Dodd-Frank Act 

amended Section 5b(c)(2) of the CEA, 

which sets forth core principles with 

which a DCO must comply in order to 

be registered and to maintain 

registration as a DCO. 

The core principles were added to the 

CEA by the Commodity Futures 

Modernization Act of 2000 (CFMA).4

The Commission did not adopt 

implementing rules and regulations, but 

instead promulgated guidance for DCOs 

on compliance with the core 

principles.5 Under Section 5b(c)(2) of 

the CEA, as amended by the Dodd-Frank 

Act, Congress expressly confirmed that 

the Commission may adopt 

implementing rules and regulations 

pursuant to its rulemaking authority 

under Section 8a(5) of the CEA.6

In light of Congress’s explicit 

affirmation of the Commission’s 

authority to adopt regulations to 

implement the core principles, the 

Commission has chosen to adopt 

regulations (which have the force of 

law) rather than guidance (which does 

not have the force of law). By issuing 

regulations, the Commission expects to 

increase legal certainty for DCOs, 

clearing members, and market 

participants, and prevent DCOs from 

lowering risk management standards for 

competitive reasons and taking on more 

risk than is prudent. The imposition of 

legally enforceable standards provides 

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Federal Register / Vol. 76, No. 216 / Tuesday, November 8, 2011 / Rules and Regulations 69335 

7See 76 FR 44763 (July 27, 2011) (FSOC authority 

to designate financial market utilities as 

systemically important; final rule). 

8The Commission is reserving for a future final 

rulemaking certain proposed amendments relating 

to participant and product eligibility. See 76 FR 

13101 (Mar. 10, 2011) (requirements for processing, 

clearing, and transfer of customer positions 

(Straight-Through Processing)); and 76 FR 45730 

(Aug. 1, 2011) (customer clearing documentation 

and timing of acceptance for clearing (Customer 

Clearing)). 

9The Commission is reserving for a future final 

rulemaking regulations to implement DCO Core 

Principles O (Governance Fitness Standards) and Q 

(Composition of Governing Boards) (76 FR 722 (Jan. 

6, 2011) (Governance)); and Core Principle P 

(Conflicts of Interest) (75 FR 63732 (Oct. 18, 2010) 

(Conflicts of Interest)). 

10See Section 5b(i) of the CEA, 7 U.S.C 7a–1(i). 11See 76 FR 13101 (Mar. 10, 2011) (StraightThrough Processing); 76 FR 3698 (Jan. 20, 2011) 

(Core Principles C, D, E, F, G, and I (Risk 

Management)); 75 FR 78185 (Dec. 15, 2010) (Core 

Principles J, K, L, and M (Information 

Management)); 75 FR 77576 (Dec. 13, 2010) (Core 

Principles A, H, N, and R (General Regulations)); 

and 75 FR 63113 (Oct. 14, 2010) (Core Principle B 

(Financial Resources)). 

12See 76 FR 25274 (May 4, 2011) (extending or 

re-opening comment periods for multiple DoddFrank proposed rulemakings); see also 76 FR 16587 

(Mar. 24, 2011) (re-opening 30-day comment period 

for reporting requirement with clause omitted in the 

notice of proposed rulemaking). 

13Comment files for each proposed rulemaking 

can be found on the Commission Web site, 

www.cftc.gov. 

assurance to market participants and the 

public that DCOs are meeting minimum 

risk management standards. This can 

serve to increase market confidence 

which, in turn, can increase open 

interest and free up resources that 

market participants might otherwise 

hold in order to compensate for weaker 

DCO risk management practices. 

Regulatory standards also can reduce 

search costs that market participants 

would otherwise incur in determining 

that DCOs are managing risk effectively. 

B. Title VIII of the Dodd-Frank Act 

Section 802(b) of the Dodd-Frank Act 

states that the purpose of Title VIII is to 

mitigate systemic risk in the financial 

system and promote financial stability. 

Section 804 authorizes the Financial 

Stability Oversight Council (FSOC) to 

designate entities involved in clearing 

and settlement as systemically 

important.7

Section 805(a) of the Dodd-Frank Act 

allows the Commission to prescribe 

regulations for those DCOs that the 

Council has determined are systemically 

important (SIDCOs). The Commission 

proposed heightened requirements for 

SIDCO financial resources and system 

safeguards for business continuity and 

disaster recovery. 

Section 807(c) of the Dodd-Frank Act 

provides the Commission with special 

enforcement authority over SIDCOs, 

which the Commission proposed to 

codify in its regulations. 

C. Regulatory Framework for DCOs 

The Commission, now responsible for 

regulating swaps markets as well as 

futures markets, has undertaken an 

unprecedented rulemaking initiative to 

implement the Dodd-Frank Act. As part 

of this initiative, the Commission has 

issued a series of eight proposed 

rulemakings that, together, would 

establish a comprehensive regulatory 

framework for the clearing and 

settlement activities of DCOs. Through 

these proposed regulations, the 

Commission sought to enhance legal 

certainty for DCOs, clearing members, 

and market participants, to strengthen 

the risk management practices of DCOs, 

and to promote financial integrity for 

swaps and futures markets. 

In this notice of final rulemaking, the 

Commission is adopting regulations to 

implement 15 DCO core principles: A 

(Compliance), B (Financial Resources), 

C (Participant and Product Eligibility),8

D (Risk Management), E (Settlement 

Procedures), F (Treatment of Funds), 

G (Default Rules and Procedures), H 

(Rule Enforcement), I (System 

Safeguards), J (Reporting), K 

(Recordkeeping), L (Public Information), 

M (Information Sharing), N (Antitrust 

Considerations), and R (Legal Risk).9 In 

addition, the Commission is adopting 

regulations to implement the CCO 

provisions of Section 725 of the DoddFrank Act.10

The final rules adopted herein were 

proposed in five separate notices of 

proposed rulemaking.11 Each proposed 

rulemaking was subject to an initial 60- 

day public comment period and a reopened comment period of 30 days.12

After the second comment period 

ended, the Commission informed the 

public that it would continue to accept 

and consider late comments and did so 

until August 25, 2011. The Commission 

received a total of approximately 119 

comment letters directed specifically at 

the proposed rules, in addition to many 

other comments applicable to the DoddFrank Act rulemaking initiative more 

generally.13 The Chairman and 

Commissioners, as well as Commission 

staff, participated in numerous meetings 

with representatives of DCOs, FCMs, 

trade associations, public interest 

groups, traders, and other interested 

parties. In addition, the Commission has 

consulted with other U.S. financial 

regulators including the Board of 

Governors of the Federal Reserve 

System and Securities and Exchange 

Commission (SEC). 

The Commission is mindful of the 

benefits of harmonizing its regulatory 

framework with that of its counterparts 

in foreign countries. The Commission 

has therefore monitored global advisory, 

legislative, and regulatory proposals, 

and has consulted with foreign 

regulators in developing the proposed 

and final regulations for DCOs. 

The Commission is of the view that 

each DCO should be afforded an 

appropriate level of discretion in 

determining how to operate its business 

within the legal framework established 

by the CEA, as amended by the DoddFrank Act. At the same time, the 

Commission recognizes that specific, 

bright-line regulations may be necessary 

to facilitate DCO compliance with a 

given core principle and, ultimately, to 

protect the integrity of the U.S. 

derivatives clearing system. 

Accordingly, in developing the 

proposed regulations and in finalizing 

the regulations adopted herein, taking 

into consideration public comments and 

views expressed by U.S. and foreign 

regulators, the Commission has 

endeavored to strike an appropriate 

balance between establishing general 

prudential standards and specific 

requirements. 

In determining the scope and content 

of the final rules, the Commission has 

taken into account concerns raised by 

commenters regarding the implications 

of specific rules for smaller versus larger 

DCOs, DCOs that do not clear customer 

positions versus those with a traditional 

customer model, clearinghouses that are 

registered as both a DCO and a 

securities clearing agency, and 

clearinghouses that operate in foreign 

jurisdictions as well as in the United 

States. The Commission addresses these 

issues in its discussion of specific rule 

provisions, below. 

The Commission has carefully 

considered the costs and benefits 

associated with each proposed rule, 

with particular attention to public 

comments. For the reasons discussed in 

this notice of final rulemaking, in the 

analyses of specific rule provisions as 

well as in the formal cost-benefit 

analysis, the Commission has 

determined that the final rules 

appropriately balance the costs and 

benefits associated with oversight and 

supervision of DCOs pursuant to the 

CEA, as amended by the Dodd-Frank 

Act. 

The Commission is herein adopting 

regulations to implement the core 

principles applicable to DCOs, to 

implement CCO requirements 

established under the Dodd-Frank Act, 

and to update the regulatory framework 

for DCOs to reflect standards and 

practices that have evolved over the past 

decade since the enactment of the 

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69336 Federal Register / Vol. 76, No. 216 / Tuesday, November 8, 2011 / Rules and Regulations 

14See Section 4s of the CEA, 7 U.S.C. 6s. 

15See 76 FR 33818 (June 9, 2011) (Protection of 

Cleared Swaps Customer Contracts and Collateral; 

Conforming Amendments to the Commodity Broker 

Bankruptcy Provisions); 76 FR 33066 (June 7, 2011) 

(Adaptation of Regulations to Incorporate Swaps). 

CFMA. The Commission is largely 

adopting final rules as proposed, 

although there are a number of proposed 

provisions that, upon further 

consideration in light of comments 

received, the Commission has 

determined to either revise or decline to 

adopt. In the discussion below, the 

Commission highlights topics of 

particular interest to commenters and 

discusses comment letters that are 

representative of the views expressed on 

those topics. The discussion does not 

explicitly respond to every comment 

submitted; rather, it addresses the most 

significant issues raised by the proposed 

rulemakings and it analyzes those issues 

in the context of specific comments. 

The final rules include a number of 

technical revisions to the proposed rule 

text, intended variously to clarify 

certain provisions, standardize 

terminology within part 39, conform 

terminology to that used in other parts 

of the Commission’s rules, and more 

precisely state regulatory standards and 

requirements. These are non-substantive 

changes. For example, the proposed 

DCO rules used the terms ‘‘contract’’ 

and ‘‘product’’ interchangeably, and 

some provisions used the statutory 

language ‘‘contracts, agreements and 

transactions’’ to refer to the products 

subject to Commission regulation. In the 

final rules adopted herein, the 

Commission has revised the 

terminology to uniformly refer to 

‘‘products,’’ which encompasses 

contracts, agreements, and transactions, 

except where the language of the rule 

codifies statutory language. In those 

cases, the rule text is unchanged. 

For easy reference and for purposes of 

clarification, in this notice of final 

rulemaking the Commission is 

publishing the complete part 39 as 

currently adopted. This means that 

certain longstanding rules that are not 

being amended (e.g., § 39.8 (formerly 

designated as § 39.7, fraud in 

connection with the clearing of 

transactions of a DCO), and rules 

recently adopted (§ 39.5, review of 

swaps for Commission determination on 

clearing requirement) are being republished along with the newly-adopted 

rules. Rules that have been proposed but 

not yet adopted in final form are 

identified in part 39 as ‘‘reserved.’’ 

II. Part 1 Amendments—Definitions 

The Commission proposed to amend 

the definitions of ‘‘clearing member,’’ 

‘‘clearing organization,’’ and ‘‘customer’’ 

found in § 1.3 of its regulations to 

conform the definitions with the 

terminology and substantive provisions 

of the CEA, as amended by the DoddFrank Act. The Commission also 

proposed to add to § 1.3, definitions for 

‘‘clearing initial margin,’’ ‘‘customer 

initial margin,’’ ‘‘initial margin,’’ 

‘‘margin call,’’ ‘‘spread margin,’’ and 

‘‘variation margin.’’ 

ISDA commented that the margin 

definitions are appropriate for futures 

and cleared derivatives, but less readily 

applicable in the uncleared OTC 

derivatives context. It suggested that the 

definitions should expressly provide 

that they apply only to cleared 

transactions. The Commission notes that 

some of the definitions by their terms 

already apply only to cleared trades, 

e.g., ‘‘clearing initial margin.’’ Other 

terms, however, have applicability to 

both cleared and uncleared trades, e.g., 

‘‘initial margin.’’ 14

The Commission proposed to define 

‘‘spread margin’’ as ‘‘reduced initial 

margin that takes into account 

correlations between certain related 

positions held in a single account.’’ 

Better Markets commented that the 

definition of ‘‘spread margin’’ omits key 

characteristics of netting initial margin 

which are needed to precisely define 

spread margin. Better Markets proposed 

to define it as ‘‘initial margin relating to 

two positions in a single account that 

has been reduced from the aggregate 

initial margin otherwise applicable to 

the two positions by application of an 

algorithm that measures statistical 

correlations between the historic price 

movements of the two positions.’’ The 

Commission is adopting the definition 

of ‘‘spread margin’’ as proposed because 

it believes that Better Markets’ 

definition adds unnecessary details that 

could have the unintended effect of 

imposing substantive margin 

methodology requirements in a 

definition. 

In light of proposed rulemakings 

issued after the Commission proposed 

the definition of ‘‘customer; commodity 

customer; swap customer,’’ the 

Commission is making certain technical 

modifications.15 First, instead of placing 

the definition in § 1.3, which serves as 

the general definition section for all of 

the Commission’s regulations, this 

definition is being moved to § 39.2, 

which sets forth definitions applicable 

only to regulations found in part 39 or 

as otherwise explicitly provided. This 

accommodates the need for further 

consideration of other proposals before 

a global definition is adopted, while 

satisfying the need for a definition for 

purposes of part 39 as adopted herein. 

Second, the Commission has made 

certain technical changes to the rule text 

in connection with the definition’s 

redesignation in 39.2 and to conform 

phraseology when incorporating by 

reference definitions that appear in the 

CEA and § 1.3. These changes include 

limiting the term to ‘‘customer,’’ 

because the terms ‘‘commodity 

customer’’ and ‘‘swap customer’’ are not 

used in Part 39. 

The Commission is adopting the other 

definitions as proposed. 

III. Part 39 Amendments—General 

Provisions 

A. Scope—§ 39.1 

As originally proposed, § 39.1 

included an updated statement of scope 

and definitions applicable to other 

provisions in part 39. The Commission 

later revised proposed § 39.1 to include 

only the statement of scope. The 

Commission did not receive any 

comments on the statement of scope, 

which was updated to include 

references to the definition of 

‘‘derivatives clearing organization’’ in 

newly-renumbered Section 1(a)(15) of 

the CEA and § 1.3(d) of the 

Commission’s regulations. The 

Commission is adopting § 39.1 as 

proposed. 

B. Definitions—§ 39.2 

The Commission proposed definitions 

of the terms ‘‘back test,’’ ‘‘compliance 

policies and procedures,’’ ‘‘customer 

account ’’ or ‘‘customer origin,’’ ‘‘house 

account’’ or ‘‘house origin,’’ ‘‘key 

personnel,’’ ‘‘stress test,’’ and 

‘‘systemically important derivatives 

clearing organization.’’ The definitions 

set forth in proposed § 39.2 would apply 

specifically to provisions contained in 

part 39 and such other rules as may 

explicitly cross-reference these 

definitions. The Commission is 

adopting the definitions as proposed, 

with the exceptions discussed below. 

CME Group, Inc. (CME) commented 

that the proposed definition of 

‘‘compliance policies and procedures’’ 

was too broad. That definition was 

proposed as an adjunct to the proposed 

rules for a DCO’s CCO. The Commission 

is not adopting a definition of 

‘‘compliance policies and procedures,’’ 

as it has concluded that a DCO’s 

compliance policies and procedures 

will likely encompass a limited, selfevident body of documents, and a 

regulatory definition could invite more 

scrutiny than is necessary or helpful to 

the DCO or the Commission. 

The Commission proposed to define 

‘‘stress test’’ as ‘‘a test that compares the 

impact of a potential price move, change 

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Federal Register / Vol. 76, No. 216 / Tuesday, November 8, 2011 / Rules and Regulations 69337 

16See discussion of stress tests in section 

IV.D.7.c, below. 17See 76 FR 44776 at 44783–84 (July 27, 2011) 

(Provisions Common to Registered Entities; final 

rule). 18See id. for further discussion of this topic. 

19See 76 FR 722 (Jan. 6, 2011) (Governance); and 

75 FR 63732 (Oct. 18, 2010) (Conflicts of Interest). 

in option volatility, or change in other 

inputs that affect the value of a position, 

to the financial resources of a [DCO], 

clearing member, or large trader to 

determine the adequacy of such 

financial resources.’’ Better Markets, 

Inc. (Better Markets) expressed the view 

that a stress test can only be useful if it 

tests unprecedented circumstances of 

illiquidity, and that basing the test on 

historic price data would make it 

meaningless. In response to this 

comment, the Commission is modifying 

the definition in one respect. The word 

‘‘extreme’’ is being inserted after the 

word ‘‘potential’’ to make clear that a 

stress test does not include typical 

events. The Commission further 

addresses Better Markets’ concerns in its 

discussion of stress tests in 

§ 39.13(h)(3).16

The Commission proposed to define 

the term ‘‘systemically important 

derivatives clearing organization’’ to 

mean ‘‘a financial market utility that is 

a derivatives clearing organization 

registered under Section 5b of the Act 

(7 U.S.C. 7a–1), which has been 

designated by the Financial Stability 

Oversight Council to be systemically 

important.’’ The Options Clearing 

Corporation (OCC) submitted a 

comment on this definition in 

connection with the Commission’s 

proposed § 40.10 (special certification 

procedures for submission of certain 

risk-related rules by SIDCOs).17 OCC 

pointed out that, under this proposed 

definition, a DCO could be a SIDCO 

even if the Commission were not its 

Supervisory Agency pursuant to Section 

803(8) of the Dodd-Frank Act. The 

Commission, recognizing that some 

DCOs like OCC may be regulated by 

more than one federal agency, is 

adopting a revised definition to clarify 

that the term ‘‘systemically important 

derivatives clearing organization’’ 

means a ‘‘financial market utility that is 

a derivatives clearing organization 

registered under Section 5b of the Act, 

which has been designated by the 

Financial Stability Oversight Council to 

be systemically important and for which 

the Commission acts as the Supervisory 

Agency pursuant to Section 803(8) of 

the Dodd-Frank Wall Street Reform and 

Consumer Protection Act.’’ 18

The Commission also is making a 

technical change to the definition of 

‘‘customer account or customer origin.’’ 

The proposed definition would provide, 

in part, that ‘‘[a] customer account is 

also a futures account, as that term is 

defined by Sec. 1.3(vv) of this chapter.’’ 

The Commission is removing this 

reference and defining ‘‘customer 

account or customer origin’’ to mean ‘‘a 

clearing member account held on behalf 

of customers, as that term is defined in 

this section, and which is subject to 

section 4d(a) or section 4d(f) of the 

Act.’’ This clarifies that the term 

encompasses both customer futures 

accounts and customer cleared swaps 

accounts, respectively. 

Similarly, the Commission is making 

a technical revision to the term ‘‘house 

account or house origin’’ to delete the 

proposed reference to proprietary 

accounts, which are currently defined in 

§ 1.3(y) only in terms of futures and 

options (not swaps). The term ‘‘house 

account or house origin’’ is now defined 

as a ‘‘clearing member account which is 

not subject to section 4d(a) or 4d(f) of 

the Act.’’ 

In connection with the proposal to 

adopt a definitions section designated as 

§ 39.2, the Commission proposed to 

rescind the existing § 39.2, which 

exempted DCOs from all Commission 

regulations except those explicitly 

enumerated in the exemption. This 

action would result in clarifying the 

applicability of § 1.49 (denomination of 

customer funds and location of 

depositories) to DCOs and, insofar as the 

rule exempted DCOs from regulations 

relating to DCO governance and 

conflicts of interest, those regulations 

are expected to themselves be replaced 

by rules to implement DCO Core 

Principles O (Governance Fitness 

Standards), P (Conflicts of Interest), and 

Q (Composition of Governing Boards).19

The Commission did not receive any 

comments on the proposed rescission of 

the exemption provided by existing 

§ 39.2 and is herein rescinding that 

exemption, as proposed. 

C. Procedures for Registration as a 

DCO—§ 39.3 

The Commission proposed several 

revisions to its procedures for DCO 

registration, including the elimination 

of the 90-day expedited review period 

and the required use of an application 

form, proposed Form DCO. The 

Commission is adopting § 39.3 as 

proposed, and is adopting the Form 

DCO with the revisions discussed 

below. 

1. Form DCO 

The Commission proposed to revise 

appendix A to part 39, ‘‘Application 

Guidance and Compliance with Core 

Principles,’’ by removing the existing 

guidance and substituting the Form 

DCO in its place. An application for 

DCO registration would consist of the 

completed Form DCO, which would 

include all applicable exhibits, and any 

supplemental information submitted to 

the Commission. 

CME commented that the proposed 

Form DCO would require the applicant 

to create and submit to the Commission 

a large number of documents. It 

questioned why certain documents were 

necessary and whether Commission 

staff would be able to meaningfully 

review all of the materials within the 

180-day timeframe contemplated in the 

proposed regulations. 

The Commission is adopting the Form 

DCO as proposed, except for the 

modifications discussed below. The 

Commission notes that the Form DCO 

standardizes and clarifies the 

information that the Commission has 

required from DCO applicants in the 

past and the Form DCO Exhibit 

Instructions, in an effort to reduce the 

burden on applicants, state that ‘‘If any 

Exhibit requires information that is 

related to, or may be duplicative of, 

information required to be included in 

another Exhibit, Applicant may 

summarize such information and 

provide a cross-reference to the Exhibit 

that contains the required information.’’ 

Based on the Commission’s experience 

with the DCO registration process over 

the past decade, it believes that its staff 

can meaningfully review the required 

information within the 180-day time 

frame. In addition, the Commission 

believes that by standardizing 

informational requirements, the Form 

DCO will allow the Commission to 

process applications more quickly and 

efficiently. This will benefit applicants 

as well as free Commission staff to 

handle other regulatory matters. 

CME specifically questioned whether, 

as part of the Form DCO cover sheet, 

applicants should be required to 

identify and list ‘‘all outside service 

providers and consultants, including 

accountants and legal counsel.’’ This 

comment mischaracterizes the 

information required by the Form DCO, 

which requires contact information for 

enumerated outside service providers 

(Certified Public Accountant, legal 

counsel, records storage or management, 

business continuity/disaster recovery) 

and ‘‘other’’ outside service providers 

‘‘such as consultants, providing services 

related to this application.’’ Such 

contact information is helpful to the 

Commission staff in processing the 

application and making a determination 

as to whether the applicant has obtained 

the services it needs to effectively 

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69338 Federal Register / Vol. 76, No. 216 / Tuesday, November 8, 2011 / Rules and Regulations 

20This requirement focuses on outside services 

‘‘related to this application.’’ Similarly, if the 

applicant intends to use the services of an outside 

service provider (including services of its clearing 

members or market participants), to enable it to 

comply with any of the core principles, the 

applicant must submit as exhibit A–10 all 

agreements entered into or to be entered into 

between the applicant and the outside service 

provider, and identify: (1) The services that will be 

provided; (2) the staff who will provide the 

services; and (3) the core principles addressed by 

such arrangement. This exhibit does not require 

that the applicant submit information and 

documentation related to all outside service 

providers. Rather, the requirement is directed at 

contractual arrangements related to compliance 

with the core principles, i.e., the DCO’s core 

business functions. 

operate as a DCO.20 Nonetheless, in 

response to CME’s comments and in 

order to clarify the scope of requesting 

contact information for ‘‘any other 

outside service providers,’’ the 

Commission has decided to revise 

section 12.e. of the Form DCO cover 

sheet to provide for contact information 

for any ‘‘Professional consultant 

providing services related to this 

application.’’ 

CME commented that proposed 

exhibit A–1, which would require the 

applicant to produce a chart 

demonstrating in detail how its rules, 

procedures, and policies address each 

DCO core principle, is not necessary. 

The Commission believes exhibit A–1 is 

necessary because it will provide a clear 

picture of which rules, procedures, and 

policies address each DCO core 

principle. The chart will greatly assist 

Commission staff in tracking and 

evaluating the materials supplied by the 

applicant and should reduce the need 

for staff to seek follow-up clarifications 

from the applicant. Again, this will also 

reduce the costs to the applicant. 

CME commented that the Commission 

has not explained its reasons for 

requiring an applicant to supply 

‘‘telephone numbers, mobile phone 

numbers and email addresses of all 

officers, managers, and directors of the 

DCO,’’ as provided in proposed exhibit 

A–6. The Commission notes that the 

exhibit A–6 instructions request contact 

and other information for ‘‘current 

officers, directors, governors, general 

partners, LLC managers, and members 

of all standing committees.’’ The exhibit 

is not directed at ‘‘all managers’’ or ‘‘all 

directors,’’ but rather at those persons 

who are in key decision-making 

positions (for example, key personnel, 

directors serving on a board of directors 

and a manager or managing member of 

a DCO organized in the form of a limited 

liability corporation). The purpose of 

obtaining contact information is to 

enable the Commission to start building 

an emergency contact database. 

CME commented that proposed 

exhibit A–7 would require the applicant 

to list all jurisdictions where the 

applicant and its affiliates are doing 

business, and the registration status of 

the applicant and its affiliates. CME 

questioned the Commission’s need for 

such information with respect to 

affiliates of the applicant. The 

Commission believes that such 

information is necessary because it 

allows the Commission to develop a 

more complete understanding of the 

applicant’s entire corporate 

organizational structure including 

potential financial commitments and 

regulatory obligations of the applicant’s 

affiliates inclusive of its parent 

organization. 

CME commented that proposed 

exhibit B–3, which would require the 

applicant to provide proof that each of 

its physical locations meets all building 

and fire codes, and that it has running 

water and a heating, ventilation and air 

conditioning system, and adequate 

office technology, is not necessary. The 

Commission believes that it is important 

for an applicant to demonstrate that it 

has a physical presence capable of 

supporting clearing and settlement 

services and is not a ‘‘shoestring’’ 

operation. Typically, Commission staff 

will conduct a site visit to an applicant’s 

headquarters and other facilities, and 

one of the purposes of such visits is to 

evaluate the suitability of the 

applicant’s physical facilities. Site 

visits, however, are conducted after a 

DCO application is deemed to be 

materially complete, and there are 

instances when it might not be feasible 

to conduct a site visit. Accordingly, at 

a minimum, a narrative statement 

discussing the applicant’s physical 

facilities and office technology must be 

submitted to the Commission as part of 

the application package so that staff can 

complete its initial review for ‘‘adequate 

* * * operational resources’’ under 

Core Principle B. 

In response to CME’s comments, the 

Commission has decided to revise 

exhibit B–3 to require the following: 

(3) A narrative statement demonstrating the 

adequacy of Applicant’s physical 

infrastructure to carry out business 

operations, which includes a principal 

executive office (separate from any personal 

dwelling) with a U.S. street address (not 

merely a post office box number). For its 

principal executive office and other facilities 

Applicant plans to occupy in carrying out its 

DCO functions, a description of the space 

(e.g., location and square footage), use of the 

space (e.g., executive office, data center), and 

the basis for Applicant’s right to occupy the 

space (e.g., lease, agreement with parent 

company to share leased space). 

(4) A narrative statement demonstrating the 

adequacy of the technological systems 

necessary to carry out Applicant’s business 

operations, including a description of 

Applicant’s information technology and 

telecommunications systems and a timetable 

for full operability. 

CME questioned the value of 

proposed exhibits C–1(9) and C–2(5), 

which would, respectively, require an 

applicant to provide a list of current and 

prospective clearing members, and to 

forecast expected volumes and open 

interest at launch date, six months, and 

one year thereafter. The Commission 

believes that this information is 

important because it would enable the 

Commission to understand the nature 

and level of the DCO’s expected start-up 

activities and to appropriately evaluate 

whether the applicant has adequate 

resources to manage the expected 

volume of business. 

CME questioned the benefits of what 

it termed the ‘‘incredibly burdensome’’ 

requirements of proposed exhibit D– 

2(b)(3), which would require an 

applicant to explain why a particular 

margin methodology was chosen over 

other potentially suitable 

methodologies, and to include a 

comparison of margin levels that would 

have been generated by using such other 

potential methodologies. To address 

CME’s comment, the Commission is 

revising exhibit D–2(b)(3) to require an 

explanation of whether other margining 

methodologies were considered and, if 

so, explain why they were not chosen. 

This information will be sufficient in 

the first instance and, when evaluating 

an applicant’s proposed margin 

methodology, Commission staff can 

request additional information if needed 

to complete its review for compliance 

with Core Principle D and § 39.13 (risk 

management). 

The Commission proposed to require 

use of the Form DCO by a registered 

DCO when requesting an amendment to 

its DCO registration order. CME and 

Minneapolis Grain Exchange, Inc. 

(MGEX) suggested that the Form DCO be 

modified so that a currently registered 

DCO would not have to expend as much 

time and resources to complete an 

amendment request as a new applicant 

for DCO registration, unless there are 

extenuating circumstances. In response 

to this suggestion, the Commission is 

revising the Form DCO General 

Instructions to clarify that if the Form 

DCO is being filed as an amendment to 

a pending application for registration or 

for the purpose of amending an existing 

registration order, the applicant need 

only submit the information and 

exhibits relevant to the application 

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Federal Register / Vol. 76, No. 216 / Tuesday, November 8, 2011 / Rules and Regulations 69339 

21See 76 FR 54538 (Sept. 1, 2011) (SDRs: 

Registration Standards, Duties and Core Principles; 

final rule); 75 FR 80572 (Dec. 22, 2010) (Core 

Principles and Other Requirements for Designated 

Contract Markets); 76 FR 1214 (Jan. 7, 2011) (Core 

Principles and Other Requirements for Swap 

Execution Facilities). 

22For example, the Commission has removed the 

specific cross-references located in exhibit P to 

Form DCO to the proposed conflicts of interest 

rules, 75 FR 63732 (Oct. 18, 2010) (Conflicts of 

Interest), and replaced such references with a 

description of the required information. When the 

Commission finalizes such proposed rules, the 

Commission intends to make technical changes to 

the Form DCO to include cross-references to such 

final rules where, in the opinion of the 

Commission, doing so will facilitate compliance 

with the Form DCO, the CEA and/or Commission 

regulations. 

23As a technical matter, the Commission is 

removing proposed § 39.3(g)(1) and adopting 

proposed § 39.3(h) as § 39.3(f); proposed § 39.3(g)(1) 

was a typographical error which repeats a 

delegation of authority already provided by 

§ 39.3(b)(2)(i). 

24See 76 FR 44464, at 44473–44474 (July 26, 

2011) (Process for Review of Swaps for Mandatory 

Clearing; final rule). 

25See 76 FR 44776 (July 27, 2011) (Provisions 

Common to Registered Entities; final rule). 

26Section 4d(h) of the CEA, 7 U.S.C. 6d(h). 

27Section 15(c)(3)(C) of the SEA, 15 U.S.C. 

78o(c)(3). 

amendment or request for an amended 

registration order. 

CME also noted that a DCO applicant 

would be required to represent that its 

Form DCO submission is true, correct, 

and complete. It suggested that the 

Commission modify this language so 

that the applicant is required to certify 

that, ‘‘to the best of its knowledge,’’ its 

Form DCO submission is true, correct, 

and complete ‘‘in all material respects.’’ 

The Commission is revising the 

language as suggested by CME, in 

recognition of the fact that some of the 

information contained in the exhibits 

may have been provided by third parties 

and there is a limit to the reach of an 

applicant’s due diligence with respect to 

such information. 

In addition to the above changes, the 

Commission has made non-substantive 

editorial changes to the Form DCO for 

purposes of internal consistency and 

conformity with the Form SDR for swap 

data repositories (SDRs) and proposed 

Form DCM and Form SEF for designated 

contract markets (DCMs) and swap 

execution facilities (SEFs), 

respectively.21 The Commission also 

has made changes to Form DCO to 

remove references to proposed 

regulations that remain pending.22

2. Request for Transfer of Registration 

and Open Interest—§ 39.3(h) 

The Commission proposed § 39.3(h) 

to clarify the procedures that a DCO 

must follow when requesting the 

transfer of its DCO registration and 

positions comprising open interest for 

clearing and settlement, in anticipation 

of a corporation change.23 The 

Commission received a comment from 

OCC suggesting that a request to transfer 

a DCO’s registration and open interest 

should be published in the Federal 

Register for public comment. 

The Commission recognizes the value 

of public comment, but it has 

determined not to formalize the public 

comment process through publication in 

the Federal Register. This procedure 

could unnecessarily delay the review 

process and completion of the transfer, 

and the Commission believes that 

posting the request on its Web site, 

which it currently does for DCO 

registration applications, will provide 

an opportunity for public comment 

without potential delay. 

3. Technical Amendments 

The Commission proposed a set of 

technical amendments to § 39.3 to 

update filing procedures, to conform 

various provisions to reflect the 

elimination of the 90-day expedited 

review period for DCO applications, and 

to correct terminology in the delegation 

provisions of § 39.3(g). The Commission 

did not receive any comments on the 

proposed technical amendments and the 

Commission is adopting the 

amendments as proposed. 

D. Procedures for Implementing DCO 

Rules and Clearing New Products— 

§ 39.4 

1. Acceptance of Certain New Products 

for Clearing—§ 39.4(c)(2) 

The Commission proposed a technical 

amendment to existing § 39.4(c)(2), 

which would require a DCO to certify to 

the Commission the terms and 

conditions of new over-the-counter 

(OTC) products that it intended to clear. 

The Commission proposed removing the 

reference to new products ‘‘not traded 

on a designated contract market or a 

registered derivatives transaction 

execution facility’’ and inserting a 

reference to new products ‘‘not traded 

on a designated contract market or a 

registered swap execution facility.’’ The 

proposed provision would retain the 

reference to filing the terms and 

conditions of the new product 

‘‘pursuant to the procedures of § 40.2 of 

this chapter.’’ 

Since proposing that technical 

amendment, the Commission has 

adopted a new § 39.5 (review of swaps 

for Commission determination on 

clearing requirement) 24 and revisions to 

§ 40.2 (listing products for trading by 

certification).25 As a result, a DCO 

seeking to clear new products that are 

not traded on a designated contract 

market or swap execution facility must 

submit to the Commission the terms and 

conditions of the product pursuant to 

the procedures of § 39.5, not § 40.2. The 

Commission is therefore adopting a 

technical revision to conform 

§ 39.4(c)(2) to the current procedural 

requirements. 

2. Holding Securities in a Futures 

Portfolio Margining Account—§ 39.4(e) 

The CEA, as amended by Section 713 

of the Dodd-Frank Act, permits, 

pursuant to an exemption, rule or 

regulation, futures and options on 

futures to be held in a portfolio 

margining account that is carried as a 

securities account and approved by the 

SEC.26 Reciprocally, the Securities 

Exchange Act of 1934 (SEA), as 

amended by Section 713 of the DoddFrank Act, permits, pursuant to an 

exemption, rule, or regulation, cash and 

securities to be held in a portfolio 

margining account that is carried as a 

futures account and approved by the 

Commission.27 Those provisions of the 

CEA and SEA further require 

consultation between the Commission 

and the SEC in drafting implementing 

regulations. As a first step toward 

meeting this goal, proposed § 39.4(e) 

would establish the procedural 

requirements applicable to a DCO 

seeking approval for a futures portfolio 

margining account program. 

OCC, Newedge USA, LLC (Newedge), 

New York Portfolio Clearing, LLC 

(NYPC), and MetLife Inc. urged the 

Commission to propose rules that would 

permit portfolio margining, not just 

establish procedural requirements. The 

Commission agrees that it should 

propose substantive portfolio margining 

rules, but it must move forward on 

proposing substantive rules with the 

SEC’s participation. 

Accordingly, the Commission is 

adopting the procedural requirements as 

proposed and anticipates consulting 

with the SEC in the future to determine 

the substantive requirements it would 

impose in approving a futures portfolio 

margining program and, additionally, in 

granting an exemption under Section 

4(c) of the CEA to permit futures and 

options on futures to be held in a 

securities portfolio margining account. 

The Dodd-Frank Act does not set a 

deadline for these actions, and the 

Commission believes that it is important 

to give this matter due consideration, 

both in terms of consultation with the 

SEC and, more broadly, in obtaining 

industry views on the topic before 

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69340 Federal Register / Vol. 76, No. 216 / Tuesday, November 8, 2011 / Rules and Regulations 

28As part of the reorganization of Part 39, § 39.6 

(Enforceability) is being redesignated as § 39.7 and 

§ 39.7 (Fraud in connection with the clearing of 

transactions on a derivatives clearing organization) 

is being redesignated as § 39.8. 

29After these technical amendments were 

proposed, the Commission adopted a final rule 

governing the process for review of swaps for 

mandatory clearing. That rule was designated as 

§ 39.5, and the former § 39.5 was redesignated as 

§ 39.8. See 76 FR at 44473 (July 26, 2011) (Process 

for Review of Swaps for Mandatory Clearing; final 

rule). In connection with adoption of the technical 

amendments described above, the provisions 

regarding fraud in connection with the clearing of 

transactions on a DCO (former § 39.7) are now 

redesignated as § 39.8. 

30Section 5b(c)(2)(A) of the CEA, 7 U.S.C. 7a– 

1(c)(2)(A). 

31See Section 5b(i) of the CEA; 7 U.S.C. 7a– 

1(b)(i). 

32See http://www.websters-online-dictionary.org/ 

definitions/enforce. 

33See Section 5b(i)(2)(E) of the CEA, 7 U.S.C. 7a– 

1(b)(i)(2)(E), which requires the CCO to ‘‘ensure 

compliance with this Act (including regulations) 

relating to agreements, contracts, or transactions, 

including each rule prescribed by the Commission 

under this section.’’ 

proposing substantive regulations or 

other guidance. 

E. Reorganization of Part 39 

With the adoption of regulations 

relating to implementation of the core 

principles and other provisions of the 

Dodd-Frank Act, the Commission is 

reorganizing part 39 of its regulations 

into two subparts, with a new appendix. 

Subpart A, ‘‘General Provisions 

Applicable to Derivatives Clearing 

Organizations’’ contains §§ 39.1 through 

39.8, which are general provisions 

including procedural requirements for 

DCO applications and other activities 

such as transfer of a DCO registration, 

clearing of new products, and 

submission of swaps for a mandatory 

clearing determination. Subpart A also 

includes pre-existing provisions 

regarding enforceability and fraud in 

connection with clearing transactions 

on a DCO.28 Subpart B, ‘‘Compliance 

with Core Principles,’’ contains §§ 39.9 

through 39.27, which are rules that 

implement the core principles under 

Section 5b of the CEA, as amended by 

the Dodd-Frank Act. 

As discussed above, the Commission 

is replacing appendix A ‘‘Application 

Guidance and Compliance with Core 

Principles,’’ with a new appendix to 

part 39, ‘‘Form DCO Derivatives 

Clearing Organization Application for 

Registration.’’ 

F. Technical Amendments 

With the objective of listing all DCO 

reporting requirements in a new § 39.19, 

the Commission proposed redesignating 

§ 39.5(a) and (b) (information relating to 

DCOs) as proposed §§ 39.19(c)(5)(i) and 

(ii), respectively, in substantially the 

same form. The Commission also 

proposed removing § 39.5(c) (large 

trader reporting by DCOs), redesignating 

§ 39.5(d) (special calls) as § 21.04 (and 

current § 21.04 as § 21.05), and adding 

§ 21.06, which would delegate authority 

under § 21.04 to the Director of the 

Division of Clearing and Risk. 

The Commission did not receive any 

comments on these proposals. 

Therefore, the Commission is adopting 

these revisions as proposed, except for 

non-substantive changes to 

§§ 39.19(c)(5)(i) and (c)(5)(ii) to clarify 

the language.29

IV. Part 39 Amendments—Compliance 

With Core Principles 

Proposed § 39.9 would establish the 

scope of the rules contained in subpart 

B of part 39, stating that all provisions 

of subpart B apply to DCOs. The 

Commission did not receive any 

comments on the statement of scope, 

and the Commission is adopting § 39.9 

as proposed. 

A. Core Principle A—Compliance With 

Core Principles—§ 39.10 

1. Core Principle A 

Core Principle A,30 as amended by the 

Dodd-Frank Act, requires a DCO to 

comply with each core principle set 

forth in Section 5b(c)(2) of the CEA and 

any requirement that the Commission 

may impose by rule or regulation 

pursuant to Section 8a(5) of the CEA. 

Core Principle A also provides a DCO 

with reasonable discretion to establish 

the manner by which it complies with 

each core principle. Proposed 

§§ 39.10(a) and 39.10(b) would codify 

these provisions, respectively. The 

Commission received no comments on 

these proposed rules and is adopting the 

rules as proposed. 

2. Designation of a Chief Compliance 

Officer—§ 39.10(c)(1) 

Section 725(b) of the Dodd-Frank Act 

added a new paragraph (i) to Section 5b 

of the CEA to require each DCO to 

designate an individual as its CCO, 

responsible for the DCO’s compliance 

with the CEA and Commission 

regulations and the filing of an annual 

compliance report.31 In proposed 

§ 39.10(c), the Commission set forth 

implementing requirements that would 

largely track the language of Section 

5b(i). 

Under the introductory provision of 

proposed § 39.10(c)(1), each DCO would 

be required to appoint a CCO with ‘‘the 

full responsibility and authority to 

develop and enforce in consultation 

with the board of directors or the senior 

officer, appropriate compliance policies 

and procedures, as defined in § 39.1(b), 

to fulfill the duties set forth in the Act 

and Commission regulations.’’ As 

previously noted, the Commission is not 

adopting the definition of ‘‘compliance 

policies and procedures’’ included in 

proposed § 39.1(b). 

CME commented that the text of the 

Dodd-Frank Act does not require a CCO 

to ‘‘enforce’’ compliance policies and 

procedures and it suggested that § 39.10 

should not do so. According to CME, it 

is important to separate the functions of 

monitoring and advising on compliance 

issues from what it considers ‘‘senior 

management functions’’ of enforcing 

and supervising compliance policies. 

The Commission believes that 

Congress intended that the CCO have 

the full responsibility and authority to 

enforce compliance in consultation with 

the board of directors or the senior 

officer. Given the specified duties of the 

CCO set forth in Section 5b(i)(2), the 

Commission finds ample support for 

this interpretation and is adopting the 

rule as proposed. 

First, one definition of the term 

‘‘enforce’’ is ‘‘to ensure observance of 

laws and rules,’’ 32 and among the CCO 

duties set forth by the Dodd-Frank Act 

is the requirement that the CCO ‘‘ensure 

compliance.’’ 33 Second, Section 

5b(i)(2)(C) requires a CCO to ‘‘resolve 

any conflicts of interest that may arise’’ 

in consultation with the board of the 

DCO or the senior officer of the DCO. 

This duty clearly indicates that the CCO 

is more than just an advisor to 

management and must have the ability 

to enforce compliance with the CEA and 

Commission regulations. The authority 

to resolve conflicts of interest is more an 

enforcement function than an audit 

function. Finally, Section 5b(i)(2)(D) 

requires the CCO to ‘‘be responsible for 

administering each policy.’’ 

While the CEA does not explicitly use 

the word ‘‘enforce,’’ the Commission 

believes that the use of this word in 

§ 39.10(c)(1) is appropriate to capture 

the meaning of Section 5b(i)(2)(C), i.e., 

that CCOs must have the authority to 

fulfill their statutory and regulatory 

obligations. Moreover, it is consistent 

with the statutory directive for the CCO 

to ensure compliance with the CEA. 

These considerations are particularly 

important given that the CCO of a DCO 

has unique responsibilities in 

connection with the DCO’s critical role 

in providing financial integrity to 

derivatives markets. In particular, a CCO 

must have the ability to effectively 

address rules and practices that could 

compromise compliance with fair and 

open access requirements (Core 

Principle C), risk management 

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34See further discussion of a CCO’s duties in 

section IV.A.7, below. 

35See 76 FR 54538 (Sept. 1, 2011) (SDRs: 

Registration Standards, Duties and Core Principles; 

final rule). 36 7 U.S.C. 7a–1(i)(2)(A). 

requirements (Core Principle D), and 

financial resource requirements (Core 

Principle B). 

The Commission, however, recognizes 

that the term ‘‘enforce’’ could imply that 

the DCO’s CCO must have direct 

supervisory authority over employees 

not otherwise in his or her direct chain 

of command, or that the CCO has 

independent authority to discipline 

employees or terminate employment to 

facilitate compliance with the CEA and 

the Commission’s regulations. To avoid 

confusion, the Commission herein 

clarifies that the term ‘‘enforce,’’ as used 

in § 39.10(c)(1), is not intended to 

include the authority to supervise 

employees not in the CCO’s direct chain 

of command, or the authority to 

terminate employment or discipline 

employees for conduct that results in 

noncompliance. The Commission notes 

that a DCO is not precluded from 

conferring such authority on its CCO; 

however, such action would be at the 

DCO’s discretion and is not required by 

§ 39.10(c)(1).34

3. Individuals Qualifying To Serve as a 

CCO—§ 39.10(c)(1)(i) 

Proposed § 39.10(c)(1)(i) would 

require a DCO to designate an 

individual with the background and 

skills appropriate for fulfilling the 

responsibilities of the CCO position. 

The Commission asked whether 

additional qualifications should be 

imposed and, in particular, whether the 

Commission should restrict the CCO 

position from being held by an attorney 

who represents the DCO or its board of 

directors, such as an in-house or general 

counsel. The Commission explained 

that the rationale for such a restriction 

would be based on concern that the 

interests of representing the DCO’s 

board of directors or management could 

be in conflict with the duties of the 

CCO. Related to this, the Commission 

specifically sought comment on whether 

there is a need for a regulation requiring 

the DCO to insulate a CCO from undue 

pressure and coercion. It further asked 

if it is necessary to adopt rules to 

address the potential conflict between 

and among compliance interests, 

commercial interests, and ownership 

interests of a DCO and, if there is no 

need for such rules, requested comment 

on how such potential conflicts would 

be addressed. 

CME, OCC, MGEX, and the Kansas 

City Board of Trade Clearing 

Corporation (KCC) commented that 

additional restrictions should not be 

imposed. MGEX commented that 

smaller DCOs will need to maximize the 

utility of each employee. It also argued 

that there is little risk if a CCO serves 

as in-house counsel because attorneys 

have additional ethical duties which 

can complement the duties and 

obligations of a CCO. According to 

MGEX, if a conflict arose, the attorney 

could step out of one or both of the 

roles. 

Better Markets commented that there 

is potential conflict between a CCO and 

in-house counsel because in-house 

counsel is an advocate for the DCO or 

its board of directors regarding any 

controversy that may relate to regulatory 

compliance, while a CCO’s duty is to 

ensure compliance. It suggested that the 

Commission prohibit a CCO from 

serving as in-house counsel. 

The Commission is adopting 

§ 39.10(c)(1)(i) as proposed. The 

Commission has considered prohibiting 

a CCO from working in the DCO’s legal 

department or serving as general 

counsel, consistent with the 

Commission’s approach to the CCO of 

an SDR.35 However, in response to 

public comments and in light of the fact 

that all currently registered DCOs have 

some form of compliance program 

already in place, with one or more staff 

members assigned to carry out 

compliance officer functions, the 

Commission has determined that the 

potential costs of hiring additional staff 

to satisfy such requirement could result 

in imposing an unnecessary burden on 

DCOs, particularly smaller ones. The 

Commission recognizes, however, that a 

conflict of interest could compromise a 

CCO’s ability to effectively fulfill his or 

her responsibilities as a CCO. The 

Commission therefore expects that as 

soon as any conflict of interest becomes 

apparent, a DCO would immediately 

implement a back-up plan for 

reassignment or other measures to 

address the conflict and ensure that the 

CCO’s duties can be performed without 

compromise. 

MGEX and KCC also recommended 

that the Commission should permit the 

Chief Regulatory Officer to function as 

the CCO. Presumably, the commenters 

are referring to circumstances in which 

a DCO (which typically would not have 

a Chief Regulatory Officer) is also 

registered as a DCM (which typically 

would have a Chief Regulatory Officer). 

The Commission notes that the rule 

does not prohibit the person serving as 

CCO from also serving as the Chief 

Regulatory Officer. 

4. CCO Reporting Structure— 

§ 39.10(c)(1)(ii) 

Section 5b(i)(2)(A) of the CEA 

requires that a CCO report directly to 

the board of directors or the senior 

officer of the DCO.36 Proposed 

§ 39.10(c)(1)(ii) would codify this 

requirement. The proposed rule also 

would require the board of directors or 

the senior officer to approve the 

compensation of the CCO. 

In the notice of proposed rulemaking, 

the Commission sought comment as to 

the degree of flexibility that should be 

provided in the reporting structure of 

the CCO. Specifically, the Commission 

requested comment on: (i) Whether it 

would be more appropriate for a CCO to 

report to the senior officer or the board 

of directors; (ii) as between the senior 

officer or board of directors, which 

generally is a stronger advocate of 

compliance matters within an 

organization; and (iii) whether the 

proposed rules allow for sufficient 

flexibility with regard to a DCO’s 

business structure. 

CME, MGEX, and KCC commented 

that the proposed rules would provide 

DCOs with the appropriate degree of 

flexibility. CME, however, believes it 

would be ‘‘logical’’ for a CCO to report 

to the senior officer, and that the board 

of directors should oversee 

implementation of compliance policies 

and ensure that compliance issues are 

resolved effectively and expeditiously 

by the senior officer with the assistance 

of the CCO. MGEX noted that each DCO 

may have a different business and 

reporting structure and believes that 

rigid rules may hinder the effectiveness 

and independence of the CCO. 

Better Markets observed that, in the 

past, businesses have placed financial 

interests over other considerations like 

risk management and have created a 

climate where people were unwilling to 

speak out against financial 

considerations for fear of being fired. 

Better Markets suggested that there 

should be a strong reporting and 

working relationship between the CCO 

and independent directors, and 

suggested that independent directors 

have sole responsibility to designate or 

terminate the CCO and to set 

compensation levels for the CCO. 

The Commission is adopting 

§ 39.10(c)(1)(ii) as proposed, declining 

to prescribe whether the CCO can only 

report to the board of directors or to the 

senior officer. The Commission 

appreciates Better Markets’ concern that 

a CCO who reports to the senior officer 

may be swayed by financial 

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69342 Federal Register / Vol. 76, No. 216 / Tuesday, November 8, 2011 / Rules and Regulations 

37See discussion in section IV.J.5.h. (The 

Commission is adopting proposed § 39.19(c)(4)(xi) 

as a renumbered § 39.19(c)(4)(ix)). 

38 7 U.S.C. 7a–1(i)(2). 

considerations. However, the DoddFrank Act permits alternative reporting 

structures and the Commission has not 

been presented with a compelling 

reason to conclude that the structure 

and operations of a DCO require the 

imposition of this limitation on the 

ability of a DCO’s board and 

management to establish lines of 

authority appropriate to the particular 

DCO. 

CME asked the Commission to clarify 

that the term ‘‘senior officer’’ may apply 

to the senior officer of a division that is 

engaged in clearing activities. The 

Commission notes that Section 

5b(i)(2)(A) of the CEA requires a CCO to 

‘‘report directly to the board or to the 

senior officer of the derivatives clearing 

organization.’’ If the division engaged in 

clearing activities is the registered DCO, 

then the senior officer of that division 

would be the ‘‘senior officer’’ for 

purposes of this provision. 

Finally, Better Markets suggested that 

compliance should be addressed on an 

entire-group basis by a senior CCO. 

According to Better Markets, a single 

senior CCO should have overall 

responsibility for each affiliated and 

controlled entity, even if the individual 

entities within the group have CCOs. 

The final rules do not require a business 

organization to have a ‘‘senior’’ CCO as 

Better Markets suggested. The 

Commission believes this would be 

overly prescriptive and that a DCO 

should have the flexibility to manage 

compliance functions across divisions 

or affiliates to accommodate its 

particular organizational structure. 

5. Annual Compliance Meeting— 

§ 39.10(c)(1)(iii) 

Proposed § 39.10(c)(1)(iii) would 

require a CCO to meet with the board of 

directors or the senior officer at least 

once a year to discuss the effectiveness 

of the DCO’s compliance policies and 

procedures, as well as the 

administration of those policies and 

procedures by the CCO. Better Markets 

suggested that a CCO meet with the 

board of directors at least quarterly. No 

comments were received on the 

proposed topics to be discussed at the 

annual meeting. 

The Commission is adopting 

§ 39.10(c)(1)(iii) in modified form. The 

final rule retains the requirement that 

the CCO meet with the board of 

directors or senior officer annually, but 

eliminates the required topics to be 

discussed at the meeting. As the 

Commission noted in the notice of 

proposed rulemaking, the requirement 

for an annual discussion would not 

preclude the board of directors or the 

senior officer from meeting with the 

CCO more frequently. While more 

frequent communication between the 

CCO and the DCO’s board or senior 

officer may be desirable, the 

Commission has concluded that 

adopting requirements to that effect 

would be overly prescriptive. Similarly, 

upon further consideration, the 

Commission has concluded that the 

purpose of the meeting should be selfevident (i.e., compliance) and it is not 

necessary for the Commission, by 

regulation, to prescribe the business that 

must be conducted at that meeting. 

6. Change in the Designation of the 

CCO—§ 39.10(c)(1)(iv) 

Proposed § 39.10(c)(1)(iv) would 

require that a change in the designation 

of the individual serving as the CCO be 

reported to the Commission, in 

accordance with the requirements of 

proposed § 39.19(c)(4)(xi). The 

Commission received no comments on 

the proposed rule and is adopting the 

provision as proposed.37

7. Duties of the CCO—§ 39.10(c)(2) 

Section 5b(i)(2) of the CEA, added by 

Section 725(a) of the Dodd-Frank Act, 

sets forth the duties of a CCO,38 and 

proposed § 39.10(c)(2) would codify 

those enumerated duties in paragraphs 

(c)(2)(i)–(vii). 

The Commission received comments 

on the CCO’s duties from CME, KCC, 

and OCC. In general, the commenters 

expressed the view that the proposed 

regulations are too broad because they 

improperly provide the CCO with what 

CME calls ‘‘senior management 

functions’’ like enforcing and 

supervising compliance policies. 

Instead, the commenters believe that the 

role of a CCO is only to serve as an 

auditor who monitors compliance and 

informs senior management of 

noncompliance. The Commission has 

carefully considered the comments and 

is adopting the rule as proposed, except 

as discussed below. 

CME acknowledged that proposed 

§ 39.10(c)(2)(ii) mirrors the language in 

the Dodd-Frank Act. However, CME 

believes that Congress did not intend to 

mean ‘‘resolve’’ in the executive or 

managerial sense such that the CCO 

alone would examine the facts and 

determine and affect the course of 

action. CME believes that Congress 

intended the CCO to identify, advise, 

and escalate, as appropriate, and to 

assist senior management in resolving 

conflicts of interest. 

KCC also believes that the board of 

directors or senior officer should resolve 

any conflict of interest in consultation 

with the CCO. KCC commented that 

compliance policies and procedures 

should be administered by DCO staff 

and not by the CCO. According to KCC, 

a DCO’s staff is most familiar with the 

day-to-day operations of the DCO and is 

in the best position to manage the 

policies and procedures. KCC believes 

that a CCO’s role should be that of 

oversight of the DCO’s compliance 

program and filing an annual report. 

The Commission disagrees with 

assertions that a CCO should only assist 

senior management in resolving 

conflicts of interest or that the board or 

senior management should resolve 

conflicts of interest in consultation with 

the CCO. Section 5b(i)(2)(C) of the CEA 

states that a CCO shall ‘‘in consultation 

with the board of the derivatives 

clearing organization, a body performing 

a function similar to the board of the 

derivatives clearing organization, or the 

senior officer of the derivatives clearing 

organization, resolve any conflicts of 

interest that may arise.’’ Given this 

express statutory direction, the 

Commission is not revising the 

proposed rule. 

The Commission points out that a 

CCO’s duty to administer compliance 

policies and procedures is set forth in 

Section 5b(i)(2)(D) of the CEA. It 

requires a CCO to ‘‘be responsible for 

administering each policy and 

procedure that is required to be 

established pursuant to this section.’’ By 

administering compliance policies and 

procedures, a CCO is not required to 

perform staff functions that have 

compliance implications. Rather, the 

CCO is responsible for oversight of such 

functions. 

The Commission is revising 

§ 39.10(c)(2)(iii) to require a CCO to 

have the duty of ‘‘[e]stablishing and 

administering written policies and 

procedures reasonably designed to 

prevent violation of the Act.’’ This does 

not change the substance of the 

requirement or alter the implementation 

of the statutory standard, as it is 

consistent with § 39.10(c)(1) which 

requires a CCO to ‘‘develop * * * 

appropriate policies and procedures 

* * * to fulfill the duties set forth in the 

Act and Commission regulations.’’ The 

Commission believes that the revised 

language eliminates the possibility of 

ambiguity and prevents too narrow a 

reading of the reference to policies and 

procedures that are ‘‘required’’ under 

the CEA. 

CME described as ‘‘impracticable’’ the 

proposed standard that a CCO must 

’’ensure’’ a DCO’s compliance and 

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Federal Register / Vol. 76, No. 216 / Tuesday, November 8, 2011 / Rules and Regulations 69343 

39See also 76 FR at 54584 (Sept. 1, 2011) (SDRs: 

Registration Standards, Duties and Core Principles; 

final rule) (adopting § 49.22(d)(4), which applies 

this standard to the CCO of an SDR). 40 7 U.S.C. 7a–1(i)(3). 

suggested that an appropriate and 

‘‘achievable’’ standard would be to 

require a CCO to put in place measures 

‘‘reasonably designed to ensure 

compliance’’ with the CEA and 

Commission regulations. 

The Commission is revising 

§ 39.10(c)(2)(iv) in response to CME’s 

comment. Although Section 5b(i)(2)(E) 

of the CEA requires a CCO to ‘‘ensure’’ 

compliance, the Commission agrees that 

a CCO cannot fully guarantee 

compliance because, as a practical 

matter, he or she will have to rely to 

some extent on information provided by 

other DCO employees or representatives 

of the DCO’s service providers. 

Accordingly, § 39.10(c)(2)(iv) is being 

modified to include as a duty of the 

CCO, ‘‘[t]aking reasonable steps to 

ensure compliance with the Act and 

Commission regulations * * * ’’ (added 

text in italics). The Commission believes 

that this revision addresses CME’s 

concern while retaining the emphasis 

on the CCO’s actions rather than 

focusing on the nature of measures put 

in place by the CCO.39

CME recommended that the 

Commission revise proposed 

§ 39.10(c)(2)(vi) to require a CCO to 

‘‘[e]stablish[] appropriate procedures 

[for] the handling, management 

response, remediation, retesting, and 

closing of noncompliance issues,’’ and 

to eliminate the requirement that a CCO 

‘‘follow[]’’ such procedures. According 

to CME, this is a function of senior 

management and Congress did not 

intend for a CCO to exercise senior 

management functions. OCC agrees with 

CME. 

Specifically, CME suggested that 

proposed § 39.10(c)(2)(vi) be modified to 

eliminate the requirement that a CCO 

‘‘follow’’ appropriate procedures 

because following procedures is a 

function of senior management. 

However, a CCO’s performance of this 

‘‘senior management’’ function is 

explicitly set forth in Section 5b(i)(2)(G) 

of the CEA, which states that ‘‘[t]he 

chief compliance officer shall * * * 

establish and follow appropriate 

procedures for the handling, 

management response, remediation, 

retesting, and closing of noncompliance 

issues.’’ The Commission does not 

believe that CME has provided a 

persuasive basis for its suggested 

modification of § 39.10(c)(2)(vi), and the 

Commission is adopting the provision 

as proposed. 

Finally, the Commission, on its own 

initiative, is revising § 39.10(c)(2)(vii) to 

eliminate the requirement that a CCO 

establish a compliance manual. While 

having a compliance manual is a good 

practice, incorporating this requirement 

into a regulation may be overly 

prescriptive and the Commission has 

concluded that a DCO should have 

discretion as to the vehicles through 

which it will carry out its compliance 

program. 

8. Annual Report—§ 39.10(c)(3) 

Section 5b(i)(3) of the CEA, added by 

Section 725(b) of the Dodd-Frank Act, 

requires a CCO to prepare an annual 

report that describes the DCO’s 

compliance with the CEA, regulations 

promulgated under the CEA, and each 

policy and procedure of the DCO, 

including the code of ethics and 

conflicts of interest policies.40

Implementation of these statutory 

requirements was addressed at proposed 

§ 39.10(c)(3)(i), (c)(3)(ii)(A), and (c)(3)(v) 

and (v). 

With respect to proposed 

§ 39.10(c)(3)(i), CME suggested that the 

Commission eliminate it and KCC 

commented that the requirement for a 

DCO to show compliance with respect 

to the CEA and Commission regulations 

is ambiguous and overreaching. KCC 

also suggested that the scope of the 

annual report should not go beyond 

reviewing the DCO core principles and 

identifying the compliance policies and 

procedures that are in place to satisfy 

the core principles. 

Although paragraph (i) mirrors the 

language and requirements set forth in 

Section 5b(i)(3)(A)(i) of the CEA, to 

address CME’s and KCC’s comments, 

the Commission has decided to revise 

the language of §§ 39.10(c)(3)(i) and (ii) 

to avoid submission of duplicative 

information and to clarify the scope of 

the annual report content requirements 

without altering the nature of the 

information that must be included in 

the report pursuant to the CEA. Final 

§ 39.10 (c)(3)(i) requires that the annual 

report ‘‘[c]ontain a description of the 

derivatives clearing organization’s 

written policies and procedures, 

including the code of ethics and conflict 

of interest policies.’’ Final § 39.10 

(c)(3)(ii) requires that the report ’’ 

[r]eview each core principle and 

applicable Commission regulations, and 

with respect to each: (A) Identify the 

compliance policies and procedures that 

are designed to ensure compliance with 

the core principle.’’ The Commission 

notes that by specifying ‘‘written’’ 

policies and procedures, the rule more 

precisely establishes the scope of 

§ 39.10(c)(3)(i). 

Proposed §§ 39.10(c)(3)(iii) and 

(c)(3)(iv) would require that the annual 

report list any material changes to 

compliance policies and procedures 

since the last annual report and describe 

the DCO’s financial, managerial, and 

operational resources for compliance 

with the Act and Commission 

regulations, respectively. The 

Commission did not receive any 

comments on these provisions and is 

adopting §§ 39.10(c)(3)(iii) and (c)(3)(iv) 

as proposed. 

Proposed § 39.10(c)(3)(v) would 

require that the annual report 

‘‘[d]escribe any material compliance 

matters, including incidents of 

noncompliance, since the date of the 

last annual report and describe the 

corresponding action taken.’’ CME 

suggested that the provision be revised 

to require that the annual report identify 

only material compliance issues that 

were not properly addressed by the 

DCO. 

The Commission is adopting 

§ 39.10(c)(3)(v) as proposed because 

receiving such information will enable 

the Commission to assess whether the 

DCO is addressing compliance matters 

effectively. It also will enable the 

Commission to become aware of 

possible future compliance issues across 

DCOs and to proactively identify best 

practices. An annual report that 

identifies only material compliance 

issues would not provide sufficient 

information. 

Finally, the Commission on its own 

initiative is not adopting proposed 

§ 39.10(c)(3)(vi) because information of 

this nature is not essential to the 

Commission’s evaluation of the DCO’s 

compliance program and, if it is relevant 

to a material compliance matter, it will 

be provided to the Commission 

pursuant to § 39.10(c)(3)(v). 

9. Submission of Annual Report to the 

Commission—§ 39.10(c)(4) 

Proposed § 39.10(c)(4) would set forth 

the requirements for submitting an 

annual report to the Commission. 

Except as noted below, the Commission 

is adopting the rule as proposed. 

Better Markets suggested that the 

Commission change proposed 

§ 39.10(c)(4)(i) to require a CCO to 

present the finalized annual report to 

the board of directors and executive 

management prior to its submission to 

the Commission. Better Markets also 

suggested that the independent directors 

as well as the entire board should be 

required to review and approve the 

report in its entirety and to detail any 

disagreement with any portion. In 

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69344 Federal Register / Vol. 76, No. 216 / Tuesday, November 8, 2011 / Rules and Regulations 

41See Section 5b(i)(3)(B)(ii) of the CEA, 7 U.S.C. 

7a–1(i)(3)(B)(ii). 

42Section 5b(c)(2)(B) of the CEA, 7 U.S.C. 7a– 

1(c)(2)(B). 

addition, Better Markets commented 

that a CCO should be required to file the 

report with the Commission, either as 

approved or with statements of 

disagreement. 

The Commission is not revising 

proposed § 39.10(c)(4)(i) per Better 

Markets’ suggestion. The Commission 

believes that a DCO should have the 

flexibility to determine whether the 

annual report will be provided to the 

board of directors, the senior officer, or 

both. The Commission also is not 

requiring the board of directors to 

approve or submit comments on the 

report given that the board of directors 

might not have sufficient information to 

approve or disagree with the report. In 

addition, there is a risk that the board 

might try to influence the CCO to 

change the report if it were required to 

express approval. The Commission 

notes that the rules do not prohibit the 

board, any of its members, or the senior 

officer from approving or disagreeing 

with aspects of the annual report. 

Proposed § 39.10(c)(4)(ii) would 

require that the annual report include a 

certification by the CCO that, to the best 

of his or her knowledge and reasonable 

belief, and under penalty of law, the 

annual report is accurate and complete. 

CME commented that the Commission 

should require the DCO’s senior officer, 

and not the CCO, to make the necessary 

certification in the annual compliance 

report. According to CME, ‘‘the best way 

to achieve the goal of a robust effective 

compliance program, and to close the 

loop on creating a culture of 

compliance, is to require the registrant’s 

senior officer—and not the CCO—to 

complete the required certification.’’ 

KCC commented that a CCO should 

not have to certify ‘‘under penalty of 

law’’ that the annual report is accurate 

and complete, and a CCO should certify 

instead that to the best of his or her 

knowledge and belief the annual report 

is accurate and complete. 

The Commission is adopting 

§ 39.10(c)(4)(ii) as proposed. The CEA 

requires (1) the CCO to sign the annual 

report and (2) that the annual report 

contain a certification that, under 

penalty of law, the compliance report is 

accurate and complete.41 Accordingly, 

the Commission believes the regulation 

accurately reflects Congressional intent. 

10. Annual Report Confidentiality 

CME suggested that Commission 

regulations should expressly state that 

annual reports are confidential 

documents that are not subject to public 

disclosure by listing annual reports as a 

specifically exempt item in part 145 of 

the Commission’s regulations. The 

Commission has not proposed and is 

not adopting CME’s proposal, which 

would provide blanket confidentiality to 

all annual reports submitted by CCOs of 

DCOs, even though the Commission 

may determine that there is information 

contained in a report that should be 

public. Accordingly, a DCO must 

petition for confidential treatment of its 

annual report under § 145.9 if it wants 

the Commission to determine that a 

particular annual report should be 

subject to confidentiality. 

11. Insulating the CCO From Undue 

Influence 

The notice of proposed rulemaking 

solicited comments as to whether the 

Commission should adopt regulations 

that require a DCO to insulate its CCO 

from undue pressure and coercion. CME 

commented that the current regulations 

are sufficient to protect a CCO from 

undue influence and it does not believe 

additional regulations are necessary. 

The Commission agrees with CME and 

is not adopting such regulations. 

12. Recordkeeping—§ 39.10(c)(5) 

Proposed § 39.10(c)(5) would require 

a DCO to maintain: (i) A copy of the 

policies and procedures adopted in 

furtherance of compliance with the CEA 

and Commission regulations; (ii) copies 

of materials, including written reports 

provided to the board of directors or the 

senior officer in connection with review 

of the annual report; and (iii) any 

records relevant to the DCO’s annual 

report, including work papers and 

financial data. The DCO would be 

required to maintain these records in 

accordance with § 1.31 and proposed 

§ 39.20. The Commission did not 

receive any comment letters discussing 

proposed § 39.10(c)(5). The Commission 

has adopted § 39.10(c)(5) as proposed, 

except that the Commission has 

modified § 39.10(c)(5)(A) to refer to ‘‘all 

compliance policies and procedures’’ 

rather than ‘‘the compliance policies 

and procedures, as defined in § 39.1(b)’’ 

in light of the Commission’s decision 

not to adopt a definition of compliance 

policies and procedures, as discussed in 

section III.B, above. 

B. Core Principle B—Financial 

Resources—§ 39.11 

Core Principle B,42 as amended by the 

Dodd-Frank Act, requires a DCO to 

possess financial resources that, at a 

minimum, exceed the total amount that 

would enable the DCO to meet its 

financial obligations to its clearing 

members notwithstanding a default by 

the clearing member creating the largest 

financial exposure for the DCO in 

extreme but plausible market conditions 

and to cover its operating costs for a 

period one year, as calculated on a 

rolling basis. Proposed § 39.11 would 

codify these requirements. The 

Commission received a total of 18 

comments on the proposed regulations. 

The Commission considered each of 

these comments in formulating the final 

regulations discussed below. 

1. Amount of Financial Resources 

Required—§§ 39.11(a) and 39.11(b)(3) 

Proposed § 39.11(a)(1) would require 

a DCO to maintain sufficient financial 

resources to meet its financial 

obligations to its clearing members 

notwithstanding a default by the 

clearing member creating the largest 

financial exposure for the DCO in 

extreme but plausible market 

conditions, and proposed § 39.11(a)(2) 

would require a DCO to maintain 

sufficient financial resources to cover its 

operating costs for at least one year, 

calculated on a rolling basis. Proposed 

§ 39.11(b)(3) would allow a DCO to 

allocate a financial resource, in whole or 

in part, to satisfy the requirements of 

either proposed § 39.11(a)(1) or 

proposed § 39.11(a)(2), but not both, and 

only to the extent that use of that 

financial resource is not otherwise 

limited by the CEA, Commission 

regulations, the DCO’s rules, or any 

contractual arrangements to which the 

DCO is a party. 

The Futures Industry Association 

(FIA) recommended that all DCOs be 

required to maintain resources sufficient 

to withstand the default of the two 

clearing members representing the 

largest financial exposure to the DCO, 

but that the Commission give DCOs 

reasonable time to come into 

compliance with the enhanced 

requirement. 

The International Swaps and 

Derivatives Association (ISDA) also 

suggested that, in the clearing of certain 

OTC derivatives such as eligible credit 

default swaps and interest rate swaps, a 

DCO should have sufficient financial 

resources that, at a minimum, enable it 

to withstand a potential default by two 

of its largest clearing members, as 

measured by the two clearing members 

with the largest obligations to the DCO 

in extreme but plausible market 

conditions. ISDA further suggested, 

however, that this heightened financial 

resource level may not be appropriate 

for all other OTC or other derivatives 

products, and offered to work with the 

Commission to determine the 

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43See Bank for International Settlements’ 

Committee on Payment and Settlement Systems and 

Technical Committee of the International 

Organization of Securities Commissions, 

‘‘Recommendations for Central Counterparties,’’ 

CPSS Publ’n No. 64 (November 2004), available at 

http://www.bis.org/publ/cpss64.pdf. 

44See Bank for International Settlements’ 

Committee on Payment and Settlement Systems and 

Technical Committee of the International 

Organization of Securities Commissions, 

‘‘Principles for financial market infrastructures: 

Consultative report,’’ CPSS Publ’n No. 94 (March 

2011), available at http://www.bis.org/publ/ 

cpss94.pdf (CPSS–IOSCO Consultative Report). 

45CPSS–IOSCO Consultative Report, Principle 4: 

Credit Risk, at 30. 

appropriate standard for derivatives in 

other asset classes. 

Similarly, Mr. Chris Barnard 

recommended that consideration be 

given to differentiating risk, and 

therefore resource requirements by 

broad derivative/product class, or at 

least by exchange-traded and OTC 

derivative types. 

Better Markets suggested that the 

default rate used in the stress test for 

DCOs should be the larger of (1) the 

member representing the largest 

exposure to the DCO, and (2) the 

members constituting at least 25 percent 

of the exposures in aggregate to the 

DCO. Americans for Financial Reform 

(AFR) stated that the calculation in 

proposed § 39.11(a)(1) should be based 

on risk exposure as well as number of 

defaults. 

LCH.Clearnet Group Limited (LCH) 

concurred with all the provisions set 

forth by the Commission under 

proposed § 39.11(a). NYPC also 

expressed support for proposed 

§§ 39.11(a)(1) and 39.11(a)(2). 

The Commission is adopting 

§ 39.11(a) as proposed. Section 39.11(a) 

is consistent with Core Principle B as 

amended by the Dodd-Frank Act. As the 

Commission noted in its notice of 

proposed rulemaking, § 39.11(a)(1) is 

also consistent with the Bank for 

International Settlements’ Committee on 

Payment and Settlement Systems and 

the Technical Committee of the 

International Organization of Securities 

Commissions (CPSS–IOSCO) 

Recommendations for Central 

Counterparties (CCPs), issued in 2004 

(2004 CPSS–IOSCO 

Recommendations).43 The Commission 

recognizes that those recommendations 

eventually will be replaced by the 

Principles for Financial Market 

Infrastructures (FMIs), which are 

currently being developed by CPSS and 

IOSCO and are expected to be finalized 

in 2012.44 For financial resources 

requirements for CCPs, CPSS and 

IOSCO are considering three 

alternatives: (1) A ‘‘cover one’’ 

minimum requirement for all CCPs; (2) 

a ‘‘cover two’’ minimum requirement for 

all CCPs; and (3) either a ‘‘cover one’’ 

or a ‘‘cover two’’ minimum requirement 

for a particular CCP, depending upon 

the risk and other characteristics of the 

particular products it clears, the markets 

it serves, and the number and type of 

participants it has.45 The Commission 

may reconsider § 39.11(a)(1) once CPSS 

and IOSCO have finished their work. 

MGEX noted that proposed 

§ 39.11(b)(3) would prohibit a DCO from 

using a financial resource for both 

default and operating cost purposes. 

While MGEX agreed this seems a logical 

approach to take to avoid counting an 

asset’s value for two different purposes, 

MGEX stated that there are practical 

implications to consider. As a DCM and 

DCO, MGEX keeps one basic set of 

financial records that are compliant 

with various accounting standards. 

MGEX recommended that the 

Commission’s proposal should not be 

interpreted to require a DCO to formally 

divide some assets and accounts. The 

Commission confirms that § 39.11(b)(3) 

does not require a DCO to formally 

divide its assets or accounts. The 

Commission is adopting § 39.11(b)(3) as 

proposed. 

2. Treatment of Affiliated Clearing 

Members—§ 39.11(a)(1) 

Proposed § 39.11(a) would state, in 

part: ‘‘A [DCO] shall maintain financial 

resources sufficient to cover its 

exposures with a high degree of 

confidence and to enable it to perform 

its functions in compliance with the 

core principles set out in Section 5b of 

the [CEA] * * * Financial resources 

shall be considered sufficient if their 

value, at a minimum, exceeds the total 

amount that would: (1) Enable the 

[DCO] to meet its financial obligations 

to its clearing members notwithstanding 

a default by the clearing member 

creating the largest financial exposure 

for the [DCO] in extreme but plausible 

market conditions; Provided that if a 

clearing member controls another 

clearing member or is under common 

control with another clearing member, 

the affiliated clearing members shall be 

deemed to be a single clearing member 

for purposes of this provision * * * ’’ 

In the notice of proposed rulemaking, 

the Commission stated: ‘‘There may be 

some instances in which one clearing 

member controls another clearing 

member or in which a clearing member 

is under common control with another 

clearing member. The Commission 

proposes to treat such affiliated clearing 

members as a single entity for purposes 

of determining the largest financial 

exposure because the default of one 

affiliate could have an impact on the 

ability of the other to meet its financial 

obligations to the DCO. However, to the 

extent that each affiliated clearing 

member is treated as a separate entity by 

the DCO, with separate capital 

requirements, separate guaranty fund 

obligations, and separate potential 

assessment liability, the Commission 

requests comment on whether a 

different approach might be warranted.’’ 

CME noted that it treats affiliated 

clearing members as separate entities, 

with separate capital requirements, 

separate guaranty fund obligations, and 

separate potential assessment liability. 

While CME acknowledged that the 

default of one affiliate may impact the 

ability of another affiliated clearing 

member to meet its financial obligations 

to the DCO, CME suggested that 

circumstances may exist in which a 

clearing member is sufficiently 

independent to continue operating 

notwithstanding a default by an affiliate. 

CME rules allow, but do not require, 

emergency action to be taken against a 

clearing member based upon the 

financial or operational condition of an 

affiliate (whether or not that affiliate is 

also a clearing member). CME urged the 

Commission to take a similar approach 

by revising the language of proposed 

§ 39.11(a) to state that ‘‘if a clearing 

member controls another clearing 

member or is under common control 

with another clearing member, the 

affiliated clearing members may be 

deemed to be a single clearing member 

* * *.’’ 

LCH agreed with the Commission’s 

proposed requirement that the DCO 

must treat any clearing member, either 

controlled by another clearing member 

or under common control with another 

clearing member, as a single clearing 

member for the purposes of 

§ 39.11(a)(1). 

The Commission is adopting 

§ 39.11(a)(1) as proposed. The 

Commission believes this treatment 

appropriately addresses the potential 

risks of affiliates. The Commission notes 

that aggregating the potential losses of 

affiliated clearing members for purposes 

of this calculation would provide more 

coverage in the event of a default. 

3. Operating Costs—§ 39.11(a)(2) 

Proposed § 39.11(a)(2) would require 

a DCO to maintain sufficient financial 

resources to cover its operating costs for 

at least one year, calculated on a rolling 

basis. 

OCC commented that while the 

statutory requirement that a DCO have 

one year of operating costs, based on a 

rolling period, may be a reasonable 

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46The Commission recognizes that assessment 

powers are also a promise to pay, but as the 

Commission noted in the notice of proposed 

rulemaking, a clearing member may have a strong 

financial incentive to pay an assessment. If a 

clearing member failed to pay its assessment 

obligation, that failure would be treated as a default 

and the clearing member would be subject to 

liquidation of its positions and forfeiture of the 

margin in its house account. Thus, in addition to 

a potential general interest in maintaining the 

viability of the DCO going forward, a non-defaulting 

clearing member may have a specific incentive to 

pay an assessment, depending on the size and 

profitability of its positions and the margin on 

deposit relative to the size of the assessment. 

47See discussion of the prohibition on accepting 

letters of credit as initial margin in section IV.F.5, 

below. 

standard to ensure that a DCO is not 

forced out of business while there is still 

open interest in the contracts it clears, 

the requirement should be calculated 

based on essential operating expenses 

for the rolling period. According to 

OCC, an appropriate wind-down budget 

would include projected revenues 

during the wind-down and would not 

include expenses associated with 

activities having value only to a DCO 

that intends to remain in business (e.g., 

product development, technological 

enhancements, lobbying activities, 

investor education, etc.). 

ISDA stated that it is appropriate that 

a DCO hold equity capital sufficient to 

cover its operating costs and likely exit 

costs during any liquidation and this 

capital should be separate from any 

DCO equity contribution to the required 

default resources. 

Eurex Clearing AG (Eurex) agreed that 

having a requirement for operating 

resources is reasonable, especially in 

view of the flexibility implied in the 

Commission’s proposed rules for types 

of financial resources, but cautioned 

that the one-year time frame may be 

unnecessarily long. 

FIA supported this aspect of the 

Commission’s proposal, including the 

requirement that a DCO not be 

permitted to ‘‘double-count’’ its 

resources to cover both this and the 

default resources requirement. 

The Commission is adopting 

§ 39.11(a)(2) as proposed. The 

Commission notes that the language in 

§ 39.11(a)(2) is virtually identical to that 

of Core Principle B. 

4. Types of Financial Resources— 

§ 39.11(b) 

Proposed § 39.11(b)(1) lists the types 

of financial resources that would be 

available to a DCO to satisfy the 

requirements of proposed § 39.11(a)(1): 

(1) The margin of the defaulting clearing 

member; (2) The DCO’s own capital; (3) 

the guaranty fund deposits of the 

defaulting clearing member and nondefaulting clearing members; (4) default 

insurance; (5) if permitted by the DCO’s 

rules, potential assessments for 

additional guaranty fund contributions 

on non-defaulting clearing members; 

and (6) any other financial resource 

deemed acceptable by the Commission. 

Proposed § 39.11(b)(2) lists the types of 

financial resources that would be 

available to a DCO to satisfy the 

requirements of proposed § 39.11(a)(2): 

(1) The DCO’s own capital and (2) any 

other financial resource deemed 

acceptable by the Commission. 

In the notice of proposed rulemaking, 

the Commission noted that a DCO 

would be able to request an informal 

interpretation from Commission staff on 

whether or not a particular financial 

resource may be acceptable to the 

Commission. The Commission also 

invited commenters to recommend 

particular financial resources for 

inclusion in the final regulation. 

ISDA encouraged the Commission to 

give prudent consideration to the use of 

standby letters of credit as an additional 

financial resource, given that many 

letter-of-credit issuing banks will be an 

affiliate of a clearing member. 

Natural Gas Exchange Inc. (NGX) 

requested that the Commission consider 

the acceptability of letters of credit as an 

asset of the guaranty fund and clarify in 

the final rule that letters of credit are 

acceptable as an asset of the guaranty 

fund if subject to certain safeguards. 

NGX also requested that the 

Commission make clear in the final 

regulation that it will interpret proposed 

§§ 39.11(b)(1)(vi) and 39.11(b)(2)(ii) 

broadly so as to permit a demonstration, 

on a case-by-case basis, that a DCO 

meets the overall policies of the 

regulation through a specific mix of 

financial resources. 

Mr. Barnard recommended splitting 

the types of financial resources 

permitted under proposed § 39.11(b)(1) 

into two classes: Class A would consist 

of the financial resources listed in 

paragraphs (b)(i) through (b)(iii), and 

would be required to make up the 

significant part of the total financial 

resources, and class B would consist of 

the financial resources listed in 

paragraphs (b)(iv) through (b)(vi), on 

which larger prudential haircuts would 

be required. MGEX suggested that 

proposed § 39.11(b)(2) should retain the 

ability for a DCO to provide its 

explanation and methodology for 

including a particular financial 

resource. MGEX further suggested that 

the list of potential financial resources 

should be broad and not pruned too 

quickly, particularly by initial 

regulation. 

Eurex commented that the 

Commission’s proposed list of financial 

resources in proposed § 39.11(b)(1) is 

appropriate. 

The Commission is adopting 

§ 39.11(b) as proposed, except for a 

technical amendment to clarify the 

scope of the use of margin as a financial 

resource to cover a default. As 

proposed, the Commission is not 

including letters of credit as an 

acceptable financial resource because 

they are only a promise by a bank to pay 

and not an asset that can be sold.46

However, both § 39.11(b)(1) and 

§ 39.11(b)(2) permit ‘‘any other financial 

resource deemed acceptable by the 

Commission,’’ which means that the 

Commission could evaluate the use of 

letters of credit on a case-by-case 

basis.47

The Commission also received 

inquiries from a few DCOs as to whether 

the Commission would deem projected 

revenue an acceptable financial resource 

to satisfy the requirements of 

§ 39.11(a)(2). The Commission expects 

that projected revenue generally would 

be deemed acceptable for established 

DCOs that can demonstrate a historical 

record of revenue, but not for DCO 

applicants or relatively new DCOs with 

no such record. 

With respect to any financial resource 

that is not enumerated in § 39.11(b) and 

for which a DCO seeks a determination 

as to its acceptability based on the 

DCO’s particular circumstances, DCO 

staff should contact Commission staff 

prior to submitting the DCO’s quarterly 

financial resources report. 

The Commission is modifying 

§ 39.11(b)(1)(i) to more precisely reflect 

the fact that the use of margin as a 

financial resource available to satisfy 

the requirements of paragraph (a)(1) is 

subject to limitations imposed by the 

Commission and a DCO, e.g., relating to 

the use of customer margin to cover a 

default. As proposed, § 39.11(b)(1)(i) 

would permit the use of ‘‘[m]argin of a 

defaulting clearing member.’’ The 

provision now refers to ‘‘[m]argin to the 

extent permitted under parts 1, 22, and 

190 of this chapter and under the rules 

of the derivatives clearing 

organization.’’ 

5. Capital Requirement 

Proposed §§ 39.11(b)(1) and (b)(2) list 

the DCO’s own capital as a type of 

financial resource that would be 

available to a DCO to satisfy the 

requirements of proposed §§ 39.11(a)(1) 

and (a)(2), respectively. In the notice of 

proposed rulemaking, the Commission 

noted that Commission regulations do 

not prescribe capital requirements for 

DCOs. The Commission invited 

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48See CPSS–IOSCO Consultative Report, 

Principle 15: General Business Risk, at 70. 

comment on whether it should consider 

adopting such requirements and if so, 

what those requirements should be. 

J.P. Morgan Chase & Co. (J.P. Morgan) 

commented that if a DCO enumerates its 

own capital as part of its waterfall, that 

DCO should be required to provide 

sufficient assurances that the capital 

will be available to meet those 

obligations and will not be reallocated 

to serve other purposes at the DCO’s 

discretion. In a separate comment letter 

on the proposed risk management 

requirements for DCOs, J.P. Morgan 

offered its support for regulations that 

would require a DCO to retain in a 

segregated deposit account, on a rolling 

basis, 50 percent of its earnings from the 

previous 4 years. In addition, J.P. 

Morgan stated that it would be 

appropriate for at least 50 percent of the 

retained earnings to have a first loss 

position. J.P. Morgan also recommended 

that the DCO contribution be subject to 

a minimum floor of $50 million. 

Mr. Michael Greenberger 

recommended that the Commission 

require DCOs to set aside a reasonable 

amount of capital, equal to an average 

size of one contract for that DCO, so that 

a DCO would have sufficient financial 

resources to absorb a default. In 

addition, Mr. Greenberger suggested that 

capital requirements for DCOs must 

require that the DCOs’ capital be highly 

liquid so that a DCO can cure a default 

in a timely manner. 

Eurex noted that clearing 

organizations exhibit a variety of 

organizational and capital structures 

and suggested the Commission should 

allow DCOs to determine their own 

mixes of protective measures, which 

might include the DCO’s own capital. 

Nevertheless, Eurex expressed support 

for an initial capital requirement of $25 

million for DCOs. 

OCC commented that an equity 

capital requirement for DCOs is not 

appropriate because DCOs rely 

primarily on member-supplied 

resources, such as clearing fund 

deposits and margin, to meet their 

obligations. According to OCC, most, if 

not all, DCOs have little capital in 

relation to their obligations. OCC 

suggested that the critical question from 

a safeness and soundness standpoint is 

whether DCOs have adequate financial 

resources, not the form in which such 

resources are held. 

CME stated that the financial 

resources requirements contained in 

Core Principle B are better suited to 

achieve the goal of ensuring adequate 

capitalization of DCOs, and that further 

capital requirements would be 

unnecessary and essentially duplicative. 

KCC commented that, with proposed 

§ 39.11(a)(1) requiring a DCO to 

maintain sufficient financial resources 

to meets its financial obligations, a 

separate capital requirement would be 

redundant. KCC also stated that onerous 

capital requirements placed on DCOs 

could have an anti-competitive effect. 

NYPC cautioned that mandating that 

DCOs hold specific forms or amounts of 

capital could have a chilling effect on 

competition, at odds with the principles 

of the CEA by potentially shutting out 

various forms of organizational 

structures for DCOs. NYPC noted that 

Core Principle B requires that DCOs 

maintain sufficient financial resources 

to perform their functions as central 

counterparties in compliance with the 

CEA. NYPC suggested that whether such 

financial resources are derived from a 

DCO’s own capital or other financial 

resources deemed acceptable to the 

Commission should be inconsequential 

to the extent such statutorily prescribed 

functions are fulfilled. 

MGEX stated that it does not support 

adopting specific capital requirements 

for DCOs. MGEX noted that the 

proposed regulation already requires a 

DCO to be able to withstand the default 

of its largest clearing member in extreme 

but plausible market conditions. MGEX 

further noted that a DCO’s capital is 

only one element of the financial 

resources necessary to cover that risk, 

and suggested that a DCO should be able 

to determine how it best needs to 

allocate that risk among its various 

financial resources. 

The Commission is not adopting a 

capital requirement for DCOs at this 

time. The Commission believes that it is 

appropriate to provide flexibility to 

DCOs in designing their financial 

resources structure so long as the 

aggregate amount is sufficient. The 

Commission notes, however, that one of 

the principles in the CPSS–IOSCO 

Consultative Report would require an 

FMI to ‘‘hold sufficiently liquid net 

assets funded by equity to cover 

potential general business losses so that 

it can continue providing services as a 

going concern.’’ 48 CPSS and IOSCO are 

considering, and requesting comment 

on, the establishment of a specific 

minimum quantitative requirement for 

liquid net assets funded by equity. If 

such a requirement is established, the 

Commission may consider a similar 

requirement for DCOs at that time. 

6. Assessments—§§ 39.11(b)(1)(v) and 

39.11(d)(2) 

Proposed § 39.11(b)(1)(v) would list 

‘‘potential assessments for additional 

guaranty fund contributions, if 

permitted by the [DCO]’s rules’’ as a 

type of financial resource that would be 

available to a DCO to satisfy the 

requirements of proposed § 39.11(a)(1). 

Proposed § 39.11(d)(2) would require a 

DCO: (i) To have rules requiring that its 

clearing members have the ability to 

meet an assessment within the time 

frame of a normal variation settlement 

cycle; (ii) to monitor, on a continual 

basis, the financial and operational 

capacity of its clearing members to meet 

potential assessments; (iii) to apply a 30 

percent haircut to the value of potential 

assessments; and (iv) to only count the 

value of assessments, after the haircut, 

to meet up to 20 percent of its default 

resources requirement. The Commission 

requested comment on whether these 

limits and requirements are appropriate 

and, more generally, whether 

assessment powers should be 

considered to be a financial resource 

available to satisfy the requirements of 

proposed § 39.11(a)(1). 

With regard to proposed 

§§ 39.11(d)(2)(i) and (ii), OCC 

commented that the requirement that 

clearing members be able to meet an 

assessment within the time frame of a 

normal variation settlement cycle is an 

aggressive but appropriate standard that 

its clearing members would be able to 

meet in most circumstances, but that 

DCOs should have discretion to extend 

this deadline on a case-by-case basis 

where appropriate to avoid severe 

strains on clearing member liquidity in 

unusual circumstances. OCC objected to 

the requirement that DCOs must 

monitor ‘‘on a continual basis’’ a 

clearing member’s ability to meet 

potential assessments, which OCC 

claimed is overly burdensome and 

difficult to administer. OCC suggested 

that a monthly review is reasonable and 

adequate. 

NYPC requested that the Commission 

clarify how the requirement of proposed 

§ 39.11(d)(2)(i) would be imposed on 

DCOs that conduct both end-of-day and 

intraday settlements each business day. 

In order to ensure that a uniform 

standard is applied across clearing 

members of all DCOs, whether the DCO 

conducts one or two settlements per 

business day, NYPC recommended that 

the Commission clarify that a DCO’s 

rules should require clearing members 

to have the ability to meet an 

assessment within one business day. 

With regard to proposed 

§ 39.11(d)(2)(ii), NYPC requested that 

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69348 Federal Register / Vol. 76, No. 216 / Tuesday, November 8, 2011 / Rules and Regulations 

the Commission provide guidance as to 

how it expects DCOs to determine 

whether a clearing member has the 

capacity to meet a potential assessment. 

In addition, NYPC expressed concern 

that the ‘‘continual’’ monitoring of 

clearing members’ ability to meet 

potential assessments, which NYPC 

believes implies daily or even real-time 

monitoring, would be extremely 

difficult, if not impossible, to 

administer. NYPC suggested that it 

would be reasonable and more 

practicable for the Commission to 

require that monitoring of clearing 

members’ ability to meet potential 

assessments be included as a mandatory 

component of the periodic financial 

reviews of clearing members that DCOs 

already conduct in the ordinary course 

of business. 

In response to these comments, the 

Commission is revising § 39.11(d)(2)(i) 

to read as follows (added text in italics): 

‘‘The derivatives clearing organization 

shall have rules requiring that its 

clearing members have the ability to 

meet an assessment within the time 

frame of a normal end-of-day variation 

settlement cycle.’’ In response to OCC’s 

comment, the Commission notes that 

§ 39.11(d)(2)(i) requires a DCO to have 

rules requiring that its clearing members 

have the ability to meet an assessment 

within the time frame of a normal endof-day variation settlement cycle, but 

would permit a DCO, in its discretion, 

to provide some flexibility to clearing 

members as to timing. 

In addition, the requirement in 

§ 39.11(d)(2)(ii) that a DCO must 

monitor the financial and operational 

capacity of its clearing members to meet 

potential assessments ‘‘on a continual 

basis’’ was intended to mean only that 

the DCO must perform such monitoring 

often enough to enable it to become 

aware of any potential problems in a 

timely manner. To eliminate possible 

ambiguity, the Commission is revising 

the final rule by removing the phrase 

‘‘on a continual basis.’’ Thus, 

§ 39.11(d)(2)(ii) establishes a standard 

whereby a DCO must monitor its 

clearing members, but the DCO can 

meet the standard through the exercise 

of its judgment in response to particular 

circumstances, e.g., a DCO might have 

reason to evaluate certain clearing 

members on a daily basis and evaluate 

others only as part of routine, periodic 

financial reviews. 

With regard to proposed 

§§ 39.11(d)(2)(iii), FIA commented that 

the 30 percent haircut and 20 percent 

cap are reasonable and prudent 

safeguards, sufficient to ensure that a 

DCO does not unduly rely on its 

assessment power. J.P. Morgan 

supported the proposal and also 

recommended that regulators adopt a 

risk-based analysis to determine the 

likelihood that a clearing member will 

be able to meet its assessment 

obligations across all DCOs. Mr. 

Greenberger, citing J.P. Morgan’s 

comments, agreed that it is absolutely 

critical that the Commission promulgate 

rules that would determine a clearing 

member’s risk of default and its 

availability of financial resources across 

all clearinghouses. Similarly, ISDA 

suggested that the Commission evaluate 

the potential impact of multiple 

assessments from different DCOs on the 

same clearing member or affiliate group 

in a short time-frame. 

CME suggested that a DCO should be 

required to completely exclude the 

potential defaulting firm’s assessment 

liability in calculating its available 

assessment resources. CME also 

commented that, in light of the 

requirements of proposed 

§§ 39.11(d)(2)(i) and (ii), and the fact 

that a clearing member that failed to pay 

an assessment would itself be in default 

to the DCO, it does not believe that a 

further haircut on assessments is 

necessary, and it is aware of no valid 

reason to cap the use of assessments at 

20 percent as proposed. 

KCC noted that the inclusion of 

assessment powers as financial 

resources is necessary for it to meet its 

obligations in the unlikely event of a 

default. KCC agreed that a reasonable 

haircut on the value of a DCO’s 

assessment power may be a prudent 

measure, but stated that the proposed 

limits are unreasonable and excessive 

and seem arbitrary. KCC suggested that 

a better approach would be for the DCO 

to be allowed the latitude to determine 

clearing member assessment haircuts on 

an individual basis, based on each 

clearing member’s financial capabilities. 

MGEX recommended that the 

Commission allow each DCO to provide 

its methodology and support for why 

any assessment might be considered a 

financial resource and how much. 

MGEX stated that the 30 percent haircut 

and 20 percent cap seem arbitrary and 

prescriptive. MGEX stated that the DCO 

should have the discretion to determine 

an appropriate haircut based on the 

clearing member’s liquidity. 

Better Markets commented that the 

proposed haircuts for assessments are 

inadequate. According to Better 

Markets, it would be far more prudent 

to require funding of risk that can be 

anticipated in stress tests and rely on 

assessments as a financial resource only 

for conditions that are not anticipated in 

stress tests. 

LCH recommended that potential 

assessments not be allowed to satisfy 

the requirements of proposed 

§ 39.11(a)(1) because, in LCH’s view, it 

is of the utmost importance that a DCO’s 

resources following a clearing member 

default be immediately and 

unconditionally available. LCH 

suggested that assessments should be 

allowed as part of the DCO’s ‘‘waterfall’’ 

of protections, but should not be taken 

into account to meet the specific test 

outlined under proposed § 39.11(a)(1). 

AFR urged the Commission to 

prohibit DCOs from including 

assessment powers in their calculation 

of financial resources because it is 

unclear, in a time of broad market 

distress, whether a DCO’s members 

would be willing and able to pay their 

assessments. 

The Commission is adopting 

§ 39.11(d)(2)(iii) as proposed. In view of 

the wide range of comments on this 

issue, the Commission believes the rule 

strikes an appropriate balance. The 30 

percent haircut recognizes that the 

defaulting firm, which by definition will 

not be paying an assessment, might 

represent a significant segment of the 

DCO’s total risk. The 20 percent cap 

recognizes that given the contingent 

nature of assessments, they should only 

be relied upon as a last resort. In 

response to ISDA’s comment, the 

Commission expects that as part of the 

evaluation of a clearing member’s risk 

profile, a DCO would take into 

consideration the potential exposure of 

the clearing member at other DCOs, to 

the extent that it is able to obtain such 

information, including the possibility of 

assessments. The Commission notes, in 

response to MGEX’s and KCC’s 

comments, that a DCO may determine 

clearing member assessment haircuts on 

an individual basis because 

§ 39.11(d)(2)(iii) only requires a 30 

percent haircut on an aggregate basis. 

7. Computation of the Financial 

Resources Requirement—§ 39.11(c)(1) 

Proposed § 39.11(c)(1) would require 

a DCO to perform stress testing on a 

monthly basis in order to make a 

reasonable calculation of the financial 

resources it needs to meet the 

requirements of proposed § 39.11(a)(1). 

The DCO would have reasonable 

discretion in determining the 

methodology used to make the 

calculation, but would be required to 

take into account both historical data 

and hypothetical situations. In the 

notice of proposed rulemaking, the 

Commission requested comment on 

whether monthly tests are appropriate. 

MGEX commented that monthly 

reporting seems reasonable as it already 

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49Reverse stress tests are stress tests that require 

a firm to assess scenarios and circumstances that 

would render its business model unviable, thereby 

identifying potential business vulnerabilities. 

Reverse stress testing starts from an outcome of 

business failure and identifies circumstances where 

this might occur. This is different from general 

stress testing, which tests for outcomes arising from 

changes in circumstances. See http:// 

www.fsa.gov.uk/pages/About/What/International/ 

stress_testing/firm_s/reverse_stress_testing/ 

index.shtml. 

50See discussion of § 39.13(h)(3) in section 

IV.D.7.c, below. 

performs stress tests on a routine basis. 

MGEX further commented that allowing 

DCOs discretion in selecting stress test 

scenarios is appropriate. 

CME suggested that annual stress 

testing would suffice for operating costs 

because operating costs are generally 

static. With regard to default coverage, 

CME suggested that stress testing should 

be done no less than monthly. 

LCH expressed concern over the 

requirement that the DCO perform stress 

testing only on a monthly basis. In 

LCH’s view, stress testing should be 

carried out by the DCO on at least a 

daily basis, and LCH strongly urged the 

Commission to amend its proposal 

accordingly. LCH suggested that 

monthly stress testing is inadequate, as 

experience has shown that market 

conditions and member positions can 

change rapidly during periods of market 

turmoil. 

ISDA suggested that reverse stress 

tests 49 should be required for 

determining the size of the financial 

resources package and that there should 

be public disclosure of the stress tests 

and their results. 

Mr. Barnard agreed that stress testing 

should be carried out at least monthly, 

and suggested that back testing should 

be carried out daily. Mr. Barnard also 

suggested that the Commission 

specifically refer to reverse stress testing 

in proposed § 39.11(c)(1) because, in his 

view, it is a useful tool for managing 

expectations and for helping the DCO to 

anticipate financial resources 

requirements in extreme conditions. 

FIA recommended that the 

Commission make clear its expectation 

that the DCOs will, at a minimum: (1) 

Conduct a range of stress tests that 

reflect the DCO’s product mix; (2) 

include the most volatile periods that 

have been experienced by the markets 

for which the DCO provides clearing 

services; (3) take into account the 

distribution of cleared positions 

between clearing members and their 

customers; and (4) test for unanticipated 

levels of volatility and for breakdowns 

in correlations within and across 

product classes. 

Mr. Greenberger recommended that 

historical market data that led up to the 

passage of the Dodd-Frank Act be taken 

into account in determining market 

conditions that could be defined as 

extreme but plausible. 

Better Markets commented that the 

passive role of the Commission in 

measuring the financial requirements 

for a DCO is inappropriate in light of the 

importance of this function. Better 

Markets proposed that the methodology, 

the historical data set, and the 

hypothetical scenarios be: (1) Jointly 

developed by the DCO and the 

Commission and (2) reviewed whenever 

ordered by the Commission, but no less 

frequently than quarterly. Better 

Markets also recommended that the 

Commission explicitly recognize the 

importance of illiquidity in developing 

hypothetical scenarios. 

AFR stated that it is critical that the 

Commission play a central role in 

establishing the standards by which 

DCOs will measure their exposure to 

future risks. AFR urged the Commission 

to define minimal standards that will 

ensure that DCO stress tests are 

stringent and incorporate realistic 

metrics of worst-case scenarios that 

DCOs may experience. 

The Commission is adopting 

§ 39.11(c)(1) as proposed. The 

Commission believes it is appropriate to 

allow the DCO discretion in designing 

stress tests because stress testing is an 

exercise that inherently entails the 

exercise of judgment at various stages. 

Furthermore, § 39.11(c)(1) allows the 

Commission to evaluate the testing and 

require changes as appropriate. In 

response to the LCH comment, the 

Commission notes that there is a 

distinction between the type of stress 

testing carried out under this rule for 

the purpose of sizing the overall 

financial resource package and the type 

of stress testing carried out under 

§ 39.13(h)(3) for the purpose of 

ascertaining the risks that may be posed 

to the DCO by individual traders and 

clearing members. The former is a 

comprehensive test across all clearing 

members and all products with the goal 

of identifying the firms posing the 

greatest risk to the DCO and quantifying 

that risk. The regulations would require 

such testing to be completed monthly. 

The latter is targeted testing addressing 

the specific risks of specific positions at 

specific firms. The regulations would 

require such testing to be completed on 

either a daily or weekly basis, as 

described in § 39.13(h)(3).50

8. Valuation of Financial Resources— 

§ 39.11(d)(1) 

Proposed § 39.11(d)(1) would require 

a DCO, no less frequently than monthly, 

to calculate the current market value of 

each financial resource used to meet its 

obligations under proposed § 39.11(a). 

When valuing a financial resource, a 

DCO would be required to reduce the 

value, as appropriate, to reflect any 

market or credit risk specific to that 

particular resource, i.e., apply a haircut. 

The Commission would permit each 

DCO to exercise its discretion in 

determining the applicable haircuts. 

However, the haircuts would have to be 

evaluated on a monthly basis, would be 

subject to Commission review, and 

would have to be acceptable to the 

Commission. 

OCC suggested that the proposed 

regulations should be modified or 

interpreted to accommodate the use of 

a true portfolio margining model that 

values collateral based on its 

relationship to an overall portfolio in 

lieu of applying fixed haircuts on 

margin collateral. 

ISDA stated that it would support an 

appropriate haircut for default 

insurance, potential assessments, and 

possibly other financial resources 

deemed acceptable by the Commission, 

as determined by the Commission upon 

review of the relevant DCO. 

FIA expressed reservations about the 

ability of a DCO to be paid promptly 

under the terms of a default insurance 

policy. FIA therefore recommended that 

default insurance coverage be subjected 

to a 30 percent haircut and a 20 percent 

cap, similar to the policies that the 

Commission has proposed to apply to a 

DCO’s assessment power. 

In discussions with Commission staff, 

Federal Reserve and Federal Reserve 

Bank of New York staff suggested that 

the liquidity of a financial resource 

should be an additional factor in 

determining an appropriate haircut. 

Considerations should include whether 

it is easy to value the financial resource 

(e.g., whether the pricing is transparent) 

and whether the financial resource 

could be divested in a short time period 

under normal market conditions. The 

Commission agrees that liquidity is an 

important factor in valuing financial 

resources. 

Accordingly, the Commission is 

revising § 39.11(d)(1) to read as follows 

(added text in italics): ‘‘At appropriate 

intervals, but not less than monthly, a 

derivatives clearing organization shall 

compute the current market value of 

each financial resource used to meet its 

obligations under paragraph (a) of this 

section. Reductions in value to reflect 

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credit, market, and liquidity risks 

(haircuts) shall be applied as 

appropriate and evaluated on a monthly 

basis.’’ In response to OCC’s comments, 

the Commission notes that § 39.11(d)(1) 

does not prohibit the valuation method 

described by OCC in its comment letter. 

The Commission believes 

§ 39.11(d)(1) takes a balanced approach 

by permitting a DCO to exercise its 

discretion in determining applicable 

haircuts for each of its financial 

resources but making those haircuts 

subject to Commission review and 

approval. Section 39.11(d)(1) requires a 

DCO to perform such valuations no less 

frequently than monthly, which means 

the Commission would expect a DCO to 

perform such valuations more 

frequently when appropriate, such as 

during periods of market volatility. 

9. Liquidity of Financial Resources— 

§ 39.11(e) 

Proposed § 39.11(e)(1) would require 

a DCO to have financial resources 

sufficiently liquid to enable the DCO to 

fulfill its obligations as a central 

counterparty during a one-day 

settlement cycle, including sufficient 

capital in the form of cash to meet the 

average daily settlement variation pay 

per clearing member over the last fiscal 

quarter. The DCO would be permitted to 

take into account a committed line of 

credit or similar facility for the purpose 

of meeting the remainder of the 

liquidity requirement. In the notice of 

proposed rulemaking, the Commission 

requested comment on whether the 

liquidity requirement should cover 

more than a one-day cycle. The 

Commission also requested comment on 

what standards might be applicable to 

lines of credit—e.g., should the 

Commission require that there be a 

diversified set of providers, or that a 

line of credit have same-day drawing 

rights? 

Proposed § 39.11(e)(2) would require 

a DCO to maintain unencumbered 

liquid financial assets in the form of 

cash or highly liquid securities, equal to 

six months’ operating costs. The DCO 

would be permitted to take into account 

a committed line of credit or similar 

facility to satisfy this requirement. 

Proposed § 39.11(e)(3) would require 

that: (i) Assets in a guaranty fund have 

minimal credit, market, and liquidity 

risks and be readily accessible on a 

same-day basis, (ii) cash balances be 

invested or placed in safekeeping in a 

manner that bears little or no principal 

risk, and (iii) letters of credit not be a 

permissible asset for a guaranty fund. 

OCC recommended that the proposed 

regulations be modified or interpreted to 

provide DCOs some flexibility in 

determining the means of managing 

their ‘‘cash’’ liquidity needs by allowing 

DCOs to use secured credit facilities and 

tri-party repo facilities in addition to 

cash held in demand deposit accounts 

to satisfy the cash requirement. OCC 

observed that permitting these 

alternatives would allow a DCO to hold 

a significant portion of its financial 

resources in the form of U.S. Treasuries, 

with the ability to convert the 

Treasuries to cash as needed. According 

to OCC, cash must generally be held at 

banks, which presents a credit risk. 

NGX suggested that immediately 

accessible bank lines of credit should be 

acceptable to cover the cash 

requirement where the underlying 

commodity is itself traded in a liquid 

market. 

CME suggested the phrase ‘‘average 

daily settlement variation pay per 

clearing member over the last fiscal 

quarter’’ in proposed § 39.11(e)(1) is 

somewhat ambiguous. CME assumed 

that the Commission intended to refer to 

the average daily variation pay for a 

single clearing member, not the average 

daily settlement variation pay for all 

clearing members. 

CME also commented that the 

Commission’s approach is not 

warranted given the potential amount of 

cash at issue and the reliability of 

liquidity facilities for short-term cash 

needs. CME suggested that the 

Commission revise the last sentence of 

proposed § 39.11(e)(1) to read as 

follows: ‘‘If any portion of such 

financial resources is not sufficiently 

liquid, the derivatives clearing 

organization may take into account a 

committed line of credit or similar 

facility for purposes of meeting these 

requirements.’’ 

In response to the Commission’s 

request for comment on what standards 

might be applicable to a liquidity 

facility, CME stated that reviews and 

evaluations by Commission staff during 

regular DCO audits are a sufficient 

check on the adequacy and soundness 

of a committed line of credit, and that 

the Commission should not attempt to 

prescribe the terms and conditions of a 

DCO’s liquidity facility. 

KCC found the language in proposed 

§ 39.11(e) to be ambiguous. KCC 

interpreted the average daily settlement 

variation pay per clearing member over 

the last fiscal quarter to mean the 

cumulative average of the pay-ins per 

each clearing member divided by the 

number of clearing members. In KCC’s 

view, a line of credit with same-day 

drawing rights should be considered as 

liquid as cash and therefore should be 

allowed to be used by the DCO to fulfill 

its financial obligations during a oneday settlement cycle. KCC commented 

that the liquidity requirement should 

cover no more than one day of market 

price movement. 

LCH was unclear on what the 

Commission intends to mean in 

proposed § 39.11(e)(1) by requiring that 

the DCO should allocate financial 

resources to meet the requirements of 

§ 39.11(a)(1) and fulfill its arising 

obligations during a ‘‘one-day 

settlement cycle.’’ LCH suggested that 

the requirement instead should be that 

the DCO is obliged to fulfill its arising 

obligations ‘‘as they fall due.’’ 

Additionally, LCH suggested that the 

requirement that the DCO must have 

‘‘sufficient capital in the form of cash to 

meet the average daily settlement 

variation pay per clearing member over 

the last fiscal quarter’’ is insufficient. 

LCH recommended that this 

requirement be replaced by a test that 

the DCO can meet its liquidity 

requirements ‘‘following the default of 

the clearing member(s) creating the 

largest liquidity requirement under 

stressed market conditions over the 

quarter.’’ 

Mr. Greenberger suggested that the 

standards for a committed line of credit 

or similar facility must be narrowly and 

strictly defined, so that the party can 

easily use such highly liquid line of 

credit or similar facility. Mr. 

Greenberger further suggested that 

greater participation by clearing 

members in a committed line of credit 

or a similar instrument at times of 

market distress would not provide 

necessary liquidity but rather would 

increase systemic risk. 

Eurex noted that proposed § 39.11(e) 

requires DCOs to monitor the liquidity 

of assets and agreed that low-credit risk, 

highly liquid assets should comprise 

guaranty funds and that this rule would 

serve important purposes. 

FIA recommended that the 

Commission clarify that the cash 

requirement is intended to measure the 

average (and not the aggregate) clearing 

member variation margin requirement. 

FIA further recommended that the 

Commission permit a DCO to satisfy this 

requirement through the use of cash or 

cash equivalents, including U.S. 

government securities and repurchase 

agreements involving highly liquid 

securities if such repurchase agreement 

matures within one business day or is 

reversible upon demand. FIA 

additionally recommended that this 

aspect of the Commission’s proposal be 

modified to clarify that DCOs are 

permitted to satisfy the liquidity 

requirement through the establishment 

of committed repo facilities. FIA 

supported allowing a DCO to obtain a 

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Federal Register / Vol. 76, No. 216 / Tuesday, November 8, 2011 / Rules and Regulations 69351 

51CFTC Interpretative Letter 03–31 concerned a 

bank that requested an interpretation that a trust 

deposit account product it developed would be 

acceptable for the deposit of customer segregated 

funds in accordance with Commission Regulation 

1.20. Based on an analysis of the account, staff of 

the Commission’s Division of Clearing and 

Intermediary Oversight issued an interpretation that 

the account would be acceptable as a deposit 

location because the account would be properly 

titled and covered by appropriate 

acknowledgements by the bank, and the funds in 

the account would at all times be immediately 

available for withdrawal on demand. 

52See CPSS–IOSCO Consultative Report, 

Principle 7: Liquidity Risk, at 46. 

committed line of credit or similar 

credit facility to cover the remainder of 

its default resources requirement, but 

recommended that this proposal be 

strengthened by the diversification of 

credit providers, with concentration 

limits of 25 percent per provider. 

MGEX commented that proposed 

§ 39.11(e)(1) requires some clarity. 

MGEX interpreted it to mean that a DCO 

must have cash that will cover the 

average of all the clearing members’ 

average daily settlement variation pays, 

which to MGEX would seem a logical 

and practical application. Rather than 

adopting multiple liquidity 

requirements (i.e., cash, clearing 

member default coverage, six months’ 

worth of operating expenses), MGEX 

suggested the process could be 

simplified to address the most relevant, 

which appeared to MGEX to be the 

clearing member default coverage. In 

addition, MGEX recommended that 

proposed § 39.11(e) should permit 

combining and then totaling its liquidity 

of financial resources as a single-entity 

DCO/DCM. 

AFR stated that DCOs should be 

required to have sufficient cash to fulfill 

their obligations for 10 business days 

and that lines of credit should not count 

toward liquidity requirements. 

NYPC commented that, to the extent 

the proposed requirement is intended to 

exclude cash equivalents, such as U.S. 

Treasury securities, the standard is 

inappropriate. NYPC recommended that 

the Commission allow DCOs to satisfy 

their liquidity needs through the use of 

any combination of cash held in 

demand deposit accounts, bank 

accounts meeting the requirements of 

CFTC Interpretative Letter 03–31,51 and 

secured credit facilities and repurchase 

agreements that allow DCOs to convert 

U.S. Treasury securities and other high 

quality collateral into cash on a sameday basis. 

In response to the comments, the 

Commission is revising § 39.11(e)(1) to 

provide greater clarity. In addition, the 

Commission is modifying the ‘‘cash’’ 

requirement to include ‘‘U.S. Treasury 

obligations and high quality, liquid, 

general obligations of a sovereign 

nation.’’ This conforms the requirement 

to existing liquidity practices and, in 

particular, it accommodates acceptable 

practices of foreign-based DCOs. 

However, the Commission is not 

including bank lines of credit as an 

acceptable financial resource for 

meeting the ‘‘cash’’ requirement because 

they are only a promise by the bank to 

pay and not an asset that can be sold. 

The Commission is revising § 39.11(e)(1) 

by deleting the following language: 

‘‘The derivatives clearing organization 

shall have sufficient capital in the form 

of cash to meet the average daily 

settlement pay per clearing member 

over the last fiscal quarter. If any 

portion of the remainder of the financial 

resources is not sufficiently liquid, the 

derivatives clearing organization may 

take into account a committed line of 

credit or similar facility for the purpose 

of meeting this requirement.’’ 

The Commission is replacing the 

deleted language with the following: 

‘‘[(ii)] The derivatives clearing 

organization shall maintain cash, U.S. 

Treasury obligations, or high quality, 

liquid, general obligations of a sovereign 

nation, in an amount greater than or 

equal to an amount calculated as 

follows: (A) Calculate the average daily 

settlement pay for each clearing member 

over the last fiscal quarter; (B) Calculate 

the sum of those average daily 

settlement pays; and (C) Using that sum, 

calculate the average of its clearing 

members’ average pays. (iii) The 

derivatives clearing organization may 

take into account a committed line of 

credit or similar facility for the purpose 

of meeting the remainder of the 

requirement under paragraph (e)(1)(ii) of 

this section.’’ 

The Commission notes that, in the 

CPSS–IOSCO Consultative Report, CPSS 

and IOSCO are considering a minimum 

liquidity requirement for CCPs that 

would be either: (1) A ‘‘cover one’’ 

minimum requirement for all CCPs; (2) 

a ‘‘cover two’’ minimum requirement for 

all CCPs; or (3) a ‘‘cover one’’ or ‘‘cover 

two’’ minimum requirement for an 

individual CCP, depending on the 

particular risk and other characteristics 

of the particular products that it clears, 

the markets it serves, and the number 

and type of participants it has.52 The 

Commission might revisit the issue after 

CPSS and IOSCO determine what 

standard they will adopt. 

10. Reporting Requirements—§ 39.11(f) 

Proposed § 39.11(f) would require a 

DCO to report to the Commission, at the 

end of each fiscal quarter or at any time 

upon Commission request: (i) The 

amount of financial resources necessary 

to meet the requirements set forth in the 

regulation; and (ii) the value of each 

financial resource available to meet 

those requirements. The DCO would be 

required to include with its report a 

financial statement (including the 

balance sheet, income statement, and 

statement of cash flows) of the DCO or 

its parent company. A DCO would have 

17 business days from the end of the 

fiscal quarter to file its report, but would 

also be able to request an extension of 

time from the Commission. 

NYPC suggested that, in light of the 

scope of information required to be 

submitted in the quarterly report (i.e., 

information regarding default risk 

financial resources and operating 

financial resources), the Commission 

should require that such reports be filed 

not later than 30 calendar days, rather 

than 17 business days, following the 

end of the DCO’s fiscal quarter. 

ISDA suggested that a DCO seeking an 

extension of the 17-day reporting 

deadline should be required to request 

the extension at least seven business 

days before the deadline. 

KCC noted that it does not prepare a 

statement of cash flows on a monthly 

basis, only on an annual basis as part of 

its audited financial statements. KCC 

commented that a monthly profit/loss 

statement is sufficient for determining 

its financial operating needs. 

MGEX suggested the Commission 

should consider a DCO’s privacy 

concerns when permitting reasonable 

discretion in the data the DCO provides 

in the monthly reports required by the 

proposed regulations. MGEX stated that 

some detail as to projected revenue and 

expenses must remain proprietary if it 

involves potential business 

opportunities or other strategic business 

decisions, and that DCOs have a 

legitimate concern that confidential 

financial information could be subject to 

Freedom of Information Act requests. 

The Commission is adopting § 39.11(f) 

as proposed. The Commission notes that 

the 17-business-day filing deadline is 

consistent with the deadline imposed 

on FCMs for the filing of monthly 

financial reports under § 1.10(b). 

Moreover, a DCO may request an 

extension if it is unable to meet the 

deadline. The Commission does not 

believe it is appropriate to require a 

DCO to request an extension at least 

seven business days before the deadline, 

because a DCO may not know that far 

in advance that it will be unable to meet 

the deadline. With regard to the 

confidentiality of the information 

contained in the reports, the 

Commission notes that Core Principle L 

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53Section 5b(c)(2)(C) of the CEA, 7 U.S.C. 7a– 

1(c)(2)(C). 

54Core Principle C, as well as the other core 

principles that are discussed herein, refer to 

‘‘members of, and participants in’’ a DCO. The 

Commission interprets this phrase to mean persons 

with clearing privileges, and has used the term 

‘‘clearing member’’ in describing the requirements 

of each core principle and in the text of the 

proposed regulations described herein. The 

Commission is also amending the definition of 

‘‘clearing member’’ in § 1.3(c), adopted herein, to 

mean ‘‘any person that has clearing privileges such 

that it can process, clear and settle trades through 

a derivatives clearing organization on behalf of 

itself or others. The derivatives clearing 

organization need not be organized as a 

membership organization.’’ 

and § 39.21(c)(4) require a DCO to 

publicly disclose the size and 

composition of the financial resources 

package available in the event of a 

clearing member default. A DCO may 

request confidential treatment under 

§ 145.9 for other information submitted 

to the Commission under these 

regulations. 

11. SIDCOs—§ 39.29 

Proposed § 39.29(a) would require a 

SIDCO to maintain sufficient financial 

resources to meet its financial 

obligations to its clearing members 

notwithstanding a default by the two 

clearing members creating the largest 

combined financial exposure for the 

SIDCO in extreme but plausible market 

conditions. Proposed § 39.29(b) would 

require that a SIDCO not count the value 

of assessments to meet the obligations 

arising from a default by the clearing 

member creating the single largest 

financial exposure and only count the 

value of assessments, after a 30 percent 

haircut, to meet up to 20 percent of the 

obligations arising from a default by the 

clearing member creating the second 

largest financial exposure. The 

Commission believes that it would be 

premature to take action regarding 

§ 39.29 at this time. The FSOC has not 

yet designated any DCOs as systemically 

important. As previously noted, the 

CPSS–IOSCO Principles for Financial 

Market Infrastructures, which are 

expected to be finalized in 2012, will 

address minimum financial resources 

requirements for CCPs. Similarly, 

certain foreign regulators, including the 

European Union, are also considering 

requirements in this area for the CCPs 

they regulate. The Commission is 

concerned that SIDCOs would be put at 

a competitive disadvantage if they are 

forced to comply with these 

requirements before non-U.S. CCPs are 

subject to comparable standards. The 

Commission is closely monitoring 

developments on this issue and is 

prepared to revisit the issue if the 

European Union or other foreign 

regulators move closer to 

implementation. Moreover, because it 

may be some time before any DCO is 

designated a SIDCO, the Commission 

believes it would be prudent to 

reconsider the regulation of SIDCOs in 

light of developments that may occur in 

the interim. The Commission expects to 

consider all the proposed rules relating 

to SIDCOs together. 

C. Core Principle C—Participant and 

Product Eligibility—§ 39.12 

1. Participant Eligibility 

Core Principle C,53 as amended by the 

Dodd-Frank Act, requires each DCO to 

establish appropriate admission and 

continuing eligibility standards for 

members of, and participants in, the 

DCO,54 including sufficient financial 

resources and operational capacity to 

meet the obligations arising from 

participation. Core Principle C further 

requires that such participation and 

membership requirements be objective, 

be publicly disclosed, and permit fair 

and open access. Core Principle C also 

requires that each DCO establish and 

implement procedures to verify 

compliance with each participation and 

membership requirement, on an ongoing 

basis. Proposed § 39.12(a) would codify 

these requirements and establish the 

minimum requirements that a DCO 

would have to meet in order to comply 

with Core Principle C. 

Although there is potential tension 

between the goals of ‘‘fair and open 

access’’ and ‘‘sufficient financial 

resources and operational capacity to 

meet obligations arising from 

participation in the derivatives clearing 

organization,’’ the Commission believes 

the rules that it is adopting herein strike 

an appropriate balance. The 

Commission has crafted the provisions 

of § 39.12 and related rules, e.g., the risk 

management requirements, to establish 

a regulatory framework that it believes 

can ensure that a DCO’s participation 

requirements do not unreasonably 

restrict any entity from becoming a 

clearing member while, at the same 

time, limiting risk to the DCO and its 

clearing members. The Commission 

expects that more widespread 

participation will reduce the 

concentration of clearing member 

portfolios, thereby diversifying risk, 

increasing market liquidity, and 

increasing competition among clearing 

members. 

a. Fair and Open Access—§ 39.12(a)(1) 

Proposed § 39.12(a) would require a 

DCO to establish appropriate admission 

and continuing participation 

requirements for clearing members of 

the DCO, which are objective, publicly 

disclosed, and risk-based. Proposed 

§ 39.12(a)(1) would require a DCO to 

have participation requirements that 

permit fair and open access, setting 

forth specific standards. 

The Managed Funds Association 

(MFA), BlackRock, Inc. (BlackRock), 

State Street Corporation (State Street), 

and the Committee on Capital Markets 

Regulation (CCMR) supported the 

proposed rules. J.P. Morgan, ISDA, and 

FIA expressed support for the fair and 

open access provisions as long as there 

is prudent risk management. 

According to MFA, more inclusive 

DCO participation requirements would 

benefit DCOs and the markets by: (1) 

Reducing DCO concentration risk; (2) 

increasing diversity of market 

participants involved in DCO 

governance; (3) enhancing competition 

in the provision of clearing services; and 

(4) lowering overall costs for nonclearing members. State Street agreed 

that more widespread participation 

could increase competition by allowing 

more entities to become clearing 

members. Blackrock commented that 

the proposed rule would allow a diverse 

group of entities to become clearing 

members, which would increase 

competition, promote more inclusive 

DCO participation requirements, and 

lower costs to customers of clearing 

members. 

Each of the provisions of § 39.12(a)(1) 

are discussed below. 

b. Less Restrictive Standards— 

§ 39.12(a)(1)(i) 

To achieve fair and open access, 

proposed § 39.12(a)(1)(i) would prohibit 

a DCO from adopting a particular 

restrictive participation requirement if it 

could adopt a less restrictive 

requirement that would not materially 

increase risk to the DCO or its clearing 

members. BlackRock, the Swaps & 

Derivatives Market Association (SDMA), 

CME, LCH, Citadel, and CCMR 

supported the proposed rule. CCMR 

commented that the proposed rule 

would help to encourage an open 

marketplace. 

KCC, ICE, and MGEX did not support 

the proposed rule. According to KCC, 

the test is highly subjective and would 

be difficult to implement in practice. 

ICE commented that the proposal would 

require a DCO to dilute current prudent 

risk management practices. MGEX 

commented that the proposed rule 

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would require DCOs to consider only 

objective, hard number risk factors, 

which would force DCOs to bear other 

risks such as financial fraud 

convictions. MGEX suggested that the 

Commission should provide DCOs with 

latitude when determining the risks to 

which it will expose itself. 

The Commission is adopting 

§ 39.12(a)(1)(i) as proposed, except for 

the addition of clarifying language to 

provide that a DCO shall not adopt 

restrictive clearing member standards if 

less restrictive requirements ‘‘that 

achieve the same objective and’’ that 

would not materially increase risk to the 

derivatives clearing organization or 

clearing members could be adopted. The 

rule balances the dual Congressional 

mandate to provide for fair and open 

access while ensuring that such 

increased access does not materially 

increase risk. Because the rule does not 

require a DCO to provide access that 

materially increases risk to the DCO or 

clearing members, the Commission does 

not agree with ICE that the rule will 

subject a DCO to increased risk. 

The Commission does not agree with 

KCC that the rule will be highly 

subjective or difficult to implement in 

practice. The rule provides a DCO with 

discretion to balance restrictions on 

participation with legitimate risk 

management concerns and, in this 

regard, a DCO is in the best position in 

the first instance to determine the 

optimal balance. Only in circumstances 

where there is a question as to the 

impact of the rule would the 

Commission ask a DCO to justify the 

balance that the DCO has struck. 

In response to MGEX’s comment, the 

Commission notes that the rule does not 

require a DCO to rely solely on 

objective, hard number risk factors. The 

rule permits a DCO to rely on both 

qualitative and quantitative analyses, 

providing each DCO with latitude to 

determine how it can facilitate open 

access while determining the risks to 

which it will expose itself. 

Except for certain bright-line 

participation requirements (e.g., capital 

requirements for clearing members), the 

Commission has not provided more 

specific guidance as to what participant 

eligibility requirements are permissible 

under Core Principle C. Such a 

clarification would only serve to limit a 

DCO’s flexibility to formulate 

participation requirements. 

The Commission encourages each 

DCO to conduct a self-assessment to 

make sure that it can provide reasoned 

support to justify a conclusion that its 

rules do not violate the ‘‘less restrictive’’ 

standard contained in § 39.12(a)(1)(i). 

Such an analysis should take into 

consideration the interaction of this 

provision with the other provisions of 

§ 39.12(a). 

c. Clearing Member Qualification— 

§ 39.12(a)(1)(ii) 

Proposed § 39.12(a)(1)(ii) would 

require a DCO to permit a market 

participant to become a clearing 

member if it meets the DCO’s 

participation requirements. SDMA, 

LCH, and CCMR supported the 

proposed rule. According to CCMR, the 

proposed rule would help to encourage 

an open marketplace. 

KCC commented that the proposed 

rule is not workable because a DCO may 

not have the operational capacity to 

admit all applicants that satisfy the 

DCO’s membership requirements. KCC 

proposed that the regulation clarify that 

a DCO may set limits on the number of 

market participants that may be 

admitted in light of the DCO’s own 

operational constraints. 

The Commission is adopting 

§ 39.12(a)(1)(ii) as proposed. The 

Commission is concerned that 

permitting a DCO to set a limit on the 

number of market participants that may 

become clearing members could enable 

a DCO to evade the open access 

requirement imposed by Core Principle 

C. If a DCO were able to demonstrate 

that operational constraints prevented it 

from admitting additional clearing 

members, the DCO could petition the 

Commission for an exemption. 

d. Non-Discriminatory Treatment— 

§ 39.12(a)(1)(iii) 

Proposed § 39.12(a)(1)(iii) would 

prohibit participation requirements that 

have the effect of excluding or limiting 

clearing membership of certain types of 

market participants unless the DCO can 

demonstrate that the restriction is 

necessary to address credit risk or 

deficiencies in the participants’ 

operational capabilities that would 

prevent them from fulfilling their 

obligations as clearing members. LCH 

and SDMA supported the proposed rule. 

CME commented that in addition to 

credit risk and deficiencies in 

operational capabilities, legal risk 

should be included in the text of this 

regulation as a basis upon which a DCO 

may exclude or limit clearing 

membership of certain types of 

participants. 

KCC did not support the proposed 

rule, commenting that a DCO’s right to 

exclude or place limitation on certain 

clearing members should not be subject 

to ex-post determinations as to the 

necessity of such restrictions, as the 

DCO itself is in the best position to 

monitor the risks posed by the activities 

of its clearing members. According to 

KCC, the proposed rule would limit the 

risk management capabilities of a DCO, 

and DCOs should be accorded flexibility 

in their assessments of the operational 

capabilities of potential clearing 

members. 

The Commission is adopting 

§ 39.12(a)(1)(iii) as proposed. CME’s 

concerns regarding heightened legal 

risk, such as the inability to attach 

property of a foreign clearing member 

under foreign law, are encompassed 

within the ‘‘credit risk’’ consideration. 

The Commission expects that most, if 

not all, bases for membership exclusion 

or limitation will fall within either 

financial or operational considerations. 

In addition, the Commission does not 

believe the rule would limit a DCO’s 

risk management capabilities as KCC 

suggested because it would not prevent 

a DCO from excluding or limiting 

certain types of market participants 

from clearing if such participation 

would introduce genuine risk that 

cannot be adequately managed by the 

DCO. The Commission expects that 

DCOs will review their existing 

participation requirements for 

compliance with this rule. 

e. Prohibition of Swap Dealer 

Requirement—§ 39.12(a)(1)(iv) 

Proposed § 39.12(a)(1)(iv) would 

prohibit a DCO from requiring that 

clearing members be swap dealers. LCH 

commented that, in the event of default, 

it relies on non-defaulting clearing 

members to hedge the defaulting 

member’s swap portfolio; to provide 

liquidity for such hedging; to bid on 

hedged portfolios; and, in extreme 

circumstances, to accept a forced 

allocation of swaps, which could be a 

risky, unhedged swaps portfolio. LCH 

commented that a clearing member who 

is not a swap dealer may not be able to 

participate in a DCO’s default 

management process. 

The Commission is adopting 

§ 39.12(a)(1)(iv) as proposed. It is 

important to note that the regulation 

would not preclude participation by 

swap dealers (on which LCH currently 

relies). It simply requires that a DCO 

provide clearing access to other entities 

that could also participate in a DCO’s 

default management process, even if to 

a lesser extent. Broader access is 

supported by other Commission 

regulations, e.g., § 39.12(a)(3), which 

mandates that a DCO require its clearing 

members to have adequate operational 

capacity to participate in default 

management activities; § 39.12(b)(5), 

which requires a DCO to select contract 

units for clearing purposes that 

maximize liquidity, facilitate 

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55Section 5b(c)(2)(C)(i)(I) of the CEA; 7 U.S.C. 7a– 

1(c)(2)(C)(i)(I). 

transparency in pricing, promote open 

access, and allow for effective risk 

management; and § 39.16(c)(2)(iii), 

which permits a DCO to require its 

clearing members to accept an 

allocation, provided that any allocation 

must be proportional to the size of the 

clearing member’s positions at the DCO. 

Thus, a DCO should be able to establish 

participation requirements that allow it 

to rely on non-defaulting clearing 

members to hedge a defaulting 

member’s swap portfolio, to provide 

liquidity for such hedging, to bid on 

hedged portfolios, and to accept a forced 

allocation of swaps. 

f. Prohibition of Swap Portfolio or Swap 

Transaction Volume Requirements— 

§ 39.12(a)(1)(v) 

Proposed § 39.12(a)(1)(v) would 

prohibit a DCO from requiring clearing 

members to maintain a swap portfolio of 

any particular size, or that clearing 

members meet a swap transaction 

volume threshold. 

According to State Street, such 

requirements are intended to 

systematically favor membership for 

financial institutions that are also 

substantial dealers in swaps. They do 

not take into account the risk 

management capabilities of many DCO 

members such as State Street, which are 

able to closely monitor risk exposures 

and effectively liquidate exposures 

through networks of interdealer 

relationships. The Commission believes 

that such requirements would have the 

effect of permitting only large swap 

dealers to provide clearing services. 

This would be inconsistent with Core 

Principle C. Accordingly, the 

Commission is adopting § 39.12(a)(1)(v) 

as proposed. 

g. Financial Resources—§ 39.12(a)(2)(i) 

Core Principle C mandates that each 

DCO must ensure that its clearing 

members have ‘‘sufficient financial 

resources and operational capacity to 

meet obligations arising from 

participation in the [DCO].’’ 55 Proposed 

§ 39.12(a)(2)(i) would require a DCO to 

establish participation requirements that 

require clearing members to have access 

to sufficient financial resources to meet 

obligations arising from participation in 

the DCO in extreme but plausible 

market conditions. The financial 

resources could include a clearing 

member’s capital, a guarantee from a 

clearing member’s parent, or a credit 

facility funding arrangement. 

CME commented that it supports the 

inclusion of parent guarantees and 

credit facility funding arrangements as 

acceptable financial resources for 

clearing members, provided that each 

DCO retains the flexibility to determine 

the particular terms and conditions of 

such arrangements. LCH, however, 

commented that credit facilities or 

funding arrangements should not be 

allowed for the purposes of fulfilling 

financial participation requirements. 

According to LCH, all clearing members’ 

resources should be immediately and 

unconditionally available. ISDA also 

commented that a credit facility funding 

arrangement from an unaffiliated entity 

should not be available to satisfy 

clearing member financial resource 

requirements. ISDA did not believe that 

such funding would be reliable. 

MGEX commented that testing for 

extreme but plausible market conditions 

would have minimal value because the 

test would be based on historical 

records or it would be based on future 

assumptions that are based on static 

conditions. MGEX believes that the 

proposed rule would require a DCO to 

devise tests for clearing members to use 

and would require a DCO to conduct the 

tests and provide the results to clearing 

members. MGEX commented that this 

specific rule seems unnecessary because 

DCOs have other methods to address 

risk, like increasing and decreasing 

margin. It noted further that it already 

requires clearing members to be in good 

financial standing, which includes 

minimum capital requirements and a 

requirement to provide a parent 

guarantee in certain circumstances. 

The Commission is adopting 

§ 39.12(a)(2)(i) with the modification 

described below. Per CME’s comment, 

the rule provides a DCO with the 

flexibility to determine what constitutes 

sufficient financial resources to meet 

obligations arising from participation in 

the DCO in extreme but plausible 

market conditions, and to determine 

what financial resources are available to 

a clearing member to satisfy this 

requirement. 

Regarding the comments of LCH and 

ISDA, the rule does not require a DCO 

to allow clearing members to use a 

credit facility funding arrangement to 

meet financial resource requirements. 

Because such arrangements can serve as 

an important source of liquidity for 

clearing members, the Commission has 

not prohibited their possible use to 

satisfy clearing member financial 

resource requirements. The Commission 

is modifying § 39.12(a)(2)(i) to clarify a 

DCO’s discretion, by rephrasing the 

second sentence to read as follows: ‘‘A 

derivatives clearing organization may 

permit such financial resources to 

include, without limitation, a clearing 

member’s capital, a guarantee from the 

clearing member’s parent, or a credit 

facility funding arrangement.’’ To 

address concerns about reliability, a 

DCO can consider requiring that a credit 

facility funding arrangement be 

supported by multiple lenders. 

Finally, the Commission does not 

believe that MGEX’s comment provides 

a basis for revising the proposed rule. 

As an initial matter, Core Principle C 

requires each DCO to establish 

participation standards that require a 

clearing member to have sufficient 

financial resources to meet obligations 

arising from participation in the DCO. 

Core Principle B requires a DCO to 

maintain financial resources that would 

enable it to meet its financial obligations 

in ‘‘extreme but plausible’’ market 

conditions. The Commission believes 

that it is appropriate for a DCO to 

subject its clearing members to a 

comparable financial standard to 

support its own compliance with 

statutory requirements. A DCO would 

have discretion in setting the terms of 

any tests to determine whether clearing 

members’ financial resources are 

sufficient to meet their obligations in 

extreme but plausible market 

conditions. 

h. Capital Requirements Must Match 

Capital to Risk—§ 39.12(a)(2)(ii) 

Proposed § 39.12(a)(2)(ii) would 

require a DCO to establish capital 

requirements that are based on 

objective, transparent, and commonly 

accepted standards, which 

appropriately match capital to risk. The 

capital requirements also would have to 

be scalable so that they are proportional 

to the risks posed by clearing members. 

J.P. Morgan, MFA, ISDA, State Street, 

SDMA, Citadel LLC (Citadel), Better 

Markets, and FIA supported the 

proposed rule. According to Better 

Markets, the proposed rule is an 

important change of practices that will 

open DCO membership to more market 

participants while protecting the risk 

management system. FIA commented 

that a DCO, when it sets capital 

requirements, should take into account 

a clearing member’s risk-derived 

exposures and its potential assessment 

obligations at each clearing organization 

of which it is a member. FIA 

recommended that a DCO should allow 

an FCM to clear positions in proportion 

to its capital net of those other riskderived exposures and assessment 

obligations. 

The Commission is adopting 

§ 39.12(a)(2)(ii) as proposed, with one 

modification. In response to a comment 

from staff of the Federal Reserve and the 

Federal Reserve Bank of New York, the 

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56See transcript of December 16, 2010 

Commission meeting at 77–81 available at 

www.cftc.gov (discussing $50 million threshold; 

Commission staff stating that of 126 FCMs, 63 

currently have capital above $50 million and most 

Continued 

Commission is deleting the phrase ‘‘so 

that they are proportional’’ from the 

rule. This is to make clear that a DCO 

should take into account nonlinear risk. 

In response to FIA’s comment, the 

Commission notes that in setting 

scalable requirements, a DCO should 

take into consideration risks that a 

clearing member carries as a result of 

positions cleared at other DCOs, to the 

extent that it is able to obtain such 

information. 

i. Minimum Capital Requirement— 

§ 39.12(a)(2)(iii) 

Proposed § 39.12(a)(2)(iii) would 

prohibit a DCO from setting a minimum 

capital requirement of more than $50 

million for any person that seeks to 

become a clearing member in order to 

clear swaps. Pierpont Securities LLC 

(Pierpont), Better Markets, SDMA, 

Newedge, MFA, Citadel, and Jefferies & 

Company (Jefferies) supported the 

proposed rule. 

Jefferies commented that the proposed 

rule would allow it to participate more 

actively in the swap market. Jefferies 

believes that taken together, the 

provisions of proposed § 39.12(a) 

provide a DCO with more than 

sufficient authority to assure the 

financial integrity and efficient 

operation of its swaps clearing 

activities. 

Newedge commented that the 

proposed rule should not increase risk 

to a DCO because a DCO can mitigate 

risk by, among other things, imposing 

position limits, stricter margin 

requirements, or stricter default deposit 

requirements on lesser capitalized 

clearing members. Newedge proposed 

that the Commission prohibit DCOs 

from imposing a requirement that 

clearing members have an internal 

trading desk capable of liquidating or 

hedging a defaulting clearing member’s 

positions. It said that there is no need 

for such a requirement because a nondefaulting member can handle a default 

event in a variety of ways, including 

having a contingent default manager. 

Newedge noted that under proposed 

§ 39.16(c)(2)(iii), any obligation of a 

clearing member to participate in an 

auction, or to accept the allocation of a 

defaulting clearing member’s positions, 

would be proportionate to the size of the 

clearing member’s own position at the 

DCO. Thus, a clearing member should 

be able to hedge an allocated position 

and carry the position over time without 

having to take a substantial charge to its 

capital. 

MFA commented that the threshold 

should not impose additional risk on a 

DCO because a DCO could ensure the 

safety of itself and clearing members by 

scaling each clearing member’s net 

capital obligation in proportion to that 

clearing member’s risk exposure. MFA 

expressed concern that a DCO could 

comply with the $50 million net capital 

requirement but impose a non-riskbased and excessive threshold guaranty 

fund contribution requirement that 

would unnecessarily exclude clearing 

members. MFA proposed that the 

regulations require that such scaling be 

determined by objective, risk-based 

methodologies that are based on 

reasonable stress and default scenarios, 

and the tests be consistently applied to 

all clearing members, without use of 

‘‘tiers’’ that could have discriminatory 

or anti-competitive effects. 

J.P. Morgan, the U.K. Financial 

Services Authority (FSA), CME, KCC, 

ISDA, IntercontinentalExchange, Inc. 

(ICE), State Street, Federal Home Loan 

Banks (FHLBanks), the Securities 

Industry and Financial Markets 

Association (SIFMA), and LCH 

expressed the view that the proposed 

rule could increase risk and the 

probability of default, and require DCOs 

to accept members who might not be 

able to participate in the default 

management process. FSA, KCC, and 

CME commented that a DCO must have 

reasonable discretion to determine the 

appropriate capital requirements for its 

clearing members based upon the DCO’s 

analysis of the particular characteristics 

of the swaps that it clears. 

J.P. Morgan, however, commented 

that a cap on a member’s minimum 

capital requirement would not impact 

the systemic stability of a DCO as long 

as: (1) Clearing members clear house 

and client business in proportion to 

their available capital; (2) DCOs employ 

real-time risk management processes to 

ensure compliance with this principle; 

(3) DCOs hold a sufficient amount of 

margin and funded default guarantee 

funds; and (4) the Commission monitors 

clearing members to ensure that they are 

able to meet their financial obligations 

with respect to all DCOs of which they 

are members. 

LCH and ISDA commented that the 

lower threshold could increase risk 

because a $50 million threshold would 

allow a clearing member to meet the 

eligibility requirements of multiple 

DCOs. 

LCH, CME, and FSA commented that 

the smaller firms may be unable to 

participate in the default management 

process. LCH and ISDA also commented 

that members should not be able to 

outsource default management to third 

parties because they may not be 

sufficiently reliable in times of stress. 

In addition, according to ISDA, there 

could be conflict-of-interest issues 

because the unaffiliated third party 

would not have ‘‘skin in the game.’’ As 

a result, through the actions of the 

unaffiliated third party, a clearing 

member could be assigned an unsuitable 

part of a defaulting clearing member’s 

proprietary portfolio and/or at a suboptimal valuation and/or wrongly 

accept customer positions from the 

defaulting clearing member. This 

conflict-of-interest concern is 

exacerbated where the entity to whom 

the default management obligations are 

outsourced is a ‘‘competing’’ clearing 

member in the same DCO. 

State Street and SDMA, however, 

commented that clearing members 

should be permitted to enter into 

committed arrangements with nonaffiliated firms to perform default 

management functions. According to 

SDMA, there is no evidence to suggest 

that a legal arrangement with a thirdparty dealer somehow lessens the 

integrity to the system. Assuming the 

legal and financial arrangements 

between such firms are sufficiently 

strong to ensure performance when 

needed, State Street commented that 

there is no appreciable difference 

between the default management 

capacity of the traditional dealeraffiliated clearing member and a nondealer clearing member outsourcing 

certain functions to a non-affiliate. 

Finally, SIFMA commented that the 

appropriate minimum capital 

requirement would be $300 million, 

while ISDA commented that if the 

Commission cannot monitor risk across 

all DCOs, a $1 billion capital 

requirement would be appropriate. 

After carefully considering the 

comments, the Commission is adopting 

§ 39.12(a)(2)(iii) as proposed. The 

Commission believes, as noted in 

numerous comments, that the rule will 

increase the number of firms clearing 

swaps, which will make markets more 

competitive, increase liquidity, reduce 

concentration, and reduce systemic risk. 

The Commission also believes that, as 

explained below, the $50 million 

threshold will not significantly increase 

risk or lead to admission of clearing 

members who are unable to 

meaningfully and responsibly 

participate in the clearing process. 

As an initial matter, the Commission 

emphasizes that the $50 million 

threshold is not arbitrary. That number 

was arrived at by reviewing the capital 

of registered FCMs.56 This amount 

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FCMs with capital below that amount are not 

clearing members). 57Clearing FCM and non-clearing FCM data for 

adjusted net capital and excess net capital was 

provided by FCM registrants and is available on the 

Commission Web site. The other data is non-public. 

Ownership equity data was provided by FCM 

registrants through the monthly financial 

statements that are submitted to the Commission. 

The data from the monthly financial statements 

reside in the Commission’s RSR Express system, 

and all data for clearing non-FCMs was provided by 

the DCOs to the Commission’s Risk Surveillance 

Group during the course of its routine oversight 

activities. 

58See 76 FR 45724 (Aug. 1, 2011) (Clearing 

Member Risk Management). 

captures firms that the Commission 

believes have the financial, operational, 

and staffing resources to participate in 

clearing swaps without posing an 

unacceptable level of risk to a DCO. 

This capital threshold is considered to 

be appropriate, particularly in light of 

other proposed rules (such as scaling 

capital and risk exposure and breaking 

down large swap positions into smaller 

units for more diversified allocation in 

the event of a clearing member default). 

The Commission considered whether 

to increase the capital threshold to 

$300 million as proposed by SIFMA or 

$1 billion as proposed by ISDA. The 

Commission analyzed the reduction in 

the number of firms that would be 

eligible to clear at CME, ICE Clear US, 

KCC, MGEX, and OCC using these 

thresholds. As set forth in the table 

below, depending on the basis used to 

measure capital, a capital threshold of 

$300 million would reduce the number 

of firms able to clear by 38–51 percent. 

A capital threshold of $1 billion would 

reduce the number of firms able to clear 

by 62–65 percent. The Commission 

believes that this reduction in 

participation would be contrary to the 

Congressional mandate for open access 

to clearing.57

The Commission does not believe that 

the rule will increase risk. Section 

39.12(a)(2)(ii) requires DCOs to impose 

capital requirements that are scalable to 

the risks posed by clearing members. 

Accordingly, a small clearing member 

should not be able to expose a DCO to 

significant risk even if it is able to clear 

at multiple DCOs because its exposure 

at each DCO would be limited. DCOs 

that participate in the Shared Market 

Information System (SHAMIS) will be 

able to see a clearing member’s pays and 

collects across participating DCOs, and 

a DCO also could on its own initiative 

require clearing members to directly 

report their clearing activity at other 

DCOs. The Commission also will be able 

to monitor clearing member exposure by 

means of DCO end-of-day reporting 

under the reporting requirements of 

§ 39.19(c)(1)(i), which the Commission 

is adopting herein. It will also be able 

to monitor the financial strength of 

clearing members that are registrants 

pursuant to financial reporting 

requirements. 

In addition, the Commission is 

adopting other rules that will reinforce 

a DCO’s oversight of its clearing 

members. In this regard, § 39.12(a)(4) 

requires a DCO to verify, on an ongoing 

basis, the compliance of each clearing 

member with each participation 

requirement; § 39.12(a)(5) requires a 

DCO to require all clearing members to 

file periodic financial statements and 

timely information that concerns any 

financial or business developments that 

may materially affect the clearing 

members’ ability to continue to comply 

with participation requirements; and 

§ 39.13(h)(5) further requires a DCO to 

adopt rules that require clearing 

members to maintain current risk 

management policies and procedures 

and requires a DCO to review such 

policies and procedures on a periodic 

basis. The Commission also has 

proposed requirements for clearing 

member risk management.58

The Commission does not believe that 

the $50 million threshold would lead to 

a DCO having to admit clearing 

members that are unable to participate 

in the default management process. As 

discussed above, the regulation does not 

preclude highly-capitalized entities 

(such as swap dealers) from 

participating in a DCO as clearing 

members. Thus, the addition of smaller 

clearing members does not eliminate the 

role that larger clearing members can 

play in default management—it merely 

spreads the risk. 

The Commission wishes to emphasize 

that it will review DCO membership 

rules as a package in light of all of the 

provisions of § 39.12(a). Thus, a DCO 

may not circumvent § 39.12(a)(2)(iii) by 

enacting some additional financial 

requirement that effectively renders the 

$50 million threshold meaningless for 

some potential clearing members. Such 

an arrangement would violate 

§ 39.12(a)(1)(i) (less restrictive 

alternatives), or § 39.12(a)(1)(iii) 

(exclusion of certain types of firms). 

As discussed below, under 

§ 39.12(a)(3), a DCO’s participation 

requirements must include provisions 

for adequate operational capacity. This 

requirement should be read in 

conjunction with § 39.12(a)(1)(i), which 

prohibits restrictive clearing member 

standards if less restrictive standards 

could be adopted; § 39.12(a)(1)(iii), 

which prohibits DCOs from excluding 

certain types of market participants 

from clearing membership if they can 

fulfill the obligations of clearing 

membership; and § 39.16(c)(2)(iii), 

which permits a DCO to require a 

clearing member to participate in an 

auction or to accept allocations of a 

defaulting clearing member’s customer 

or house positions, provided the 

allocated positions are proportional to 

the size of the clearing member’s 

positions at the DCO and are permitted 

to be outsourced to a qualified third 

party subject to safeguards imposed by 

the DCO. 

Several commenters discussed the use 

of outsourcing to satisfy default 

management obligations. The 

Commission believes that open access to 

clearing and effective risk management 

need not be viewed as conflicting goals. 

Subject to appropriate safeguards, 

outsourcing of certain obligations can be 

an effective means of harmonizing these 

goals. For example, a small clearing 

member might have less ability to 

contribute meaningfully to a DCO’s 


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59See discussion of revised § 39.16(c)(2)(iii) in 

section IV.G.4, below. 

60See discussion of § 39.13(h)(5) in section 

IV.D.7.e, below. 

61See 76 FR at 45729–45730 (Aug. 1, 2011) 

(Clearing Member Risk Management). 

62See Section 5b(c)(2)(C)(ii) of the CEA; 7 U.S.C. 

7a–1(c)(2)(C)(ii). 

auction process acting on its own than 

if an entity with greater expertise in the 

relevant markets acted in its place. 

Therefore, the Commission believes 

that it would be inconsistent with 

§ 39.12(a)(1)(i) and § 39.12(a)(1)(iii) for a 

DCO to prohibit outsourcing. 

Accordingly, as discussed below, the 

Commission is adopting revised default 

procedure rules to require a DCO to 

permit outsourcing to qualified third 

parties of obligations to participate in 

auctions or in allocations, subject to 

appropriate safeguards imposed by the 

DCO.59

Finally, the Commission has 

determined that it will not permit a 

DCO to require members to post a 

minimum amount of liquid margin or 

default guarantee contributions, or to 

participate in a liquidity facility per J.P. 

Morgan’s suggestion. The Commission 

believes that the rules are sufficient to 

ensure that each member has adequate 

resources to withstand another 

member’s default and such 

requirements could be used by a DCO to 

evade the open access to clearing 

intended by the Dodd-Frank Act. 

j. Operational Requirements— 

§ 39.12(a)(3) 

Proposed § 39.12(a)(3) would require 

a DCO to require its clearing members 

to have adequate operational capacity to 

meet their obligations arising from 

participation in the DCO. The 

requirements would include, but not be 

limited to: The ability to process 

expected volumes and values of 

transactions cleared by a clearing 

member within required time frames, 

including at peak times and on peak 

days; the ability to fulfill collateral, 

payment, and delivery obligations 

imposed by the DCO; and the ability to 

participate in default management 

activities under the rules of the DCO 

and in accordance with proposed 

§ 39.16. 

LCH, FIA, Jefferies, and SDMA 

commented that the Commission has 

correctly identified the operational 

requirements. Jefferies commented that 

demonstrating sufficient operational 

capacity is more important than capital 

considerations. According to SDMA, 

these operational requirements are 

directly related to the core business of 

the clearing member and provide the 

services needed and relied upon by the 

DCO to clear trades. SDMA also believes 

that DCOs should be prohibited from 

imposing operational requirements that 

are not part of a clearing member’s core 

business because they create 

discriminatory barriers to clearing, and 

it points to the following as examples of 

discriminatory operational eligibility 

requirements: Clearing members must 

(1) Have both execution and clearing 

capabilities; (2) provide end-of-day 

prices to mark its positions; and (3) have 

extensive experience in clearing swaps 

or ‘‘sophistication.’’ 

J.P. Morgan and FIA commented that 

a DCO must ensure that each member 

has risk management resources to assist 

the DCO in its risk management process, 

and FIA suggested that the final rules 

add appropriate risk management 

requirements as a participant eligibility 

criterion, or make clear that nothing in 

the proposed rules is intended to 

prevent a DCO from adopting such 

requirements. 

ISDA commented that the ability to 

bid for portfolios of other clearing 

members of the DCO is critically 

important. According to ISDA, an 

appropriate risk management framework 

for a clearing member may be broadly 

categorized as follows: (1) Board and 

senior management oversight; (2) 

organizational structure; and (3) strong 

systems and procedures for controlling, 

monitoring and reporting risk. 

Finally, State Street commented that a 

clearing member must be able to 

demonstrate it can carry out its 

obligations to a DCO under a default 

scenario. That demonstration could 

include having the capacity to trade 

swaps using experienced swap traders, 

and the ability to execute transactions in 

the market by having appropriate 

trading relationships. A clearing 

member must also demonstrate an 

ability to monitor positions, calculate 

potential losses and market risk, 

perform stress tests, and maintain 

liquidity, among numerous other 

requirements. 

The Commission is adopting 

§ 39.12(a)(3) as proposed. The 

Commission believes that the rule 

correctly identifies the necessary 

operational requirements and is 

concerned that the heightened 

operational requirements suggested by 

some commenters could allow a DCO to 

evade the open access to DCO clearing 

intended by the Dodd-Frank Act. The 

Commission emphasizes that under the 

rule, any operational requirements must 

be necessary to meet clearing 

obligations. In addition, the 

Commission is adopting § 39.13(h)(5) 

herein, which requires a DCO to adopt 

rules requiring clearing members to 

maintain current written risk 

management policies and procedures.60

The Commission has also proposed 

rules requiring clearing members that 

are FCMs (proposed § 1.73) and swap 

dealers and major swap participants 

(proposed § 23.609) to engage in specific 

risk management activities.61

k. Monitoring, Reporting, and 

Enforcement—§ 39.12(a)(4) 

Core Principle C requires each DCO to 

‘‘establish and implement procedures to 

verify, on an ongoing basis, the 

compliance of each clearing member 

with each participation requirement of 

the derivatives clearing organization.’’ 62

Proposed § 39.12(a)(4) would codify 

these requirements. 

OCC supported the proposed rule ‘‘if 

interpreted reasonably.’’ J.P. Morgan 

commented that a clearing member may 

have committed to additional unfunded 

assessments at more than one 

clearinghouse and proposes that the 

Commission and DCOs monitor clearing 

members to ensure that they have 

sufficient liquid resources to support 

the business they clear at each DCO. 

According to J.P. Morgan, a DCO should 

monitor exposures against risk-based 

position limits on a real-time basis. 

The Commission is adopting 

§ 39.12(a)(4) as proposed. In response to 

J.P. Morgan’s comments, the 

Commission notes that in monitoring 

firms, a DCO should take into 

consideration risks that the firm faces 

outside of that DCO. The Commission 

further notes that it is not prescribing 

the means by which DCOs should 

monitor compliance. 

l. Reporting Requirements—§ 39.12(a)(5) 

Proposed § 39.12(a)(5)(i) would 

mandate that a DCO require all clearing 

members, including those that are not 

FCMs, to file with the DCO periodic 

financial reports containing any 

financial information that the DCO 

determines is necessary to assess 

whether participation requirements are 

met on an ongoing basis. The proposed 

rule also would mandate that a DCO 

require clearing members that are FCMs 

to file the financial reports that are 

specified in § 1.10 of the Commission’s 

regulations with the DCO, and would 

require the DCO to review all such 

financial reports for risk management 

purposes. Proposed § 39.12(a)(5)(i) 

would also require a DCO to require its 

clearing members that are not FCMs to 

make the periodic financial reports that 

they file with the DCO available to the 

Commission upon the Commission’s 

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63See discussion of § 39.17 in section IV.H, 

below. 

64See 76 FR 13101 (Mar. 10, 2011) (StraightThrough Processing). 

65See 76 FR 45730 (Aug. 1, 2011) (Customer 

Clearing). 

66As proposed, § 39.12(b)(1)(vii) referred to 

addressing any ‘‘unique’’ risk characteristics of a 

product. The Commission is revising this provision 

in the final rule to refer to any ‘‘unusual’’ risk 

characteristics to clarify that such characteristics 

are not limited to those that are one of a kind. 

request. Proposed § 39.12(a)(5)(ii) would 

mandate that a DCO adopt rules that 

require clearing members to provide to 

the DCO, in a timely manner, 

information that concerns any financial 

or business developments that may 

materially affect the clearing members’ 

ability to continue to comply with 

participation requirements. 

LCH commented that a DCO based 

outside the U.S. may have clearing 

members that are not subject to the 

Commission’s jurisdiction and would be 

regulated in their home jurisdiction. 

LCH proposed this provision be revised 

such that only FCMs and U.S.-based 

members that are not FCMs are required 

to provide this information to the 

Commission upon request. According to 

LCH, all other members should be 

required to submit the information to 

the DCO only or to their equivalent local 

regulator. 

LCH and MGEX commented that 

proposed § 39.12(a)(5)(ii) would be more 

appropriately imposed on clearing 

members themselves, rather than on the 

DCO. KCC suggested that the 

Commission should evaluate its 

statutory authority to enact the 

proposed rule. MGEX commented that 

the proposed rules appear to require 

clearing members to report to each DCO 

with which they clear, which would 

create an additional, duplicative burden 

on clearing members. MGEX suggested 

that the Commission regulate the 

clearing members directly. As an 

alternative, MGEX proposed a new 

industry group similar to the Joint Audit 

Committee (JAC) in which each DCO 

would be represented and participate in 

developing an overall risk management 

program that would be used in fulfilling 

the new proposed requirements. 

The Commission is adopting 

§ 39.12(a)(5) with modifications to (1) 

provide that the financial information 

provided by non-FCM clearing members 

may be submitted by the clearing 

members to the Commission pursuant to 

DCO rules or may be submitted to the 

Commission by the DCO, in either case, 

upon the Commission’s request; and (2) 

eliminate the proposed requirement that 

the DCO must review clearing members’ 

financial reports for risk management 

purposes. 

The rule is intended to address 

circumstances where the Commission 

must obtain information in the 

possession of a clearing member. The 

Commission anticipates such requests 

will be few in number. However, when 

those occasions arise, the Commission 

must be able to obtain the information 

as expeditiously as possible. The rule 

addresses this need by allowing the 

Commission to obtain the information 

directly from the source and to 

minimize the burden on DCOs. In 

response to the comments, the 

Commission is revising the rule to 

provide that a DCO may either provide 

the requested information directly to the 

Commission or require clearing 

members to provide the information to 

the Commission. 

The Commission is eliminating the 

requirement that the DCO must review 

clearing members’ financial reports for 

risk management purposes. Upon 

further consideration, the Commission 

has concluded that although a DCO may 

review such financial reports for several 

reasons, including risk management and 

to ensure that clearing members 

continue to meet participation 

requirements, it is not necessary to be 

prescriptive in this regard. 

In response to MGEX suggestion of a 

new industry group, Commission staff is 

considering such a step. 

The Commission is making certain 

technical revisions to § 39.12(a)(5) in 

connection with these changes. 

m. Enforcement of Participation 

Requirements—§ 39.12(a)(6) 

Proposed § 39.12(a)(6) would require 

a DCO to enforce compliance with its 

participation requirements and establish 

procedures for the suspension and 

orderly removal of clearing members 

that no longer meet the requirements. 

MGEX commented that the proposed 

rule goes beyond the language of the 

Dodd-Frank Act. 

The Commission is adopting 

§ 39.12(a)(6) as proposed. A DCO must 

have the ability to enforce compliance 

with its participation requirements or its 

clearing members may not satisfy these 

requirements. A DCO also must have 

procedures for the suspension and 

orderly removal of clearing members 

that no longer meet the requirements. 

Otherwise, the enforcement process may 

not be orderly and could introduce 

additional risk to the DCO. This 

requirement complements § 39.17, 

adopted herein, which implements Core 

Principle H (Rule Enforcement).63

2. Product Eligibility 

Core Principle C requires that each 

DCO establish appropriate standards for 

determining the eligibility of 

agreements, contracts, or transactions 

submitted to the DCO for clearing. 

Proposed § 39.12(b) would codify these 

requirements. 

a. General Comments 

Citadel and MFA supported the 

proposed rules. To ensure nondiscriminatory clearing, Citadel and 

MFA recommended the Commission 

make explicit that a DCO must provide 

highly standardized mechanisms and 

procedures for establishing connectivity 

with SEFs and any other permitted 

trading venue. According to Citadel, 

these mechanisms and procedures must 

be objective, commercially reasonable, 

publicly available, and treat all 

applicant execution facilities in an 

unbiased manner. Citadel and MFA also 

proposed that the rules mandate that a 

DCO keep the clearing acceptance 

process anonymous (i.e., without the 

customer’s clearing member knowing 

the identity of the customer’s executing 

counterparty). 

The Commission agrees that a DCO 

must provide mechanisms for 

establishing connectivity with SEFs and 

DCMs, which would provide executing 

counterparties with fair and open 

access. The Commission has proposed 

rules addressing this issue.64 The 

Commission also has proposed rules 

that address the anonymity issue.65

b. Products Eligible for Clearing— 

§ 39.12(b)(1) 

Proposed § 39.12(b)(1) would require 

a DCO to establish appropriate 

requirements for determining the 

eligibility of agreements, contracts, or 

transactions submitted to the DCO for 

clearing, taking into account the DCO’s 

ability to manage the risks associated 

with such agreements, contracts, or 

transactions. Factors to be considered in 

determining product eligibility would 

include but would not be limited to: (1) 

Trading volume; (2) liquidity; (3) 

availability of reliable prices; (4) ability 

of market participants to use portfolio 

compression with respect to a particular 

swap product; (5) ability of the DCO and 

clearing members to gain access to the 

relevant market for purposes of creating 

and liquidating positions; (6) ability of 

the DCO to measure risk for purposes of 

setting margin requirements; and (7) 

operational capacity of the DCO and 

clearing members to address any unique 

risk characteristics of a product.66

OCC noted that the factors to be 

considered are already among the 

factors that a DCO would naturally 

consider and that OCC in fact considers, 

and it suggested that the application of 

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67This is also consistent with § 39.16(c)(2)(ii), 

adopted herein and discussed in section IV.G.4, 

below, which requires a DCO to adopt rules that set 

forth the actions that a DCO may take in the event 

of a default, which must include the prompt 

transfer, liquidation, or hedging of the defaulting 

clearing member’s positions, and which may 

include the auctioning or allocation of such 

positions to other clearing members. 

this new rule be limited to swaps. OCC 

also noted that the trading volume of 

new products is often unknown and 

unpredictable and suggested that factor 

not be a barrier to accepting a product 

for clearing. 

MGEX commented that the proposed 

rule considers legitimate factors, but 

mandating that a DCO establish 

eligibility requirements is not necessary, 

other than requirements for the contract 

size of swaps. Like OCC, MGEX noted 

that DCOs already use these factors as 

part of their sound business judgment in 

making these types of decisions. MGEX 

recommended that the Commission 

issue suggested guidelines or core 

principles and, on an as-needed basis, 

request that a DCO file with the 

Commission the rationale supporting its 

conclusion that a contract qualifies for 

clearing. 

LCH expressed concerns with 

proposed § 39.12(b)(1)(iv) and 

commented that compression services 

have been developed only when swap 

markets are relatively large and wellestablished, and the introduction of 

cleared facilities has largely pre-dated 

the introduction of compression 

services. According to LCH, making 

swap clearing contingent on swap 

portfolio compression may have the 

effect of permitting fewer swaps to be 

cleared. LCH proposed that the 

Commission encourage the use of 

compression services where suitable 

and available, but not constrain the 

ability of a DCO to clear a given swap 

based on the availability of such 

services. 

LCH also commented that it is 

imperative that a DCO have the ability 

to ‘‘transfer,’’ ‘‘auction,’’ or ‘‘allocate’’ 

cleared swaps. LCH proposed that the 

factor listed in proposed § 39.12(b)(1)(v), 

the ‘‘[a]bility of the [DCO] and clearing 

members to gain access to the relevant 

market for purposes of creating and 

liquidating positions’’ be modified to 

reflect these additional actions. 

The Commission agrees with LCH that 

a DCO must have the ability to 

‘‘transfer,’’ ‘‘auction,’’ or ‘‘allocate’’ 

cleared swaps and it is revising 

§ 39.12(b)(1)(v) to incorporate LCH’s 

suggestion.67 The Commission is 

otherwise adopting Section 39.12(b)(1) 

as proposed. The Commission believes 

that setting forth the minimum factors 

that all DCOs must consider when 

determining contract eligibility is 

necessary to prevent a DCO from 

seeking to clear transactions that present 

an unacceptable level of risk. The 

Commission also believes that OCC’s 

and LCH’s concerns are unfounded. The 

rule provides factors to be considered 

and does not prohibit a DCO from 

accepting a product for clearing if it 

does not satisfy one of the factors. 

Finally, the Commission is declining to 

limit the rule to swaps because it 

believes the eligibility factors are 

applicable to all products cleared by a 

DCO. The Commission is also declining 

to issue suggested guidelines or core 

principles, or to request that a DCO file 

with the Commission the rationale for 

why a contract qualifies for clearing. 

The Commission believes that 

§ 39.12(b)(1) is not burdensome because, 

as MGEX and OCC commented, these 

factors are already considered by DCOs. 

In contrast, filing rationales on an asneeded basis could be burdensome to 

the DCO and the Commission, and 

would not serve to mitigate risk more 

effectively. 

c. Economic Equivalence—§ 39.12(b)(2) 

Proposed § 39.12(b)(2) would require 

a DCO to adopt rules providing that all 

swaps with the same terms and 

conditions (as defined by templates 

established under DCO rules) submitted 

to the DCO for clearing are economically 

equivalent within the DCO and may be 

offset with each other within the DCO. 

ISDA, CME, and FIA commented that 

the term ‘‘template’’ is inappropriate. 

According to ISDA, ‘‘template’’ has no 

clear meaning, and it assumes that the 

term refers to the contract specifications 

currently used by a variety of futures 

facilities. ISDA noted that the 

development of specific templates for 

swap transactions is a mixed business/ 

technological project that requires 

significant discussion involving each 

DCO and its market participants. It 

suggested that the Commission’s 

regulations guide the meaning of 

‘‘template’’ to achieve as much 

individual transactional variability as 

possible within the transaction or range 

of transactions that a template may 

cover. 

CME commented that references to 

‘‘templates’’ are confusing because swap 

dealers generally maintain standard 

templates for documenting their trading 

relationships, and their counterparties 

frequently negotiate changes to those 

templates. According to CME, a DCO 

does not define the templates used by 

OTC participants, and DCO rules do not 

function as templates from which 

counterparties may negotiate. Rather, a 

DCO sets forth in its rulebook the 

product specifications of each contract 

it accepts for clearing, including swaps. 

CME suggested that the Commission 

revise § 39.12(b)(2) to state as follows 

(change in italics): ‘‘A [DCO] shall adopt 

rules providing that all swaps with the 

same terms and conditions, as defined 

by product specifications established 

under [DCO] rules, submitted to the 

[DCO] for clearing are economically 

equivalent within the [DCO] and may be 

offset with each other within the 

[DCO].’’ 

FIA requested that Commission 

confirm that economically equivalent 

swaps must have the same cash flows, 

values, and liquidation dates. FIA also 

suggested that terms and conditions of 

such templates—for example, events of 

default—should also be consistent with 

market practice. 

Finally, KCC commented that the 

proposed rule is redundant because 

Chapter 21 of the KCC rulebook already 

defines the terms and conditions for 

swaps that KCC will clear. 

The Commission is revising 

§ 39.12(b)(2) as suggested by CME to 

substitute the phrase ‘‘product 

specifications’’ for the word 

‘‘templates.’’ As noted above, some 

commenters found the use of the word 

‘‘templates’’ confusing. The 

Commission’s intent was to ensure that 

a DCO sets the specifications for cleared 

products. The Commission is otherwise 

adopting the rule as proposed. 

In response to FIA, the Commission 

confirms that it regards cash flows, 

values, and liquidation dates as terms 

and conditions encompassed by this 

rule. The Commission, however, 

declines to require that terms and 

conditions be consistent with market 

practice. The Commission believes that 

a DCO should have the flexibility to 

determine whether to conform terms 

and conditions to market practice. 

d. Non-Discriminatory Treatment of 

Swaps—§ 39.12(b)(3) 

Proposed § 39.12(b)(3) would require 

a DCO to provide for non-discriminatory 

clearing of a swap executed bilaterally 

or on or subject to the rules of an 

unaffiliated SEF or DCM. FIA and MFA 

commented in support of the proposed 

rule. 

OCC suggested that it should not be 

deemed a violation of § 39.12(b)(3) for a 

DCO to require a SEF or DCM desiring 

to transmit swaps to the DCO for 

clearing to enter into a non-exclusive 

clearing agreement on nondiscriminatory terms similar to those 

offered by the DCO to other SEFs or 

DCMs for clearing of similar products. 

OCC believes that such agreements are 

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69360 Federal Register / Vol. 76, No. 216 / Tuesday, November 8, 2011 / Rules and Regulations 

68See 76 FR 45730 (Aug. 1, 2011) (Customer 

Clearing). 

69See 76 FR 45730 (Aug. 1, 2011) (Customer 

Clearing). 

70See 76 FR 13101 (Mar. 10, 2011) (StraightThrough Processing). 

71 Id. 

necessary and appropriate for purposes 

of addressing matters between the 

parties such as information sharing and 

furnishing price data by the exchange to 

the DCO. 

LCH suggested that the Commission 

clarify that ‘‘non-discriminatory’’ 

includes costs, technology, and other 

related considerations. LCH also 

suggested that the Commission impose 

the reverse requirements on execution 

venues such as DCMs and SEFs, so that 

those venues are also required to 

provide trade feeds to DCOs on a nondiscriminatory basis. 

The Commission is adopting 

§ 39.12(b)(3) as proposed. In response to 

OCC, the Commission notes that the 

rule does not prohibit a DCO from 

requiring a SEF or DCM desiring to 

transmit swaps to the DCO for clearing 

to enter into a non-exclusive clearing 

agreement on non-discriminatory terms 

similar to those offered by the DCO to 

other SEFs or DCMs for clearing of 

similar products. The Commission 

agrees that such agreements are 

necessary and appropriate for purposes 

of addressing matters between the 

parties such as information sharing and 

furnishing price data by the exchange to 

the DCO. The Commission notes that it 

expects DCOs to review clearing 

agreements for compliance with 

§ 39.12(b)(3), the open access 

requirements of Core Principle C, and 

any relevant requirements of other core 

principles. 

In response to LCH’s comment, the 

Commission notes that the requirement 

applies to the factors LCH enumerated. 

The Commission also notes that LCH’s 

suggestion regarding trading venues is 

outside the scope of this rulemaking 

e. Prohibition on Requirement That 

Executing Party Is a Clearing Member— 

§ 39.12(b)(4) 

Proposed § 39.12(b)(4) would prohibit 

a DCO from requiring one of the original 

executing parties to be a clearing 

member in order for a contract, 

agreement, or transaction to be eligible 

for clearing. 

CME concurred with the 

Commission’s analysis and fully 

supported the proposed regulation. FIA, 

Citadel, and MFA also supported the 

proposed regulation. 

MFA suggested strengthening the 

proposed rule. According to MFA, when 

a non-clearing member trades with 

another non-clearing member, the 

clearing process should be identical and 

as prompt as when one of the parties is 

a clearing member, so long as the 

transaction satisfies the relevant DCO’s 

rules, requirements, and standards 

otherwise applicable to such trades. 

MFA believes that providing this parity 

would allow new liquidity providers to 

efficiently and effectively enter into and 

compete within the market. 

MFA also suggested that the 

Commission revise the proposed rule to 

prohibit a DCO from adopting rules or 

engaging in conduct that is prejudicial 

to non-clearing members as compared to 

clearing members with respect to 

eligibility or the timing of clearing or 

processing of trades generally. The 

Commission has addressed this issue in 

the recently proposed rules on clearing 

documentation.68

ISDA commented that rules barring 

trades that don’t involve a clearing 

member as a party are inappropriate in 

established DCOs, but new DCOs may 

need to roll out products and 

procedures in a contained way. 

According to ISDA, ‘‘initial decisions on 

which market constituencies should 

have access to clearing must be the 

subject of legitimate, reasoned decisionmaking by each DCO with regard to its 

ability to properly serve each 

constituency and each constituency’s 

readiness to participate in a cleared 

market.’’ 

Finally, NGX commented that if the 

proposed rule were applied to a nonintermediated DCO such as NGX, the 

rule would require a fundamental 

restructuring of the manner in which 

the DCO admits members, guarantees 

trades, and provides risk management. 

DCOs like NGX require all participants 

to become clearing participants at the 

DCO, and they do not clear contracts 

that involve non-clearing participants. 

The Commission is adopting 

§ 39.12(b)(4) as proposed. In response to 

the comments of ISDA and NGX, the 

Commission notes that some DCOs 

currently have only direct participants, 

i.e., participants that do not offer client 

clearing. NGX, for example, provides 

direct access to commercial end users 

who clear for themselves. The 

Commission notes that, consistent with 

principles of open access, a DCO must 

have rules in place to offer client 

clearing promptly if an FCM or a 

customer requests access. However, 

from a cost-benefit perspective, the 

Commission would expect that any DCO 

investment in building systems would 

be proportionate to evidence of demand 

for the service. 

Finally, in a separate rulemaking, the 

Commission has proposed rules that 

address MFA’s suggestion that trades 

between indirect clearing members 

should have parity with trades between 

clearing members.69

f. Product Standardization— 

§ 39.12(b)(5) 

Proposed § 39.12(b)(5) would require 

a DCO to select contract unit sizes and 

other product terms and conditions that 

maximize liquidity, facilitate 

transparency in pricing, promote open 

access, and allow for effective risk 

management.70 To the extent 

appropriate to further these objectives, a 

DCO would be required to select 

contract units for clearing purposes that 

were smaller than the contract units in 

which trades submitted for clearing 

were executed. 71

ISDA supported the goals identified 

by the Commission; however, it 

commented that ‘‘unit size’’ is not a 

meaningful concept in swap 

transactions because contract size is not 

standardized. According to ISDA, the 

only meaningful size limit is the 

smallest unit of relevant currency or 

relevant underlying. ISDA suggested 

that the Commission avoid focusing on 

‘‘unit size’’ and instead articulate its 

ultimate objectives, as it has, leaving 

DCOs with the discretion to set suitable 

terms and conditions to further those 

objectives. 

FIA did not support the requirement 

that a DCO select contract unit sizes 

because FIA does not believe that the 

swap market has evolved to the point 

where DCOs can do this. FIA also does 

not believe the market is at a point 

where it would be appropriate for a 

DCO to establish templates regarding 

the terms and conditions of 

standardized swaps eligible for clearing. 

FIA believes that requiring swaps to fit 

within artificial, prescribed templates 

would be disruptive to the market and 

would not benefit customers. FIA, 

however, would support a requirement 

that DCOs study this matter and submit 

a report to the Commission on the 

feasibility of establishing templates 

regarding the terms and conditions of 

standardized swaps as soon as 

practicable. 

Finally, LCH commented that it is not 

appropriate to require a DCO to select 

contract units for clearing purposes that 

are smaller than the contract units in 

which trades submitted for clearing 

were executed. According to LCH, a 

DCO clearing swaps should be able to 

accept such swaps in any size, and 

swaps submitted for clearing should not 

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Federal Register / Vol. 76, No. 216 / Tuesday, November 8, 2011 / Rules and Regulations 69361 

72This provision was originally designated as 

§ 39.12(b)(7)(v) in 76 FR 13101 (Mar. 10, 2011) 

(Straight-Through Processing). It was later proposed 

to be renumbered as § 39.12(b)(8) in 76 FR 45730 

(Aug. 1, 2011) (Customer Clearing). Section 

39.12(b)(7), as currently proposed (76 FR at 13110), 

will be addressed in a separate final rulemaking. 

be broken down into sub-units. LCH 

suggested that the Commission strike 

§ 39.12(b)(5) and that any rules 

addressing average size of exposure 

traded in the swap markets be addressed 

in rules pertaining to trading and 

execution venues. 

The Commission is adopting 

§ 39.12(b)(5) as proposed. The 

Commission believes that standardizing 

products, including swaps, by requiring 

a DCO to determine product terms and 

conditions, including product size, will 

increase liquidity, lower prices, and 

increase participation. In addition, 

standardized products should make it 

easier for members to accept a forced 

allocation in the event of bankruptcy. 

The Commission recognizes that 

standardized products may create basis 

risk for some hedge positions. However, 

this circumstance has long existed in 

the futures markets. The Commission 

believes that the benefits of 

standardization, such as competitive 

pricing, liquid markets, and open 

access, outweigh the costs of imperfect 

hedging. 

In response to LCH, the Commission 

notes that the product unit size of a 

particular swap executed bilaterally 

may reflect the immediate 

circumstances of the two parties to the 

transaction. Once submitted for 

clearing, it may be possible to split the 

trade into smaller units without 

compromising the interests of the two 

original parties. Smaller units can 

promote liquidity by permitting more 

parties to trade the product, facilitate 

open access by permitting more clearing 

members to clear the product, and aid 

risk management by enabling a DCO, in 

the event of a default, to have more 

potential counterparties for liquidation. 

The Commission notes that under the 

rule, DCOs retain some discretion in 

determining how best to promote 

liquidity, facilitate open access, and aid 

risk management. 

g. Novation—§ 39.12(b)(6) 

Proposed § 39.12(b)(6) would require 

a DCO that clears swaps to have rules 

providing that upon acceptance of a 

swap: (i) The original swap is 

extinguished; (ii) the original swap is 

replaced by equal and opposite swaps 

between clearing members and the DCO; 

(iii) the terms of the cleared swaps 

conform to templates established under 

DCO rules; and (iv) if a swap is cleared 

by a clearing member on behalf of a 

customer, all terms of the swap, as 

carried in the customer account on the 

books of the clearing member, must 

conform to the terms of the cleared 

swap established under the DCO’s rules. 

Newedge supported this rule, in 

particular, the requirement for 

standardization. 

CME, FIA, and ICE commented that 

the proposed rule appears to presume 

the use of a ‘‘principal’’ model for all 

cleared swaps, even those swaps cleared 

on behalf of customers. CME noted that 

at CME, an FCM clearing customer 

business acts as an agent for 

undisclosed principals (i.e., the FCM’s 

customers) vis-a-vis CME and 

guarantees its customers’ performance 

to CME. CME suggested that in order to 

preserve the agency model for customercleared swaps, the Commission should 

adopt a revised § 39.12(b)(6)(ii) to 

provide that, upon acceptance of a swap 

for clearing, ‘‘the original swap is 

replaced by equal and opposite swaps 

with the DCO.’’ As previously noted, 

CME also commented that the use of the 

term ‘‘template’’ is confusing. It 

suggested that the Commission revise 

§ 39.12(b)(6)(iii) to state: ‘‘All terms of 

the cleared swaps must conform to 

product specifications established under 

[DCO] rules.’’ 

FIA commented that the proposed 

rule would conflict with the FCMs’ 

position that, with respect to customer 

positions, FCMs are acting as agent, and 

not as principal, for customers in 

executing and clearing swaps (and 

futures) on behalf of customers. FIA 

suggested that the proposed rule be 

revised to confirm that, in clearing 

swaps on behalf of customers, a clearing 

member shall be deemed a guarantor 

and agent of a cleared swap and not a 

principal. 

ICE noted that U.S. futures markets 

may clear on an open offer basis, which 

allows straight-through processing. ICE 

commented that the Commission should 

not preclude open offer clearing of 

swaps by requiring the underlying swap 

to be novated. 

Finally, LCH suggested that the 

Commission revise the rule so that the 

obligation would fall on the clearing 

member rather than the DCO because 

the provisions relate to the clearing 

member’s books and records, not the 

DCO’s. 

The Commission is adopting 

§ 39.12(b)(6) with modifications to 

clarify its intended meaning. In 

response to the comments from CME, 

FIA, and ICE, the Commission is 

revising § 39.12(b)(6)(ii) to provide that 

a DCO that clears swaps must have rules 

providing that, upon acceptance of a 

swap by the DCO for clearing, ‘‘[t]he 

original swap is replaced by an equal 

and opposite swap between the 

derivatives clearing organization and 

each clearing member acting as 

principal for a house trade or acting as 

agent for a customer trade.’’ 

In response to the comment from 

CME, the Commission is revising 

§ 39.12(b)(6)(iii) to substitute the phrase 

‘‘product specifications’’ for the word 

‘‘templates.’’ This is consistent with the 

change to § 39.12(b)(2), discussed above. 

In response to the comment by ICE, 

the Commission notes that ‘‘open offer’’ 

systems are acceptable under the rule. 

Effectively, under an open offer system 

there is no ‘‘original’’ swap between 

executing parties that needs to be 

novated; the swap that is created upon 

execution is between the DCO and the 

clearing member, acting either as 

principal or agent. 

Finally, with regard to LCH’s 

comment, the Commission believes that 

it is proper for the requirement to fall on 

the DCO. The DCO is the central 

counterparty and is responsible for the 

transaction going forward. 

h. Confirmation of Terms—§ 39.12(b)(8) 

Proposed § 39.12(b)(8) would require 

a DCO to have rules that provide that all 

swaps submitted to the DCO for clearing 

must include written documentation 

that memorializes all of the terms of the 

transaction and legally supersedes any 

previous agreement.72 The confirmation 

of all terms of the transaction would be 

required to take place at the same time 

as the swap is accepted for clearing. 

CME suggested that the Commission 

revise the proposed regulation to require 

a DCO to ‘‘provide each clearing 

member carrying a cleared swap with a 

definitive record of the terms of the 

agreement, which will serve as a 

confirmation of the swap.’’ 

ISDA commented that it is not clear 

what efficiencies the proposed rule 

would achieve for the parties to the 

swap in confirming through a DCO. It 

suggested that the Commission be less 

prescriptive and recognize that the act 

of clearing a swap transaction through a 

DCO in and of itself should produce a 

definitive written record, tailored to the 

particular category of swap transaction 

by the DCO and its market constituency, 

which fulfills the Commission’s 

objective of facilitating the timely 

processing and confirmation of swaps 

not executed on a SEF or a DCM. 

FIA requested that the Commission 

clarify the obligations of the parties 

under this proposed rule. According to 

FIA, the rule appears to place 

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69362 Federal Register / Vol. 76, No. 216 / Tuesday, November 8, 2011 / Rules and Regulations 

73The notice of proposed rulemaking states: 

‘‘Proposed § 39.12(b)(7)(v) would require that DCOs 

accepting a swap for clearing provide the 

counterparties with a definitive written record of 

the terms of their agreement, which will serve as 

a confirmation of the swap.’’ 76 FR at 13105–13106 

(Mar. 10, 2011) (Straight-Through Processing). 

74See 75 FR 81519, at 81521 (Dec. 28, 2010) 

(Confirmation, Portfolio Reconciliation, and 

Portfolio Compression Requirements for Swap 

Dealers and Major Swap Participants) (‘‘if a swap 

is executed bilaterally, but subsequently submitted 

to a DCO for clearing, the DCO will require a 

definitive written record of all terms to the 

counterparties’ agreement prior to novation by the 

DCO’’). 

75Section 5b(c)(2)(D) of the CEA, 7 U.S.C. 7a– 

1(c)(2)(D). 

responsibility on the parties to the swap 

to submit a written confirmation of the 

terms of the transaction to the DCO, 

which, upon acceptance by the DCO, 

will supersede any prior documents and 

serve as the confirmation of the trade. 

However, the notice of proposed 

rulemaking places responsibility on the 

DCO, explaining that the proposed rule 

‘‘would require that DCOs accepting a 

swap for clearing provide the 

counterparties with a definitive written 

record of the terms of their agreement, 

which will serve as a confirmation of 

the swap.’’ Further, the proposed rule 

appears to apply to all swaps submitted 

for clearing, but the notice of proposed 

rulemaking appears to limit the 

requirement to swaps not executed on a 

SEF or DCM, noting that swaps 

executed on a SEF or DCM are 

confirmed upon execution.73

OCC commented that the terms and 

conditions applicable to a cleared swap 

would already be specified in the DCO 

rules or product specifications, and it 

does not think it is necessary for a DCO 

to provide a confirmation that is similar 

in form to detailed trade documentation 

such as an ISDA Master Agreement. 

OCC believes that the term ‘‘written 

documentation’’ should be interpreted 

broadly to mean any documentation that 

sufficiently memorialized the agreement 

of the counterparties with respect to the 

terms of a swap, which may consist of 

a confirmation (electronic or otherwise) 

that confirms the values agreed upon for 

terms that can be varied by the parties. 

MarkitSERV noted that the proposed 

rule would require a confirmation of all 

terms of the transaction at the time the 

swap is accepted for clearing, and 

commented that the rule is unclear as to 

whether, when a swap is to be 

submitted for clearing, confirmation 

would ever be required of the preclearing initial transaction between the 

original counterparties. In contrast, the 

Commission has elsewhere stated that it 

expects a DCO to require pre-clearing 

transactions to be confirmed before 

clearing.74 MarkitSERV also noted that 

when a transaction is not rapidly 

accepted for clearing the parties will 

still be responsible for confirming the 

transaction under Commission 

regulations. It recommended that the 

Commission clarify that when a 

transaction is not accepted for clearing 

within the time frame established for 

mandatory confirmation the parties 

should be permitted to satisfy their 

confirmation obligations by confirming 

the transaction prior to clearing. 

The Commission is adopting 

§ 39.12(b)(8) in modified form to read as 

set forth in the regulatory text of this 

final rule. 

The change to the heading is 

responsive to the comment by FIA that 

it was unclear whether the rule applied 

to all cleared swaps or only to those that 

are executed bilaterally. Regardless of 

the execution venue, confirmation of a 

cleared swap is ultimately provided by 

the DCO. In the case of a trading facility 

with a central limit order book, 

execution and acceptance for clearing 

are simultaneous and confirmation 

occurs at that time. In all other cases, 

there is an interim time between 

execution and acceptance, or rejection, 

for clearing. 

The Commission notes that applicable 

confirmation requirements may depend 

on the length of time between execution 

and acceptance or rejection for clearing. 

For example, if a trade executed on a 

SEF is accepted for clearing within 

seconds, the DCO notification would 

serve as the single confirmation. But, if 

a trade is executed bilaterally and later 

submitted for clearing, there may need 

to be an initial bilateral confirmation 

that is later superseded by the clearing 

confirmation. 

The changes to the text are responsive 

to the comments of FIA, CME, ISDA, 

OCC, and MarkitSERV. As FIA pointed 

out, the proposed rule text seems to 

place the confirmation obligation on the 

submitting parties, while the discussion 

in the notice of proposed rulemaking 

places it on the DCO. Consistent with 

the language in the discussion and the 

recommendations of FIA, CME, and 

ISDA, the revised rule clarifies that 

DCOs provide confirmations of cleared 

trades. This interpretation was implicit 

in the proposal given that the second 

sentence of the rule provides that 

confirmation takes place when the trade 

‘‘is accepted’’ for clearing. 

D. Core Principle D—Risk 

Management—§ 39.13 

Core Principle D, 75 as amended by 

the Dodd-Frank Act, requires each DCO 

to ensure that it possesses the ability to 

manage the risks associated with 

discharging the responsibilities of the 

DCO through the use of appropriate 

tools and procedures. It further requires 

each DCO to measure its credit 

exposures to each clearing member not 

less than once during each business day 

and to monitor each such exposure 

periodically during the business day. 

Core Principle D also requires each DCO 

to limit its exposure to potential losses 

from defaults by clearing members, 

through margin requirements and other 

risk control mechanisms, to ensure that 

its operations would not be disrupted 

and that non-defaulting clearing 

members would not be exposed to 

losses that non-defaulting clearing 

members cannot anticipate or control. 

Finally, Core Principle D provides that 

a DCO must require margin from each 

clearing member sufficient to cover 

potential exposures in normal market 

conditions and that each model and 

parameter used in setting such margin 

requirements must be risk-based and 

reviewed on a regular basis. The 

Commission proposed to adopt § 39.13 

to establish requirements that a DCO 

would have to meet in order to comply 

with Core Principle D. 

1. General—§ 39.13(a) 

Proposed § 39.13(a) would require a 

DCO to ensure that it possesses the 

ability to manage the risks associated 

with discharging its responsibilities 

through the use of appropriate tools and 

procedures. The Commission did not 

receive any comments on proposed 

§ 39.13(a) and is adopting § 39.13(a) as 

proposed. 

2. Risk Management Framework— 

§ 39.13(b) 

Proposed § 39.13(b) would require a 

DCO to establish and maintain written 

policies, procedures, and controls, 

approved by its board of directors, 

which establish an appropriate risk 

management framework that, at a 

minimum, clearly identifies and 

documents the range of risks to which 

the DCO is exposed, addresses the 

monitoring and management of the 

entirety of those risks, and provides a 

mechanism for internal audit. In 

addition, proposed § 39.13(b) would 

require a DCO to regularly review its 

risk management framework and update 

it as necessary. 

Mr. Barnard recommended that the 

Commission comprehensively and 

explicitly address all elements that 

make up a risk management framework, 

including organizational structure, 

governance, risk functions, internal 

controls, compliance, internal audit, 

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Federal Register / Vol. 76, No. 216 / Tuesday, November 8, 2011 / Rules and Regulations 69363 

76Mr. Barnard also recommended that the 

Commission focus more on operational risk and the 

role of reporting and public disclosures. With 

respect to operational risk, the Commission notes 

that it is adopting § 39.18 herein, which addresses 

system safeguards, and which is discussed in 

section I, below. Reporting and public information 

are addressed in §§ 39.19 and 39.21, respectively, 

also adopted herein, which are discussed in 

sections J and L, respectively, below. 

77See CPSS–IOSCO Consultative Report, 

Principle 2: Governance, Key Consideration 5, at 23. 

78See 75 FR at 63750 (Oct. 18, 2010) (Conflicts 

of Interest). In that proposed rulemaking, the 

provisions relating to the Risk Management 

Committee were designated as § 39.13(g). In the 

final rulemaking with respect to that proposal, 

those provisions will be redesignated as § 39.13(d). 

79However, the Commission has proposed rules 

regarding a CCO for futures commission merchants, 

swap dealers, and major swap participants, at 75 FR 

70881 (Nov. 19, 2010) (Designation of a Chief 

Compliance Officer; Required Compliance Policies; 

and Annual Report of a Futures Commission 

Merchant, Swap Dealer, or Major Swap Participant), 

with respect to which Better Markets filed a 

comment letter. 

and legal functions.76 In particular, with 

respect to organizational structure, Mr. 

Barnard noted that reporting lines and 

the allocation of responsibilities and 

authority within a DCO should be clear, 

complete, well-defined and enforced. 

The Commission believes that a DCO 

should adopt a comprehensive and 

documented risk management 

framework that addresses all of the 

various types of risks to which it is 

exposed and the manner in which they 

may relate to each other. The 

Commission believes that a written risk 

policy is important because it will help 

to ensure the DCO has carefully 

considered its risk management 

framework, and it will provide guidance 

to DCO management, staff, and market 

participants. It will also allow the 

Commission to assess the DCO’s risk 

management framework more 

efficiently. The risks to be addressed 

may include, but are not limited to, 

legal risk, credit risk, liquidity risk, 

custody and investment risk, 

concentration risk, default risk, 

operational risk, market risk, and 

business risk. However, the Commission 

does not believe that it is necessary to 

explicitly list such risks in the final 

rule. 

MGEX commented that the 

documentary and procedural 

requirements of proposed § 39.13(b) 

would impose heavy costs and turn the 

goal of practical risk management into 

one of paperwork compliance, and that 

while having a framework containing all 

the various policies can be beneficial for 

DCOs, the development and 

implementation of such policies must 

be flexible and left to each DCO. The 

Commission notes that DCOs generally 

already have certain written risk 

management policies, procedures and 

controls, although the substance, level 

of detail, and integration of each DCO’s 

documentation of such policies, 

procedures and controls may vary. The 

Commission believes that § 39.13(b) 

provides DCOs with the appropriate 

amount of flexibility with regard to the 

documentation of their risk management 

frameworks, without imposing 

significant additional costs upon DCOs. 

OCC noted that its risk management 

policies are highly complex and are 

embodied in multiple separate written 

documents, and much of its day-to-day 

operations are related to risk 

management. OCC stated that the 

Commission should make it clear that 

the proposal would not require the 

board to approve every document 

related to risk management, as it would 

be burdensome and would 

inappropriately require the board to 

micro-manage the day-to-day functions 

of a DCO. OCC indicated that it does not 

believe that the function of the 

committee that is responsible for the 

oversight of its risk management 

activities would be enhanced by the 

creation of additional written policies, 

procedures, and controls. 

The Commission recognizes that 

many of the day-to-day functions of a 

DCO are related to risk management, 

and § 39.13(b) is not intended to require 

that a DCO’s board must approve every 

document at a DCO that addresses risk 

management issues nor is it intended to 

require that a DCO’s board must 

approve every day-to-day decision 

regarding the implementation of the 

DCO’s risk management framework. 

CME and ICE took the position that a 

DCO’s Risk Management Committee 

should have the authority to approve 

the written policies, procedures, and 

controls that establish a DCO’s risk 

management framework, noting that this 

would be consistent with proposed 

§ 39.13(c), which would require a DCO’s 

Chief Risk Officer to make appropriate 

recommendations to the DCO’s Risk 

Management Committee or board of 

directors, as applicable, regarding the 

DCO’s risk management function. 

The Commission believes that a 

DCO’s risk management framework 

should be subject to the approval of its 

board of directors. The Commission 

recognizes that a DCO’s Risk 

Management Committee may play a 

crucial role in the development of the 

risk management policies of a DCO. 

However, the board has the ultimate 

responsibility for the management of the 

DCO’s risks. Requiring board approval 

of a DCO’s risk management framework 

is also consistent with proposed 

international standards.77

In addition, a requirement that a 

DCO’s board approve its risk 

management framework is consistent 

with § 39.13(c), which permits a DCO’s 

Chief Risk Officer to make appropriate 

recommendations to the DCO’s Risk 

Management Committee regarding the 

DCO’s risk management functions. 

Although the board would approve the 

framework, it could delegate defined 

decision-making authority to the Risk 

Management Committee in connection 

with the implementation of the 

framework. The Commission is adopting 

§ 39.13(b) as proposed. 

3. Chief Risk Officer—§ 39.13(c) 

Proposed § 39.13(c) would require a 

DCO to have a Chief Risk Officer (CRO) 

who would be responsible for the 

implementation of the risk management 

framework and for making appropriate 

recommendations regarding the DCO’s 

risk management functions to the DCO’s 

Risk Management Committee or board 

of directors, as applicable. In a separate 

rulemaking, the Commission has 

proposed to adopt § 39.13(d) to require 

DCOs to have a Risk Management 

Committee with defined composition 

requirements and specified minimum 

functions.78

Better Markets commented that the 

proposal should provide substantive 

parameters for a CRO and that the CRO 

rules applicable to FCMs should be 

applied to DCOs. Mr. Greenberger 

indicated that the CRO of a DCO should 

be subject to the same rules regarding 

reporting and independence as the 

CROs of other registered entities. 

The Commission does not believe that 

it is necessary to further define the 

responsibilities of a DCO’s CRO in the 

final rule. The Commission notes that it 

has not proposed any rules regarding a 

CRO for FCMs or any other registered 

entities, as suggested by Better Markets 

and Mr. Greenberger.79

As noted in the notice of proposed 

rulemaking, given the importance of the 

risk management function and the 

comprehensive nature of the 

responsibilities of a DCO’s CCO, which 

are governed by § 39.10, as adopted in 

this rulemaking, the Commission 

expects that a DCO’s CRO and its CCO 

would be two different individuals. The 

Commission is adopting § 39.13(c) as 

proposed. 

4. Measurement of Credit Exposure— 

§ 39.13(e) 

Proposed § 39.13(e) would require a 

DCO to: (1) Measure its credit exposure 

to each clearing member and mark to 

market such clearing member’s open 

positions at least once each business 

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80See CPSS–IOSCO Consultative Report, 

Principle 6: Margin, Key Consideration 4, at 40. 

81See Section 5b(c)(2)(D)(iii) of the CEA, 7 U.S.C. 

7a–1(c)(2)(D)(iii). 

day; and (2) monitor its credit exposure 

to each clearing member periodically 

during each business day. Proposed 

§ 39.13(e) was a prerequisite for 

proposed § 39.14(b), which would 

address daily settlements based on a 

DCO’s measurement of its credit 

exposures to its clearing members. 

LCH commented that a DCO should 

be required to measure its credit 

exposures ‘‘several times each business 

day’’ and that a DCO should be obliged 

to recalculate initial and variation 

margin requirements more than once 

each business day. By contrast, OCC 

requested that the Commission clarify 

that the proposed requirement that a 

DCO monitor its credit exposure to each 

clearing member periodically during 

each business day would not require a 

DCO to update clearing member 

positions on an intra-day basis for 

purposes of monitoring risk, which 

would not be practical, and that intraday monitoring of credit exposures 

based on periodic revaluation of 

beginning-of-day positions would be 

sufficient to comply with the proposed 

rule. 

The Commission does not believe that 

a DCO should be required to mark each 

clearing member’s open positions to 

market and recalculate initial and 

variation margin requirements more 

than once each business day, and notes 

that the requirement that a DCO monitor 

its credit exposure to each clearing 

member periodically during each 

business day could be satisfied through 

intra-day monitoring of credit exposures 

based on periodic revaluation of 

beginning-of-day positions as suggested 

by OCC. 

However, as discussed in section 

IV.E.2, below, § 39.14(b) requires a DCO 

to effect a settlement with each clearing 

member at least once each business day, 

and to have the authority and 

operational capacity to effect a 

settlement with each clearing member, 

on an intraday basis, either routinely, 

when thresholds specified by the DCO 

are breached, or in times of extreme 

market volatility. Therefore, in order to 

comply with § 39.14(b), a DCO would be 

required to have the authority and 

operational capacity to mark each 

clearing member’s open positions to 

market and recalculate initial and 

variation margin requirements, on an 

intraday basis, under the circumstances 

defined in § 39.14(b). 

The Commission is adopting 

§ 39.13(e) as proposed, except that the 

Commission is making a technical 

revision by replacing the phrase ‘‘such 

clearing member’s open positions’’ with 

the phrase ‘‘such clearing member’s 

open house and customer positions’’ to 

eliminate possible ambiguity and to 

clarify the Commission’s intent to 

reflect current industry practice and 

include both house and customer 

positions, not just house positions. The 

Commission notes that § 39.13(e) is 

consistent with international 

recommendations.80

5. Limitation of Exposure to Potential 

Losses From Defaults—§ 39.13(f) 

Proposed § 39.13(f) would require a 

DCO, through margin requirements and 

other risk control mechanisms, to limit 

its exposure to potential losses from 

defaults by its clearing members to 

ensure that: (1) Its operations would not 

be disrupted; and (2) non-defaulting 

clearing members would not be exposed 

to losses that nondefaulting clearing 

members cannot anticipate or control. 

The language of proposed § 39.13(f) is 

virtually identical to the language in 

Section 5b(c)(2)(D)(iii) of the CEA, as 

amended by the Dodd-Frank Act. 

FIA supported the proposal and 

MGEX stated that it appeared reasonable 

if applied appropriately. FIA 

acknowledged that clearing members 

understand and accept that they are 

subject to losses in the event of a default 

of another clearing member but noted 

that these potential losses must be 

measurable and subject to a reasonable 

cap over a period of simultaneous or 

multiple defaults. MGEX suggested that 

the Commission adopt an interpretation 

that each clearing member, by becoming 

a clearing member, can reasonably 

anticipate that another clearing member 

may potentially default and that a DCO 

can apply its rules accordingly. 

The Commission believes that every 

clearing member is aware that another 

clearing member may default. The 

Commission also notes that the 

potential losses resulting from such a 

default will be mitigated to the extent 

that a DCO is bound to comply with the 

CEA, Commission regulations, and its 

own rules, particularly with regard to 

financial resources and default rules 

and procedures. 

KCC commented that there would 

appear to be little cost/benefit 

justification for duplicating the statutory 

language of the core principle in the 

form of a rule.81 The Commission 

believes that codifying provisions of the 

CEA does not impose an additional cost 

on a DCO because a DCO must satisfy 

such requirements to comply with the 

law. At the same time, the Commission 

believes that codifying this statutory 

provision provides a DCO with a single 

location in which to identify the 

minimum standards necessary to fulfill 

the requirements of Core Principle D. 

The Commission is adopting § 39.13(f) 

as proposed. 

6. Margin Requirements—§ 39.13(g) 

a. General 

Several commenters made general 

comments about margin requirements 

that did not address specific provisions 

of proposed § 39.13(g). The Commission 

has summarized those comments, and 

responded to those comments, below. 

KCC expressed its belief that the 

Commission’s detailed proposed margin 

requirements are not consistent with the 

Dodd-Frank Act’s changes to the CEA, 

which simply require that a DCO’s 

margin models and parameters must be 

‘‘risk-based.’’ The Commission notes 

that Section 5b(c)(2) of the CEA, as 

amended by the Dodd-Frank Act, 

requires a DCO to comply with the 

statutory core principles ‘‘and any 

requirement that the Commission may 

impose by rule or regulation pursuant to 

section 8a(5).’’ As noted in section I.A, 

above, legally enforceable standards set 

forth in regulations serve to increase 

legal certainty, prevent DCOs from 

lowering risk management standards for 

competitive reasons, and increase 

market confidence. These goals are 

especially important with respect to 

margin, which is one of the key tools 

used by DCOs in managing risk. 

Therefore, the Commission believes it is 

appropriate to impose more detailed 

margin requirements than those 

contained in the statutory language of 

Core Principle D. 

ISDA urged the Commission to adopt 

rules requiring DCOs to adopt risk 

methodologies that would reduce the 

impact that customer account risk has 

on the size of default fund 

contributions. ISDA noted that this 

would enable DCOs to better guaranty 

the portability of client portfolios, but 

would increase risk to the DCO; 

however, ISDA stated that this increased 

risk could be addressed by increasing 

the risk margin of the customer account. 

The Commission has not proposed and 

is not adopting such rules. The 

Commission believes that a DCO should 

have reasonable discretion to determine 

how it will calculate the amounts of any 

default fund contributions that it may 

require from its clearing members, and 

the extent to which customer risk will 

be a factor in such calculations. 

MFA and Citadel stated that it is 

important that a DCO’s process for 

setting initial margin be transparent in 

order to give all market participants 

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Federal Register / Vol. 76, No. 216 / Tuesday, November 8, 2011 / Rules and Regulations 69365 

82See e.g., http://www.cmegroup.com/clearing/ 

cme-core-cme-clearing-online-risk-engine.html and 

https://www.theice.com/publicdocs/ice_trust/ 

ICE_Margin_

Simulation_Calculator_Training_Presentation.pdf. 

83The term ‘‘initial margin’’ is now defined in 

§ 1.3(lll), adopted herein. 

84See 2004 CPSS–IOSCO Recommendations at 

21. 

85See CPSS–IOSCO Consultative Report, 

Principle 6: Margin, Key Consideration 3, at 40. 

86As proposed, § 39.13(g)(2)(i) referred to 

addressing any ‘‘unique’’ characteristics of, or risks 

associated with, particular products or portfolios. 

The Commission is revising this provision in the 

final rule to refer to any ‘‘unusual’’ characteristics 

of, or risks associated with, particular products or 

portfolios to clarify that such characteristics or risks 

are not limited to those that are one of a kind. See 

also n. 66, above. 

87 In the notice of proposed rulemaking, the 

Commission defined jump-to-default risk as 

referring to the possibility that a CDS portfolio with 

large net sales of protection on an underlying 

reference entity could experience significant losses 

Continued 

certainty as to the margin they can 

expect the DCO to assess. Therefore, 

MFA and Citadel urged the Commission 

to adopt final rules that would require 

a DCO to make available to all market 

participants, at no cost, a margin 

calculation utility, so that they would be 

able to replicate the calculation of the 

margin that the DCO would assess. 

The Commission notes that it is 

adopting §§ 39.21(c)(3) and (d) herein, 

which require a DCO to disclose 

information concerning its marginsetting methodology on its Web site. 

However, the Commission is not 

requiring a DCO to provide a margin 

calculation utility to market participants 

free of cost, although the Commission 

notes that some DCOs have chosen to do 

so.82 The Commission believes that 

whether a DCO will provide a margin 

calculation utility to market 

participants, and whether and how 

much it might charge for such a utility, 

is a business decision that should be left 

to the discretion of a DCO. 

The FHLBanks indicated that it may 

be appropriate, in some circumstances, 

for a DCO to waive its initial margin 

requirements with respect to certain 

highly creditworthy customers of a 

clearing member. Therefore, the 

FHLBanks urged the Commission to 

grant DCOs discretion to waive initial 

margin requirements when doing so 

would not pose risk to the DCO or its 

clearing members. In light of the fact 

that the Dodd-Frank Act requires the 

removal of reliance on credit ratings, the 

FHLBanks recommended that the 

Commission adopt alternative criteria 

by which a DCO could exercise such 

discretionary waivers, or alternatively 

grant DCOs discretion to establish their 

own criteria, subject to Commission 

approval, or to guidelines established by 

the Commission in the final rule. 

The Commission has not proposed a 

rule that would permit it to grant DCOs 

the discretion to waive initial margin 

requirements and it is not adopting such 

a rule, as requested by the FHLBanks. 

Even if there were an objective way to 

define highly creditworthy customers, 

the Commission does not believe that 

permitting such waivers would 

constitute prudent risk management. 

b. Amount of Initial Margin Required— 

§ 39.13(g)(1) 

Proposed § 39.13(g)(1) would require 

that the initial margin 83 that a DCO 

requires from each clearing member 

must be sufficient to cover potential 

exposures in normal market conditions 

and that each model and parameter used 

in setting initial margin requirements 

must be risk-based and reviewed on a 

regular basis. The Commission invited 

comment regarding whether a definition 

of ‘‘normal market conditions’’ should 

be included in the proposed regulation 

and, if so, how normal market 

conditions should be defined. 

MFA, BlackRock, and Citadel 

expressed their support for the proposal. 

CME and OCC commented that the 

Commission should not define normal 

market conditions, while ISDA stated 

that the Commission should define 

normal market conditions. The 

Commission noted in the notice of 

proposed rulemaking that the 2004 

CPSS–IOSCO Recommendations 

defined ‘‘normal market conditions’’ as 

‘‘price movements that produce changes 

in exposures that are expected to breach 

margin requirements or other risk 

control mechanisms only 1 percent of 

the time, that is, on average on only one 

trading day out of 100.’’ 84 The CPSS– 

IOSCO Consultative Report was 

published subsequent to the issuance of 

proposed § 39.13(g)(1). The CPSS– 

IOSCO Consultative Report replaced the 

concept of ‘‘normal market conditions’’ 

with a proposed requirement that 

‘‘[i]nitial margin should meet an 

established single-tailed confidence 

level of at least 99 percent for each 

product that is margined on a product 

basis, each spread within or between 

products for which portfolio margining 

is permitted, and for each clearing 

member’s portfolio losses.’’ 85 The 

Commission had also proposed similar 

requirements for a 99 percent 

confidence level in proposed 

§ 39.13(g)(2)(iii), discussed below. 

Therefore, in adopting § 39.13(g)(1), the 

Commission is declining to adopt the 

proposed explicit requirement that 

initial margin must be sufficient to 

cover potential exposures in normal 

market conditions, in order to avoid any 

ambiguity over the meaning of ‘‘normal 

market conditions.’’ 

FIA recommended that parameters 

used in setting initial margin 

requirements should be reviewed 

monthly and models should be 

reviewed annually and on an ad hoc 

basis if substantive changes are made, 

whereas OCC took the position that the 

Commission should permit a DCO to 

use its reasonable discretion in 

determining what constitutes a ‘‘regular 

basis’’ for reviewing margin models and 

parameters. The Commission has 

determined not to specify the 

appropriate frequency of review, as it 

may differ based on the characteristics 

of particular products and markets, and 

the nature of the margin models and 

parameters that apply to those products 

and markets. However, although 

§ 39.13(g)(1) would permit a DCO to 

exercise its discretion in determining 

how often it should review its margin 

models and parameters, the Commission 

would apply a reasonableness standard 

in determining whether the frequency of 

reviews conducted by a particular DCO 

was appropriate. 

Moreover, as discussed in section 

IV.D.6.d, below, § 39.13(g)(3) requires 

that a DCO’s systems for generating 

initial margin requirements, including 

the DCO’s theoretical models, must be 

reviewed and validated by a qualified 

and independent party, on a regular 

basis. As the Commission noted in the 

notice of proposed rulemaking, the 

Commission would expect a DCO to 

obtain an independent validation prior 

to implementation of a new margin 

model and when making any significant 

change to a model that is in use by the 

DCO. This express expectation would 

address FIA’s suggestion that a DCO 

should be required to review its margin 

models on an ad hoc basis if substantive 

changes are made. For the reasons 

discussed, the Commission is adopting 

§ 39.13(g)(1) with the modification 

described above. 

c. Methodology and Coverage 

(1) General—§ 39.13(g)(2)(i) 

Proposed § 39.13(g)(2)(i) would 

require a DCO to establish initial margin 

requirements that are commensurate 

with the risks of each product and 

portfolio, including any unique 

characteristics of, or risks associated 

with, particular products or portfolios.86

In particular, proposed § 39.13(g)(2)(i) 

would require a DCO that clears credit 

default swaps (CDS) to appropriately 

address jump-to-default risk in setting 

initial margins.87 The Commission 

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69366 Federal Register / Vol. 76, No. 216 / Tuesday, November 8, 2011 / Rules and Regulations 

over a very short period of time following an 

unexpected event of default by the reference entity. 

88The term ‘‘variation margin’’ is now defined in 

§ 1.3(ooo), adopted herein. 

89See discussion of § 39.13(h)(6)(ii) in section 

IV.D.7.f, below. 

90See Section 2(h)(1)(B) of the CEA, 7 U.S.C. 

2(h)(1)(B). 91See discussion of § 39.12(b)(2) in section 

IV.C.2.c, above. 92Section 731 of the Dodd-Frank Act amended 

the CEA to insert Section 4s. See Section 

4s(e)(3)(A)(ii) of the CEA, 7 U.S.C. 6s(e)(3)(A)(ii). 93NGX estimated that the impact of transitioning 

from its current two-day requirement to a five-day 

requirement for all of the energy products that it 

clears would lead to an approximate 60 percent 

increase in initial margins. 

invited comment regarding whether 

there are specific risks that should be 

identified and addressed in the 

proposed regulation in addition to 

jump-to-default risk. 

CME and Nadex, Inc. (Nadex) 

expressed the opinion that it would not 

be beneficial to attempt to identify 

additional specific risks that a DCO 

must address in determining initial 

margins and LCH commented that the 

reference to jump-to-default risk should 

either be removed or amended to cover 

all other products that are subject to 

jump-to-default risk. The Commission 

agrees with CME and Nadex that it is 

not necessary to identify additional 

specific risks in the regulation, and also 

agrees with LCH that the reference to 

jump-to-default risk should generally 

apply to any product that may be 

subject to such risk. Therefore, the 

Commission is adopting a revised 

§ 39.13(g)(2)(i) that eliminates the 

specific reference to CDS. The 

Commission has also added the phrase 

‘‘or similar jump risk.’’ This is intended 

to address the possibility of a large 

payment obligation in a product 

accumulating in a very short period of 

time following an extreme market event. 

(2) Liquidation Time—§ 39.13(g)(2)(ii) 

Proposed § 39.13(g)(2)(ii) would 

require a DCO to use margin models that 

generate initial margin requirements 

sufficient to cover the DCO’s potential 

future exposures to clearing members 

based on price movements in the 

interval between the last collection of 

variation margin 88 and the time within 

which the DCO estimates that it would 

be able to liquidate a defaulting clearing 

member’s positions (liquidation time). 

As proposed, a DCO would have to use 

a liquidation time that is a minimum of 

five business days for cleared swaps that 

were not executed on a DCM, and a 

liquidation time that is a minimum of 

one business day for all other products 

that it clears, although it would be 

required to use longer liquidation times, 

if appropriate, based on the unique 

characteristics of particular products or 

portfolios. The Commission invited 

comment regarding whether the 

minimum liquidation times specified in 

proposed § 39.13(g)(2)(ii) were 

appropriate, or whether there were 

minimum liquidation times that were 

more appropriate. 

LCH suggested that ‘‘or transfer’’ 

should be inserted after ‘‘liquidate’’ in 

the proposed rule and that an 

appropriate liquidation period should 

be a period that would be sufficient to 

enable a DCO to adequately hedge or 

close out a defaulting member’s risk. 

The Commission does not believe that it 

is appropriate to add ‘‘or transfer,’’ or to 

interpret the liquidation period to 

include the time that would be 

sufficient to hedge a defaulting clearing 

member’s positions. In a worst-case 

scenario, a DCO would need to liquidate 

a defaulting clearing member’s 

positions, and the time it would take to 

do so should be the relevant 

consideration in setting initial margin 

requirements. 

ISDA commented that a DCO should 

continually monitor the risk associated 

with concentration in participants’ 

positions, and if a DCO determines that 

a participant’s cleared portfolio is so 

large that it could not be liquidated 

within the liquidation period assumed 

in the DCO’s default management plan, 

the DCO should have the discretion to 

include an extra charge for 

concentration risk in the initial margin 

requirements of that participant. FIA 

made similar comments but suggested 

that prudent risk management should 

require the imposition of concentration 

margin in appropriate circumstances. 

FIA further noted that when a DCO 

imposes concentration margin on a 

clearing member, the additional margin 

should be included in the DCO’s 

minimum margin calculations for any 

customers of the clearing member that 

generate the increased risk. 

Although the regulations adopted by 

the Commission herein do not 

specifically address concentration 

margin as described by ISDA and FIA, 

they do not limit a DCO’s discretion to 

impose extra charges on its clearing 

members for concentration risk. It 

should also be noted that § 39.13(h)(6), 

adopted herein,89 requires a DCO to take 

additional actions with respect to 

particular clearing members, when 

appropriate, based on the application of 

objective and prudent risk management 

standards, which actions may include 

imposing enhanced margin 

requirements. 

Numerous commenters objected to the 

proposed difference in requirements 

that would subject swaps that were 

either executed bilaterally or executed 

on a SEF to a minimum five-day 

liquidation time, while permitting 

equivalent swaps that were executed on 

a DCM to be subject to a minimum oneday liquidation time. Commenters 

variously argued that the proposed oneday/five-day distinction for swap 

transactions depending on the venue of 

execution would: (1) Be inconsistent 

with the open access provisions of 

Section 2(h)(1)(B) of the CEA 90 and/or 

proposed § 39.12(b)(2) 91 (GFI Group 

Inc. (GFI), VMAC, LCC (VMAC), 

BlackRock, Wholesale Markets Brokers’ 

Association, Americas (WMBAA), and 

FX Alliance Inc. (FXall)); (2) be 

inconsistent with Congressional intent, 

expressed in Section 731 of the DoddFrank Act,92 which recognizes a 

difference in risk between cleared and 

uncleared swaps that could be 

addressed by differential margin 

requirements, but does not differentiate 

between the risk of swaps executed on 

a DCM and those executed on a SEF 

(Asset Management Group of the 

Securities Industry and Financial 

Markets Association (AMG)); (3) 

discriminate against trades not executed 

on DCMs by requiring DCOs to impose 

higher margin requirements for swaps 

that are executed on SEFs than for 

swaps that are executed on DCMs (GFI, 

VMAC, MarketAxess Corporation 

(MarketAxess), WMBAA, Tradeweb 

Markets LLC (Tradeweb), Nodal 

Exchange, LLC (Nodal), and FXall); (4) 

raise the cost of clearing for swaps 

traded on a SEF (National Energy 

Marketers Association (NEM), NGX, and 

BlackRock); 93 (5) put SEFs at a 

competitive disadvantage to DCMs (GFI, 

MarketAxess, and BlackRock); (6) 

artificially restrict the ability of market 

participants, including asset managers, 

to select the best means of execution for 

their swap transactions (BlackRock); (7) 

penalize market participants that desire 

to effect swap transactions on a SEF 

rather than a DCM (WMBAA and 

Tradeweb); (8) undermine the goal of 

the Dodd-Frank Act to promote trading 

of swaps on SEFs (Tradeweb and FXall); 

(9) potentially create detrimental 

arbitrage between standardized swaps 

traded on a SEF and futures contracts 

with the same terms and conditions 

traded on a DCM (Nodal); (10) impose 

onerous and unnecessary administrative 

costs on DCOs, which would likely be 

passed on to clearing members and their 

customers (VMAC and BlackRock); (11) 

create a disincentive for DCOs to 

practice appropriate default 

management ‘‘drills’’ to reduce the 

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Federal Register / Vol. 76, No. 216 / Tuesday, November 8, 2011 / Rules and Regulations 69367 

94Citadel further commented that excessive 

margin requirements relative to risk exposure could 

adversely affect market liquidity and deter clearing. 

95FIA also commented that liquidation times 

should be set at times appropriate to manage the 

liquidation of the vast majority of the portfolios 

carried by a DCO’s clearing members, and not 

necessarily that of the largest clearing member. 

96NYMEX, now CME, has cleared OTC swaps 

generally with a one day liquidation time since 

2002. CME currently offers more than 1,000 

products for clearing through its ClearPort system. 

97 In particular, ICE Clear Credit LLC and CME 

use a five-day liquidation time for credit default 

swaps and LCH and CME use a five-day liquidation 

time for interest rate swaps. 

98E.g., the 950,000 trades in LCH’s SwapClear 

have an aggregate notional principal amount of over 

$295 trillion. Source: http://www.lch.com/swaps/ 

swapclear_for_clearing_members/. 99See Section 2(h)(1)(B) of the CEA and 

§ 39.12(b)(2), adopted herein (swaps submitted to a 

DCO with the same terms and conditions are 

economically equivalent within the DCO and may 

be offset with each other within the DCO). 

100See 76 FR 41048 (July 13, 2011) (Agricultural 

Commodity Definition; final rule). 

liquidation time of portfolios of swaps 

(ISDA); (12) remove the incentive for 

DCOs to detail, practice and leverage 

clearing member expertise in default 

management (FIA); (13) discourage 

voluntary clearing (NGX); and (14) 

require DCOs and clearing members to 

manage margin calls and netting based 

on the execution platform for the 

relevant swaps (VMAC and BlackRock). 

In addition, a number of commenters 

argued that there was no basis for 

concluding that swaps executed on a 

SEF would be less liquid than swaps 

executed on a DCM (GFI, WMBAA, 

NGX, MarketAxess, AMG, and FXall). 

BlackRock recommended that the 

Commission require a DCO to use a 

consistent liquidation time for cleared 

swaps that are executed on SEFs and 

DCMs. 

Commenters variously contended that 

a liquidation time of five business days 

may be excessive for some swaps (CME 

and Citadel 94), a one-day liquidation 

period is too short (LCH), a one-day 

liquidation period is appropriate for 

swaps executed on a DCM or a SEF 

(AMG), and a two-day liquidation 

period is appropriate for cleared swaps 

(NGX). 

Various commenters encouraged the 

Commission to permit a DCO to 

determine the appropriate liquidation 

time for all products that it clears based 

on the unique characteristics and 

liquidity of each relevant product or 

portfolio (CME, MFA, ISDA, LCH, 

NYPC, NGX, FIA,95 Nadex, Citadel, and 

FXall) or to grant DCOs such discretion 

subject to a one-day minimum for all 

products, including cleared swaps (GFI, 

VMAC, MarketAxess, Nodal, WMBAA, 

and Tradeweb). 

FIA and ISDA commented that the 

appropriate liquidation time should be 

derived from a DCO’s default 

management plan and the results of its 

periodic testing of such plan. FIA 

further stated that a DCO should adjust 

its minimum margin requirements if its 

periodic testing of its default 

management plan demonstrates that a 

defaulting clearing member’s positions 

could be resolved in a shorter period of 

time. Similarly, NGX stated that the 

Commission should permit a DCO to 

demonstrate through back testing and 

stress testing that a particular type of 

cleared transaction should be subject to 

a shorter liquidation time. 

MFA and Citadel recommended that 

if the Commission were to mandate 

minimum liquidation times in the final 

rules, it should allow DCOs to apply for 

exemptions for specific groups of swaps 

if market conditions prove that such 

minimum liquidation times are 

excessive. Citadel further recommended 

that the Commission make it explicit 

that the Commission may re-evaluate 

and, if necessary, re-calibrate such 

minimum liquidation times as markets 

evolve. 

The Commission is persuaded by the 

views expressed by numerous 

commenters that requiring different 

minimum liquidation times for cleared 

swaps that are executed on a DCM and 

equivalent cleared swaps that are 

executed on a SEF could have negative 

consequences. Therefore, after further 

consideration, the Commission has 

determined not to mandate different 

minimum liquidation times for cleared 

swaps based on their venue of 

execution, and has further determined 

that the same minimum liquidation time 

should be used with respect to cleared 

swaps that are executed bilaterally. This 

approach is consistent with the open 

access requirements of Section 

2(h)(1)(B) of the CEA and § 39.12(b)(2), 

adopted herein. 

The Commission also acknowledges 

the concerns expressed by commenters 

that a five-day liquidation period may 

be excessive for some swaps. For 

example, for a number of years, CME 

and ICE have successfully cleared swaps 

based on physical commodities using a 

one-day liquidation time.96 By contrast, 

as noted in the notice of proposed 

rulemaking, several DCOs currently use 

a five-day liquidation time in 

determining margin requirements for 

certain swaps based on financial 

instruments.97 These differences reflect 

differences in the risk characteristics of 

the products. 

The Commission has carefully 

considered whether it should prescribe 

any liquidation time or, alternatively, 

permit each DCO to exercise its 

discretion in applying liquidation times 

based on the risk profile of particular 

products or portfolios. In this regard, the 

Commission notes that even without a 

specified minimum liquidation time, 

under Sections 5b(c)(2)(D) and 8a(7)(D) 

of the CEA, the Commission can require 

a DCO to adjust its margin methodology 

if it determines that the current margin 

levels for a product or portfolio are 

inadequate based on back testing or 

current market volatility. 

Weighing the advantages and 

drawbacks of the alternatives, the 

Commission believes that a bright-line 

requirement, with a provision for 

making exceptions, will best serve the 

public interest. While a DCO will still 

have considerable latitude in setting 

risk-based margin levels, the 

Commission has determined that 

establishing a minimum liquidation 

time will provide legal certainty for an 

evolving marketplace, will offer a 

practical means for assuring that the 

thousands of different swaps that are 

going to be cleared subject to the 

Commission’s oversight will have 

prudent minimum margin requirements, 

and will prevent a potential ‘‘race to the 

bottom’’ by competing DCOs. Moreover, 

given the large number of swaps already 

cleared, this alleviates the need for the 

Commission, with its limited staff 

resources, to evaluate immediately the 

liquidation time for each swap that is 

cleared.98

Taking into account these 

considerations, and in response to the 

comments, the Commission is adopting 

§ 39.13(g)(2)(ii) with a number of 

modifications. First, the final rule 

requires a DCO to use the same 

liquidation time for a product whether 

it is executed on a DCM, a SEF, or 

bilaterally. This addresses the 

competitive concerns raised by 

numerous commenters and recognizes 

that once a swap is cleared, its risk 

profile is not affected by the method by 

which it was executed.99

Second, the final rule provides that 

the minimum liquidation time for swaps 

based on certain physical commodities, 

i.e., agricultural commodities,100 energy, 

and metals, is one day. For all other 

swaps, the minimum liquidation time is 

five days. This distinction is based on 

the differing risk characteristics of these 

product groups and is consistent with 

existing requirements that reflect the 

risk assessments DCOs have made over 

the course of their experience clearing 

these types of swaps. The longer 

liquidation time, currently five days for 

credit default swaps at ICE Clear Credit, 

LLC, and CME, and for interest rate 

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69368 Federal Register / Vol. 76, No. 216 / Tuesday, November 8, 2011 / Rules and Regulations 

101See e.g., Cleared OTC Interest Rate Swaps at 

7 (Aug. 2011), available at http:// 

www.cmegroup.com/clearing/cme-core-cmeclearing-online-risk-engine.html; ICE Clear Credit 

Clearing Rules, Schedule 401 (Jul. 16, 2011) 

available at https://www.theice.com/publicdocs/ 

clear_credit/ICE_Clear_Credit_Rules.pdf. 

102The liquidation of the Lehman interest rate 

swap portfolio in the fall of 2008 demonstrates that 

the actual liquidation time for a swap portfolio 

could be longer than 5 days. Between September 15, 

2008 (the day Lehman Bros. Holdings declared 

bankruptcy) and October 3, 2008, LCH and 

‘‘OTCDerivnet,’’ an interest rate derivatives forum 

of major market dealers, wound down the cleared 

OTC interest rate swap positions of Lehman Bros. 

Special Financing Inc. (LBSFI). This portfolio had 

a notional value of $9 trillion and consisted of 

66,390 trades across 5 major currencies. LCH and 

OTCDerivnet competitively auctioned off LBSFI’s 

five hedge currency portfolios to their members 

between September 24 and October 3, 2008. The 

margin held by LCH proved sufficient to cover the 

costs incurred. Source: LCH Press Release of 

October 8, 2008, available at: http:// 

www.lchclearnet.com/Images/2008-10- 

08%20SwapClear%20default_tcm6–46506.pdf. 

103As proposed, § 39.13(g)(2)(ii) referred to the 

‘‘unique’’ characteristics of particular products or 

portfolios. The Commission is revising this phrase 

in the final rule to refer to the ‘‘specific’’ 

characteristics of a particular product or portfolio 

to clarify that such characteristics are not limited 

to those that are one of a kind. 

104 In a technical revision, the Commission has 

eliminated the phrase, ‘‘whether the swaps are 

carried in a customer account subject to Section 

4d(a) or 4d(f) of the Act, or carried in a house 

account,’’ because it is superfluous. 

105The terms ‘‘customer account or customer 

origin’’ and ‘‘house account or house origin’’ are 

now defined in § 39.2, adopted herein. 

106 ISDA contended that if there were a 

requirement to have individualized client accounts, 

the appropriate confidence level should be higher 

than 99 percent because the funds available to a 

DCO to manage a client account default would be 

reduced. 

107MGEX requested that the Commission clarify 

that this proposed requirement applies to the net 

account of each clearing member and not the 

underlying accounts at each clearing member. The 

Commission did not intend proposed 

§ 39.13(g)(2)(iii)(C), which would refer to ‘‘[e]ach 

account held by a clearing member at the DCO, by 

customer origin and house origin * * *, ’’ to apply 

to individual customer accounts by beneficial 

owner. However, the Commission notes that 

§ 39.13(g)(2)(iii)(D), as proposed and as adopted 

herein, applies the 99 percent confidence level 

requirement to ‘‘[e]ach swap portfolio, by beneficial 

owner.’’ 

108 KCC also expressed its belief that ultra-high 

confidence level modeling does not protect against 

risk as well as direct margin intervention by the 

DCO in the case of significant market movements, 

such as retaining the right to review recent price 

movements to re-establish margins at a higher level 

and retaining the right to demand special margin 

from certain clearing members. The Commission 

believes that a DCO should retain the right to take 

such actions in addition to, rather than instead of, 

using a 99 percent confidence level, as required by 

§ 39.13(g)(2)(iii). For example, § 39.13(h)(6)(ii), 

discussed below, requires a DCO to take additional 

actions with respect to particular clearing members, 

when appropriate, including imposing enhanced 

margin requirements. 

swaps at LCH and CME, is based on 

their assessment of the higher risk 

associated with these products.101

Contributing factors include a 

concentration of positions among 

clearing members, the number and 

variety of products listed, the 

complexity of the portfolios, the longdated expiration time for many swaps, 

and the challenges of the liquidation 

process in the event of a default.102

Third, to provide further flexibility, 

the Commission is adding a provision 

specifying that, by order, the 

Commission may provide for a different 

minimum liquidation time for particular 

products or portfolios. As markets 

evolve, it may become appropriate to 

ease the requirement for certain swaps 

subject to the five-day minimum. 

Conversely, analysis may reveal that for 

other products or portfolios the five-day 

or one-day minimum is insufficient. The 

Commission believes that in light of the 

novelty, complexity, and potential 

magnitude of the risk posed by financial 

swaps, prudential considerations dictate 

that this type of fine-tuning should be 

used in appropriate circumstances. 

Such an order could be granted upon 

the Commission’s initiative or in 

response to a petition from a DCO. 

In this regard, the Commission 

emphasizes that it is retaining the 

proposed requirement that a DCO must 

use longer liquidation times, if 

appropriate, based on the specific 

characteristics of particular products or 

portfolios.103 Such longer liquidation 

times may be based on a DCO’s testing 

of its default management plan. If a DCO 

determines that a longer liquidation 

time is appropriate for a particular 

swap, the Commission would expect 

that the DCO would use the same longer 

liquidation time for the equivalent 

swaps that it clears, whether the swaps 

are executed on a DCM, a SEF, or 

bilaterally. Among the factors that DCOs 

should consider in establishing 

minimum liquidation times are: (i) 

Average daily trading volume in a 

product; (ii) average daily open interest 

in a product; (iii) concentration of open 

interest; (iv) availability of a predictable 

basis relationship with a highly liquid 

product; and (v) availability of multiple 

market participants in related markets to 

take on positions in the market in 

question. The Commission would also 

consider these factors in determining 

whether a particular liquidation time 

was appropriate. 

The Commission is adopting 

§ 39.13(g)(2)(ii) revised to read as set 

forth in the regulatory text of this final 

rule.104

(3) Confidence Level—§ 39.13(g)(2)(iii) 

Proposed § 39.13(g)(2)(iii) would 

require that the actual coverage of the 

initial margin requirements produced by 

a DCO’s margin models, along with 

projected measures of the models’ 

performance, would have to meet a 

confidence level of at least 99 percent, 

based on data from an appropriate 

historic time period with respect to: (A) 

each product that is margined on a 

product basis; (B) each spread within or 

between products for which there is a 

defined spread margin rate, as described 

in proposed § 39.13(g)(3); (C) each 

account held by a clearing member at 

the DCO, by customer origin and house 

origin,105 and (D) each swap portfolio, 

by beneficial owner. The Commission 

invited comment regarding whether a 

confidence level of 99 percent is 

appropriate with respect to all 

applicable products, spreads, accounts, 

and swap portfolios. 

Alice Corporation supported the 

proposed 99 percent confidence level, 

especially for new swaps and swaps 

with non-linear characteristics. ISDA 

commented that the proposed 99 

percent confidence level is appropriate 

given current levels of mutualization in 

a DCO default fund and mutualization 

in omnibus client accounts.106 MGEX 

stated that it did not oppose the 

proposed 99 percent confidence level 

for each account held by a clearing 

member at a DCO, by customer origin 

and house origin.107

FIA opposed the proposed 99 percent 

requirement because it sets an artificial 

floor that may remove the incentive for 

DCOs to conduct the rigorous analysis 

necessary to establish an appropriate 

confidence level. FIA further stated that 

if a different regulatory scheme than 

loss mutualization for the protection of 

customer funds were to be adopted for 

cleared swaps, a much higher level of 

confidence may be required. 

CME, Nadex, KCC,108 and Citadel 

took the position that the Commission 

should not prescribe a specific 

confidence level, but should instead 

continue to give each DCO the 

discretion to determine the appropriate 

confidence levels. CME and Nadex 

noted that one or more of the following 

factors could be considered by a DCO in 

determining the appropriate confidence 

levels: the particular characteristics of 

the products and portfolios it clears, the 

depth of the underlying markets, the 

existence of multiple venues trading 

similar products on which a defaulting 

clearing member’s portfolio could be 

liquidated or hedged, the duration of the 

products, the size of the DCO and its 

systemic importance, its customer base, 

or its other risk management tools. 

The Commission does not agree such 

discretion is appropriate and has 

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Federal Register / Vol. 76, No. 216 / Tuesday, November 8, 2011 / Rules and Regulations 69369 

109See CPSS–IOSCO Consultative Report, 

Principle 6: Margin, Key Consideration 3, at 40. In 

addition, on September 15, 2010, the European 

Commission (EC) proposed the European Market 

Infrastructure Regulation (EMIR), available at http:// 

ec.europa.eu/internal_market/financial-markets/ 

docs/derivatives/20100915_proposal_en.pdf, ‘‘to 

ensure implementation of the G20 commitments to 

clear standardized derivatives [which can be 

accessed at http://www.g20.org/Documents/ 

pittsburgh_summit_leaders_statement_250909.pdf, 

and that Central Counterparties (CCPs) comply with 

high prudential standards * * *,’’ among other 

things, and expressed its intent to be consistent 

with the Dodd-Frank Act. (EMIR, at 2–3). The EMIR 

requires that margins ‘‘* * * shall be sufficient to 

cover losses that result from at least 99 per cent of 

the exposures movements over an appropriate time 

horizon * * *.’’ (EMIR, Article 39, paragraph 1, at 

46). 

110See 2004 CPSS–IOSCO Recommendations at 

23. 

111See discussion of § 39.15(b)(2), adopted 

herein, in section IV.F.3, below. 

112For purposes of clarification, certain 

references to customer origin in §§ 39.13 and 39.19 

have been replaced with references to ‘‘each 

customer origin’’ to clarify the distinction between 

customer positions in futures and options 

segregated pursuant to Section 4d(a) of the CEA, 

and customer positions in swaps segregated 

pursuant to Section 4d(f) of the CEA. 

determined to establish a minimum 

confidence level. The Commission 

believes that a minimum confidence 

level will provide legal certainty for an 

evolving marketplace, will offer a 

practical means for assuring market 

participants that the thousands of 

different products that are going to be 

cleared subject to the Commission’s 

oversight will have prudent minimum 

margin requirements, and will prevent a 

potential ‘‘race to the bottom’’ by 

competing DCOs. Moreover, given the 

large number of products already 

cleared, this alleviates the need for the 

Commission, with its limited staff 

resources, to evaluate immediately the 

confidence level requirements for each 

product that is cleared. 

The Commission is adopting the 

proposed minimum 99 percent 

confidence level. This is consistent with 

proposed international standards.109

Moreover, given the potential costs of 

default, the Commission agrees with 

those commenters who stated that a 99 

percent level is appropriate. An 

individual DCO may determine to set a 

higher confidence level, in its 

discretion. 

NASDAQ OMX Commodities Clearing 

Company (NOCC) supported an 

approach that would allow DCOs to set 

margin requirements for new and lowvolume products at a lower coverage 

level if the potential losses resulting 

from such products are minimal. 

According to NOCC, this would allow 

DCOs to include more products and 

market participants by attracting them at 

an early stage without materially 

increasing the risk of the DCO. 

VMAC suggested that the Commission 

add to the requirement that initial 

margin levels must be based upon ‘‘an 

established confidence level of at least 

99 percent,’’ language that states ‘‘or, 

subject to specific authorization from 

the CFTC, a lower confidence level.’’ In 

particular, VMAC commented that 

although a DCO should be required to 

demonstrate that the given confidence 

level results in an initial margin amount 

which is sufficient to allow the DCO to 

fully discharge its obligations upon a 

clearing member default, a DCO should 

not be required to collect margin 

substantially in excess of its obligations 

to clearing members in a default 

scenario. 

The Commission is not modifying the 

language of § 39.13(g)(2)(iii) in a manner 

that would permit DCOs to set margin 

requirements at a lower coverage level 

for new and low-volume products, as 

recommended by NOCC, or provide for 

a lower confidence level subject to 

specific Commission authorization, as 

suggested by VMAC. In the notice of 

proposed rulemaking, the Commission 

noted that the 2004 CPSS–IOSCO 

Recommendations stated that ‘‘[m]argin 

requirements for new and low-volume 

products might be set at a lower 

coverage level [than the major products 

cleared by a CCP] if the potential losses 

resulting from such products are 

minimal.’’ 110 However, the CPSS– 

IOSCO Consultative Report, which was 

issued subsequent to the Commission’s 

proposed rules, does not contain similar 

language. The Commission believes that 

it is prudent to apply the same standard 

to all products. 

OCC and NYPC encouraged the 

Commission to modify its proposal to 

make clear that, when swaps are 

commingled in either a Section 4d(a) 

futures account or a Section 4d(f) 

cleared swaps account, pursuant to 

§ 39.15(b)(2),111 the 99 percent test need 

not be separately applied to the swaps 

positions alone. The Commission agrees 

with OCC and NYPC that if swaps and 

futures are held in the same customer 

account pursuant to rules approved by 

the Commission or a 4d order issued by 

the Commission, as specified in 

§ 39.15(b)(2), the 99 percent test would 

apply to the entire commingled account, 

and not just the swap positions, under 

§ 39.13(g)(2)(iii)(D). Therefore, the 

Commission is modifying 

§ 39.13(g)(2)(iii)(D) to add ‘‘including 

any portfolio containing futures and/or 

options and held in a commingled 

account pursuant to § 39.15(b)(2) of this 

part,’’ after ‘‘[e]ach swap portfolio.’’ The 

Commission is making similar 

modifications in § 39.13(g)(7) with 

respect to back testing requirements, 

which are discussed in section IV.D.6.g, 

below. 

OCC also requested that the 

Commission clarify that, in the case of 

a margin system that calculates margin 

for all positions in an account on the 

basis of the net risk of those positions 

based upon historical price correlations 

rather than on a product or a predefined spread basis, the 99 percent 

confidence level would be applied only 

on an account-by-account basis, and not 

to individual products, product groups, 

or specified spread positions. NYPC 

made a similar request, stating that its 

historical Value at Risk (VaR)-based 

margin model calculates initial margin 

requirements at the portfolio level, 

rather than on a product or spread basis. 

The Commission notes that, as 

proposed, § 39.13(g)(2)(iii)(A) would 

require the application of the 99 percent 

confidence level to ‘‘[e]ach product (that 

is margined on a product basis)’’ and 

§ 39.13(g)(2)(iii)(B) would require the 

application of the 99 percent confidence 

level to ‘‘[e]ach spread within or 

between products for which there is a 

defined spread margin rate * * *.’’ The 

Commission’s intent was that 

§§ 39.13(g)(2)(iii)(A) and (B) would 

apply to products and pre-defined 

spreads under margin models that 

calculate initial margin requirements on 

a product and pre-defined spread basis, 

respectively. Further, with respect to 

margin models that do not calculate 

margin on a product or pre-defined 

spread basis, the 99 percent requirement 

would apply with respect to each 

account held by a clearing member at 

the DCO by house origin and by each 

customer origin, and to each swap 

portfolio, by beneficial owner, pursuant 

to §§ 39.13(g)(2)(iii)(C) and (D), 

respectively.112

In order to clarify the Commission’s 

intent, the Commission is adopting 

§ 39.13(g)(2)(iii)(A) to read as follows: 

‘‘[e]ach product for which the 

derivatives clearing organization uses a 

product-based margin methodology,’’ 

while striking ‘‘(that is margined on a 

product basis).’’ In addition, the 

Commission is adopting 

§ 39.13(g)(2)(iii)(B) to read as follows: 

‘‘[e]ach spread within or between 

products for which there is a defined 

spread margin rate,’’ while striking ‘‘as 

described in paragraph (g)(4) of this 

section.’’ 

LCH commented that the 

Commission’s approach to setting 

margin based on products and spreads, 

while appropriate for futures, is not 

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113See CPSS–IOSCO Consultative Report, 

Principle 6: Margin, Explanatory Note 3.6.7, at 43. 

114The Commission also notes that the CPSS– 

IOSCO Consultative Report recommends that a 

CCP’s initial margin models should be 

independently validated at least on a yearly basis. 

CPSS–IOSCO Consultative Report, Principle 6: 

Margin, Explanatory Note 3.6.8, at 43. The 

Commission is not requiring an annual validation 

at this time, although it may revisit this issue in the 

future. 

115Section 39.18(j)(2), as proposed, and as 

adopted herein, states that testing shall be 

conducted by qualified, independent professionals. 

Such qualified independent professionals may be 

independent contractors or employees of the 

derivatives clearing organization, but shall not be 

persons responsible for development or operation of 

the systems or capabilities being tested. 

116 In particular, OCC noted that the Office of the 

Comptroller of the Currency, the Department of the 

Treasury, the Federal Reserve System and the 

Federal Deposit Insurance Corporation recently 

proposed revisions to their risk-based capital 

guidelines, which would require that, with respect 

to the validation of banks’ internal risk models, 

‘‘[t]he review personnel [would] not necessarily 

have to be external to the bank in order to achieve 

the required independence’’ but that ‘‘[a] bank 

should ensure that individuals who perform the 

review are not biased in their assessment due to 

their involvement in the development, 

implementation, or operation of the models.’’ See 

76 FR 1890, at 1897 (Jan. 11, 2011) (Risk-Based 

Capital Guidelines: Market Risk). 

suitable or sufficient for swaps. LCH 

proposed that the key requirement for 

swaps should be for the DCO to ensure 

that it has enough margin and guarantee 

funds to cover its exposures, and for the 

DCO to prove this on an individual 

client and clearing member basis. The 

Commission did not intend to suggest 

that swaps should be margined pursuant 

to a product-based margin methodology, 

nor that they should be subject to 

defined spread margin rates. The 

Commission recognizes that swaps are 

often margined on a portfolio basis and 

specifically addressed swap portfolios 

in § 39.13(g)(2)(iii)(D). The Commission 

would also like to clarify that a 99 

percent confidence level, as applied to 

swap portfolios, means that each 

portfolio is covered 99 percent of the 

time, and not that a collection of 

portfolios is covered 99 percent of the 

time on an aggregate basis. 

The Commission is adopting 

§ 39.13(g)(2)(iii) with the modifications 

described above. 

(4) Appropriate Historic Time Period— 

§ 39.13(g)(2)(iv) 

Proposed § 39.13(g)(2)(iv) would 

require each DCO to determine the 

appropriate historic time period of data 

that it would use for establishing the 99 

percent confidence level based on the 

characteristics, including volatility 

patterns, as applicable, of each product, 

spread, account, or portfolio. 

LCH recommended that the 

Commission define the ‘‘historic time 

period’’ as a minimum of one calendar 

year in order to provide for adequate 

historical observations. The 

Commission believes that a DCO should 

be permitted to exercise its discretion 

with respect to the appropriate time 

periods that should be used, based on 

the characteristics, including volatility 

patterns, as applicable, of the relevant 

products, spreads, accounts, or 

portfolios. The Commission also notes 

that proposed international standards 

do not specify a historic time period 

that would be appropriate in all 

circumstances, recognizing that either a 

shorter or a longer historic time period 

may be appropriate based on the 

volatility patterns of a particular 

product.113 The Commission expects 

that DCOs would include periods of 

significant financial stress. Therefore, 

the Commission is adopting 

§ 39.13(g)(2)(iv) as proposed. 

d. Independent Validation— 

§ 39.13(g)(3) 

Proposed § 39.13(g)(3) would require 

that a DCO’s systems for generating 

initial margin requirements, including 

the DCO’s theoretical models, must be 

reviewed and validated by a qualified 

and independent party, on a regular 

basis. The Commission invited 

comment regarding whether a qualified 

and independent party must be a third 

party or whether there may be 

circumstances under which an 

employee of a DCO could be considered 

to be independent. 

In the notice of proposed rulemaking, 

the Commission explained that a 

validation should include a 

comprehensive analysis to ensure that 

such systems and models achieve their 

intended goals. The Commission also 

noted that, although the proposed 

regulation did not define the meaning of 

‘‘regular basis,’’ the Commission would 

expect that, at a minimum, a DCO 

would obtain such an independent 

validation prior to implementation of a 

new margin model and when making 

any significant change to a model that 

was in use by the DCO.114 The 

Commission further stated that 

significant changes would be those that 

could materially affect the nature or 

level of risks to which a DCO would be 

exposed, and that the Commission 

would expect a DCO to obtain an 

independent validation prior to any 

significant change that would relax risk 

management standards. However, the 

Commission noted that if a DCO needed 

to adopt a significant change in an 

expedited manner to enhance risk 

protections, the Commission would 

expect the DCO to obtain an 

independent validation promptly after 

the change was made. 

CME, OCC, MGEX, and KCC all 

expressed the view that an employee of 

a DCO could be independent in 

appropriate circumstances. CME 

commented that permitting employees 

of a DCO to conduct the required 

reviews would be consistent with 

proposed § 39.18(j)(2), which would 

allow employees of a DCO to conduct 

the required testing of a DCO’s business 

continuity and disaster recovery 

systems, provided that such employees 

are not the persons responsible for 

developing or operating the systems 

being tested.115 OCC and MGEX took 

the position that employees of a DCO 

could be independent as long as they 

are not, or have not been, involved in 

designing the models, and OCC further 

stated that internal personnel must not 

otherwise be biased due to their 

involvement in implementation of the 

models.116 However, FIA argued that 

margin models should be required to be 

validated by an independent third party 

with expertise in risk and the product 

being cleared. 

The Commission recognizes that a 

third party could be more critical of a 

DCO’s margin model than an employee 

of a DCO, even if that employee is 

‘‘qualified and independent.’’ However, 

the Commission also believes that a 

third party could be less critical if, for 

example, it seeks to provide services to 

the DCO or the industry in the future. 

The Commission agrees with CME, 

OCC, MGEX, and KCC that an employee 

of a DCO could be a ‘‘qualified and 

independent party,’’ and thus could 

review and validate the DCO’s systems 

for generating initial margin 

requirements, under appropriate 

circumstances. It would probably be 

more costly for a DCO to use a third 

party for this purpose rather than an 

employee. 

On balance, the Commission believes 

that it may be appropriate for a DCO to 

have an employee review and validate 

its margin systems. Therefore, the 

Commission is adopting § 39.13(g)(3) 

with the addition of a sentence stating 

that ‘‘[s]uch qualified and independent 

parties may be independent contractors 

or employees of the derivatives clearing 

organization, but shall not be persons 

responsible for development or 

operation of the systems and models 

being tested.’’ This is consistent with 

the language contained in § 39.18(j)(2), 

as adopted herein, as well as the 

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117 Id. 

118For a description of SPAN, see CME’s Web 

site, at http://www.cmegroup.com/clearing/riskmanagement/span-overview.html#works. 

119See id. for a description of SPAN parameters. 

Therefore, § 39.13(g)(1), which requires that a DCO 

review its margin models and parameters, on a 

regular basis, requires a broader review than would 

be met by compliance with § 39.13(g)(3). 

120 In addition to the other comments discussed 

herein, Alice Corporation noted that it supported 

the cautious approach taken by the Commission 

and that offsets across products with different 

maturities and risk profiles should be avoided 

where possible, and ISDA stated that spread 

margins should only permitted when a DCO can 

demonstrate a strong correlation in stressed market 

conditions and agrees to periodic public disclosure 

of its methodology and results. With respect to 

ISDA’s comment, the Commission notes that 

§ 39.13(g)(2)(iii), discussed in section IV.D.6.c.(3), 

above, requires a DCO to ensure that the actual 

coverage of its initial margin requirements, along 

with projected measures of the performance of its 

margin models, must meet an established 

confidence level of at least 99 percent, based on 

data from an appropriate historic time period, for, 

among other things, spreads within or between 

products for which there is a defined spread margin 

rate, for each account held by a clearing member 

at the DCO, by customer and house origin, and for 

each swap portfolio, by beneficial owner, and 

§ 39.13(g)(7), discussed in section IV.D.6.g, below, 

imposes related back testing requirements. In 

addition, § 39.21(c)(3), discussed in section IV.L, 

below, requires a DCO to publicly disclose its 

margin methodology. 

proposed approach of other financial 

regulators.117 The Commission also 

notes that the reference to independent 

contractors as well as employees in the 

added language will also prohibit a DCO 

from using a particular third party to 

conduct the validation if that third party 

was or is responsible for development or 

operation of the relevant systems and 

models. 

KCC requested that the Commission 

clarify that the CRO or other comparable 

personnel with responsibility for overall 

risk management at the DCO would 

meet the requirements of a ‘‘qualified 

and independent party.’’ The 

Commission does not believe that a 

DCO’s CRO or personnel responsible for 

overall risk management would 

categorically qualify as an ‘‘independent 

party.’’ This determination would need 

to be made on a case-by-case basis 

depending on whether the CRO or other 

similar person was or is responsible for 

development or operation of the systems 

and models being tested. 

MGEX requested that the Commission 

clarify whether the requirement for 

independent validation would apply to 

the primary risk-based portfolio system 

such as SPAN,118 or each DCO’s 

analysis program for determining 

margins, noting its belief that requiring 

independent tests on the latter would be 

excessive. It is not clear what MGEX 

means by ‘‘each DCO’s analysis program 

for determining margins.’’ However, 

§ 39.13(g)(3) requires independent 

validation with respect to a DCO’s 

underlying model, e.g., SPAN or OCC’s 

STANS model, as well as the 

methodology used to compute the 

inputs to any such model. On the other 

hand, a DCO would not be required to 

obtain an independent validation of a 

change in SPAN parameters as 

described by CME.119

OCC commented that, as described in 

the notice of proposed rulemaking, the 

‘‘could materially affect’’ standard is 

deficient in two respects in that: (1) It 

fails to include any reference to the 

likelihood that a change would actually 

materially affect the nature or level of 

risk, and (2) it omits any reference to the 

direction of the change in level of risk. 

OCC contended that a more appropriate 

standard would be to provide that 

significant changes are those that ‘‘are 

reasonably likely to materially change 

the nature or increase the level of risks 

to which the DCO would be exposed.’’ 

In response to this comment, the 

Commission is modifying the standard 

to provide that significant changes are 

those for which there is a reasonable 

possibility that they would materially 

affect the nature or level of risks to 

which a DCO would be exposed. While 

this standard identifies the likelihood 

that a change would materially affect 

the nature or level of such risks, the 

Commission believes that it is more 

appropriate than identifying significant 

changes as only those that are 

‘‘reasonably likely to materially change’’ 

the nature or level of such risks. 

The Commission does not believe that 

significant changes should be limited to 

those that are likely to increase the level 

of risks. As described in the notice of 

proposed rulemaking, the Commission 

would expect a DCO to obtain an 

independent validation prior to any 

significant change that would relax risk 

management standards, but the 

Commission would permit a DCO to 

obtain an independent validation 

promptly after a significant change that 

would enhance risk protections, in 

appropriate circumstances. A DCO 

should obtain such a validation even if 

the change were designed to enhance 

risk protections, in order to ensure that 

the change would be effective in 

achieving its objective. 

OCC also requested that the 

Commission clarify that the addition of 

a new product or new underlying 

interest would not inherently be 

deemed to trigger the independent 

evaluation requirement. The 

Commission believes that whether the 

addition of a new product or a new 

underlying interest would trigger the 

independent validation requirement 

would need to be determined on a caseby-case basis, depending on whether 

there is a reasonable possibility that 

such addition will materially change the 

nature or level of risks to which the 

DCO would be exposed. One example 

would be if the addition necessitates a 

significant change to the margin model 

as it applies to the new product or new 

underlying interest. Thus, the addition 

of a futures contract based on a new 

broad-based securities index where the 

DCO already clears futures contracts 

based on broad-based securities indexes 

might not require a significant change to 

the applicable margin model. However, 

the addition of a new category of swaps, 

even if the DCO already clears swaps, 

might require a significantly different 

margin model. Another example might 

be if a swap cleared by a DCO became 

subject to a clearing mandate and the 

risk profile changed because of changes 

in volume and open interest. 

e. Spread and Portfolio Margins— 

§ 39.13(g)(4)(i) 

Proposed § 39.13(g)(4)(i) would 

permit a DCO to allow reductions in 

initial margin requirements for related 

positions (spread margins), if the price 

risks with respect to such positions 

were significantly and reliably 

correlated. Under the proposed 

regulation, the price risks of different 

positions would only be considered to 

be reliably correlated if there were a 

theoretical basis for the correlation in 

addition to an exhibited statistical 

correlation. Proposed § 39.13(g)(4)(i) 

would include a non-exclusive list of 

possible theoretical bases, including the 

following: (A) The products on which 

the positions are based are complements 

of, or substitutes for, each other; (B) one 

product is a significant input into the 

other product(s); (C) the products share 

a significant common input; or (D) the 

prices of the products are influenced by 

common external factors. The 

Commission requested comment 

regarding the appropriateness of 

requiring a theoretical basis for the 

correlation between related positions 

before reductions in initial margin 

requirements would be permitted. In 

addition, proposed § 39.13(g)(4)(ii) 

would require a DCO to regularly review 

its spread margins and the correlations 

on which they are based.120

KCC and OCC addressed the proposed 

requirement that the price risks of 

related positions would only be 

considered to be reliably correlated, and 

thus be eligible for initial margin 

reductions, if there were a theoretical 

basis for the correlation in addition to 

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69372 Federal Register / Vol. 76, No. 216 / Tuesday, November 8, 2011 / Rules and Regulations 

121A defined spread margin rate may also apply 

to three related products, e.g., the Chicago Board of 

Trade’s soybean crush spread with respect to 

soybeans, soybean oil and soybean meal. 

an exhibited statistical correlation. KCC 

contended that the proposed 

requirement would be difficult for the 

Commission to implement and 

unnecessary because DCOs have no 

incentive to offer margin reductions in 

the absence of high correlation between 

positions. KCC further noted that the 

proposal does not detail what level of 

observed statistical correlation is 

required, and the proposed requirement 

to articulate a theoretical basis is vague. 

OCC also questioned the 

appropriateness of the requirement that 

there must be a theoretical basis for the 

correlation, noting that a theoretical 

basis for correlation is, by definition, 

theoretical and may not be directly 

observable or verifiable except through 

the correlation. OCC stated that it is 

difficult to imagine a correlation for 

which no theoretical basis can be 

constructed, and in many if not most 

cases, the theoretical basis for any 

significant correlation is obvious. 

The Commission continues to believe 

that reductions in initial margin 

requirements should only be allowed if 

a DCO is able to articulate a reasonable 

theoretical explanation for an observed 

statistical correlation to ensure that the 

positions are reliably correlated. The 

Commission notes that it is a matter of 

basic statistics that correlation does not 

equal causation. The world is replete 

with examples of events or data that are 

highly correlated at various points in 

time but for which there is no 

theoretical relationship. If there is no 

theoretical relationship, a DCO has no 

basis to believe that a statistical 

relationship—no matter how strong—is 

stable, and a margin based on such a 

relationship may be insufficient to 

capture price variation. 

Several commenters addressed the 

appropriateness of applying proposed 

§ 39.13(g)(4) to portfolio-based margin 

systems. LCH commented that the 

spread margin measure which the 

Commission proposed is unsuited and 

inappropriate for swaps clearing and 

that the Portfolio Approach to Interest 

Rate Scenarios (PAIRS), the historical 

simulation method that LCH uses, is 

more suitable to non-standardized 

swaps. Therefore, LCH urged the 

Commission to amend proposed 

§ 39.13(g)(4) to afford recognition to this 

technique. OCC requested that the 

Commission acknowledge that its 

STANS methodology meets the 

requirements of proposed § 39.13(g)(4), 

noting that STANS currently relies on 

over 20 million separate correlations. 

OCC stated that it would be impractical 

to attempt to document or even 

articulate the ‘‘theoretical basis’’ for all 

of these correlations even though it 

believes that they would be supportable 

on a theoretical level, and further 

believes that its systems for determining 

and reviewing the validity of the 

correlations it uses are sufficient to 

ensure that OCC does not allow 

unjustified margin offsets. NYPC 

requested that the Commission clarify 

that § 39.13(g)(4) would not be 

applicable to margin models that 

calculate initial margin requirements at 

the account level, including NYPC’s 

historical VaR-based margin model. 

The Commission intends § 39.13(g)(4) 

to apply to portfolio-based margin 

models as well as product-based margin 

models. For some products, DCOs 

establish defined spread margin rates, 

pursuant to a product-based margin 

methodology. Typically, this occurs 

where there is a bilateral correlation, 

e.g., a March-June calendar spread or a 

correlation between two related 

products.121 For other products, there 

may be multilateral correlations for 

which margin is calculated on a 

portfolio basis, pursuant to a portfoliobased margin methodology. In the latter 

instance, there is not a defined margin 

amount or margin reduction for a 

defined portfolio that remains the same 

over time. Instead, margin is 

recalculated each day for each 

individual portfolio. 

Therefore, the Commission is 

adopting § 39.13(g)(4), with several 

modifications, in order to clarify that 

margin reductions calculated on a 

portfolio basis are also permissible if 

they meet the standards of the 

regulation. First, the Commission is 

changing the heading of the provision 

from ‘‘[s]pread margins’’ to ‘‘[s]pread 

and portfolio margins.’’ The 

Commission is also removing the 

parenthetical ‘‘(spread margins)’’ after 

the clause in § 39.13(g)(4)(i) that states 

‘‘[a] derivatives clearing organization 

may allow reductions in initial margin 

requirements for related positions.’’ 

Finally, the Commission is changing the 

reference to ‘‘spread margins’’ in 

§ 39.13(g)(4)(ii) to ‘‘margin reductions.’’ 

These changes are designed to make it 

clear that § 39.13(g)(4) applies to 

reductions in initial margin 

requirements for related positions, 

whether a DCO uses a product-based 

margin model or a portfolio-based 

margin model. 

Better Markets and Mr. Greenberger 

commented that § 39.13(g)(4) must 

require that the relationship between 

positions be calculated using the same 

standards (with respect to volatility and 

liquidity requirements) that are applied 

to the calculation of initial margin for 

the individual positions. The 

Commission agrees with Better Markets 

and Mr. Greenberger and, as discussed 

above, spread and portfolio margins 

would also be subject to a 99 percent 

coverage standard. 

f. Price Data—§ 39.13(g)(5) 

Proposed § 39.13(g)(5) would require 

a DCO to have a reliable source of 

timely price data to measure its credit 

exposure accurately, and to have written 

procedures and sound valuation models 

for addressing circumstances where 

pricing data is not readily available or 

reliable. 

Interactive Data Corporation 

expressed its belief that the concept of 

‘‘sound valuation models’’ should be 

expanded further with additional 

prescriptive guidance in four key 

dimensions, including: (1) Leveraging 

greater trade transparency; (2) using 

multiple sources; (3) mitigating conflicts 

of interest; and (4) sourcing of 

independent price data. 

The Commission does not believe that 

it is necessary to be more specific or 

prescriptive with respect to this 

requirement, and is adopting 

§ 39.13(g)(5) as proposed. As the 

Commission noted in the notice of 

proposed rulemaking, the nature of the 

applicable valuation models would 

necessarily depend on the particular 

products and the available sources of 

any relevant pricing data. 

g. Daily Review and Back Tests— 

§§ 39.13(g)(6) and (g)(7) 

Proposed § 39.13(g)(6) would require 

a DCO to determine the adequacy of its 

initial margin requirements for each 

product, on a daily basis, with respect 

to those products that are margined on 

a product basis. 

Proposed § 39.13(g)(7) would require 

a DCO to conduct certain back tests. The 

Commission has defined ‘‘back test’’ in 

§ 39.2, adopted herein, as ‘‘a test that 

compares a derivatives clearing 

organization’s initial margin 

requirements with historical price 

changes to determine the extent of 

actual margin coverage.’’ 

For purposes of proposed 

§ 39.13(g)(7)(i) and (ii), the introductory 

paragraph of proposed § 39.13(g)(7) 

would require that, in conducting back 

tests, a DCO use historical price change 

data based on a time period that is 

equivalent in length to the historic time 

period used by the applicable margin 

model for establishing the minimum 99 

percent confidence level or a longer 

time period. The applicable time period 

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122MGEX correctly understands that the 

Commission’s reference to ‘‘each account held by a 

clearing member at the DCO, by origin, house and 

customer’’ in proposed § 39.13(g)(7)(iii) was not 

intended to apply to individual accounts by 

beneficial owner, although proposed 

§ 39.13(g)(7)(iii) would require monthly back tests 

with respect to initial margin requirements for each 

swap portfolio, by beneficial owner. 

123The Commission believes that each DCO 

should determine what ‘‘significant volatility’’ 

means based upon the volatility patterns of each 

individual product or swap portfolio that it clears. 

124The Commission has not defined a 

‘‘significant position,’’ leaving that determination to 

the discretion of each DCO, as the size of a position 

that would be a ‘‘significant position’’ may vary 

depending on the nature of the particular product 

or the composition of the particular account. 

125See discussion of the addition of the same 

language to § 39.13(g)(2)(iii)(D), in section 

IV.D.6.c.(3), above. 

was separately specified for the back 

tests required by proposed 

§ 39.13(g)(7)(iii), as discussed below. 

Proposed § 39.13(g)(7)(i) would 

require a DCO, on a daily basis, to 

conduct back tests with respect to 

products that are experiencing 

significant market volatility. 

Specifically, a DCO would be required 

to test the adequacy of its initial margin 

requirements and its spread margin 

requirements for such products that are 

margined on a product basis. 

Proposed § 39.13(g)(7)(ii) would 

require a DCO, on at least a monthly 

basis, to conduct back tests to test the 

adequacy of its initial margin 

requirements and spread margin 

requirements for each product that is 

margined on a product basis. The 

Commission requested comment 

regarding whether initial margin 

requirements for all products should be 

subject to back tests on a monthly basis 

or whether some other time period, such 

as quarterly, would be sufficient to meet 

prudent risk management standards. 

Proposed § 39.13(g)(7)(iii) would 

require a DCO, on at least a monthly 

basis, to conduct back tests to test the 

adequacy of its initial margin 

requirements for each clearing member’s 

accounts, by customer origin and house 

origin, and each swap portfolio, by 

beneficial owner, over at least the 

previous 30 days. In the notice of 

proposed rulemaking, the Commission 

noted that, since the composition of 

such accounts and swap portfolios may 

change on a daily basis, it was 

anticipated that back tests with respect 

to such accounts and portfolios would 

involve a review of the initial margin 

requirements for each account and 

portfolio as it existed on each day 

during the 30-day period. The 

Commission also requested comment 

regarding whether initial margin 

requirements for all clearing members’ 

accounts, by origin, and swap portfolios, 

by beneficial owner, should be subject 

to back tests on a monthly basis or 

whether some other time period, such as 

quarterly (based on the previous 

quarter’s historical data), would be 

sufficient to meet prudent risk 

management standards. 

Several commenters addressed the 

appropriate frequency of back tests and/ 

or the appropriate historic time period 

for the analysis of price change data. 

FIA commented that initial margin 

requirements should be back tested 

monthly. MGEX stated that it was not 

opposed to a monthly back testing 

requirement with respect to proposed 

§ 39.13(g)(7)(iii) based on its 

understanding that the Commission 

intended that the DCO must look at its 

clearing member’s net account and not 

each underlying customer account with 

the exception of swaps.122

LCH took the position that back tests 

should be conducted at least on a daily 

basis for all products cleared by a DCO. 

However, LCH argued that such back 

tests should be conducted at the 

portfolio level because margining 

techniques appropriate for swaps, such 

as LCH’s PAIRS methodology, do not 

allow for the disaggregation of initial 

margin and spread margin requirements 

at a product level. LCH also commented 

that, for back tests to be statistically 

meaningful, the applicable historic time 

period should be a minimum of one 

calendar year. 

KCC stated that it may be appropriate 

for the Commission to further define 

‘‘significant market volatility,’’ for 

purposes of proposed § 39.13(g)(7)(i),123

but that, more generally, any backtesting requirements should be based on 

a discretionary, risk-based 

determination by the DCO. In addition, 

KCC expressed its belief that the back 

testing period should be subject to the 

discretion of the DCO in light of thencurrent market conditions, i.e., 

imposing a specific back-testing period 

may inappropriately reflect an 

exaggerated or understated level of 

market volatility. 

NOCC took the position that products, 

customers or spread credits should 

reach a specified volume or risk 

exposure level before being required to 

be back tested with the proposed 

frequencies so long as the DCO can 

demonstrate that it is meeting the core 

principle objectives underlying 

proposed § 39.13(f). 

NYPC requested that the Commission 

clarify that proposed §§ 39.13(g)(6) and 

(g)(7)(i)–(ii) would not be applicable to 

margin models that calculate initial 

margin requirements at the account 

level, including NYPC’s historical VaRbased margin model. OCC also stated its 

belief that it would not be subject to the 

requirement for daily review in 

proposed § 39.13(g)(7)(i), as it does not 

margin on a product basis, but noted 

that it does conduct daily back testing 

on all accounts, i.e., on a portfolio basis. 

The Commission is adopting 

§ 39.13(g)(6), eliminating the language 

stating ‘‘for each product (that is 

margined on a product basis),’’ in order 

to correct a potential inconsistency 

between the text of the rule and the 

notice of proposed rulemaking. In the 

notice of proposed rulemaking, the 

Commission stated that ‘‘[d]aily review 

and periodic back testing are essential to 

enable a DCO to provide adequate 

coverage of the DCO’s risk exposures to 

its clearing members.’’ As proposed, 

§ 39.13(g)(6) would only require a DCO 

to determine the adequacy of its initial 

margin requirements, on a daily basis, 

for products that were margined on a 

product basis. The adequacy of a DCO’s 

initial margin requirements for futures 

and options on futures products 

margined on a portfolio basis, and for 

swap portfolios, would not have been 

subject to such daily review. The 

Commission believes that such a result 

is untenable, as one of the most 

rudimentary steps in risk management 

is to conduct daily review of margin 

coverage, i.e., to determine whether any 

margin breaches have occurred. 

Moreover, the Commission believes that 

the change will not impose any burden 

because it believes that all DCOs 

currently conduct some form of daily 

review of the adequacy of their initial 

margin requirements, whether they use 

a product-based or a portfolio-based 

margin methodology. 

The Commission is adopting 

§ 39.13(g)(7)(i) with modifications that 

require a DCO to conduct back tests, on 

a daily basis, to test the adequacy of its 

initial margin requirements with respect 

to products or swap portfolios that are 

experiencing significant market 

volatility: (a) For that product if the 

DCO uses a product-based margin 

methodology; (b) for each spread 

involving that product if there is a 

defined spread margin rate; (c) for each 

account held by a clearing member at 

the DCO that contains a significant 

position 124 in that product, by house 

origin and by each customer origin; and 

(d) for each such swap portfolio, 

including any portfolio containing 

futures and/or options and held in a 

commingled account pursuant to 

§ 39.15(b)(2),125 by beneficial owner. 

Similarly, the Commission is adopting 

§ 39.13(g)(7)(ii) with modifications that 

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126 Id. 

127The Commission does not believe that it is 

appropriate to adopt a regulation establishing an 

exemption process with respect to back testing 

requirements based on volume or risk exposure or 

otherwise. 

128LCH also expressed its belief that a DCO 

should also collect margin from all affiliated legal 

entities within a house account on a gross basis 

unless there is legal certainty of the DCO’s right to 

offset risks across the affiliates in the event of the 

default of the group or one or more of its affiliated 

legal entities. The Commission has not proposed 

and is not adopting such a requirement. However, 

although § 39.13(g)(8)(i) permits a DCO to collect 

initial margin for its clearing members’ house 

accounts on a net basis, it does not require it to do 

so, and a DCO could determine to collect house 

margin in the manner suggested by LCH. 

129See further discussion of these costs in section 

VII, below. NYPC also commented that given the 

necessary technology builds, it would need more 

than three years to come into compliance with 

proposed §§ 39.13(g)(8)(i) and 39.13(h)(2). The 

Commission believes that the modifications to 

§ 39.13(g)(8)(i), discussed in this section, would 

minimize any technology changes that would be 

necessary in order to comply with § 39.13(g)(8)(i). 

require a DCO to conduct back tests, on 

at least a monthly basis: (a) For each 

product for which the DCO uses a 

product-based margin methodology; (b) 

for each spread for which there is a 

defined spread margin rate; (c) for each 

account held by a clearing member at 

the DCO, by house origin and by each 

customer origin; and (d) for each swap 

portfolio, including any portfolio 

containing futures and/or options and 

held in a commingled account pursuant 

to § 39.15(b)(2),126 by beneficial owner. 

As adopted, § 39.13(g)(7) no longer 

contains a paragraph (iii) as paragraph 

(ii) now describes all monthly back 

testing requirements. 

As originally proposed, § 39.13(g)(7) 

would only require daily back testing 

for products that were experiencing 

significant market volatility if the DCO 

used a product-based margin 

methodology, and for spreads involving 

that product if there was a defined 

spread margin rate. It would not require 

daily back testing for each account, by 

customer origin and house origin, that 

contained a significant position in that 

product, whether the DCO used a 

product-based or a portfolio-based 

margin methodology, or for each swap 

portfolio that was experiencing 

significant market volatility. As with 

respect to § 39.13(g)(6), there was a 

potential inconsistency in the treatment 

of different positions. There is no 

reasonable basis to require daily back 

tests solely with respect to products that 

are experiencing significant market 

volatility for which the DCO uses a 

product-based margin methodology and 

spreads involving such products if there 

is a defined spread margin rate, and not 

to require daily back tests with respect 

to accounts, by customer origin and 

house origin, which contain significant 

positions in those products simply 

because the DCO uses a portfolio-based 

margin methodology. Similarly, there is 

no justification for requiring daily back 

tests with respect to products that are 

experiencing significant market 

volatility and not requiring daily back 

tests with respect to swap portfolios that 

are experiencing significant market 

volatility. A DCO should be required to 

conduct daily back tests when the 

instruments that it clears are subject to 

significant market volatility, whether 

the DCO bases its initial margin 

requirements on a product-based or a 

portfolio-based margin methodology, 

and whether those instruments are 

futures, options on futures, or swaps. 

Although OCC stated that it currently 

conducts daily back tests on all 

accounts on a portfolio basis, and LCH 

expressed its view that back tests should 

be conducted on a daily basis for all 

products and swap portfolios cleared by 

a DCO, the Commission has determined 

to permit a DCO to conduct back tests 

on at least a monthly basis when 

significant market volatility is not 

present. FIA and MGEX supported 

monthly back testing. Apart from KCC’s 

contention that back testing should be 

subject to the discretion of the DCO, and 

NOCC’s suggestion that DCOs should be 

able to obtain an exemption from the 

proposed frequencies for products, 

customers and spread credits that have 

not reached a specified volume or risk 

exposure level,127 none of the 

commenters indicated that back tests 

should be conducted less frequently 

than monthly. Moreover, a particular 

DCO would be able to exercise its 

discretion to conduct back tests on a 

more frequent basis than that required 

by the Commission’s regulation. 

The Commission has not proposed 

and is not adopting LCH’s suggestion 

that the applicable historic time period 

for the price change data used for back 

testing should be a minimum of one 

calendar year. However, the 

Commission is removing the proposed 

language from the introductory 

paragraph of § 39.13(g)(7) regarding the 

time periods for historical price changes 

that must be used in the required back 

tests and is revising the introductory 

paragraph to require a DCO to use an 

appropriate time period but not less 

than the previous 30 days for all of the 

back tests required by §§ 39.13(g)(7)(i) 

and (ii). 

h. Customer Margin 

(1) Gross Margin for Customer Accounts 

—§ 39.13(g)(8)(i) 

Proposed § 39.13(g)(8)(i) would 

require a DCO to collect initial margin 

on a gross basis for each clearing 

member’s customer account equal to the 

sum of the initial margin amounts that 

would be required by the DCO for each 

individual customer within that account 

if each individual customer were a 

clearing member and would prohibit a 

DCO from netting positions of different 

customers against one another. The 

proposed regulation would permit a 

DCO to collect initial margin for its 

clearing members’ house accounts on a 

net basis. 

Better Markets and LCH (with a 

suggested exception described below) 

supported proposed § 39.13(g)(8)(i).128

CME, KCC, OCC, ICE, NYPC, FIA, and 

the Commodity Markets Council (CMC) 

argued against the adoption of proposed 

§ 39.13(g)(8)(i). 

KCC and ICE pointed out that DCOs 

that perform net margining have not had 

any clearing member defaults or 

customer losses, including during the 

2008 financial crisis. 

Various commenters opposed the 

proposal based on the potential extent 

and costs of operational and technology 

changes that would need to be made by 

clearing members and DCOs: (1) To 

convert net margining systems to gross 

margining systems, and (2) to permit 

clearing members to provide individual 

customer position information to DCOs, 

and DCOs to receive individual 

customer position information and 

calculate the margin required for each 

individual customer account (CME, 

KCC, ICE, NYPC, and CMC). 

OCC stated that the only means by 

which it could calculate margin 

requirements on a customer-bycustomer basis within a clearing 

member’s omnibus futures customers’ 

account would be to create subaccounts 

for each customer. CME, NYPC, KCC, 

and FIA commented that DCOs do not 

currently receive position-level 

information for each individual 

customer of their clearing members. 

CME and FIA expressed concern about 

the costs associated with clearing 

members having to provide individual 

customer position information, and 

CME indicated that DCOs would incur 

costs in processing the information 

received from clearing members in order 

to calculate margin requirements on 

individual customer accounts on a daily 

basis. NYPC also stated that the 

adoption of proposed § 39.13(g)(8)(i) 

would require it to make significant 

changes to its systems.129

KCC stated that managing gross 

customer margin at the DCO level 

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130The Commission is including the phrase ‘‘to 

the extent not inconsistent with other Commission 

regulations’’ because, in a separate rulemaking, the 

Commission has proposed regulations that would 

require FCM clearing members to provide daily 

information identifying the positions of individual 

cleared swaps customers to the relevant DCO and 

that would require such DCOs to calculate the 

amount of collateral required for each cleared 

swaps customer of such clearing members on a 

daily basis. If these regulations are adopted, they 

will supersede the provisions of § 39.13(g)(8)(i) to 

the extent that they are inconsistent with such 

provisions, with respect to cleared swaps. See 76 

FR 33818 (June 9, 2011) (Protection of Cleared 

Swaps Customer Contracts and Collateral; 

Conforming Amendments to the Commodity Broker 

Bankruptcy Provisions). 

The Commission is also making a conforming 

amendment by inserting ‘‘and may not permit its 

clearing members to’’ in the sentence that now 

reads as follows (added text in italics): ‘‘A 

derivatives clearing organization may not, and may 

not permit its clearing members to, net positions of 

different customers against one another.’’. 

131See, e.g., Margins Handbook, http:// 

www.nfa.futures.org/NFA-compliance/publicationlibrary/margins-handbook.pdf, at 34; CME Rule 

930.J.; ICE Futures U.S. Inc. Rule 5.04; and CBOE 

Futures Exchange, LLC Rule 516. 

would require a DCO to assume the role 

of a back-office account management 

service, requiring continuous updates 

from each clearing member regarding 

customer positions. KCC further noted 

that DCOs would be required to adjust 

the timing deadlines for margin 

payments, DCOs’ ability to track margin 

requirements closely with market 

movements would be decreased, and 

DCOs may face difficulty in relaying 

variation margin payment information 

to their settlement banks quickly. 

ICE noted that converting to a gross 

margining system would be a major 

operational change for clearing firms 

and DCOs that use net margining. 

However, ICE also stated that most 

DCOs currently use gross margining, 

including ICE Trust (now ICE Clear 

Credit LLC) and ICE Clear U.S., 

although ICE Clear Europe uses net 

margining. In particular, ICE stated that 

gross margining would require 

reengineering of firms’ end-of-day 

processing. According to ICE, changes 

would need to be made to such DCOs’ 

margining technology, data submission/ 

input mechanism and margin reporting 

specifications, and clearing firms or 

their service providers would need to 

implement software updates. ICE noted 

that changes to position reporting, 

reconciliation and margining 

methodology are challenging technology 

changes for clearing members and their 

third-party software vendors and 

typically take at least six to nine months 

to complete. However, ICE indicated 

that an implementation period of at 

least 12 months would allow DCOs that 

currently use net margining, and their 

clearing members, to adequately test 

and implement the systems necessary 

for gross margining. 

CME, KCC, and CMC all argued that 

requiring clearing members to report 

gross customer positions by beneficial 

owner to DCOs is not necessary in order 

to accomplish reasonable and adequate 

‘‘modified’’ gross margining. 

Specifically, CME and KCC urged the 

Commission to permit a version of gross 

margining of customer accounts that 

would only require clearing members to 

report gross customer positions to DCOs 

(not by beneficial owner) and that 

would allow clearing firms to submit 

positions as spreadable for those 

accounts that have recognized calendar 

spreads or spreads between correlated 

products. However, CME further 

represented that ‘‘[t]his version of gross 

margining will sometimes lead to less 

than aggregate gross margins as a result 

of optimal spreading that occasionally 

occurs between accounts. Nevertheless, 

it approximates aggregate gross margins 

without imposing significant costs on 

the industry.’’ 

In light of the various concerns raised 

by CME, KCC, ICE, NYPC, and CMC 

regarding the operational and 

technology changes that would be 

needed and related costs of requiring a 

DCO to obtain individual customer 

position information from its clearing 

members and to use such information to 

calculate the margin requirements for 

each individual customer, the 

Commission is modifying 

§ 39.13(g)(8)(i). In particular, the 

Commission is adding a provision, 

which states that ‘‘[f]or purposes of 

calculating the gross initial margin 

requirement for each clearing member’s 

customer account(s), to the extent not 

inconsistent with other Commission 

regulations, a derivatives clearing 

organization may require its clearing 

members to report the gross positions of 

each individual customer to the 

derivatives clearing organization, or it 

may permit each clearing member to 

report the sum of the gross positions of 

its customers to the derivatives clearing 

organization.’’ 130

Thus, the Commission is providing a 

DCO with the discretion to either 

calculate customer gross margin 

requirements based on individual 

customer position information that it 

obtains from its clearing members or 

based on the sum of the gross positions 

of all of a clearing member’s customers 

that the clearing member provides to the 

DCO, without forwarding individual 

customer position information to the 

DCO. In either case, the customer gross 

margin requirement determined by a 

DCO must equal ‘‘the sum of the initial 

margin amounts that would be required 

by the derivatives clearing organization 

for each individual customer within that 

account if each individual customer 

were a clearing member.’’ The customer 

gross margin collected by a DCO may 

not be subject to ‘‘spreading that 

occasionally occurs between accounts’’ 

that may lead to ‘‘less than aggregate 

gross margins,’’ as described by CME. 

CME commented that proposed 

§ 39.13(g)(8)(i) was unclear regarding 

how DCOs would be expected to treat 

customer omnibus accounts of nonclearing FCMs and foreign brokers for 

which the clearing firm carrying the 

account generally does not know the 

identities of individual customers 

within the omnibus accounts. Under 

current industry practice, omnibus 

accounts report gross positions to their 

clearing members and clearing members 

collect margins on a gross basis for 

positions held in omnibus accounts.131

The Commission does not intend to 

alter this current practice by adopting 

§ 39.13(g)(8)(i). Therefore, the 

Commission is adding a provision, 

which states that ‘‘[f]or purposes of this 

paragraph, a derivatives clearing 

organization may rely, and may permit 

its clearing members to rely, upon the 

sum of the gross positions reported to 

the clearing members by each domestic 

or foreign omnibus account that they 

carry, without obtaining information 

identifying the positions of each 

individual customer underlying such 

omnibus accounts.’’ 

The Commission believes that giving 

a DCO the option of permitting its 

clearing members to provide the sum of 

their customers’ gross positions to a 

DCO, without the need to provide 

individual customer position 

information to the DCO, allows DCOs to 

provide their clearing members with a 

much less costly alternative to requiring 

clearing members to provide individual 

customer position information to the 

DCO, and requiring the DCO to calculate 

the gross margin requirement for each 

customer of each clearing member. 

The Commission recognizes that 

§ 39.13(g)(8)(i), even as modified, will 

require DCOs and their clearing 

members to incur certain costs. 

However, the Commission continues to 

believe, as stated in the notice of 

proposed rulemaking, that gross 

margining of customer accounts will: (a) 

More appropriately address the risks 

posed to a DCO by its clearing members’ 

customers than net margining; (b) will 

increase the financial resources 

available to a DCO in the event of a 

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132 ICE commented that the Commission’s 

rationale for gross margining, i.e., that it would 

increase the financial resources available to a DCO 

in the event of a customer default, is based upon 

the mutualization of customer risk to protect the 

DCO. ICE stated its belief that this rationale 

conflicts with the reasoning behind the proposal 

that DCOs individually segregate cleared swaps 

customer funds to protect such customers from 

fellow customer risk. The Commission notes, 

however, that gross margining is not only consistent 

with, but will be instrumental in achieving, 

complete legal segregation for cleared swaps 

accounts. See 76 FR 33818 (June 9, 2011) 

(Protection of Cleared Swaps Customer Contracts 

and Collateral; Conforming Amendments to the 

Commodity Broker Bankruptcy Provisions). 

133As pointed out in the CPSS–IOSCO 

Consultative Report, under certain circumstances 

gross margining may also increase the portability of 

customer positions in an FCM insolvency. That is, 

a gross margining requirement would increase the 

likelihood that there will be sufficient collateral on 

deposit in support of a customer position to enable 

the DCO to transfer it to a solvent FCM. See CPSS– 

IOSCO Consultative Report, Principle 14: 

Segregation and Portability, Explanatory Notes 

3.14.6 and 3.14.8, at 67–68. 

134See 76 FR 33818 (June 9, 2011) (Protection of 

Cleared Swaps Customer Contracts and Collateral; 

Conforming Amendments to the Commodity Broker 

Bankruptcy Provisions). 

135See Financial markets: OTC derivatives, 

central counterparties and trade repositories 

(amend. Directive 98/26/EC), COD/2010/0250 (June 

7, 2011), available at http:// 

www.europarl.europa.eu/oeil/ 

FindByProcnum.do?lang=en&procnum=COD/2010/ 

0250. 

136As originally proposed, § 39.19(c)(1)(iv) would 

require each DCO to report to the Commission, on 

a daily basis, the end-of-day positions for each 

clearing member, by customer origin and house 

origin. See 75 FR 78185 (Dec. 15, 2010) 

(Information Management). The preamble in the 

notice of proposed rulemaking (76 FR 3698 (Jan. 20, 

2011) (Risk Management)), described a proposed 

amendment to proposed § 39.19(c)(1)(iv) to add 

‘‘and for customer origin, separately, the gross 

positions of each beneficial owner.’’ However, this 

clause was inadvertently omitted from the language 

of the regulation in the notice of proposed 

rulemaking. Therefore, the Commission 

subsequently issued a correction at 76 FR 16588 

(Mar. 24, 2011) (Risk Management Requirements for 

Derivatives Clearing Organizations; Correction). 

customer default; 132 and (c) with 

respect to cleared swaps, will support 

the requirement in § 39.13(g)(2)(iii) that 

a DCO must margin each swap portfolio 

at a minimum 99 percent confidence 

level. 

The Commission believes that the 

clearing of swaps will increase the risk 

that DCOs face. Gross margining will 

maximize the amount of money DCOs 

hold. Because a DCO may not have 

access to customer initial margin 

collected by and held at an FCM if the 

DCO collects initial margin on a net 

basis, if the FCM defaults, the 

Commission believes that holding gross 

initial margin at a DCO is the safest 

mechanism by which DCOs can protect 

themselves from increased risk. If a DCO 

is unable to obtain customer margin in 

the event of default, there is significant 

risk of contagion. Consequently, if more 

margin is held at the DCO, the potential 

risk that the failure of one clearing 

member will propagate throughout the 

financial system to other clearing 

members and other entities is 

decreased.133

CME and KCC commented that 

proposed § 39.13(g)(8)(i) would require 

clearing members to ‘‘pass-through’’ the 

margin deposits that they receive from 

their customers to the DCO, thus 

requiring clearing members to apply to 

their customers the DCO’s standards for 

acceptable collateral as well as the 

DCO’s concentration limits with respect 

to collateral types. CME indicated that 

this would add pressure with respect to 

the available collateral pool, and argued 

that the Commission should not impose 

such additional and costly constraints 

on market participants in the absence of 

significant and demonstrable benefits. 

The Commission notes that, although as 

a business matter clearing members may 

determine to ‘‘pass-through’’ the margin 

deposits that they receive from their 

customers to the relevant DCO, 

proposed § 39.13(g)(8)(i) does not 

require that a clearing member only 

accept from its customers those types of 

margin assets that are acceptable for the 

clearing member to deposit with the 

DCO. 

KCC requested that the Commission 

clarify whether the requirement to 

collect gross customer margin imposes 

an obligation on the DCO to determine 

the defaulting customer accounts in a 

customer default situation (which 

would be costly and burdensome) and 

stated that having the total customer 

gross margin available to the DCO in the 

event of a customer default is a prudent 

risk management technique. The 

Commission notes that Commission 

rules currently permit a DCO to 

commingle the initial margin with 

respect to all of a clearing member’s 

customers in a single customer origin 

account at the DCO and to apply the 

entire customer origin account to cover 

losses with respect to a customer 

default, whether the DCO collects initial 

margin on a net basis or on a gross basis. 

The Commission does not intend 

§ 39.13(g)(8)(i), by its terms, to alter this 

approach. 

In a separate rulemaking, however, 

the Commission has proposed to require 

DCOs to legally segregate customer 

funds and assets margining swap 

positions that are held by a clearing 

member at the DCO in a commingled 

cleared swaps customer account.134 In 

addition, European Union legislation, 

although not yet finalized, would 

require central counterparties to provide 

individual customer segregation in 

certain circumstances.135 As previously 

noted, gross margining will be 

instrumental if individual customer 

segregation is adopted. OCC requested 

that the Commission restrict the 

applicability of proposed § 39.13(g)(8)(i) 

to futures customer accounts at both the 

clearing level and the FCM level, to 

make it clear that it does not intend to 

impose these margin requirements on 

accounts that are restricted to securities 

products (with respect to an entity that 

is both a DCO and an SEC-regulated 

clearing agency). OCC is correct that 

§ 39.13(g)(8)(i) applies only to customer 

and house accounts, cleared by a DCO, 

which contain futures, options on 

futures, and/or swap positions that are 

subject to the jurisdiction of the 

Commission. It does not apply to 

accounts that only contain securities 

products that are subject to the 

jurisdiction of the SEC. 

LCH requested that the Commission 

allow DCOs operating from non-U.S. 

jurisdictions to offer ‘‘net omnibus’’ 

account structures for associated entities 

operating under the same group or 

umbrella structure to customers outside 

the U.S. The treatment of customers is 

outside the scope of this rulemaking. 

However, to the extent a DCO is clearing 

products subject to the Commission’s 

jurisdiction, this rule would apply at the 

clearing level regardless of the location 

of the DCO or the customer. 

The Commission is adopting 

§ 39.13(g)(8)(i) with the modifications 

described above. The Commission 

recognizes that DCOs that currently use 

net margining, or that use a ‘‘modified’’ 

version of gross margining, as well as 

their clearing members and their service 

providers, will need time to make the 

necessary operational and technology 

enhancements that will facilitate gross 

margining, as described herein. 

Therefore, the Commission is adopting 

an effective date that is 12 months after 

the publication of final § 39.13(g)(8)(i) in 

the Federal Register. 

(2) End-of-Day Position Reporting— 

§ 39.19(c)(1)(iv) 

Proposed § 39.19(c)(1)(iv) would 

require each DCO to report to the 

Commission, on a daily basis, the endof-day positions for each clearing 

member, by customer origin and house 

origin; and for customer origin, 

separately, the gross positions of each 

beneficial owner.136

As noted by KCC and CMC, the 

Commission currently receives certain 

information about the ownership and 

control of reportable positions through 

its large trader reporting program, under 

Parts 15 through 21 of the Commission’s 

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137For example, the Commission recently 

adopted final rules on Large Trader Reporting for 

Physical Commodity Swaps at 76 FR 43851 (July 

22, 2011). 

138See further discussion of § 39.19, adopted 

herein, in section IV.J, below. 

139The term ‘‘customer initial margin’’ is now 

defined in § 1.3(kkk), adopted herein. 

140A DCO’s initial margin requirements are also 

referred to herein as ‘‘clearing initial margin’’ 

requirements. ‘‘Clearing initial margin’’ is defined 

as ‘‘initial margin posted by a clearing member with 

a [DCO]’’ in § 1.3(jjj), adopted herein. 

141Section 5b(c)(2)(D)(iii) of the CEA, 7 U.S.C. 

7a–1(c)(2)(D)(iii). 

regulations. Commission staff reviews 

the effectiveness of this program on a 

regular basis, and will continue to adopt 

enhancements where appropriate.137

The large trader reporting system, 

however, does not currently apply to 

many swaps that are, or may be, cleared. 

The Commission may need information 

about large swap positions to assess the 

risk profile of a DCO or a clearing FCM. 

CME, KCC, MGEX, FIA, and CMC 

commented that clearing members do 

not generally have information 

identifying the underlying customers in 

customer omnibus accounts carried on 

behalf of non-clearing member FCMs, 

foreign brokers, hedge funds or 

commodity pools, and therefore clearing 

members cannot reasonably be expected 

to report such information to DCOs, and 

DCOs cannot reasonably be expected to 

report such information to the 

Commission. The Commission notes 

that a DCO may be able to obtain such 

information under its own rules. For 

example, CME Rule 960 requires a 

clearing member to immediately 

disclose the identities and positions of 

the beneficial owners of any omnibus 

account to CME upon its request. 

MGEX expressed its concern that the 

significant costs resulting from 

compliance with a requirement for the 

routine daily reporting of all gross 

customer positions by beneficial owner 

could lead to further consolidation in 

the industry at the FCM, clearing 

member, and DCO levels. 

The Commission is not adopting the 

proposed requirement in 

§ 39.19(c)(1)(iv) that a DCO provide 

daily reports to the Commission of the 

gross positions of each beneficial owner 

within each clearing member’s customer 

origin account. However, the 

Commission is adopting 

§ 39.19(c)(5)(iii),138 which requires a 

DCO to provide this information to the 

Commission upon the Commission’s 

request, in the format and manner, and 

within the time, specified by the 

Commission. 

For example, the Commission could 

request that a DCO provide information 

about customer positions by beneficial 

owner, on a case-by-case basis, with 

respect to a particular clearing member, 

customer, or product. Moreover, the 

Commission could request that such 

information be provided for a particular 

day, month, or until further notice by 

the Commission. In recent years, the 

Commission has worked cooperatively 

with several DCOs to obtain information 

about cleared swap positions. The 

Commission notes that any potential 

costs should be substantially reduced by 

the modified requirement that a DCO 

provide information to the Commission 

identifying the positions of beneficial 

owners of customer accounts only upon 

Commission request and not on a daily 

basis. 

(3) Customer Initial Margin 

Requirements—§ 39.13(g)(8)(ii) 

Proposed § 39.13(g)(8)(ii) would 

require a DCO to require its clearing 

members to collect customer initial 

margin 139 from their customers for nonhedge positions at a level that is greater 

than 100 percent of the DCO’s initial 

margin requirements 140 with respect to 

each product and swap portfolio. 

Proposed § 39.13(g)(8)(ii) would permit 

a DCO to have reasonable discretion in 

determining the percentage by which 

customer initial margins would have to 

exceed the DCO’s initial margin 

requirements with respect to particular 

products or swap portfolios. However, 

under the proposed regulation, the 

Commission could review such 

percentage levels and require different 

percentage levels if the Commission 

deemed the levels insufficient to protect 

the financial integrity of the clearing 

members or the DCO in accordance with 

Core Principle D.141

OCC stated its view that exchanges, 

which have historically set customer 

level margin requirements, should 

continue to do so, rather than DCOs, 

noting that clearing organizations would 

ordinarily have no means to enforce 

customer level margin requirements. 

KCC stated that it generally supports 

the concept that clearing members 

should collect customer initial margin at 

a level above that of DCO initial margin, 

but requested that the Commission 

clarify the circumstances in which it 

may deem the ratio of customer initial 

margin to DCO initial margin 

insufficient to protect the DCO. 

Although the FHLBanks opposed the 

proposal, they recommended that if the 

Commission were to adopt it, the 

Commission should provide additional 

guidance and/or establish criteria for 

DCOs with respect to setting the 

required amount of excess margin. 

MGEX noted that although it currently 

maintains a 130 percent requirement, 

this is a decision that should be left to 

each DCO and its clearing members to 

determine. Because the circumstances 

for each DCO or the nature of its 

clearing members vary, it would be 

difficult to provide the general 

clarification or criteria that KCC and the 

FHLBanks are seeking, because such a 

determination would need to be made 

on a case-by-case basis. 

MFA argued that a requirement that a 

DCO must require its clearing members 

to collect customer initial margin at a 

level that is greater than the DCO’s 

initial margin requirements would be 

inappropriate because DCOs do not 

have information about individual 

customers’ creditworthiness and such a 

requirement would impair market 

liquidity by limiting the trading activity 

of certain market participants, resulting 

in greater market concentration. Citadel 

and the FHLBanks made similar 

comments. 

ICE stated that FCMs are best able to 

determine how much to charge above 

the initial margin requirement because 

they have complete visibility into their 

customers’ positions, and the 

Commission should not place this 

requirement on a DCO, but should 

address this with FCMs through another 

set of rules. FIA opposed the proposed 

rule stating that the amount of excess 

margin, if any, that an FCM may require 

from its customers is a credit decision 

that should be made by each FCM based 

on its analysis of the creditworthiness of 

the particular customer, including the 

nature of the customer’s trading activity 

and its record of meeting margin calls. 

Currently DCMs require their FCM 

members to impose customer initial 

margin requirements that are a specified 

percentage higher than the DCO’s initial 

margin requirements, generally in the 

neighborhood of 125 percent to 140 

percent, as determined by the DCM. 

DCMs generally permit FCM members 

to impose customer initial margin 

requirements for hedge positions that 

are equal to the applicable maintenance 

margin requirements (which are 

generally the same as the applicable 

clearing initial margin requirements). 

This rule simply shifts the 

responsibility for establishing customer 

initial margin requirements from DCMs 

to DCOs. 

DCOs have greater expertise in risk 

management and a direct financial stake 

in whether their clearing members’ 

customers, and consequently their 

clearing members, are able to meet their 

margin obligations. Moreover, it is 

anticipated that some DCOs will clear 

fungible swaps that may be listed on 

multiple SEFs. SEFs may or may not 

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69378 Federal Register / Vol. 76, No. 216 / Tuesday, November 8, 2011 / Rules and Regulations 

142See discussion of § 39.13(h)(5), adopted 

herein, in section IV.D.7.e, below. 143OCC commented that its STANS margin 

system calculates margin based on all positions in 

an account and not on a position-by-position basis; 

therefore it would not be able to furnish clearing 

members with a number representing the initial 

margin on a particular position without conducting 

subaccounting for each customer. OCC also noted 

that since STANS requirements are data-driven on 

a month-to-month, and even a day-to-day, basis 

they can vary in ways that cannot be readily 

predicted. The Commission is adopting 

§ 39.13(g)(8)(i) herein, which requires a DCO to 

collect initial margin on a gross basis for its clearing 

members’ customer accounts. Therefore, a clearing 

member (or the DCO) will be required to determine 

the initial margin that must be posted with the DCO 

with respect to each customer’s positions. Even if 

that amount changes from day to day as a result of 

the application of a portfolio-based margin system, 

a DCO could require that its clearing members 

collect customer initial margin in an amount that 

is a given percentage in excess of 100 percent of the 

daily clearing initial margin requirement with 

respect to each customer. 

144See, e.g., CME Rule 8G930.E (‘‘IRS Clearing 

members may call for additional performance bond 

at their discretion.’’) (available at http:// 

www.cmegroup.com/rulebook/CME/I/8G/) and 

International Derivatives Clearinghouse, LLC Rule 

614(g) (‘‘A Clearing Member may call, at any time, 

for [margin] above and beyond the minimums 

required by the Clearinghouse.’’) (available at 

http://www.idch.com/pdfs/idch/ 

20100901rulebook.pdf). 

145MFA stated that it would be highly 

burdensome to distinguish between hedge and nonhedge positions for purposes of the application of 

differentiated margining, especially in a portfolio 

margining context. As noted in n. 143, above, a 

DCO that uses a portfolio-based margin model 

could require that its clearing members collect 

customer initial margin in an amount that is a given 

percentage in excess of 100 percent of the daily 

clearing initial margin requirement with respect to 

each customer. If all of a particular customer’s 

positions were hedge positions, the DCO could 

permit the clearing member to collect customer 

initial margin in an amount that equals the amount 

of clearing initial margin with respect to that 

customer’s positions. It is only in those 

circumstances where a hedger may also engage in 

speculative trading that it may be difficult to 

distinguish between positions for purposes of the 

application of differentiated margining in a 

portfolio margining context. 

impose customer initial margin 

requirements on their members for 

cleared swaps. Requirements set by 

DCOs may be less susceptible to 

pressure to being lowered for 

competitive reasons. Finally, DCOs will 

be the only self-regulatory organizations 

that will be in a position to set customer 

initial margin requirements for swaps 

that are executed bilaterally, and 

voluntarily cleared. Moreover, DCOs 

will have the opportunity to review 

whether their clearing members are 

collecting customer initial margin, as 

required by the DCO, during their 

reviews of the risk management 

policies, procedures, and practices of 

their clearing members, pursuant to 

§ 39.13(h)(5).142

Section 39.13(g)(8)(ii) permits a DCO 

to exercise its discretion in determining 

the appropriate percentage by which the 

customer initial margin for a particular 

product or swap portfolio should exceed 

the clearing initial margin,143 as DCMs 

do today with respect to futures and 

options. This percentage should be 

based on the nature and volatility 

patterns of the particular product or 

swap portfolio, and the DCO’s related 

evaluation of the potential risks posed 

by customers in general to their clearing 

members and, in turn, the potential 

risks posed by such clearing members in 

general to the DCO, rather than the 

creditworthiness of particular 

customers. Consequently, a DCO will 

retain the flexibility to establish an 

appropriate percentage for customer 

initial margin that applies to each 

product that it clears, which will apply 

to all of its clearing FCMs and all of 

their customers. However, as is also the 

case today, such clearing FCMs would 

remain free to exercise their discretion 

to determine whether they will collect 

additional margin over and above that 

amount either from all of their 

customers, or from particular customers 

based on such customers’ risk 

profiles.144

The Commission continues to believe 

that requiring a DCO to require its 

clearing members to collect customer 

initial margin in a percentage higher 

than 100 percent of the clearing initial 

margin, for non-hedge positions, 

provides a valuable cushion of readily 

available customer margin. Citadel 

stated that the market’s extensive 

experience in a range of cleared markets 

demonstrates preparedness for the 

regular exchange of margin between 

clearing members and their customers 

for cleared OTC derivatives, even where 

margin calls occur more frequently than 

once daily, and that frequent exchange 

of margin is also current market practice 

for uncleared trades. However, the 

maintenance of such a cushion would 

enable clearing members to deposit 

additional margin with a DCO on behalf 

of their customers, as necessitated by 

adverse market movements, without the 

need for the clearing members to make 

such frequent margin calls to their 

customers. In addition, many clearing 

members choose to deposit excess 

margin with their DCOs to provide their 

own cushion, which may in some 

instances obviate the need to transfer 

funds to the DCO on a daily basis in 

order to meet variation margin 

requirements. 

ISDA, FIA, and the FHLBanks 

commented that if the Commission were 

to adopt proposed § 39.13(g)(8)(ii), it 

should clarify the meaning of ‘‘nonhedge positions.’’ The FHLBanks also 

stated that the Commission should 

provide guidance regarding how the 

determination as to whether a position 

is a hedge or a non-hedge position 

would be made, whether by the DCO, 

the clearing member, or the customer, 

and expressed the belief that a clearing 

member’s customers should be 

responsible for determining and 

certifying, to their clearing members or 

DCOs, whether their swap positions are 

‘‘hedge’’ or ‘‘non-hedge’’ positions. 

Several commenters have argued that 

there is no basis for distinguishing 

between hedge positions and non-hedge 

positions in determining whether such 

positions should be subject to customer 

initial margin requirements in excess of 

clearing initial margin requirements.145

LCH stated that it does not believe that 

a DCO or a clearing member should 

distinguish in any way between a 

customer’s hedge and non-hedge 

positions because: (1) if the two parts of 

the hedge are carried by the same 

clearing member within the same DCO, 

such hedges would in any event 

implicitly be recognized by the DCO’s 

risk calculations and the provision 

would be unnecessary; and (2) if one or 

the other leg of the hedge is uncleared, 

or is carried by a different clearing 

member, or by the same or another 

clearing member at another DCO, no 

recognition of the offsetting hedge 

should be allowed either by the DCO(s) 

or by the clearing member(s), as neither 

party would have the economic benefit 

of the hedged transaction. The 

Commission notes that the 

categorization of a position as a hedge 

for purposes of this regulation does not 

affect the margin collected by the DCO; 

it only affects the additional increment 

that the clearing member collects from 

its customer. 

Freddie Mac indicated that the 

Commission should consider 

eliminating the proposed requirement 

for increased customer initial margin for 

‘‘non-hedge positions,’’ noting that 

customers with non-hedge positions are 

not inherently riskier or more likely to 

miss margin calls than customers with 

‘‘hedge positions.’’ 

As previously noted, DCMs have 

historically drawn a distinction between 

hedge positions and non-hedge 

positions in setting customer initial 

margin requirements, and the 

Commission believes that it is 

reasonable to assume that hedgers may 

present less risk than speculators, in 

that losses on their derivatives positions 

should be offset by gains on the 

positions whose risks they are hedging. 

The relevant consideration is the 

relative risks posed by hedgers versus 

non-hedgers, rather than the 

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Federal Register / Vol. 76, No. 216 / Tuesday, November 8, 2011 / Rules and Regulations 69379 

146See 75 FR 80174 (Dec. 21, 2010) (Further 

Definition of ‘‘Swap Dealer,’’ ‘‘Security-Based Swap 

Dealer,’’ ‘‘Major Swap Participant,’’ ‘‘Major 

Security-Based Swap Participant’’ and ‘‘Eligible 

Contract Participant’’). 

147See 75 FR 80747 (Dec. 23, 2010) (End-User 

Exception to Mandatory Clearing). 

148The Commission has proposed a definition of 

‘‘hedging or mitigating commercial risk,’’ to be 

codified at § 1.3(ttt), for the purposes of the 

definition of ‘‘Major Swap Participant,’’ 75 FR at 

80214–80215 (Further Definition of ‘‘Swap Dealer,’’ 

‘‘Security-Based Swap Dealer,’’ ‘‘Major Swap 

Participant,’’ ‘‘Major Security-Based Swap 

Participant’’ and ‘‘Eligible Contract Participant’’). 

149The Commission does not believe that it 

would be practical for the Commission to review 

each clearing member of each DCO to determine 

whether the clearing member is prohibiting its 

customers from making impermissible withdrawals 

from their accounts. 

150See http://www.nfa.futures.org/NFAcompliance/publication-library/marginshandbook.pdf, at 45. 

151See discussion of § 39.13(h)(5), adopted 

herein, in section IV.D.7.e, below. 

creditworthiness of particular 

customers. 

Freddie Mac recommended that, if the 

Commission does not eliminate the 

distinction between hedge and nonhedge positions, the Commission should 

clarify that, for purposes of 

§ 39.13(g)(8)(ii): (1) ‘‘hedge positions’’ 

would include all swaps that hedge or 

mitigate any form of a customer’s 

business risks; (2) such swaps may 

qualify as ‘‘hedge positions’’ regardless 

of whether they qualify as ‘‘bona fide 

hedging transactions’’ under the CEA 

and § 1.3(z) or qualify as hedges under 

applicable accounting standards; and (3) 

such swaps may qualify as ‘‘hedge 

positions’’ regardless of the nature of the 

entity that holds such positions (e.g., 

whether it is a financial entity or a nonfinancial entity). Freddie Mac indicated 

that such treatment would be consistent 

with Commission proposals for defining 

hedging for purposes of other DoddFrank Act rules, including the definition 

of a ‘‘major-swap participant’’ 146 and 

rules relating to the availability of the 

end-user exception to mandatory 

clearing.147

The Commission intends to interpret 

‘‘hedge positions,’’ for purposes of 

§ 39.13(g)(8)(ii), as referring to those that 

meet either the definition set forth in 

§ 1.3(z), or the definition set forth in 

§ 1.3(ttt), when, and in the form in 

which, it is ultimately adopted.148 The 

Commission also believes that, as is 

currently the practice, it would be the 

customer’s responsibility to identify its 

positions as hedge positions to its 

clearing FCM. 

The Commission is adopting 

§ 39.13(g)(8)(ii) as proposed. 

(4) Withdrawal of Customer Initial 

Margin—§ 39.13(g)(8)(iii) 

Proposed § 39.13(g)(8)(iii) would 

require a DCO to require its clearing 

members to prohibit their customers 

from withdrawing funds from their 

accounts with such clearing members 

unless the net liquidating value plus the 

margin deposits remaining in the 

customer’s account after the withdrawal 

would be sufficient to meet the 

customer initial margin requirements 

with respect to the products or swap 

portfolios in the customer’s account, 

which were cleared by the DCO. 

LCH agreed with the underlying 

requirement, but stated that it should be 

imposed in rules that directly apply to 

clearing members rather than in rules 

applicable to DCOs. KCC also supported 

the concept but noted that DCM rules 

already require customers to maintain 

minimum margin levels and that these 

restrictions are generally tested by a 

clearing member’s risk department and 

the clearing member’s self-regulatory 

organization during examinations. KCC 

further noted that DCOs do not have full 

access to information regarding each 

customer’s financial condition. MGEX 

took the position that the 

Commission 149 or a clearing member’s 

designated self-regulatory organization 

(DSRO) should monitor compliance 

with such a requirement rather than the 

DCO, indicating that it would not be 

economically feasible for the DCO to do 

so. 

As noted in the notice of proposed 

rulemaking, the requirement stated in 

§ 39.13(g)(8)(iii) is consistent with the 

definition of ‘‘Margin Funds Available 

for Disbursement’’ in the Margins 

Handbook prepared by the JAC.150

Therefore, DSROs currently review 

FCMs to determine whether they are 

appropriately prohibiting their 

customers from withdrawing funds from 

their futures accounts unless the net 

liquidating value plus the margin 

deposits remaining in such customers’ 

accounts after the withdrawal would be 

sufficient to meet the customer initial 

margin requirements with respect to 

such accounts. However, it is unclear to 

what extent this requirement would 

apply to cleared swaps accounts when 

such swaps are executed on a DCM 

which participates in the JAC. 

Moreover, clearing members which only 

clear swaps that are executed on a SEF 

will not be subject to the requirements 

set forth in the Margins Handbook or 

subject to review by a DSRO. 

The Commission anticipates that, at a 

minimum, DCOs will be able to review 

whether their clearing members are 

ensuring that customers do not make 

withdrawals from their accounts unless 

the specified conditions are met, when 

they conduct reviews of their clearing 

members’ risk management policies, 

procedures, and practices pursuant to 

§ 39.13(h)(5).151

The Commission is adopting 

§ 39.13(g)(8)(iii) as proposed. 

i. Time Deadlines—§ 39.13(g)(9) 

Proposed § 39.13(g)(9) would require 

a DCO to establish and enforce time 

deadlines for initial and variation 

margin payments. 

LCH submitted a comment letter 

indicating that it agrees with the 

proposal, but stated that it should apply 

only to a DCO’s clearing members since 

a DCO has no direct relationship with 

clients of its clearing members. 

Consistent with its original intent, the 

Commission is adopting § 39.13(g)(9) 

with a modification to make it clear that 

it only applies to time deadlines for 

initial and variation margin payments to 

a DCO by its clearing members. 

7. Other Risk Control Mechanisms 

a. Risk Limits—§ 39.13(h)(1)(i) 

Proposed § 39.13(h)(1)(i) would 

require a DCO to impose risk limits on 

each clearing member, by customer 

origin and house origin, in order to 

prevent a clearing member from 

carrying positions where the risk 

exposure of those positions exceeds a 

threshold set by the DCO relative to the 

clearing member’s financial resources, 

the DCO’s financial resources, or both. 

The Commission believes that an FCM 

engages in excess risk-taking if it, or its 

customers, take on positions that require 

financial resources that exceed this 

threshold. The DCO would have 

reasonable discretion in determining: (1) 

the method of computing risk exposure; 

(2) the applicable threshold(s); and (3) 

the applicable financial resources, 

provided however, that the ratio of 

exposure to capital would have to 

remain the same across all capital 

levels. For example, if a DCO set limits 

under which margin could not exceed 

200 percent of capital, the limit for a 

$100 million clearing member would be 

$200 million and the limit for a $200 

million clearing member would be $400 

million. The Commission could review 

any of these determinations and require 

different methods, thresholds, or 

financial resources, as appropriate. 

Proposed § 39.13(h)(1)(ii) would allow 

a DCO to permit a clearing member to 

exceed the threshold(s) applied 

pursuant to paragraph (h)(1)(i) provided 

that the DCO required the clearing 

member to post additional initial margin 

that the DCO deemed sufficient to 

appropriately eliminate excessive risk 

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69380 Federal Register / Vol. 76, No. 216 / Tuesday, November 8, 2011 / Rules and Regulations 

152See discussion of § 39.13(h)(6), adopted 

herein, in section IV.D.7.f, below. 

153 KCC further noted that, in its case, the 

exchange in turn receives the relevant large trader 

reports from the Commission. 

exposure at the clearing member. The 

Commission could review the amount of 

additional initial margin and require a 

different amount, as appropriate. 

J.P. Morgan and Alice Corporation 

supported the proposal to require DCOs 

to establish risk-based position limits 

for their clearing members. J.P. Morgan 

indicated that in setting such position 

limits applicable to any one clearing 

member, a DCO should consider its 

overall exposure to clearing members in 

the aggregate. The Commission agrees 

that this would be prudent and expects 

that DCOs would take into 

consideration the aggregate exposure in 

establishing individual levels. J.P. 

Morgan further took the position that 

DCOs should monitor exposures against 

these limits on a real time basis. As 

discussed in section IV.D.4, above, 

§ 39.13(e)(2) requires a DCO to monitor 

its credit exposure to each clearing 

member periodically during each 

business day. 

FIA stated that it generally agrees 

with the proposed requirement that ‘‘the 

ratio of exposure to capital must remain 

the same across all capital levels’’ but 

indicated that the rule should make 

clear that, in computing the ratio of 

exposure to capital, a clearing member’s 

capital should be calculated net of all 

risk exposures and potential assessment 

obligations at other clearing 

organizations of which it is a clearing 

member. The Commission agrees that it 

would be appropriate for a DCO to 

consider a clearing member’s exposures 

to other clearing organizations, to the 

extent that it is able to obtain such 

information, in determining a clearing 

member’s applicable financial resources 

for the purpose of setting appropriate 

risk limits. 

CME argued that a requirement that 

DCOs impose risk limits for every 

clearing member would be overly 

prescriptive and unnecessary, provided 

that a DCO collects adequate margin, its 

stress-test results regarding the clearing 

member’s exposures are acceptable, and 

it employs concentration margining 

(whereby the DCO would set a level of 

risk at which it would begin to charge 

higher margins based on indicative 

stress-test levels). In other words, CME 

suggested that risk limits may be 

unnecessary if a DCO sets a level of risk 

at which it would begin to charge higher 

margins based on stress test results with 

respect to a clearing member. However, 

§ 39.13(h)(1)(ii) would allow a DCO to 

permit a clearing member to exceed an 

established risk limit provided that the 

DCO required the clearing member to 

post additional margin. Although CME’s 

proposed approach is worded slightly 

differently, the effect would be the same 

as that of § 39.13(h)(1)(ii), i.e., a clearing 

member could only exceed a defined 

risk level if it posted additional margin. 

MGEX indicated that the proposed 

rule requiring DCOs to impose risk 

limits on each clearing member might 

not be practical, adding additional cost 

with little benefit, noting that DCOs 

currently address credit and default risk 

via margins and security deposits on a 

daily basis and conduct risk reviews. 

Rather, according to MGEX, a DCO 

should be looking for risk signs and 

focusing on those that are most relevant. 

The Commission believes that the 

establishment of risk limits for clearing 

members would impose little additional 

cost on DCOs since DCOs are already 

required to monitor their clearing 

members’ capital levels and their own 

financial resources, as well as the 

trading activity of their clearing 

members. On the other hand, the 

Commission believes that the 

establishment of such risk limits would 

add significant risk management 

benefits to the benefits already 

conferred by margins, security deposits, 

and reviews of clearing members’ risk 

management policies and procedures. 

The Commission is adopting 

§ 39.13(h)(i) as proposed, except for a 

technical revision that replaces the 

phrase ‘‘by customer orgin and house 

origin’’ with ‘‘by house origin and by 

each customer origin,’’ which conforms 

the language with other provisions of 

part 39. OCC requested that the 

Commission clarify that proposed 

§ 39.13(h)(i) would not apply to 

securities accounts of broker-dealers 

that are not FCMs and do no futures 

business. The Commission does not 

intend for § 39.13(h)(i) to apply to such 

accounts. The Commission is also 

adopting § 39.13(h)(ii) as proposed. 

b. Large Trader Reports—§ 39.13(h)(2) 

Proposed § 39.13(h)(2) would require 

a DCO to obtain from its clearing 

members, copies of all reports that such 

clearing members are required to file 

with the Commission pursuant to part 

17 of the Commission’s regulations, i.e., 

large trader reports. Large trader reports 

are necessary for stress testing to ensure 

that FCMs and their customers have not 

taken on too much risk. A DCO would 

be required to obtain such reports 

directly from the relevant reporting 

market if the reporting market 

exclusively listed self-cleared contracts, 

and would therefore be required to file 

such reports on behalf of clearing 

members pursuant to § 17.00(i). 

Proposed § 39.13(h)(2) would further 

require a DCO to review the large trader 

reports that it receives from its clearing 

members, or reporting markets, as 

applicable, on a daily basis to ascertain 

the risk of the overall portfolio of each 

large trader. A DCO would be required 

to review positions for each large trader, 

across all clearing members carrying an 

account for the large trader. A DCO 

would also be required to take 

additional actions with respect to such 

clearing members in order to address 

any risks posed by a large trader, when 

appropriate. Such actions would 

include those actions specified in 

proposed § 39.13(h)(6).152

FIA supported the proposal to require 

DCOs to obtain copies of all large trader 

reports that are filed with the 

Commission. MGEX commented that 

the Commission should provide large 

trader reports to each DCO rather than 

imposing a requirement that would 

require clearing members to make 

redundant filings. KCC argued that the 

proposed requirement that DCOs obtain 

large trader reports from clearing 

members is duplicative because a DCO 

receives large trader information from 

the exchange.153

MGEX recommended that the 

Commission perform the review of large 

trader reports itself or permit a clearing 

member’s DSRO to perform such review 

instead of DCOs. 

NYPC recommended that the 

Commission not adopt proposed 

§ 39.13(h)(2) because the Commission 

has expended considerable resources to 

modify its own internal programs and 

processes in order to glean potentially 

relevant financial and risk management 

information from the large trader data 

that it receives from clearing members 

and DCMs, and even if DCOs had 

comparable financial and human 

resources that they could deploy for 

such a purpose, the information that 

they would obtain would frequently be 

fragmented and inconclusive, given 

that—unlike the Commission—no single 

DCO will ever have access to 

information relating to the futures, 

option and swap positions that are 

cleared by other DCOs or to uncleared 

swaps. NYPC further argued that given 

the necessary technology builds, it 

would need more than three years to 

come into compliance with proposed 

§§ 39.13(g)(8)(i) and 39.13(h)(2). 

OCC indicated that it should be the 

role of a clearing member’s DSRO to 

require that an FCM submit sufficient 

information to permit the DSRO to 

identify customer accounts that could 

potentially cause a clearing member to 

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Federal Register / Vol. 76, No. 216 / Tuesday, November 8, 2011 / Rules and Regulations 69381 

154The Commission is modifying the language in 

proposed § 39.13(h)(2), which would have referred 

to ‘‘positions at all clearing members carrying 

accounts for each such large trader’’ by revising it 

to read as follows: ‘‘futures, options, and swaps 

cleared by the [DCO] which are held by all clearing 

members carrying accounts for each such large 

trader.’’ This will make it clear that the Commission 

is not attempting to require a DCO to review a large 

trader’s positions that were cleared by another DCO, 

as it would not typically have access to information 

about such positions. The technical change from 

‘‘positions’’ to ‘‘futures, options, and swaps’’ 

conforms the language with other provisions of part 

39. 

155See discussion of § 39.13(h)(3), adopted 

herein, in section IV.D.7.c, below. 

156 ISDA also stated that further clarity regarding 

how the Commission intends to apply the large 

trader definition to swaps is needed. The 

Commission notes that it has begun this process by 

adopting final rules for Large Trader Reporting for 

Physical Commodity Swaps, in a new part 20, at 76 

FR 43851 (July 22, 2011). Since these large trader 

reporting rules were adopted subsequent to the 

Commission’s proposal of § 39.13(h)(2), the 

Commission is modifying § 39.13(h)(2) to refer to 

reports required to be filed with the Commission 

by, or on behalf of, clearing members pursuant to 

parts 17 and 20 of this chapter. 

157See further discussion of § 39.2 in section 

III.B, above. 

default, and that if DCOs were required 

to perform all tasks required by the 

proposed rules alone, they would be 

required to build new surveillance 

systems and significantly increase their 

surveillance staff. 

In response to suggestions that the 

Commission should conduct the 

required review of large trader reports, 

the Commission notes that it does 

review large trader reports for financial, 

market, and risk surveillance purposes. 

However, the Commission believes that 

DCOs should also have an obligation to 

review large trader reports for those 

large traders whose trades they clear, for 

their own risk surveillance purposes, 

even though as noted by NYPC, they 

may not have access to information 

relating to positions cleared by other 

DCOs or to uncleared swaps. Moreover, 

§ 39.13(h)(2) requires a DCO to review 

such large trader reports with a view 

toward taking any necessary additional 

actions with respect to such large 

traders’ clearing members in order to 

address risks posed by such large 

traders to the DCO. 

In addition, it would not be feasible 

for a clearing member’s DSRO to review 

large trader reports. DSRO designations 

apply to FCMs that are members of 

multiple DCMs. Therefore, clearing 

members that only trade for their own 

accounts do not have a DSRO. Clearing 

members that solely clear SEF-executed 

trades also will not have DSROs. 

Moreover, risk management ultimately 

is the responsibility of each DCO. A 

DSRO would not be in a position to 

analyze the daily risk of the overall 

portfolio of each large trader at a 

particular DCO, nor to take any 

additional actions to address such risks 

at a particular DCO. 

KCC stated that it is the clearing 

member’s obligation to determine the 

financial fitness of large trader 

customers, in that clearing members 

have better, more direct information 

regarding the credit quality of the 

customer and the exposures of the 

customer under positions the customer 

may hold outside the DCO. KCC stated 

its belief that imposing a duplicative 

requirement on DCOs would achieve 

little risk management benefit at a high 

cost. The Commission agrees that 

clearing members must determine the 

financial capacity of their customers 

and they may have information which a 

particular DCO may not have regarding 

positions that they may clear for their 

customers on other DCOs.154 However, 

this does not obviate the need for each 

relevant DCO to ascertain the risks that 

the large trader poses to that DCO based 

on the information which the DCO is 

able to obtain through large trader 

reports. 

ISDA noted that while the expansion 

of oversight required by proposed 

§§ 39.13(h)(2) and § 39.13(h)(3) 155 may 

provide benefits, many DCOs do not 

currently have the systems or 

infrastructure to monitor or assess nonclearing member risk.156

In response to ISDA’s comment, as 

well as other comments that in order to 

comply with § 39.13(h)(2), DCOs would 

need technology builds (NYPC), new 

surveillance systems and additional 

surveillance staff (OCC), and that there 

would be a high cost (KCC), the 

Commission notes that some DCOs 

already receive and review large trader 

reports for risk surveillance purposes on 

a daily basis. In fact, KCC stated in its 

comment letter that ‘‘KCC would also 

remind the Commission that DCO 

compliance staff review the reportable 

position files that they receive on a 

daily basis to ascertain large trader risks 

that [clearing members] face.’’ In 

addition, at least five years ago, 

Commission staff began recommending 

that DCOs do so, if they had not already 

been doing so, in DCO reviews that 

Commission staff has conducted to 

determine whether such DCOs were in 

compliance with relevant core 

principles under the CEA. 

The Commission is modifying 

§ 39.13(h)(2) to require a DCO to obtain 

large trader reports either from its 

clearing members or from a DCM or a 

SEF for which it clears, which are 

required to be filed with the 

Commission by, or on behalf of, such 

clearing members. However, the 

Commission does not believe that it is 

practical or appropriate for a DCO to 

rely on the Commission to provide large 

trader reports to the DCO. 

The Commission is adopting 

§ 39.13(h)(2) with the modifications 

described above. 

c. Stress Tests—§ 39.13(h)(3) 

Proposed § 39.13(h)(3) would require 

a DCO to conduct certain daily and 

weekly stress tests. The Commission has 

defined a ‘‘stress test’’ in § 39.2, adopted 

herein, as ‘‘a test that compares the 

impact of potential extreme price 

moves, changes in option volatility, 

and/or changes in other inputs that 

affect the value of a position, to the 

financial resources of a derivatives 

clearing organization, clearing member, 

or large trader, to determine the 

adequacy of such financial 

resources.’’ 157

Proposed § 39.13(h)(3)(i) would 

require a DCO to conduct daily stress 

tests with respect to each large trader 

who poses significant risk to a clearing 

member or the DCO in the event of 

default, including positions at all 

clearing members carrying accounts for 

the large trader. The DCO would have 

reasonable discretion in determining 

which traders to test and the 

methodology used to conduct the stress 

tests. However, the Commission could 

review the selection of accounts and the 

methodology and require changes, as 

appropriate. 

Proposed § 39.13(h)(3)(ii) would 

require a DCO to conduct stress tests at 

least once a week with respect to each 

account held by a clearing member at 

the DCO, by customer origin and house 

origin, and each swap portfolio, by 

beneficial owner, under extreme but 

plausible market conditions. The DCO 

would have reasonable discretion in 

determining the methodology used to 

conduct the stress tests. However, the 

Commission could review the 

methodology and require any 

appropriate changes. The Commission 

requested comment regarding whether 

all clearing member accounts, by origin, 

and all swap portfolios should be 

subject to such stress tests on a weekly 

basis or whether some other time 

period, such as monthly, would be 

sufficient to meet prudent risk 

management standards. 

Several commenters addressed daily 

stress testing. FIA recommended that all 

of the proposed stress tests should be 

conducted on a daily basis. LCH stated 

its belief that stress testing requirements 

should not be extended to cover large 

traders that are clients of clearing 

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69382 Federal Register / Vol. 76, No. 216 / Tuesday, November 8, 2011 / Rules and Regulations 

158As noted above, proposed § 39.13(h)(3)(i) 

would not require daily stress tests on each large 

trader, but only with respect to those large traders 

who pose significant risk to a clearing member or 

the DCO in the event of default. 

159NOCC made a similar comment with respect 

to the frequency of back testing, which is discussed 

in section IV.D.6.g,, above. The Commission does 

not believe that it is appropriate to adopt a 

regulation establishing an exemption process with 

respect to stress testing requirements based on 

volume or risk exposure or otherwise. 

160A DCO that is dually-registered as a securities 

clearing agency would not be subject to the stress 

testing requirements of § 39.13(h)(3)(ii) with respect 

to an account that only contains securities 

positions. However, such a DCO would be subject 

to the requirements of § 39.13(h)(3)(ii) with respect 

to any relevant account that contains positions in 

instruments regulated by the Commission, even if 

that account also contains securities positions. In 

this regard, the Commission is revising 

§ 39.13(h)(3)(ii) to refer to ‘‘each clearing member 

account, by house origin and by each customer 

origin, and each swap portfolio, including any 

portfolio containing futures and/or options and 

held in a commingled account pursuant to 

§ 39.15(b)(2) of this part, * * *’’ 

161See discussion of §§ 39.13(g)(6) and (g)(7) in 

section IV.D.6.g, above. 

members but that the proposed weekly 

stress tests should be conducted daily. 

OCC stated that it did not see a 

sufficient benefit to justify the increased 

DCO resources that would be required 

to undertake daily stress tests on each 

large trader,158 noting that the costs 

would be passed on to clearing members 

and their customers. MGEX indicated 

that a requirement for daily stress 

testing of large traders seems excessive 

since the data may be dated even after 

one day and may not be more relevant 

than doing an average stress test over a 

weekly or monthly period. MGEX also 

expressed the view that the value of 

stress testing large traders is diminished 

if they have accounts with different 

clearing members. 

As stated above, proposed 

§ 39.13(h)(3)(i) would require a DCO to 

include positions at all clearing 

members carrying accounts for the large 

trader in the required stress tests. The 

Commission is making the same change 

to § 39.13(h)(3)(i) that it is making to 

§ 39.13(h)(2) by replacing the reference 

to ‘‘positions at all clearing members 

carrying accounts for each such large 

trader’’ with ‘‘futures, options, and 

swaps cleared by the derivatives 

clearing organization, which are held by 

all clearing members carrying accounts 

for each such large trader.’’ 

KCC stated its belief that the 

frequency of stress testing should be left 

to the discretion of the DCO and should 

be risk-based in light of prevailing 

market conditions. NOCC indicated that 

products, customers or spread credits 

should reach a specified volume or risk 

exposure level before being required to 

be stress tested with the proposed 

frequencies so long as the DCO can 

demonstrate that it is meeting the core 

principle objectives underlying 

proposed § 39.13(f).159

The Commission believes that it is 

appropriate to specify the minimum 

frequency of stress tests as set forth in 

§ 39.13(h)(3). As noted above, several 

commenters supported certain daily 

stress testing requirements. With the 

exception of KCC’s and NOCC’s 

comments, no commenters suggested 

that stress tests should be conducted 

less frequently than weekly. 

LCH recommended that the 

Commission prescribe that the stress 

scenarios used by the DCO in its testing 

should be adapted for current market 

conditions such that price or market 

shifts should not be translated literally, 

but rather proportionally. The 

Commission believes that § 39.13(h)(3) 

should explicitly permit DCOs to 

exercise reasonable discretion in 

determining the methodology to be used 

in conducting the required stress tests. 

The Commission would recognize the 

approach suggested by LCH to be an 

appropriate element of a DCO’s stress 

testing methodology, but does not 

believe that it is necessary to adopt such 

a prescriptive requirement. 

OCC indicated that for regulatory 

reasons associated with OCC’s status as 

a dual SEC/Commission registrant, 

OCC’s system does not consolidate all 

positions into a single ‘‘customer 

origin’’ and ‘‘house origin’’ for each 

clearing member, but rather permits 

multiple account types, including a firm 

(proprietary) account that incorporates 

both securities and futures positions, a 

securities customers’ account, a regular 

futures customer segregated funds 

account subject to Section 4d of the 

CEA, separate segregated funds accounts 

for cross-margining arrangements as 

provided in various Commission orders 

approving such arrangements, and 

others. OCC further stated that because 

of the mathematical properties of the 

risk measures that it uses, its 

unconsolidated account level stress 

testing is more rigorous than if such 

stress testing were conducted at the 

level of each origin as a whole and 

argued that it makes sense to aggregate 

positions for stress testing in the same 

manner as they would be aggregated or 

netted for liquidation purposes. 

Therefore, OCC requested that the 

Commission clarify that this method of 

stress testing at the unconsolidated 

account level based on appropriate 

historical data would meet the 

requirements of proposed 

§ 39.13(h)(3)(ii). The Commission agrees 

with OCC that it would be appropriate 

for a DCO to conduct the stress tests 

required by § 39.13(h)(3)(ii) with respect 

to separate house origin and customer 

origin accounts such as the house 

account that incorporates both securities 

and futures positions identified by 

OCC,160 separate customer accounts 

subject to Sections 4d(a) and 4d(f) of the 

CEA, respectively, or cross-margining 

accounts. 

OCC also argued that while the 

requirement of conducting stress tests 

under ‘‘extreme but plausible’’ market 

conditions may be appropriate for 

determining the adequacy of a clearing 

organization’s resources for 

withstanding the default of its largest 

participant, it would be inappropriate 

for measuring the adequacy of an 

individual clearing member’s margin 

deposits. In particular, OCC expressed 

its belief that stress testing the positions, 

including margin assets, in clearing 

member accounts on a daily basis to 

ensure a positive liquidating value at 

more than a 99 percent confidence level 

is adequate and appropriate and that 

DCOs should have the ability to cover 

for more extreme market conditions 

through the use of additional financial 

resources, including clearing fund 

deposits. 

A stress test, as defined by the 

Commission, is not designed to measure 

the adequacy of a clearing member’s 

margin deposits or to ensure that margin 

assets in clearing members’ accounts 

meet a 99 percent confidence level. 

Rather, these are the functions of the 

daily review and back testing required 

by §§ 39.13(g)(6) and (g)(7), adopted 

herein.161 Stress tests address the 

adequacy of the applicable financial 

resources to cover losses resulting from 

potential extreme price moves, changes 

in option volatility, and/or changes in 

other inputs that affect the value of a 

position. In other words, if margin 

deposits would be sufficient to cover 

losses 99 percent of the time, stress tests 

would determine whether other 

financial resources would be available 

and sufficient to cover losses the 

remaining 1 percent of the time. Such 

other financial resources could include 

the capital of the clearing member or the 

DCO, or a DCO’s guaranty fund. 

The Commission is adopting 

§ 39.13(h)(3) with the modifications 

described above. 

d. Portfolio Compression—§ 39.13(h)(4) 

Proposed § 39.13(h)(4)(i) would 

require a DCO to offer multilateral 

portfolio compression exercises, on a 

regular basis, for its clearing members 

that clear swaps, to the extent that such 

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Federal Register / Vol. 76, No. 216 / Tuesday, November 8, 2011 / Rules and Regulations 69383 

162This also addresses the FHLBanks’ comment 

that the Commission should specify what types of 

swaps are to be included in portfolio compression 

exercises. 

exercises are appropriate for those 

swaps that it clears. The Commission 

requested comment regarding whether 

such exercises should be offered 

monthly, quarterly, or on another 

frequency. In addition, the Commission 

requested comment regarding whether 

the frequency of such exercises should 

vary for different categories of swaps. 

Proposed § 39.13(h)(4)(ii) would 

mandate that a DCO require its clearing 

members to participate in all 

multilateral portfolio compression 

exercises offered by the DCO, to the 

extent that any swap in the applicable 

portfolio was eligible for inclusion in 

the exercise, unless including the swap 

would be reasonably likely to 

significantly increase the risk exposure 

of the clearing member. 

Proposed § 39.13(h)(4)(iii) would 

permit a DCO to allow clearing members 

participating in such exercises to set 

risk tolerance limits for their portfolios, 

provided that the clearing members 

could not set such risk tolerances at an 

unreasonable level or use such risk 

tolerances to evade the requirements of 

proposed § 39.13(h)(4). 

CME commended the Commission for 

recognizing the importance of portfolio 

compression exercises as an important 

risk management tool. CME further 

suggested that the Commission refrain 

from prescribing the frequency of such 

exercises, stating its belief that each 

DCO is best positioned to determine the 

optimal frequency of portfolio 

compression exercises for the swaps 

that it clears, based on the unique 

characteristics of the particular products 

and markets. On the other hand, the 

FHLBanks stated that the Commission 

should specify how often portfolio 

compression exercises are to take place. 

The Commission agrees with CME and 

is retaining the language that simply 

refers to ‘‘a regular basis.’’ 

ISDA requested that the Commission 

clarify the meaning of ‘‘multilateral 

portfolio compression’’ in these 

proposals. ISDA stated that if the 

Commission is referring to position 

netting, then it agrees that a DCO must 

offer such exercises. However, ISDA 

indicated that if it refers to the provision 

of multilateral portfolio compression 

services such as those currently 

provided by entities such as TriOptima, 

DCOs should not be required to build 

such duplicative services, which would 

be likely to delay their roll-out of 

comprehensive clearing services. The 

Commission agrees that a DCO should 

not be required to incur the expense of 

building its own multilateral 

compression services. Therefore, the 

Commission is modifying the 

requirement to make it clear that 

although a DCO may develop its own 

portfolio compression services if it 

chooses, it is only required to make 

such exercises available to its clearing 

members if applicable portfolio 

compression services have been 

developed by a third party for those 

swaps that it clears.162

The FHLBanks urged the Commission 

to further define ‘‘reasonably likely to 

increase risk exposure to a clearing 

member’’ to include the risk exposures 

of a clearing member’s customers, and 

also stated their view that a clearing 

member’s customers must have the 

ability to ‘‘opt-out’’ of portfolio 

compression requirements to the extent 

that those customers’ swap positions 

need to be retained for hedge accounting 

and other business purposes. In 

particular, the FHLBanks expressed 

their concern that the proposal’s 

ambiguities would cause the internal 

risk management strategies of entities 

that are not swap dealers or major swap 

participants to be adversely affected, 

noting that portfolio compression could 

potentially jeopardize hedge accounting 

treatment for customers’ swap 

transactions and disrupt anticipated 

cash flows. 

LCH stated that it strongly supports 

the use of compression services and 

believes that they should be encouraged 

by the Commission to the greatest extent 

possible, but it would not necessarily 

always be appropriate for a DCO to 

require its clearing members to 

participate in all such exercises. First, 

LCH noted that a DCO’s clearing 

members may not always be subject to 

the Commission’s supervision and may 

not be required to engage in such 

compression activities; therefore 

imposing such a requirement on the 

DCO may discourage such firms from 

becoming clearing members of that DCO 

and thereby have the perverse effect of 

discouraging such firms from clearing. 

Second, LCH stated that a clearing 

member may have legitimate reasons for 

not participating in such compression 

exercises at all times, or for not 

submitting all eligible swaps to such 

exercises. Therefore, LCH took the 

position that the use of compression 

services should be encouraged but 

should not be compulsory, and 

suggested that the Commission 

eliminate § 39.13 (h)(4)(ii) in its entirety. 

For the reasons stated by LCH and the 

FHLBanks, the Commission is 

modifying § 39.13(h)(4) to provide that 

participation in compression exercises 

by clearing members and their 

customers would be voluntary. 

e. Clearing Members’ Risk Management 

Policies and Procedures—§ 39.13(h)(5) 

Proposed § 39.13(h)(5) would impose 

several requirements upon DCOs 

relating to their clearing members’ risk 

management policies and procedures. 

Specifically, a DCO would be required 

to adopt rules that: (a) require its 

clearing members to maintain current 

written risk management policies and 

procedures (proposed 

§ 39.13(h)(5)(i)(A)); (b) ensure that the 

DCO has the authority to request and 

obtain information and documents from 

its clearing members regarding their risk 

management policies, procedures, and 

practices, including, but not limited to, 

information and documents relating to 

the liquidity of their financial resources 

and their settlement procedures 

(proposed § 39.13(h)(5)(i)(B)); and (c) 

require its clearing members to make 

information and documents regarding 

their risk management policies, 

procedures, and practices available to 

the Commission upon the Commission’s 

request (proposed § 39.13(h)(5)(i)(C)). 

In addition, proposed § 39.13(h)(5)(ii) 

would require a DCO to review the risk 

management policies, procedures, and 

practices of each of its clearing members 

on a periodic basis and document such 

reviews. The Commission invited 

comment regarding whether it should 

require that a DCO must conduct risk 

reviews of its clearing members on an 

annual basis or within some other time 

frame. The Commission also requested 

comment regarding whether it should 

require that such reviews be conducted 

in a particular manner, e.g., whether 

there must be an on-site visit or whether 

any particular testing should be 

required. In addition, the Commission 

invited comment regarding whether, 

and to what extent, a DCO should be 

permitted to vary the method and depth 

of such reviews based upon the nature, 

risk profiles, or other regulatory 

supervision of particular clearing 

members. 

ISDA and FIA supported the proposed 

requirement in § 39.13(h)(5)(i)(A) that 

clearing members must have written 

risk management policies and 

procedures. FIA also recommended that 

clearing members should be required to 

have adequate staff and systems to 

monitor customer risk on a real-time or 

near-real time basis and to routinely test 

their risk management procedures under 

theoretical stress scenarios. 

NGX stated that the requirement that 

clearing members have and follow risk 

management policies is a sensible 

requirement in the context of the 

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69384 Federal Register / Vol. 76, No. 216 / Tuesday, November 8, 2011 / Rules and Regulations 

163For example, in a separate rulemaking, 

proposed § 23.600 would set forth detailed 

requirements for the risk management programs of 

swap dealers and major swap participants, and 

would require such entities to maintain written 

procedures and policies describing their Risk 

Management Programs. See 75 FR 71397 (Nov. 23, 

2010) (Regulations Establishing and Governing the 

Duties of Swap Dealers and Major Swap 

Participants). Such swap dealers and major swap 

participants may or may not be clearing members. 

164See 76 FR 45724 (Aug. 1, 2011) (Clearing 

Member Risk Management). In that rulemaking, the 

Commission has proposed to require FCMs, swap 

dealers, and major swap participants, each of which 

are clearing members, to adopt certain specified risk 

management procedures, including written 

procedures to comply with the proposed 

requirements. 

165 In another context, e.g., a DCM has adopted a 

rule that requires the operator of a DCM-approved 

delivery facility to ’’ * * * make such reports, keep 

such records and permit such facility visitation as 

the Exchange, the Commodity Futures Trading 

Commission or any other applicable government 

agency may require * * * .’’ See CBOT Rule 703.A. 

typical, intermediated 

clearinghouse.However, NGX argued 

that such requirements should not apply 

to a non-intermediated DCO such as 

NGX, where clearing participants are 

commercial end users, trading and 

clearing for their own accounts, and 

none of the clearing participants are 

exposed to the default risk of any other 

clearing participant or to that of fellow 

customers of a clearing participant. 

The Commission believes that it is 

appropriate for a DCO to require all of 

its clearing members to maintain written 

risk management policies and 

procedures, regardless of whether such 

clearing members have customer 

business or are exclusively self-clearing. 

As noted above, the Commission 

believes that written policies are a 

crucial component of any risk 

management framework. Moreover, 

§ 39.13(h)(5)(i)(A) does not specify the 

nature or extent of the required written 

risk management policies and 

procedures, which could vary as 

appropriate to a particular type of 

clearing member, subject to the 

requirements of any other applicable 

Commission regulations.163

The Commission has not proposed 

and is not adopting the additional 

requirements suggested by FIA, 

described above, as part of this 

rulemaking. However, the Commission 

has proposed additional requirements 

with respect to clearing members’ risk 

management policies and procedures in 

a separate rulemaking applicable 

directly to clearing members.164

With respect to the proposed 

requirement in § 39.13(h)(5)(i)(C) that a 

DCO must have rules requiring its 

clearing members to make information 

regarding their risk management 

policies, procedures, and practices 

available to the Commission, MGEX 

stated that the Commission should seek 

access to a clearing member’s risk 

management policies and processes 

directly and a DCO should not act as an 

unnecessary conduit between the 

Commission and clearing members. The 

Commission notes that even if it were to 

propose a regulation to impose such a 

requirement directly on clearing 

members in the future, it does not 

preclude the Commission from 

requiring DCOs to impose this 

requirement on their clearing members 

at this time.165

LCH stated that it concurs with the 

provisions of proposed § 39.13(h)(5) but 

suggested that the Commission limit the 

requirements under proposed paragraph 

(h)(5)(C) so that they would be 

applicable only to those clearing 

members that are subject to the 

Commission’s oversight and not to all 

clearing members of a DCO regardless of 

the jurisdiction in which they operate. 

The Commission notes that risk 

management practices of clearing 

members of registered DCOs, to the 

extent that such clearing members are 

clearing products subject to the 

Commission’s oversight, are of 

importance to the Commission in its 

capacity as the regulator of the DCO. For 

purposes of risk management oversight, 

there is no basis for differentiating 

among clearing members because of 

their registration status or domicile. 

Although the Commission does not 

directly supervise non-registrants, the 

Commission has previously adopted 

rules that apply to clearing members, 

whether or not they are Commission 

registrants, e.g., §§ 1.35(b) and (c) 

(recordkeeping requirements), and Part 

17 of the Commission’s regulations 

(reporting requirements). Section 

39.13(h)(5)(C) is consistent with the 

Commission’s approach with respect to 

such other rules, and is an appropriate 

component of the regulatory framework 

for DCO risk management. 

With regard to the proposed 

requirement in § 39.13(h)(5)(ii) that a 

DCO must review the risk management 

policies, procedures, and practices of 

each of its clearing members on a 

periodic basis, FIA stated that all 

clearing members should be subject to 

on-site audits at least annually. NGX 

suggested that if the Commission 

requires non-intermediated DCOs to 

require their members to have written 

risk management policies, the 

Commission should provide guidance 

that a non-intermediated DCO would 

not be required to conduct on-site audits 

of clearing participants and that the 

DCO would meet its obligations to 

review the policies of such clearing 

participants if it does so only on a forcause basis. 

The Commission is adopting 

§ 39.13(h)(5)(ii) as proposed, without 

prescribing the specific frequency, 

depth, or methodology of such reviews, 

and without specifying when an on-site 

audit may or may not be appropriate. 

The Commission believes that such a 

review is important to ensure that each 

clearing member’s risk management 

framework is sufficient and properly 

implemented. The Commission also 

believes that a DCO should be permitted 

to exercise reasonable discretion with 

respect to each of these matters, based 

upon the nature, risk profiles, or other 

regulatory supervision of particular 

clearing members. The requirement that 

such reviews must be conducted on a 

‘‘periodic basis’’ means that reviews 

must be conducted routinely and, 

therefore, the requirement would not 

permit a DCO to only conduct such 

reviews on a for-cause basis. 

A number of commenters noted that 

many clearing members are clearing 

members of multiple DCOs and thus 

could be subject to multiple duplicative 

risk reviews. CME, OCC, MGEX, ICE, 

and NYPC indicated that this would be 

burdensome for such clearing members. 

For example, MGEX noted ‘‘the burden 

a clearing member may be faced with 

due to duplication of efforts and 

associated costs.’’ KCC indicated that 

such duplicative reviews would achieve 

little with great expenditure of 

resources. 

OCC and NYPC also expressed their 

concerns about the costs to DCOs. In 

particular, OCC noted that requiring 

DCOs to conduct such reviews would 

impose a very high cost on a DCO that 

is not integrated with a DCM. NYPC 

noted its concern that the Commission 

may be underestimating the immensity 

of conducting such reviews in that a 

clearing member’s risk management 

plan will not address solely the risks 

associated with clearing membership, 

but will be integrated and cover the 

broad spectrum of risks, including 

market, credit, liquidity, capital, and 

operational risk, that are associated with 

the entirety of the clearing member’s 

securities, banking and futures business, 

much of which may have nothing to do 

with business through the DCO. 

In order to address NYPC’s specific 

concern, the Commission is modifying 

§ 39.13(h)(5)(i)(A) to add the qualifier 

‘‘which address the risks that such 

clearing members may pose to the 

derivatives clearing organization’’ after 

‘‘risk management policies and 

procedures’’ and is adding the same 

qualifier in § 39.13(h)(5)(ii) after ‘‘risk 

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166Section 5b(c)(2)(E) of the CEA, 7 U.S.C. 7a– 

1(c)(2)(E) (Core Principle E). 

167Without addressing any specific aspect of 

proposed § 39.14, LCH commented that it agrees 

with the Commission’s proposals for settlement 

procedures. 

management policies, procedures, and 

practices of each of its clearing 

members.’’ 

To reduce the potential burden of 

duplicative risk reviews of clearing 

members that are clearing members of 

multiple DCOs, CME and NYPC urged 

the Commission to give each DCO 

reasonable discretion regarding the 

frequency, scope, or manner in which it 

conducts risk reviews of its clearing 

members, taking into account various 

factors including other regulatory 

supervision, or review by a 

governmental entity or self-regulatory 

organization, of particular firms. Other 

commenters variously suggested that 

risk reviews should be conducted by the 

Commission (OCC and MGEX), by the 

clearing member’s DSRO or a similar 

DCO industry group (KCC, OCC, ICE, 

and MGEX), or by NFA (OCC). 

The Commission notes that the 

current DSRO system is not a viable 

option for reviewing clearing members’ 

risk management policies, procedures 

and practices. Because DSROs are only 

responsible for conducting 

examinations of DCM-member FCMs’ 

compliance with financial requirements, 

clearing members that only engage in 

house trading do not have a DSRO, nor 

will clearing members that solely clear 

SEF-executed trades. Moreover, such 

examinations do not address all of the 

risk issues which would concern a 

particular DCO. Furthermore, even if the 

current DSRO system were expanded to 

include DCOs, or a similar industry 

group composed of DCOs were formed, 

it would be impractical to allocate the 

responsibility to one DCO to analyze the 

risk management policies, procedures 

and practices of a common clearing 

member, on behalf of all relevant DCOs, 

when each DCO may impose different 

risk management requirements on its 

clearing members and each DCO may 

have differing margin methodologies 

that call for different risk management 

responses from clearing members. 

The Commission does not believe that 

it should assume the sole oversight of 

the risk management policies, 

procedures, and practices of clearing 

members of DCOs. The Commission 

conducts risk surveillance with respect 

to both DCOs and clearing members; 

however, this cannot replace a DCO’s 

obligation to ensure that its clearing 

members are appropriately managing 

the risks that such clearing members 

pose to that particular DCO. Similarly, 

it does not appear that NFA would be 

an efficient alternative. The Commission 

recognizes that certain DCMs have 

entered into regulatory services 

agreements with NFA, and that NFA has 

thereby assumed certain audit 

responsibilities with respect to FCMs 

that are members of those DCMs. 

However, a DCO remains in the best 

position to review the risk management 

policies, procedures, and practices of its 

clearing members in the context of their 

obligations to that particular DCO. 

The Commission is adopting 

§ 39.13(h)(5) with the modifications 

described above. 

f. Additional Authority—§ 39.13(h)(6) 

Proposed § 39.13(h)(6) would require 

a DCO to take additional actions with 

respect to particular clearing members, 

when appropriate, based on the 

application of objective and prudent 

risk management standards. Such 

actions could include, but would not be 

limited to: (i) Imposing enhanced 

capital requirements; (ii) imposing 

enhanced margin requirements; (iii) 

imposing position limits; (iv) 

prohibiting an increase in positions; (v) 

requiring a reduction of positions; (vi) 

liquidating or transferring positions; and 

(vii) suspending or revoking clearing 

membership. 

KCC stated that it generally supports 

the concept that DCOs should impose 

heightened risk management 

requirements on clearing members as 

their risk profiles change and requested 

that the Commission clarify whether 

each of the potential heightened risk 

management requirements enumerated 

in proposed § 39.13(h)(6)(i)–(vii) must 

be explicitly delineated in DCO rules or 

in the DCO’s clearing membership 

agreement. The Commission believes 

that a DCO must have the authority and 

ability to take appropriate additional 

actions with respect to particular 

clearing members, as described in 

§ 39.13(h)(6), but how the DCO asserts 

such authority, whether by rule or 

contractual agreement, should be left to 

the discretion of the DCO. 

J.P. Morgan expressed the view that 

higher margin multipliers should be 

adopted for members who present a 

higher risk profile as a result of 

excessive concentration of risk cleared, 

reduced creditworthiness, or other 

factors affecting a particular member, 

and that such margin multipliers should 

be documented in risk management 

policies applicable to all members. 

J.P. Morgan’s concern that margin 

multipliers should be applied to 

clearing members with a higher risk 

profile, is addressed in § 39.13(h)(1), 

adopted herein and discussed in section 

IV.D.7.a, above, which requires a DCO 

to impose risk limits on each clearing 

member. 

The Commission is adopting 

§ 39.13(h)(6) as proposed. 

E. Core Principle E—Settlement 

Procedures—§ 39.14 

Core Principle E,166 as amended by 

the Dodd-Frank Act, requires a DCO to: 

(1) Complete money settlements on a 

timely basis, but not less frequently than 

once each business day; (2) employ 

money settlement arrangements to 

eliminate or strictly limit its exposure to 

settlement bank risks (including credit 

and liquidity risks from the use of banks 

to effect money settlements); (3) ensure 

that money settlements are final when 

effected; (4) maintain an accurate record 

of the flow of funds associated with 

money settlements; (5) possess the 

ability to comply with the terms and 

conditions of any permitted netting or 

offset arrangement with another clearing 

organization; (6) establish rules that 

clearly state each obligation of the DCO 

with respect to physical deliveries; and 

(7) ensure that it identifies and manages 

each risk arising from any of its 

obligations with respect to physical 

deliveries. The Commission proposed 

§ 39.14 to establish requirements that a 

DCO would have to meet in order to 

comply with Core Principle E.167

1. Definitions—§ 39.14(a) 

‘‘Settlement’’ was defined in proposed 

§ 39.14(a)(1) to include: (i) Payment and 

receipt of variation margin for futures, 

options, and swap positions; (ii) 

payment and receipt of option 

premiums; (iii) deposit and withdrawal 

of initial margin for futures, options, 

and swap positions; (iv) all payments 

due in final settlement of futures, 

options, and swap positions on the final 

settlement date with respect to such 

positions; and (v) all other cash flows 

collected from or paid to each clearing 

member, including but not limited to, 

payments related to swaps such as 

coupon amounts. ‘‘Settlement bank’’ 

was defined in proposed § 39.14(a)(2) as 

‘‘a bank that maintains an account either 

for the [DCO] or for any of its clearing 

members, which is used for the purpose 

of transferring funds and receiving 

transfers of funds in connection with 

settlements with the [DCO].’’ 

ISDA and FIA commented that 

posting of variation margin on swaps 

should not be viewed as ‘‘settling’’ the 

present value of the trade and noted that 

price alignment interest would still be 

paid on variation margin. ISDA stated 

that, similarly, initial margin is not 

‘‘paid’’ by a clearing member to a DCO 

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168E.g., a DCO could establish thresholds that 

relate to the extent of market volatility, or with 

respect to a particular clearing member, the extent 

of losses that it has suffered on a particular day or 

whether it has reached a risk limit established by 

the DCO pursuant to § 39.13(h)(1)(i), which is 

discussed in section IV.D.7.a, above. 

169See CPSS–IOSCO Consultative Report, 

Principle 6: Margin, Key Consideration 4, at 40; 

EMIR, Article 39, paragraph 3, at 46. 

170NEM stated that REMs ‘‘sell electricity and 

natural gas to consumers as a competitive 

alternative to the local utility’’ and ‘‘often purchase 

wholesale physical natural gas and electricity on a 

spot (delivery) month (day) basis and also purchase 

swaps to lock in prices for any consumers who 

want a long-term fixed price contract.’’ 

171NGX stated that it ‘‘operates a trading and 

clearing system for energy products that provides 

electronic trading, central counterparty clearing and 

data services to the North American natural gas, 

electricity and oil markets.’’ 

but is often posted with a security 

interest granted by the clearing member. 

FIA also commented that the deposit 

and withdrawal of initial margin is not 

properly defined as a settlement. 

NGX stated that, with the exception of 

a relatively small power contract, its 

clearing model does not require daily 

variation margin payments and 

collections from its clearing 

participants; rather, it holds collateral 

(initial margin) in an account at a 

depository bank rather than in a 

settlement account, and additional 

collateral may be called for as required. 

Therefore, NGX stated that it would be 

clearer when applied to the NGX model, 

to use the term ‘‘payment and receipt’’ 

rather than the term ‘‘deposit’’ when 

referring to initial margin. 

The Commission proposed a broad 

definition of ‘‘settlement’’ in 

§ 39.14(a)(1) to encompass all cash flows 

between clearing members and a DCO. 

The Commission recognizes that 

accounts that are used for the payment 

and receipt of variation margin are 

frequently called settlement accounts, 

while accounts that are used for the 

deposit and withdrawal of initial margin 

may be called deposit accounts, or 

custody accounts, if the initial margin 

deposited therein is in the form of 

securities. The definition of ‘‘settlement 

bank’’ in § 39.14(a)(2) was intended to 

encompass any bank that a DCO uses for 

settlements, as defined in § 39.14(a)(1), 

whether the relevant accounts are called 

settlement accounts, deposit accounts, 

or custody accounts. In order to avoid 

confusion, the Commission is modifying 

§ 39.14(a)(2) to define a settlement bank 

simply as ‘‘a bank that maintains an 

account either for the [DCO] or for any 

of its clearing members, which is used 

for the purpose of any settlement 

described in paragraph (a)(1) above.’’ 

The Commission is adopting 

§ 39.14(a)(1) as proposed, except for a 

non-substantive change, which replaces 

each reference to ‘‘futures, options, and 

swap positions’’ with ‘‘futures, options, 

and swaps.’’ 

2. Daily Settlements—§ 39.14(b) 

Proposed § 39.14(b) would require a 

DCO to effect a settlement with each 

clearing member at least once each 

business day, and to have the authority 

and operational capacity to effect a 

settlement with each clearing member, 

on an intraday basis, either routinely, 

when thresholds specified by the DCO 

were breached, or in times of extreme 

market volatility. 

CME expressed its support for intraday settlements. LCH suggested that a 

DCO must measure its credit exposures 

‘‘several times each business day,’’ and 

should be obliged to recalculate initial 

and variation margin requirements more 

than once each business day. J.P. 

Morgan stated that intraday margin calls 

should be made with greater frequency 

for clearing members who have a higher 

risk profile. 

The Commission does not believe that 

it is necessary to adopt a requirement 

that all DCOs recalculate initial and 

variation margin requirements more 

than once each business day or an 

explicit requirement for intraday margin 

calls for clearing members with a higher 

risk profile. The Commission believes 

that it has struck the appropriate 

balance in § 39.14(b), by requiring a 

DCO to conduct daily settlements, while 

permitting a DCO to exercise its 

discretion regarding whether it will 

conduct routine intraday settlements, or 

whether it will settle positions on an 

intraday basis only when certain 

thresholds are breached 168 or in times 

of extreme market volatility. This 

approach is also generally consistent 

with proposed international 

standards.169 A particular DCO could 

determine to conduct routine intraday 

settlements, as some have done, or to 

conduct intraday settlements for 

particular clearing members based on 

their risk profiles. 

NEM, NGX, and NOCC all requested 

that the Commission afford recognition 

to a clearing model that does not require 

daily variation margin payments and 

collections but permits accrual 

accounting with respect to certain 

energy products. 

NEM noted that most Retail Energy 

Marketers (REMs) 170 use an accrual 

accounting practice that recognizes 

revenues and costs after energy delivery 

to their retail customers and that 

clearing solutions that require daily 

cash settlements would either 

complicate their accounting practices or 

significantly impact REM cash flows. 

NGX stated that its clearing model 

generally does not require daily 

variation margin payments and 

collections, and that settlement on its 

energy contracts 171 occurs only on a 

monthly basis, after clearing participant 

obligations have been netted, consistent 

with practices in the cash market and 

with the end-user nature of the vast 

majority of NGX clearing participants. 

NGX noted that, therefore, the type of 

daily settlement risk that proposed 

§ 39.14 addresses is not present in the 

NGX model and the degree of risk in the 

monthly settlement process is reduced. 

Although NOCC supported adoption 

of proposed § 39.14(b) for traditional 

futures and cleared swaps, it indicated 

that it intends to develop a 

clearinghouse that will seek registration 

as a DCO to clear energy products, 

including commercial forward contracts 

that it believes will be outside the scope 

of regulation as futures contracts or as 

swaps under the CEA, as well as 

financial forwards that it believes will 

fall within the definition of swaps under 

the CEA. NOCC stated that while gains 

and losses on the commercial forward 

contracts and financial forwards that it 

intends to clear are calculated daily, 

they are accrued throughout the 

delivery period and following the 

delivery period, and are not cash settled 

until final payment occurs 

approximately three weeks after the 

month in which the commodity is 

delivered. NOCC proposed that the 

Commission adopt a rule that would 

permit exemptions for alternative risk 

management frameworks, which would 

provide NOCC with the ability to 

demonstrate to the Commission that 

daily accrual settlement of variation 

margin is a sound practice appropriately 

tailored to the unique characteristics of 

the cash energy markets and market 

participants for which NOCC is seeking 

to provide the benefits of clearing. 

The Commission has not proposed 

and is not adopting a rule permitting 

exemptions for alternative risk 

management frameworks. However, a 

particular DCO may petition the 

Commission for an exemption if it 

believes that it can demonstrate that the 

daily accrual of gains and losses 

provides the same protection to the DCO 

as would daily variation margin 

payments and collections. Therefore, 

the Commission is adding a clause to 

§ 39.14(b) that states ‘‘[e]xcept as 

otherwise provided by Commission 

order’’ prior to the requirement that a 

DCO ‘‘shall effect a settlement with each 

clearing member at least once each 

business day.’’ 

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172See Section 5b(c)(2)(E)(ii) of the CEA, 7 U.S.C. 

7a–1(c)(2)(E)(ii). 

173See CPSS–IOSCO Consultative Report, 

Principle 9: Money Settlements, Key Consideration 

3, at 54. 

174Some DCOs have their own settlement 

accounts at each settlement bank used by their 

clearing members, in which case a clearing 

member’s settlement bank is also the DCO’s 

settlement bank, and transfers between a clearing 

member’s settlement account and a DCO’s 

settlement account are made internally. Other DCOs 

permit their clearing members to use settlement 

banks at which such DCOs do not have their own 

settlement accounts, and settlement transfers are 

made between a clearing member’s settlement bank 

and the DCO’s settlement bank. In either event, the 

settlement bank with the largest share of settlement 

activity will always be a bank at which the DCO 

maintains a settlement account, as all settlement 

activity will involve the DCO. 

3. Settlement Banks—§ 39.14(c) 

The introductory paragraph of 

proposed § 39.14(c) would require a 

DCO to employ settlement arrangements 

that eliminate or strictly limit its 

exposure to settlement bank risks, 

including the credit and liquidity risks 

arising from the use of such banks to 

effect settlements with its clearing 

members. 

OCC commented that it would not be 

possible for a DCO to ‘‘eliminate’’ all 

exposure to settlement bank risks and 

that the Commission had not provided 

any guidance as to what it means to 

‘‘strictly limit’’ such exposure. The 

Commission notes that the language in 

the introductory paragraph of proposed 

§ 39.14(c), which would require a DCO 

to ‘‘employ settlement arrangements 

that eliminate or strictly limit its 

exposure to settlement bank risks, 

including the credit and liquidity risks 

arising from the use of such banks to 

effect settlements * * *,’’ is virtually 

identical to the statutory language in 

Core Principle E.172 The Commission is 

adopting the introductory paragraph of 

§ 39.14(c) with two modifications. First, 

in response to OCC’s comment, the 

Commission is adding the words ‘‘as 

follows:’’ at the end of the sentence, in 

order to clarify that a DCO that complies 

with § 39.14(c)(1), (2), and (3), discussed 

below, will be deemed to have 

‘‘employ[ed] settlement arrangements 

that eliminate or strictly limit its 

exposure to settlement bank risks’’ 

within the meaning of § 39.14(c). The 

Commission is also inserting 

parentheses around the letter ‘‘s’’ in the 

word ‘‘banks’’ in order to clarify that the 

Commission is not intending to require 

that a DCO must have more than one 

settlement bank in all circumstances. 

However, a DCO will need to have more 

than one settlement bank to the extent 

that it is reasonably necessary in order 

to eliminate or strictly limit the DCO’s 

exposures to settlement bank risks, 

pursuant to § 39.14(c)(3), as further 

discussed below. 

4. Criteria for Acceptable Settlement 

Banks—§§ 39.14(c)(1) and (c)(2) 

Proposed § 39.14(c)(1) would require 

a DCO to have documented criteria with 

respect to those banks that are 

acceptable settlement banks for the DCO 

and its clearing members, including 

criteria addressing the capitalization, 

creditworthiness, access to liquidity, 

operational reliability, and regulation or 

supervision of such banks. Proposed 

§ 39.14(c)(2) would require a DCO to 

monitor each approved settlement bank 

on an ongoing basis to ensure that such 

bank continues to meet the criteria 

established pursuant to § 39.14(c)(1). 

Proposed §§ 39.14(c)(1) and (c)(2) are 

consistent with international 

recommendations.173

NYPC agreed with the proposed 

requirement that DCOs must articulate 

the standards that they apply to the 

selection of settlement banks. 

OCC indicated that a DCO may have 

to deviate from its written policies on 

the selection of clearing banks during a 

major market disruption, as those 

settlement banks that are the best 

options available at the time may not 

meet the technical criteria set forth in a 

DCO’s written policies. The 

Commission agrees with OCC that a 

DCO may have to deviate from its 

written policies during a major market 

disruption. However, whether the 

Commission would permit a DCO to do 

so would need to be addressed in the 

context of the particular major market 

disruption, e.g., based on an analysis of 

whether all available settlement banks 

no longer meet such written criteria. 

MGEX commented that the Federal 

Reserve and other banking authorities 

are in the best position to review a 

bank’s financial condition. NYPC 

recommended that the Commission 

modify the proposed rule to reflect the 

fact that the only criteria that are likely 

to be susceptible to observation by a 

DCO are a bank’s operational reliability, 

regulatory capital, and the rating of its 

parent bank holding company. The 

Commission agrees that the Federal 

Reserve and other banking authorities 

may be in the best position to review a 

bank’s financial condition and that there 

is certain information about settlement 

banks to which a DCO will not have 

regular access. Nonetheless, a DCO has 

a responsibility to undertake reasonable 

efforts to ensure that its settlement 

bank(s) continue to meet the criteria 

established by the DCO. A DCO may be 

able to obtain pertinent information 

from public sources, and it should be 

able to request and obtain information 

from an approved settlement bank, 

which demonstrates whether the bank 

continues to meet the criteria 

established by the DCO. 

The Commission is adopting 

§ 39.14(c)(1) with a modification that 

replaces the language that states: ‘‘with 

respect to those banks that are 

acceptable settlement banks for the 

derivatives clearing organization and its 

clearing members’’ with ‘‘that must be 

met by any settlement bank used by the 

derivatives clearing organization or its 

clearing members.’’ In addition, the 

Commission is inserting parentheses 

around the letter ‘‘s’’ in the word 

‘‘banks.’’ Consistent with the 

modification to the introductory 

paragraph of § 39.14(c) described above, 

these modifications also clarify that 

there may be circumstances in which it 

may be appropriate for a DCO to use a 

single settlement bank. The Commission 

is adopting § 39.14(c)(2) as proposed. 

5. Monitoring and Addressing Exposure 

to Settlement Banks—§ 39.14(c)(3) 

Proposed § 39.14(c)(3) would require 

a DCO to monitor the full range and 

concentration of its exposures to its own 

and its clearing members’ settlement 

banks and assess its own and its 

clearing members’ potential losses and 

liquidity pressures in the event that the 

settlement bank with the largest share of 

settlement activity were to fail.174 A 

DCO would be required to: (i) maintain 

settlement accounts at additional 

settlement banks; (ii) approve additional 

settlement banks for use by its clearing 

members; (iii) impose concentration 

limits with respect to its own or its 

clearing members’ settlement banks; 

and/or (iv) take any other appropriate 

actions if any such actions are 

reasonably necessary in order to 

eliminate or strictly limit such 

exposures. 

OCC commented that the requirement 

that a DCO monitor its clearing 

members’ exposure to the settlement 

banks used by such clearing members 

could result in a massive duplication of 

effort and would be very burdensome 

for the DCO. Therefore, OCC suggested 

that clearing members or their primary 

regulators should be responsible for 

monitoring clearing members’ exposure 

to their settlement banks. 

The Commission does not agree with 

OCC that proposed § 39.14(c)(3) could 

result in a massive duplication of effort. 

The focus of the monitoring required by 

§ 39.14(c)(3) is on a DCO’s exposures 

and its clearing members’ potential 

losses insofar as they may create 

exposures for the DCO. Therefore, each 

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175See CPSS–IOSCO Consultative Report, 

Principle 9: Money Settlements, Explanatory Note, 

3.9.5, at 56. 

176CME also expressed concern that, as drafted, 

the proposed regulation appears to require a DCO 

to approve at least two more settlement banks, 

because of the reference to ‘‘settlement banks’’ in 

the plural. 

177However, NGX stated that where a DCO has 

daily settlements or monthly settlements in a 

greater amount, requiring more than one settlement 

bank may materially reduce systemic risk without 

adverse effects. 

DCO must conduct the required 

monitoring as each DCO’s exposures are 

unique to that DCO. In addition, this 

provision of § 39.14(c)(3) is consistent 

with proposed international 

standards.175

NYPC commented that since initial 

and variation margin requirements 

fluctuate daily, proposed § 39.14(c)(3) 

would require DCOs to monitor their 

exposures to all settlement banks and 

not merely the largest. The Commission 

agrees with NYPC. Proposed 

§ 39.14(c)(3) would require a DCO to 

‘‘monitor the full range and 

concentration of its exposures to its own 

and its clearing members’ settlement 

banks,’’ which means that a DCO must 

conduct such monitoring with respect to 

all such settlement banks. The reference 

to ‘‘the settlement bank with the largest 

share of settlement activity’’ was made 

in the context of requiring a DCO to 

assess the potential impact of the failure 

of such bank. 

CME and OCC requested that the 

Commission clarify that a DCO would 

only be required to take any of the 

actions specified in proposed 

§ 39.14(c)(3)(i)–(iv), if the specific action 

were reasonably necessary in order to 

eliminate or strictly limit exposures to 

settlement banks, and that a DCO would 

not be required to take all of the 

specified actions in all cases. CME 

supported this interpretation and OCC 

stated its belief that these requirements 

would be reasonable if the final rule 

were expressly limited in this manner. 

The Commission is modifying 

§ 39.14(c)(3)(i)–(iv) to clarify the 

Commission’s intent to obligate a DCO 

to employ any one or more of the 

actions specified in (i) through (iv), only 

if any one or more of such actions is 

reasonably necessary in order to 

eliminate or strictly limit such 

exposures. 

CME, ICE, MGEX, and KCC variously 

commented that prescribing 

concentration limits and requiring that 

a DCO and its clearing members 

maintain multiple settlement banks 

would impose significant expenses on 

the DCO, its clearing members, and their 

customers. CME, MGEX, and NYPC 

stated their belief that it would be 

difficult to comply with this regulation 

given the limited number of banks that 

are qualified and willing to serve as 

settlement banks.176 CME also 

commented that the meaning of 

‘‘concentration limits’’ is unclear, and 

stated its belief that it would be unwise 

to impose artificial limits on the number 

of clearing members or the size of 

clearing member accounts at a particular 

settlement bank. 

ICE took the position that hard 

concentration limits could increase 

systemic risk because a DCO would 

need to distribute funds across multiple 

banks. ICE indicated that as settlement 

funds increased, highly rated banks 

would eventually be consumed by the 

concentration limits and DCOs may 

have to open accounts with lower rated 

banks. ICE further commented that 

concentration limits could act as a 

constraint on customer choice, in that if 

one bank had a large number of 

settlement customers, there would be 

natural concentration of settlement 

flows, and the DCO could have to direct 

customers not to use their chosen bank. 

NYPC also questioned whether 

current settlement banks would be 

willing to continue to act in that role if 

the Commission required a DCO and 

some of its clearing members to transfer 

their business to other banks. NYPC 

stated that this would leave the existing 

settlement banks with an expensive 

infrastructure supported by fewer client 

accounts. 

MGEX stated its belief that requiring 

a DCO to oversee clearing members’ 

banks and establishing credit or 

concentration limits would be intrusive 

and suggested that the final rule should 

provide DCOs with flexibility. 

The Commission notes that proposed 

§ 39.14(c)(3)(iii) would require a DCO to 

impose concentration limits with 

respect to its own or its clearing 

members’ settlement banks if such 

action were reasonably necessary in 

order to eliminate or strictly limit its 

exposures to such settlement banks. 

Section 39.14(c)(3) would provide a 

DCO with other possible options for 

addressing such exposures. For 

example, a DCO could open an account 

at an additional settlement bank 

pursuant to § 39.14(c)(3)(i), or approve 

an additional settlement bank for use by 

its clearing members pursuant to 

§ 39.14(c)(3)(ii), without imposing 

concentration limits, if doing so would 

mean that such limits would not be 

reasonably necessary. In addition, 

proposed § 39.14(c)(3)(iv) would allow a 

DCO to take other appropriate actions, 

which could obviate the potential need 

for concentration limits. 

KCC commented that identifying 

multiple settlement banks for use by 

clearing members could increase a 

DCO’s operational risk by fragmenting 

the DCO’s margin pool. KCC suggested 

that there is no need for multiple 

settlement banks because there would 

be little effect on the operations of a 

DCO if a non-systemically significant 

settlement bank failed. KCC noted that 

the Federal Deposit Insurance 

Corporation generally facilitates the 

transfer of the accounts and operations 

of a failed bank to a successor 

institution or a bridge bank with little or 

no disruption to depositors at the failed 

bank. KCC further stated that a DCO’s 

settlement account is essentially a passthrough account and DCOs generally do 

not maintain large, long-term balances 

in the account. According to KCC, even 

if a DCO held significant guaranty funds 

or security deposits at a settlement 

bank, such assets would likely be held 

in a trust or custody account, which 

would be unavailable to creditors of the 

failed institution and would generally 

be available to the DCO within a short 

period of time following the insolvency 

of the settlement bank. KCC also noted 

that a requirement that DCOs identify 

additional settlement banks for use by 

clearing members would cause a 

significant rise in bank service fees for 

DCOs and clearing members. 

NGX noted that proposed § 39.14(c) 

generally refers to settlement banks, in 

the plural, assuming that all DCOs will 

maintain accounts with at least two 

settlement banks. NGX questioned the 

benefit of requiring all DCOs, regardless 

of size, to use multiple settlement 

banks. According to NGX, settlement 

risk varies across DCOs, and the type of 

daily settlement risk the proposed rule 

addresses is not present at a DCO like 

NGX, which does not engage in daily 

variation margin payments and 

collections from its clearing 

participants. NGX stated that the rule 

should take account of the level of 

settlement activity because requiring a 

DCO with a relatively small need for 

settlement services to divide the flow of 

funds may cause the DCO to be less 

attractive, bear higher costs, and be less 

competitive with larger DCOs, while 

having a negligible impact on systemic 

risk.177 NGX also commented that the 

rule could result in increased 

operational risk at a DCO like NGX with 

complex contract settlement and 

delivery that requires a settlement bank 

to have specialized expertise and to 

maintain specialized processes and 

operational capabilities. NGX requested 

that the Commission provide the 

flexibility to permit a DCO to 

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178For example, it appears that CME may have 

interpreted proposed § 39.14(c)(3)(ii) in this 

unintended manner, since it stated that ‘‘we do not 

believe the CFTC should require clearing members 

to have accounts at multiple settlement banks, 

which may prove to be an impossible (and/or 

extremely costly) requirement to satisfy.’’ It appears 

that KCC may also have interpreted proposed 

§ 39.14(c)(3)(ii) in this manner, in light of its 

comment that a requirement that DCOs identify 

additional settlement banks for use by clearing 

members would cause a significant rise in bank 

service fees for DCOs and clearing members. There 

is no reason that providing greater choice to 

clearing members regarding which single settlement 

bank they could elect to use would cause a rise in 

bank service fees for clearing members. 

179 ISDA also requested that the Commission 

clarify how the proposed requirement would be 

compatible with the fact that title transfer of initial 

margin may not occur when it is posted to a DCO. 

Title transfer is not a necessary element of 

settlement finality. Although in some jurisdictions 

a clearing member may need to transfer title to 

margin collateral to a DCO in order for the DCO to 

effectively exert control over such collateral, in 

other jurisdictions a clearing member may transfer 

margin collateral to a DCO and grant a security 

interest to the DCO without transfer of title. 

180See Section 5b(c)(2)(E)(iii) of the CEA, 7 U.S.C. 

7a–1(c)(2)(E)(iii). 

181 11 U.S.C. 546(e). 

182See Section 5b(c)(2)(E)(iv) of the CEA, 7 U.S.C. 

7a–1(c)(2)(E)(iv). 

183Prior to amendment by the Dodd Frank Act, 

Core Principle E provided, in part, that a [DCO] 

applicant shall have the ability to ‘‘* * * 

[m]aintain an adequate record of the flow of funds 

associated with each transaction that the applicant 

clears. * * *’’ 

184See Section 5b(c)(2)(E)(v) of the CEA, 7 U.S.C. 

7a–1(c)(2)(E)(v). 

demonstrate that the use of a single 

settlement bank is appropriate from 

both a policy and a financial 

perspective. 

As noted above, the Commission does 

not intend to require a DCO to use more 

than one settlement bank if the 

particular DCO otherwise employs 

settlement arrangements that eliminate 

or strictly limit its exposure to 

settlement bank risks. The Commission 

understands that the number of banks 

that are willing to serve settlement 

functions might be limited, particularly 

for smaller DCOs. The Commission 

further understands that it might be 

costly for some DCOs that currently 

only have one settlement bank to use an 

additional settlement bank. However, 

pursuant to § 39.14(c)(3), a DCO would 

be required to have a second settlement 

bank, if it were reasonably necessary in 

order to eliminate or strictly limit the 

DCO’s exposures to settlement bank 

risks. 

The Commission is modifying 

§§ 39.14(c)(3)(i) and (ii) to refer to ‘‘one 

or more’’ additional settlement banks, so 

that it will be clear that a DCO would 

not necessarily be required to maintain 

settlement accounts with more than one 

additional settlement bank or to approve 

more than one additional settlement 

bank that its clearing members could 

choose to use, under the specified 

circumstances. In addition, the 

Commission is modifying 

§ 39.14(c)(3)(iii) to similarly clarify that 

a DCO may only be required to impose 

concentration limits with respect to 

‘‘one or more’’ of its own or its clearing 

members’ settlement banks, under the 

specified circumstances. The 

Commission is also modifying 

§ 39.14(c)(3)(ii) by replacing ‘‘for use by 

its clearing members’’ with ‘‘that its 

clearing members could choose to use’’ 

to make it clear that the Commission is 

not suggesting that a single clearing 

member might be required to use more 

than one settlement bank.178

The Commission is adopting 

§ 39.14(c)(3) with the modifications 

described above. 

6. Settlement Finality—§ 39.14(d) 

Proposed § 39.14(d) would require a 

DCO to ensure that settlement fund 

transfers are irrevocable and 

unconditional when the DCO’s accounts 

are debited or credited. In addition, the 

proposed regulation would require that 

a DCO’s legal agreements with its 

settlement banks must state clearly 

when settlement fund transfers would 

occur and a DCO was required to 

routinely confirm that its settlement 

banks were effecting fund transfers as 

and when required by those legal 

agreements. 

ISDA and FIA requested that the rule 

allow for the correction of errors.179 The 

Commission agrees with ISDA and FIA 

that settlement finality should not 

preclude the correction of errors, and is 

adding a clause to § 39.14(d) that 

explicitly provides that a DCO’s legal 

agreements with its settlement banks 

may provide for the correction of errors. 

In addition, the Commission is adding 

the modifier ‘‘no later than’’ before 

‘‘when the derivatives clearing 

organization’s accounts are debited or 

credited’’ in recognition of the fact that 

a DCO’s legal agreements with its 

settlement banks may provide for 

settlement finality prior to the time 

when the DCO’s accounts are debited or 

credited, e.g., upon the bank’s 

acceptance of a settlement instruction. 

KCC commented that a DCO can 

never effectively ensure that settlement 

payments are irrevocable, given the 

existence of a legal risk that a settlement 

payment may be deemed to be an 

inappropriate transfer pursuant to 

applicable bankruptcy law. Therefore, 

KCC urged the Commission to eliminate 

the requirement or to restate the rule as 

a requirement to monitor operational 

risks related to settlement finality. The 

Commission does not believe that it is 

appropriate to do so. Core Principle E 

requires a DCO to ‘‘ensure that money 

settlements are final when effected.’’ 180

In addition, Section 546(e) of the U.S. 

Bankruptcy Code 181 provides that a 

bankruptcy trustee may not avoid a 

transfer that is a margin payment or a 

settlement payment made to a DCO by 

a clearing member, or made to a clearing 

member by a DCO (with the exception 

of fraudulent transfers). However, the 

Commission is modifying § 39.14(d) to 

state that ‘‘[a DCO] shall ensure that 

settlements are final when effected by 

ensuring that it has entered into legal 

agreements that state that settlement 

fund transfers are irrevocable and 

unconditional * * *’’ (added text in 

italics). 

The Commission is adopting 

§ 39.14(d) with the modifications 

described above. 

7. Recordkeeping—§ 39.14(e) 

Proposed § 39.14(e) would require a 

DCO to maintain an accurate record of 

the flow of funds associated with each 

settlement. 

KCC expressed its general support of 

the concept of maintaining accurate 

records of settlement fund flows, but 

stated that it may be prudent for the 

Commission to further clarify the extent 

to which the additional recordkeeping 

applies to cross-margining and netting 

arrangements that a DCO may have in 

place with certain clearing members and 

their customers. The language in 

§ 39.14(e) is virtually identical to the 

Core Principle E language, which the 

Dodd-Frank Act added to the CEA.182

Moreover, this language is similar to the 

language that had been contained in 

Core Principle E prior to its amendment 

by the Dodd-Frank Act.183

Therefore, proposed § 39.14(e) would 

not impose any additional 

recordkeeping requirements. The 

Commission believes that the 

requirement that a DCO must maintain 

an accurate record of the flow of funds 

associated with each settlement would 

necessarily require the maintenance of 

an accurate record with respect to any 

cross-margining or netting 

arrangements, without the need to 

separately address such arrangements. 

The Commission is adopting § 39.14(e) 

as proposed. 

8. Netting Arrangements—§ 39.14(f) 

Proposed § 39.14(f) would incorporate 

Core Principle E’s requirement that a 

DCO must possess the ability to comply 

with each term and condition of any 

permitted netting or offset arrangement 

with any other clearing organization.184

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69390 Federal Register / Vol. 76, No. 216 / Tuesday, November 8, 2011 / Rules and Regulations 

185Section 5b(c)(2)(F) of the CEA, 7 U.S.C. 7a– 

1(c)(2)(F) (Core Principle F). 

186Such ‘‘assets’’ would include any securities or 

property that clearing members deposit with a DCO 

in order to satisfy initial margin obligations, which 

are also sometimes referred to as ‘‘collateral.’’ 

Proposed § 39.15 uses the term ‘‘assets’’ rather than 

‘‘securities or property’’ or ‘‘collateral’’ in order to 

be consistent with the statutory language. 

187See 76 FR 33818 (June 9, 2011) (Protection of 

Cleared Swaps Customer Contracts and Collateral; 

Conforming Amendments to the Commodity Broker 

Bankruptcy Provisions). 

188The DCO’s rule filing would also need to 

comply with the procedural requirements of 

§ 40.5(a). 

The Commission did not receive any 

comment letters discussing § 39.14(f) 

and is adopting § 39.14(f) as proposed. 

9. Physical Delivery—§ 39.14(g) 

Proposed § 39.14(g) would require a 

DCO to establish rules clearly stating 

each obligation that the DCO has 

assumed with respect to physical 

deliveries, including whether it has an 

obligation to make or receive delivery of 

a physical instrument or commodity, or 

whether it indemnifies clearing 

members for losses incurred in the 

delivery process, and to ensure that the 

risks of each such obligation are 

identified and managed. 

KCC commented that it generally 

supports the concept of proposed 

§ 39.14(g), but requested that the 

Commission clarify that a DCO may be 

deemed to have satisfied its obligation 

to establish rules relating to physical 

deliveries if the rules of the exchange 

that lists the cleared contracts clearly 

delineates such physical delivery 

obligations. The Commission notes that 

the rules referenced in § 39.14(g) must 

be enforceable by and against the DCO. 

If a DCO were integrated with a DCM 

and the DCM’s rules were enforceable 

by and against the DCO, then it may be 

that the DCM’s rules would satisfy the 

requirements of § 39.14(g). However, 

such compliance would need to be 

determined on a case-by-case basis. The 

Commission is adopting § 39.14(g) as 

proposed, except for a technical revision 

that replaces ‘‘contracts, agreements and 

transactions’’ with ‘‘products’’ to ensure 

consistency with other provisions in 

part 39. 

F. Core Principle F—Treatment of 

Funds—§ 39.15 

Core Principle F, 185 as amended by 

the Dodd-Frank Act, requires a DCO to: 

(i) Establish standards and procedures 

that are designed to protect and ensure 

the safety of its clearing members’ funds 

and assets; (ii) hold such funds and 

assets in a manner by which to 

minimize the risk of loss or of delay in 

the DCO’s access to the assets and 

funds; and (iii) only invest such funds 

and assets in instruments with minimal 

credit, market, and liquidity risks. The 

Commission proposed § 39.15 to 

establish requirements that a DCO 

would have to meet in order to comply 

with Core Principle F. 

1. Required Standards and Procedures— 

§ 39.15(a) 

Proposed § 39.15(a) would require a 

DCO to establish standards and 

procedures that are designed to protect 

and ensure the safety of funds and 

assets belonging to clearing members 

and their customers.186 The 

Commission did not receive any 

comments on proposed § 39.15(a) and is 

adopting the provision as proposed. 

2. Segregation—§ 39.15(b)(1) 

Proposed § 39.15(b)(1) would require 

a DCO to comply with the segregation 

requirements of Section 4d of the CEA 

and Commission regulations 

thereunder, or any other applicable 

Commission regulation or order 

requiring that customer funds and assets 

be segregated, set aside, or held in a 

separate account. 

LCH suggested that the Commission 

clarify the meaning of ‘‘segregated’’ and 

limit the segregation requirement to the 

funds of clearing members’ clients. LCH 

also urged the Commission to limit 

these requirements to client business 

cleared by the DCO under the FCM 

clearing structure, noting that a DCO 

based outside the United States may 

offer client clearing services through 

alternative structures and that it did not 

believe it would be appropriate for 

clients clearing under these non-U.S. 

structures to be subject to the 

segregation requirements of Section 4d 

of the CEA, but rather to the 

requirements set out by the DCO’s home 

or other regulators. 

FIA recommended that the proposed 

rule be revised to make clear that a DCO 

should keep margin posted by clearing 

members to support proprietary 

positions separate from the DCO’s own 

assets, noting that although proprietary 

funds held at a DCO are not subject to 

the segregation provisions of the CEA, it 

is essential that these funds are 

protected in the event of the default of 

the DCO. The Commission has not 

proposed and is not adopting FIA’s 

suggestion that the Commission expand 

the applicability of § 39.15(b)(1) in this 

manner. 

BlackRock and FHLBanks expressed 

their views on specific segregation 

models. The Commission has proposed 

rules in a separate rulemaking regarding 

the segregation of cleared swaps 

customer contracts and collateral, and 

the Commission will address 

BlackRock’s and FHLBanks’ comments 

in connection with the final rulemaking 

for that proposal.187

The comments submitted by LCH, 

FIA, BlackRock, and FHLBanks all 

address the substance or applicability of 

segregation requirements. Proposed 

§ 39.15(b)(1) would not have imposed 

any additional substantive segregation 

requirements upon a DCO. It would 

simply require a DCO to comply with 

the substantive segregation 

requirements of the CEA and other 

Commission regulations or orders, 

which are currently applicable or which 

may become applicable in the future. In 

particular, § 39.15(b)(1) is not intended 

to extend the extraterritorial reach of 

existing segregation requirements 

beyond that which may already exist in 

such requirements. However, in order to 

clarify the Commission’s intent in this 

regard, the Commission has added 

‘‘applicable’’ before ‘‘segregation 

requirements’’ in § 39.15(b)(1). In 

addition, the Commission wishes to 

clarify that its current segregation 

requirements apply to a non-U.S. based 

DCO with respect to clearing members 

that are registered as FCMs, whether 

they are clearing business for U.S. based 

customers or non-U.S. based customers. 

Such requirements do not apply with 

respect to clearing members that are 

non-U.S. based and that are not 

registered as FCMs, nor required to be 

registered as FCMs. 

The Commission is adopting 

§ 39.15(b)(1) with the modification 

described above. 

3. Commingling of Futures, Options on 

Futures, and Swap Positions— 

§ 39.15(b)(2) 

Proposed § 39.15(b)(2)(i) would 

permit a DCO to commingle, and a DCO 

to permit clearing member FCMs to 

commingle, customer positions in 

futures, options on futures, and swaps, 

and any money, securities, or property 

received to margin, guarantee, or secure 

such positions, in an account subject to 

the requirements of Section 4d(f) of the 

CEA (cleared swaps account), pursuant 

to DCO rules that have been approved 

by the Commission under § 40.5 of the 

Commission’s regulations. The DCO’s 

rule filing 188 would have to include, at 

a minimum, the following: (A) an 

identification of the futures, options on 

futures, and swaps that would be 

commingled, including contract 

specifications or the criteria that would 

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Federal Register / Vol. 76, No. 216 / Tuesday, November 8, 2011 / Rules and Regulations 69391 

189As noted in the Commission’s notice of 

proposed rulemaking regarding the protection of 

cleared swaps customer contracts and collateral, 76 

FR at 33818 (June 9, 2011) (Protection of Cleared 

Swaps Customer Contracts and Collateral; 

Conforming Amendments to the Commodity Broker 

Bankruptcy Provisions), if the complete legal 

segregation model is adopted for cleared swaps, a 

DCO could more easily justify the approval of rules 

or the issuance of a 4d order allowing the 

commingling of futures, options, and swaps, since 

the impact of any different risk from the product 

being brought into the portfolio would be limited 

to the customer who chooses to trade that product. 

In such case, the Commission may still wish to 

obtain and review all of the information specified 

in proposed § 39.15(b)(2)(i), although its specific 

concerns may be minimized. However, if the 

complete legal segregation model is adopted for 

cleared swaps, and after the Commission obtains 

experience with respect to considering requests to 

commingle futures, options, and swaps under 

§ 39.15(b)(2) in an environment where that margin 

model applies, the Commission may revisit its 

ongoing need for all of the information listed in 

§ 39.15(b)(2)(i). 

190A rule submitted for prior approval would be 

approved unless the rule is inconsistent with the 

CEA or the Commission’s regulations. See Section 

5c(c)(5) of the CEA, 7 U.S.C. 7a–2(c)(5); and 75 FR 

at 44793–44794 (Provisions Common to Registered 

Entities; final rule). 

191E.g., CME and FIA raised operational concerns 

in the event the Commission adopts a different 

segregation regime for each type of customer 

account. Those comments will be considered in 

connection with the Commission’s proposal 

regarding the appropriate segregation regime for 

cleared swaps accounts. See 76 FR 33818 (June 9, 

2011) (Protection of Cleared Swaps Customer 

Contracts and Collateral; Conforming Amendments 

to the Commodity Broker Bankruptcy Provisions). 

192E.g., LCH suggested additional factors that the 

Commission should consider before a DCO or its 

clearing members should be able to commingle, and 

offer offsets between, futures, options on futures, 

and swaps, including: (a) clients must hold their 

futures, options, and swaps under the same account 

structure and within the same legal entity, and (b) 

the DCO must margin the futures, options, and 

swaps using the same margin model; and ELX 

expressed the view that in order for a customer to 

gain the portfolio margining benefits of 

commingling futures, options, and swaps executed 

on a SEF, it would be necessary for a customer to 

clear its futures, options, and swaps through the 

same DCO. 

193LCH stated that all offset assumptions in the 

DCO’s margin calculations must, at a minimum, be 

replicated in the DCO’s stress testing and must be 

recalibrated frequently. The Commission notes that 

permitted spread and portfolio margins are 

addressed in § 39.13(g)(4), discussed in section 

IV.D.6.e, above, and back testing of such spread and 

portfolio margins is addressed in § 39.13(g)(7), 

discussed in section IV.D.6.g, above. 

be used to define eligible futures, 

options on futures, and swaps; (B) an 

analysis of the risk characteristics of the 

eligible products; (C) a description of 

whether the swaps would be executed 

bilaterally and/or executed on a DCM 

and/or a SEF; (D) an analysis of the 

liquidity of the respective markets for 

the futures, options on futures, and 

swaps that would be commingled, the 

ability of clearing members and the DCO 

to offset or mitigate the risks of such 

products in a timely manner, without 

compromising the financial integrity of 

the account, and, as appropriate, 

proposed means for addressing 

insufficient liquidity; (E) an analysis of 

the availability of reliable prices for 

each of the eligible products; (F) a 

description of the financial, operational, 

and managerial standards or 

requirements for clearing members that 

would be permitted to commingle the 

eligible products; (G) a description of 

the systems and procedures that would 

be used by the DCO to oversee such 

clearing members’ risk management of 

the commingled positions; (H) a 

description of the financial resources of 

the DCO, including the composition and 

availability of a guaranty fund with 

respect to the commingled products; (I) 

a description and analysis of the margin 

methodology that would be applied to 

the commingled products, including 

any margin reduction applied to 

correlated positions, and any applicable 

margin rules with respect to both 

clearing members and customers; (J) an 

analysis of the ability of the DCO to 

manage a potential default with respect 

to any of the commingled products; (K) 

a discussion of the procedures that the 

DCO would follow if a clearing member 

defaulted, and the procedures that a 

clearing member would follow if a 

customer defaulted, with respect to any 

of the commingled products; and (L) a 

description of the arrangements for 

obtaining daily position data from each 

beneficial owner of the commingled 

products.189

Proposed § 39.15(b)(2)(ii) would 

address situations where customer 

positions in futures, options on futures, 

and cleared swaps could be carried in 

a futures account subject to Section 

4d(a) of the CEA. Proposed 

§ 39.15(b)(2)(ii) would incorporate the 

informational requirements of proposed 

§ 39.15(b)(2)(i), but would require a 

DCO to file a petition with the 

Commission for an order pursuant to 

Section 4d(a) of the CEA, permitting the 

DCO and its clearing members to 

commingle customer positions in 

futures, options on futures, and swaps 

in a futures account (4d order). 

Proposed § 39.15(b)(2)(iii)(A) would 

provide that the Commission may 

request additional information in 

support of a rule submission and that it 

may approve the rules in accordance 

with § 40.5.190 Proposed 

§ 39.15(b)(2)(iii)(B) would provide that 

the Commission could request 

additional information in support of a 

petition and that it could issue a 4d 

order in its discretion. 

As noted in the notice of proposed 

rulemaking, in the case of a rule 

approval under § 39.15(b)(2)(i), as well 

as the issuance of an order under 

§ 39.15(b)(2)(ii), the Commission would 

take action pursuant to Section 4d of the 

CEA (permitting commingling) and 

Section 4(c) of the CEA (exempting the 

DCO and clearing members from the 

requirement to hold customer positions 

in a 4d(a) or 4d(f) account, as 

applicable). 

The Commission requested comment 

on whether it should take the same 

approach (rule submission or petition 

for an order) with respect to the futures 

account and the cleared swap account 

and, if so, what that approach should 

be. In addition, the Commission 

requested comment on whether the 

enumerated informational requirements 

fully capture the relevant considerations 

for making a determination on either 

rule approval or the granting of an 

order, and whether the Commission’s 

analysis should take into consideration 

the type of account in which the 

positions would be carried, the 

particular type of products that would 

be involved, or the financial resources 

of the clearing members that would hold 

such accounts. The Commission further 

requested comment on what, if any, 

additional or heightened requirements 

should be imposed to manage the 

increased risks introduced to a futures 

account that also holds cleared swaps. 

In some instances, commenters 

addressed topics that are more properly 

considered by the Commission in 

connection with a separate 

rulemaking,191 that relate to substantive 

requirements that the Commission 

might impose as a condition of 

approving a rule or granting an order 

under § 39.15(b)(2),192 or that relate to 

other provisions adopted herein.193 The 

Commission is not addressing those 

comments in its discussion of 

§ 39.15(b)(2) because they are not within 

the scope of the proposal. 

CME, FIA, and MFA expressed their 

general support for the adoption of rules 

that would allow commingling of 

customer positions in futures, options 

on futures, and cleared swaps. In 

particular, CME indicated that such 

commingling could achieve important 

benefits with respect to greater capital 

efficiency which would result from 

margin reductions for correlated 

positions, and that adoption of a 

regulation permitting such commingling 

would be consistent with the public 

interest, in accordance with Section 4(c) 

of the CEA. CME further stated that 

‘‘[h]aving positions in a single account 

can also enhance risk management 

practices and systemic risk containment 

by allowing the customer’s portfolio to 

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69392 Federal Register / Vol. 76, No. 216 / Tuesday, November 8, 2011 / Rules and Regulations 

194See 76 FR 33818 (June 9, 2011) (Protection of 

Cleared Swaps Customer Contracts and Collateral; 

Conforming Amendments to the Commodity Broker 

Bankruptcy Provisions). 

195This conforming terminology, which appears 

elsewhere in part 39, streamlines the rule text 

without changing the meaning of the provision. The 

scope of part 39 covers only those products subject 

to the Commission’s oversight and would not 

include, for example, options on securities. 

Refinements in the definitions of products subject 

to Commission oversight will be addressed in the 

future. 

196 J.P. Morgan also suggested that DCOs could 

maintain liquidity by requiring clearing members to 

make guarantee fund contributions or by requiring 

clearing members to participate in a liquidity 

facility. The Commission has not proposed and is 

not adopting such requirements. 

197See CPSS–IOSCO Consultative Report, 

Principle 5: Collateral, at 37. 

be handled in a coordinated fashion in 

a transfer or liquidation scenario.’’ 

CME stated its belief that it would be 

logical to apply the same methodology 

(rule submission or petition for an 

order) with respect to the futures 

account and the cleared swaps account, 

and that a rule submission would be the 

most efficient and optimal approach. 

The Commission is retaining the 

proposed distinction whereby the 

Commission may permit futures to be 

commingled in a Section 4d(f) cleared 

swaps account subject to a rule approval 

process, and may permit cleared swaps 

to be commingled in a Section 4d(a) 

futures account subject to a 4d order. In 

the latter instance, the 4d petition 

process would provide additional 

procedural protections in that: (1) 

Review of a 4d petition by the 

Commission is not subject to the time 

limits that apply to a request for rule 

approval under § 40.5; and (2) the 

Commission may impose conditions in 

a 4d order, as appropriate. The 

Commission has determined that, at this 

time, it is appropriate to provide these 

additional procedural protections before 

exposing futures customers to the risks 

of swaps that may be commingled in a 

futures account. As also noted in other 

contexts in this notice of final 

rulemaking, DCOs have greater 

experience in clearing futures. Swaps 

will expose DCOs to risks that can differ 

in their nature and magnitude. 

However, as the Commission and the 

industry gain more experience with 

cleared swaps, the Commission may 

revisit this issue in the future. 

The Commission is adopting CME’s 

suggestion that it revise 

§ 39.15(b)(2)(i)(L) to remove the 

reference to obtaining daily position 

data ‘‘from each beneficial owner.’’ 

Therefore, § 39.15(b)(2)(i)(L), as 

modified, requires a DCO to submit ‘‘[a] 

description of the arrangements for 

obtaining daily position data with 

respect to futures, options on futures, 

and swaps in the account,’’ without 

specifying the level of detail or the 

source of the daily position data that the 

DCO must obtain. As noted by CME, the 

Commission could request additional 

information from the DCO, in support of 

its request for rule approval or petition 

for a 4d order, pursuant to 

§ 39.15(b)(2)(iii). 

The Commission is also making 

conforming changes to § 39.15(b)(2), to 

replace a reference to ‘‘cleared swap 

account’’ with ‘‘cleared swaps account’’ 

to achieve consistency with the 

terminology in another Commission 

rulemaking; 194 is revising the references 

to ‘‘futures, options on futures, and 

swap positions’’ and ‘‘futures, options 

on futures, and swaps’’ to read ‘‘futures, 

options, and swaps;’’ 195 is replacing a 

reference to ‘‘contract’’ with ‘‘product;’’ 

and is correcting the references to 

§ 39.15(b)(2)(i) and (ii) in 

§ 39.15(b)(iii)(A) and (B), respectively. 

The Commission is adopting 

§ 39.15(b)(2) with the modifications 

described above. 

4. Holding of Funds and Assets— 

§ 39.15(c) 

The introductory paragraph of 

proposed § 39.15(c) would require that a 

DCO hold funds and assets belonging to 

clearing members and their customers 

in a manner that minimizes the risk of 

loss or of delay in the DCO’s access to 

those funds and assets. The Commission 

did not receive any comment letters 

discussing the introductory paragraph of 

proposed § 39.15(c) and is adopting the 

provision as proposed. 

5. Types of Assets—§ 39.15(c)(1) 

Proposed § 39.15(c)(1) would require 

a DCO to limit the assets it accepts as 

initial margin to those that have 

minimal credit, market, and liquidity 

risks, and prohibit a DCO from 

accepting letters of credit as initial 

margin. 

LCH agreed with the provisions of 

proposed § 39.15(c), but added that the 

rules might more properly require that 

a DCO must be able to convert any 

funds and assets held promptly into 

cash, and should prove that it is able to 

do so on an ongoing basis. J.P. Morgan 

stated that it is necessary for DCOs to 

maintain sufficient liquidity, and that 

this could be achieved by requiring that 

clearing members post a minimum 

amount of liquid (cash and qualifying 

government securities) margin, among 

other things.196

The Commission believes that the 

standard of ‘‘minimal credit, market, 

and liquidity risks’’ is sufficient and 

that it is not necessary to modify the 

language of the regulation to include an 

explicit requirement that a DCO must be 

able to convert funds and assets 

promptly into cash or to require that 

clearing members must post a minimum 

amount of cash and qualifying 

government securities. Moreover, the 

requirement that a DCO shall limit the 

assets that it accepts as initial margin to 

those that have ‘‘minimal credit, market, 

and liquidity risks’’ is consistent with 

international recommendations.197

OCC expressed its belief that the 

proposal places an excessive focus on 

the types of assets that may be used as 

margin and that the Commission’s 

central focus should be on whether a 

DCO’s procedures and risk management 

systems are sufficient to provide a high 

degree of assurance that a portfolio, 

including margin assets, can be 

liquidated with a positive liquidation 

value. OCC further noted its concern 

that some of the collateral that it 

currently accepts as initial margin, 

including less-liquid stocks and longdated Treasury securities, would no 

longer be permitted under the proposed 

rule. OCC explained that its ‘‘collateral 

in margins’’ or ‘‘CIM’’ program looks at 

each type of collateral as an asset with 

specific risk characteristics rather than 

as a fixed value, and it recognizes both 

positive and negative correlations with 

other assets and liabilities in a 

particular account. 

As an example, OCC stated that even 

though XYZ stock may be less liquid 

than other stocks, it may have a greater 

value than a more liquid stock when it 

is used as margin for a short position in 

XYZ call options. Therefore, OCC urged 

the Commission not to impose a 

standard of ‘‘minimal credit, market, 

and liquidity risk,’’ or not to adopt an 

interpretation of such a standard in a 

manner that would reduce the 

opportunities for diversification of 

collateral and use of assets that may 

have specific risk-reducing properties in 

a particular portfolio. In particular, OCC 

stated that ‘‘[w]here a DCO is capable of 

reflecting the risk of certain assets in its 

margin model, we see no reason why 

less liquid instruments or instruments 

with higher than average credit or 

market risks should not be acceptable 

for initial margin.’’ 

The Commission agrees that a DCO 

should be permitted to accept assets as 

initial margin if such assets have 

specific risk-reducing properties in a 

particular portfolio and the DCO’s 

margin model is capable of 

appropriately reflecting the risk of those 

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198The Commission notes that the minimum 

initial and variation margin requirements 

referenced in Section 4s(e)(3)(D) of the CEA, 7 

U.S.C. 6s(e)(3)(D), apply to uncleared swaps. 

NGX also stated its view that in a nonintermediated model, such as that operated by 

NGX, the DCO is familiar with its clearing 

participants, and can exercise a degree of discretion 

in accepting letters of credit without the same risk 

management challenges that may be faced by an 

intermediated DCO. 

199The FHLBanks further noted that the 

prohibition on letters of credit may unnecessarily 

constrain certain end-users from clearing swaps 

because they may be precluded from pledging other 

assets, e.g., by loan covenants. 

200 ICE noted that the CPSS–IOSCO Consultative 

Report did not prohibit any type of collateral. 

201Redesignation of this provision and several 

other provisions proposed as part of § 39.15 is a 

non-substantive change that moves the provisions 

to the risk management rules for margin 

requirements. As a risk management rule, the 

provision implements Core Principle D, Section 

5b(c)(2)(D)(iii) of the CEA, which provides that 

‘‘Each [DCO], through margin requirements and 

other risk control mechanisms, shall limit the 

exposure of the [DCO] to potential losses from 

defaults by members and participants of the 

[DCO].’’ 

assets. Accordingly, although the 

Commission is retaining the standard of 

minimal credit, market, and liquidity 

risk, it is revising the provision to add 

the following: ‘‘A [DCO] may take into 

account the specific risk-reducing 

properties that particular assets have in 

a particular portfolio.’’ As illustrated by 

OCC, an asset that would not generally 

be acceptable could be acceptable for 

use in connection with a particular 

portfolio. 

Freddie Mac requested that the 

Commission clarify that DCOs may 

accept collateral types beyond those 

specified as permitted investments 

under § 1.25. Section 39.15(c) does not 

prohibit a DCO from accepting collateral 

types that are not specified as permitted 

investments under § 1.25. The 

Commission believes that it is 

appropriate to permit DCOs to retain the 

flexibility to accept a broader range of 

assets that meet the general requirement 

of ‘‘minimal credit, market, and 

liquidity risks’’ than those which are 

appropriate investments for funds 

received from clearing members. 

Several comment letters specifically 

discussed the proposal to prohibit the 

use of letters of credit as initial margin. 

The commenters disagreed with the 

Commission’s proposed requirement 

that a DCO may not accept letters of 

credit for this purpose. CME stated that 

letters of credit provide an absolute 

assurance of payment and, therefore, the 

issuing bank must honor the demand 

even in circumstances where the DCO 

(the beneficiary) breached its duty to the 

clearing member and even if the 

clearing member is unable to reimburse 

the bank for its payment. CME also 

stated that it was not aware of any 

instances in the cleared derivatives 

industry in which a beneficiary of a 

letter of credit posted as collateral had 

sought to draw upon the letter of credit 

and had not been promptly paid by the 

issuer. CME noted that letters of credit 

have been especially useful for clearing 

members to post as collateral for lateday margin calls. ICE and NOCC 

similarly commented that letters of 

credit should be permitted to serve as 

non-cash collateral. NGX indicated that 

letters of credit are consistent with 

Section 4s(e)(3)(D) of the CEA, which 

provides that the financial regulators 

shall establish comparable capital 

requirements and minimum initial and 

variation margin requirements, 

including the use of non-cash collateral, 

for swap dealers.198

Many commenters suggested that 

letters of credit should be acceptable if 

they are subject to appropriate 

conditions. OCC recommended that the 

Commission should allow letters of 

credit as long as a DCO sets criteria with 

respect to issuers, diversifies 

concentration of risk among issuers, and 

limits the proportion of a clearing 

member’s margin requirement that can 

be represented by letters of credit. In 

addition, OCC stated that it would be 

appropriate for the Commission to 

prohibit a DCO from accepting a letter 

of credit from a clearing member if the 

letter of credit is issued by an institution 

affiliated with the clearing member. 

Similarly, FIA suggested that a DCO 

should be permitted to accept letters of 

credit on a case-by-case basis subject to 

the credit quality of the bank and 

appropriate limits on the percentage of 

a clearing member’s margin 

requirements that can be met by letters 

of credit. FIA also indicated that DCOs 

should limit the aggregate value of 

letters of credit that may be issued by 

any one bank. 

FHLBanks wrote that ‘‘a hard and fast 

prohibition against letters of credit is 

inappropriate because it fails to take 

into account that a letter of credit issued 

by a highly creditworthy entity could 

contain terms that would make the letter 

of credit just as liquid as a funded 

asset.’’ 199

CME stated that it only accepts letters 

of credit that comply with its specified 

terms and conditions, including 

payment within one hour of notification 

of a draw, from issuers that it has 

reviewed and approved and that meet 

its criteria for issuing banks. CME 

further noted that it conducts periodic 

reviews of approved banks and uses 

caps and concentration limits in 

connection with letters of credit. 

NGX stated that it has accepted letters 

of credit that comply with its 

requirements regarding timing and 

acceptable institutions, for many years, 

and has successfully drawn on such 

letters of credit. 

Several commenters warned of the 

potential risks associated with 

prohibiting letters of credit, including 

higher costs for clearing members and 

their customers (OCC), the placement of 

U.S. DCOs at a disadvantage to foreign 

clearing houses (ICE),200 and increased 

systemic risk as a result of decreased 

voluntary clearing (NOCC). 

The Commission acknowledges that 

DCOs have historically been permitted 

to exercise their discretion regarding 

whether and to what extent they would 

accept letters of credit for initial margin 

for futures and options. Certain DCOs 

have accepted such letters of credit 

without incident and continue to do so. 

On the other hand, as stated in the 

notice of proposed rulemaking, letters of 

credit are unfunded financial resources 

with respect to which funds might be 

not be available when they are most 

needed by the DCO. Moreover, the 

initial margin of a defaulting clearing 

member would typically be the first 

asset tapped to cure the clearing 

member’s default. Taking into account 

both the strong track record of letters of 

credit in connection with cleared 

futures and options on futures and the 

potentially greater risks of cleared 

swaps, the Commission is modifying the 

provision to permit DCOs to accept 

letters of credit as initial margin for 

futures and options on futures. 

However, the Commission has 

determined to maintain an additional 

safeguard for swaps at this time by 

prohibiting a DCO from accepting letters 

of credit as initial margin for swaps. In 

cases where futures and swaps are 

margined together, the Commission has 

determined that letters of credit may not 

be accepted. The Commission will 

monitor developments in this area and 

may revisit this issue in the future. 

The Commission is adopting 

§ 39.15(c)(1), redesignated as 

§ 39.13(g)(10),201 with the modification 

described above. 

6. Valuation and Haircuts— 

§§ 39.15(c)(2) and 39.15(c)(3) 

Proposed § 39.15(c)(2) would require 

a DCO to use prudent valuation 

practices to value assets posted as initial 

margin on a daily basis. Proposed 

§ 39.15(c)(3) would require a DCO to 

apply appropriate reductions in value to 

reflect the market and credit risk of the 

assets that it accepts in satisfaction of 

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69394 Federal Register / Vol. 76, No. 216 / Tuesday, November 8, 2011 / Rules and Regulations 

202Credit, market, and liquidity risks are concepts 

that are not mutually exclusive, and this 

articulation of the types of risks to be evaluated by 

a DCO appears in the CEA (Core Principle F, 

Treatment of Funds (requiring that ‘‘[f]unds and 

assets invested by a [DCO] shall be held in 

instruments with minimal credit, market, and 

liquidity risks’’), and ‘‘minimal credit, market, and 

liquidity risks’’ is set forth as the standard for assets 

acceptable for a guaranty fund (§ 39.11(e)(3)(i)), and 

as the standard for assets acceptable as initial 

margin (§ 39.13(g)(10)). 

203See CPSS–IOSCO Consultative Report, 

Principle 5: Collateral, Explanatory Note 3.5.4, at 

38. 

204 76 FR 13101 (March 10, 2011) (StraightThrough Processing). 

initial margin obligations and to 

evaluate the appropriateness of its 

haircuts on at least a quarterly basis. 

OCC commented that if a DCO can 

only accept instruments with minimal 

risk, then haircuts should either not be 

required at all or should be very small. 

The Commission notes that, as defined 

in § 39.15(c)(3), haircuts are 

‘‘appropriate reductions in value to 

reflect market and credit risk.’’ This is 

a flexible standard that would allow a 

DCO to determine the extent of the 

haircut based on the extent of the risk 

posed by the instrument deposited as 

initial margin. 

OCC further stated that proposed 

§ 39.15(c)(3) is ambiguous regarding 

what OCC would be required to test on 

a quarterly basis. OCC explained that its 

STANS margin methodology does not 

apply fixed haircuts to securities 

deposited as collateral, but rather treats 

collateral as part of a clearing member’s 

overall portfolio, revisiting each 

‘‘haircut’’ or valuation on a security-bysecurity, account-by-account, and dayby-day basis. Thus, OCC stated that it 

checks the adequacy of its haircuts 

through back testing and not through a 

periodic review. 

The general language of § 39.15(c)(3), 

requiring a DCO to ‘‘apply appropriate 

reductions in value to reflect market and 

credit risk * * * to the assets that it 

accepts in satisfaction of initial margin 

obligations’’ and to ‘‘evaluate the 

appropriateness of such haircuts on at 

least a quarterly basis,’’ is broad enough 

to encompass the method of daily 

valuation and back testing described by 

OCC. 

The Commission is adopting 

§ 39.15(c)(2), redesignated as 

§ 39.13(g)(11), as proposed. The 

Commission is adopting a technical 

revision to § 39.15(c)(3), redesignated as 

§ 39.13(g)(12), by adding a reference to 

‘‘liquidity’’ risk to conform the 

terminology used to describe haircuts 

(proposed as ‘‘appropriate reductions in 

value to reflect market and credit risk’’) 

with the terminology used in 

§ 39.13(g)(10), which refers to assets that 

have ‘‘minimal credit, market, and 

liquidity risks.’’ 202 The Commission is 

also making a non-substantive revision 

to replace the phrase ‘‘including in 

stressed market conditions’’ with 

‘‘taking into consideration stressed 

market conditions.’’ 

7. Concentration Limits—§ 39.15(c)(4) 

Proposed § 39.15(c)(4) would require 

a DCO to apply appropriate limitations 

on the concentration of assets posted as 

initial margin, as necessary, in order to 

ensure the DCO’s ability to liquidate 

those assets quickly with minimal 

adverse price effects. The proposed 

regulation also would require a DCO to 

evaluate the appropriateness of its 

concentration limits, on at least a 

monthly basis. 

OCC indicated that the proposed rule 

was not clear regarding whether it 

would be sufficient to impose 

concentration charges rather than 

imposing concentration limits, but 

argued that if the margin system 

adequately penalizes concentration of 

risk, it does not believe that fixed 

concentration limits are required. The 

Commission agrees that concentration 

charges, rather than concentration 

limits, may be appropriate in certain 

circumstances, and is modifying the 

provision to permit a DCO to apply 

‘‘appropriate limitations or charges on 

the concentration of assets posted as 

initial margin’’ and to ‘‘evaluate the 

appropriateness of any such 

concentration limits or charges, on at 

least a monthly basis.’’ The inclusion of 

concentration charges as an acceptable 

alternative to concentration limits is 

consistent with international 

recommendations.203

CME stated its view that the 

Commission should not prescribe the 

frequency of a DCO’s reviews of its 

concentration limits and it urged the 

Commission to revise § 39.15(c)(4) to 

replace ‘‘on at least a monthly basis’’ 

with ‘‘on a regular basis.’’ The 

Commission believes that it is 

appropriate to require a DCO to evaluate 

the appropriateness of its concentration 

limits (or charges) on at least a monthly 

basis and notes that § 39.15(c)(4) 

provides a DCO with the discretion to 

determine the nature of such evaluation. 

The Commission is adopting 

§ 39.15(c)(4), redesignated as 

§ 39.13(g)(13), with the modifications 

described above. 

8. Pledged Assets—§ 39.15(c)(5) 

Under proposed § 39.15(c)(5), if a 

DCO were to permit its clearing 

members to pledge assets for initial 

margin while retaining such assets in 

accounts in the names of such clearing 

members, the DCO would have to 

ensure that the assets are unencumbered 

and that the pledge has been validly 

created and validly perfected in the 

relevant jurisdiction. The Commission 

did not receive any comments 

discussing proposed § 39.15(c)(5) and is 

adopting the provision, redesignated as 

§ 39.13(g)(14), as proposed. 

9. Permitted Investments—§ 39.15(d) 

Proposed § 39.15(d) would require 

that clearing members’ funds and assets 

that are invested by a DCO must be held 

in instruments with minimal credit, 

market, and liquidity risks and that any 

investment of customer funds or assets 

by a DCO must comply with § 1.25 of 

the Commission’s regulations. 

Moreover, the proposed regulation 

would apply the limitations contained 

in § 1.25 to all customer funds and 

assets, whether they are the funds and 

assets of futures and options customers 

subject to the segregation requirements 

of Section 4d(a) of the CEA, or the funds 

and assets of cleared swaps customers 

subject to the segregation requirements 

of Section 4d(f) of the CEA. 

The Commission did not receive any 

comment letters discussing proposed 

§ 39.15(d). The Commission is adopting 

the provision, redesignated as § 39.15(e), 

as proposed. 

10. Transfer of Customer Positions— 

§ 39.15(d) 

The Commission proposed 

regulations addressing the processing, 

clearing, and transfer of customer 

positions by swap dealers (SDs), major 

swap participants (MSPs), FCMs, SEFs, 

DCMs, and DCOs.204 Proposed 

§ 39.15(d) would require a DCO to have 

rules providing that, upon the request of 

a customer and subject to the consent of 

the receiving clearing member, the DCO 

would promptly transfer all or a portion 

of such customer’s portfolio of positions 

and related funds from the carrying 

clearing member of the DCO to another 

clearing member of the DCO, without 

requiring the close-out and rebooking of 

the positions prior to the requested 

transfer. 

MFA, Citadel, and FHLBanks 

supported the proposal. MFA and 

Citadel suggested that the Commission 

clarify that associated margin should 

transfer simultaneously with the 

transferred positions. 

LCH also suggested that the section 

should be revised to require that the 

transfer of positions and related funds 

be effected simultaneously. LCH 

believes that absent such a provision, a 

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205Section 5b(c)(2)(G) of the CEA, 7 U.S.C. 7a– 

1(c)(2)(G) (Core Principle G). 

DCO could be understood to be required 

to transfer either the positions or the 

funds, but not both, and such an 

obligation would expose the DCO to risk 

during the customer transfer. 

FIA agreed with the Commission that 

a customer should not be required to 

close-out and re-book positions as a 

condition of transferring such positions, 

and that a clearing member should not 

unnecessarily interfere with a 

customer’s request to transfer positions. 

However, FIA noted that a DCO will not 

have the immediate ability to determine 

which positions carried in a clearing 

member’s omnibus account belong to a 

particular customer. FIA suggested that 

a DCO’s rules provide that the customer 

submit its request to transfer its 

positions to the clearing member 

carrying the positions, not to the DCO. 

FIA also suggested that the Commission 

revise the proposed rule to confirm that 

a clearing member is required to transfer 

a customer’s positions only after that 

customer has met all contractual 

obligations, including outstanding 

margin calls and any additional margin 

required to support any remaining 

positions. 

OCC also noted that a customer will 

not ask a DCO directly to transfer a 

customer position. Like FIA, OCC 

believes that any such transfer must be 

subject to all legitimate conditions or 

restrictions established by the DCO in 

connection with its clearing of swaps. 

CME stated that it fully supports the 

concept of applying the same standards 

to transfer of customer cleared swaps as 

have historically been applied to 

transfer of customer futures. It noted 

that a customer request to transfer its 

account is made not to a DCO but to the 

FCM that carries the customer’s 

account. 

ISDA commented that any transfer 

rule must provide that a party seeking 

transfer not be in default to its existing 

clearing member. ISDA believes that the 

transfer rule must take into account any 

cross-cleared or cross-margined 

transactions and in the case where only 

a portion of a customer’s portfolio is 

transferred, clearing members must have 

the ability to condition the transfer on 

the posting of additional margin by the 

customer. 

KCC commented that this rule is not 

necessary because KCC has never 

required a futures position to be closed 

out and re-booked prior to transfer from 

the carrying clearing member to another 

clearing member, nor would KCC 

require a wheat calendar swap to be 

closed out and re-booked prior to 

transfer. The Commission notes that 

such a requirement has been imposed 

by other clearinghouses in connection 

with swaps. 

In response to concerns raised by 

commenters, the Commission is revising 

§ 39.15(d) to read as set forth in the 

regulatory text of this final rule. 

The language making it explicit that 

positions and margin be transferred at 

the same time is responsive to the 

comments of MFA, Citadel, and LCH 

and consistent with prudent risk 

management procedures. The language 

clarifying that a customer transfer 

instruction would go to a clearing 

member and not directly to the DCO is 

responsive to the comments of FIA, 

OCC, and CME. The requirement that a 

customer may not be in default is 

responsive to the comments of FIA and 

ISDA and consistent with the statement 

in the notice of proposed rulemaking 

that transfers should be subject to 

contractual requirements. The 

requirement that positions at both 

clearing members will have appropriate 

margin is responsive to the comments of 

MFA, Citadel, and ISDA and consistent 

with the statement in the notice of 

proposed rulemaking that transfers 

should be subject to contractual 

requirements. 

G. Core Principle G—Default Rules and 

Procedures—§ 39.16 

Core Principle G,205 as amended by 

the Dodd-Frank Act, requires each DCO 

to have rules and procedures designed 

to allow for the efficient, fair, and safe 

management of events during which 

clearing members become insolvent or 

otherwise default on their obligations to 

the DCO. In addition, Core Principle G 

requires each DCO to clearly state its 

default procedures, make its default 

rules publicly available, and ensure that 

it may take timely action to contain 

losses and liquidity pressures and to 

continue meeting its obligations. The 

Commission proposed § 39.16 to 

establish requirements that a DCO 

would have to meet in order to comply 

with Core Principle G. 

1. General—§ 39.16(a) 

Proposed § 39.16(a) would require a 

DCO to adopt rules and procedures 

designed to allow for the efficient, fair, 

and safe management of events during 

which clearing members become 

insolvent or default on the obligations of 

such clearing members to the DCO. 

The Commission did not receive any 

comment letters discussing proposed 

§ 39.16(a), although LCH stated that it 

concurs with all the provisions set out 

under proposed § 39.16. The 

Commission is adopting § 39.16(a) as 

proposed. 

2. Default Management Plan—§ 39.16(b) 

Proposed § 39.16(b) would require a 

DCO to maintain a current written 

default management plan that delineates 

the roles and responsibilities of its 

board of directors, its Risk Management 

Committee, any other committee that 

has responsibilities for default 

management, and the DCO’s 

management, in addressing a default, 

including any necessary coordination 

with, or notification of, other entities 

and regulators. The proposed regulation 

also would require the default 

management plan to address any 

differences in procedures with respect 

to highly liquid contracts (such as 

certain futures) and less liquid contracts 

(such as certain swaps). In addition, 

proposed § 39.16(b) would require a 

DCO to conduct and document a test of 

its default management plan on at least 

an annual basis. 

OCC agreed with the proposal for 

annual testing of a DCO’s default 

management plan, while ISDA stated 

that such tests should be conducted at 

least on a semi-annual basis. FIA 

indicated that the default management 

plan should be subject to frequent, 

periodic testing. The Commission 

believes that it is appropriate and 

sufficient to require at least annual 

testing of a DCO’s default management 

plan. A particular DCO could determine 

to test its plan on a semi-annual or other 

periodic basis, in its discretion. 

ISDA expressed its view that 

regulators should review and sign off on 

the default management plans of DCOs. 

KCC requested that the Commission 

clarify that the default management plan 

concepts in proposed § 39.16(b) may be 

satisfied by annual testing of the DCO’s 

existing set of default rules and 

procedures. The Commission does not 

believe that it is necessary to adopt an 

explicit requirement that the 

Commission review and approve a 

DCO’s default management plan. 

However, Commission staff will review 

a DCO’s default management plan in the 

context of the Commission’s ongoing 

DCO review program, including a 

determination of whether a DCO’s 

‘‘existing set of default rules and 

procedures’’ meet the requirements of 

§ 39.16(b). 

The Commission is making a 

technical revision to § 39.16(b), 

removing the parentheticals and 

substituting the word ‘‘products’’ for the 

word ‘‘contracts.’’ The sentence now 

reads: ‘‘Such plan shall address any 

differences in procedures with respect 

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69396 Federal Register / Vol. 76, No. 216 / Tuesday, November 8, 2011 / Rules and Regulations 

206This is consistent with the segregation 

requirements of Section 4d of the CEA and § 1.20 

of the Commission’s regulations. 207See discussion in section IV.C.1.i, above. 

208See 76 FR 33818 (June 9, 2011) (Protection of 

Cleared Swaps Customer Contracts and Collateral; 

Conforming Amendments to the Commodity Broker 

Bankruptcy Provisions). 

to highly liquid products and less liquid 

products.’’ 

3. Default Procedures—§ 39.16(c)(1) 

Proposed § 39.16(c)(1) would require 

a DCO to adopt procedures that would 

permit the DCO to take timely action to 

contain losses and liquidity pressures 

and to continue meeting its obligations 

in the event of a default on the 

obligations of a clearing member to the 

DCO. 

The Commission did not receive any 

comment letters discussing proposed 

§ 39.16(c)(1) and is adopting 

§ 39.16(c)(1) as proposed. 

4. Default Rules—§ 39.16(c)(2) 

Proposed § 39.16(c)(2) would require 

a DCO to include certain identified 

procedures in its default rules. In 

particular, proposed § 39.16(c)(2)(i) 

would require a DCO to set forth its 

definition of a default. Proposed 

§ 39.16(c)(2)(ii) would require a DCO to 

set forth the actions that it is able to take 

upon a default, which must include the 

prompt transfer, liquidation, or hedging 

of the customer or proprietary positions 

of the defaulting clearing member, as 

applicable. Proposed § 39.16(c)(2)(ii) 

would further state that such procedures 

could also include, in the DCO’s 

discretion, the auctioning or allocation 

of such positions to other clearing 

members. Proposed § 39.16(c)(2)(iii) 

would require a DCO to include in its 

default rules any obligations that the 

DCO imposed on its clearing members 

to participate in auctions, or to accept 

allocations, of a defaulting clearing 

member’s positions, and would 

specifically provide that any allocation 

would have to be proportional to the 

size of the participating or accepting 

clearing member’s positions at the DCO. 

Proposed § 39.16(c)(2)(iv) would 

require that a DCO’s default rules 

address the sequence in which the 

funds and assets of the defaulting 

clearing member and the financial 

resources maintained by the DCO would 

be applied in the event of a default. 

Proposed § 39.16(c)(2)(v) would require 

that a DCO’s default rules contain a 

provision that customer margin posted 

by a defaulting clearing member could 

not be applied in the event of a 

proprietary default.206 Proposed 

§ 39.16(c)(2)(vi) would require that a 

DCO’s default rules contain a provision 

that proprietary margins posted by a 

defaulting clearing member would have 

to be applied in the event of a customer 

default, if the relevant customer margin 

were insufficient to cover the shortfall. 

The Commission did not receive any 

comment letters discussing proposed 

§ 39.16(c)(2)(i), (ii) or (iii). The 

Commission is adopting § 39.16(c)(2)(i) 

as proposed. The Commission is making 

technical revisions to §§ 39.16(c)(2)(ii), 

(iii), (v) and (vi), as well as § 39.16(d)(3), 

by replacing each use of the word 

‘‘proprietary’’ with ‘‘house.’’ 

As discussed above in connection 

with participant eligibility requirements 

under § 39.12,207 the Commission is 

revising § 39.16(c)(2)(iii) to require a 

DCO that imposes obligations on its 

clearing members to participate in 

auctions or to accept allocations of a 

defaulting clearing member’s positions, 

to permit its clearing members to 

outsource these obligations to qualified 

third parties, subject to appropriate 

safeguards imposed by the DCO. The 

Commission believes that it is important 

to permit outsourcing, while 

recognizing that it is essential to limit 

participation only to qualified third 

parties. Accordingly, a DCO’s rules may 

impose appropriate terms and 

conditions on outsourcing 

arrangements, addressing, for example, 

the necessary qualifications to be 

eligible to act in the clearing member’s 

place and conflicts of interest issues. 

Thus, for example, a clearing member 

could hire a qualified third party to act 

as its agent in an auction. The 

Commission cautions, however, that any 

DCO imposing terms and conditions 

that could indirectly deny fair and open 

access and therefore are not 

‘‘appropriate,’’ i.e., not supported by 

sound risk management policies, may 

run afoul of Core Principle C and 

§ 39.12. 

The Commission is also making two 

additional technical revisions to 

§ 39.16(c)(2)(iii). First, the Commission 

is replacing ‘‘a defaulting clearing 

member’s positions’’ with ‘‘the customer 

or house positions of the defaulting 

clearing member,’’ to correct an 

oversight in the proposed language. 

Second, the Commission is revising 

§ 39.16(c)(2)(iii)(A) to provide that any 

allocation shall be ‘‘[p]roportional to the 

size of the participating or accepting 

clearing member’s positions in the same 

product class at the derivatives clearing 

organization’’ (added text in italics) to 

clarify the Commission’s intent. 

With respect to proposed 

§ 39.16(c)(2)(iv), OCC agreed that it 

would be appropriate to require DCOs to 

adopt rules that would define the 

sequence in which the funds and assets 

of a defaulting clearing member and the 

financial resources maintained by the 

DCO would be applied in the event of 

a default. 

Freddie Mac expressed concern with 

the broad discretion that would be given 

to DCOs to determine the sequence in 

which financial resources would be 

applied in the event of a clearing 

member default, and recommended that 

DCOs should be required to place noncustomer resources (e.g., clearing 

member guaranty funds and their own 

capital) ahead of non-defaulting 

customer collateral in the risk waterfall. 

In particular, Freddie Mac indicated 

that if the Commission does not require 

individual segregation of customer 

collateral, it should require DCOs to 

place non-defaulting customers at the 

bottom of the risk waterfall. Freddie 

Mac stated that the Commission should 

defer adoption of proposed § 39.16(c) 

until after adoption of rules relating to 

customer segregation. 

The Commission is adopting 

§ 39.16(c)(2)(iv) to require that a DCO 

adopt rules that identify the sequence of 

its default waterfall, as proposed, 

without imposing any substantive 

requirements with respect to such 

sequence, as suggested by Freddie Mac. 

The Commission is addressing the issue 

of the application of the collateral of 

non-defaulting swaps customers in a 

separate pending rulemaking,208 but 

does not believe that it is appropriate to 

defer the adoption of proposed 

§ 39.16(c) until that rulemaking is 

complete. 

The Commission is making a 

technical revision to § 39.16(c)(2)(iv) by 

inserting ‘‘and its customers’’ after ‘‘the 

funds and assets of the defaulting 

clearing member’’ to correct an 

oversight in the proposed language. 

ISDA commented that proposed 

§ 39.16(c)(2)(v), which would require a 

DCO to adopt ‘‘[a] provision that 

customer margin posted by a defaulting 

clearing member shall not be applied in 

the event of a proprietary default’’ 

should be revised to replace the words 

‘‘in the event of’’ with ‘‘to cover losses 

in respect of’’; otherwise, ISDA believed 

that customer margin would not be able 

to be applied even to cover customer 

losses. The Commission agrees with 

ISDA and is modifying § 39.16(c)(2)(v) 

by replacing ‘‘in the event of’’ with ‘‘to 

cover losses with respect to’’ and has 

made a similar modification to 

§ 39.16(c)(2)(vi). 

CME recommended that the 

Commission replace ‘‘proprietary 

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Federal Register / Vol. 76, No. 216 / Tuesday, November 8, 2011 / Rules and Regulations 69397 

209See discussion of § 39.21 in section IV.L, 

below. 

210Section 5b(c)(2)(H) of the CEA, 7 U.S.C. 7a– 

1(c)(2)(H). 

211See discussion of rule enforcement reporting 

in section IV.J.5.j, below. 

212See id. (The Commission is adopting 

§ 39.19(c)(4)(xiii) as a renumbered § 39.19(c)(4)(xi)). 

213Section 5b(c)(2)(I) of the CEA, 7 U.S.C. 7a– 

1(c)(2)(I). 

margins posted by a defaulting clearing 

member’’ in § 39.16(c)(2)(vi) with 

‘‘proprietary margins, positions and any 

other assets in the account of the 

defaulting clearing member.’’ CME 

argued that the Commission’s proposed 

reference to ‘‘proprietary margins posted 

by a defaulting clearing member’’ is too 

narrow in scope, since in the event of 

a clearing member default (whether 

originating in the customer origin or the 

house origin), a DCO would likely 

liquidate positions in the defaulting 

clearing member’s house account and 

then apply excess funds and not just 

proprietary margins to cure the default. 

The Commission agrees that 

‘‘proprietary margins posted by a 

defaulting clearing member’’ is too 

narrow and is replacing the phrase in 

§ 39.16(c)(2)(vi) with ‘‘house funds and 

assets of a defaulting clearing member.’’ 

The Commission believes that ‘‘house 

funds and assets’’ is broad enough to 

include ‘‘proprietary margins, positions 

and any other assets,’’ as suggested by 

CME, and is consistent with the 

language in § 39.16(c)(2)(iv) and § 39.15. 

The Commission is similarly replacing 

‘‘customer margin posted by a 

defaulting clearing member’’ in 

§ 39.16(c)(2)(v) with ‘‘the funds and 

assets of a defaulting clearing member’s 

customers’’ and is replacing ‘‘customer 

margin’’ in § 39.16(c)(2)(vi) with 

‘‘customer funds and assets.’’ 

ISDA commented that proposed 

§ 39.16(c)(2)(vi) should be revised to 

insert the word ‘‘excess’’ immediately 

before the words ‘‘proprietary margins’’ 

to make it clear that proprietary margin 

is to be applied first to cover proprietary 

losses, noting that the use of proprietary 

margin to cover customer losses ahead 

of proprietary losses would hasten the 

mutualization of losses among clearing 

members, which would likely result in 

higher margin levels being imposed 

with respect to customer positions in 

order to avoid that outcome. The 

Commission agrees with ISDA and is 

modifying § 39.16(c)(2)(vi) by inserting 

‘‘excess’’ before ‘‘house funds and assets 

of a defaulting clearing member,’’ as 

suggested by ISDA. 

The Commission is adopting 

§ 39.16(c)(2) with the modifications 

described above. 

5. Publication of Default Rules— 

§ 39.16(c)(3) 

Proposed § 39.16(c)(3) would require 

that a DCO must make its default rules 

publicly available, and would crossreference § 39.21, adopted herein, which 

also addresses this requirement.209

The Commission did not receive any 

comment letters discussing proposed 

§ 39.16(c)(3) and is adopting 

§ 39.16(c)(3) as proposed. 

6. Insolvency of a Clearing Member— 

§ 39.16(d) 

Proposed § 39.16(d)(1) would require 

a DCO to adopt rules that require a 

clearing member to provide prompt 

notice to the DCO if the clearing 

member becomes the subject of a 

bankruptcy petition, a receivership 

proceeding, or an equivalent 

proceeding, e.g., a foreign liquidation 

proceeding. Proposed § 39.13(d)(2) 

would require a DCO to review the 

clearing member’s continuing eligibility 

for clearing membership, upon receipt 

of such notice. Proposed § 39.16(d)(3) 

would require a DCO to take any 

appropriate action, in its discretion, 

with respect to the clearing member or 

its positions, including but not limited 

to liquidation or transfer of positions, 

and suspension or revocation of clearing 

membership, upon receipt of such 

notice. 

CME recommended that, in order to 

preserve a DCO’s right to take 

appropriate steps before a clearing 

member files for, or is placed into, 

bankruptcy, the Commission should 

amend proposed §§ 39.16(d)(2) and (3) 

to require DCOs to take appropriate 

actions ‘‘no later than upon receipt’’ of 

notice that the clearing member is the 

subject of a bankruptcy petition or 

similar proceeding. The Commission is 

adopting § 39.16(d) with the 

modifications to §§ 39.16(d)(2) and (3) 

suggested by CME. In addition, the 

Commission is making a technical 

revision to § 39.16(d)(3) by replacing the 

phrase ‘‘with respect to such clearing 

member or its positions’’ with the 

phrase ‘‘with respect to such clearing 

member or its house or customer 

positions.’’ This revision eliminates 

possible ambiguity in the reference to 

‘‘its positions,’’ which was intended to 

reflect current industry practice and 

include both house and customer 

positions, not just house positions. 

H. Core Principle H—Rule 

Enforcement—§ 39.17 

Core Principle H,210 as amended by 

the Dodd-Frank Act, requires a DCO to 

maintain adequate arrangements and 

resources for the effective monitoring 

and enforcement of compliance with its 

rules and resolution of disputes. It also 

requires a DCO to have the authority 

and ability to discipline, limit, suspend, 

or terminate the activities of a member 

or participant due to a violation by the 

member or participant of any rule of the 

DCO. It further requires that a DCO 

report to the Commission regarding rule 

enforcement activities and sanctions 

imposed against clearing members. 

Proposed § 39.17 would codify these 

requirements, adding a provision that 

would require a DCO to report to the 

Commission in accordance with 

proposed § 39.19(c)(4)(xiii). As 

proposed, § 39.19(c)(4)(xiii) would 

require a DCO to report the initiation of 

a rule enforcement action against a 

clearing member or the imposition of 

sanctions against a clearing member, no 

later than two business days after the 

DCO takes such action. As discussed in 

connection with rules implementing 

Core Principle J (Reporting), the 

Commission is adopting that reporting 

requirement with a modification that 

only requires a DCO to report sanctions 

imposed against a clearing member.211

The Commission received no 

comments on proposed § 39.17. The 

Commission is adopting § 39.17 as 

proposed, but with a change to the 

cross-reference to § 39.19(c)(4)(xiii) in 

§ 39.17(a)(3) to reflect the redesignation 

of that provision as § 39.19(c)(4)(xi).212

I. Core Principle I—System 

Safeguards—§ 39.18 

Core Principle I,213 as amended by the 

Dodd-Frank Act, requires a DCO to 

establish and maintain a program of risk 

analysis and oversight that identifies 

and minimizes sources of operational 

risk through the development of 

appropriate controls and procedures, 

and automated systems that are reliable, 

secure and have adequate scalable 

capacity. Core Principle I also requires 

that the emergency procedures, back-up 

facilities, and disaster recovery plans 

that a DCO is obligated to establish and 

maintain specifically allow for the 

timely recovery and resumption of the 

DCO’s operations and the fulfillment of 

each obligation and responsibility of the 

DCO. Finally, Core Principle I requires 

that a DCO periodically conduct tests to 

verify that the DCO’s back-up resources 

are sufficient to ensure daily processing, 

clearing, and settlement. 

Proposed § 39.18 would codify the 

obligations contained in Core Principle 

I and delineate the minimum 

requirements that a DCO would be 

required to satisfy in order to comply 

with Core Principle I. Proposed § 39.18 

also would define the terms ‘‘relevant 

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69398 Federal Register / Vol. 76, No. 216 / Tuesday, November 8, 2011 / Rules and Regulations 

214For example, paragraph (a)(2) of the 

application guidance to Core Principle 9 (prior to 

amendment by the Dodd-Frank Act) for contract 

markets noted that ‘‘Any program of independent 

testing and review of [an automated] system should 

be performed by a qualified, independent 

professional.’’ 17 CFR part 38, appendix B at Core 

Principle 9, paragraph (a)(2). 

area,’’ ‘‘recovery time objective,’’ and 

‘‘wide-scale disruption’’ for purposes of 

that section. 

The Commission received one general 

comment from LCH. LCH generally 

‘‘concurred with all the provisions set 

out under proposed rule 39.18,’’ but 

urged the Commission to align these 

provisions with the CPSS–IOSCO 

standards, and to phase in such 

standards. 

As discussed below, the Commission 

received comments on proposed 

§§ 39.18 (h), (j), and (k), and proposed 

§ 39.30(a). 

The Commission did not receive any 

comments specifically related to the 

definitions contained in proposed 

§ 39.18(a); proposed §§ 39.18(b),(c) and 

(d), which would address the required 

program of risk analysis and oversight; 

proposed § 39.18(e), which would 

require a DCO to have a business 

continuity and disaster recovery (BC– 

DR) plan and resources sufficient to 

enable the DCO to resume daily 

processing, clearing and settlement no 

later than the next business day 

following a disruption; proposed 

§ 39.18(f), which would address 

outsourcing by a DCO of resources 

required to meet its responsibilities with 

respect to business continuity and 

disaster recovery plans; proposed 

§ 39.18(g), which would delineate 

certain exceptional events upon the 

occurrence of which a DCO would be 

obligated to notify promptly the 

Commission’s Division of Clearing and 

Risk; proposed § 39.18(h)(1), which 

would require a DCO to provide timely 

advance notice to the Division of 

Clearing and Risk of certain planned 

changes to automated systems; or 

proposed § 39.18(i), which would set 

forth certain records that a DCO would 

be required to maintain. The 

Commission is adopting each of these 

provisions as proposed, except that the 

Commission is replacing ‘‘contracts’’ 

with ‘‘products’’ in § 39.18(a) and is 

adding ‘‘of the derivatives clearing 

organization’s’’ before ‘‘own and 

outsourced resources’’ in § 39.18(f)(2)(ii) 

for clarification. 

1. Notice of Changes to Program of Risk 

Analysis and Oversight—§ 39.18(h)(2) 

Proposed § 39.18(h)(2) would require 

a DCO to give Division of Clearing and 

Risk staff ‘‘timely advance notice’’ of 

‘‘planned changes to the DCO’s program 

of risk analysis and oversight.’’ CME 

commented that this is an 

‘‘extraordinarily broad requirement’’ 

and urged the Commission to 

‘‘appropriately consider[] context and 

relative risks.’’ 

The Commission is adopting 

§ 39.18(h)(2) as proposed. The provision 

merely requires that DCOs submit such 

notice as part of their planning process. 

The Commission expects that staff will 

evaluate compliance with this 

provision, as with all other provisions, 

giving appropriate consideration to 

context and relative risks. 

2. Testing—§ 39.18(j) 

Proposed § 39.18(j) would set forth 

the requirements for the testing that a 

DCO must conduct of its automated 

systems and BC–DR plans. Proposed 

§ 39.18(j)(1) would require that DCOs 

conduct regular, periodic, and objective 

testing and review of (i) their automated 

systems, to ensure that such systems are 

reliable, secure, and have adequate 

scalable capacity, and (ii) their BC–DR 

capabilities, to ensure that the DCO’s 

backup resources meet the standards set 

forth in proposed § 39.18(e). Proposed 

§ 39.18(j)(2) would require that these 

tests ‘‘be conducted by qualified, 

independent professionals * * * [who] 

may be independent contractors or 

employees [of the DCO] but shall not be 

persons responsible for development or 

operation of the capabilities being 

tested.’’ Proposed § 39.18(j)(3) would 

require that reports setting forth the 

protocols for, and the results of, such 

tests ‘‘be communicated to, and 

reviewed by, senior management of the 

[DCO]’’ and that ‘‘[p]rotocols of tests 

which result in few or no exceptions 

shall be subject to more searching 

review.’’ 

ICE, OCC, and MGEX objected to the 

obligation that the testing required by 

§ 39.18(j) be performed by ‘‘qualified, 

independent professionals.’’ ICE 

contended that the proper standard 

should be to have qualified, 

independent professionals review, 

rather than conduct testing of, systems 

or capabilities. Similarly, OCC 

suggested that the testing could be 

overseen, rather than conducted, by an 

independent professional. MGEX 

objected more generally to the 

requirement that tests of its BC–DR 

capabilities be performed by 

‘‘independent professionals’’ and 

expressly objected to the proposal’s 

prohibition on the use of any employees 

who participated in the development or 

the operation of the systems or 

capabilities being tested to fulfill this 

role. MGEX argued that such persons 

are the most qualified persons to run the 

tests. KCC requested that a DCO’s CRO 

or other similar official qualify as an 

‘independent professional’ for purposes 

of the testing rule. 

The Commission is adopting § 39.18(j) 

as proposed. The Commission notes that 

the obligation that the required testing 

of automated systems and BC–DR 

capabilities be performed by qualified, 

independent professionals is consistent 

with the Commission’s historical 

practice of requiring independent 

testing of systems where appropriate.214

The Commission recognizes that 

persons charged with developing or 

operating a system are frequently called 

upon to test that system. The 

Commission believes, however, that the 

active involvement and direction of 

qualified, independent professionals in 

the testing process is needed to ensure 

objective and accurate results. 

MGEX’s requested approach would 

result in tests being conducted only by 

persons with an inherent conflict of 

interest (because negative results of the 

tests might call into question the work 

of those who developed or operate the 

systems) and, separately, would deny 

the DCO the benefit of an independent 

analysis of the workings of the system. 

Accordingly, while some testing of a 

DCO’s automated systems and BC–DR 

capabilities may be conducted by 

persons who design or operate such 

system or capabilities, the Commission 

has decided to retain the requirement 

that the objective testing performed to 

satisfy § 39.18(j) must be conducted by 

qualified, independent persons, as 

defined therein. While a DCO’s CRO 

may appropriately serve this function if 

he or she has the appropriate training 

and experience to be ‘‘qualified’’ in this 

context, and the appropriate role in the 

organization to be ‘‘independent,’’ the 

Commission does not believe it would 

be advisable to determine that the 

person serving in such a role is 

necessarily qualified and independent. 

3. Coordination of BC–DR Plans With 

Members and Providers of Essential 

Services—§ 39.18(k) 

Proposed § 39.18(k) would require 

that a DCO to the extent practicable: (1) 

Coordinate its BC–DR plan with those of 

its clearing members, in a manner 

adequate to enable effective resumption 

of daily processing, clearing, and 

settlement following a disruption; (2) 

initiate and coordinate periodic, 

synchronized testing of its BC–DR plans 

and the plans of its clearing members; 

and (3) ensure that its BC–DR plan takes 

into account the plans of its providers 

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Federal Register / Vol. 76, No. 216 / Tuesday, November 8, 2011 / Rules and Regulations 69399 

215Section 5b(c)(2)(J) of the CEA, 7 U.S.C. 7a– 

1(c)(2)(J). 216See 76 FR at 44790 (July 27, 2011) (Provisions 

Common to Registered Entities; final rule). 

of essential services, including 

telecommunications, power, and water. 

MGEX proposed that industrysponsored events should suffice to 

satisfy the requirement that a DCO must 

coordinate its BC–DR plan with those of 

its members. Similarly, KCC requested 

that the Commission clarify that 

coordination would be deemed to be 

satisfied if the DCO reviews the BC–DR 

plans of its clearing members and 

essential service providers and 

subsequently provides to such parties 

the DCO’s own BC–DR plan. KCC stated 

that it does not believe that coordination 

should involve extensive efforts at 

achieving specific consistency between 

the procedures of each party, as each 

has a distinct business model that faces 

varying operational risks. 

NYPC objected to the requirement 

contained in proposed § 39.18(k)(3). 

NYPC noted that its business continuity 

plan (BCP) would be invoked any time 

a service provider ceases to provide an 

essential service, regardless of whether 

that service provider has invoked its 

own BCP, and thus such information 

would not necessarily give DCOs any 

additional insight into their own BCP. 

Similarly, CME noted that, while it 

obtains representations that its major 

vendors have disaster recovery plans, 

CME does not control, or generally have 

access to, the details of the proprietary 

plans of those service providers. 

The Commission is adopting 

§ 39.18(k) as proposed. With respect to 

the requirements of §§ 39.18(k)(1) and 

(2), the Commission recognizes that 

participation in industry-sponsored 

events, such as the annual testing 

conducted by FIA, serves as an 

important assessment of the 

connectivity between the systems of 

DCOs and their members (including 

backup sites), but such participation 

would not, in and of itself, satisfy the 

requirements of these regulations. The 

level of participation of a particular 

DCO in a particular industry test is left 

to the discretion of the DCO, and 

different DCOs may participate in such 

tests to different extents. Moreover, 

while such industry-sponsored events 

may be helpful, it is the responsibility 

of each DCO—not that of an industry 

organization—to ensure that the 

functionality of clearing will be 

maintained between the DCO and its 

members. The Commission believes that 

a DCO will best be able to meet its 

responsibilities reliably in a wide-area 

disaster that affects a DCO and its 

clearing members if the DCO has 

actively worked together with those 

clearing members to coordinate their 

plans and has obtained some evidence 

that such plans will appropriately mesh 

when implemented. 

While it is true that a DCO should 

have backup arrangements that 

promptly can be engaged to address a 

failure of essential services, it is likely 

that most DCOs will prepare for a 

temporary, rather than an indefinite, 

loss of such services. Among the 

benefits provided by coordination of a 

DCO’s BCP with that of providers of 

essential services is an insight into the 

period of time for which the DCO 

should be prepared to provide such 

services itself. 

The Commission recognizes that a 

service provider may reasonably be 

reluctant to provide sensitive details of 

its own BCP, such as the precise 

location of backup facilities, and notes 

that the proposed requirement is 

prefaced with the limitation that a DCO 

is required to obtain this information 

only ‘‘to the extent practicable.’’ 

Nonetheless, merely obtaining a 

representation that states that a service 

provider has a backup plan—with no 

detail as to the Recovery Time Objective 

(RTO) of that service provider, and no 

insight into how that service provider’s 

BCP might affect the BCP of the DCO— 

would likely be insufficient. 

4. Recovery Time Objective—§ 39.18(a) 

Proposed § 39.18(a) would define an 

RTO as the period within which an 

entity should be able to achieve 

recovery and resumption of clearing and 

settlement of existing and new contracts 

after those capabilities become 

temporarily inoperable for any reason 

up to a wide-scale disruption, and 

defines a wide-scale disruption as an 

event that causes a severe disruption or 

destruction of transportation, 

telecommunications, power, water or 

other critical infrastructure components 

in a relevant area, or an event that 

results in an evacuation or 

unavailability of the population in a 

relevant area. Proposed § 39.18(e)(3) 

would require that a DCO have an RTO 

of the next business day, while 

proposed § 39.30(a) would require that a 

SIDCO have an RTO of two hours. 

ICE noted that proposed § 39.18(a) 

does not specify a minimum time that 

a wide-scale disruption must be 

accommodated, and that costs would be 

higher if the unavailability of staff in the 

relevant area that must be 

accommodated is the total loss of 

personnel. ICE suggested that one week 

would allow relocation of personnel 

outside the affected area. 

The Commission is adopting 

§§ 39.18(a) and 39.18(e)(3) as proposed. 

However, as discussed above in 

connection with the financial resources 

requirements, the Commission believes 

that it would be premature to take 

action regarding § 39.30 at this time. 

The Commission will consider the 

proposals relating to SIDCOs together in 

the future. 

J. Core Principle J—Reporting 

Requirements—§ 39.19 

Core Principle J,215 as amended by the 

Dodd-Frank Act, requires a DCO to 

provide the Commission with all 

information that the Commission 

determines to be necessary to conduct 

oversight of the DCO. The Commission 

proposed § 39.19 to establish 

requirements that a DCO would have to 

meet in order to comply with Core 

Principle J. Under proposed § 39.19, 

certain reports would have to be made 

by a DCO to the Commission: (1) On a 

periodic basis (daily, quarterly, or 

annually), (2) where the reporting 

requirement is triggered by the 

occurrence of a significant event; and (3) 

upon request by the Commission. 

Section 39.19(a) states the general 

requirement of Core Principle J. The 

Commission did not receive any 

comment letters discussing § 39.19(a) 

and is adopting the provision as 

proposed. 

1. Submission of Reports—§ 39.19(b) 

The Commission proposed § 39.19(b) 

to establish procedural requirements for 

electronic submission of reports and 

determination of time zones applicable 

to filing deadlines. The Commission 

received no comments and is adopting 

§§ 39.19(b)(1) and (2) as proposed. For 

purposes of clarification, the 

Commission is also adopting 

§ 39.19(b)(3) to provide a definition of 

‘‘business day’’ as ‘‘the intraday period 

of time starting at the business hour of 

8:15 a.m. and ending at the business 

hour of 4:45 p.m., on all days except 

Saturdays, Sundays, and Federal 

holidays.’’ This is consistent with the 

definition of ‘‘business day’’ set forth in 

§ 40.1(a).216

2. Daily Reporting—§ 39.19(c)(1) 

Proposed § 39.19(c)(1) would require 

a DCO to submit daily reports with 

certain initial margin and variation 

margin data as well as other cash flows 

for each clearing member. More 

specifically, § 39.19(c)(1)(i) would 

require a DCO to report both the initial 

margin requirement for each clearing 

member, by customer origin and house 

origin, and the initial margin on deposit 

for each clearing member, by origin. 

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69400 Federal Register / Vol. 76, No. 216 / Tuesday, November 8, 2011 / Rules and Regulations 

217This requirement would apply to options 

transactions only to the extent a DCO uses futuresstyle margining for options. 

218See further discussion of reports of beneficial 

ownership in section IV.D.6.h.(2), above. 

219MGEX noted that it is already ‘‘internally 

performing these tasks’’ in reference to the several 

daily reporting requirements. KCC has also noted 

that it already submits trading activity and 

positions by each clearing member by origin on a 

daily basis in file formats prescribed by the 

Commission. 

220The Commission notes that its staff is in the 

process of developing a plan for uniform 

submission of DCO reports. 

221See further discussion of the costs and benefits 

of the reporting requirements in section VII.J, 

below. 

222See further discussion of the quarterly 

reporting requirement under § 39.11(f) in section 

IV.B.10, above. 

223See 76 FR at 736 (Jan. 6, 2011) (Governance). 

Proposed § 39.19(c)(1)(ii) would require 

a DCO to report the daily variation 

margin collected and paid by the DCO, 

listing the mark-to-market amount 

collected from or paid to each clearing 

member, by origin.217

Proposed § 39.19(c)(1)(iii) would 

require a DCO to report all other cash 

flows relating to clearing and settlement 

including, but not limited to, option 

premiums and payments related to 

swaps such as coupon amounts, 

collected from or paid to each clearing 

member, by origin. Proposed 

§ 39.19(c)(1)(iv) would require a DCO to 

report the end-of-day positions for each 

clearing member, by customer origin 

and house origin. 

In addition, as discussed in section 

IV.D.6.h.(2), above, in connection with 

the Commission’s proposal to require 

DCOs to collect initial margin for 

customer accounts on a gross basis 

under proposed § 39.13(g)(8)(i), the 

Commission further proposed an 

addition to proposed § 39.19(c)(1)(iv) 

that would also require DCOs to report, 

for each clearing member’s customer 

account, the end-of-day positions of 

each beneficial owner. The Commission 

is adopting § 39.19(c)(1) with two 

modifications. First, the Commission is 

not requiring reporting of customer 

positions by beneficial owner, except 

upon Commission request.218 Second, 

as discussed below, the Commission is 

renumbering the paragraphs in 

§ 39.19(c)(1) and adding a new 

paragraph (ii) to clarify the applicability 

of the daily reporting requirements to 

FCM/BDs. In addition, the Commission 

is replacing ‘‘by customer origin and 

house origin’’ with ‘‘by house origin and 

by each customer origin’’; and is 

replacing ‘‘options on futures positions’’ 

with ‘‘options positions.’’ 

MGEX and KCC commented that 

while such information is available to 

them,219 they are concerned that if the 

Commission mandates a specific form of 

delivery, the cost to DCOs will be 

significantly higher than expected. 

MGEX referred to its recent experience 

with the Trade Capture Reporting 

initiative conversion to the 

Commission’s new FIXML standards, 

which was more costly and time 

consuming than expected. KCC 

commented that all of the data proposed 

to be reported to the Commission is 

already made readily available to the 

Commission in varying degrees, and 

there is little need for the Commission 

to require the increasing level of 

detailed information in specified 

formats. In addition, MGEX expressed 

concern with the Commission’s 

potential data storage capacity 

limitations. MGEX concluded that the 

combination of these two factors suggest 

that the burden of the daily reporting 

requirements on DCOs and the 

Commission outweigh the value of these 

reports. 

MGEX suggested that requiring such 

data on an as-needed, rather than a 

daily, basis would limit the burden on 

DCOs and the Commission while 

ensuring relevancy as to the data being 

requested. KCC asked that the 

Commission reconsider the amount and 

detail of information necessary for its 

oversight role. While CME supported 

the proposed reporting requirement, it 

suggested that the Commission work 

with DCOs to determine the form and 

manner of delivery. 

As mentioned in the notice of 

proposed rulemaking, many DCOs 

already provide the Commission with 

much of the data required under this 

provision. The Commission recognizes 

that the daily reporting requirements 

may place an additional burden on a 

DCO, particularly if the DCO must 

employ a specific form of delivery that 

it does not already have in place. 

However, establishment of an 

automated reporting system is a onetime cost, and a uniform reporting 

format for all DCOs is necessary to 

facilitate the Commission’s ability to 

receive data promptly and quickly 

disseminate it within the agency.220

The overall purpose of receiving the 

daily data is to enable Commission staff 

to analyze the data on a regular basis so 

that it can detect certain trends or 

unusual activity on a timely basis. 

Receiving such data less frequently 

would significantly reduce its 

usefulness. While there may be initial 

costs for DCOs to set up the reporting 

systems, there should be little cost to 

DCOs on a continuing basis.221 Finally, 

MGEX’s suggestion to require such data 

on an as-needed basis does not further 

the objective of enhanced risk 

surveillance, given that the purpose of 

gathering the data is to identify and 

address potential problems at the 

earliest possible time. 

OCC expressed concern that the 

reporting requirements make no 

accommodation for clearing members 

that are FCM/BDs, with respect to their 

securities positions. In response to 

OCC’s comment, the Commission is 

adding a new paragraph (ii) to 

§ 39.19(c)(1) to clarify the limited 

applicability of the daily reporting 

requirements to securities positions. 

The final rule provides that ‘‘The report 

shall contain the information required 

by paragraph (c)(1)(i) of this section for 

(A) all futures positions, and options on 

futures positions, as applicable; (B) all 

swaps positions; and (C) all securities 

positions that are held in a customer 

account subject to Section 4d of the Act 

or are subject to a cross-margining 

agreement.’’ 

3. Quarterly Reporting—§ 39.19(c)(2) 

The Commission is adopting 

§ 39.19(c)(2), requirements for quarterly 

reporting of financial resources, as 

proposed.222

4. Annual Reporting—§ 39.19(c)(3) 

Proposed § 39.19(c)(3) would require 

a DCO to submit a report of the CCO and 

an audited financial statement annually, 

as required by § 39.10(c). The 

Commission received no comments on 

proposed § 39.19(c)(3), and the 

Commission is adopting § 39.19(c)(3) as 

proposed. 

The Commission notes that in a 

separate proposed rulemaking 

implementing Core Principle O 

(Governance Fitness Standards), it 

proposed a new § 39.24(b)(4) which 

would require annual verification that 

directors, members of the disciplinary 

panel and disciplinary committee, 

clearing members, persons with direct 

access, and certain affiliates of a DCO, 

satisfy applicable fitness standards.223

In connection with this, the 

Commission subsequently proposed to 

cross-reference this annual reporting 

obligation as a renumbered 

§ 39.19(c)(3)(iii). At such time as the 

Commission may adopt the verification 

requirement as a final rule, § 39.19(c)(3) 

will be amended accordingly. 

5. Event-Specific Reporting— 

§ 39.19(c)(4) 

a. Decrease in Financial Resources— 

§ 39.19(c)(4)(i) 

Under proposed § 39.19(c)(4)(i), a 

DCO would be required to report to the 

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224 KCC mentioned that changes in the level of 

excess permanent margin deposited by clearing 

members, changes in the minimum margin 

requirements on contracts or in the level of the 

guarantee pool requirements, and changes in the 

level of assessments that can be levied against 

clearing members in the event of a default, could 

cause financial resources to drop more than 10 

percent within the ordinary course of business. 

OCC stated it would cross the 10 percent threshold 

on an almost monthly basis, i.e., the day after 

monthly expirations occur. 

225See discussion of proposed § 39.19(c)(4)(xiv) 

(finalized as § 39.19(c)(4)(xii)) in section IV.J.5.k, 

below. 

226Section 1.12(b)(2) requires an FCM to give 24 

hours notice to the Commission if it ‘‘knows or 

should have known’’ that its adjusted net capital is 

at any time less than 110 percent of the amount 

required by the Commission’s net capital rule. 

227Section 1.12(g)(1) requires an FCM to provide 

written notice within two business days of a 

substantial reduction in capital as compared to that 

last reported in a financial report if there is a 

reduction in net capital of 20 percent or more. 

Commission a 10 percent decrease in 

the total value of the financial resources 

required to be maintained by the DCO 

under § 39.11(a), either from the last 

quarterly report. or from the value as of 

the close of the previous business day. 

Such notification would alert the 

Commission of potential strain on the 

DCO’s financial resources, either 

gradual or precipitous. 

The Commission invited comments 

regarding possible alternatives as to 

what would be considered a significant 

drop in the value of financial resources. 

Although many commenters opposed 

using the 10 percent threshold as a 

barometer for a ‘‘significant’’ decrease, 

no commenter questioned the 

Commission’s objective in obtaining this 

type of information in a timely manner. 

MGEX commented that 10 percent is 

an arbitrary threshold and it is not 

uncommon for financial resources to 

fluctuate by 10 percent even in a stable 

market. Similarly, OCC and KCC stated 

that the threshold is arbitrary and would 

most likely be crossed on a frequent 

basis during the ordinary course of 

business.224 In addition, KCC suggested 

that this requirement is duplicative, as 

a material drop in financial resources 

would already be required to be 

reported by the proposed requirement to 

report all material adverse changes 

(Material Adverse Change Reporting 

Requirement).225

OCC, Better Markets, and Mr. Barnard 

were also concerned about the types of 

financial resources to consider when 

calculating a decrease. OCC suggested it 

is counterproductive to report a 

decrease in financial resources as a 

result of a decrease in margin 

requirements, which is a sign of risk 

reduction. Similarly, Better Markets 

suggested that coincidental increases in 

margin-based financial resources, which 

could fluctuate substantially, could 

offset decreases by more important 

financial resources. In addition, Mr. 

Barnard raised concerns regarding: (1) 

Grouping all types of financial resources 

together for purposes of calculating 

decreases, and (2) whether only 

requiring a report of a decrease in 

financial resources is sufficient. 

Several commenters proposed using a 

different threshold: (1) OCC suggested 

25 percent; (2) MGEX suggested 

allowing a DCO to determine what 

constitutes a material decrease or, as an 

alternative, adopting a threshold of 30 

percent over a five-day period and 25 

percent when compared to the previous 

quarter; and (3) Better Markets 

suggested adopting a threshold of 5 

percent of non-margin-based financial 

resources. NYPC recommended taking 

an approach similar to the FCM ‘‘early 

warning’’ reporting requirement.226

To compensate for an upwards 

adjustment of the financial resources 

requirement, Better Markets suggested 

also requiring a report if the ratio of 

financial resources to minimum 

required levels decreases to 1 to 1. Mr. 

Barnard suggested splitting financial 

resources into two groups: (1) The more 

‘‘robust’’ financial resources (a DCO’s 

own capital and guaranty fund), and (2) 

market or risk-related items (margins); 

and requiring a report for a decrease in 

either amount or a decrease in the total 

of both amounts. Mr. Barnard also 

suggested requiring a DCO to report a 

calculation of its ‘‘solvency ratio’’ 

(available financial resources/financial 

resources requirements) and a 5 percent 

or more drop in such ratio. 

In response to commenters’ objections 

to setting the level at 10 percent, the 

Commission is setting the reporting 

threshold at a level of 25 percent for 

both the daily and quarterly financial 

resources decreases. As noted, OCC 

suggested 25 percent while MGEX 

suggested 25 percent for the quarterly 

and 30 percent for a report covering any 

5-day period. MGEX did not explain 

why there should be a distinction 

between the percentage decrease 

triggering the quarterly and shorter-term 

reports. The Commission believes that a 

25 percent level addresses the 

commenters’ concerns about ‘‘noise’’ 

while providing the Commission with 

notification of material decreases. 

The Commission is not excluding 

certain financial resources from the 

decrease calculation as suggested by 

several commenters. Although there are 

certain financial resources that may 

fluctuate in the ordinary course of 

business, the Commission believes that 

setting the reporting threshold level 

higher should resolve many of these 

issues because fewer fluctuations that 

occur in the ordinary course of business 

would trigger the higher 25 percent 

threshold. Additionally, the purpose of 

the financial resources requirement in 

Core Principle B and as codified in the 

Commission’s regulations is to ensure 

that a DCO has adequate resources to 

cover the default of the clearing member 

with the largest exposure. Financial 

resources are looked at in the aggregate. 

Thus, fluctuations during the ordinary 

course of business, even coincidental 

decreases in financial resources, all 

reflect the financial health of the DCO 

at that time. 

The Commission is not replacing the 

financial resources percentage decrease 

reporting requirement with a 

requirement similar to the FCM ‘‘early 

warning’’ reporting requirement, as 

suggested by NYPC. While FCMs do 

have an ‘‘early warning’’ reporting 

requirement, this is only in addition to 

an FCM’s requirement to also report 

decreases of 20 percent pursuant to 

§ 1.12(g)(1).227 In fact, even with the 

new financial resources reporting 

requirement for DCOs, DCOs still have 

a lesser reporting requirement than 

FCMs in this regard: DCOs are only 

required to report 25 percent decreases, 

while FCMs are required to report 20 

percent decreases in addition to 

reporting decreases below certain 

thresholds (the ‘‘early warning’’ 

requirement). 

The Commission is adopting the 

modified § 39.19(c)(4)(i) reporting 

requirement described herein. The 

Commission does not consider it to be 

duplicative of the Material Adverse 

Change Reporting Requirement, or the 

quarterly financial resource reporting 

requirement under § 39.11(f), as 

suggested by KCC. Each reporting 

requirement, including the financial 

resources reporting requirement, relates 

to specific circumstances that the 

Commission has determined to be 

material and which, based on its 

experience in conducting financial risk 

surveillance, the Commission believes 

warrants notification. The Material 

Adverse Change Reporting Requirement 

is intended to cover more unusual 

changes that are not readily identifiable 

in advance but would nonetheless be of 

interest to Commission staff in 

conducting its oversight of a DCO. The 

Commission is also not requiring the 

solvency ratio decrease reporting 

requirement suggested by Mr. Barnard. 

The Commission believes that receiving 

reports regarding financial resources 

decreases will serve the purpose of 

alerting the Commission to possible 

financial distress at a DCO, without 

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69402 Federal Register / Vol. 76, No. 216 / Tuesday, November 8, 2011 / Rules and Regulations 

228See discussion of § 39.19(c)(4)(iv) in section 

IV.J.5.d, below. 

229As a technical matter, ICE Clear sought 

clarification in the rule text regarding the reference 

to § 39.11(a), pointing out that § 39.11(a) sets the 

standard for financial resources and § 39.11(b) lists 

the financial resources available to satisfy those 

standards. ICE Clear recommended that 

§ 39.19(c)(4)(i) be revised to refer to both §§ 39.11(a) 

and (b). The Commission declines to include a 

reference to § 39.11(b) as the purpose of the crossreference is to incorporate by reference the 

standard, not the means for satisfying the standard. 

230CME referred to the immediate notice required 

under proposed §§ 39.19(c)(4)(v)–(ix). 

231See further discussion of the Material Adverse 

Change Reporting Requirement in section IV.J.5.k, 

below. 

unnecessarily burdening a DCO with 

additional reporting requirements. 

NYPC pointed out that the proposed 

rule language referring to a decrease in 

the ‘‘total value of financial resources’’ 

could be read to refer to the total 

combined default and operating 

resources. It also raised a question as to 

whether the reference to financial 

resources ‘‘required to be maintained 

* * * under § 39.11(a)’’ referred to the 

minimum amount ‘‘required’’ or if it 

was intended to encompass all financial 

resources ‘‘available to satisfy’’ the 

requirements. 

The Commission intends the 

reporting requirement in § 39.19(c)(4)(i) 

to refer only to financial resources 

available to cover a default in 

accordance with § 39.11(a)(1). A 

significant change in the amount of 

financial resources available to meet 

operating expenses is addressed by 

§ 39.19(c)(4)(iv).228 In response to the 

interpretive issues raised by NYPC, the 

Commission is revising the language in 

§ 39.19(c)(4)(i) to clarify that the 

decrease in financial resources refers to 

a decrease in resources ‘‘available to 

satisfy the requirements under 

§ 39.11(a)(1)’’ so it is clear that the 

reporting requirement applies only to 

default resources and refers to those 

resources available to the DCO to satisfy 

the default resource requirements, even 

if the amount of those resources exceeds 

the minimum amount that is required 

by § 39.11(a)(1).229

The Commission notes that it should 

be apprised when a DCO experiences a 

25 percent decrease in the value of its 

default resources from the value as of 

the close of the previous business day, 

even if their value has increased 

substantially since the last quarterly 

report. Such a change could signal a 

significant change in a DCO’s risk 

profile and early reporting will enable 

the Commission to take appropriate 

measures to facilitate proper risk 

management at the DCO. 

b. Decrease in Ownership Equity— 

§ 39.19(c)(4)(ii) 

Proposed § 39.19(c)(4)(ii) would 

require a DCO to report an expected 20 

percent decrease in ownership equity 

two business days prior to the event (or 

two business days following the event, 

if the DCO does not and reasonably 

should not have known prior to the 

event). Such report must include pro 

forma financial statements (or current 

financial statements) reflecting the 

anticipated condition of the DCO 

following the decrease (or current 

condition). The report is intended to 

alert the Commission of major planned 

events that would significantly affect 

ownership equity, most of which are 

events of which the DCO would have 

advance knowledge, such as a 

reinvestment of capital, dividend 

payment, or a major acquisition. 

Better Markets commented that a 

decrease in ownership equity is an 

extraordinary event which would 

warrant notification for even a 5 percent 

decrease, the threshold the SEC uses for 

triggering reporting of acquisition of 

beneficial ownership of a class of 

shares. While a decrease in ownership 

equity can have a significant effect on 

the financial resources of a DCO, the 

Commission determined that 20 percent 

is a level that would represent a 

significant decrease and yet would not 

occur on a frequent basis. The 

Commission believes that setting the 

threshold lower than 20 percent would 

unnecessarily increase the potential 

burden on DCOs as well as on the 

Commission, which could then be 

responsible for reviewing a larger 

number of reports. 

Better Markets also suggested that five 

business days advance notice is more 

appropriate and would not pose a 

significant burden for DCOs. While 

changing the requirement to five 

business days does not itself pose an 

additional burden on a DCO, the 

Commission is adopting the two-day 

notification requirement, as proposed. 

The Commission has determined that 

requiring the report two days prior to 

such an event is sufficient for its 

purposes in reviewing the transaction, 

particularly given the confidential 

nature of such a transaction. 

OCC expressed concern that it would 

be problematic to provide the necessary 

financial statements within the time 

frame required; OCC stated that it runs 

financial statements on a monthly basis, 

thus it would not have them readily 

available within two days. Rather, OCC 

suggested keeping the notification time 

frame at two days, but allowing up to 30 

days, or when the financial statements 

are ready, whichever occurs first, to 

provide the financial statements. The 

Commission is adopting the two-day 

requirement, as proposed. A 20 percent 

decrease in ownership equity is 

generally a major, planned event and 

the Commission believes it would be 

highly unusual for a DCO not to have 

financial statements prepared in 

connection with such a transaction. 

The Commission is adopting 

§ 39.19(c)(4)(ii) as proposed. 

c. Six-Month Liquid Asset Test— 

§ 39.19(c)(4)(iii) 

Proposed § 39.19(c)(4)(iii) would 

require immediate notice of a deficit in 

the six months of liquid assets required 

by § 39.11(e)(2). CME expressed concern 

with other ‘‘immediate notice’’ 

events,230 stating that this would require 

a DCO to immediately notify the 

Commission, in the specific form and 

manner requested, even before the DCO 

attends to the situation and gathers all 

the relevant information. CME 

recommended only requiring ‘‘prompt’’ 

notice, which would require the DCO to 

notify the Commission ‘‘quickly and 

expeditiously,’’ while allowing the DCO 

to first attend to the situation at hand 

and ensure that the information 

reported to the Commission is correct 

and accurate. CME also suggested 

‘‘prompt’’ notice for the Material 

Adverse Change Reporting Requirement. 

The Commission is adopting the rule 

as proposed and retaining the 

‘‘immediate’’ reporting requirement for 

both § 39.19(c)(4)(iii) and the Material 

Adverse Change Reporting 

Requirement.231 While the Commission 

appreciates that in such situations a 

DCO would be busy attending to the 

matter at hand, the burden to contact 

the Commission is minimal. The 

Commission does not specify a 

particular form or manner of delivery, 

so as to minimize the burden on the 

DCO. Moreover, the Commission is 

concerned that using a time frame of 

‘‘prompt’’ would leave too much open 

to interpretation by the DCO and could 

lead to untimely notices. 

d. Change in Working Capital (Current 

Assets)—§ 39.19(c)(4)(iv) 

Proposed § 39.19(c)(4)(iv) would 

require a DCO to report to the 

Commission no later than two business 

days after working capital is negative. 

The report must include a current 

balance sheet of the DCO. Better 

Markets commented that allowing a 

DCO two days to report negative 

working capital is too much time, given 

the potential gravity of the situation, 

and that anything less than a 

requirement of immediate notification is 

‘‘simply indefensible.’’ 

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Federal Register / Vol. 76, No. 216 / Tuesday, November 8, 2011 / Rules and Regulations 69403 

232MGEX also commented on the highly 

confidential nature of changes in ownership, 

corporate or organizational structure. The 

Commission believes MGEX’s concerns are 

addressed by the Commission’s procedures for 

nonpublic records and confidential treatment 

requests set forth in Part 145 of the Commission’s 

regulations. 

As with the ownership equity 

decrease reporting requirement, OCC 

commented that it is problematic to 

submit a balance sheet in two business 

days. OCC suggested keeping the 

notification requirement at two days, 

but allowing up to 30 days (or sooner if 

ready) to provide a balance sheet. 

The Commission is adopting 

§ 39.19(c)(4)(iv) as proposed, except that 

it is revising certain terminology to 

clarify the intended meaning of the term 

‘‘working capital.’’ While the 

Commission agrees that negative 

working capital is a serious matter, 

immediate reporting is not necessary to 

further the Commission’s purpose in 

obtaining this information. The 

Commission is allowing up to two days 

for notification because immediate 

notification would require a DCO to put 

in place a potentially expensive system 

to allow for real-time tracking of 

working capital. Nonetheless, a DCO is 

expected to have a general knowledge of 

the level of its working capital at all 

times. By allowing two days for 

notification, a DCO will have time to 

compute whether working capital is 

negative if it has reason to believe that 

this may be the case, without being 

required to implement a real-time 

notification system. Thus, the purpose 

of the two business days is actually to 

give a DCO time to become aware of its 

obligation to report, not to allow the 

DCO to wait two days after it becomes 

aware of the situation. 

The Commission is also requiring the 

DCO to submit a balance sheet within 

two business days of the DCO 

experiencing negative working capital. 

Given that a DCO would be expected to 

update its balance sheet upon realizing 

that it has negative working capital, the 

Commission does not believe this 

requirement imposes an additional 

burden on the DCO. 

As ‘‘working capital’’ is not a defined 

term, the Commission is substituting the 

term ‘‘current assets’’ for ‘‘working 

capital’’ for purposes of clarification. 

Thus, ‘‘negative working capital’’ now 

refers to a situation when current 

liabilities exceed current assets. Section 

39.19(c)(4)(iv) now reads as follows: 

‘‘Change in current assets. No later than 

two business days after current 

liabilities exceed current assets; the 

notice shall include a balance sheet that 

reflects the derivatives clearing 

organization’s current assets and current 

liabilities and an explanation as to the 

reason for the negative balance.’’ 

e. Intraday Initial Margin Calls— 

§ 39.19(c)(4)(v) 

Proposed § 39.19(c)(4)(v) would 

require a DCO to report to the 

Commission any intraday margin call to 

a clearing member, no later than one 

hour following the margin call. Several 

commenters stated that the requirement 

is unnecessary and a burden on DCOs, 

while other commenters requested 

certain modifications to the proposal. 

The Commission is not adopting the 

intraday margin call reporting 

requirement in proposed 

§ 39.19(c)(4)(v). While such information 

could provide early notice of potential 

problems at a DCO, the Commission has 

concluded that the requirement would 

be overly burdensome to DCOs given 

the amount of work commenters 

indicated it would entail. In addition, 

the Commission will still receive much 

of the same information as part of each 

DCO’s daily reporting under 

§ 39.19(c)(1), and unusual intraday 

initial margin calls that reflect a 

material adverse change will still be 

reported under the Material Adverse 

Change Reporting Requirement. 

f. Issues Related to Clearing Members— 

§§ 39.19(c)(4)(vi)–(ix) 

Proposed §§ 39.19(c)(4)(vi)–(ix) would 

require a DCO to report the following 

issues related to clearing members: (1) A 

delay in collection of initial margin; (2) 

a request to clearing members to reduce 

positions; (3) a determination by the 

DCO to transfer or liquidate a clearing 

member position; and (4) a default of a 

clearing member. The Commission 

received comments suggesting that these 

reporting requirements are unnecessary 

or, at the very least, require some 

modification. KCC suggested not 

adopting these requirements altogether, 

because notification of these events 

would still be required under the 

Material Adverse Change Reporting 

Requirement. 

The Commission has concluded that 

delays in the collection of initial margin 

are not necessarily signs of a financial 

problem at either the DCO or its clearing 

members. The Commission therefore is 

not adopting the requirement to report 

such delays under proposed 

§ 39.19(c)(4)(vi). Nonetheless, if a delay 

is evidence of a material adverse change 

in the financial condition of a clearing 

member, it would still have to be 

reported under the Material Adverse 

Change Reporting Requirement. 

The Commission is adopting the 

remainder of these reporting 

requirements as proposed. However, it 

is redesignating proposed 

§§ 39.19(c)(4)(vii)–(ix) as 

§§ 39.19(c)(4)(v)–(vii). These reporting 

requirements relate to events that occur 

infrequently but can be of significance 

to the Commission’s risk surveillance 

program even if they do not rise to the 

level of having ‘‘a material adverse 

financial impact’’ on the DCO or 

represent ‘‘a material adverse change in 

the financial condition of any clearing 

member’’ under the Material Adverse 

Change Reporting Requirement. Thus, 

with respect to these reports, the 

Commission is not relying on the 

Material Adverse Change Reporting 

Requirement as suggested by KCC. 

In connection with these proposed 

requirements, the Commission also 

proposed removing § 1.12(f)(1) in light 

of the fact that its requirements were 

substantially similar to those being 

proposed as § 39.19(c)(4)(viii). The 

Commission did not receive any 

comments on this proposal and is 

removing § 1.12(f)(1) as proposed. 

g. Change in Ownership or Corporate or 

Organizational Structure— 

§ 39.19(c)(4)(x) 

Proposed § 39.19(c)(4)(x) would 

require a DCO to report certain changes 

in ownership or corporate or 

organizational structure. In general, 

such reports must be submitted to the 

Commission three months in advance of 

the anticipated change. With the 

exception of the change discussed 

below, the Commission is adopting 

§ 39.19(c)(4)(x) as proposed, 

redesignated as § 39.19(c)(4)(viii). 

Proposed § 39.19(c)(4)(x)(A)(2) 

(redesignated as § 39.19(c)(4)(viii)(A)(2)) 

would require a DCO to report the 

creation of a new subsidiary, or the 

elimination of a current subsidiary, of 

the DCO or its parent company. CME 

commented that the creation or 

elimination of a separate subsidiary of 

the DCO’s parent company would not 

serve the Commission’s purpose of 

conducting effective oversight of the 

DCO or enhance the Commission’s 

ability to conduct timely analysis of a 

DCO’s activities. CME added that the 

plans of a DCO’s parent company to 

create (or eliminate) a subsidiary may be 

highly confidential.232 CME urged the 

Commission to eliminate such reporting 

requirement, asserting that ‘‘the value of 

this information to the [Commission] is 

questionable, and the burdens 

associated with providing it may be 

substantial.’’ CME did not provide any 

explanation as to why the burden of 

reporting might be substantial. 

While information about corporate 

changes that potentially impact a DCO’s 

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69404 Federal Register / Vol. 76, No. 216 / Tuesday, November 8, 2011 / Rules and Regulations 

233As proposed, the provision referred to the 

DCO’s ‘‘parent company.’’ The Commission is 

adopting a technical amendment to refer to the 

‘‘parent(s)’’ to clarify that there could be more than 

one parent, such as in the case of a DCO owned by 

a joint venture, and the parent need not have any 

particular corporate form. For purposes of these 

reporting requirements, a ‘‘parent’’ is a direct 

parent, not an entity further up the chain of 

ownership. 

234Core Principle H provides in relevant part that 

‘‘each derivatives clearing organization shall * * * 

(iii) report to the Commission regarding rule 

enforcement activities and sanctions imposed 

against members and participants. * * * ’’ See also 

discussion of § 39.17 in section IV.H, above. 

financial standing or operations is 

helpful to the Commission in its 

oversight of a DCO, to avoid creating an 

unintended burden on DCOs and 

Commission staff, particularly where a 

DCO is part of a complex corporate 

structure, the Commission is modifying 

§ 39.19(c)(4)(viii)(A)(2) to eliminate the 

requirement to report a change in 

subsidiaries of the DCO’s parent 

company. Thus, § 39.19(c)(4)(viii)(A) 

now requires only that a DCO report 

‘‘[a]ny anticipated change in the 

ownership or corporate or 

organizational structure of the [DCO] or 

its parent(s) that would: * * * (2) 

Create a new subsidiary or eliminate a 

current subsidiary of the [DCO]. 

*** 233

h. Change in Key Personnel— 

§ 39.19(c)(4)(xi) 

Proposed § 39.19(c)(4)(xi) would 

require a DCO to report the departure or 

addition of any person who qualifies as 

‘‘key personnel,’’ as defined in § 39.2, 

no later than two business days 

following the change. KCC suggested 

requiring a report ‘‘within a reasonable 

period of time.’’ The Commission notes 

that key personnel are not likely to 

change often, and KCC did not provide 

any explanation as to why the two 

business day notification period is 

inappropriate. The Commission is 

adopting § 39.19(c)(4)(xi) as proposed, 

but redesignated as § 39.19(c)(4)(ix). 

i. Change in Credit Facility Funding 

Arrangement—§ 39.19(c)(4)(xii) 

Proposed § 39.19(c)(4)(xii) would 

require a DCO to report no later than 

one business day after a DCO changes 

an existing credit facility funding 

arrangement, is notified that such 

arrangement has changed, or knows or 

reasonably should have known that the 

arrangement will change. KCC 

commented that this requirement is 

duplicative: such reports would already 

be required by the Material Adverse 

Change Reporting Requirement. CME 

had no objection to the requirement to 

report such changes, but opposed the 

requirement to notify the Commission 

when it knows that the arrangement will 

change in the future, stating that it 

serves little purpose to notify the 

Commission without knowing what will 

change. CME suggested that the 

requirement should be to report to the 

Commission after the terms have 

changed. Conversely, Better Markets 

opposed several components of the 

proposed rule, asserting that it is ‘‘too 

narrow and too loose,’’ allowing one 

business day is too long, and the 

standard of reporting when the DCO 

‘‘knows or reasonably should have 

known’’ is insufficient. Better Markets 

suggested expanding the reporting 

requirement to cover alternative sources 

of liquidity such as access to 

commercial paper and repurchase 

agreement markets. It also suggested 

requiring such a report (i) immediately, 

and (ii) when ‘‘there is a reasonable 

likelihood that the arrangement may 

change.’’ 

The Commission is modifying the rule 

as suggested by CME by removing the 

following: ‘‘or knows or reasonably 

should have known that the 

arrangement will change.’’ Thus, a DCO 

is required to report a change in a credit 

facility funding arrangement no later 

than one business day after it changes 

the arrangement or is notified that such 

arrangement has changed. The provision 

is also being redesignated as 

§ 39.19(c)(4)(x). The Commission is not 

adopting KCC’s suggestion to rely on the 

Material Adverse Change Reporting 

Requirement because a change in a 

credit facility funding arrangement 

would be of specific interest to the 

Commission in its conduct of DCO 

oversight, but such a change is not 

likely to rise to the level of being a 

material adverse change. The 

Commission also is declining to adopt 

Better Markets’ recommendations 

because they would result in the filing 

of multiple reports, many of limited 

usefulness, which, on balance, would 

place an unnecessary burden on DCOs 

and Commission staff. Nonetheless, the 

Commission notes that unusual market 

conditions such as those that might 

limit a DCO’s access to commercial 

paper or ability to enter into repurchase 

agreements, thereby adversely affecting 

the DCO’s liquidity, could constitute a 

material adverse change that would 

have to be reported under the Material 

Adverse Change Reporting Requirement. 

j. Rule Enforcement—§ 39.19(c)(4)(xiii) 

Proposed § 39.19(c)(4)(xiii) would 

require a DCO to report the initiation of 

a rule enforcement action against a 

clearing member or the imposition of 

sanctions against a clearing member, no 

later than two business days after the 

DCO takes such action. Several 

commenters observed that this would 

result in multiple reports with little 

useful information. They further noted 

that the DCO would otherwise inform 

the Commission about serious financial 

issues, as a matter of current practice 

and pursuant to the Material Adverse 

Change Reporting Requirement. MGEX 

recommended that the Commission not 

adopt the rule enforcement reporting 

requirement. OCC and CME 

recommended that the Commission not 

adopt the enforcement reporting 

requirement as proposed. 

MGEX commented that requiring 

notification of the initiation of rule 

enforcement is unnecessary and 

premature, noting that many 

investigations are unrelated to financial 

risk and many are routine. OCC made a 

similar comment. MGEX expressed 

concern about the harm such a report 

could cause to a clearing member’s 

reputation by notifying the Commission 

before there has been any determination 

of any guilt. MGEX also noted that the 

Commission is already routinely 

informed or is aware of ongoing or 

potential actions. 

OCC stated that the proposed 

enforcement reports would serve no 

purpose because if there were serious 

financial issues, the DCO would already 

have been in regular contact with the 

Commission long before the DCO 

reached the stage of initiating a rule 

enforcement action. Thus, OCC believes 

these reports would not serve as an 

effective early warning sign. OCC 

further opposed this reporting 

requirement because a clearing member 

could appeal a decision after a sanction 

is imposed. OCC recommended 

notification to the Commission within 

30 days after a final decision on a 

disciplinary matter. 

CME believes it is unclear when the 

notification requirement would be 

triggered, and that there are situations 

when it is unclear when an enforcement 

action is considered to be initiated. 

The Commission is adopting the rule 

with modifications. While the 

Commission considers information 

about enforcement actions to be useful 

in its oversight of a DCO’s rule 

enforcement program under Core 

Principle H, and more broadly in its 

oversight of a DCO’s overall risk 

management program, the Commission 

has concluded that the requirement, as 

proposed, could result in the reporting 

of many events that are not material to 

the Commission’s oversight of a DCO.234

The Commission recognizes that many 

enforcement actions may be based on 

relatively minor offenses and are 

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235Because of the potential impact on a DCO of 

an adverse change in the financial condition of a 

clearing member, this reporting requirement would 

apply to ‘‘any’’ clearing member, including one that 

is solely a BD engaging in securities activities. 

236See discussion of timing requirements in 

section IV.J.5.c, above. 

237The Commission is also making a technical 

non-substantive change by substituting the word 

‘‘shall’’ for the word ‘‘must’’ to conform this 

provision with other provisions in § 39.19. 

238See 76 FR at 736 (Jan. 6, 2011) (Governance). 

239 Id. 

unlikely to have a significant impact on 

a DCO’s ability to manage risk related to 

the provision of clearing and settlement 

services. 

Therefore, the Commission is 

adopting the regulation with a 

modification such that it would only 

require the reporting of sanctions 

against clearing members, no later than 

two business days after the DCO takes 

such action, and would not require the 

reporting of the initiation of rule 

enforcement actions. The Commission is 

also redesignating the provision as 

§ 39.19(c)(4)(xi). The Commission notes 

that events or circumstances that rise to 

the level of having a material adverse 

impact on a DCO’s ability to comply 

with the requirements of Part 39, or 

relate to a material adverse change in 

the financial condition of any clearing 

member, whether or not they form the 

basis of an enforcement action, will 

have to be formally reported under 

§ 39.19(c)(4)(xii)(B) or (C), respectively. 

Last, OCC requested clarification as to 

whether the rule enforcement reporting 

requirement applies to DCO 

enforcement activities involving a 

clearing member that is only registered 

as a BD. The Commission confirms that 

the requirement to report the imposition 

of sanctions against clearing members 

does not apply to a DCO’s clearing 

members that are registered as BDs only 

and engaged solely in securities-based 

transactions. However, insofar as such a 

clearing member’s actions might have a 

material adverse impact on the DCO’s 

ability to comply with the requirements 

of Part 39 or would constitute a material 

adverse change in the financial 

condition of a clearing member, the 

DCO would be required to submit a 

Material Adverse Change Report, as 

discussed below. 

k. Financial Condition and Events 

(Material Adverse Change Reporting 

Requirement)—§ 39.19(c)(4)(xiv) 

Proposed § 39.19(c)(4)(xiv) would 

require a DCO to immediately notify the 

Commission after the DCO knows or 

reasonably should have known of 

certain material adverse changes, i.e., 

the institution of any legal proceedings 

which may have a material adverse 

financial impact on the DCO; any event, 

circumstance or situation that materially 

impedes the DCO’s ability to comply 

with part 39 of the Commission’s 

regulations and is not otherwise 

required to be reported; or a material 

adverse change in the financial 

condition of any clearing member that is 

not otherwise required to be reported.235

CME and OCC are opposed to this 

‘‘catch-all’’ requirement. In particular, 

CME is concerned that the requirement 

is too broad and thus would include a 

reporting requirement for anything that 

is technically in violation of Part 39, 

e.g., even if the DCO’s email or Web site 

goes down temporarily. OCC also 

commented that the requirement is 

unnecessary because the Commission 

will be receiving adequate reporting as 

a result of other reporting requirements 

in Part 39 and the reporting 

requirements for FCMs. Alternatively, 

CME suggested requiring ‘‘prompt’’ 

notice, rather than ‘‘immediate’’ notice. 

The Commission is adopting 

§ 39.19(c)(4)(xiv) as proposed, but 

redesignated as § 39.19(c)(4)(xii). CME’s 

concerns are unwarranted as the 

reporting requirement would only 

require reporting incidents that could 

have a material adverse effect on the 

DCO. A Web site temporarily going 

down would not necessarily be 

expected to have a ‘‘material’’ adverse 

effect on the DCO. However, if it did 

have a material adverse impact, the 

Commission would expect it to be 

reported. The Commission recognizes 

that it is requiring a DCO to exercise its 

discretion in the first instance to 

determine what events trigger this 

reporting requirement, but the 

Commission considers this to be an 

appropriate responsibility for a DCO. 

Moreover, while the Commission will 

be getting information as a result of 

other Part 39 and FCM reporting 

requirements, there may be certain 

conditions or events that could 

materially impact a DCO that the 

Commission could not anticipate, yet 

about which it would still be important 

for the Commission to be notified. This 

is especially important in light of the 

Commission’s decision not to adopt 

certain proposed reporting 

requirements, as discussed above. 

The Commission is also keeping the 

timing of the reporting requirement as 

‘‘immediate’’ rather than ‘‘prompt,’’ as 

these are material changes for which 

immediate notification is essential and 

for which the more ambiguous 

‘‘prompt’’ is not appropriate.236

l. Financial Statements Material 

Inadequacies—§ 39.19(c)(4)(xv) 

Proposed § 39.19(c)(4)(xv) would 

require a DCO to report material 

inadequacies in its financial statements. 

The Commission received no comments 

on this requirement, and the 

Commission is adopting 

§ 39.19(c)(4)(xv) as proposed 

(redesignated as § 39.19(c)(4)(xiii)), with 

the exception of a technical revision to 

add a reference to ‘‘in a financial 

statement’’ so that the language now 

reads ‘‘If a derivatives clearing 

organization discovers or is notified by 

an independent public accountant of the 

existence of any material inadequacy in 

a financial statement, such derivatives 

clearing organization shall give notice. 

* * *’’ 237

m. Action of Board of Directors or Risk 

Management Committee— 

§ 39.19(c)(4)(xvi) 

In a separate proposed rulemaking 

that would implement Core Principle P 

(Conflicts of Interest), the Commission 

proposed § 39.25(b), which would 

require a DCO to report when the board 

of directors of a DCO rejects a 

recommendation or supersedes an 

action of the DCO’s Risk Management 

Committee, or when the Risk 

Management Committee rejects a 

recommendation or supersedes an 

action of its subcommittee.238 In 

connection with this, the Commission 

subsequently proposed to cross 

reference this reporting obligation in 

proposed § 39.19(c)(4)(xvi). At such 

time as the Commission may adopt the 

reporting requirement in § 39.25(b) as a 

final rule, § 39.19(c)(4) will be amended 

accordingly. 

n. Election of Board of Directors— 

§ 39.19(c)(4)(xvii) 

In a separate proposed rulemaking 

that would implement Core Principles P 

(Conflicts of Interest) and Q 

(Composition of Governing Boards), the 

Commission proposed § 40.9(b)(1)(iii), 

which would require a DCO to report 

certain information to the Commission 

after each election of its board of 

directors.239 In connection with this, the 

Commission subsequently proposed to 

cross-reference this reporting obligation 

in proposed § 39.19(c)(4)(xvii). At such 

time as the Commission may adopt the 

reporting requirement in § 40.9(b)(1)(iii) 

as a final rule, § 39.19(c)(4) will be 

amended accordingly. 

o. System Safeguards— 

§ 39.19(c)(4)(xviii) 

Proposed § 39.19(c)(4)(xviii) would 

require a DCO to report certain 

exceptional events and planned changes 

as required by § 39.18(g) and § 39.18(h), 

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240See discussion of system safeguards reporting 

in section IV.I, above. 

241Section 5b(c)(2)(K) of the CEA, 7 U.S.C. 7a– 

1(c)(2)(K). 

242See, e.g., § 1.31 of the Commission’s 

regulations. 

243See 75 FR 76574 (Dec. 8, 2010) (Swap Data 

Recordkeeping and Reporting Requirements). 

244Section 5b(c)(2)(L) of the CEA, 7 U.S.C. 7a– 

1(c)(2)(L). 

245The statutory language refers to fees charged 

to ‘‘members and participants,’’ and the 

Commission interprets this phrase to mean fees 

charged to ‘‘clearing members.’’ 

246 In particular, Better Markets stated that, at a 

minimum, a DCO should be required to publicly 

disclose (i) the adequacy of its financial resources, 

measured by the required level of financial 

resources under Commission rules, and (ii) to the 

extent they must be reported to the Commission, a 

reduction in financial resources, decrease in 

ownership equity, or change in ownership or 

corporate structure. 

247Section 5b(c)(2)(M) of the CEA, 7 U.S.C. 7a– 

1(c)(2)(M). 

respectively. The Commission received 

no comments on this reporting 

requirement, and the Commission is 

adopting § 39.19(c)(4)(xviii), 

redesignated as § 39.19(c)(4)(xvi), as 

proposed.240

K. Core Principle K—Recordkeeping— 

§ 39.20 

Core Principle K,241 as amended by 

the Dodd-Frank Act, requires a DCO to 

maintain records of all activities related 

to the business of the DCO as a DCO, in 

a form and manner that is acceptable to 

the Commission and for a period of not 

less than 5 years. The Commission 

proposed § 39.20 to establish 

requirements that a DCO would have to 

meet in order to comply with Core 

Principle K. 

Under proposed § 39.20(b), a DCO 

would have to maintain records of all 

activities related to its business as a 

DCO ‘‘for a period of not less than 5 

years,’’ except for swap data that must 

be maintained in accordance with the 

SDR rules in part 45 of the 

Commission’s regulations. Mr. Barnard 

expressed the view that limiting record 

retention to five years is insufficient and 

records should be required to be kept 

indefinitely. 

The Commission is adopting § 39.20 

as proposed. The Commission believes 

that codifying the statutory minimum 

requirement of five years is appropriate, 

noting that a five-year minimum is 

consistent with other Commission 

recordkeeping requirements.242 In 

addition, the exception for swap data 

recordkeeping addresses situations 

where the Commission has previously 

determined that a five-year minimum 

may not be sufficient.243

L. Core Principle L—Public 

Information—§ 39.21 

Core Principle L,244 as amended by 

the Dodd-Frank Act, requires a DCO to 

provide market participants sufficient 

information to enable the market 

participants to identify and evaluate 

accurately the risks and costs associated 

with using the DCO’s services. More 

specifically, a DCO is required to make 

available to market participants 

information concerning the rules and 

operating and default procedures 

governing its clearing and settlement 

systems and also to disclose publicly 

and to the Commission the terms and 

conditions of each contract, agreement, 

and transaction cleared and settled by 

the DCO, each clearing and other fee 

charged to members,245 the DCO’s 

margin-setting methodology, daily 

settlement prices, and other matters 

relevant to participation in the DCO’s 

clearing and settlement activities. 

Proposed § 39.21 would require a 

DCO to provide market participants 

with sufficient information to enable the 

market participants to identify and 

evaluate accurately the risks and costs 

associated with using the services of the 

DCO. In particular, proposed 

§§ 39.21(c)(2), (3) and (4) would require 

a DCO to disclose publicly and to the 

Commission information concerning its 

margin-setting methodology and the size 

and composition of the financial 

resource package available in the event 

of a clearing member default. 

KCC, MGEX, and NGX variously 

commented that DCO fees and charges, 

margin methodology and financial 

resource information are confidential 

and should not be required to be 

publicly disclosed for the following 

reasons: (1) It is intellectual property, 

(2) there is no correlation between the 

availability of such information and the 

decision whether to invest in or trade 

with a DCO, and (3) privately held 

companies (or non-intermediated DCOs 

in the case of NGX) should not have to 

disclose such information. MGEX also 

suggested that making margin 

methodology information available to 

the public could lead to market 

manipulation by those who might 

attempt to influence the margin level. 

MGEX suggested that the rule should 

only require making the financial 

resource package information available 

upon request by a clearing member that 

has signed the DCO’s confidentiality 

agreement. Conversely, Better Markets 

believes that § 39.21 does not go far 

enough and that many of the DCO 

reports required by § 39.19 should also 

be required to be disclosed to the 

public, as the Dodd-Frank Act requires 

that market participants and the public 

be informed of the risks and other 

potential consequences of transacting 

with a DCO.246 Similarly, Mr. Barnard 

suggested requiring public disclosure of 

all items of public interest, including 

event-specific reports under 

§ 39.19(c)(4), except for those that 

would expose business-specific 

confidential issues. 

The Commission is adopting § 39.21 

as proposed, except for proposed 

§ 39.21(c)(7), which would require the 

public disclosure of information related 

to governance and conflicts of interest 

in accordance with provisions that were 

proposed in a separate rulemaking. At 

such time as the Commission adopts 

those provisions, § 39.21 will be 

amended accordingly. The requirement 

to publicly disclose clearing and other 

fees charged by the DCO, margin 

methodology and financial resources 

information comes directly from Core 

Principle L. Moreover, the Commission 

believes that concerns regarding the 

confidential nature of this information 

are unfounded because such 

information would seem to be 

fundamental to a clearing member or 

potential clearing member’s assessment 

of the strengths and weaknesses of a 

DCO. This does not necessarily require 

disclosure of proprietary information; 

certain DCOs, e.g., CME, already 

disclose this type of information on 

their Web sites. 

The Commission is not revising the 

rule to incorporate Better Markets’ or 

Mr. Barnard’s proposals. From a 

practical standpoint, some of the 

information Better Markets and Mr. 

Barnard have requested to be publicly 

disclosed is otherwise going to be public 

information, particularly if the DCO is a 

public company, and thus subject to 

SEC filing requirements. Regardless, the 

Commission does not interpret Core 

Principle L as requiring disclosure of all 

of the financial workings of a DCO. 

M. Core Principle M—Information 

Sharing—§ 39.22 

Core Principle M,247 as amended by 

the Dodd-Frank Act, requires a DCO to 

enter into and abide by the terms of 

each appropriate and applicable 

domestic and international informationsharing agreement and to use relevant 

information obtained under such 

agreements in carrying out its risk 

management program. The Commission 

proposed § 39.22 to codify the statutory 

requirement. 

Proposed § 39.22 would require a 

DCO to enter into certain informationsharing agreements and use relevant 

information obtained from those 

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248Section 5b(c)(2)(N) of the CEA, 7 U.S.C. 7a– 

1(c)(2)(N). 

249See Section 5(d)(19) of the CEA, 7 U.S.C. 

7(d)(19) (DCM Core Principle 19). 

250Section 5b(c)(2)(R) of the CEA, 7 U.S.C. 7a– 

1(c)(2)(R). 

251 12 U.S.C. 1818. 

252The Commission has already delegated 

authority to the Director of the Division of Clearing 

and Risk to: (1) consolidate multiple swap 

submissions from one DCO or subdivide a 

submission as appropriate for review under 

§ 39.5(b)(2); and request information from a DCO to 

assist the Commission’s review of a clearing 

requirement that has been stayed under § 39.5(d)(3). 

See 76 FR at 44474 (July 26, 2011) (Process for 

Review of Swaps for Mandatory Clearing; final 

rule). 

agreements in carrying out the risk 

management program of the DCO. 

MGEX is opposed to sharing 

confidential information such as 

proprietary intellectual property. MGEX 

also asked for further clarity to be able 

to comment further on this requirement. 

The Commission is adopting § 39.22 

as proposed. The provision purposely 

lacks specific details to allow each DCO 

the discretion to make its own 

determination as to which informationsharing agreements are necessary and 

appropriate, including taking into 

account confidentiality concerns. DCOs 

may seek further guidance from 

Commission staff if they have specific 

questions about existing or potential 

information-sharing arrangements. 

N. Core Principle N—Antitrust 

Considerations—§ 39.23 

Core Principle N,248 as amended by 

the Dodd-Frank Act, conforms the 

standard for DCOs with the standard 

applied to DCMs under Core Principle 

19.249 Proposed § 39.23 would codify 

Core Principle N. CME commented that 

the proposed regulation is adequate, and 

the Commission is adopting the rule as 

proposed. 

O. Core Principle R—Legal Risk— 

§ 39.27 

Section 725(c) of the Dodd-Frank Act 

sets forth a new Core Principle R (Legal 

Risk).250 Core Principle R requires a 

DCO to have a well-founded, 

transparent, and enforceable legal 

framework for each aspect of the DCO’s 

activities. Proposed § 39.27 would set 

forth the required elements of such a 

legal framework. The Commission 

solicited comment as to the legal risks 

addressed in proposed § 39.27 and 

whether the rule should address 

additional legal risks. 

CME commented that proposed 

§ 39.27(c)(1), which would require a 

DCO that provides clearing services 

outside the United States to identify and 

address all conflict of law issues, should 

only require a DCO to identify and 

address any ‘‘material’’ conflict of law 

issues. The Commission agrees with 

CME that a DCO should not be 

burdened to identify non-material 

conflict of law issues and has revised 

§ 39.27(c)(1) to provide that such a DCO 

must identify and address ‘‘any material 

conflict of law issues.’’ The Commission 

is otherwise adopting the rule as 

proposed. 

P. Special Enforcement Authority for 

SIDCOs 

Under Section 807(c) of the DoddFrank Act, for purposes of enforcing the 

provisions of Title VIII, a SIDCO is 

subject to, and the Commission has 

authority under the provisions of 

subsections (b) through (n) of Section 8 

of, the Federal Deposit Insurance Act 251

in the same manner and to the same 

extent as if the SIDCO were an insured 

depository institution and the 

Commission were the appropriate 

Federal banking agency for such insured 

depository institution. Proposed § 39.31 

would codify this special authority. The 

Commission did not receive any 

comments on this provision. 

Nevertheless, as discussed above in 

connection with the proposals relating 

to SIDCO financial resources and system 

safeguards for SIDCOs, the Commission 

is not finalizing the rules relating to 

SIDCOs at this time. The Commission 

expects to consider all the proposals 

relating to SIDCOs together in the 

future. 

V. Part 140 Amendments—Delegations 

of Authority 

Under § 140.94, the Commission 

delegates the authority to perform 

certain functions that are reserved to the 

Commission to the Director of the 

Division of Clearing and Risk. In 

connection with the regulations the 

Commission is adopting herein, as well 

as previously adopted § 39.5, the 

Commission is amending § 140.94 to 

delegate authority to perform certain 

functions to the Director of the Division 

of Clearing and Risk, as discussed 

below. 

With respect to DCO applications, 

under § 140.94(a)(6), the Commission is 

delegating authority to determine 

whether a DCO application is materially 

complete under § 39.3(a)(2), and to 

request that an applicant submit 

supplemental information in order for 

the Commission to process a DCO 

application under § 39.3(a)(3). 

In addition to the authority delegated 

to the Director of the Division of 

Clearing and Risk in connection with 

the Commission’s final rulemaking for 

§ 39.5,252 § 140.94(a)(7) delegates 

authority to request specific additional 

information as part of a DCO’s swap 

submission under § 39.5(b)(3)(ix). 

Section 140.94(a)(8) delegates 

authority to grant an extension of time 

for a DCO to file its annual compliance 

report under § 39.10(c)(4)(iv). 

With respect to financial resources 

requirements for DCOs, § 140.94(a)(9) 

delegates authority to: (1) determine 

whether a particular financial resource 

may be used to satisfy the requirements 

of § 39.11(a)(1) under § 39.11(b)(1)(vi); 

(2) determine whether a particular 

financial resource may be used to satisfy 

the requirements of § 39.11(a)(2) under 

§ 39.11(b)(2)(ii); (3) review the 

methodology used to compute the 

requirements of § 39.11(a)(1) and require 

changes as appropriate under 

§ 39.11(c)(1); (4) review the 

methodology used to compute the 

requirements of § 39.11(a)(2) and require 

changes as appropriate under 

§ 39.11(c)(2); (5) request financial 

reporting from a DCO (in addition to the 

quarterly reports) under § 39.11(f)(1); 

and (6) grant an extension of time for a 

DCO to file its quarterly financial report 

under § 39.11(f)(4). 

Section 140.94(a)(10) delegates 

authority to request the periodic 

financial reports of a DCO’s clearing 

members that are not FCMs under 

§ 39.12(a)(5)(i)(B). 

With respect to risk management 

requirements, § 140.94(a)(11) delegates 

authority to: (1) Review percentage 

levels for customer initial margin 

requirements and require different 

percentage levels if levels are deemed 

insufficient under § 39.13(g)(8)(ii); (2) 

review methods, thresholds, and 

financial resources and require the 

application of different methods, 

thresholds, and financial resources as 

appropriate (relating to risk limits on 

clearing members) under 

§ 39.13(h)(1)(i)(C); (3) review the 

amount of additional initial margin 

required of a clearing member permitted 

to exceed its risk threshold and require 

a different amount as appropriate under 

§ 39.13(h)(1)(ii); (4) review the selection 

of accounts and methodology used in 

daily stress testing of large trader 

positions and require changes as 

appropriate under § 39.13(h)(3)(i); (5) 

review methodology for weekly stress 

testing of clearing member accounts and 

swap portfolios and require changes as 

appropriate under § 39.13(h)(3)(ii); and 

(6) request clearing member information 

and documents regarding their risk 

management policies, procedures, and 

practices under § 39.13(h)(5)(i)(A). 

With respect to rule submissions and 

4d petitions relating to the commingling 

of futures, options on futures, and 

cleared swaps in a cleared swaps 

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253See 76 FR at 3715–3716 (Jan. 20, 2011) (Risk 

Management). 

254 7 U.S.C. 6(c). 255 7 U.S.C. 19(a). 

account or futures account, respectively, 

§ 140.94(a)(12) delegates authority to 

request additional information in 

support of a rule submission, under 

§ 39.15(b)(2)(iii)(A), and to request 

additional information in support of a 

4d petition, under § 39.15(b)(2)(iii)(B). 

With respect to DCO reporting 

requirements, § 140.94(a)(13) delegates 

authority to: (1) Grant an extension of 

time for filing of reports required to be 

filed annually under § 39.19(c)(3)(iv); (2) 

request that a DCO file information 

related to its business as a clearing 

organization, including information 

relating to trade and clearing details, 

under § 39.19(c)(5)(i); (3) request that a 

DCO file a written demonstration that 

the DCO is in compliance with one or 

more core principles and relevant rule 

provisions under § 39.19(c)(5)(ii); and 

(4) request that a DCO file, for each 

clearing member, by customer origin, 

the end-of day positions for each 

beneficial owner under § 39.19(c)(5)(iii). 

Finally, § 140.94(a)(14) delegates 

authority to permit a DCO to refrain 

from publishing on its Web site 

information that is otherwise required to 

be published under § 39.21(d). 

VI. Effective Dates 

For purposes of publication in the 

Code of Federal Regulations, all of the 

rules adopted herein will have an 

effective date of 60 days after 

publication in the Federal Register. The 

Commission received a number of 

comments, however, that discussed a 

DCO’s need for time to develop 

appropriate systems and procedures to 

come into compliance with some of the 

rules. The Commission is extending the 

date by which DCOs must come into 

compliance for certain rules as follows: 

DCOs must comply with the following 

rules 180 days after publication in the 

Federal Register: Financial resources— 

§ 39.11; participant and product 

eligibility—§ 39.12; risk management— 

§ 39.13 (except gross margin— 

§ 39.13(g)(8)(i)); and settlement 

procedures—§ 39.14. 

DCOs must comply with the following 

rules 1 year after publication in the 

Federal Register: chief compliance 

officer—§ 39.10(c); gross margin— 

§ 39.13(g)(8)(i); system safeguards— 

§ 39.18; reporting—§ 39.19; and 

recordkeeping—§ 39.20. 

VII. Section 4(c) 

Proposed §§ 39.15(b)(2)(i) and 

39.15(b)(2)(ii) would establish 

procedures for permitting futures and 

options on futures to be carried in a 

cleared swaps account (subject to 

Section 4d(f) of the CEA), and for 

cleared swaps to be carried in a futures 

account (subject to Section 4d(a) of the 

CEA), respectively. In connection with 

proposing those rules, the Commission 

proposed to grant an exemption under 

Section 4(c) of the CEA and requested 

comment on its proposed exemption.253

Section 4(c) of the CEA provides that, 

in order to promote responsible 

economic or financial innovation and 

fair competition, the Commission, by 

rule, regulation or order, after notice 

and opportunity for hearing, may 

exempt any agreement, contract, or 

transaction, or class thereof, 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 CEA, 

or any other provision of the CEA other 

than certain enumerated provisions, if 

the Commission determines that the 

exemption would be consistent with the 

public interest.254

Proper treatment of customer funds 

requires, among other things, 

segregation of customer money, 

securities and property received to 

margin, guarantee, or secure positions in 

futures or options on futures, in an 

account subject to Section 4d(a) of the 

CEA (i.e., a futures account), and 

segregation of customer money, 

securities and property received to 

margin, guarantee, or secure positions in 

cleared swaps, in an account subject to 

Section 4d(f) of the CEA (i.e., a cleared 

swaps account). Customer funds 

required to be held in a futures account 

cannot be commingled with noncustomer funds and cannot be held in 

an account other than an account 

subject to Section 4d(a), absent 

Commission approval in the form of a 

rule, regulation or order. Section 4d(f) of 

the CEA mirrors these limitations as 

applied to customer positions in cleared 

swaps. 

Under the proposed exemption, a 

DCO and its clearing members would be 

exempt from complying with the 

segregation requirements of Section 

4d(a) when holding customer segregated 

funds in a cleared swaps account 

subject to Section 4d(f) of the CEA, 

instead of a futures account; and 

similarly, a DCO and its clearing 

members would be exempt from 

complying with the segregation 

requirements of Section 4d(f) when 

holding customer funds related to 

cleared swap positions in a futures 

account subject to Section 4d(a) of the 

CEA, instead of a cleared swaps 

account. For the reasons discussed 

below, the Commission has determined 

to grant the exemption under Section 

4(c) of the CEA. 

In the notice of proposed rulemaking, 

the Commission expressed its view that 

the adoption of proposed 

§§ 39.15(b)(2)(i) and 39.15(b)(2)(ii) 

would promote responsible economic 

and financial innovation and fair 

competition, and would be consistent 

with the ‘‘public interest,’’ as that term 

is used in Section 4(c) of the CEA. 

However, the Commission solicited 

public comment on whether the 

proposed regulations would satisfy the 

requirements for exemption under 

Section 4(c) of the CEA. 

The Commission received one 

comment. CME supported the 

Commission’s conclusion, agreeing that 

in appropriate circumstances, the 

commingling of customer positions in 

futures, options on futures, and cleared 

swaps could achieve important benefits 

with respect to greater capital efficiency 

resulting from margin reductions for 

correlated positions. CME believes that 

adoption of a regulation permitting such 

commingling would be consistent with 

the public interest, adding that 

‘‘[h]aving positions in a single account 

can also enhance risk management 

practices and systemic risk containment 

by allowing the customer’s portfolio to 

be handled in a coordinated fashion in 

a transfer or liquidation scenario.’’ 

In light of the foregoing, the 

Commission finds that permitting the 

commingling of positions pursuant to 

§§ 39.15(b)(2)(i) and 39.15(b)(2)(ii) will 

promote responsible economic and 

financial innovation and fair 

competition, and is consistent with the 

‘‘public interest,’’ as that term is used in 

Section 4(c) of the CEA. 

VIII. Considerations of Costs and 

Benefits 

Section 15(a) of the CEA requires the 

Commission to ‘‘consider the costs and 

benefits’’ of its actions before 

promulgating a regulation.255 In 

particular, these costs and benefits must 

be evaluated in light of five broad areas 

of market and public concern: (1) 

Protection of market participants and 

the public; (2) efficiency, 

competitiveness, and financial integrity 

of futures markets; (3) price discovery; 

(4) sound risk management practices; 

and (5) other public interest 

considerations. In conducting its 

evaluation, the Commission may, in its 

discretion, give greater weight to any 

one of the five enumerated areas and it 

may determine that, notwithstanding 

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256See, e.g., Fisherman’s Doc Co-op., Inc v. 

Brown, 75 F.3d 164 (4th Cir. 1996); Center for Auto 

Safety v. Peck, 751 F.2d 1336 (D.C. Cir. 1985) 

(noting that an agency has discretion to weigh 

factors in undertaking cost-benefit analysis). 

Section 3 of the CEA states the purposes of the Act: 

It is the purpose of this Act to serve the public 

interests described in subsection (a) through a 

system of effective self-regulation of trading 

facilities, clearing systems, market participants and 

market professionals under the oversight of the 

Commission. To foster these public interests, it is 

further the purpose of this Act to deter and prevent 

price manipulation or any other disruptions to 

market integrity; to ensure the financial integrity of 

all transactions subject to this Act and the 

avoidance of systemic risk; to protect all market 

participants from fraudulent or other abusive sales 

practices and misuses of customer assets; and to 

promote responsible innovation and fair 

competition among boards of trade, other markets 

and market participants. 

257See Letter from Better Markets dated June 3, 

2011; Letter from MFA dated March 21, 2011 

(comment file for 76 FR 3698 (Risk Management)). 

costs, a particular rule is necessary to 

protect the public interest or to 

effectuate any of the provisions or to 

accomplish any of the purposes of the 

CEA.256

In the following discussion, the 

Commission presents its considerations 

of the costs and benefits of the final 

rulemaking in light of the comments it 

received, other relevant data and 

information, and the five broad areas of 

market and public concern as required 

by section 15(a) of the CEA. 

A. Background 

A derivatives clearing organization 

(DCO) is an entity registered with the 

Commission through which derivatives 

transactions are cleared and settled. A 

DCO acts as a central counterparty, 

serving principally to ensure 

performance of the contractual 

obligations of the original counterparties 

to derivatives transactions and to 

manage and mitigate counterparty risk 

and systemic risk in the markets they 

serve. This is accomplished by 

interposing the DCO between the 

counterparties so that the DCO becomes 

the buyer to every seller and the seller 

to every buyer. Upon novation by the 

original parties to a transaction, the 

contractual obligations of the original 

parties to one another are extinguished 

and replaced by a pair of equal and 

opposite transactions between the DCO 

and the counterparties or their agents. 

The DCO’s role as central 

counterparty potentially exposes the 

DCO itself to risk from every user whose 

transactions are cleared through the 

DCO. Conversely, if a DCO itself fails or 

suffers a risk of failure, the 

consequences for the market at large are 

likely to be serious and widespread. 

Effective risk management, therefore, is 

critical to the functioning of a 

marketplace in which swaps are cleared 

through DCOs. 

Clearing members are the entities that 

deal directly with DCOs. They may be 

acting on their own behalf or as agents. 

DCOs establish rules and risk 

management requirements for their 

clearing members, which typically 

include specified levels of financial 

resources, operational capacity, and risk 

management capability; deposit of riskbased initial margin and payment of 

daily variation margin sized to cover 

current and potential losses of the 

member; and contribution to a guaranty 

fund that can be used in the event of a 

clearing member default. These 

requirements lower systemic risk by 

reducing the likelihood of a clearing 

member default and, in the event a 

clearing member default does occur, 

reducing the likelihood that it will 

result in the default of other market 

participants. 

Additionally, unlike bilateral 

derivatives transactions where parties 

do not know the exposures their 

counterparties have to other market 

participants, as a result of the 

multilateral nature of centralized 

clearing, DCOs have a real-time, more 

complete picture of each clearing 

member’s risk exposure to multiple 

parties. Thus the DCO can more 

effectively and quickly identify 

developing risk exposures for individual 

clearing members and better manage 

these risks if clearing members become 

distressed. 

B. General Comments and 

Considerations 

The Dodd-Frank Act is intended to 

facilitate stability in the financial 

system of the United States by reducing 

risk, increasing transparency, and 

promoting market integrity. To 

accomplish these objectives, among 

other things, the Dodd-Frank Act 

provides for the mandatory clearing of 

certain swaps by DCOs and explicitly 

authorizes the Commission to 

promulgate rules to establish 

appropriate standards for DCOs in 

carrying out their risk mitigation 

function. Regulatory standards for DCOs 

will serve to assure market participants 

that credit and other risks associated 

with cleared swap transactions are being 

appropriately managed by DCOs. This, 

in turn, can promote the use of cleared 

swaps. Regulatory standards also can 

foster market confidence in the integrity 

of the derivatives clearing system. 

In this final rulemaking, the 

Commission is adopting regulations to 

implement 15 DCO core principles: A 

(Compliance), B (Financial Resources), 

C (Participant and Product Eligibility), D 

(Risk Management), E (Settlement 

Procedures), F (Treatment of Funds), G 

(Default Rules and Procedures), H (Rule 

Enforcement), I (System Safeguards), J 

(Reporting), K (Recordkeeping), L 

(Public Information), M (Information 

Sharing), N (Antitrust Considerations), 

and R (Legal Risk). In addition, the 

Commission is adopting regulations to 

implement the Chief Compliance Officer 

provisions of Section 725 of the DoddFrank Act, and to update the regulatory 

framework for DCOs to reflect standards 

and practices that have evolved over the 

past decade since the enactment of the 

CFMA. 

This rulemaking process has 

generated an extensive record, which is 

discussed at length throughout this 

notice as it relates to the substantive 

provisions in the final rules. A number 

of commenters expressed the view that 

there would be significant costs 

associated with implementing and 

complying with proposed rules. The 

Commission also received comments 

from KCC, CME, and OCC who stated 

generally that the cost-benefit analysis 

presented in the proposed rulemakings 

was insufficient. The Commission has 

carefully considered alternatives 

suggested by commenters, and in a 

number of instances, for reasons 

discussed in detail above, has adopted 

such alternatives or modifications to the 

proposed rules where, in the 

Commission’s judgment, the alternative 

or modified standard accomplishes the 

same regulatory objective in a more 

cost-effective manner. 

The Commission invited comments 

on the comprehensive or ‘‘systemic’’ 

costs and benefits of the proposed rules. 

MFA and Better Markets addressed this 

issue stating that the Commission’s costbenefit analyses presented in the notices 

of proposed rulemaking may have 

understated the benefits of the proposed 

rules.257 MFA commented that the costs 

to market participants would be 

substantial if the Commission does not 

adopt the proposed regulations. Better 

Markets commented that the only 

reasonable way to consider costs and 

benefits of any of the Commission’s rule 

proposals under Dodd-Frank is to view 

them as a whole. According to Better 

Markets: 

It is undeniable that the Proposed Rules are 

intended and designed to work as a system. 

Costing-out individual components of the 

Proposed Rules inevitably double counts 

costs which are applicable to multiple 

individual rules. It also prevents the 

consideration of the full range of benefits that 

arise from the system as a whole that 

provides for greater stability, reduces 

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69410 Federal Register / Vol. 76, No. 216 / Tuesday, November 8, 2011 / Rules and Regulations 

systemic risk and protects taxpayers and the 

public treasury from future bailouts. 

Better Markets believes that the 

benefits must include the avoided risk 

of a new financial crisis and the best 

measure of this benefit is the cost of the 

2008 financial crisis, which is still 

accumulating. It cited Andrew G. 

Haldane, Executive Director, Financial 

Stability of the Bank of England, who 

estimated that the worldwide cost of the 

crisis in terms of lost output was 

between $60 trillion and $200 trillion, 

depending primarily on the long term 

persistence of the effects. 

The Commission agrees with Better 

Markets that the DCO rules operate in 

an integrated, systemic manner to 

ensure that the risks associated with 

cleared swap transactions are being 

appropriately managed or addressed by 

DCOs. When implemented in their 

entirety, these rules have the potential 

to significantly change not only the 

aggregate risk profile of the entire 

derivatives clearing industry, but also 

the allocation of risks among DCOs, 

clearing firms, and market participants. 

The final rules require DCOs to admit 

firms as clearing members that may 

differ substantially from existing 

members with respect to size, risk 

profiles, specializations, and risk 

management abilities. The rules also 

help create an environment in which 

DCOs will compete for the business of 

clearing trades of different sizes, and of 

many different derivatives products— 

both futures and swaps. In a potentially 

much more diverse range of both 

participants and products, these final 

rules will allow, and in some cases 

require, DCOs to make use of a number 

of risk management tools, including, 

among others, periodic valuation of 

financial resources; a potentially more 

rigorous design for margins; stress 

testing and back testing for financial 

resources and margin, respectively; and 

additional rules and procedures 

designed to allow for management of 

events associated with a clearing 

member defaulting on its obligations to 

the DCO. These rules help reduce the 

potential for DCO default, and the 

potential follow-on effects on financial 

markets as a whole. In addition, the 

daily, quarterly, annual, and eventspecific reporting requirements for 

DCOs enhance the tools available to the 

Commission in conducting its financial 

risk surveillance in connection with 

derivatives clearing by DCOs. 

Certain of the regulations 

promulgated in this final rulemaking 

merely codify the requirements of the 

CEA, as amended by the Dodd-Frank 

Act, e.g., §§ 39.10(a) and (b) (compliance 

with core principles); 39.17 (rule 

enforcement); 39.22 (information 

sharing); and 39.23 (antitrust 

considerations). For such provisions, 

the Commission has not considered 

alternatives to the statute’s prescribed 

requirements, even though a DCO may 

incur costs to comply with these 

provisions. As these requirements are 

imposed by the Dodd-Frank Act, any 

associated costs and benefits are the 

result of statutory directives, as 

previously determined by the Congress, 

that govern DCO activities independent 

of the Commission’s regulations. By its 

terms, CEA Section 15(a) requires the 

Commission to consider and evaluate 

the prospective costs and benefits of 

regulations and orders of the 

Commission prior to their issuance; it 

does not require the Commission to 

evaluate the costs and benefits of the 

actions or mandates of the Congress. 

In its notice of proposed rulemaking, 

the Commission requested data or other 

information in connection with its costbenefit considerations. The Commission 

received only a few comments 

providing quantitative information on 

the costs of the proposed rules. It 

received two comments on the benefits 

of the proposed rules. 

The Commission invited but did not 

receive public comments specific to, or 

related to, its consideration of costs and 

benefits for proposed §§ 1.3, 39.1, 39.2, 

39.4, 39.9, 39.16, 39.18, 39.20, 39.21, 

and 39.27. However, the Commission 

received comments on substantive 

provisions of those proposed rules and 

such comments are addressed above. 

The following discussion summarizes 

the Commission’s consideration of the 

costs and benefits of the final rules 

pursuant to CEA Section 15(a). 

C. Form DCO—§ 39.3(a)(2) 

Section 5b(c)(1) of the CEA provides 

that ‘‘[a] person desiring to register as a 

derivatives clearing organization shall 

submit to the Commission an 

application in such form and containing 

such information as the Commission 

may require for the purpose of making 

the determinations required for 

approval under paragraph (2).’’ 

Paragraph (2), which sets forth the 18 

core principles applicable to DCOs, 

further provides in paragraph (i) that 

‘‘[t]o be registered and to maintain 

registration as a derivatives clearing 

organization, a derivatives clearing 

organization shall comply with each 

core principle described in this 

paragraph and any requirement that the 

Commission may impose by rule or 

regulation pursuant to section 8a(5) [of 

the CEA].’’ Accordingly, the standard 

for approval of DCO registration is the 

applicant’s ability to satisfy the DCO 

core principles. 

Proposed § 39.3(a)(2) would require 

that any person seeking to register as a 

DCO submit a completed Form DCO, 

which would be provided as an 

appendix to part 39 of the Commission’s 

regulations. The Form DCO, composed 

of a cover sheet and list of exhibits, 

would replace the general guidance 

contained in Appendix A to Part 39, 

‘‘Application Guidance and Compliance 

With Core Principles’’ (Guidance), 

which was adopted by the Commission 

in 2001. In accordance with Section 

5b(c) of the Act, the Form DCO is 

designed to elicit a demonstration that 

an applicant can satisfy each of the DCO 

core principles. Toward this end, the 

Form DCO requires submission of 

extensive information about an 

applicant’s intended operations. This 

information has been required of 

applicants under the previous 

Guidance, and the use of the Form DCO 

does not represent a departure in 

substance from the Commission’s 

practices over the past decade. 

Rather, as explained in the proposed 

rulemaking, the Form DCO was 

designed to standardize and clarify the 

information that the Commission has 

required from DCO applicants in the 

past, in an effort to facilitate a more 

streamlined and efficient application 

process. The Commission has learned 

from experience that the general 

guidance contained in the previous 

Appendix A did not provide sufficiently 

specific instructions to applicants. As a 

result, the registration process has been 

prolonged in some cases because of the 

need for Commission staff to provide 

applicants with additional guidance 

about the nature of the information that 

the Commission requires to conclude 

that the applicant has demonstrated its 

ability to comply with the core 

principles. 

The Commission did not receive 

comments specifically with respect to 

its cost-benefit analysis of proposed 

§ 39.3(a)(2) or to its Paperwork 

Reduction Act estimate that the cost of 

preparing a completed application 

would be $100,000. The Commission 

notes that applicants for DCO 

registration will incur direct costs 

associated with the preparation of the 

completed Form DCO. However, 

because the Form DCO to a large extent 

captures information that has already 

been required by the Commission under 

the Guidance or, with respect to new 

core principles, captures information 

that tracks the statutory 

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258Exhibits O, P, and Q, relating to the 

requirements of Core Principles O (Governance 

Fitness Standards), P (Conflicts of Interest), and Q 

(Composition of Governing Boards), respectively. 

259See discussion in Section III.C.1, above. 

requirements,258 the use of the Form 

DCO will not impose greater costs than 

have been imposed in the past. In fact, 

by providing greater clarity as to what 

is expected from an applicant and by 

reducing the need for Commission staff 

to request, and the applicant to provide, 

supplementary information, the Form 

DCO should reduce costs for applicants. 

As discussed in more detail in this 

notice of final rulemaking, the 

Commission received two comment 

letters that addressed the proposed 

Form DCO.259 The comments did not 

oppose the concept of the Form DCO. 

The comments were directed at the large 

amount of information required and the 

necessity of submitting certain specific 

information. One of the comment letters 

focused on the use of the Form DCO for 

amending an existing DCO registration, 

and the Commission has provided a 

clarification to address that 

commenter’s concerns. The Commission 

has determined to adopt the final Form 

DCO largely as proposed, but it has 

modified several of the exhibits in 

response to specific comments. 

The Commission has evaluated the 

costs and benefits of the required use of 

Form DCO, under § 39.3(a)(2), in light of 

the specific considerations identified in 

Section 15(a) of the CEA as follows: 

1. Protection of Market Participants and 

the Public 

Costs 

Applicants currently incur costs in 

demonstrating compliance with the core 

principles. As described above, based 

on the staff’s experience in processing 

DCO applications over the last ten years, 

the Commission believes that use of the 

Form DCO will not increase, and often 

may decrease, the time and expense 

associated with applying for registration 

as a DCO for future applicants. 

Benefits 

The Commission expects that use of 

the Form DCO will promote the 

protection of market participants and 

the public. Given the critical role that 

DCOs play in providing financial 

integrity to the markets for which they 

clear—which now include swaps as 

well as futures markets—it is essential 

that the Commission conduct a 

comprehensive and thorough review of 

all DCO applications. Such review is 

essential for the protection of market 

participants and the public insofar as it 

serves to limit the performance of DCO 

functions to only those entities that 

have provided adequate demonstration 

that they are capable of satisfying the 

core principles. 

2. Efficiency, Competitiveness, and 

Financial Integrity 

Costs 

As noted, the Commission believes 

that use of the Form DCO will not 

increase, and often may decrease, the 

time and expense associated with 

applying for registration as a DCO for 

future applicants. 

Benefits 

The Commission expects that use of 

the Form DCO will promote efficiency, 

competitiveness, and financial integrity. 

As discussed above, the CEA requires 

that prospective DCO registrants submit 

an application and comply with the core 

principles. In connection with these 

requirements, in 2001, the Commission 

adopted the Guidance to assist 

applicants in preparing application 

materials. However, the Commission’s 

experience with protracted reviews of 

draft applications and materially 

incomplete final submissions has 

indicated a need for streamlining the 

application process. 

By requiring the use of Form DCO, the 

Commission is promoting increased 

efficiency by providing greater clarity to 

applicants before they undertake the 

application process, thereby facilitating 

the submission of a materially complete 

final application in the first instance. 

This will also reduce the need for 

submission of supplemental materials 

and consultation between applicants 

and the Commission staff. The result 

will be more cost effective and 

expeditious review and approval of 

applications. This will benefit 

applicants as well as free Commission 

staff to handle other regulatory matters. 

In addition, use of the Form DCO 

makes available to the public the 

Commission’s informational 

requirements so that all prospective 

applicants have a heightened 

understanding of what is involved in 

the preparation and processing of an 

application. It promotes greater 

transparency in the process and will 

enhance competition among DCOs by 

making it easier for qualified applicants 

to undertake and navigate the 

application process in a timely manner. 

The Form DCO is designed to address 

an applicant’s ability to comply with the 

core principles. Compliance with the 

core principles is essential to ensure the 

financial integrity of the derivatives 

clearing process and of derivatives 

markets, generally. In particular, the 

required information in Form DCO 

Exhibits B (financial resources), D (risk 

management), E (settlement 

procedures), F (treatment of funds), G 

(default rules and procedures) and I 

(system safeguards) elicits important 

information supporting the applicant’s 

ability to operate a financially sound 

clearing organization that can provide 

reliable clearing and settlement services 

and appropriately manage the risks 

associated with its role as a central 

counterparty. 

3. Price Discovery 

The Commission does not anticipate 

that use of the Form DCO will impact 

the price discovery process. 

4. Sound Risk Management Practices 

Costs 

As noted, the Commission believes 

that use of the Form DCO will not 

increase, and often may decrease, the 

time and expense associated with 

applying for registration as a DCO for 

future applicants. 

Benefits 

The Commission expects that use of 

the Form DCO will promote sound risk 

management practices. Use of the Form 

DCO will reinforce sound risk 

management by requiring an applicant 

to examine its proposed risk 

management program through the 

preparation of a series of detailed 

exhibits. The submission of exhibits 

relating to risk management also make 

it easier for Commission staff to analyze 

and evaluate an applicant’s ability to 

comply with Core Principle D (risk 

management, which includes 

monitoring and addressing credit 

exposure through margin requirements 

and other risk control mechanisms). 

Sound risk management practices are 

required by the CEA and Commission 

regulations, and are essential to the 

effective functioning of a DCO. 

5. Other Public Interest Considerations 

Costs 

As noted, the Commission believes 

that use of the Form DCO will not 

increase, and often may decrease, the 

time and expense associated with 

applying for registration as a DCO for 

future applicants. 

Benefits 

There are considerable benefits to the 

public in standardizing and 

streamlining the DCO application 

process in terms of more efficient use of 

Commission resources and more costeffective and transparent requirements 

for applicants. DCOs play a key role in 

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69412 Federal Register / Vol. 76, No. 216 / Tuesday, November 8, 2011 / Rules and Regulations 

260The Commission believes that even in the 

absence of this specific rule many DCOs would 

employ well-qualified persons to perform the 

responsibilities of the statutorily-required CCO. In 

such circumstances this rule would not result in 

any additional costs for a DCO. 

261As noted in section IV.A.3, above, the rules do 

not require that the person designated as the CCO 

hold that position, exclusively. A CCO may have 

dual responsibilities so long as the CCO can 

effectively carry out his or her duties as the CCO. 

Accordingly, depending on the skills and 

background of the personnel within a particular 

DCO, a DCO may be able to use an existing staff 

member to perform the duties of the CCO. 

262 In light of the variations that exist today 

among DCO compliance programs, including the 

qualifications of DCO compliance personnel, the 

Commission does not believe it is feasible to 

quantify the incremental costs associated with 

§ 39.10(c). 

supporting the financial integrity of 

derivatives markets, and this role takes 

on even greater significance with the 

Dodd-Frank requirements for swaps 

clearing. A coherent and comprehensive 

approach to DCO registration is needed 

to ensure that only qualified applicants 

will be approved and that they are 

capable of satisfying the requirements of 

the core principles and Commission 

regulations. 

D. Chief Compliance Officer—§ 39.10(c) 

Section 725(b) of the Dodd-Frank Act 

added a new paragraph (i) to Section 5b 

of the CEA to require each DCO to 

designate an individual as its CCO, 

responsible for the DCO’s compliance 

with the CEA and Commission 

regulations and the filing of an annual 

compliance report. 

The provisions regarding the CCO in 

proposed § 39.10(c) would largely 

codify Section 5b(i) of the CEA. There 

are certain provisions, however, that 

effectuate or implement the statutory 

requirements. For example, the 

proposed rules would require that the 

CCO have the appropriate background 

and skills for the position and not be 

disqualified from registration under 

Sections 8a(2) or 8a(3) of the CEA; meet 

with the board of directors or the senior 

officer at least once a year to discuss the 

DCO’s compliance program; and 

perform duties including establishing a 

code of ethics. In addition, with respect 

to the annual report, the proposed rules 

would set forth certain content 

requirements (e.g., discussing areas for 

compliance program improvement and 

listing any material changes to 

compliance policies and procedures 

since the last annual report) and 

procedural requirements (e.g., 

submitting the annual report to the 

board of directors or senior officer prior 

to submitting the report to the 

Commission, and submitting the annual 

report not more than 90 days after the 

end of the DCO’s fiscal year unless the 

Commission grants an extension of 

time.) 

As discussed in detail above, the 

Commission received a number of 

comments that supported the proposed 

rules for CCOs and the annual 

compliance report, and other comments 

that suggested alternatives or 

refinements to the Commission’s 

proposed rules. Commenters did not 

provide any quantitative data regarding 

the costs to either DCOs or market 

participants and the public. The 

Commission addressed those comments 

above and, where appropriate, the final 

rules reflect commenters’ suggestions. 

One commenter, MGEX, expressed 

concerns that relate to the Commission’s 

implementation of the compliance 

framework established by Congress. 

MGEX stated that the regulations 

regarding organizational structure and 

reporting lines seem ‘‘excessive and 

beyond what was contemplated by the 

passage of the Dodd-Frank Act.’’ It also 

believes that the regulations do not 

‘‘guarantee improved market protection, 

which is one of the main goals of the 

Dodd-Frank Act.’’ 

The Commission does not agree with 

MGEX that the rules exceed what was 

contemplated by Congress. To a great 

extent the rules codify the relevant 

provisions of the CEA, as amended, and 

it was Congress, not the Commission, 

that specified the compliance 

framework that the Commission is now 

implementing. The additional 

requirements set forth by the rules are 

designed to increase the CCO’s 

effectiveness and ensure that the annual 

report is a useful compliance and 

oversight tool. 

MGEX also commented that ‘‘the rules 

will impose a cost and burden on the 

market that will be passed along to the 

market participants which decreases the 

overall efficiency and risk mitigation.’’ 

MGEX did not provide any details to 

support its conclusion. 

The Commission disagrees with 

MGEX that the Commission’s rules will 

impose such a significant burden on the 

market and market participants. The 

principal costs of the CCO requirement 

result from the statutory provisions of 

the CEA which, as amended by the 

Dodd-Frank Act, requires each DCO to 

designate a CCO and submit an annual 

compliance report. Although the 

Commission’s rules would impose 

certain additional costs in order to 

implement this statutory requirement, 

these additional costs are not expected 

to significantly increase costs to the 

DCO or market participants. For 

example, a DCO may incur higher costs 

to the extent that it needs to pay a 

higher salary to a person who has the 

qualifications set forth in the rule to 

perform the statutory and regulatory 

duties of the CCO.260 The Commission 

believes that such costs are appropriate 

because it has determined that a CCO 

should have these qualifications to be 

effective, and notes that the standards 

are general enough to provide 

reasonable discretion to the DCO in its 

designation of a CCO.261 Similarly, a 

DCO may have to incur higher costs in 

terms of staff time to prepare an annual 

report that contains the information 

required by § 39.10(c)(3), as opposed to 

a less comprehensive annual report. 

However, the Commission believes that 

the annual report must contain adequate 

information if it is to be useful to the 

DCO and the Commission. The 

Commission does not anticipate that 

these costs of hiring a qualified CCO, or 

of preparing a more detailed annual 

report, will be significantly higher than 

the costs to the DCO imposed by the 

basic statutory requirements for the 

CCO.262

For purposes of the Paperwork 

Reduction Act, the notice of proposed 

rulemaking estimated the cost of 

preparing the annual report to be $8000 

to $9000 per year. The Commission 

received no comments on this estimate. 

The Commission received comments 

that the annual report should be more 

limited than proposed. The Commission 

notes that those comments did not 

suggest limiting the annual report to 

achieve a more favorable cost-benefit 

ratio, and the Commission addressed 

those comments above. 

The Commission has evaluated the 

costs and benefits of § 39.10(c) in light 

of the specific considerations identified 

in Section 15(a) of the CEA as follows: 

1. Protection of Market Participants and 

the Public 

Costs 

As discussed above, there are likely to 

be direct costs to DCOs in connection 

with designating a qualified CCO and 

annually preparing a comprehensive 

compliance report. To the extent that 

the Commission’s regulations impose 

more specific or supplemental 

requirements when compared to those 

requirements explicitly imposed by 

Section 5b(i) of the CEA, those 

incremental costs are not likely to be 

significant. While it is possible that 

those incremental costs will be passed 

along to clearing members and market 

participants in the form of increased 

clearing fees, the size of those 

incremental costs, when spread across 

recipients of clearing services, are likely 

to be negligible. 

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Federal Register / Vol. 76, No. 216 / Tuesday, November 8, 2011 / Rules and Regulations 69413 

263The Commission also proposed § 39.29 which 

would apply certain stricter requirements to 

SIDCOs. As discussed above, the Commission is not 

taking action on those proposed rules as part of this 

final rulemaking. 

264See discussion in Section IV.B, above. 

Benefits 

The Commission believes that the 

CCO rules will protect market 

participants and the public by 

promoting compliance with the core 

principles and Commission regulations 

through the designation and effective 

functioning of the CCO, and the 

establishment of a framework for 

preparation of a meaningful annual 

review of a DCO’s compliance program. 

While there may be incremental costs 

associated with imposition of the 

Commission’s regulatory standards, 

those costs may be mitigated by the 

countervailing benefits of an effective 

compliance program that fosters 

financial integrity of the clearing 

process and responsible risk 

management practices to protect the 

public from the adverse consequences 

that would result from a DCO failure. 

The annual compliance report, in 

particular, will help the DCO and the 

Commission to assess whether the DCO 

has mechanisms in place to adequately 

address compliance issues and whether 

the DCO remains in compliance with 

the core principles and the 

Commission’s regulations. Such 

compliance will protect market 

participants and the public. 

2. Efficiency, Competitiveness, and 

Financial Integrity 

Costs 

The Commission believes that 

designation of a qualified CCO who will 

effectively perform required duties, 

including the preparation of an annual 

compliance report, will not increase 

costs and is likely to lead to reduction 

of costs, in terms of the efficiency, 

competitiveness, and financial integrity 

of the derivatives markets. 

Benefits 

Clearing is a critical component of the 

efficient, competitive, and financially 

sound functioning of derivatives 

markets. The financial integrity of these 

markets, in particular, is achieved 

through layers of protection. 

Requirements for an effective DCO 

compliance program will add a new 

layer of protection to ensure that the 

DCO remains compliant with the CEA 

and Commission regulations, especially 

relating to Core Principles B (financial 

resources), D (risk management), E 

(settlement procedures), F (treatment of 

funds), G (default rules and procedures), 

I (system safeguards), and N (antitrust 

considerations). 

An effective CCO will provide 

benefits to DCOs and the markets they 

serve by implementing measures that 

enhance the safety and efficiency of 

DCOs and reduce systemic risk. Reliable 

and financially sound DCOs are 

essential for the stability of the 

derivatives markets they serve, and for 

the greater public which benefits from a 

sound financial system. 

3. Price Discovery 

The Commission does not anticipate 

that § 39.10(c) will impact the price 

discovery process. 

4. Sound Risk Management Practices 

Costs 

The Commission does not believe that 

the CCO provisions will impose costs in 

terms of sound risk management 

practices. To the contrary, the 

Commission perceives there to be 

benefits that will result from its CCO 

implementing regulations. 

Benefits 

The regulatory provisions that 

interpret or implement the statutory 

requirements for the CCO and annual 

report serve to enhance the standards 

for a DCO’s compliance program which 

will necessarily emphasize risk 

management compliance because of its 

significance to the overall purpose and 

functioning of the DCO. Compliance 

with Core Principle D (risk 

management) and related regulations 

encompasses, among other things, 

measurement and monitoring of credit 

exposures to clearing members, 

implementation of effective risk-based 

margin methodologies, and appropriate 

calculation and back testing of margin 

levels. It is the responsibility of the CCO 

to ensure that the DCO is compliant 

with Core Principle D and the 

regulations thereunder, and is otherwise 

engaged in appropriate risk management 

activities in accordance with the DCO’s 

own rules, policies and procedures. 

5. Other Public Interest Considerations 

The Commission does not believe that 

the rule will have a material effect on 

public interest considerations other than 

those identified above. 

E. Financial Resources—§ 39.11 

Section 5b(c)(2)(B) of the CEA, Core 

Principle B, as amended by the DoddFrank Act, requires a DCO to possess 

financial resources that, at a minimum, 

exceed the total amount that would 

enable the DCO to meet its financial 

obligations to its clearing members 

notwithstanding a default by the 

clearing member creating the largest 

financial exposure for the DCO in 

extreme but plausible market 

conditions, and to cover its operating 

costs for a period of one year, calculated 

on a rolling basis. 

Proposed § 39.11 would codify these 

requirements and set forth additional 

standards for the types of financial 

resources that are acceptable 

(§ 39.11(b)); computation of the amount 

of financial resources required to satisfy 

the statutory default and operational 

resources requirements (§ 39.11(c)); 

valuation of financial resources 

(§ 39.11(d)); liquidity of financial 

resources (§ 39.11(e)); and quarterly 

reporting of financial resources 

(§ 39.11(f)).263

As discussed in more detail above, the 

Commission received comment letters 

requesting further clarity as to the 

proposed requirements. The 

Commission also received comment 

letters that discussed how the proposed 

rules might impose costs or burdens on 

DCOs.264 Two commenters objected to 

the requirement that DCOs must 

monitor ‘‘on a continual basis’’ a 

clearing member’s ability to meet 

potential assessments, which one of the 

commenters characterized as ‘‘overly 

burdensome and difficult to 

administer.’’ Regarding the proposed 

restrictions on the use of assessment 

powers, another commenter stated that 

the inclusion of assessment powers as a 

financial resource is necessary for it to 

meet its obligations in the event of a 

default. Two commenters recommended 

that the Commission permit letters of 

credit to be considered in the financial 

resources computation. Finally, several 

DCOs urged the Commission to allow 

U.S. Treasuries, in addition to cash, as 

a financial resource sufficient to meet 

the proposed financial resource 

liquidity requirement. 

As discussed above, in proposing that 

a DCO ‘‘monitor, on a continual basis, 

the financial and operational capacity of 

its clearing members to meet potential 

assessments,’’ the Commission did not 

intend to require real-time monitoring of 

clearing members. Rather, the purpose 

of the provision was to require a DCO 

to monitor often enough to enable it to 

become aware of any potential problems 

in a timely manner. The Commission 

has modified § 39.11(d)(2)(ii) to remove 

the ‘‘continual basis’’ standard, leaving 

the DCO to exercise its discretion in 

determining the appropriate frequency 

of periodic reviews or more frequent 

reviews as circumstances warrant in 

connection with particular clearing 

members. 

The Commission is permitting DCOs 

to include potential clearing member 

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69414 Federal Register / Vol. 76, No. 216 / Tuesday, November 8, 2011 / Rules and Regulations 

265Commenters did not provide the Commission 

with quantitative data regarding such costs. 

assessments in calculating default 

financial resources, as proposed, subject 

to the limitations of § 39.11(d)(2)(iii) (30 

percent haircut) and § 39.11(d)(2)(iv) 

(DCO may count the value of 

assessments, after the haircut, to meet 

up to 20 percent of its default resources 

requirement). The comments on this 

proposal were varied. Some commenters 

stated that the Commission had 

proposed an appropriate, balanced 

approach; others stated that the 

limitations on assessments were too 

strict; and still others stated that the 

Commission should not permit 

assessments to count at all. 

It is the Commission’s view that, in 

light of recent market events and as a 

general matter, it is not prudent to 

permit a DCO to rely on letters of credit. 

However, for the reasons discussed 

above, the Commission would consider 

permitting letters of credit to be 

included as a DCO financial resource on 

a very limited case-by-case basis. 

Finally, the Commission is revising 

§ 39.11(e)(1) so that, in addition to cash, 

a DCO may use U.S. Treasury 

obligations and high quality, liquid, 

general obligations of a sovereign nation 

to satisfy financial resource liquidity 

requirements. This revised standard 

reflects the current practices of U.S. and 

foreign-based DCOs. 

The Commission has evaluated the 

costs and benefits of § 39.11 in light of 

the specific considerations identified in 

Section 15(a) of the CEA as follows: 

1. Protection of Market Participants and 

the Public 

Costs 

The regulations require DCOs to take 

specific actions to ensure that they are 

able to meet the statutory requirements 

for covering default and operating 

expenses. These actions include 

monthly stress testing to calculate what 

those financial obligations are, and 

quarterly reporting to the Commission 

to demonstrate the adequacy of financial 

resources in terms of dollar amount and 

liquidity. DCOs will incur direct costs 

related to staffing and technology 

programming to calculate, monitor, and 

report financial resources. 

Existing DCOs will have already 

implemented certain practices and 

systems for tracking and managing 

financial resources in order to comply 

with Core Principle B, as originally 

enacted in 2000. Given the staffing and 

operational differences among DCOs, 

the Commission is unable to accurately 

estimate or quantify the additional costs 

DCOs may incur to comply with the 

new financial resource rules.265

Moreover, the cost-effects of new 

cleared products and new market 

participants clearing those products are 

too speculative and uncertain for the 

Commission to be able to quantify or 

estimate at this time. Such costs or 

benefits will depend upon a number of 

variables that are not estimable or 

quantifiable at this time, such as the 

nature and number of the new products 

that become subject to clearing, the 

nature and number of market 

participants that enter into transactions 

involving such products, and the 

resulting costs or benefits to such 

market participants from the clearing of 

such products. 

As to costs associated with 

restrictions the Commission is imposing 

on the types and valuation of financial 

resources that may be counted as 

financial resources for purposes of 

satisfying Core Principle B, those too 

will vary among DCOs. For example, for 

DCOs that do not include potential 

clearing member assessments in their 

calculations of financial resources, the 

limitations on assessments will not 

result in increased costs. For DCOs that 

to any extent rely on potential 

assessments, the new limitations might 

require revisions to their default 

management plans, an increase in 

guaranty fund requirements, or an 

infusion of additional capital. The same 

would apply to letters of credit that 

cannot be considered to be financial 

resources for purposes of complying 

with Core Principle B, absent relief. 

Again, because of the range of 

circumstances of different DCOs, it is 

not feasible to estimate or quantify the 

costs of the safeguards imposed by the 

Commission’s financial resource rules. 

Benefits 

The financial resource rules establish 

uniform standards that further the goals 

of avoiding market disruptions and 

financial losses to market participants 

and the general public, and avoiding 

systemic problems that could arise from 

a DCO’s failure to maintain adequate 

default or operating resources. While it 

is not possible to estimate or quantify 

the benefits to market participants and 

the public in facilitating the financial 

soundness of a DCO, the Commission 

believes that a DCO failure, regardless of 

the size of the DCO, could adversely 

affect the financial markets, market 

participants, and the public. 

2. Efficiency, Competitiveness, and 

Financial Integrity 

Costs 

As discussed in connection with 

factor 1 above, quantification or 

estimation of these costs and benefits is 

not readily feasible. For some DCOs, the 

financial resource rules will have little 

or no direct or indirect impact. For 

others, the impact may be more 

substantial. Although there may be 

disparate impact among DCOs, overall 

the rules are not expected to impose 

significant costs in terms of efficiency, 

competitiveness, or financial integrity of 

derivatives markets. 

Benefits 

The regulations promote financial 

strength and stability, thereby fostering 

efficiency and a greater ability to 

compete in the broader financial 

markets. The regulations promote 

competition by preventing DCOs that 

lack adequate financial safeguards from 

expanding in ways that may ultimately 

harm the broader financial market. The 

regulations promote efficiency insofar as 

DCOs that operate with adequate 

financial resources are less likely to fail. 

The regulations are designed to ensure 

that DCOs can meet their financial 

obligations to market participants, thus 

contributing to the financial integrity of 

the derivatives markets as a whole. 

As highlighted by recent events in the 

global financial markets, maintaining 

sufficient financial resources is a critical 

aspect of any financial entity’s risk 

management system, and ultimately 

contributes to the goal of stability in the 

broader financial markets. Therefore, 

the Commission believes it is prudent to 

include financial resources 

requirements for entities applying to 

become or operating as DCOs. Finally, 

Congress has determined that a DCO 

must comply with Core Principle B to 

achieve the purposes of the CEA and the 

Commission has determined that § 39.11 

sets forth the minimum standards for a 

DCO to do so. 

3. Price Discovery 

The Commission does not believe that 

this rule will have a material effect on 

price discovery. 

4. Sound Risk Management Practices 

Costs 

Adequate financial resources are a 

corollary to strong risk management. To 

the extent that the financial resource 

rules result in additional costs, these 

costs are associated with implementing 

the practices and procedures that are 

necessary to ensure a DCO has adequate 

financial resources. 

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Federal Register / Vol. 76, No. 216 / Tuesday, November 8, 2011 / Rules and Regulations 69415 

Benefits 

The regulations, by setting specific 

standards with respect to how DCOs 

should assess, monitor, and report the 

adequacy of their financial resources, 

contribute to DCOs’ maintenance of 

sound risk management practices and 

further the goal of minimizing systemic 

risk. The reporting requirements, in 

particular, will enable the Commission 

to conduct more thorough and 

meaningful oversight of DCOs that will 

contribute to improved risk 

management by DCOs overall. 

5. Other Public Interest Considerations 

Costs 

The Commission has not identified 

any public interest considerations that 

would be negatively affected by the 

provisions of the financial resource 

rules that effectuate or implement the 

statutory requirements of Core Principle 

B (financial resources). 

Benefits 

The benefits to the public of a DCO 

maintaining adequate financial 

resources are discussed above. 

F. Participant and Product Eligibility— 

§ 39.12 

Participant Eligibility 

Section 5b(c)(2)(C) of the CEA, Core 

Principle C, as amended by the DoddFrank Act, requires each DCO to 

establish appropriate admission and 

continuing eligibility standards for 

members of, and participants in, the 

DCO, including sufficient financial 

resources and operational capacity to 

meet the obligations arising from 

participation. Core Principle C further 

requires that such participation and 

membership requirements be objective, 

be publicly disclosed, and permit fair 

and open access. Core Principle C also 

requires that each DCO establish and 

implement procedures to verify 

compliance with each participation and 

membership requirement, on an ongoing 

basis. 

As discussed above, the Commission 

crafted the provisions of proposed 

§ 39.12(a) and related rules to establish 

a regulatory framework that 

accomplishes two goals: (1) to provide 

for fair and open access, while (2) 

limiting risk to the DCO and its clearing 

members. The provisions in 

§ 39.12(a)(1) provide for fair and open 

access in a number of ways. A DCO is 

prohibited from adopting restrictive 

clearing member standards if less 

restrictive requirements that would not 

materially increase risk to the DCO or 

clearing members could be adopted 

(§ 39.12(a)(1)(i)); a DCO must allow all 

market participants who satisfy 

participation requirements to become 

clearing members (§ 39.12(a)(1)(ii)); the 

standards must be non-discriminatory 

(§ 39.12(a)(1)(iii)); and they may not 

require clearing members to be swap 

dealers (§ 39.12(a)(1)(iv)), or clearing 

members to maintain a swap portfolio of 

any particular size or meet a swap 

transaction volume threshold 

(§ 39.12(a)(1)(v)). 

Section 39.12(a)(2) facilitates greater 

participation by requiring that capital 

requirements for clearing members be 

based on objective, transparent, and 

commonly accepted standards that 

appropriately match capital to risk 

(§ 39.12(a)(2)(i)); and by setting the 

minimum capital requirement at not 

more than $50 million (§ 39.12(a)(2)(ii)). 

A number of commenters supported 

the proposed rules. They asserted that 

increased access to clearing would 

stimulate competition and diversify 

risk. A number of other commenters 

opposed aspects of the proposed rules, 

particularly the $50 million capital 

standard. They argued that these 

provisions could increase risk by 

providing access to firms with 

insufficient financial resources or 

operational capacity. 

The Commission did not receive any 

comments that quantified the costs 

associated with the proposed 

participation rules. Instead, commenters 

focused on qualitative considerations, 

including how the proposed rules 

would affect market participants, market 

risk, efficiency, competitiveness, the 

financial integrity of futures markets, 

and price discovery. 

The Commission is adopting these 

provisions essentially as proposed. 

The Commission has evaluated the 

costs and benefits of the proposed 

regulations in light of the specific 

considerations identified in Section 

15(a) of the CEA, as follows: 

1. Protection of Market Participants and 

the Public 

Costs 

The participant eligibility rules may 

result in costs beyond those incurred in 

the normal course of operating a DCO or 

clearing firm, but such potential costs 

are, at this time, speculative in nature 

and impossible to estimate or quantify. 

By providing access to clearing to 

additional firms, the rules could impose 

costs on DCOs, other clearing members, 

or customers if a firm admitted to 

clearing membership in a DCO pursuant 

to these rules failed to meet its 

obligations. Any such costs depend 

upon a number of factors that are not 

presently knowable, quantifiable, or 

estimable. 

It is not possible to estimate or 

quantify these costs in a reliable way for 

a number of reasons. The historical 

record prior to the enactment of the 

Dodd-Frank Act with respect to the 

operation of clearing organizations 

provides little guidance as to the costs 

that may be incurred in the future in the 

unlikely event of a default at a DCO. 

Defaults at DCOs are very rare and the 

circumstances of each one are unique. 

Moreover, the Dodd-Frank Act and 

implementing regulations will alter the 

landscape significantly. Existing DCOs 

and FCMs will be clearing new 

products. New DCOs and FCMs will 

enter the market. Mandatory clearing 

will bring new products and 

participants to DCOs and FCMs. The 

interaction of all these factors creates a 

wide range of uncertainty as to the 

nature of the potential consequences of 

a default under the new regulatory 

regime. In sum, the Commission 

believes that the possible future 

circumstances leading to and potential 

resulting consequences of a DCO default 

are too speculative and uncertain to be 

able to quantify or estimate the resulting 

costs to DCOs, clearing members, or 

market participants with any precision 

or degree of magnitude. 

Whatever these potential costs, the 

Commission believes that the 

participant eligibility rules will reduce 

the risk that clearing members will in 

fact incur such costs. First, increased 

access to clearing membership should 

reduce concentration at any one clearing 

member and diversify risk. Second, the 

rules contain risk management 

provisions specifically designed to 

minimize the likelihood and extent of 

defaults. The provisions in § 39.12(a)(2) 

set forth requirements that mandate 

DCOs: Require that all clearing members 

have sufficient financial resources to 

meet obligations arising from 

participation in the DCO 

(§ 39.12(a)(2)(i)); establish capital 

requirements that are scalable so that 

they are proportional to the risks posed 

by clearing members (§ 39.12(a)(2)(ii)); 

require that clearing members have 

adequate operational capacity to meet 

obligations arising from participation in 

the DCO (§ 39.12(a)(3)); verify the 

compliance of each clearing member 

with the requirements of the DCO 

(§ 39.12(a)(4)); satisfy certain reporting 

requirements (§ 39.12(a)(5)); and have 

the ability to enforce participation 

requirements (§ 39.12(a)(6)). 

For reasons similar to those described 

above, it is also not feasible to quantify 

or estimate this reduction in costs with 

any confidence. Based on its judgment 

and experience with the regulation and 

operation of clearing organizations, the 

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69416 Federal Register / Vol. 76, No. 216 / Tuesday, November 8, 2011 / Rules and Regulations 

266Proposed § 39.12(b)(7) will be addressed in a 

separate rulemaking. 

Commission believes that these rules 

will lower the risk that clearing 

members will in fact incur such costs. 

However, the possible future 

circumstances leading to and potential 

resulting consequences of a future 

default are too speculative and 

uncertain to quantify or estimate, either 

under the current regulatory regime or 

under the rules being adopted by the 

Commission. 

Benefits 

Greater access to clearing should 

benefit market participants by 

increasing competition among clearing 

members. Allowing more firms to clear 

should increase competition among 

clearing firms on both price and service 

which should, in turn, reduce costs to 

market participants. Further, the 

safeguards in § 39.12(a)(2) will benefit 

DCOs, clearing members, and market 

participants by reducing risk. 

Reductions in risk also benefit the 

general public by decreasing the 

probability of a systemic failure. 

For the reasons described above in 

connection with costs, it is also 

impractical to quantify or estimate these 

benefits associated with reductions in 

risk to clearing members, market 

participants, and the public. 

2. Efficiency, Competitiveness, and 

Financial Integrity 

Costs 

The considerations under this factor 

are very similar to the considerations 

under the previous factor with respect 

to participant eligibility requirements. 

Quantification or estimation of these 

costs and benefits is not feasible for the 

reasons set forth under the first factor. 

The potential increase in risk of default 

resulting from open access is mitigated 

by the decrease in risk resulting from 

diversification of risk, increased 

competition, and the safeguards set 

forth in § 39.12(a)(2). 

Benefits 

By opening access the rules should 

increase competition among clearing 

members thereby resulting in increased 

efficiency in the provision of clearing 

services. The safeguards in the rules 

such as the requirement that DCOs 

impose risk limits on clearing members 

will enhance the financial integrity of 

the DCO and its clearing members. 

3. Price Discovery 

Costs 

The Commission has not identified 

any way in which the rules will impair 

price discovery. 

Benefits 

Increased competition among clearing 

members could bring more participants 

into the markets which could result in 

more competitive pricing and enhanced 

price discovery. 

4. Sound Risk Management Practices 

Costs 

According to some commenters, the 

open access rules could hinder sound 

risk management practices by admitting 

clearing members unable to participate 

in the default management process. 

Other commenters assert that the rules 

provide appropriate protections and 

will facilitate sound risk management 

practices. The Commission believes that 

the open access rules, when coupled 

with the default management rules 

discussed below, will not impair sound 

risk management practices. Under the 

rules, clearing members will be required 

to demonstrate that they have 

operational capacity to carry out their 

responsibilities as well as sufficient 

financial resources to meet their 

obligations. 

Benefits 

As explained above, the provisions in 

§ 39.12(a)(2) require that DCOs establish 

a risk management framework with 

respect to their members. In addition, 

open access should lead to 

diversification of risk at DCOs and allow 

additional firms to assist in the 

resolution of any defaults. 

5. Other Public Interest Considerations 

Costs 

The Commission has not identified 

any other public interest considerations 

that would be negatively affected by the 

potential costs of the eligibility 

requirements. 

Benefits 

The CEA, as amended by the DoddFrank Act, requires DCOs to allow for 

open access and, therefore, broader 

participation. The Commission believes 

that greater participation in clearing 

could increase liquidity in the markets. 

This could help prevent price 

manipulation or other anti-competitive 

practices because it will be harder to 

organize concerted efforts to achieve 

such ends. Finally, Congress has 

determined that a DCO must comply 

with Core Principle C to achieve the 

purposes of the CEA and the 

Commission has determined that 

§ 39.12(a) sets forth the minimum 

standards for a DCO to comply with the 

CEA’s participation requirements. 

Product Eligibility 

Core Principle C also requires a DCO 

to establish ‘‘appropriate standards for 

determining the eligibility of 

agreements, contracts, or transactions 

submitted to the [DCO] for clearing.’’ 

Section 39.12(b) implements this 

provision. 

Proposed § 39.12(b)(1) would require 

a DCO to establish requirements for 

determining product eligibility taking 

into account the DCO’s ability to 

manage risks associated with the 

product. Proposed §§ 39.12(b)(2) and 

(b)(3) would codify section 2(h)(1)(B) of 

the CEA. Proposed § 39.12(b)(4) would 

prohibit a DCO from requiring an 

executing party to be a clearing member 

in order for the product to be eligible for 

clearing. Proposed § 39.12(b)(5) would 

require a DCO to select contract units 

for clearing purposes that maximize 

liquidity, facilitate transparency, 

promote open access, and allow for 

effective risk management. Proposed 

§ 39.12(b)(6) would require novation 

upon acceptance of a swap. Finally, 

proposed § 39.12(b)(8) would require a 

DCO to confirm the terms of a swap at 

the time the swap is accepted for 

clearing.266

The Commission did not receive any 

comments directly addressing costbenefit considerations. The Commission 

did receive several comments on 

substantive provisions that bear on 

those considerations. One commenter 

suggested that § 39.12(b)(4) may be an 

impediment to the development of new 

DCOs. Several commenters suggested 

that it would be impractical or 

inappropriate for a DCO to establish 

unit sizes for clearing that differ from 

the unit size at execution (§ 39.12(b)(5)). 

The Commission also received several 

comments requesting clarification of 

certain provisions. As discussed above, 

the Commission has made changes to 

these rules that are responsive to the 

comments. 

The Commission is adopting 

§ 39.12(b) largely as proposed with 

several clarifying amendments as 

discussed above. 

The Commission has evaluated the 

costs and benefits of § 39.12(b) in light 

of the specific considerations identified 

in Section 15(a) of the CEA, as follows: 

1. Protection of Market Participants and 

the Public 

Costs 

The Commission has not identified 

any new costs arising out of 

§§ 39.12(b)(1), 39.12(b)(6), or 

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267Section 5b(c)(2)(D) of the CEA; 7 U.S.C. 7a– 

1(c)(2)(D). 

39.12(b)(8). DCOs currently perform risk 

analysis before accepting new products 

for clearing, currently novate trades 

upon acceptance, and currently issue 

confirmations to clearing members. 

As noted, one commenter suggested 

that prohibiting a DCO from requiring 

one of the original executing parties to 

be a clearing member in order for a 

contract to be eligible for clearing may 

be an impediment to the development of 

new DCOs. The Commission believes 

that, to the contrary, such restrictions on 

product eligibility for clearing increase 

overall costs for market participants, 

and that prohibiting such restrictions 

will lead to lower overall costs. Such 

restrictions deny the availability and 

benefits of clearing to non-clearing 

members. Open access will enable nonclearing members to obtain the benefits 

of clearing and increase competition in 

clearing and trading, thereby increasing 

liquidity, and reducing costs. 

The commenters who questioned the 

unit size provision did not elaborate on 

the costs. It is not feasible to quantify 

these costs for a number of reasons. The 

rule provides DCOs with significant 

flexibility in selecting unit sizes. 

Different DCOs may select different 

sizes for the same or similar products. 

Numerous SEFs will also be making 

judgments concerning unit size which 

will influence the decisions of DCOs 

and traders. Some products will be 

subject to mandatory clearing and others 

to voluntary clearing. The unpredictable 

interaction of these variables creates a 

wide range of uncertainty as to the 

nature of the consequences of the 

selection of unit sizes by DCOs. Similar 

considerations apply to the other 

provisions of § 39.12(b). In sum, the 

Commission believes that the possible 

future circumstances leading to, and the 

potential resulting consequences of, the 

implementation of § 39.12(b) are too 

speculative and uncertain to be able to 

quantify or estimate resulting costs with 

any precision or degree of magnitude. 

Benefits 

The Commission believes that 

§ 39.12(b) will protect market 

participants and the public in many 

ways. First, these provisions are likely 

to facilitate the standardization of 

swaps, thereby eliminating differences 

between the terms of a swap as cleared 

at the DCO level and as carried at the 

customer level. Any such outstanding 

differences would raise both customer 

protection and systemic risk concerns. 

From a customer protection standpoint, 

if the terms of the swap at the customer 

level differ from those at the clearing 

level, then the customer still has a 

bilateral position opposite its 

counterparty. The customer is still 

exposed to the credit risk of the 

counterparty and the position would not 

be able to be offset against other 

positions at the DCO. Similarly, from a 

systemic perspective, any differences in 

terms between the trades would 

eliminate the possibility of multilateral 

offset and thereby diminish liquidity. 

Second, § 39.12(b) can promote 

liquidity by permitting more parties to 

trade the product and by permitting 

more clearing members to clear the 

product. Third, it can enhance risk 

management by enabling a DCO, in the 

event of a default, to have more 

potential counterparties for liquidation. 

Fourth, these provisions will support 

the requirement in section 2(h)(1)(B) of 

the CEA and proposed § 39.12(b)(2) that 

a DCO must adopt rules providing that 

all swaps with the same terms and 

conditions submitted to the DCO are 

economically equivalent within the 

DCO and may be offset with each other. 

Fifth, clearing will eliminate the need 

for a counterparty to ascertain the 

credit-worthiness of each of its 

counterparties. This will promote 

liquidity, competition, and financial 

integrity to the benefit of all market 

participants. 

2. Efficiency, Competitiveness, and 

Financial Integrity 

Costs 

The Commission has not identified 

any ways in which the proposals would 

reduce efficiency, competitiveness, or 

financial integrity. 

Benefits 

The rules should increase 

participation by clearing members, 

which should increase competition 

among clearing members to provide 

services to customers. In addition, the 

rules will lead to standardization of 

products. Finally, the rules will allow 

for more clearing through novation, 

which should result in increased open 

interest and liquidity. In turn, this 

should lead to more competitive and 

efficient markets. As noted above, 

smaller units can promote liquidity and 

encourage prospective clearing members 

to bid on positions and enable them to 

accept a forced allocation in the event 

of a clearing member’s default. This 

facilitates open access, and at same time 

promotes risk management by enabling 

a DCO, in the event of a default, to be 

able to rely on more potential 

counterparties for liquidation. 

3. Price Discovery 

Costs 

The Commission has not identified 

any ways in which the rules would 

reduce price discovery. 

Benefits 

As discussed above, the rules will 

increase competition, which should 

enhance price discovery by bringing 

more participants into the markets. In 

addition, standardization means that 

prices observed on different trades are 

more directly comparable, which can 

improve price discovery. 

4. Sound Risk Management Practices 

Costs 

The Commission has not identified 

any ways in which the rules would 

impair sound risk management 

practices. 

Benefits 

The rules require DCOs to establish 

appropriate standards for determining 

the eligibility of contracts submitted to 

the DCO for clearing taking into account 

the DCO’s ability to manage risks 

associated with the product. Such 

standards are a sound risk management 

practice. 

5. Other Public Interest Considerations 

Costs 

The Commission has not identified 

any ways in which the rules would 

harm any other public interest 

considerations. 

Benefits 

As discussed above, open access, 

increased competition, greater liquidity, 

improved price discovery, and greater 

financial integrity are all benefits of the 

rules. All these factors will benefit the 

general public, which may not 

participate in these markets directly but 

may feel their impact on the larger 

economy. 

G. Risk Management—§ 39.13 

In General 

Core Principle D,267 as amended by 

the Dodd-Frank Act, requires each DCO 

to ensure that it possesses the ability to 

manage the risks associated with 

discharging the responsibilities of the 

DCO through the use of appropriate 

tools and procedures. It further requires 

each DCO to measure its credit 

exposures to each clearing member not 

less than once during each business day 

and to monitor each such exposure 

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69418 Federal Register / Vol. 76, No. 216 / Tuesday, November 8, 2011 / Rules and Regulations 

268The Commission notes that ‘‘[t]he existence of 

significant outstanding notional exposures, trading 

liquidity, and adequate pricing data’’ is one of the 

factors the Commission must consider in reviewing 

whether a swap or group or class of swaps is subject 

to the mandatory clearing requirement in CEA 

Section 2(h)(1). See Section 2(h)(2)(D) of the CEA. 

To enable the Commission to make this 

determination, the Commission requires DCOs that 

periodically during the business day. 

Core Principle D also requires each DCO 

to limit its exposure to potential losses 

from defaults by clearing members, 

through margin requirements and other 

risk control mechanisms, to ensure that 

its operations would not be disrupted 

and that non-defaulting clearing 

members would not be exposed to 

losses that non-defaulting clearing 

members cannot anticipate or control. 

Finally, Core Principle D provides that 

a DCO must require margin from each 

clearing member sufficient to cover 

potential exposures in normal market 

conditions and that each model and 

parameter used in setting such margin 

requirements must be risk-based and 

reviewed on a regular basis. 

The Commission proposed § 39.13 to 

establish requirements that a DCO 

would have to meet in order to comply 

with Core Principle D. For a number of 

provisions of proposed § 39.13, the 

Commission did not receive any 

comments on the associated costs or on 

cost-benefit analysis. The Commission 

discussed in the notice of proposed 

rulemaking and above why it believes a 

DCO must satisfy each of those 

provisions to be in compliance with the 

Core Principle D and why it is 

appropriate for market participants to 

incur any costs associated with 

implementing each of those provisions. 

The Commission also addressed 

comments that suggested alternative 

standards, frameworks, or procedures. 

Where appropriate, the Commission 

revised the proposed rules. To avoid 

repetition, the Commission incorporates 

by reference the above discussion of 

§ 39.13. 

Commenters raised concerns about 

the costs of §§ 39.13(g)(2)(ii) (minimum 

liquidation time), 39.13(g)(2)(iii) 

(margin confidence level), 39.13(g)(8)(i) 

(gross margin), 39.13(h)(1)(i) (risk 

limits), 39.13(h)(2) (large trader reports), 

and 39.13(h)(5)(ii) (clearing member risk 

review) or the Commission’s costbenefit analysis relating to these rules. 

The Commission’s consideration of the 

costs and benefits associated with these 

rules is discussed in greater detail 

below. 

Minimum Liquidation Time 

As proposed, § 39.13(g)(2)(ii) would 

require a DCO to use a liquidation time 

that is a minimum of five business days 

for cleared swaps that are not executed 

on a DCM, and a liquidation time that 

is a minimum of one business day for 

all other products that it clears, 

although it would be required to use 

longer liquidation times, if appropriate, 

based on the unique characteristics of 

particular products or portfolios. 

Numerous commenters objected to the 

proposed difference in requirements 

that would subject swaps that were 

either executed bilaterally or executed 

on a SEF to a minimum five-day 

liquidation time, while permitting 

equivalent swaps that were executed on 

a DCM to be subject to a minimum oneday liquidation time. The Commission 

did not receive any comments that 

quantified the costs of this rule. 

As to the actual periods proposed, 

commenters variously contended that a 

liquidation time of five business days 

may be excessive for some swaps, a oneday liquidation period is too short, a 

one-day liquidation period is 

appropriate for swaps executed on a 

DCM or a SEF, and a two-day 

liquidation period is appropriate for 

cleared swaps. 

Some commenters encouraged the 

Commission to permit a DCO to 

determine the appropriate liquidation 

time for all products that it clears based 

on the unique characteristics and 

liquidity of each relevant product or 

portfolio. Two commenters 

recommended that if the Commission 

were to mandate minimum liquidation 

times in the final rules, it should allow 

DCOs to apply for exemptions for 

specific groups of swaps if market 

conditions prove that such minimum 

liquidation times are excessive. 

Upon consideration of the comments, 

the Commission is adopting 

§ 39.13(g)(2)(ii) with a number of 

modifications. First, the final rule 

requires a DCO to use the same 

liquidation time for a product whether 

it is executed on a DCM, a SEF, or 

bilaterally. Second, the final rule 

provides that the minimum liquidation 

time for swaps based on certain physical 

commodities, i.e., agricultural 

commodities, energy, and metals, as 

well as futures and options, is one day. 

For all other swaps, the minimum 

liquidation time is five days. Third, to 

provide further flexibility, the 

Commission is adding a provision 

specifying that, by order, the 

Commission may provide for a different 

minimum liquidation time for particular 

products or portfolios. 

The Commission has evaluated the 

costs and benefits of the proposed 

regulations in light of the specific 

considerations identified in Section 

15(a) of the CEA, as follows: 

1. Protection of Market Participants and 

the Public 

Costs 

The Commission anticipates that 

using only one criterion—i.e., the 

characteristic of the commodity 

underlying a swap—to determine 

liquidation time could result in lessthan-optimal margin calculations. For 

some products, a five-day minimum 

may prove to be excessive and tie up 

more funds than are strictly necessary 

for risk management purposes. For other 

products, a one-day or even a five-day 

period may be insufficient and expose a 

DCO and market participants to 

additional risk. 

The Commission believes that it is not 

feasible to estimate or quantify these 

costs reliably. In addition to the 

liquidation time frame, the margin 

requirements for a particular instrument 

depend upon a variety of characteristics 

of the instrument and the markets in 

which it is traded, including the risk 

characteristics of the instrument, its 

historical price volatility, and liquidity 

in the relevant market. Determining 

such margin requirements does not 

solely depend upon such quantitative 

factors, but also requires expert 

judgment as to the extent to which such 

characteristics and data may be an 

accurate predictor of future market 

behavior with respect to such 

instruments, and applying such 

judgment to the quantitative results. 

Thousands of different swap products 

may be subject to clearing. Determining 

the risk characteristics, price volatility, 

and market liquidity of even a sample 

for purposes of determining a 

liquidation time specifically for such 

instrument would be a formidable task 

for the Commission to undertake and 

any results would be subject to a range 

of uncertainty. Reliable data is not 

readily available for many swaps that 

prior to the Dodd-Frank Act were 

executed in unregulated markets. 

Given the amount of uncertainty in 

estimating margin requirements using 

either a five-day liquidation time or a 

one-day liquidation time, the amount of 

uncertainty in estimating the cost of 

using one rather than the other is 

compounded. For all the reasons stated 

in the previous paragraph, the possible 

range within which the size of the 

difference would fall is very large. In 

sum, in the absence of a reasonably 

feasible and reliable methodology at the 

present time for the Commission to use 

in calculating the appropriate margin 

requirements for swaps with either fiveday or one-day liquidation times,268 the 

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Federal Register / Vol. 76, No. 216 / Tuesday, November 8, 2011 / Rules and Regulations 69419 

submit swaps to the Commission for a mandatory 

clearing determination to submit data and other 

information that would enable the Commission to 

effectively consider this factor. See 

§ 39.5(b)(3)(ii)(A), 76 FR at 44473 (July 26, 2011) 

(Process for Review of Swaps for Mandatory 

Clearing; final rule). Not only is this type of 

information needed for the Commission to consider 

the statutory factors and make the determinations 

as to which swaps should be subject to mandatory 

clearing, but it also would be needed to calculate 

appropriate margin amounts for such swaps, were 

the Commission to attempt such calculations. 

Commission believes that possible 

future circumstances surrounding 

margin levels are too speculative and 

uncertain to be able to quantify or 

estimate the resulting costs to DCOs, 

clearing members, or the public from 

the rule with any precision or degree of 

magnitude. 

Moreover, any potential costs of this 

rule may be mitigated by the provision 

that allows DCOs to request, or the 

Commission on its own initiative to 

make, a determination that the 

liquidation time for a particular contract 

is too long or too short. As markets 

evolve, it may become appropriate to 

ease the requirement for certain swaps 

subject to the five-day minimum. 

Conversely, analysis may reveal that for 

other products or portfolios the five-day 

or one-day minimum is insufficient. 

This procedure could serve to reduce 

costs that may arise from application of 

the rule. 

Benefits 

A minimum liquidation time is a 

standard input in value-at-risk models 

used by DCOs to compute a confidence 

interval to estimate their risk. The 

value-at-risk confidence interval 

protects DCOs, their clearing members, 

market participants, and the public by 

fixing the probability that a default will 

occur and the position cannot be 

liquidated in time. 

The five-day/one-day distinction for 

different types of swaps is based on the 

ease of liquidation of different product 

groups and is consistent with existing 

requirements that reflect the risk 

assessments DCOs have made over the 

course of their experience clearing these 

types of swaps. Several DCOs have 

determined that these are the 

appropriate standards for these 

instruments and apply it to their margin 

requirements. The Commission believes 

that this is a reasonable and prudent 

judgment. 

A minimum standard is designed to 

prevent DCOs from competing by 

offering lower margin requirements than 

other DCOs and, as a result, taking on 

more risk than is prudent. In addition, 

the Commission is concerned that a 

DCO may misjudge the appropriate 

liquidation time frame because of 

limited experience with clearing and 

managing the risks of financial swaps. A 

minimum liquidation time frame should 

prevent DCOs from taking on too much 

risk. 

While it is not possible to estimate or 

quantify the benefits to market 

participants and the public in 

facilitating the financial soundness of 

DCOs, the Commission believes that a 

DCO failure, regardless of the size of the 

DCO, could adversely affect the 

financial markets, market participants, 

and the public. This rule will diminish 

the chances that such a failure will 

occur. 

2. Efficiency, Competitiveness, and 

Financial Integrity 

Costs 

The considerations under this factor 

are similar to the considerations under 

the first factor. 

Benefits 

The rule will promote efficiency, 

competitiveness and financial integrity 

by establishing a minimum standard for 

all DCOs. While a DCO will still have 

considerable latitude in setting riskbased margin levels, the Commission 

has determined that establishing a 

minimum liquidation time will provide 

legal certainty for an evolving 

marketplace, will offer a practical means 

for assuring that the thousands of 

different swaps that are going to be 

cleared subject to the Commission’s 

oversight will have prudent minimum 

margin requirements, and will help 

prevent a potential ‘‘race to the bottom’’ 

by competing DCOs. Competition 

among DCOs will be channeled to other 

areas such as level of service. 

The Commission believes that default 

by a clearing member could have a 

significant, adverse effect on market 

participants or the public. Market 

participants may have to incur the costs 

of making up any shortfall in margin 

through guaranty fund deposits and/or 

assessments, and any costs associated 

with participation in an auction or 

allocation of the positions of a 

defaulting clearing member. In a worst 

case scenario, a default by a clearing 

member may undermine the financial 

integrity of the DCO, which could have 

serious and widespread consequences 

for the U.S. financial markets. This rule 

protects market participants and the 

public from bearing these costs by 

requiring a DCO to follow certain 

minimum standards in establishing 

margin requirements. 

3. Price Discovery 

The Commission does not believe that 

this rule will have a material effect on 

price discovery. 

4. Sound Risk Management Practices 

Costs 

Because the rule simply establishes 

minimums, it will not hinder the 

exercise of sound risk management 

practices. The rule specifically requires 

DCOs to use longer liquidation times if 

appropriate for particular products. 

Benefits 

As discussed under the first two 

factors, the rule will foster sound risk 

management practices. 

5. Other Public Interest Considerations 

The Commission has not identified 

any costs or benefits beyond those 

discussed under the first factor. 

Margin Confidence Level 

As proposed, § 39.13(g)(2)(iii) would 

require a DCO’s initial margin models to 

meet an established confidence level of 

at least 99% based on data from an 

appropriate historical period. 

A number of commenters stated that 

each DCO should have discretion to 

establish confidence levels based on the 

particular characteristics of the products 

and portfolios it clears and their 

underlying markets. However, a number 

of other commenters stated that a 99% 

confidence level was the proper 

minimum. 

The Commission is adopting the rule 

as proposed. 

The Commission has evaluated the 

costs and benefits of the proposed 

regulation in light of the specific 

considerations identified in Section 

15(a) of the CEA, as follows: 

1. Protection of Market Participants and 

the Public 

Costs 

A 99% confidence level will require 

that more money be held as margin as 

compared to a lower confidence level. 

There is an opportunity cost to clearing 

members holding this money as margin. 

The Commission believes that it is not 

feasible to estimate or quantify this cost 

reliably. In addition to the confidence 

level, the margin requirements for a 

particular instrument depend upon a 

variety of characteristics of the 

instrument and the markets in which it 

is traded, including the risk 

characteristics of the instrument, its 

historical price volatility, and liquidity 

in the relevant market. Determining 

such margin requirements does not 

solely depend upon such quantitative 

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69420 Federal Register / Vol. 76, No. 216 / Tuesday, November 8, 2011 / Rules and Regulations 

269 Id. 

270See CPSS–IOSCO Consultative Report, 

Principle 6: Margin, Key Consideration 3, at 40; 

EMIR, Article 39, paragraph 1, at 46. 

271As discussed in section IV.D.6.h.(1), above, 

certain DCOs already use a version of gross 

margining, in which case the costs of complying 

with § 39.13(g)(8)(i) would be considerably less. 

factors, but also requires expert 

judgment as to the extent to which such 

characteristics and data may be an 

accurate predictor of future market 

behavior with respect to such 

instruments, and applying such 

judgment to the quantitative results. 

Thousands of different swap products 

may be subject to clearing. Determining 

the risk characteristics, price volatility, 

and market liquidity of even a sample 

for purposes of determining a 

confidence level specifically for such 

instrument would be a formidable task 

for the Commission to undertake and 

any results would be subject to a range 

of uncertainty. Reliable data is not 

readily available for many swaps that 

prior to the Dodd-Frank Act were 

executed in unregulated markets. In 

sum, in the absence of a reasonably 

feasible and reliable methodology at the 

present time for the Commission to use 

in calculating the margin requirements 

for swaps,269 the Commission believes 

that possible future circumstances 

surrounding margin levels are too 

speculative and uncertain to be able to 

quantify or estimate the resulting costs 

to DCOs, clearing members, or the 

public from the rule with any precision 

or degree of magnitude. 

Benefits 

A minimum confidence level is 

essential to protect market participants 

and the public. A minimum confidence 

level will prevent DCOs from competing 

with respect to how much risk they are 

willing to take on or from misjudging 

the amount of risk they would take on 

if they operated under lower standards. 

In addition, it will provide assurance to 

market participants that every DCO has 

sufficient margin to effectively manage 

a default. 

Some DCOs currently apply the 99 

percent standard. Others use 95–99 

percent for some contracts depending 

on facts and circumstances. 

International standards currently 

recommend 99 percent.270 In view of 

the increased risk that DCOs will face as 

a result of clearing swaps, the 

Commission believes that protection of 

market participants and the public 

dictates that the minimum standard on 

this key risk management element 

should be set in accordance with 

current best practices among DCOs and 

international standards. 

2. Efficiency, Competitiveness, and 

Financial Integrity 

Costs 

The considerations under this factor 

are very similar to the considerations 

under the first factor. 

Benefits 

The rule will promote efficiency, 

competitiveness and financial integrity 

by establishing a minimum standard for 

all DCOs. While a DCO will still have 

considerable latitude in setting riskbased margin levels, the Commission 

has determined that establishing a 

minimum confidence level will provide 

legal certainty for an evolving 

marketplace, will offer a practical means 

for assuring that the thousands of 

different swaps that are going to be 

cleared subject to the Commission’s 

oversight will have prudent minimum 

margin requirements, and will prevent a 

potential ‘‘race to the bottom’’ by 

competing DCOs. As noted above, the 

Commission is adopting a 99% standard 

in order to conform to current best 

practices among DCOs as well as 

international standards. Competition 

among DCOs will be channeled to other 

areas such as level of service. 

The Commission believes that default 

by a clearing member could have a 

significant, adverse effect on market 

participants and the public. Market 

participants may have to incur the costs 

of making up any shortfall in margin 

through guaranty fund deposits and/or 

assessments, and any costs associated 

with participation in an auction or 

allocation of the positions of a 

defaulting clearing member. In a worst 

case scenario, a default by a clearing 

member may undermine the financial 

integrity of the DCO, which could have 

significant negative consequences for 

the financial stability of U.S. financial 

markets. As highlighted by recent events 

in the global financial markets, the 

ability to manage the risks associated 

with clearing is critical to the goal of 

stability in the broader financial 

markets. This rule protects market 

participants and the public from bearing 

these costs by requiring a DCO to follow 

certain minimum standards in 

establishing margin requirements. 

3. Price Discovery 

The Commission does not believe that 

this rule will have a material effect on 

price discovery. 

4. Sound Risk Management Practices 

Costs 

Because the rule simply establishes 

minimums, it will not hinder the 

exercise of sound risk management 

practices. The rule specifically requires 

DCOs to use higher confidence levels if 

appropriate for particular products. 

Benefits 

As discussed under the first two 

factors, the rule will foster sound risk 

management practices. 

5. Other Public Interest Considerations 

The Commission does not believe that 

the rule will have a material effect on 

public interest considerations other than 

those identified above. 

Gross Margin 

As proposed, § 39.13(g)(8)(i) would 

require a DCO to collect initial margin 

on a gross basis for customer accounts. 

Two commenters supported the 

proposal. Several commenters stated 

that the provision of individual 

customer position information to DCOs 

may entail significant, costly, and timeconsuming changes to systems 

infrastructure at the clearing member 

level and the DCO level. 

In light of the various concerns 

regarding the operational and 

technology changes that would be 

needed and related costs of requiring a 

DCO to obtain individual customer 

position information from its clearing 

members and to use such information to 

calculate the margin requirements for 

each individual customer, the 

Commission is modifying 

§ 39.13(g)(8)(i). As amended, the rule 

provides a DCO with the discretion to 

either calculate customer gross margin 

requirements based on individual 

customer position information that it 

obtains from its clearing members or 

based on the sum of the gross positions 

of all of a clearing member’s customers 

that the clearing member provides to the 

DCO, without forwarding individual 

customer position information to the 

DCO. 

The Commission has evaluated the 

costs and benefits of the proposed 

regulation in light of the specific 

considerations identified in Section 

15(a) of the CEA, as follows: 

1. Protection of Market Participants and 

the Public 

Costs 

Three kinds of costs could result from 

a change from net to gross margining, 

for those DCOs that currently use net 

margining.271 First, gross margining 

could change the loss that customers of 

a clearing member may face in the event 

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Federal Register / Vol. 76, No. 216 / Tuesday, November 8, 2011 / Rules and Regulations 69421 

272Offsetting this effect is the potential for a 

failing FCM to misappropriate customer funds. That 

potential is greater under net margining. 

273The Commission has proposed rules that 

would not permit this in the case of swaps. See 76 

FR 33818 (June 9, 2011) (Protection of Cleared 

Swaps Customer Contracts and Collateral; 

Conforming Amendments to the Commodity Broker 

Bankruptcy Provisions). 

of default by a fellow customer of that 

clearing member. Under net margining, 

a greater portion of customer margin is 

held at the clearing member and thereby 

insulated from the DCO, so that nondefaulting customers face lower risk of 

losing their margin deposits to the DCO 

if a fellow customer defaults. Gross 

margining gives a DCO access to the 

margin deposits of non-defaulting 

customers of a defaulting FCM.272 In 

this sense, gross margining could shift a 

portion of the default risk from the DCO 

to fellow customers.273

It is not possible to estimate or 

quantify these costs—which would only 

arise in the event of a default of a 

customer—in a reliable way for a 

number of reasons. The historical record 

prior to the enactment of the DoddFrank Act with respect to the operation 

of clearing organizations provides little 

guidance as to the costs that may be 

incurred in the future in the unlikely 

event of a default at a DCO. Defaults at 

DCOs are very rare and the 

circumstances of each one are unique. 

Moreover, the Dodd-Frank Act and 

implementing regulations will alter the 

landscape significantly. Existing DCOs 

and FCMs will be clearing new 

products. New DCOs and FCMs will 

enter the market. Mandatory clearing 

will bring new products and 

participants to DCOs and FCMs. The 

interaction of all these factors creates a 

wide range of uncertainty as to the 

nature of the potential consequences of 

a default under the new regulatory 

regime. In sum, the Commission 

believes that the possible future 

circumstances leading to and potential 

resulting consequences of a future 

default are too speculative and 

uncertain to be able to quantify or 

estimate the resulting costs to clearing 

members with any precision or degree 

of magnitude. 

Second, because gross margining 

means that more customer margin is 

held at the DCO, rather than the FCM, 

gross margining also means that any 

return on this margin (e.g., interest 

earned) is earned by the DCO, rather 

than the FCM. This is largely a transfer 

between those parties. If there is no 

offsetting change in other terms of the 

relationship between customers, FCMs 

and DCOs, gross margining leads to a 

cost for FCMs and a benefit to DCOs 

from this change. 

Third, gross margining could result in 

changes in operating costs for DCOs and 

clearing members. Gross margining 

could require the DCO to possess more 

detailed information about customer 

positions. The provision of individual 

customer position information to DCOs 

may entail significant, costly, and timeconsuming changes to systems 

infrastructure at the clearing firm level 

and the DCO level. For example, NYPC 

stated that its preliminary cost estimate 

for compliance with the customer gross 

margin and large trader report 

requirements contained in proposed 

§§ 39.13(g)(8)(i) and 39.13(h)(2) was 

approximately 128,650 hours and $14.5 

million. 

In order to reduce the potential costs, 

the Commission has revised 

§ 39.13(g)(8)(i) to allow a DCO to permit 

an FCM to provide the DCO with the 

sum of the gross positions of all of its 

customers so that the DCO may 

calculate the applicable gross margin 

requirement based on that sum. Under 

this scenario, a DCO will not have to 

establish a framework to receive each 

customer’s position information and 

calculate the initial margin requirement 

applicable to each customer’s positions. 

The Commission believes this 

alternative framework will be 

significantly less expensive for market 

participants. Whether a DCO chooses to 

make the calculation based on 

individual customer position 

information or the sum of customers’ 

gross positions submitted by the 

clearing member, the clearing member’s 

customer gross margin requirement will 

be the same. 

NYPC also commented that such 

implementation costs could 

significantly deter new clearinghouses 

like NYPC from launching. However, 

NYPC did not provide an estimate for 

the costs of a new clearinghouse system 

capable of gross margining in relation to 

the cost of retrofitting an existing net 

margin system. The Commission 

believes that retrofitting an existing 

system may be more expensive than 

implementing a new system from 

scratch, and that it is unclear whether 

additional implementation costs would 

deter any new clearinghouses. 

Benefits 

The Commission believes that the 

clearing of swaps will increase the risk 

that DCOs face. Gross margining will 

increase the amount of money that 

DCOs hold. Under gross margining, the 

amount of margin at the DCO more 

accurately approximates the risks posed 

to a DCO by its clearing members’ 

customers than net margining and 

increases the financial resources 

available to a DCO in the event of a 

customer default. 

A DCO may not be able to collect 

initial customer margin from an FCM if 

the FCM defaults. This could have a 

serious adverse impact on the financial 

stability of a DCO, non-defaulting 

customers, and potentially wider 

markets. In this regard, a significant 

customer default leading to an FCM 

default could strain a DCO’s financial 

resources, causing it to exhaust the 

initial margin available to cover the 

default and forcing other clearing 

members and/or the DCO to incur 

related costs. In the worst case, an FCM 

default resulting from a large customer 

default could cause a DCO to fail if its 

financial resources are inadequate to 

cover the losses it incurs as a result of 

the default. Gross margining provides 

the DCO with a larger financial cushion 

that can be tapped in the event of a 

default. Initial margin is the DCO’s first 

‘‘line of defense’’ in managing a default, 

and a larger initial margin held at the 

DCO will help compensate for the 

DCO’s inability to collect additional 

margin from a defaulting clearing 

member. This rule protects market 

participants and the public from bearing 

these costs by requiring a DCO to hold 

additional margin. 

2. Efficiency, Competitiveness, and 

Financial Integrity 

Costs 

The considerations under this factor 

are very similar to the considerations 

under the first factor. 

Benefits 

The rule promotes efficiency, 

competitiveness, and financial integrity 

by providing that the amount of margin 

at the DCO more accurately 

approximates the risks posed to a DCO 

by its clearing members’ customers and 

by increasing the financial resources 

available to a DCO in the event of a 

customer default. 

3. Price Discovery 

The Commission does not believe that 

this rule will have a material effect on 

price discovery. 

4. Sound Risk Management Practices 

The considerations relating to sound 

risk management practices are very 

similar to the considerations under the 

first factor. 

5. Other Public Interest Considerations 

The Commission does not believe that 

the rule will have a material effect on 

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69422 Federal Register / Vol. 76, No. 216 / Tuesday, November 8, 2011 / Rules and Regulations 

public interest considerations other than 

those identified above. 

Risk Limits 

As proposed, § 39.13(h)(1)(i) would 

require a DCO to impose risk limits on 

each clearing member, by customer 

origin and house origin, in order to 

prevent a clearing member from 

carrying positions where the risk 

exposure of those positions exceeds a 

threshold set by the DCO relative to the 

clearing member’s financial resources, 

the DCO’s financial resources, or both. 

Several commenters supported the 

rule as an appropriate risk management 

procedure. Two commenters suggested 

that the rule is overly prescriptive. The 

Commission did not receive any 

comments that quantified the costs of 

this rule. 

The Commission is adopting 

§ 39.13(h)(i) as proposed. 

The Commission has evaluated the 

costs and benefits of the proposed 

regulation in light of the specific 

considerations identified in Section 

15(a) of the CEA, as follows: 

1. Protection of Market Participants and 

the Public 

Costs 

Some DCOs already set limits and 

will not incur any costs. Others will 

incur the costs of calculating limits for 

each clearing member. Such costs will 

be incremental because all DCOs 

currently have procedures for 

monitoring clearing member risk and 

may already have informal triggers or 

alerts in place. For clearing members, 

the rule would impose opportunity 

costs to the extent the limits constrain 

their activities. 

Under the rule each DCO would have 

discretion to set limits for each clearing 

member. It would be pure conjecture for 

the Commission to estimate what levels 

DCOs would set for their clearing 

members and how much that would 

constrain such clearing members. Each 

DCO would rely on the informed 

judgment of its risk management 

committee and/or risk management staff 

to assess the risks and resources of each 

clearing member and arrive at the 

applicable limits for each one. 

Estimating the extent to which this 

would constrain clearing members is 

even more speculative. That would 

entail a guess as to the risk appetite of 

each clearing member. In sum, the 

Commission believes that possible 

future circumstances surrounding risk 

limits are too speculative and uncertain 

to be able to quantify or estimate the 

resulting costs to DCOs, clearing 

members, or the public with any 

precision or degree of magnitude. 

Benefits 

The rule will benefit market 

participants by reducing the ability of 

clearing members and their customers to 

assume excessive risks. This will 

diminish the chances of default with all 

the attendant consequences previously 

discussed. 

2. Efficiency, Competitiveness, and 

Financial Integrity 

Costs 

The considerations under this factor 

are very similar to the considerations 

under the first factor. 

Benefits 

Because the rule provides DCOs the 

discretion to tailor the limits for each 

clearing member in accordance with the 

DCO’s assessment of the risk that the 

clearing member poses, it will foster 

efficiency and competitiveness in the 

markets. Because it will decrease the 

chance of default it will foster financial 

integrity. 

The Commission believes that default 

by a clearing member could have a 

significant, adverse effect on market 

participants or the public. Market 

participants may have to incur the costs 

of making up any shortfall in margin 

through guaranty fund deposits and/or 

assessments, and any costs associated 

with participation in an auction or 

allocation of the positions of a 

defaulting clearing member. In a worst 

case scenario, a default by a clearing 

member may undermine the financial 

integrity of the DCO, which could have 

serious and widespread consequences 

for the stability of U.S. financial 

markets. This rule protects market 

participants and the public from bearing 

these costs by requiring a DCO to 

analyze the risk posed by each clearing 

member and impose appropriate limits. 

3. Price Discovery 

The Commission does not believe that 

this rule will have a material effect on 

price discovery. 

4. Sound Risk Management Practices 

Costs 

The considerations under this factor 

are very similar to the considerations 

under the first factor. 

Benefits 

Risk limits are a sound risk 

management practice currently 

employed by several DCOs. The rule 

will extend the practice across all DCOs. 

5. Other Public Interest Considerations 

The Commission does not believe that 

the rule will have a material effect on 

public interest considerations other than 

those identified above. 

Large Trader Reports 

As proposed, § 39.13(h)(2) would 

require a DCO to obtain from its clearing 

members, copies of all reports that such 

clearing members are required to file 

with the Commission pursuant to part 

17 of the Commission’s regulations, i.e., 

large trader reports. Proposed 

§ 39.13(h)(2) would further require a 

DCO to review the large trader reports 

that it receives from its clearing 

members on a daily basis to ascertain 

the risk of the overall portfolio of each 

large trader. 

One commenter supported the 

proposal. One commenter argued that 

the proposed requirement that DCOs 

obtain large trader reports from clearing 

members is duplicative because a DCO 

receives large trader information from 

the exchange. One commenter stated 

that a DCO would need new technology 

to implement the rule. One commenter 

stated that a DCO would need 

additional surveillance staff. 

The Commission is modifying 

§ 39.13(h)(2) to require a DCO to obtain 

large trader reports either from its 

clearing members or from a DCM or a 

SEF for which it clears. 

The Commission has evaluated the 

costs and benefits of the proposed 

regulations in light of the specific 

considerations identified in Section 

15(a) of the CEA, as follows: 

1. Protection of Market Participants and 

the Public 

Costs 

The Commission notes that some 

DCOs already receive large trader 

reports from DCMs and review large 

trader reports for risk surveillance 

purposes on a daily basis. For them, this 

rule imposes no additional cost. For 

other DCOs, the receipt and analysis of 

large trader information may entail 

significant, costly, and time-consuming 

changes to systems infrastructure. 

Clearing members could also incur costs 

to provide large trader reports to DCOs. 

For example, NYPC stated that its 

preliminary cost estimate for 

compliance with the customer gross 

margin and large trader report 

requirements contained in proposed 

§§ 39.13(g)(8)(i) and 39.13(h)(2) was 

approximately 128,650 hours and $14.5 

million. 

In order to reduce costs, the 

Commission modified § 39.13(h)(2) to 

permit a DCO to obtain large trader 

reports either from its clearing members 

or from a DCM or a SEF for which it 

clears. The latter approach would 

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Federal Register / Vol. 76, No. 216 / Tuesday, November 8, 2011 / Rules and Regulations 69423 

274To the extent that some DCOs would conduct 

risk reviews in the absence of a rule, the 

incremental benefits of the rule are reduced. Even 

for these DCOs, however, a rule provides the market 

with the benefit of greater certainty that risk 

reviews of members will be continued in the future. 

275Figures used in the estimate are based on the 

judgment of Commission staff with experience 

overseeing DCO reviews of clearing member risk. 

276For example, 20 hours supervisor time per 

review × $250/hr plus 80 hours analyst time per 

review × $150/hr = $17,000 × 40 reviews = 

$680,000. 

eliminate duplicative reporting for 

clearing members and would 

significantly reduce costs for DCOs by 

enabling them to obtain the data from a 

single source. 

Benefits 

Currently, at some DCOs, the receipt 

and analysis of large trader reports is an 

integral part of their risk management 

programs. Extension of this practice to 

all DCOs would benefit market 

participants and the public. Proactive 

analysis of this information allows 

DCOs to identify and to address 

incipient problems in customer 

accounts before they get out of hand. In 

particular, large trader reports are an 

essential part of a rigorous risk 

management system because they 

provide information that is required for 

stress testing. 

A default by a clearing member could 

have a significant, adverse effect on 

market participants or the public. 

Market participants may have to incur 

the costs of making up any shortfall in 

margin through guaranty fund deposits 

and/or assessments, and any costs 

associated with participation in an 

auction or allocation of the positions of 

a defaulting clearing member. In a worst 

case scenario, a default by a clearing 

member may undermine the financial 

integrity of the DCO, which could have 

serious and widespread consequences 

for the stability of U.S. financial 

markets. This rule protects market 

participants and the public by requiring 

a DCO to analyze the potential risks at 

an earlier stage. 

2. Efficiency, Competitiveness, and 

Financial Integrity 

The considerations under this factor 

are very similar to the considerations 

under the first factor. 

3. Price Discovery 

The Commission does not believe that 

this rule will have a material effect on 

price discovery. 

4. Sound Risk Management Practices 

The considerations under this factor 

are very similar to the considerations 

under the first factor. 

5. Other Public Interest Considerations 

The Commission does not believe that 

the rule will have a material effect on 

public interest considerations other than 

those identified above. 

Clearing Member Risk Review 

As proposed, § 39.13(h)(5)(ii) would 

require each DCO to review the risk 

management policies, procedures, and 

practices of each of its clearing members 

on a periodic basis. 

Several commenters asserted that the 

review would be burdensome for such 

clearing members. The Commission did 

not receive any comments that 

quantified the costs of this rule. 

The Commission is adopting the rule 

with two modifications. These changes 

clarify that a DCO’s review need only 

cover those procedures of a clearing 

member which address the risks that 

such clearing member may pose to the 

DCO. 

The Commission has evaluated the 

costs and benefits of § 39.13(h)(5)(ii) in 

light of the specific considerations 

identified in Section 15(a) of the CEA, 

as follows: 

1. Protection of Market Participants and 

the Public 

Costs 

Those DCOs that currently conduct 

risk reviews of their clearing members 

are not likely to incur any additional 

costs as a result of the rule.274 Those 

DCOs that do not currently have such a 

program will incur costs to build on 

existing procedures for reviewing 

applicants for clearing membership in 

order to develop programs for ongoing 

review of clearing members. Clearing 

members will incur costs in working 

with the DCOs that review them. 

Commission staff intends to work with 

the DCOs to develop arrangements 

designed to avoid duplicative efforts 

without compromising the requirement 

that each DCO maintain an 

understanding of the risks of each of its 

clearing members. 

In recognition that each DCO has a 

unique product mix and set of rules, the 

rule does not prescribe the specific 

frequency, depth, or methodology of 

such reviews, nor does it specify when 

an on-site audit may or may not be 

appropriate. Nevertheless, based on the 

Commission’s experience overseeing 

DCOs that currently conduct risk 

reviews of clearing members, the 

Commission estimates the approximate 

costs of this rule as follows.275

The Commission estimates that a risk 

review by a large DCO typically would 

require on the order of 100 person-hours 

of work by a supervisor and several risk 

analysts. This includes preparation, an 

on-site visit, and drafting the report. The 

Commission also estimates that a large 

DCO would perform, on average, 40 risk 

reviews a year, although the number 

would vary depending on the number of 

clearing members a particular DCO has, 

and other circumstances. The 

Commission estimates compensation 

costs on the order of $150 an hour for 

risk analysts, and $250 an hour for a 

supervisor. Based on these estimates, 

the Commission estimates that the 

annual cost to a large DCO would be 

roughly on the order of $700,000.276

Costs for particular DCOs are likely to 

vary from this amount based on the size 

of the DCO, the DCO’s management and 

compensation practices, and the DCO’s 

exercise of the flexibility allowed by the 

rule provision. In light of the potential 

consequences of risk management 

failures by clearing members discussed 

below, and of the Commission’s 

judgment that DCOs are the market 

participants in the best position to 

review clearing member risk 

management programs, the Commission 

believes that the benefits of this 

provision would justify the costs even if 

costs proved to be substantially larger 

than the Commission’s estimate. 

Benefits 

Rigorous risk management programs 

at clearing members benefit market 

participants by providing safeguards to 

prevent default. Clearing members are at 

the front line of risk management. The 

Commission believes that risk reviews 

are important to ensure that each 

clearing member’s risk management 

framework is sufficient and properly 

implemented. The Commission believes 

that a clearing member’s DCO should 

undertake the review because that DCO 

is in the best position to review the risk 

management policies, procedures, and 

practices of its clearing members in the 

context of the clearing members’ 

obligations under the DCO’s rules. 

2. Efficiency, Competitiveness, and 

Financial Integrity 

Costs 

The considerations under this factor 

are very similar to the considerations 

under the first factor. 

Benefits 

Ensuring that each clearing member 

has proper risk management procedures 

for each DCO at which it clears will 

promote efficiency and competitiveness 

in the clearing process by ensuring that 

the clearing member is in compliance 

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69424 Federal Register / Vol. 76, No. 216 / Tuesday, November 8, 2011 / Rules and Regulations 

with each such DCO’s rules and 

encouraging the exercise of best 

practices. The rule will foster financial 

integrity for the reasons set forth under 

the first factor. 

The Commission believes that default 

by a clearing member could have a 

significant, adverse effect on market 

participants and the public. Market 

participants may have to incur the costs 

of making up any shortfall in margin 

through guaranty fund deposits and/or 

assessments, and any costs associated 

with participation in an auction or 

allocation of the positions of a 

defaulting clearing member. In a worst 

case scenario, a default by an FCM may 

undermine the financial integrity of the 

DCO, which could have serious and 

widespread consequences for the 

stability of U.S. financial markets. This 

rule protects market participants and 

the public from bearing these costs by 

requiring a DCO to periodically review 

the risk management procedures of each 

of its clearing members. 

3. Price Discovery 

The Commission does not believe that 

this rule will have a material effect on 

price discovery. 

4. Sound Risk Management Practices 

The considerations under this factor 

are similar to the considerations under 

the first factor. 

5. Other Public Interest Considerations 

The Commission does not believe that 

the rule will have a material effect on 

public interest considerations other than 

those identified above. 

H. Settlement Procedures—§ 39.14(c)(3) 

Section 5b(c)(2)(E) of the CEA, Core 

Principle E, as amended by the DoddFrank Act, requires a DCO to: (1) 

complete money settlements on a timely 

basis, but not less frequently than once 

each business day; (2) employ money 

settlement arrangements to eliminate or 

strictly limit its exposure to settlement 

bank risks (including credit and 

liquidity risks from the use of banks to 

effect money settlements); (3) ensure 

that money settlements are final when 

effected; (4) maintain an accurate record 

of the flow of funds associated with 

money settlements; (5) possess the 

ability to comply with the terms and 

conditions of any permitted netting or 

offset arrangement with another clearing 

organization; (6) establish rules that 

clearly state each obligation of the DCO 

with respect to physical deliveries; and 

(7) ensure that it identifies and manages 

each risk arising from any of its 

obligations with respect to physical 

deliveries. 

The Commission proposed § 39.14 to 

implement Core Principle E. With the 

exception of proposed § 39.14(c), the 

commenters did not address the costs of 

the proposed rule or the Commission’s 

consideration of costs and benefits. 

Proposed § 39.14(c)(3) would require 

a DCO to ‘‘monitor the full range and 

concentration of its exposures to its own 

and its clearing members’ settlement 

banks and assess its own and its 

clearing members’ potential losses and 

liquidity pressures in the event that the 

settlement bank with the largest share of 

settlement activity were to fail.’’ It 

would further require that a DCO (i) 

maintain settlement accounts at 

additional settlement banks; (ii) approve 

additional settlement banks for use by 

its clearing members; (iii) impose 

concentration limits with respect to its 

own or its clearing members’ settlement 

banks; and/or (iv) take any other 

appropriate actions reasonably 

necessary in order to eliminate or 

strictly limit such exposures. 

As discussed above, several 

commenters expressed concern that 

these provisions would impose costly 

requirements that are unnecessary or 

could have unintended adverse 

consequences. In this regard, one 

commenter claimed that the 

requirement to monitor clearing 

members’ exposure to their settlement 

banks could result in a duplication of 

effort that would be burdensome for a 

DCO. Commenters also stated that there 

are a limited number of banks that are 

qualified and willing to serve as 

settlement banks; as such, it may be 

difficult for smaller DCOs to maintain 

more than one settlement bank given the 

associated costs. Further, commenters 

stated that imposing concentration 

limits could increase systemic risk 

because a DCO would need to distribute 

funds across multiple banks and as 

settlement funds increased, highly rated 

banks would eventually reach the 

applicable concentration limit, 

potentially forcing DCOs to open 

accounts with lower rated banks. 

None of the commenters provided 

quantitative data or information to 

support their assertions as to the 

potential costs and burdens of 

compliance with § 39.14(c)(3), and none 

addressed the benefits of the rule. 

As discussed above, the Commission 

believes that there are risks associated 

with a DCO concentrating all its funds 

in a single settlement bank. Bank failure 

in such a circumstance could have 

adverse consequences for the DCO, its 

clearing members, and their customers. 

However, the Commission also 

acknowledges the concerns expressed 

by commenters, particularly given the 

settlement practices and procedures that 

DCOs currently maintain in the absence 

of such a regulation. 

Accordingly, the Commission is 

modifying § 39.14(c)(3) to eliminate any 

implied requirement that all DCOs must 

maintain settlement accounts at more 

than one bank, and is retaining the 

requirement that a DCO monitor 

exposure to its settlement bank(s) and 

those of its clearing members, including 

an ongoing assessment of the effect to 

the DCO of a failure of the settlement 

bank that has the largest share of 

settlement activity. It is also clarifying 

its intent to qualify the need to take 

actions set forth in § 39.14(c)(3)(i)–(iv) 

(such as imposing concentration limits) 

‘‘to the extent that any such action or 

actions are reasonably necessary in 

order to eliminate or strictly limit such 

exposures.’’ Thus, the Commission is 

providing DCOs with more flexibility 

than would have been provided under 

the proposed rule which, in turn, 

should reduce the costs associated with 

compliance. 

The Commission has evaluated the 

costs and benefits of § 39.14(c)(3) in 

light of the specific considerations 

identified in Section 15(a) of the CEA, 

as follows: 

1. Protection of Market Participants and 

the Public 

Costs 

A DCO’s monitoring of its exposure to 

its settlement bank(s) and those of its 

clearing members is a sound business 

practice in which a DCO should be 

engaged notwithstanding the rule. 

Nevertheless, the Commission believes 

the rule will require commitment of 

DCO staff resources, the costs of which 

could be passed along to clearing 

members and market participants as 

part of the DCO’s clearing fees. Such 

costs could vary significantly across 

DCOs given differences in operational 

and risk management procedures, 

settlement arrangements, and fee pricing 

practices. Given these circumstances, 

the Commission is unable to quantify 

the costs attributable to the 

Commission’s rule, and no commenter 

provided an estimate. As a general 

matter, however, the Commission is 

mindful that the measures set forth in 

§ 39.14(c)(3)(i)–(iv), specifically the 

requirement that DCOs take actions that 

are ‘‘reasonably necessary in order to 

eliminate or strictly limit’’ exposure to 

settlement banks, could cause DCOs to 

incur costs. Such costs could include, 

for example, the costs of establishing an 

account at an additional settlement 

bank, which would entail evaluating the 

bank to ensure that it meets the DCO’s 

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Federal Register / Vol. 76, No. 216 / Tuesday, November 8, 2011 / Rules and Regulations 69425 

277Section 5b(c)(2)(F) of the CEA; 7 U.S.C. 7a– 

1(c)(2)(F) (Core Principle F). 

278The Commission notes that proposed 

39.15(c)(1) regarding types of assets that can be 

accepted as initial margin has been redesignated as 

§ 39.13(g)(10) under the risk management rules. 

criteria for a settlement bank, reviewing 

account agreements, and establishing 

connectivity to the bank. There may also 

be fees charged by a bank for standby 

services if the bank is not used as the 

primary settlement bank, or there may 

be other account-related fees. The 

Commission is unable to ascertain the 

specific amount of any such costs for 

DCOs because of the varying nature of 

settlement bank arrangements across 

DCOs. 

Benefits 

Use of multiple settlement banks by 

DCOs, as well as imposition of 

concentration limits and other 

safeguards provided for in 

§ 39.14(c)(3)(i)–(iv), when reasonably 

necessary, could help insulate the DCO 

and its members from the risk of default 

by a settlement bank. This in turn could 

provide market participants and the 

public with greater protection from 

disruption of markets, as well as the 

clearing and settlement system. 

Affording a DCO flexibility in 

managing its settlement bank 

arrangements and, to a lesser degree, 

those of its clearing members, benefits 

market participants and the public by 

reducing the costs and potential 

inefficiencies associated with 

maintaining settlement arrangements 

with multiple settlement banks when 

that might not yield a concomitant 

benefit in the form of risk reduction. 

The rule sets forth general standards 

while permitting each DCO to tailor its 

settlement bank arrangements to its 

unique circumstances and risk 

tolerances. 

2. Efficiency, Competitiveness, and 

Financial Integrity 

Costs 

Quantification or estimation of costs 

to efficiency, competitiveness, and 

financial integrity of markets are not 

readily ascertainable, and no commenter 

provided an estimate. 

Benefits 

The rule permits DCOs to obtain 

settlement services from a single bank if 

the size and needs of the DCO, as well 

as the availability of suitable settlement 

bank services, makes the use of more 

than one settlement bank costprohibitive and it is not reasonably 

necessary to have more than one 

settlement bank in order to eliminate or 

strictly limit the DCO’s exposures. More 

efficient use of DCO resources can result 

in enhanced efficiency and financial 

integrity of the markets for which the 

DCO clears. Particularly for smaller 

DCOs, it may not be practical to obtain 

settlement services from more than one 

settlement bank because of the costs of 

evaluating a bank’s suitability to 

perform settlement functions, reviewing 

account agreements, and establishing 

connectivity to the bank. There also may 

be account-related fees charged by a 

bank, including fees for standby 

services, if the bank is used as a backup settlement bank and not the primary 

settlement bank. 

3. Price Discovery 

The Commission has not identified 

any ways in which § 39.14(c)(3) could 

affect price discovery. 

4. Sound Risk Management Practices 

Costs 

The Commission has not identified 

any ways in which § 39.14(c)(3) could 

impair sound risk management 

practices. 

Benefits 

The Commission regards an effective 

settlement framework as a sound risk 

management practice because it reduces 

the risks associated with a bank’s 

potential failure to make timely 

settlement. The requirements that a 

DCO monitor risk exposures to 

settlement banks and address 

diversification concerns, as reasonably 

necessary, are important adjuncts to a 

DCO’s overall risk management 

practices. 

5. Other Public Interest Considerations. 

The Commission has not identified 

any other costs or benefits that should 

be taken into account. 

I. Treatment of Funds—§ 39.15 

Core Principle F, as amended by the 

Dodd-Frank Act, requires a DCO to: (i) 

Establish standards and procedures that 

are designed to protect and ensure the 

safety of its clearing members’ funds 

and assets; (ii) hold such funds and 

assets in a manner by which to 

minimize the risk of loss or of delay in 

the DCO’s access to the assets and 

funds; and (iii) only invest such funds 

and assets in instruments with minimal 

credit, market, and liquidity risks.277

Proposed § 39.15 would establish 

minimum standards for DCO 

compliance with Core Principle F. 

Among other things, it would set forth 

standards for the types of assets that 

could be accepted as initial margin. In 

this regard, proposed § 39.15(c)(1) 

would require a DCO to limit the assets 

it accepts as initial margin to those that 

have minimal credit, market, and 

liquidity risk. It would further specify 

that a DCO may not accept letters of 

credit as initial margin. 

The Commission received comments 

on substantive aspects of the proposed 

rules, and it has addressed those 

comments above. The Commission also 

received several comments on potential 

costs associated with the proposed 

§ 39.15(c)(1) prohibition on the 

acceptance of letters of credit as initial 

margin.278 CME asserted that the 

prohibition is unnecessary because 

letters of credit provide an absolute 

assurance of payment and, therefore, the 

issuing bank must honor the demand 

even in circumstances where the 

beneficiary is unable to reimburse the 

bank for its payment. Other commenters 

suggested that letters of credit should be 

acceptable if they are subject to 

appropriate conditions. Finally, several 

commenters warned of the potential 

risks associated with prohibiting letters 

of credit, including higher costs for 

clearing members and their customers, 

the potential placement of U.S. DCOs at 

a disadvantage as compared to foreign 

clearing houses, and increased systemic 

risk as a result of decreased voluntary 

clearing. 

Taking into account both the strong 

track record of letters of credit in 

connection with cleared futures and 

options on futures and the potentially 

greater risks of cleared swaps, the 

Commission has determined to modify 

the rule to permit letters of credit in 

connection with cleared futures and 

options on futures but to retain the 

prohibition on letters of credit as initial 

margin for swaps. Certain DCOs have 

accepted letters of credit as initial 

margin for futures and options on 

futures for a number of years without 

incident and continue to do so. On the 

other hand, letters of credit are only a 

promise by a bank to pay, not an asset 

that can be sold. The Commission is 

concerned that the potential losses that 

swap market participants could incur 

may be of a greater magnitude than 

potential losses with respect to futures 

and options. Initial margin is the first 

financial resource that a DCO will apply 

in the event of a clearing member 

default. If a DCO were to need to draw 

on a letter of credit posted by a clearing 

member whose customers had suffered 

such losses, the larger the amount that 

it would need to draw, the greater the 

risk that the issuing bank may be unable 

to pay under the terms of the letter of 

credit. Accordingly, the Commission is 

modifying the proposal as described. 

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69426 Federal Register / Vol. 76, No. 216 / Tuesday, November 8, 2011 / Rules and Regulations 

279Section 5b(c)(2)(J) of the CEA, 7 U.S.C. 7a– 

1(c)(2)(J). 

The Commission has evaluated the 

costs and benefits of § 39.13(g)(10) in 

light of the specific considerations 

identified in Section 15(a) of the CEA, 

as follows: 

1. Protection of Market Participants and 

the Public 

Costs 

The prohibition on accepting letters of 

credit as initial margin for swaps may 

impose higher costs for clearing 

members because they will have to 

deposit cash or other assets that have 

minimal credit, market, and liquidity 

risk for those products. This could 

increase costs for market participants 

and decrease capital efficiency. It may 

also place U.S. DCOs at a disadvantage 

to those foreign clearing houses that 

permit letters of credit to be used as 

initial margin for swaps. The 

Commission notes, however, that in 

response to the comments it has 

modified the rule to permit letters of 

credit for futures. Therefore, futures 

market participants will not incur any 

costs as a result of this provision. 

It is not possible to estimate or 

quantify these costs for a number of 

reasons. The Dodd-Frank Act and 

implementing regulations will 

significantly affect the manner in which 

swaps are developed, traded, executed, 

and cleared. Existing DCOs and FCMs 

will be clearing new products. New 

DCOs and FCMs will enter the market. 

Mandatory clearing will bring new 

products and participants to DCOs and 

FCMs. The interaction of all these 

factors creates a wide range of 

uncertainty as to which products will be 

cleared, what their margin requirements 

will be, and the extent to which clearing 

members would post letters of credit as 

margin if permitted. Under these 

circumstances, the potential 

opportunity costs that may arise from 

the deposit of cash or other assets rather 

than letters of credit depends on a 

variety of future circumstances and 

actions of market participants that 

cannot be known or predicted at the 

present time. In sum, the Commission 

believes that the possible future 

circumstances involving the posting of 

letters of credit as margin is too 

speculative and uncertain to be able to 

quantify or estimate the resulting costs 

to clearing members with any precision 

or degree of magnitude. 

Benefits 

One of the primary functions of a 

DCO is to guarantee financial 

performance, which includes 

performing daily variation settlement. 

Daily pays are made in cash, and to the 

extent a DCO relies on margin deposits 

to meet its end-of-day obligations, it 

must have access to sufficient cash or 

highly liquid assets. Similarly, initial 

margin may be tapped by a DCO in the 

event of a clearing member default. By 

limiting the use of letters of credit, the 

DCO will avoid the possibility that a 

letter of credit would be dishonored 

when presented to the issuing bank. 

Thus, requiring initial margin in the 

form of assets that can be immediately 

sold provides greater financial 

protection to the DCO, clearing 

members, and market participants. 

2. Efficiency, Competitiveness, and 

Financial Integrity 

Costs 

As noted above, there could be 

competitive disadvantages to DCOs if 

foreign competitors do not impose 

similar restrictions on initial margin 

deposits. In addition, the prospect of 

increased costs may reduce voluntary 

clearing of swaps, which would be 

inconsistent with the goals of the DoddFrank Act and could potentially lead to 

systemic risk. 

Benefits 

A DCO can be more efficient in 

facilitating payments if it has readily 

available liquid assets as opposed to a 

conditional obligation that must be 

presented for payment. Holding actual 

assets provides greater assurance of 

financial integrity to the clearing 

process, as the DCO will not have to 

bear the costs of possible default on the 

part of the issuing bank. Even an 

irrevocable letter of credit can be 

dishonored, with the DCO’s only 

recourse being a lawsuit. 

3. Price Discovery 

The Commission does not believe this 

rule will have a material effect on price 

discovery. 

4. Sound Risk Management Practices 

Costs 

The Commission does not believe this 

rule will have a material adverse impact 

on sound risk management practices. 

Benefits 

The Commission expects that 

prohibiting the use of letters of credit as 

initial margin for swaps could serve to 

strengthen a DCO’s risk management 

program. It eliminates the risk of funds 

not being available if a letter of credit 

were to be dishonored, which could 

have a significant impact because initial 

margin is the first financial resource to 

be tapped in the event of a clearing 

member default. 

5. Other Public Considerations 

The Commission does not believe this 

rule will have a material impact on 

public interest considerations other than 

those discussed above. 

J. Reporting—§ 39.19 

Core Principle J,279 as amended by the 

Dodd-Frank Act, requires a DCO to 

provide the Commission with all 

information that the Commission 

determines to be necessary to conduct 

oversight of the DCO. 

The Commission proposed § 39.19 to 

establish minimum requirements that a 

DCO would have to meet in order to 

comply with Core Principle J. Under 

proposed § 39.19, certain reports would 

have to be made by a DCO to the 

Commission (1) On a periodic basis 

(daily, quarterly, or annually); (2) where 

the reporting requirement is triggered by 

the occurrence of a significant event; 

and (3) upon request by the 

Commission. 

The rules would require DCOs to 

provide information that the 

Commission has determined is 

necessary to conduct oversight of DCOs. 

The proposed reporting regime would 

assist the Commission in monitoring the 

financial strength and operational 

capabilities of a DCO and in evaluating 

whether a DCO’s risk management 

practices are effective. The required 

reports also would assist the 

Commission in taking prompt action as 

necessary to identify incipient problems 

and address them at an early stage. A 

self-reporting program of this type 

enhances the Commission’s ability to 

conduct oversight given its limited 

resources which do not permit routine 

on-site surveillance of DCOs. 

The proposed rules would require 

submission of information electronically 

and in a form and manner prescribed by 

the Commission. These general 

procedural standards would provide 

flexibility to the Commission in 

establishing and updating uniform 

format and delivery protocols that 

would assist the Commission in 

conducting timely review of 

submissions. In this regard, the 

transmission of information using a 

uniform format would enable 

Commission staff to sort and interpret 

data without the need to convert the 

data into a format that provides the 

necessary functionality, e.g., it would be 

designed to provide the Commission 

with the ability to compare data across 

DCOs when necessary. 

A number of commenters discussed 

costs associated with proposed § 39.19 

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Federal Register / Vol. 76, No. 216 / Tuesday, November 8, 2011 / Rules and Regulations 69427 

in the form of comments on the 

substantive provisions of the proposed 

rule. For example, a number of 

commenters discussed whether 

alternative reporting requirements might 

better inform the Commission of 

potential risks. Some commenters 

questioned the need for certain 

information and some commenters 

questioned the feasibility of the 

reporting requirements. The 

Commission has addressed those 

comments above. 

The Commission also received 

comments that directly addressed two 

areas of the Commission’s cost-benefit 

analysis of proposed § 39.19: (1) The 

cost of preparing and submitting daily 

and annual audited financial reports; 

and (2) the cost of reporting a 10 percent 

decrease in financial resources. Those 

comments are discussed in detail below. 

a. Cost of Preparing and Submitting 

Daily and Annual Reports 

Proposed § 39.19(c) would require a 

DCO to submit various periodic reports 

for the purposes of risk surveillance and 

oversight of the DCO’s compliance with 

the core principles and Commission 

regulations. In the notice of proposed 

rulemaking, the Commission observed 

that the information that would be 

reported was information readily 

available to a DCO and which, in certain 

instances, was already being reported to 

the Commission. The Commission 

requested data or other information that 

could quantify or qualify costs. 

Only NYPC provided an estimate of 

the fixed cost of implementing an 

automated system for daily reporting. In 

a comment letter submitted by NYPC, 

the cost was estimated at $582,000. 

In a follow-up phone conversation 

with representatives of NYPC, 

Commission staff discussed the basis for 

NYPC’s estimate that implementing an 

automated system for daily reporting 

would cost $582,000. Staff was told that 

NYPC already provides certain daily 

reports to the Commission, but that the 

additional data that it would have to 

report under the proposal (not including 

the proposed gross margin data or large 

trader data) would necessitate 

implementing an automated system. 

NYPC representatives confirmed that 

the estimate was for a one-time cost, not 

the cost of generating and transmitting 

the actual daily reports. NYPC also 

confirmed that the cost of generating 

and transmitting the actual daily reports 

would be minimal. 

The Commission was able to estimate 

the costs of providing reports and 

presented this information in the 

Paperwork Reduction Act discussion. It 

estimated that daily reporting could 

require a DCO to expend up to $8,280 

per year, and an annual report could 

require a DCO to expend up to $482,110 

per year. 

KCC and MGEX commented that the 

variable cost for daily reporting could be 

significantly more than the 

Commission’s estimates if the 

Commission were to require a costly 

format and method of delivery. MGEX 

also commented that the Commission 

may have underestimated the cost of 

providing the annual report (audited 

financial report under § 39.19(c)(3)(ii)), 

and that the Commission’s estimate is 

‘‘extremely excessive, particularly when 

most of [the annual reporting 

requirements do] not appear to be 

required by the Dodd-Frank Act.’’ 

Finally, MGEX believes that the 

proposed rules will not guarantee 

increased market participation or 

improve legitimate risk management 

and hedging activity, and the additional 

costs will create barriers to entry and 

decrease DCO competition. 

Although KCC and MGEX commented 

that the costs of preparing the reports 

may be greater than the Commission’s 

estimates, neither DCO provided an 

alternative estimate. Nor did they 

suggest alternative reporting 

requirements that would achieve the 

purposes of the CEA with a more 

favorable cost-benefit ratio. As to the 

estimated costs of the required format 

and method of delivery, the 

Commission notes that it based its 

estimate on the cost of using the 

SHAMIS system. The Commission has 

no basis for concluding that the cost of 

using an alternative system would be 

less substantial and it received no 

comments on this. 

The Commission believes that the 

costs that DCOs will incur to implement 

a system to provide such information to 

the Commission are necessary and 

justified. As explained above, the 

Commission has determined that the 

information required in the reports is 

necessary for the Commission to 

conduct adequate oversight of DCOs, 

particularly given its limited ability to 

conduct on-site reviews. 

b. Reporting a 10 Percent Decrease in 

Financial Resources 

Under proposed § 39.19(c)(4)(i), a 

DCO would be required to report a 

decrease of 10 percent in the total value 

of its financial resources either from (1) 

the value reported in the DCO’s last 

quarterly report or (2) from the value as 

of the close of the previous business 

day. This would allow the Commission 

to more quickly identify and address 

financial problems at the DCO. As 

discussed above, the Commission raised 

the reporting threshold from 10 percent 

to 25 percent in response to comments 

that a higher percentage might yield 

more meaningful results. In addition, 

the higher threshold is likely to reduce 

the number of reports that might be 

submitted under this requirement. 

NYPC commented that compliance 

with the proposed reporting 

requirement would necessitate an 

expenditure of approximately 15,000 

hours and $1.7 million. NYPC explained 

that this estimate reflects implementing 

a system that would track default 

resources and working capital, 

combined. After talking with 

Commission staff, NYPC submitted a 

comment letter that provided a 

preliminary estimate of approximately 

4,600 hours and $566,000 for designing, 

building, and testing a reporting system 

for a decline in default resources only. 

Based on NYPC’s initial comment 

letter, the Commission believes that the 

material costs associated with 

§ 39.19(c)(4)(i) are the initial 

investments made by a DCO to develop 

and implement a system (automated or 

not) to alert the DCO that the valuation 

threshold has been met. As discussed 

above, it is important for the 

Commission to be apprised of a 25% 

reduction in default resources because it 

could indicate that the DCO’s financial 

resources are strained and corrective 

action may be needed. 

The Commission has evaluated the 

costs and benefits of § 39.19 in light of 

the specific considerations identified in 

Section 15(a) of the CEA as follows: 

1. Protection of Market Participants and 

the Public 

Costs 

Section 39.19 requires DCOs to 

provide information that the 

Commission has determined is 

necessary for oversight of DCOs and to 

provide that information in a time 

frame, format, and delivery method that 

will enable effective use of the 

information. To the extent that DCOs do 

not already have an infrastructure for 

preparing and transmitting reports, they 

will incur one-time costs to put such a 

framework in place. 

Benefits 

The comprehensive regulatory 

reporting program will enhance 

protection of market participants and 

the public by promoting more in-depth 

and effective oversight by the 

Commission. The reports will assist the 

Commission’s Risk Surveillance staff in 

monitoring clearing house risk and 

evaluating DCOs’ management and 

mitigation of that risk. In addition, the 

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280 5 U.S.C. 601 et seq. 281 47 FR 18618 (Apr. 30, 1982). 282See 66 FR 45604, at 45609 (Aug. 29, 2001) 

(New Regulatory Framework for Clearing 

Organizations). 283 44 U.S.C. 3501 et seq. 

284See 75 FR at 63119 (Oct. 14, 2010) (Financial 

Resources) (requirement to file quarterly reports); 

see also discussion of the financial resources 

reporting requirements in section IV.B.10, above. 

See 75 FR at 77583–77584 (Dec. 13, 2010) 

(General Regulations) (proposed requirements: (i) 

For the CCO to submit an annual report to the 

Commission; (ii) to retain a copy of the policies and 

procedures adopted in furtherance of compliance 

with the CEA; (iii) to retain copies of materials, 

including written reports provided to the board of 

directors in connection with the board’s review of 

the annual report; and (iv) to retain any records 

relevant to the annual report, including, but not 

limited to, work papers and other documents that 

form the basis of the report, and memoranda, 

correspondence, other documents, and records that 

are (a) created, sent or received in connection with 

the annual report and (b) contain conclusions, 

opinions, analyses, or financial data related to the 

annual report); see also discussion of § 39.10 in 

section IV.A, above. 

See 75 FR at 78193 (Dec. 15, 2010) (Information 

Management) (proposed requirements to file 

specified information with the Commission (i) 

periodically, on a daily, quarterly, and annual basis; 

(ii) as specified events occur; and (iii) upon 

Commission request); see also discussion of 

reporting requirements in section IV.J, above. 

See 75 FR at 78196 (Dec. 15, 2010) (Information 

Management) (proposed requirement to maintain 

records of all activities related to its business as a 

DCO, including all information required to be 

created, generated, or reported under part 39, 

including but not limited to the results of and 

methodology used for all tests, reviews, and 

calculations); see also discussion of recordkeeping 

requirements in section IV.K, above. 

information will assist the Commission 

to identify incipient problems and 

address them at an early stage. 

2. Efficiency, Competitiveness, and 

Financial Integrity 

Costs 

The Commission does not believe that 

the reporting requirements will 

adversely impact efficiency, 

competitiveness, or the financial 

integrity of derivatives markets. 

Benefits 

The reporting requirements will 

protect the financial integrity of 

derivatives markets because they will 

support effective and timely oversight of 

DCOs. This will help to minimize the 

risk of default and the impact default 

would have on the markets. 

3. Price Discovery 

The Commission does not believe that 

§ 39.19 will have a material impact on 

price discovery. 

4. Sound Risk Management Practices 

Costs 

The Commission does not believe that 

the reporting requirements will 

adversely impact sound risk 

management practices. 

Benefits 

The reporting requirements are 

expected to enhance sound risk 

management practices because the 

Commission will be able to more 

effectively evaluate a DCO’s risk 

management practices on an on-going 

basis. The Commission staff can build a 

knowledge base that will support 

prompt action if there are adverse 

changes in trends or financial profiles. 

5. Other Public Interest Considerations 

The Commission does not believe this 

rule will have a material impact on 

public interest considerations other than 

those discussed above. Effective 

oversight of DCOs will enhance the 

safety and efficiency of DCOs and 

reduce systemic risk. Safe and reliable 

DCOs are essential not only for the 

stability of the derivatives markets they 

serve but also the public which relies on 

the prices formed in these markets for 

all manner of commerce. 

IX. Related Matters 

A. Regulatory Flexibility Act 

The Regulatory Flexibility Act 

(‘‘RFA’’) requires that agencies consider 

whether the rules they propose will 

have a significant economic impact on 

a substantial number of small entities 

and, if so, provide a regulatory 

flexibility analysis respecting the 

impact.280 The rules adopted herein will 

affect only DCOs). The Commission has 

previously established certain 

definitions of ‘‘small entities’’ to be used 

by the Commission in evaluating the 

impact of its regulations on small 

entities in accordance with the RFA.281

The Commission has previously 

determined that DCOs are not small 

entities for the purpose of the RFA.282

Accordingly, the Chairman, on behalf of 

the Commission, hereby certifies 

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

rules will not have a significant 

economic impact on a substantial 

number of small entities. The Chairman 

made the same certification in the 

proposed rulemakings, and the 

Commission did not receive any 

comments on the RFA in relation to any 

of those rulemakings. 

B. Paperwork Reduction Act 

The Commission may not conduct or 

sponsor, and a registered entity is not 

required to respond to, a collection of 

information unless it displays a 

currently valid Office of Management 

and Budget (OMB) control number. The 

Commission’s adoption of §§ 39.3 (DCO 

registration application requirements), 

39.10 (annual compliance report and 

recordkeeping), 39.11 (financial 

resources quarterly report), 39.14 

(settlement recordkeeping), 39.18 

(system safeguards reporting and 

recordkeeping), 39.19 (periodic and 

event-specific reporting), and 39.20 

(general recordkeeping), imposes new 

information collection requirements on 

registered entities within the meaning of 

the Paperwork Reduction Act.283

Accordingly, the Commission 

requested and OMB assigned control 

numbers for the required collections of 

information. The Commission has 

submitted this notice of final 

rulemaking along with supporting 

documentation for OMB’s review in 

accordance with 44 U.S.C. 3507(d) and 

5 CFR 1320.11. The titles for these 

collections of information are 

‘‘Financial Resources Requirements for 

Derivatives Clearing Organizations, 

OMB control number 3038–0066,’’ 

‘‘Information Management 

Requirements for Derivatives Clearing 

Organizations, OMB control number 

3038–0069,’’ ‘‘General Regulations and 

Derivatives Clearing Organizations, 

OMB control number 3038–0081,’’ and 

‘‘Risk Management Requirements for 

Derivatives Clearing Organizations, 

OMB control number 3038–0076.’’ 

Many of the responses to this new 

collection of information are mandatory. 

The Commission protects proprietary 

information according to the Freedom of 

Information Act and 17 CFR part 145, 

‘‘Commission Records and 

Information.’’ In addition, Section 

8(a)(1) of the CEA strictly prohibits the 

Commission, unless specifically 

authorized by the Act, from making 

public ‘‘data and information that 

would separately disclose the business 

transactions or market positions of any 

person and trade secrets or names of 

customers.’’ The Commission also is 

required to protect certain information 

contained in a government system of 

records according to the Privacy Act of 

1974, 5 U.S.C. 552a. 

The regulations require each 

respondent to file certain information 

with the Commission and to maintain 

certain records.284 The Commission 

received comments from NYPC and 

MGEX regarding the estimated costs of 

preparing and submitting daily reports. 

It also received comments from MGEX 

regarding costs associated with annual 

reports and the proposed rules in 

general. 

NYPC and MGEX commented that the 

costs associated with the rules in the 

Information Management proposed 

rulemaking would be higher than the 

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Federal Register / Vol. 76, No. 216 / Tuesday, November 8, 2011 / Rules and Regulations 69429 

285See 75 FR at 78193 (Dec. 15, 2010) 

(Information Management). In the Paperwork 

Reduction Act discussion, the Commission 

estimated that daily reporting would result in an 

aggregated cost of $8,280 initially (12 respondents 

× $690) and $16,800 per annum (12 respondents × 

$1,400). Annual reporting would result in an 

aggregated cost of $5,785,320 per annum (12 

respondents × $482,110). 

286 In a follow-up phone conversation with 

representatives of NYPC, Commission staff 

discussed the basis for NYPC’s estimate that 

implementing an automated system for daily 

reporting would cost $582,000. Commission staff 

was told that NYPC already provides certain daily 

reports to the Commission’s Risk Surveillance 

Group, but that the additional data that it would 

have to report under the Information Management 

NPRM (not including the gross margin data or large 

trader data) would necessitate implementing an 

automated system. NYPC representatives confirmed 

that the estimate was for a one-time cost, not the 

cost of generating and transmitting the actual daily 

reports. NYPC also confirmed that the cost of 

generating and transmitting the actual daily reports 

would be minimal. 

287See 76 FR at 3716–3717 (Jan. 20, 2011) (Risk 

Management). 

288See further discussion of the costs and benefits 

associated with the reporting requirements in 

section VII.J, above. 

Commission estimated.285 With respect 

to daily reporting, NYPC commented 

that designing, building, and testing the 

application necessary to automate the 

process of producing daily reports 

would require approximately 5,200 

hours and cost $582,000.286 MGEX 

commented that the cost to a DCO could 

be significantly more than the estimated 

cost if the Commission were to require 

a costly format and method of delivery. 

With respect to annual reporting, 

MGEX commented that the Commission 

may have underestimated the associated 

costs because the Commission did not 

address the costs of building reporting 

methods, forms, programs, or the 

allocation of labor resources. In 

addition, MGEX believes that the 

estimated costs associated with the 

annual report are ‘‘extremely excessive, 

particularly when most of [the annual 

report requirements do] not appear to be 

required by the Dodd-Frank Act.’’ 

MGEX further commented that the 

proposed rules will not guarantee 

increased market participation or 

improve legitimate risk management 

and hedging activity, and the additional 

costs would create barriers to entry and 

decreased DCO competition. 

Finally, with respect to the estimated 

costs identified in the Risk Management 

notice of proposed rulemaking,287

MGEX noted that the Commission had 

estimated the total hours for the 

proposed collection of information to be 

50 hours per year per respondent for the 

additional reporting requirements at an 

annual cost of $500 per respondent (50 

hours × $10). MGEX stated its belief that 

these estimates, both in hours and cost, 

are extremely low, and that it did not 

appear that the Commission had 

accounted for the costs to implement a 

system; collect, forward and format 

data; monitor and enforce compliance; 

and document compliance with the 

proposed rulemaking. MGEX noted that 

the costs are not limited to reporting to 

the Commission for many of the 

proposed rules, and that reporting may 

be the least expensive facet. MGEX 

specifically identified reporting the 

gross position of each beneficial owner 

as a requirement for which the 

Commission did not provide any cost 

estimates. 

Although MGEX commented that the 

costs of the proposed requirements may 

be greater than the costs the 

Commission set forth in the Information 

Management and Risk Management 

proposed rulemakings, and that the 

Commission did not estimate the costs 

of building reporting methods, forms, 

programs, or the allocation of labor 

resources, MGEX did not provide an 

estimate of these costs. Nor did MGEX 

suggest alternative reporting 

requirements that would achieve the 

purposes of the CEA with a more 

favorable cost-benefit ratio. 

As to the estimated costs of the 

required format and method of delivery, 

the Commission notes that the estimates 

of these costs were based on the cost of 

using the SHAMIS system. There was 

no basis for concluding that the cost of 

using an alternative system would be 

more substantial and the Commission 

received no comment to that effect. 

Moreover, Core Principle J requires a 

DCO to provide reports to the 

Commission, and all DCOs will have to 

bear these costs in order to comply with 

Core Principle J. Core Principle J 

requires each DCO ‘‘to provide to the 

Commission all information that the 

Commission determines to be necessary 

to conduct oversight of the [DCO].’’ As 

discussed above and in the Information 

Management proposed rulemaking, the 

Commission believes that the daily and 

annual reporting requirements provide 

the Commission with information that is 

important to its oversight of a DCO to 

ensure the DCO is in compliance with 

the core principles. This can lead to 

increased market participation and 

improve legitimate risk management 

and hedging activity. Accordingly, the 

Commission believes the collection of 

information related to the reporting 

rules is necessary to achieve the 

purposes of the CEA, particularly in 

light of the Dodd-Frank Act clearing 

mandate for swaps.288

The Commission has considered the 

comments of NYPC and MGEX but is 

declining to revise the estimated costs. 

The Commission believes that its 

original estimates remain appropriate 

for PRA purposes. 

List of Subjects 

17 CFR Part 1 

Brokers, Commodity futures, 

Consumer protection, Definitions, 

Swaps. 

17 CFR Part 21 

Brokers, Commodity futures, 

Reporting and recordkeeping 

requirements. 

17 CFR Part 39 

Definitions, Commodity futures, 

Reporting and recordkeeping 

requirements, Swaps, Business and 

industry, Participant and product 

eligibility, Risk management, Settlement 

procedures, Treatment of funds, Default 

rules and procedures, System 

safeguards, Enforcement authority, 

Application form. 

17 CFR Part 140 

Authority delegations (Government 

agencies), Conflict of interests, 

Organization and functions 

(Government agencies). 

For the reasons stated in the 

preamble, amend 17 CFR parts 1, 21, 39, 

and 140 as follows: 

PART 1—GENERAL REGULATIONS 

UNDER THE COMMODITY EXCHANGE 

ACT 

■ 1. The authority citation for part 1 is 

revised to read as follows: 

Authority: 7 U.S.C. 1a, 2, 5, 6, 6a, 6b, 6c, 

6d, 6e, 6f, 6g, 6h, 6i, 6j, 6k, 6l, 6m, 6n, 6o, 

6p, 7, 7a, 7b, 8, 9, 12, 12a, 12c, 13a, 13a–1, 

16, 16a, 19, 21, 23, and 24, as amended by 

Pub. L. 111–203, 124 Stat. 1376. 

■ 2. Amend § 1.3 to revise paragraphs 

(c) and (d), remove and reserve 

paragraph (k), and add paragraphs (aaa), 

(bbb), (ccc), (ddd), (eee), and (fff) to read 

as follows: 

§ 1.3 Definitions. 

* * * * * 

(c) Clearing member. This term means 

any person that has clearing privileges 

such that it can process, clear and settle 

trades through a derivatives clearing 

organization on behalf of itself or others. 

The derivatives clearing organization 

need not be organized as a membership 

organization. 

(d) Clearing organization or 

derivatives clearing organization. This 

term means a clearinghouse, clearing 

association, clearing corporation, or 

similar entity, facility, system, or 

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69430 Federal Register / Vol. 76, No. 216 / Tuesday, November 8, 2011 / Rules and Regulations 

organization that, with respect to an 

agreement, contract, or transaction— 

(1) Enables each party to the 

agreement, contract, or transaction to 

substitute, through novation or 

otherwise, the credit of the derivatives 

clearing organization for the credit of 

the parties; 

(2) Arranges or provides, on a 

multilateral basis, for the settlement or 

netting of obligations resulting from 

such agreements, contracts, or 

transactions executed by participants in 

the derivatives clearing organization; or 

(3) Otherwise provides clearing 

services or arrangements that mutualize 

or transfer among participants in the 

derivatives clearing organization the 

credit risk arising from such agreements, 

contracts, or transactions executed by 

the participants. 

(4) Exclusions. The terms clearing 

organization and derivatives clearing 

organization do not include an entity, 

facility, system, or organization solely 

because it arranges or provides for— 

(i) Settlement, netting, or novation of 

obligations resulting from agreements, 

contracts or transactions, on a bilateral 

basis and without a central 

counterparty; 

(ii) Settlement or netting of cash 

payments through an interbank payment 

system; or 

(iii) Settlement, netting, or novation of 

obligations resulting from a sale of a 

commodity in a transaction in the spot 

market for the commodity. 

* * * * * 

(k) [Reserved] 

* * * * * 

(aaa) Clearing initial margin. This 

term means initial margin posted by a 

clearing member with a derivatives 

clearing organization. 

(bbb) Customer initial margin. This 

term means initial margin posted by a 

customer with a futures commission 

merchant, or by a non-clearing member 

futures commission merchant with a 

clearing member. 

(ccc) Initial margin. This term means 

money, securities, or property posted by 

a party to a futures, option, or swap as 

performance bond to cover potential 

future exposures arising from changes in 

the market value of the position. 

(ddd) Margin call. This term means a 

request from a futures commission 

merchant to a customer to post customer 

initial margin; or a request by a 

derivatives clearing organization to a 

clearing member to post clearing initial 

margin or variation margin. 

(eee) Spread margin. This term means 

reduced initial margin that takes into 

account correlations between certain 

related positions held in a single 

account. 

(fff) Variation margin. This term 

means a payment made by a party to a 

futures, option, or swap to cover the 

current exposure arising from changes 

in the market value of the position since 

the trade was executed or the previous 

time the position was marked to market. 

■ 3. Amend § 1.12 to remove and 

reserve paragraph (f)(1). 

PART 21—SPECIAL CALLS 

■ 4. The authority citation for part 21 is 

revised to read as follows: 

Authority: 7 U.S.C. 1a, 2, 2a, 4, 6a, 6c, 6f, 

6g, 6i, 6k, 6m, 6n, 7, 7a, 12a, 19 and 21, as 

amended by Pub. L. 111–203, 124 Stat. 1376; 

5 U.S.C. 552 and 552(b), unless otherwise 

noted. 

■ 5. Redesignate § 21.04 as § 21.05. 

■ 6. Add a new § 21.04 to read as 

follows: 

§ 21.04 Special calls for information on 

customer accounts or related cleared 

positions. 

Upon special call by the Commission, 

each futures commission merchant, 

clearing member or foreign broker shall 

provide information to the Commission 

concerning customer accounts or related 

positions cleared on a derivatives 

clearing organization in the format and 

manner and within the time provided 

by the Commission in the special call. 

■ 7. Add § 21.06 to read as follows: 

§ 21.06 Delegation of authority to the 

Director of the Division of Clearing and 

Risk. 

The Commission hereby delegates, 

until the Commission orders otherwise, 

the special call authority set forth in 

§ 21.04 to the Director of the Division of 

Clearing and Risk to be exercised by 

such Director or by such other employee 

or employees of such Director as 

designated from time to time by the 

Director. The Director of the Division of 

Clearing and Risk may submit to the 

Commission for its consideration any 

matter which has been delegated in this 

section. Nothing in this section shall be 

deemed to prohibit the Commission, at 

its election, from exercising the 

authority delegated in this section to the 

Director. 

PART 39—DERIVATIVES CLEARING 

ORGANIZATIONS 

■ 8. Revise part 39 to read as follows: 

Subpart A—General Provisions Applicable 

to Derivatives Clearing Organizations 

Sec. 

39.1 Scope. 

39.2 Definitions. 

39.3 Procedures for registration. 

39.4 Procedures for implementing 

derivatives clearing organization rules 

and clearing new products. 

39.5 Submission of swaps for Commission 

determination regarding clearing 

requirements. 

39.6 [Reserved] 

39.7 Enforceability. 

39.8 Fraud in connection with the clearing 

of transactions on a derivatives clearing 

organization. 

Subpart B—Compliance With Core 

Principles 

39.9 Scope. 

39.10 Compliance with core principles. 

39.11 Financial resources. 

39.12 Participant and product eligibility. 

39.13 Risk management. 

39.14 Settlement procedures. 

39.15 Treatment of funds. 

39.16 Default rules and procedures. 

39.17 Rule enforcement. 

39.18 System safeguards. 

39.19 Reporting. 

39.20 Recordkeeping. 

39.21 Public information. 

39.22 Information sharing. 

39.23 Antitrust considerations. 

39.24 [Reserved] 

39.25 [Reserved] 

39.26 [Reserved] 

39.27 Legal risk considerations. 

Appendix A to Part 39—Form DCO 

Derivatives Clearing Organization 

Application for Registrations 

Authority: 7 U.S.C. 7a–1 as amended by 

Pub. L. 111–203, 124 Stat. 1376. 

Subpart A—General Provisions 

Applicable to Derivatives Clearing 

Organizations 

§ 39.1 Scope. 

The provisions of this subpart A 

apply to any derivatives clearing 

organization as defined under section 

1a(15) of the Act and § 1.3(d) of this 

chapter which is registered or deemed 

to be registered with the Commission as 

a derivatives clearing organization, is 

required to register as such with the 

Commission pursuant to section 5b(a) of 

the Act, or which voluntarily applies to 

register as such with the Commission 

pursuant to section 5b(b) or otherwise. 

§ 39.2 Definitions. 

For the purposes of this part, 

Back test means a test that compares 

a derivatives clearing organization’s 

initial margin requirements with 

historical price changes to determine 

the extent of actual margin coverage. 

Customer means a person trading in 

any commodity named in the definition 

of commodity in section 1a(9) of the Act 

or in § 1.3 of this chapter, or in any 

swap as defined in section 1a(47) of the 

Act or in § 1.3 of this chapter; Provided, 

however, an owner or holder of a house 

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account as defined in this section shall 

not be deemed to be a customer within 

the meaning of section 4d of the Act, the 

regulations that implement sections 4d 

and 4f of the Act and § 1.35, and such 

an owner or holder of such a house 

account shall otherwise be deemed to be 

a customer within the meaning of the 

Act and §§ 1.37 and 1.46 of this chapter 

and all other sections of these rules, 

regulations, and orders which do not 

implement sections 4d and 4f of the Act. 

Customer account or customer origin 

means a clearing member account held 

on behalf of customers, as that term is 

defined in this section, and which is 

subject to section 4d(a) or section 4d(f) 

of the Act. 

House account or house origin means 

a clearing member account which is not 

subject to section 4d(a) or 4d(f) of the 

Act. 

Key personnel means derivatives 

clearing organization personnel who 

play a significant role in the operations 

of the derivatives clearing organization, 

the provision of clearing and settlement 

services, risk management, or oversight 

of compliance with the Act and 

Commission regulations and orders. Key 

personnel include, but are not limited 

to, those persons who are or perform the 

functions of any of the following: chief 

executive officer; president; chief 

compliance officer; chief operating 

officer; chief risk officer; chief financial 

officer; chief technology officer; and 

emergency contacts or persons who are 

responsible for business continuity or 

disaster recovery planning or program 

execution. 

Stress test means a test that compares 

the impact of potential extreme price 

moves, changes in option volatility, 

and/or changes in other inputs that 

affect the value of a position, to the 

financial resources of a derivatives 

clearing organization, clearing member, 

or large trader, to determine the 

adequacy of such financial resources. 

Systemically important derivatives 

clearing organization means a financial 

market utility that is a derivatives 

clearing organization registered under 

section 5b of the Act, which has been 

designated by the Financial Stability 

Oversight Council to be systemically 

important and for which the 

Commission acts as the Supervisory 

Agency pursuant to section 803(8) of the 

Dodd-Frank Wall Street Reform and 

Consumer Protection Act. 

§ 39.3 Procedures for registration. 

(a) Application procedures. (1) An 

organization desiring to be registered as 

a derivatives clearing organization shall 

file electronically an application for 

registration with the Secretary of the 

Commission in the format and manner 

specified by the Commission. The 

Commission will review the application 

for registration as a derivatives clearing 

organization pursuant to the 180-day 

timeframe and procedures specified in 

section 6(a) of the Act. The Commission 

may approve or deny the application or, 

if deemed appropriate, register the 

applicant as a derivatives clearing 

organization subject to conditions. 

(2) Application. Any person seeking 

to register as a derivatives clearing 

organization, any applicant amending 

its pending application, or any 

registered derivatives clearing 

organization seeking to amend its order 

of registration (applicant), shall submit 

to the Commission a completed Form 

DCO, which shall include a cover sheet, 

all applicable exhibits, and any 

supplemental materials, including 

amendments thereto, as provided in the 

appendix to this part 39 (application). 

An applicant, when filing a Form DCO 

for purposes of amending its pending 

application or requesting an amendment 

to an existing registration, is only 

required to submit exhibits and updated 

information that are relevant to the 

requested amendment and are necessary 

to demonstrate compliance with the 

core principles affected by the requested 

amendment. The Commission will not 

commence processing an application 

unless the applicant has filed the 

application as required by this section. 

Failure to file a completed application 

will preclude the Commission from 

determining that an application is 

materially complete, as provided in 

section 6(a) of the Act. Upon its own 

initiative, an applicant may file with its 

completed application additional 

information that may be necessary or 

helpful to the Commission in processing 

the application. 

(3) Submission of supplemental 

information. The filing of a completed 

application is a minimum requirement 

and does not create a presumption that 

the application is materially complete or 

that supplemental information will not 

be required. At any time during the 

application review process, the 

Commission may request that the 

applicant submit supplemental 

information in order for the Commission 

to process the application. The 

applicant shall file electronically such 

supplemental information with the 

Secretary of the Commission in the 

format and manner specified by the 

Commission. 

(4) Application amendments. An 

applicant shall promptly amend its 

application if it discovers a material 

omission or error, or if there is a 

material change in the information 

provided to the Commission in the 

application or other information 

provided in connection with the 

application. 

(5) Public information. The following 

sections of all applications to become a 

registered derivatives clearing 

organization will be public: first page of 

the Form DCO cover sheet, proposed 

rules, regulatory compliance chart, 

narrative summary of proposed clearing 

activities, documents establishing the 

applicant’s legal status, documents 

setting forth the applicant’s corporate 

and governance structure, and any other 

part of the application not covered by a 

request for confidential treatment, 

subject to § 145.9 of this chapter. 

(b) Stay of application review. (1) The 

Commission may stay the running of the 

180-day review period if an application 

is materially incomplete, in accordance 

with section 6(a) of the Act. 

(2) Delegation of authority. (i) The 

Commission hereby delegates, until it 

orders otherwise, to the Director of the 

Division of Clearing and Risk or the 

Director’s designee, with the 

concurrence of the General Counsel or 

the General Counsel’s designee, the 

authority to notify an applicant seeking 

designation under section 6(a) of the Act 

that the application is materially 

incomplete and the running of the 180- 

day period is stayed. 

(ii) The Director of the Division of 

Clearing and Risk may submit to the 

Commission for its consideration any 

matter which has been delegated in this 

paragraph. 

(iii) Nothing in this paragraph 

prohibits the Commission, at its 

election, from exercising the authority 

delegated in paragraph (b)(2)(i) of this 

section. 

(c) Withdrawal of application for 

registration. An applicant for 

registration may withdraw its 

application submitted pursuant to 

paragraph (a) of this section by filing 

electronically such a request with the 

Secretary of the Commission in the 

format and manner specified by the 

Commission. Withdrawal of an 

application for registration 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 application for registration 

was pending with the Commission. 

(d) Reinstatement of dormant 

registration. Before listing or relisting 

products for clearing, a dormant 

registered derivatives clearing 

organization as defined in § 40.1 of this 

chapter must reinstate its registration 

under the procedures of paragraph (a) of 

this section; provided, however, that an 

application for reinstatement may rely 

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upon previously submitted materials 

that still pertain to, and accurately 

describe, current conditions. 

(e) Request for vacation of 

registration. A registered derivatives 

clearing organization may vacate its 

registration under section 7 of the Act 

by filing electronically such a request 

with the Secretary of the Commission in 

the format and manner specified by the 

Commission. Vacation of registration 

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 entity was 

registered by the Commission. 

(f) Request for transfer of registration 

and open interest. (1) In anticipation of 

a corporate change that will result in the 

transfer of all or substantially all of a 

derivatives clearing organization’s assets 

to another legal entity, the derivatives 

clearing organization shall submit a 

request for approval to transfer the 

derivatives clearing organization’s 

registration and positions comprising 

open interest for clearing and 

settlement. 

(2) Timing of submission and other 

procedural requirements. (i) The request 

shall be submitted no later than three 

months prior to the anticipated 

corporate change, or as otherwise 

permitted under § 39.19(c)(4)(viii)(C) of 

this part. 

(ii) The derivatives clearing 

organization shall submit a request for 

transfer by filing electronically such a 

request with the Secretary of the 

Commission in the format and manner 

specified by the Commission. 

(iii) The derivatives clearing 

organization shall submit a confirmation 

of change report pursuant to 

§ 39.19(c)(4)(viii)(D) of this part. 

(3) Required information. The request 

shall include the following: 

(i) The underlying agreement that 

governs the corporate change; 

(ii) A narrative description of the 

corporate change, including the reason 

for the change and its impact on the 

derivatives clearing organization’s 

financial resources, governance, and 

operations, and its impact on the rights 

and obligations of clearing members and 

market participants holding the 

positions that comprise the derivatives 

clearing organization’s open interest; 

(iii) A discussion of the transferee’s 

ability to comply with the Act, 

including the core principles applicable 

to derivatives clearing organizations, 

and the Commission’s regulations 

thereunder; 

(iv) The governing documents of the 

transferee, including but not limited to 

articles of incorporation and bylaws; 

(v) The transferee’s rules marked to 

show changes from the current rules of 

the derivatives clearing organization; 

(vi) A list of products for which the 

derivatives clearing organization 

requests transfer of open interest; 

(vii) A representation by the 

derivatives clearing organization that it 

is in compliance with the Act, including 

the core principles applicable to 

derivatives clearing organizations, and 

the Commission’s regulations 

thereunder; and 

(viii) A representation by the 

transferee that it understands that the 

derivatives clearing organization is a 

regulated entity that must comply with 

the Act, including the core principles 

applicable to derivatives clearing 

organizations, and the Commission’s 

regulations thereunder, in order to 

maintain its registration as a derivatives 

clearing organization; and further, that 

the transferee will continue to comply 

with all self-regulatory requirements 

applicable to a derivatives clearing 

organization under the Act and the 

Commission’s regulations thereunder. 

(4) Commission determination. The 

Commission will review a request as 

soon as practicable, and based on the 

Commission’s determination as to the 

transferee’s ability to continue to 

operate the derivatives clearing 

organization in compliance with the Act 

and the Commission’s regulations 

thereunder, such request will be 

approved or denied pursuant to a 

Commission order. 

§ 39.4 Procedures for implementing 

derivatives clearing organization rules and 

clearing new products. 

(a) Request for approval of rules. An 

applicant for registration, or a registered 

derivatives clearing organization, may 

request, pursuant to the procedures of 

§ 40.5 of this chapter, that the 

Commission approve any or all of its 

rules and subsequent amendments 

thereto, including operational rules, 

prior to their implementation or, 

notwithstanding the provisions of 

section 5c(c)(2) of the Act, at any time 

thereafter, under the procedures of 

§ 40.5 of this chapter. A derivatives 

clearing organization may label as, 

‘‘Approved by the Commission,’’ only 

those rules that have been so approved. 

(b) Self-certification of rules. Proposed 

new or amended rules of a derivatives 

clearing organization not voluntarily 

submitted for prior Commission 

approval pursuant to paragraph (a) of 

this section must be submitted to the 

Commission with a certification that the 

proposed new rule or rule amendment 

complies with the Act and rules 

thereunder pursuant to the procedures 

of § 40.6 of this chapter. 

(c) Acceptance of new products for 

clearing. (1) A dormant derivatives 

clearing organization within the 

meaning of § 40.1 of this chapter may 

not accept for clearing a new product 

until its registration as a derivatives 

clearing organization is reinstated under 

the procedures of § 39.3 of this part; 

provided however, that an application 

for reinstatement may rely upon 

previously submitted materials that still 

pertain to, and accurately describe, 

current conditions. 

(2) A derivatives clearing organization 

that accepts for clearing a new product 

that is a swap shall comply with the 

requirements of § 39.5 of this part. 

(d) Orders regarding competition. An 

applicant for registration or a registered 

derivatives clearing organization may 

request that the Commission issue an 

order concerning whether a rule or 

practice of the organization is the least 

anticompetitive means of achieving the 

objectives, purposes, and policies of the 

Act. 

(e) Holding securities in a futures 

portfolio margining account. A 

derivatives clearing organization 

seeking to provide a portfolio margining 

program under which securities would 

be held in a futures account as defined 

in § 1.3(vv) of this chapter, shall submit 

rules to implement such portfolio 

margining program for Commission 

approval in accordance with § 40.5 of 

this chapter. Concurrent with the 

submission of such rules for 

Commission approval, the derivatives 

clearing organization shall petition the 

Commission for an order under section 

4d of the Act. 

§ 39.5 Review of swaps for Commission 

determination on clearing requirement. 

(a) Eligibility to clear swaps. (1) A 

derivatives clearing organization shall 

be presumed eligible to accept for 

clearing any swap that is within a 

group, category, type, or class of swaps 

that the derivatives clearing 

organization already clears. Such 

presumption of eligibility, however, is 

subject to review by the Commission. 

(2) A derivatives clearing organization 

that wishes to accept for clearing any 

swap that is not within a group, 

category, type, or class of swaps that the 

derivatives clearing organization already 

clears shall request a determination by 

the Commission of the derivatives 

clearing organization’s eligibility to 

clear such a swap before accepting the 

swap for clearing. The request, which 

shall be filed electronically with the 

Secretary of the Commission, shall 

address the derivatives clearing 

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organization’s ability, if it accepts the 

swap for clearing, to maintain 

compliance with section 5b(c)(2) of the 

Act, specifically: 

(i) The sufficiency of the derivatives 

clearing organization’s financial 

resources; and 

(ii) The derivative clearing 

organization’s ability to manage the 

risks associated with clearing the swap, 

especially if the Commission determines 

that the swap is required to be cleared. 

(b) Swap submissions. (1) A 

derivatives clearing organization shall 

submit to the Commission each swap, or 

any group, category, type, or class of 

swaps that it plans to accept for 

clearing. The derivatives clearing 

organization making the submission 

must be eligible under paragraph (a) of 

this section to accept for clearing the 

submitted swap, or group, category, 

type, or class of swaps. 

(2) A derivatives clearing organization 

shall submit swaps to the Commission, 

to the extent reasonable and practicable 

to do so, by group, category, type, or 

class of swaps. The Commission may in 

its reasonable discretion consolidate 

multiple submissions from one 

derivatives clearing organization or 

subdivide a derivatives clearing 

organization’s submission as 

appropriate for review. 

(3) The submission shall be filed 

electronically with the Secretary of the 

Commission and shall include: 

(i) A statement that the derivatives 

clearing organization is eligible to 

accept the swap, or group, category, 

type, or class of swaps for clearing and 

describes the extent to which, if the 

Commission were to determine that the 

swap, or group, category, type, or class 

of swaps is required to be cleared, the 

derivatives clearing organization will be 

able to maintain compliance with 

section 5b(c)(2) of the Act; 

(ii) A statement that includes, but is 

not limited to, information that will 

assist the Commission in making a 

quantitative and qualitative assessment 

of the following factors: 

(A) The existence of significant 

outstanding notional exposures, trading 

liquidity, and adequate pricing data; 

(B) The availability of rule framework, 

capacity, operational expertise and 

resources, and credit support 

infrastructure to clear the contract on 

terms that are consistent with the 

material terms and trading conventions 

on which the contract is then traded; 

(C) The effect on the mitigation of 

systemic risk, taking into account the 

size of the market for such contract and 

the resources of the derivatives clearing 

organization available to clear the 

contract; 

(D) The effect on competition, 

including appropriate fees and charges 

applied to clearing; and 

(E) The existence of reasonable legal 

certainty in the event of the insolvency 

of the relevant derivatives clearing 

organization or one or more of its 

clearing members with regard to the 

treatment of customer and swap 

counterparty positions, funds, and 

property; 

(iii) Product specifications, including 

copies of any standardized legal 

documentation, generally accepted 

contract terms, standard practices for 

managing any life cycle events 

associated with the swap, and the extent 

to which the swap is electronically 

confirmable; 

(iv) Participant eligibility standards, if 

different from the derivatives clearing 

organization’s general participant 

eligibility standards; 

(v) Pricing sources, models, and 

procedures, demonstrating an ability to 

obtain sufficient price data to measure 

credit exposures in a timely and 

accurate manner, including any 

agreements with clearing members to 

provide price data and copies of 

executed agreements with third-party 

price vendors, and information about 

any price reference index used, such as 

the name of the index, the source that 

calculates it, the methodology used to 

calculate the price reference index and 

how often it is calculated, and when 

and where it is published publicly; 

(vi) Risk management procedures, 

including measurement and monitoring 

of credit exposures, initial and variation 

margin methodology, methodologies for 

stress testing and back testing, 

settlement procedures, and default 

management procedures; 

(vii) Applicable rules, manuals, 

policies, or procedures; 

(viii) A description of the manner in 

which the derivatives clearing 

organization has provided notice of the 

submission to its members and a 

summary of any views on the 

submission expressed by the members 

(a copy of the notice to members shall 

be included with the submission); and 

(ix) Any additional information 

specifically requested by the 

Commission. 

(4) The Commission must have 

received the submission by the open of 

business on the business day preceding 

the acceptance of the swap, or group, 

category, type, or class of swaps for 

clearing. 

(5) The submission will be made 

available to the public and posted on 

the Commission Web site for a 30-day 

public comment period. A derivatives 

clearing organization that wishes to 

request confidential treatment for 

portions of its submission may do so in 

accordance with the procedures set out 

in § 145.9(d) of this chapter. 

(6) The Commission will review the 

submission and determine whether the 

swap, or group, category, type, or class 

of swaps described in the submission is 

required to be cleared. The Commission 

will make its determination not later 

than 90 days after a complete 

submission has been received, unless 

the submitting derivatives clearing 

organization agrees to an extension. The 

determination of when such submission 

is complete shall be at the sole 

discretion of the Commission. In making 

a determination that a clearing 

requirement shall apply, the 

Commission may impose such terms 

and conditions to the clearing 

requirement as the Commission 

determines to be appropriate. 

(c) Commission-initiated reviews. (1) 

The Commission, on an ongoing basis, 

will review swaps that have not been 

accepted for clearing by a derivatives 

clearing organization to make a 

determination as to whether the swaps 

should be required to be cleared. In 

undertaking such reviews, the 

Commission will use information 

obtained pursuant to Commission 

regulations from swap data repositories, 

swap dealers, and major swap 

participants, and any other available 

information. 

(2) Notice regarding any 

determination made under paragraph 

(c)(1) of this section will be made 

available to the public and posted on 

the Commission Web site for a 30-day 

public comment period. 

(3) If no derivatives clearing 

organization has accepted for clearing a 

particular swap, group, category, type, 

or class of swaps that the Commission 

finds would otherwise be subject to a 

clearing requirement, the Commission 

will: 

(i) Investigate the relevant facts and 

circumstances; 

(ii) Within 30 days of the completion 

of its investigation, issue a public report 

containing the results of the 

investigation; and 

(iii) Take such actions as the 

Commission determines to be necessary 

and in the public interest, which may 

include requiring the retaining of 

adequate margin or capital by parties to 

the swap, group, category, type, or class 

of swaps. 

(d) Stay of clearing requirement. (1) 

After making a determination that a 

swap, or group, category, type, or class 

of swaps is required to be cleared, the 

Commission, on application of a 

counterparty to a swap or on its own 

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initiative, may stay the clearing 

requirement until the Commission 

completes a review of the terms of the 

swap, or group, category, type, or class 

of swaps and the clearing arrangement. 

(2) A counterparty to a swap that 

wishes to apply for a stay of the clearing 

requirement for that swap shall submit 

a written request to the Secretary of the 

Commission that includes: 

(i) The identity and contact 

information of the counterparty to the 

swap; 

(ii) The terms of the swap subject to 

the clearing requirement; 

(iii) The name of the derivatives 

clearing organization clearing the swap; 

(iv) A description of the clearing 

arrangement; and 

(v) A statement explaining why the 

swap should not be subject to a clearing 

requirement. 

(3) A derivatives clearing organization 

that has accepted for clearing a swap, or 

group, category, type, or class of swaps 

that is subject to a stay of the clearing 

requirement shall provide any 

information requested by the 

Commission in the course of its review. 

(4) The Commission will complete its 

review not later than 90 days after 

issuance of the stay, unless the 

derivatives clearing organization that 

clears the swap, or group, category, 

type, or class of swaps agrees to an 

extension. 

(5) Upon completion of its review, the 

Commission may: 

(i) Determine, subject to any terms 

and conditions as the Commission 

determines to be appropriate, that the 

swap, or group, category, type, or class 

of swaps must be cleared; or 

(ii) Determine that the clearing 

requirement will not apply to the swap, 

or group, category, type, or class of 

swaps, but clearing may continue on a 

non-mandatory basis. 

§ 39.6 [Reserved] 

§ 39.7 Enforceability. 

An agreement, contract or transaction 

submitted to a derivatives clearing 

organization for clearing shall not be 

void, voidable, subject to rescission, or 

otherwise invalidated or rendered 

unenforceable as a result of: 

(a) A violation by the derivatives 

clearing organization of the provisions 

of the Act or of Commission regulations; 

or 

(b) Any Commission proceeding to 

alter or supplement a rule under section 

8a(7) of the Act, to declare an 

emergency under section 8a(9) of the 

Act, or any other proceeding the effect 

of which is to alter, supplement, or 

require a derivatives clearing 

organization to adopt a specific rule or 

procedure, or to take or refrain from 

taking a specific action. 

§ 39.8 Fraud in connection with the 

clearing of transactions on a derivatives 

clearing organization. 

It shall be unlawful for any person, 

directly or indirectly, in or in 

connection with the clearing of 

transactions by a derivatives clearing 

organization: 

(a) To cheat or defraud or attempt to 

cheat or defraud any person; 

(b) Willfully to make or cause to be 

made to any person any false report or 

statement or cause to be entered for any 

person any false record; or 

(c) Willfully to deceive or attempt to 

deceive any person by any means 

whatsoever. 

Subpart B—Compliance with Core 

Principles 

§ 39.9 Scope. 

The provisions of this subpart B apply 

to any derivatives clearing organization, 

as defined under section 1a(15) of the 

Act and § 1.3(d) of this chapter, which 

is registered or deemed to be registered 

with the Commission as a derivatives 

clearing organization, is required to 

register as such with the Commission 

pursuant to section 5b(a) of the Act, or 

which voluntarily registers as such with 

the Commission pursuant to section 

5b(b) or otherwise. 

§ 39.10 Compliance with core principles. 

(a) To be registered and to maintain 

registration as a derivatives clearing 

organization, a derivatives clearing 

organization shall comply with each 

core principle set forth in section 

5b(c)(2) of the Act and any requirement 

that the Commission may impose by 

rule or regulation pursuant to section 

8a(5) of the Act; and 

(b) Subject to any rule or regulation 

prescribed by the Commission, a 

registered derivatives clearing 

organization shall have reasonable 

discretion in establishing the manner by 

which it complies with each core 

principle. 

(c) Chief compliance officer—(1) 

Designation. Each derivatives clearing 

organization shall establish the position 

of chief compliance officer, designate an 

individual to serve as the chief 

compliance officer, and provide the 

chief compliance officer with the full 

responsibility and authority to develop 

and enforce, in consultation with the 

board of directors or the senior officer, 

appropriate compliance policies and 

procedures, to fulfill the duties set forth 

in the Act and Commission regulations. 

(i) The individual designated to serve 

as chief compliance officer shall have 

the background and skills appropriate 

for fulfilling the responsibilities of the 

position. No individual who would be 

disqualified from registration under 

sections 8a(2) or 8a(3) of the Act may 

serve as a chief compliance officer. 

(ii) The chief compliance officer shall 

report to the board of directors or the 

senior officer of the derivatives clearing 

organization. The board of directors or 

the senior officer shall approve the 

compensation of the chief compliance 

officer. 

(iii) The chief compliance officer shall 

meet with the board of directors or the 

senior officer at least once a year. 

(iv) A change in the designation of the 

individual serving as the chief 

compliance officer of the derivatives 

clearing organization shall be reported 

to the Commission in accordance with 

the requirements of § 39.19(c)(4)(ix) of 

this part. 

(2) Chief compliance officer duties. 

The chief compliance officer’s duties 

shall include, but are not limited to: 

(i) Reviewing the derivatives clearing 

organization’s compliance with the core 

principles set forth in section 5b of the 

Act, and the Commission’s regulations 

thereunder; 

(ii) In consultation with the board of 

directors or the senior officer, resolving 

any conflicts of interest that may arise; 

(iii) Establishing and administering 

written policies and procedures 

reasonably designed to prevent violation 

of the Act; 

(iv) Taking reasonable steps to ensure 

compliance with the Act and 

Commission regulations relating to 

agreements, contracts, or transactions, 

and with Commission regulations 

prescribed under section 5b of the Act; 

(v) Establishing procedures for the 

remediation of noncompliance issues 

identified by the chief compliance 

officer through any compliance office 

review, look-back, internal or external 

audit finding, self-reported error, or 

validated complaint; and 

(vi) Establishing and following 

appropriate procedures for the handling, 

management response, remediation, 

retesting, and closing of noncompliance 

issues. 

(3) Annual report. The chief 

compliance officer shall, not less than 

annually, prepare and sign a written 

report that covers the most recently 

completed fiscal year of the derivatives 

clearing organization, and provide the 

annual report to the board of directors 

or the senior officer. The annual report 

shall, at a minimum: 

(i) Contain a description of the 

derivatives clearing organization’s 

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written policies and procedures, 

including the code of ethics and conflict 

of interest policies; 

(ii) Review each core principle and 

applicable Commission regulation, and 

with respect to each: 

(A) Identify the compliance policies 

and procedures that are designed to 

ensure compliance with the core 

principle; 

(B) Provide an assessment as to the 

effectiveness of these policies and 

procedures; 

(C) Discuss areas for improvement, 

and recommend potential or prospective 

changes or improvements to the 

derivatives clearing organization’s 

compliance program and resources 

allocated to compliance; 

(iii) List any material changes to 

compliance policies and procedures 

since the last annual report; 

(iv) Describe the financial, 

managerial, and operational resources 

set aside for compliance with the Act 

and Commission regulations; and 

(v) Describe any material compliance 

matters, including incidents of 

noncompliance, since the date of the 

last annual report and describe the 

corresponding action taken. 

(4) Submission of annual report to the 

Commission. (i) Prior to submitting the 

annual report to the Commission, the 

chief compliance officer shall provide 

the annual report to the board of 

directors or the senior officer of the 

derivatives clearing organization for 

review. Submission of the report to the 

board of directors or the senior officer 

shall be recorded in the board minutes 

or otherwise, as evidence of compliance 

with this requirement. 

(ii) The annual report shall be 

submitted electronically to the Secretary 

of the Commission in the format and 

manner specified by the Commission 

not more than 90 days after the end of 

the derivatives clearing organization’s 

fiscal year, concurrently with 

submission of the fiscal year-end 

audited financial statement that is 

required to be furnished to the 

Commission pursuant to § 39.19(c)(3)(ii) 

of this part. The report shall include a 

certification by the chief compliance 

officer that, to the best of his or her 

knowledge and reasonable belief, and 

under penalty of law, the annual report 

is accurate and complete. 

(iii) The derivatives clearing 

organization shall promptly submit an 

amended annual report if material errors 

or omissions in the report are identified 

after submission. An amendment must 

contain the certification required under 

paragraph (c)(4)(ii) of this section. 

(iv) A derivatives clearing 

organization may request from the 

Commission an extension of time to 

submit its annual report in accordance 

with § 39.19(c)(3) of this part. 

(5) Recordkeeping. (i) The derivatives 

clearing organization shall maintain: 

(A) A copy of all compliance policies 

and procedures and all other policies 

and procedures adopted in furtherance 

of compliance with the Act and 

Commission regulations; 

(B) Copies of materials, including 

written reports provided to the board of 

directors or the senior officer in 

connection with the review of the 

annual report under paragraph (c)(4)(i) 

of this section; and 

(C) Any records relevant to the annual 

report, including, but not limited to, 

work papers and other documents that 

form the basis of the report, and 

memoranda, correspondence, other 

documents, and records that are created, 

sent, or received in connection with the 

annual report and contain conclusions, 

opinions, analyses, or financial data 

related to the annual report. 

(ii) The derivatives clearing 

organization shall maintain records in 

accordance with § 1.31 of this chapter 

and § 39.20 of this part. 

§ 39.11 Financial resources. 

(a) General. A derivatives clearing 

organization shall maintain financial 

resources sufficient to cover its 

exposures with a high degree of 

confidence and to enable it to perform 

its functions in compliance with the 

core principles set out in section 5b of 

the Act. A derivatives clearing 

organization shall identify and 

adequately manage its general business 

risks and hold sufficient liquid 

resources to cover potential business 

losses that are not related to clearing 

members’ defaults, so that the 

derivatives clearing organization can 

continue to provide services as an 

ongoing concern. Financial resources 

shall be considered sufficient if their 

value, at a minimum, exceeds the total 

amount that would: 

(1) Enable the derivatives clearing 

organization to meet its financial 

obligations to its clearing members 

notwithstanding a default by the 

clearing member creating the largest 

financial exposure for the derivatives 

clearing organization in extreme but 

plausible market conditions; Provided 

that if a clearing member controls 

another clearing member or is under 

common control with another clearing 

member, the affiliated clearing members 

shall be deemed to be a single clearing 

member for purposes of this provision; 

and 

(2) Enable the derivatives clearing 

organization to cover its operating costs 

for a period of at least one year, 

calculated on a rolling basis. 

(b) Types of financial resources. (1) 

Financial resources available to satisfy 

the requirements of paragraph (a)(1) of 

this section may include: 

(i) Margin to the extent permitted 

under parts 1, 22, and 190 of this 

chapter and under the rules of the 

derivatives clearing organization; 

(ii) The derivatives clearing 

organization’s own capital; 

(iii) Guaranty fund deposits; 

(iv) Default insurance; 

(v) Potential assessments for 

additional guaranty fund contributions, 

if permitted by the derivatives clearing 

organization’s rules; and 

(vi) Any other financial resource 

deemed acceptable by the Commission. 

(2) Financial resources available to 

satisfy the requirements of paragraph 

(a)(2) of this section may include: 

(i) The derivatives clearing 

organization’s own capital; and 

(ii) Any other financial resource 

deemed acceptable by the Commission. 

(3) A financial resource may be 

allocated, in whole or in part, to satisfy 

the requirements of either paragraph 

(a)(1) or paragraph (a)(2) of this section, 

but not both paragraphs, and only to the 

extent the use of such financial resource 

is not otherwise limited by the Act, 

Commission regulations, the derivatives 

clearing organization’s rules, or any 

contractual arrangements to which the 

derivatives clearing organization is a 

party. 

(c) Computation of financial resources 

requirement. (1) A derivatives clearing 

organization shall, on a monthly basis, 

perform stress testing that will allow it 

to make a reasonable calculation of the 

financial resources needed to meet the 

requirements of paragraph (a)(1) of this 

section. The derivatives clearing 

organization shall have reasonable 

discretion in determining the 

methodology used to compute such 

requirements, provided that the 

methodology must take into account 

both historical data and hypothetical 

scenarios. The Commission may review 

the methodology and require changes as 

appropriate. 

(2) A derivatives clearing organization 

shall, on a monthly basis, make a 

reasonable calculation of its projected 

operating costs over a 12-month period 

in order to determine the amount 

needed to meet the requirements of 

paragraph (a)(2) of this section. The 

derivatives clearing organization shall 

have reasonable discretion in 

determining the methodology used to 

compute such projected operating costs. 

The Commission may review the 

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methodology and require changes as 

appropriate. 

(d) Valuation of financial resources. 

(1) At appropriate intervals, but not less 

than monthly, a derivatives clearing 

organization shall compute the current 

market value of each financial resource 

used to meet its obligations under 

paragraph (a) of this section. Reductions 

in value to reflect credit, market, and 

liquidity risks (haircuts) shall be 

applied as appropriate and evaluated on 

a monthly basis. 

(2) If assessments for additional 

guaranty fund contributions are 

permitted by the derivatives clearing 

organization’s rules, in calculating the 

financial resources available to meet its 

obligations under paragraph (a)(1) of 

this section: 

(i) The derivatives clearing 

organization shall have rules requiring 

that its clearing members have the 

ability to meet an assessment within the 

time frame of a normal end-of-day 

variation settlement cycle; 

(ii) The derivatives clearing 

organization shall monitor the financial 

and operational capacity of its clearing 

members to meet potential assessments; 

(iii) The derivatives clearing 

organization shall apply a 30 percent 

haircut to the value of potential 

assessments, and 

(iv) The derivatives clearing 

organization shall only count the value 

of assessments, after the haircut, to meet 

up to 20 percent of those obligations. 

(e) Liquidity of financial resources. (1) 

(i) The derivatives clearing organization 

shall effectively measure, monitor, and 

manage its liquidity risks, maintaining 

sufficient liquid resources such that it 

can, at a minimum, fulfill its cash 

obligations when due. The derivatives 

clearing organization shall hold assets 

in a manner where the risk of loss or of 

delay in its access to them is minimized. 

(ii) The financial resources allocated 

by the derivatives clearing organization 

to meet the requirements of paragraph 

(a)(1) of this section shall be sufficiently 

liquid to enable the derivatives clearing 

organization to fulfill its obligations as 

a central counterparty during a one-day 

settlement cycle. The derivatives 

clearing organization shall maintain 

cash, U.S. Treasury obligations, or high 

quality, liquid, general obligations of a 

sovereign nation, in an amount greater 

than or equal to an amount calculated 

as follows: 

(A) Calculate the average daily 

settlement pay for each clearing member 

over the last fiscal quarter; 

(B) Calculate the sum of those average 

daily settlement pays; and 

(C) Using that sum, calculate the 

average of its clearing members’ average 

pays. 

(iii) The derivatives clearing 

organization may take into account a 

committed line of credit or similar 

facility for the purpose of meeting the 

remainder of the requirement under 

paragraph (e)(1)(ii) of this section. 

(2) The financial resources allocated 

by the derivatives clearing organization 

to meet the requirements of paragraph 

(a)(2) of this section must include 

unencumbered, liquid financial assets 

(i.e., cash and/or highly liquid 

securities) equal to at least six months’ 

operating costs. If any portion of such 

financial resources is not sufficiently 

liquid, the derivatives clearing 

organization may take into account a 

committed line of credit or similar 

facility for the purpose of meeting this 

requirement. 

(3)(i) Assets in a guaranty fund shall 

have minimal credit, market, and 

liquidity risks and shall be readily 

accessible on a same-day basis; 

(ii) Cash balances shall be invested or 

placed in safekeeping in a manner that 

bears little or no principal risk; and 

(iii) Letters of credit shall not be a 

permissible asset for a guaranty fund. 

(f) Reporting requirements. 

(1) Each fiscal quarter, or at any time 

upon Commission request, a derivatives 

clearing organization shall: 

(i) Report to the Commission; 

(A) The amount of financial resources 

necessary to meet the requirements of 

paragraph (a); 

(B) The value of each financial 

resource available, computed in 

accordance with the requirements of 

paragraph (d) of this section; and 

(C) The manner in which the 

derivatives clearing organization meets 

the liquidity requirements of paragraph 

(e) of this section; 

(ii) Provide the Commission with a 

financial statement, including the 

balance sheet, income statement, and 

statement of cash flows, of the 

derivatives clearing organization or of 

its parent company; and 

(iii) Report to the Commission the 

value of each individual clearing 

member’s guaranty fund deposit, if the 

derivatives clearing organization reports 

having guaranty funds deposits as a 

financial resource available to satisfy 

the requirements of paragraph (a)(1) of 

this section. 

(2) The calculations required by this 

paragraph shall be made as of the last 

business day of the derivatives clearing 

organization’s fiscal quarter. 

(3) The derivatives clearing 

organization shall provide the 

Commission with: 

(i) Sufficient documentation 

explaining the methodology used to 

compute its financial resources 

requirements under paragraph (a) of this 

section, 

(ii) Sufficient documentation 

explaining the basis for its 

determinations regarding the valuation 

and liquidity requirements set forth in 

paragraphs (d) and (e) of this section, 

and 

(iii) Copies of any agreements 

establishing or amending a credit 

facility, insurance coverage, or other 

arrangement evidencing or otherwise 

supporting the derivatives clearing 

organization’s conclusions. 

(4) The report shall be filed not later 

than 17 business days after the end of 

the derivatives clearing organization’s 

fiscal quarter, or at such later time as the 

Commission may permit, in its 

discretion, upon request by the 

derivatives clearing organization. 

§ 39.12 Participant and product eligibility. 

(a) Participant eligibility. A 

derivatives clearing organization shall 

establish appropriate admission and 

continuing participation requirements 

for clearing members of the derivatives 

clearing organization that are objective, 

publicly disclosed, and risk-based. 

(1) Fair and open access for 

participation. The participation 

requirements shall permit fair and open 

access; 

(i) A derivatives clearing organization 

shall not adopt restrictive clearing 

member standards if less restrictive 

requirements that achieve the same 

objective and that would not materially 

increase risk to the derivatives clearing 

organization or clearing members could 

be adopted; 

(ii) A derivatives clearing organization 

shall allow all market participants who 

satisfy participation requirements to 

become clearing members; 

(iii) A derivatives clearing 

organization shall not exclude or limit 

clearing membership of certain types of 

market participants unless the 

derivatives clearing organization can 

demonstrate that the restriction is 

necessary to address credit risk or 

deficiencies in the participants’ 

operational capabilities that would 

prevent them from fulfilling their 

obligations as clearing members. 

(iv) A derivatives clearing 

organization shall not require that 

clearing members be swap dealers. 

(v) A derivatives clearing organization 

shall not require that clearing members 

maintain a swap portfolio of any 

particular size, or that clearing members 

meet a swap transaction volume 

threshold. 

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(2) Financial resources. (i) The 

participation requirements shall require 

clearing members to have access to 

sufficient financial resources to meet 

obligations arising from participation in 

the derivatives clearing organization in 

extreme but plausible market 

conditions. A derivatives clearing 

organization may permit such financial 

resources to include, without limitation, 

a clearing member’s capital, a guarantee 

from the clearing member’s parent, or a 

credit facility funding arrangement. For 

purposes of this paragraph, ‘‘capital’’ 

means adjusted net capital as defined in 

§ 1.17 of this chapter, for futures 

commission merchants, and net capital 

as defined in § 240.15c3–1of this title, 

for broker-dealers, or any similar risk 

adjusted capital calculation for all other 

clearing members. 

(ii) The participation requirements 

shall set forth capital requirements that 

are based on objective, transparent, and 

commonly accepted standards that 

appropriately match capital to risk. 

Capital requirements shall be scalable to 

the risks posed by clearing members. 

(iii) A derivatives clearing 

organization shall not set a minimum 

capital requirement of more than $50 

million for any person that seeks to 

become a clearing member in order to 

clear swaps. 

(3) Operational requirements. The 

participation requirements shall require 

clearing members to have adequate 

operational capacity to meet obligations 

arising from participation in the 

derivatives clearing organization. The 

requirements shall include, but are not 

limited to: the ability to process 

expected volumes and values of 

transactions cleared by a clearing 

member within required time frames, 

including at peak times and on peak 

days; the ability to fulfill collateral, 

payment, and delivery obligations 

imposed by the derivatives clearing 

organization; and the ability to 

participate in default management 

activities under the rules of the 

derivatives clearing organization and in 

accordance with § 39.16 of this part. 

(4) Monitoring. A derivatives clearing 

organization shall establish and 

implement procedures to verify, on an 

ongoing basis, the compliance of each 

clearing member with each participation 

requirement of the derivatives clearing 

organization. 

(5) Reporting. (i) A derivatives 

clearing organization shall require all 

clearing members, including nonfutures commission merchants, to 

provide to the derivatives clearing 

organization periodic financial reports 

that contain any financial information 

that the derivatives clearing 

organization determines is necessary to 

assess whether participation 

requirements are being met on an 

ongoing basis. 

(A) A derivatives clearing 

organization shall require clearing 

members that are futures commission 

merchants to provide the financial 

reports that are specified in § 1.10 of 

this chapter to the derivatives clearing 

organization. 

(B) A derivatives clearing organization 

shall require clearing members that are 

not futures commission merchants to 

make the periodic financial reports 

provided pursuant to paragraph (a)(5)(i) 

of this section available to the 

Commission upon the Commission’s 

request or, in lieu of imposing this 

requirement, a derivatives clearing 

organization may provide such financial 

reports directly to the Commission upon 

the Commission’s request. 

(ii) A derivatives clearing organization 

shall adopt rules that require clearing 

members to provide to the derivatives 

clearing organization, in a timely 

manner, information that concerns any 

financial or business developments that 

may materially affect the clearing 

members’ ability to continue to comply 

with participation requirements. 

(6) Enforcement. A derivatives 

clearing organization shall have the 

ability to enforce compliance with its 

participation requirements and shall 

establish procedures for the suspension 

and orderly removal of clearing 

members that no longer meet the 

requirements. 

(b) Product eligibility. (1) A 

derivatives clearing organization shall 

establish appropriate requirements for 

determining the eligibility of 

agreements, contracts, or transactions 

submitted to the derivatives clearing 

organization for clearing, taking into 

account the derivatives clearing 

organization’s ability to manage the 

risks associated with such agreements, 

contracts, or transactions. Factors to be 

considered in determining product 

eligibility include, but are not limited 

to: 

(i) Trading volume; 

(ii) Liquidity; 

(iii) Availability of reliable prices; 

(iv) Ability of market participants to 

use portfolio compression with respect 

to a particular swap product; 

(v) Ability of the derivatives clearing 

organization and clearing members to 

gain access to the relevant market for 

purposes of creating, liquidating, 

transferring, auctioning, and/or 

allocating positions; 

(vi) Ability of the derivatives clearing 

organization to measure risk for 

purposes of setting margin 

requirements; and 

(vii) Operational capacity of the 

derivatives clearing organization and 

clearing members to address any 

unusual risk characteristics of a 

product. 

(2) A derivatives clearing organization 

shall adopt rules providing that all 

swaps with the same terms and 

conditions, as defined by product 

specifications established under 

derivatives clearing organization rules, 

submitted to the derivatives clearing 

organization for clearing are 

economically equivalent within the 

derivatives clearing organization and 

may be offset with each other within the 

derivatives clearing organization. 

(3) A derivatives clearing organization 

shall provide for non-discriminatory 

clearing of a swap executed bilaterally 

or on or subject to the rules of an 

unaffiliated swap execution facility or 

designated contract market. 

(4) A derivatives clearing organization 

shall not require that one of the original 

executing parties be a clearing member 

in order for a product to be eligible for 

clearing. 

(5) A derivatives clearing organization 

shall select product unit sizes and other 

terms and conditions that maximize 

liquidity, facilitate transparency in 

pricing, promote open access, and allow 

for effective risk management. To the 

extent appropriate to further these 

objectives, a derivatives clearing 

organization shall select product units 

for clearing purposes that are smaller 

than the product units in which trades 

submitted for clearing were executed. 

(6) A derivatives clearing organization 

that clears swaps shall have rules 

providing that, upon acceptance of a 

swap by the derivatives clearing 

organization for clearing: 

(i) The original swap is extinguished; 

(ii) The original swap is replaced by 

an equal and opposite swap between the 

derivatives clearing organization and 

each clearing member acting as 

principal for a house trade or acting as 

agent for a customer trade; 

(iii) All terms of a cleared swap must 

conform to product specifications 

established under derivatives clearing 

organization rules; and 

(iv) If a swap is cleared by a clearing 

member on behalf of a customer, all 

terms of the swap, as carried in the 

customer account on the books of the 

clearing member, must conform to the 

terms of the cleared swap established 

under the derivatives clearing 

organization’s rules. 

(7) [Reserved] 

(8) Confirmation. A derivatives 

clearing organization shall provide each 

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69438 Federal Register / Vol. 76, No. 216 / Tuesday, November 8, 2011 / Rules and Regulations 

clearing member carrying a cleared 

swap with a definitive written record of 

the terms of the transaction which shall 

legally supersede any previous 

agreement and serve as a confirmation 

of the swap. The confirmation of all 

terms of the transaction shall take place 

at the same time as the swap is accepted 

for clearing. 

§ 39.13 Risk management. 

(a) General. A derivatives clearing 

organization shall ensure that it 

possesses the ability to manage the risks 

associated with discharging the 

responsibilities of the derivatives 

clearing organization through the use of 

appropriate tools and procedures. 

(b) Documentation requirement. A 

derivatives clearing organization shall 

establish and maintain written policies, 

procedures, and controls, approved by 

its board of directors, which establish an 

appropriate risk management framework 

that, at a minimum, clearly identifies 

and documents the range of risks to 

which the derivatives clearing 

organization is exposed, addresses the 

monitoring and management of the 

entirety of those risks, and provides a 

mechanism for internal audit. The risk 

management framework shall be 

regularly reviewed and updated as 

necessary. 

(c) Chief risk officer. A derivatives 

clearing organization shall have a chief 

risk officer who shall be responsible for 

implementing the risk management 

framework, including the procedures, 

policies and controls described in 

paragraph (b) of this section, and for 

making appropriate recommendations to 

the derivatives clearing organization’s 

risk management committee or board of 

directors, as applicable, regarding the 

derivatives clearing organization’s risk 

management functions. 

(d) [Reserved] 

(e) Measurement of credit exposure. A 

derivatives clearing organization shall: 

(1) Measure its credit exposure to 

each clearing member and mark to 

market such clearing member’s open 

house and customer positions at least 

once each business day; and 

(2) Monitor its credit exposure to each 

clearing member periodically during 

each business day. 

(f) Limitation of exposure to potential 

losses from defaults. A derivatives 

clearing organization, through margin 

requirements and other risk control 

mechanisms, shall limit its exposure to 

potential losses from defaults by its 

clearing members to ensure that: 

(1) The operations of the derivatives 

clearing organization would not be 

disrupted; and 

(2) Non-defaulting clearing members 

would not be exposed to losses that 

non-defaulting clearing members cannot 

anticipate or control. 

(g) Margin requirements. (1) General. 

Each model and parameter used in 

setting initial margin requirements shall 

be risk-based and reviewed on a regular 

basis. 

(2) Methodology and coverage. (i) A 

derivatives clearing organization shall 

establish initial margin requirements 

that are commensurate with the risks of 

each product and portfolio, including 

any unusual characteristics of, or risks 

associated with, particular products or 

portfolios, including but not limited to 

jump-to-default risk or similar jump 

risk. 

(ii) A derivatives clearing organization 

shall use models that generate initial 

margin requirements sufficient to cover 

the derivatives clearing organization’s 

potential future exposures to clearing 

members based on price movements in 

the interval between the last collection 

of variation margin and the time within 

which the derivatives clearing 

organization estimates that it would be 

able to liquidate a defaulting clearing 

member’s positions (liquidation time); 

provided, however, that a derivatives 

clearing organization shall use: 

(A) A minimum liquidation time that 

is one day for futures and options; 

(B) A minimum liquidation time that 

is one day for swaps on agricultural 

commodities, energy commodities, and 

metals; 

(C) A minimum liquidation time that 

is five days for all other swaps; or 

(D) Such longer liquidation time as is 

appropriate based on the specific 

characteristics of a particular product or 

portfolio; provided further that the 

Commission, by order, may establish 

shorter or longer liquidation times for 

particular products or portfolios. 

(iii) The actual coverage of the initial 

margin requirements produced by such 

models, along with projected measures 

of the models’ performance, shall meet 

an established confidence level of at 

least 99 percent, based on data from an 

appropriate historic time period, for: 

(A) Each product for which the 

derivatives clearing organization uses a 

product-based margin methodology; 

(B) Each spread within or between 

products for which there is a defined 

spread margin rate; 

(C) Each account held by a clearing 

member at the derivatives clearing 

organization, by house origin and by 

each customer origin; and 

(D) Each swap portfolio, including 

any portfolio containing futures and/or 

options and held in a commingled 

account pursuant to § 39.15(b)(2) of this 

part, by beneficial owner. 

(iv) A derivatives clearing 

organization shall determine the 

appropriate historic time period based 

on the characteristics, including 

volatility patterns, as applicable, of each 

product, spread, account, or portfolio. 

(3) Independent validation. A 

derivatives clearing organization’s 

systems for generating initial margin 

requirements, including its theoretical 

models, must be reviewed and validated 

by a qualified and independent party, 

on a regular basis. Such qualified and 

independent parties may be 

independent contractors or employees 

of the derivatives clearing organization, 

but shall not be persons responsible for 

development or operation of the systems 

and models being tested. 

(4) Spread and portfolio margins. (i) 

A derivatives clearing organization may 

allow reductions in initial margin 

requirements for related positions if the 

price risks with respect to such 

positions are significantly and reliably 

correlated. The price risks of different 

positions will only be considered to be 

reliably correlated if there is a 

theoretical basis for the correlation in 

addition to an exhibited statistical 

correlation. That theoretical basis may 

include, but is not limited to, the 

following: 

(A) The products on which the 

positions are based are complements of, 

or substitutes for, each other; 

(B) One product is a significant input 

into the other product(s); 

(C) The products share a significant 

common input; or 

(D) The prices of the products are 

influenced by common external factors. 

(ii) A derivatives clearing organization 

shall regularly review its margin 

reductions and the correlations on 

which they are based. 

(5) Price data. A derivatives clearing 

organization shall have a reliable source 

of timely price data in order to measure 

the derivatives clearing organization’s 

credit exposure accurately. A 

derivatives clearing organization shall 

also have written procedures and sound 

valuation models for addressing 

circumstances where pricing data is not 

readily available or reliable. 

(6) Daily review. On a daily basis, a 

derivatives clearing organization shall 

determine the adequacy of its initial 

margin requirements. 

(7) Back tests. A derivatives clearing 

organization shall conduct back tests, as 

defined in § 39.2 of this part, using an 

appropriate time period but not less 

than the previous 30 days, as follows: 

(i) On a daily basis, a derivatives 

clearing organization shall conduct back 

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tests with respect to products or swap 

portfolios that are experiencing 

significant market volatility, to test the 

adequacy of its initial margin 

requirements, as follows: 

(A) For that product if the derivatives 

clearing organization uses a productbased margin methodology; 

(B) For each spread involving that 

product if there is a defined spread 

margin rate; 

(C) For each account held by a 

clearing member at the derivatives 

clearing organization that contains a 

significant position in that product, by 

house origin and by each customer 

origin; and 

(D) For each such swap portfolio, 

including any portfolio containing 

futures and/or options and held in a 

commingled account pursuant to 

§ 39.15(b)(2) of this part, by beneficial 

owner. 

(ii) On at least a monthly basis, a 

derivatives clearing organization shall 

conduct back tests to test the adequacy 

of its initial margin requirements, as 

follows: 

(A) For each product for which the 

derivatives clearing organization uses a 

product-based margin methodology; 

(B) For each spread for which there is 

a defined spread margin rate; 

(C) For each account held by a 

clearing member at the derivatives 

clearing organization, by house origin 

and by each customer origin; and 

(D) For each swap portfolio, including 

any portfolio containing futures and/or 

options and held in a commingled 

account pursuant to § 39.15(b)(2) of this 

part, by beneficial owner. 

(8) Customer margin. (i) Gross margin. 

(A) A derivatives clearing organization 

shall collect initial margin on a gross 

basis for each clearing member’s 

customer account(s) equal to the sum of 

the initial margin amounts that would 

be required by the derivatives clearing 

organization for each individual 

customer within that account if each 

individual customer were a clearing 

member. 

(B) For purposes of calculating the 

gross initial margin requirement for 

each clearing member’s customer 

account(s), to the extent not inconsistent 

with other Commission regulations, a 

derivatives clearing organization may 

require its clearing members to report 

the gross positions of each individual 

customer to the derivatives clearing 

organization, or it may permit each 

clearing member to report the sum of 

the gross positions of its customers to 

the derivatives clearing organization. 

(C) For purposes of this paragraph 

(g)(8), a derivatives clearing 

organization may rely, and may permit 

its clearing members to rely, upon the 

sum of the gross positions reported to 

the clearing members by each domestic 

or foreign omnibus account that they 

carry, without obtaining information 

identifying the positions of each 

individual customer underlying such 

omnibus accounts. 

(D) A derivatives clearing 

organization may not, and may not 

permit its clearing members to, net 

positions of different customers against 

one another. 

(E) A derivatives clearing organization 

may collect initial margin for its 

clearing members’ house accounts on a 

net basis. 

(ii) Customer initial margin 

requirements. A derivatives clearing 

organization shall require its clearing 

members to collect customer initial 

margin, as defined in § 1.3 of this 

chapter, from their customers, for nonhedge positions, at a level that is greater 

than 100 percent of the derivatives 

clearing organization’s initial margin 

requirements with respect to each 

product and swap portfolio. The 

derivatives clearing organization shall 

have reasonable discretion in 

determining the percentage by which 

customer initial margins must exceed 

the derivatives clearing organization’s 

initial margin requirements with respect 

to particular products or swap 

portfolios. The Commission may review 

such percentage levels and require 

different percentage levels if the 

Commission deems the levels 

insufficient to protect the financial 

integrity of the clearing members or the 

derivatives clearing organization. 

(iii) Withdrawal of customer initial 

margin. A derivatives clearing 

organization shall require its clearing 

members to ensure that their customers 

do not withdraw funds from their 

accounts with such clearing members 

unless the net liquidating value plus the 

margin deposits remaining in a 

customer’s account after such 

withdrawal are sufficient to meet the 

customer initial margin requirements 

with respect to all products and swap 

portfolios held in such customer’s 

account which are cleared by the 

derivatives clearing organization. 

(9) Time deadlines. A derivatives 

clearing organization shall establish and 

enforce time deadlines for initial and 

variation margin payments to the 

derivatives clearing organization by its 

clearing members. 

(10) Types of assets. A derivatives 

clearing organization shall limit the 

assets it accepts as initial margin to 

those that have minimal credit, market, 

and liquidity risks. A derivatives 

clearing organization may take into 

account the specific risk-reducing 

properties that particular assets have in 

a particular portfolio. A derivatives 

clearing organization may accept letters 

of credit as initial margin for futures and 

options on futures but shall not accept 

letters of credit as initial margin for 

swaps. 

(11) Valuation. A derivatives clearing 

organization shall use prudent valuation 

practices to value assets posted as initial 

margin on a daily basis. 

(12) Haircuts. A derivatives clearing 

organization shall apply appropriate 

reductions in value to reflect credit, 

market, and liquidity risks (haircuts), to 

the assets that it accepts in satisfaction 

of initial margin obligations, taking into 

consideration stressed market 

conditions, and shall evaluate the 

appropriateness of such haircuts on at 

least a quarterly basis. 

(13) Concentration limits or charges. 

A derivatives clearing organization shall 

apply appropriate limitations or charges 

on the concentration of assets posted as 

initial margin, as necessary, in order to 

ensure its ability to liquidate such assets 

quickly with minimal adverse price 

effects, and shall evaluate the 

appropriateness of any such 

concentration limits or charges, on at 

least a monthly basis. 

(14) Pledged assets. If a derivatives 

clearing organization permits its 

clearing members to pledge assets for 

initial margin while retaining such 

assets in accounts in the names of such 

clearing members, the derivatives 

clearing organization shall ensure that 

such assets are unencumbered and that 

such a pledge has been validly created 

and validly perfected in the relevant 

jurisdiction. 

(h) Other risk control mechanisms— 

(1) Risk limits. (i) A derivatives clearing 

organization shall impose risk limits on 

each clearing member, by house origin 

and by each customer origin, in order to 

prevent a clearing member from 

carrying positions for which the risk 

exposure exceeds a specified threshold 

relative to the clearing member’s and/or 

the derivatives clearing organization’s 

financial resources. The derivatives 

clearing organization shall have 

reasonable discretion in determining: 

(A) The method of computing risk 

exposure; 

(B) The applicable threshold(s); and 

(C) The applicable financial resources 

under this provision; provided however, 

that the ratio of exposure to capital must 

remain the same across all capital 

levels. The Commission may review 

such methods, thresholds, and financial 

resources and require the application of 

different methods, thresholds, or 

financial resources, as appropriate. 

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(ii) A derivatives clearing organization 

may permit a clearing member to exceed 

the threshold(s) applied pursuant to 

paragraph (h)(1)(i) of this section 

provided that the derivatives clearing 

organization requires the clearing 

member to post additional initial margin 

that the derivatives clearing 

organization deems sufficient to 

appropriately eliminate excessive risk 

exposure at the clearing member. The 

Commission may review the amount of 

additional initial margin and require a 

different amount of additional initial 

margin, as appropriate. 

(2) Large trader reports. A derivatives 

clearing organization shall obtain from 

its clearing members or from a relevant 

designated contract market or swap 

execution facility, copies of all reports 

that are required to be filed with the 

Commission by, or on behalf of, such 

clearing members pursuant to parts 17 

and 20 of this chapter. A derivatives 

clearing organization shall review such 

reports on a daily basis to ascertain the 

risk of the overall portfolio of each large 

trader, including futures, options, and 

swaps cleared by the derivatives 

clearing organization, which are held by 

all clearing members carrying accounts 

for each such large trader, and shall take 

additional actions with respect to such 

clearing members, when appropriate, as 

specified in paragraph (h)(6) of this 

section, in order to address any risks 

posed by any such large trader. 

(3) Stress tests. A derivatives clearing 

organization shall conduct stress tests, 

as defined in § 39.2 of this part, as 

follows: 

(i) On a daily basis, a derivatives 

clearing organization shall conduct 

stress tests with respect to each large 

trader who poses significant risk to a 

clearing member or the derivatives 

clearing organization, including futures, 

options, and swaps cleared by the 

derivatives clearing organization, which 

are held by all clearing members 

carrying accounts for each such large 

trader. The derivatives clearing 

organization shall have reasonable 

discretion in determining which traders 

to test and the methodology used to 

conduct such stress tests. The 

Commission may review the selection of 

accounts and the methodology and 

require changes, as appropriate. 

(ii) On at least a weekly basis, a 

derivatives clearing organization shall 

conduct stress tests with respect to each 

clearing member account, by house 

origin and by each customer origin, and 

each swap portfolio, including any 

portfolio containing futures and/or 

options and held in a commingled 

account pursuant to § 39.15(b)(2) of this 

part, by beneficial owner, under extreme 

but plausible market conditions. The 

derivatives clearing organization shall 

have reasonable discretion in 

determining the methodology used to 

conduct such stress tests. The 

Commission may review the 

methodology and require changes, as 

appropriate. 

(4) Portfolio compression. A 

derivatives clearing organization shall 

make portfolio compression exercises 

available, on a regular and voluntary 

basis, for its clearing members that clear 

swaps, to the extent that such exercises 

are appropriate for those swaps that it 

clears; provided, however, a derivatives 

clearing organization is not required to 

develop its own portfolio compression 

services, and is only required to make 

such portfolio compression exercises 

available, if applicable portfolio 

compression services have been 

developed by a third party. 

(5) Clearing members’ risk 

management policies and procedures. 

(i) A derivatives clearing organization 

shall adopt rules that: 

(A) Require its clearing members to 

maintain current written risk 

management policies and procedures, 

which address the risks that such 

clearing members may pose to the 

derivatives clearing organization; 

(B) Ensure that it has the authority to 

request and obtain information and 

documents from its clearing members 

regarding their risk management 

policies, procedures, and practices, 

including, but not limited to, 

information and documents relating to 

the liquidity of their financial resources 

and their settlement procedures; and 

(C) Require its clearing members to 

make information and documents 

regarding their risk management 

policies, procedures, and practices 

available to the Commission upon the 

Commission’s request. 

(ii) A derivatives clearing organization 

shall review the risk management 

policies, procedures, and practices of 

each of its clearing members, which 

address the risks that such clearing 

members may pose to the derivatives 

clearing organization, on a periodic 

basis and document such reviews. 

(6) Additional authority. A derivatives 

clearing organization shall take 

additional actions with respect to 

particular clearing members, when 

appropriate, based on the application of 

objective and prudent risk management 

standards including, but not limited to: 

(i) Imposing enhanced capital 

requirements; 

(ii) Imposing enhanced margin 

requirements; 

(iii) Imposing position limits; 

(iv) Prohibiting an increase in 

positions; 

(v) Requiring a reduction of positions; 

(vi) Liquidating or transferring 

positions; and 

(vii) Suspending or revoking clearing 

membership. 

§ 39.14 Settlement procedures. 

(a) Definitions—(1) Settlement. For 

purposes of this section, ‘‘settlement’’ 

means: 

(i) Payment and receipt of variation 

margin for futures, options, and swaps; 

(ii) Payment and receipt of option 

premiums; 

(iii) Deposit and withdrawal of initial 

margin for futures, options, and swaps; 

(iv) All payments due in final 

settlement of futures, options, and 

swaps on the final settlement date with 

respect to such positions; and 

(v) All other cash flows collected from 

or paid to each clearing member, 

including but not limited to, payments 

related to swaps such as coupon 

amounts. 

(2) Settlement bank. For purposes of 

this section, ‘‘settlement bank’’ means a 

bank that maintains an account either 

for the derivatives clearing organization 

or for any of its clearing members, 

which is used for the purpose of any 

settlement described in paragraph (a)(1) 

above. 

(b) Daily settlements. Except as 

otherwise provided by Commission 

order, a derivatives clearing 

organization shall effect a settlement 

with each clearing member at least once 

each business day, and shall have the 

authority and operational capacity to 

effect a settlement with each clearing 

member, on an intraday basis, either 

routinely, when thresholds specified by 

the derivatives clearing organization are 

breached, or in times of extreme market 

volatility. 

(c) Settlement banks. A derivatives 

clearing organization shall employ 

settlement arrangements that eliminate 

or strictly limit its exposure to 

settlement bank risks, including the 

credit and liquidity risks arising from 

the use of such bank(s) to effect 

settlements with its clearing members, 

as follows: 

(1) A derivatives clearing organization 

shall have documented criteria that 

must be met by any settlement bank 

used by the derivatives clearing 

organization or its clearing members, 

including criteria addressing the 

capitalization, creditworthiness, access 

to liquidity, operational reliability, and 

regulation or supervision of such 

bank(s). 

(2) A derivatives clearing organization 

shall monitor each approved settlement 

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bank on an ongoing basis to ensure that 

such bank continues to meet the criteria 

established pursuant to paragraph (c)(1) 

of this section. 

(3) A derivatives clearing organization 

shall monitor the full range and 

concentration of its exposures to its own 

and its clearing members’ settlement 

bank(s) and assess its own and its 

clearing members’ potential losses and 

liquidity pressures in the event that the 

settlement bank with the largest share of 

settlement activity were to fail. A 

derivatives clearing organization shall 

take any one or more of the following 

actions, to the extent that any such 

action or actions are reasonably 

necessary in order to eliminate or 

strictly limit such exposures: 

(i) Maintain settlement accounts at 

one or more additional settlement 

banks; and/or 

(ii) Approve one or more additional 

settlement banks that its clearing 

members could choose to use; and/or 

(iii) Impose concentration limits with 

respect to one or more of its own or its 

clearing members’ settlement banks; 

and/or 

(iv) Take any other appropriate 

actions. 

(d) Settlement finality. A derivatives 

clearing organization shall ensure that 

settlements are final when effected by 

ensuring that it has entered into legal 

agreements that state that settlement 

fund transfers are irrevocable and 

unconditional no later than when the 

derivatives clearing organization’s 

accounts are debited or credited; 

provided, however, a derivatives 

clearing organization’s legal agreements 

with its settlement banks may provide 

for the correction of errors. A 

derivatives clearing organization’s legal 

agreements with its settlement banks 

shall state clearly when settlement fund 

transfers will occur and a derivatives 

clearing organization shall routinely 

confirm that its settlement banks are 

effecting fund transfers as and when 

required by such legal agreements. 

(e) Recordkeeping. A derivatives 

clearing organization shall maintain an 

accurate record of the flow of funds 

associated with each settlement. 

(f) Netting arrangements. A 

derivatives clearing organization shall 

possess the ability to comply with each 

term and condition of any permitted 

netting or offset arrangement with any 

other clearing organization. 

(g) Physical delivery. With respect to 

products that are settled by physical 

transfers of the underlying instruments 

or commodities, a derivatives clearing 

organization shall: 

(1) Establish rules that clearly state 

each obligation that the derivatives 

clearing organization has assumed with 

respect to physical deliveries, including 

whether it has an obligation to make or 

receive delivery of a physical 

instrument or commodity, or whether it 

indemnifies clearing members for losses 

incurred in the delivery process; and 

(2) Ensure that the risks of each such 

obligation are identified and managed. 

§ 39.15 Treatment of funds. 

(a) Required standards and 

procedures. A derivatives clearing 

organization shall establish standards 

and procedures that are designed to 

protect and ensure the safety of funds 

and assets belonging to clearing 

members and their customers. 

(b) Segregation of funds and assets. 

(1) Segregation. A derivatives clearing 

organization shall comply with the 

applicable segregation requirements of 

section 4d of the Act and Commission 

regulations thereunder, or any other 

applicable Commission regulation or 

order requiring that customer funds and 

assets be segregated, set aside, or held 

in a separate account. 

(2) Commingling of futures, options, 

and swaps. (i) Cleared swaps account. 

In order for a derivatives clearing 

organization and its clearing members to 

commingle customer positions in 

futures, options, and swaps, and any 

money, securities, or property received 

to margin, guarantee or secure such 

positions, in an account subject to the 

requirements of section 4d(f) of the Act, 

the derivatives clearing organization 

shall file rules for Commission approval 

pursuant to § 40.5 of this chapter. Such 

rule submission shall include, at a 

minimum, the following: 

(A) Identification of the futures, 

options, and swaps that would be 

commingled, including product 

specifications or the criteria that would 

be used to define eligible futures, 

options, and swaps; 

(B) Analysis of the risk characteristics 

of the eligible products; 

(C) Identification of whether the 

swaps would be executed bilaterally 

and/or executed on a designated 

contract market and/or a swap 

execution facility; 

(D) Analysis of the liquidity of the 

respective markets for the futures, 

options, and swaps that would be 

commingled, the ability of clearing 

members and the derivatives clearing 

organization to offset or mitigate the risk 

of such futures, options, and swaps in 

a timely manner, without compromising 

the financial integrity of the account, 

and, as appropriate, proposed means for 

addressing insufficient liquidity; 

(E) Analysis of the availability of 

reliable prices for each of the eligible 

products; 

(F) A description of the financial, 

operational, and managerial standards 

or requirements for clearing members 

that would be permitted to commingle 

such futures, options, and swaps; 

(G) A description of the systems and 

procedures that would be used by the 

derivatives clearing organization to 

oversee such clearing members’ risk 

management of any such commingled 

positions; 

(H) A description of the financial 

resources of the derivatives clearing 

organization, including the composition 

and availability of a guaranty fund with 

respect to the futures, options, and 

swaps that would be commingled; 

(I) A description and analysis of the 

margin methodology that would be 

applied to the commingled futures, 

options, and swaps, including any 

margin reduction applied to correlated 

positions, and any applicable margin 

rules with respect to both clearing 

members and customers; 

(J) An analysis of the ability of the 

derivatives clearing organization to 

manage a potential default with respect 

to any of the futures, options, or swaps 

that would be commingled; 

(K) A discussion of the procedures 

that the derivatives clearing 

organization would follow if a clearing 

member defaulted, and the procedures 

that a clearing member would follow if 

a customer defaulted, with respect to 

any of the commingled futures, options, 

or swaps in the account; and 

(L) A description of the arrangements 

for obtaining daily position data with 

respect to futures, options, and swaps in 

the account. 

(ii) Futures account. In order for a 

derivatives clearing organization and its 

clearing members to commingle 

customer positions in futures, options, 

and swaps, and any money, securities, 

or property received to margin, 

guarantee or secure such positions, in 

an account subject to the requirements 

of section 4d(a) of the Act, the 

derivatives clearing organization shall 

file with the Commission a petition for 

an order pursuant to section 4d(a) of the 

Act. Such petition shall include, at a 

minimum, the information required 

under paragraph (b)(2)(i) of this section. 

(iii) Commission action. (A) The 

Commission may request additional 

information in support of a rule 

submission filed under paragraph 

(b)(2)(i) of this section, and may grant 

approval of such rules in accordance 

with § 40.5 of this chapter. 

(B) The Commission may request 

additional information in support of a 

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petition filed under paragraph (b)(2)(ii) 

of this section, and may issue an order 

under section 4d of the Act in its 

discretion. 

(c) Holding of funds and assets. A 

derivatives clearing organization shall 

hold funds and assets belonging to 

clearing members and their customers 

in a manner which minimizes the risk 

of loss or of delay in the access by the 

derivatives clearing organization to such 

funds and assets. 

(d) Transfer of customer positions. A 

derivatives clearing organization shall 

have rules providing that the derivatives 

clearing organization will promptly 

transfer all or a portion of a customer’s 

portfolio of positions and related funds 

at the same time from the carrying 

clearing member of the derivatives 

clearing organization to another clearing 

member of the derivatives clearing 

organization, without requiring the 

close-out and re-booking of the 

positions prior to the requested transfer, 

subject to the following conditions: 

(1) The customer has instructed the 

carrying clearing member to make the 

transfer; 

(2) The customer is not currently in 

default to the carrying clearing member; 

(3) The transferred positions will have 

appropriate margin at the receiving 

clearing member; 

(4) Any remaining positions will have 

appropriate margin at the carrying 

clearing member; and 

(5) The receiving clearing member has 

consented to the transfer. 

(e) Permitted investments. Funds and 

assets belonging to clearing members 

and their customers that are invested by 

a derivatives clearing organization shall 

be held in instruments with minimal 

credit, market, and liquidity risks. Any 

investment of customer funds or assets 

by a derivatives clearing organization 

shall comply with § 1.25 of this chapter, 

as if all such funds and assets comprise 

customer funds subject to segregation 

pursuant to section 4d(a) of the Act and 

Commission regulations thereunder. 

§ 39.16 Default rules and procedures. 

(a) General. A derivatives clearing 

organization shall adopt rules and 

procedures designed to allow for the 

efficient, fair, and safe management of 

events during which clearing members 

become insolvent or default on the 

obligations of such clearing members to 

the derivatives clearing organization. 

(b) Default management plan. A 

derivatives clearing organization shall 

maintain a current written default 

management plan that delineates the 

roles and responsibilities of its board of 

directors, its risk management 

committee, any other committee that a 

derivatives clearing organization may 

have that has responsibilities for default 

management, and the derivatives 

clearing organization’s management, in 

addressing a default, including any 

necessary coordination with, or 

notification of, other entities and 

regulators. Such plan shall address any 

differences in procedures with respect 

to highly liquid products and less liquid 

products. A derivatives clearing 

organization shall conduct and 

document a test of its default 

management plan at least on an annual 

basis. 

(c) Default procedures. (1) A 

derivatives clearing organization shall 

adopt procedures that would permit the 

derivatives clearing organization to take 

timely action to contain losses and 

liquidity pressures and to continue 

meeting its obligations in the event of a 

default on the obligations of a clearing 

member to the derivatives clearing 

organization. 

(2) A derivatives clearing organization 

shall adopt rules that set forth its default 

procedures, including: 

(i) The derivatives clearing 

organization’s definition of a default; 

(ii) The actions that the derivatives 

clearing organization may take upon a 

default, which shall include the prompt 

transfer, liquidation, or hedging of the 

customer or house positions of the 

defaulting clearing member, as 

applicable, and which may include, in 

the discretion of the derivatives clearing 

organization, the auctioning or 

allocation of such positions to other 

clearing members; 

(iii) Any obligations that the 

derivatives clearing organization 

imposes on its clearing members to 

participate in auctions, or to accept 

allocations, of the customer or house 

positions of the defaulting clearing 

member, provided that: 

(A) The derivatives clearing 

organization shall permit a clearing 

member to outsource to a qualified third 

party, authority to act in the clearing 

member’s place in any auction, subject 

to appropriate safeguards imposed by 

the derivatives clearing organization; 

(B) The derivatives clearing 

organization shall permit a clearing 

member to outsource to a qualified third 

party, authority to act in the clearing 

member’s place in any allocations, 

subject to appropriate safeguards 

imposed by the derivatives clearing 

organization; and 

(C) Any allocation shall be 

proportional to the size of the 

participating or accepting clearing 

member’s positions in the same product 

class at the derivatives clearing 

organization; 

(iv) The sequence in which the funds 

and assets of the defaulting clearing 

member and its customers and the 

financial resources maintained by the 

derivatives clearing organization would 

be applied in the event of a default; 

(v) A provision that the funds and 

assets of a defaulting clearing member’s 

customers shall not be applied to cover 

losses with respect to a house default; 

(vi) A provision that the excess house 

funds and assets of a defaulting clearing 

member shall be applied to cover losses 

with respect to a customer default, if the 

relevant customer funds and assets are 

insufficient to cover the shortfall; and 

(3) A derivatives clearing organization 

shall make its default rules publicly 

available as provided in § 39.21 of this 

part. 

(d) Insolvency of a clearing member. 

(1) A derivatives clearing organization 

shall adopt rules that require a clearing 

member to provide prompt notice to the 

derivatives clearing organization if it 

becomes the subject of a bankruptcy 

petition, receivership proceeding, or the 

equivalent; 

(2) No later than upon receipt of such 

notice, a derivatives clearing 

organization shall review the continuing 

eligibility of the clearing member for 

clearing membership; and 

(3) No later than upon receipt of such 

notice, a derivatives clearing 

organization shall take any appropriate 

action, in its discretion, with respect to 

such clearing member or its house or 

customer positions, including but not 

limited to liquidation or transfer of 

positions, suspension, or revocation of 

clearing membership. 

§ 39.17 Rule enforcement. 

(a) General. Each derivatives clearing 

organization shall: 

(1) Maintain adequate arrangements 

and resources for the effective 

monitoring and enforcement of 

compliance with the rules of the 

derivatives clearing organization and 

the resolution of disputes; 

(2) Have the authority and ability to 

discipline, limit, suspend, or terminate 

the activities of a clearing member due 

to a violation by the clearing member of 

any rule of the derivatives clearing 

organization; and 

(3) Report to the Commission 

regarding rule enforcement activities 

and sanctions imposed against clearing 

members as provided in paragraph (a) 

(2) of this section, in accordance with 

§ 39.19(c)(4)(xi) of this part. 

(b) Authority to enforce rules. The 

board of directors of the derivatives 

clearing organization may delegate 

responsibility for compliance with the 

requirements of paragraph (a) of this 

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section to the risk management 

committee, unless the responsibilities 

are otherwise required to be carried out 

by the chief compliance officer pursuant 

to the Act or this part. 

§ 39.18 System safeguards. 

(a) Definitions. For purposes of this 

section: 

Recovery time objective means the 

time period within which an entity 

should be able to achieve recovery and 

resumption of clearing and settlement of 

existing and new products, after those 

capabilities become temporarily 

inoperable for any reason up to or 

including a wide-scale disruption. 

Relevant area means the metropolitan 

or other geographic area within which a 

derivatives clearing organization has 

physical infrastructure or personnel 

necessary for it to conduct activities 

necessary to the clearing and settlement 

of existing and new products. The term 

‘‘relevant area’’ also includes 

communities economically integrated 

with, adjacent to, or within normal 

commuting distance of that 

metropolitan or other geographic area. 

Wide-scale disruption means an event 

that causes a severe disruption or 

destruction of transportation, 

telecommunications, power, water, or 

other critical infrastructure components 

in a relevant area, or an event that 

results in an evacuation or 

unavailability of the population in a 

relevant area. 

(b) General—(1) Program of risk 

analysis. Each derivatives clearing 

organization shall establish and 

maintain a program of risk analysis and 

oversight with respect to its operations 

and automated systems to identify and 

minimize sources of operational risk 

through: 

(i) The development of appropriate 

controls and procedures; and 

(ii) The development of automated 

systems that are reliable, secure, and 

have adequate scalable capacity. 

(2) Resources. Each derivatives 

clearing organization shall establish and 

maintain resources that allow for the 

fulfillment of each obligation and 

responsibility of the derivatives clearing 

organization in light of the risks 

identified pursuant to paragraph (b)(1) 

of this section. 

(3) Verification of adequacy. Each 

derivatives clearing organization shall 

periodically verify that resources 

described in paragraph (b)(2) of this 

section are adequate to ensure daily 

processing, clearing, and settlement. 

(c) Elements of program. A derivatives 

clearing organization’s program of risk 

analysis and oversight with respect to 

its operations and automated systems, 

as described in paragraph (b) of this 

section, shall address each of the 

following categories of risk analysis and 

oversight: 

(1) Information security; 

(2) Business continuity and disaster 

recovery planning and resources; 

(3) Capacity and performance 

planning; 

(4) Systems operations; 

(5) Systems development and quality 

assurance; and 

(6) Physical security and 

environmental controls. 

(d) Standards for program. In 

addressing the categories of risk analysis 

and oversight required under paragraph 

(c) of this section, a derivatives clearing 

organization shall follow generally 

accepted standards and industry best 

practices with respect to the 

development, operation, reliability, 

security, and capacity of automated 

systems. 

(e) Business continuity and disaster 

recovery. (1) Plan and resources. A 

derivatives clearing organization shall 

maintain a business continuity and 

disaster recovery plan, emergency 

procedures, and physical, technological, 

and personnel resources sufficient to 

enable the timely recovery and 

resumption of operations and the 

fulfillment of each obligation and 

responsibility of the derivatives clearing 

organization following any disruption of 

its operations. 

(2) Responsibilities and obligations. 

The responsibilities and obligations 

described in paragraph (e)(1) of this 

section shall include, without 

limitation, daily processing, clearing, 

and settlement of transactions cleared. 

(3) Recovery time objective. The 

derivatives clearing organization’s 

business continuity and disaster 

recovery plan described in paragraph 

(e)(1) of this section, shall have the 

objective of, and the physical, 

technological, and personnel resources 

described therein shall be sufficient to, 

enable the derivatives clearing 

organization to resume daily processing, 

clearing, and settlement no later than 

the next business day following the 

disruption. 

(f) Location of resources; outsourcing. 

A derivatives clearing organization may 

maintain the resources required under 

paragraph (e)(1) of this section either: 

(1) Using its own employees as 

personnel, and property that it owns, 

licenses, or leases (own resources); or 

(2) Through written contractual 

arrangements with another derivatives 

clearing organization or other service 

provider (outsourcing). 

(i) Retention of responsibility. A 

derivatives clearing organization that 

enters into such a contractual 

arrangement shall retain complete 

liability for any failure to meet the 

responsibilities specified in paragraph 

(e) of this section, although it is free to 

seek indemnification from the service 

provider. The outsourcing derivatives 

clearing organization must employ 

personnel with the expertise necessary 

to enable it to supervise the service 

provider’s delivery of the services. 

(ii) Testing. The testing referred to in 

paragraph (j) of this section shall 

include all of the derivatives clearing 

organization’s own and outsourced 

resources, and shall verify that all such 

resources will work effectively together. 

(g) Notice of exceptional events. A 

derivatives clearing organization shall 

notify staff of the Division of Clearing 

and Risk promptly of: 

(1) Any hardware or software 

malfunction, cyber security incident, or 

targeted threat that materially impairs, 

or creates a significant likelihood of 

material impairment, of automated 

system operation, reliability, security, or 

capacity; or 

(2) Any activation of the derivatives 

clearing organization’s business 

continuity and disaster recovery plan. 

(h) Notice of planned changes. A 

derivatives clearing organization shall 

give staff of the Division of Clearing and 

Risk timely advance notice of all: 

(1) Planned changes to automated 

systems that are likely to have a 

significant impact on the reliability, 

security, or adequate scalable capacity 

of such systems; and 

(2) Planned changes to the derivatives 

clearing organization’s program of risk 

analysis and oversight. 

(i) Recordkeeping. A derivatives 

clearing organization shall maintain, 

and provide to Commission staff 

promptly upon request, pursuant to 

§ 1.31 of this chapter, current copies of 

its business continuity plan and other 

emergency procedures, its assessments 

of its operational risks, and records of 

testing protocols and results, and shall 

provide any other documents requested 

by Commission staff for the purpose of 

maintaining a current profile of the 

derivatives clearing organization’s 

automated systems. 

(j) Testing.—(1) Purpose of testing. A 

derivatives clearing organization shall 

conduct regular, periodic, and objective 

testing and review of: 

(i) Its automated systems to ensure 

that they are reliable, secure, and have 

adequate scalable capacity; and 

(ii) Its business continuity and 

disaster recovery capabilities, using 

testing protocols adequate to ensure that 

the derivatives clearing organization’s 

backup resources are sufficient to meet 

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the requirements of paragraph (e) of this 

section. 

(2) Conduct of testing. Testing shall be 

conducted by qualified, independent 

professionals. Such qualified, 

independent professionals may be 

independent contractors or employees 

of the derivatives clearing organization, 

but shall not be persons responsible for 

development or operation of the systems 

or capabilities being tested. 

(3) Reporting and review. Reports 

setting forth the protocols for, and 

results of, such tests shall be 

communicated to, and reviewed by, 

senior management of the derivatives 

clearing organization. Protocols of tests 

which result in few or no exceptions 

shall be subject to more searching 

review. 

(k) Coordination of business 

continuity and disaster recovery plans. 

A derivatives clearing organization 

shall, to the extent practicable: 

(1) Coordinate its business continuity 

and disaster recovery plan with those of 

its clearing members, in a manner 

adequate to enable effective resumption 

of daily processing, clearing, and 

settlement following a disruption; 

(2) Initiate and coordinate periodic, 

synchronized testing of its business 

continuity and disaster recovery plan 

and the plans of its clearing members; 

and 

(3) Ensure that its business continuity 

and disaster recovery plan takes into 

account the plans of its providers of 

essential services, including 

telecommunications, power, and water. 

§ 39.19 Reporting. 

(a) General. Each derivatives clearing 

organization shall provide to the 

Commission the information specified 

in this section and any other 

information that the Commission deems 

necessary to conduct its oversight of a 

derivatives clearing organization. 

(b) Submission of reports. (1) Unless 

otherwise specified by the Commission 

or its designee, each derivatives clearing 

organization shall submit the 

information required by this section to 

the Commission electronically and in a 

format and manner specified by the 

Commission. 

(2) Time zones. Unless otherwise 

specified by the Commission or its 

designee, any stated time in this section 

is Central time for information 

concerning derivatives clearing 

organizations located in that time zone, 

and Eastern time for information 

concerning all other derivatives clearing 

organizations. 

(3) Unless otherwise specified by the 

Commission or its designee, business 

day means the intraday period of time 

starting at the business hour of 8:15 a.m. 

and ending at the business hour of 4:45 

p.m., on all days except Saturdays, 

Sundays, and Federal holidays. 

(c) Reporting requirements. Each 

registered derivatives clearing 

organization shall provide to the 

Commission or other person as may be 

required or permitted by this paragraph 

the information specified below: 

(1) Daily reporting. (i) A report 

containing the information specified by 

this paragraph (c)(1), which shall be 

compiled as of the end of each trading 

day and shall be submitted to the 

Commission by 10 a.m. on the following 

business day: 

(A) Initial margin requirements and 

initial margin on deposit for each 

clearing member, by house origin and 

by each customer origin; 

(B) Daily variation margin, separately 

listing the mark-to-market amount 

collected from or paid to each clearing 

member, by house origin and by each 

customer origin; 

(C) All other daily cash flows relating 

to clearing and settlement including, but 

not limited to, option premiums and 

payments related to swaps such as 

coupon amounts, collected from or paid 

to each clearing member, by house 

origin and by each customer origin; and 

(D) End-of-day positions for each 

clearing member, by house origin and 

by each customer origin. 

(ii) The report shall contain the 

information required by paragraph 

(c)(1)(i) of this section for: 

(A) All futures positions, and options 

positions, as applicable; 

(B) All swaps positions; and 

(C) All securities positions that are 

held in a customer account subject to 

section 4d of the Act or are subject to 

a cross-margining agreement. 

(2) Quarterly reporting. A report of the 

derivatives clearing organization’s 

financial resources as required by 

§ 39.11(f) of this part; provided that, 

additional reports may be required by 

paragraph (c)(4)(i) of this section or 

§ 39.11(f) of this part. 

(3) Annual reporting—(i) Annual 

report of chief compliance officer. The 

annual report of the chief compliance 

officer required by § 39.10 of this part. 

(ii) Audited financial statements. 

Audited year-end financial statements 

of the derivatives clearing organization 

or, if there are no financial statements 

available for the derivatives clearing 

organization itself, the consolidated 

audited year-end financial statements of 

the derivatives clearing organization’s 

parent company. 

(iii) [Reserved] 

(iv) Time of report. The reports 

required by this paragraph (c)(3) shall be 

submitted concurrently to the 

Commission not more than 90 days after 

the end of the derivatives clearing 

organization’s fiscal year; provided that, 

a derivatives clearing organization may 

request from the Commission an 

extension of time to submit a report, 

provided the derivatives clearing 

organization’s failure to submit the 

report in a timely manner could not be 

avoided without unreasonable effort or 

expense. Extensions of the deadline will 

be granted at the discretion of the 

Commission. 

(4) Event-specific reporting—(i) 

Decrease in financial resources. If there 

is a decrease of 25 percent in the total 

value of the financial resources 

available to satisfy the requirements 

under § 39.11(a)(1) of this part, either 

from the last quarterly report submitted 

under § 39.11(f) of this part or from the 

value as of the close of the previous 

business day, the derivatives clearing 

organization shall report such decrease 

to the Commission no later than one 

business day following the day the 25 

percent threshold was reached. The 

report shall include: 

(A) The total value of the financial 

resources: 

(1) As of the close of business the day 

the 25 percent threshold was reached, 

and 

(2) If reporting a decrease in value 

from the previous business day, the total 

value of the financial resources 

immediately prior to the 25 percent 

decline; 

(B) A breakdown of the value of each 

financial resource reported in each of 

paragraphs (c)(4)(i)(A)(1) and (2) of this 

section, calculated in accordance with 

the requirements of § 39.11(d) of this 

part, including the value of each 

individual clearing member’s guaranty 

fund deposit if the derivatives clearing 

organization reports guaranty fund 

deposits as a financial resource; and 

(C) A detailed explanation for the 

decrease. 

(ii) Decrease in ownership equity. No 

later than two business days prior to an 

event which the derivatives clearing 

organization knows or reasonably 

should know will cause a decrease of 20 

percent or more in ownership equity 

from the last reported ownership equity 

balance as reported on a quarterly or 

audited financial statement required to 

be submitted by paragraph (c)(2) or 

(c)(3)(ii), respectively, of this section; 

but in any event no later than two 

business days after such decrease in 

ownership equity for events that caused 

the decrease about which the 

derivatives clearing organization did not 

know and reasonably could not have 

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known prior to the event. The report 

shall include: 

(A) Pro forma financial statements 

reflecting the derivatives clearing 

organization’s estimated future financial 

condition following the anticipated 

decrease for reports submitted prior to 

the anticipated decrease and current 

financial statements for reports 

submitted after such a decrease; and 

(B) Details describing the reason for 

the anticipated decrease or decrease in 

the balance. 

(iii) Six-month liquid asset 

requirement. Immediate notice when a 

derivatives clearing organization knows 

or reasonably should know of a deficit 

in the six-month liquid asset 

requirement of § 39.11(e)(2). 

(iv) Change in current assets. No later 

than two business days after current 

liabilities exceed current assets; the 

notice shall include a balance sheet that 

reflects the derivatives clearing 

organization’s current assets and current 

liabilities and an explanation as to the 

reason for the negative balance. 

(v) Request to clearing member to 

reduce its positions. Immediate notice, 

of a derivatives clearing organization’s 

request to a clearing member to reduce 

its positions because the derivatives 

clearing organization has determined 

that the clearing member has exceeded 

its exposure limit, has failed to meet an 

initial or variation margin call, or has 

failed to fulfill any other financial 

obligation to the derivatives clearing 

organization. The notice shall include: 

(A) The name of the clearing member; 

(B) The time the clearing member was 

contacted; 

(C) The number of positions by which 

the derivatives clearing organization 

requested the reduction; 

(D) All products that are the subject 

of the request; and 

(E) The reason for the request. 

(vi) Determination to transfer or 

liquidate positions. Immediate notice, of 

a determination that any position a 

derivatives clearing organization carries 

for one of its clearing members must be 

liquidated immediately or transferred 

immediately, or that the trading of any 

account of a clearing member shall be 

only for the purpose of liquidation 

because that clearing member has failed 

to meet an initial or variation margin 

call or has failed to fulfill any other 

financial obligation to the derivatives 

clearing organization. The notice shall 

include: 

(A) The name of the clearing member; 

(B) The time the clearing member was 

contacted; 

(C) The products that are subject to 

the determination; 

(D) The number of positions that are 

subject to the determination; and 

(E) The reason for the determination. 

(vii) Default of a clearing member. 

Immediate notice, upon the default of a 

clearing member. An event of default 

shall be determined in accordance with 

the rules of the derivatives clearing 

organization. The notice of default shall 

include: 

(A) The name of the clearing member; 

(B) The products the clearing member 

defaulted upon; 

(C) The number of positions the 

clearing member defaulted upon; and 

(D) The amount of the financial 

obligation. 

(viii) Change in ownership or 

corporate or organizational structure. 

(A) Reporting requirement. Any 

anticipated change in the ownership or 

corporate or organizational structure of 

the derivatives clearing organization or 

its parent(s) that would: 

(1) Result in at least a 10 percent 

change of ownership of the derivatives 

clearing organization, 

(2) Create a new subsidiary or 

eliminate a current subsidiary of the 

derivatives clearing organization, or 

(3) Result in the transfer of all or 

substantially all of the assets of the 

derivatives clearing organization, 

including its registration as a derivatives 

clearing organization to another legal 

entity. 

(B) Required information. The report 

shall include: a chart outlining the new 

ownership or corporate or 

organizational structure; a brief 

description of the purpose and impact 

of the change; and any relevant 

agreements effecting the change and 

corporate documents such as articles of 

incorporation and bylaws. With respect 

to a corporate change for which a 

derivatives clearing organization 

submits a request for approval to 

transfer its derivatives clearing 

organization registration and open 

interest under § 39.3(f) of this part, the 

informational requirements of this 

paragraph (c)(4)(viii)(B) shall be 

satisfied by the derivatives clearing 

organization’s compliance with 

§ 39.3(f)(3). 

(C) Time of report. The report shall be 

submitted to the Commission no later 

than three months prior to the 

anticipated change; provided that the 

derivatives clearing organization may 

report the anticipated change to the 

Commission later than three months 

prior to the anticipated change if the 

derivatives clearing organization does 

not know and reasonably could not have 

known of the anticipated change three 

months prior to the anticipated change. 

In such event, the derivatives clearing 

organization shall immediately report 

such change to the Commission as soon 

as it knows of such change. 

(D) Confirmation of change report. 

The derivatives clearing organization 

shall report to the Commission the 

consummation of the change no later 

than two business days following the 

effective date of the change. 

(ix) Change in key personnel. No later 

than two business days following the 

departure, or addition of persons who 

are key personnel as defined in 

§ 39.1(b), a report that includes, as 

applicable, the name of the person who 

will assume the duties of the position 

on a temporary basis until a permanent 

replacement fills the position. 

(x) Change in credit facility funding 

arrangement. No later than one business 

day after a derivatives clearing 

organization changes an existing credit 

facility funding arrangement it may 

have in place, or is notified that such 

arrangement has changed, including but 

not limited to a change in lender, 

change in the size of the facility, change 

in expiration date, or any other material 

changes or conditions. 

(xi) Sanctions. Notice of action taken, 

no later than two business days after the 

derivatives clearing organization 

imposes sanctions against a clearing 

member. 

(xii) Financial condition and events. 

Immediate notice after the derivatives 

clearing organization knows or 

reasonably should have known of: 

(A) The institution of any legal 

proceedings which may have a material 

adverse financial impact on the 

derivatives clearing organization; 

(B) Any event, circumstance or 

situation that materially impedes the 

derivatives clearing organization’s 

ability to comply with this part and is 

not otherwise required to be reported 

under this section; or 

(C) A material adverse change in the 

financial condition of any clearing 

member that is not otherwise required 

to be reported under this section. 

(xiii) Financial statements material 

inadequacies. If a derivatives clearing 

organization discovers or is notified by 

an independent public accountant of the 

existence of any material inadequacy in 

a financial statement, such derivatives 

clearing organization shall give notice of 

such material inadequacy within 24 

hours, and within 48 hours after giving 

such notice file a written report stating 

what steps have been and are being 

taken to correct the material 

inadequacy. 

(xiv) [Reserved] 

(xv) [Reserved] 

(xvi) System safeguards. A report of: 

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(A) Exceptional events as required by 

§ 39.18(g) of this part; or 

(B) Planned changes as required by 

§ 39.18(h) of this part. 

(5) Requested reporting. (i) Upon 

request by the Commission, a 

derivatives clearing organization shall 

file with the Commission such 

information related to its business as a 

clearing organization, including 

information relating to trade and 

clearing details, in the format and 

manner specified, and within the time 

provided, by the Commission in the 

request. 

(ii) Upon request by the Commission, 

a derivatives clearing organization shall 

file with the Commission a written 

demonstration, containing such 

supporting data, information and 

documents, that the derivatives clearing 

organization is in compliance with one 

or more core principles and relevant 

provisions of this part, in the format and 

manner specified, and within the time 

provided, by the Commission in the 

request. 

(iii) Upon request by the Commission, 

a derivatives clearing organization shall 

file with the Commission, for each 

customer origin of each clearing 

member, the end-of-day gross positions 

of each beneficial owner, in the format 

and manner specified, and within the 

time provided, by the Commission in 

the request. Nothing in this paragraph 

shall affect the obligation of a 

derivatives clearing organization to 

comply with the daily reporting 

requirements of paragraph (c)(1) of this 

section. 

§ 39.20 Recordkeeping. 

(a) Requirement to maintain 

information. Each derivatives clearing 

organization shall maintain records of 

all activities related to its business as a 

derivatives clearing organization. Such 

records shall include, but are not 

limited to, records of: 

(1) All cleared transactions, including 

swaps; 

(2) All information necessary to 

record allocation of bunched orders for 

cleared swaps; 

(3) All information required to be 

created, generated, or reported under 

this part 39, including but not limited 

to the results of and methodology used 

for all tests, reviews, and calculations in 

connection with setting and evaluating 

margin levels, determining the value 

and adequacy of financial resources, 

and establishing settlement prices; 

(4) All rules and procedures required 

to be submitted pursuant to this part 39 

and part 40 of this chapter, including all 

proposed changes in rules, procedures 

or operations subject to § 40.10 of this 

chapter; and 

(5) Any data or documentation 

required by the Commission or by the 

derivatives clearing organization to be 

submitted to the derivatives clearing 

organization by its clearing members, or 

by any other person in connection with 

the derivatives clearing organization’s 

clearing and settlement activities. 

(b) Form and manner of maintaining 

information. (1) General. The records 

required to be maintained by this 

chapter shall be maintained in 

accordance with the provisions of § 1.31 

of this chapter, for a period of not less 

than 5 years, except as provided in 

paragraph (b)(2) of this section. 

(2) Exception for swap data. Each 

derivatives clearing organization that 

clears swaps must maintain swap data 

in accordance with the requirements of 

part 45 of this chapter. 

§ 39.21 Public information. 

(a) General. Each derivatives clearing 

organization shall provide to market 

participants sufficient information to 

enable the market participants to 

identify and evaluate accurately the 

risks and costs associated with using the 

services of the derivatives clearing 

organization. In furtherance of this 

objective, each derivatives clearing 

organization shall have clear and 

comprehensive rules and procedures. 

(b) Availability of information. Each 

derivatives clearing organization shall 

make information concerning the rules 

and the operating and default 

procedures governing the clearing and 

settlement systems of the derivatives 

clearing organization available to market 

participants. 

(c) Public disclosure. Each derivatives 

clearing organization shall disclose 

publicly and to the Commission 

information concerning: 

(1) The terms and conditions of each 

contract, agreement, and transaction 

cleared and settled by the derivatives 

clearing organization; 

(2) Each clearing and other fee that 

the derivatives clearing organization 

charges its clearing members; 

(3) The margin-setting methodology; 

(4) The size and composition of the 

financial resource package available in 

the event of a clearing member default; 

(5) Daily settlement prices, volume, 

and open interest for each contract, 

agreement, or transaction cleared or 

settled by the derivatives clearing 

organization; 

(6) The derivatives clearing 

organization’s rules and procedures for 

defaults in accordance with § 39.16 of 

this part; and 

(7) Any other matter that is relevant 

to participation in the clearing and 

settlement activities of the derivatives 

clearing organization. 

(d) Publication of information. The 

derivatives clearing organization shall 

make its rulebook, a list of all current 

clearing members, and the information 

listed in paragraph (c) of this section 

readily available to the general public, 

in a timely manner, by posting such 

information on the derivatives clearing 

organization’s Web site, unless 

otherwise permitted by the Commission. 

The information required in paragraph 

(c)(5) of this section shall be made 

available to the public no later than the 

business day following the day to which 

the information pertains. 

§ 39.22 Information sharing. 

Each derivatives clearing organization 

shall enter into, and abide by the terms 

of, each appropriate and applicable 

domestic and international informationsharing agreement, and shall use 

relevant information obtained from each 

such agreement in carrying out the risk 

management program of the derivatives 

clearing organization. 

§ 39.23 Antitrust considerations. 

Unless necessary or appropriate to 

achieve the purposes of the Act, a 

derivatives clearing organization shall 

not adopt any rule or take any action 

that results in any unreasonable 

restraint of trade, or impose any 

material anticompetitive burden. 

§ 39.24 [Reserved] 

§ 39.25 [Reserved] 

§ 39.26 [Reserved] 

§ 39.27 Legal risk considerations. 

(a) Legal authorization. A derivatives 

clearing organization shall be duly 

organized, legally authorized to conduct 

business, and remain in good standing 

at all times in the relevant jurisdictions. 

If the derivatives clearing organization 

provides clearing services outside the 

United States, it shall be duly organized 

to conduct business and remain in good 

standing at all times in the relevant 

jurisdictions, and be authorized by the 

appropriate foreign licensing authority. 

(b) Legal framework. A derivatives 

clearing organization shall operate 

pursuant to a well-founded, transparent, 

and enforceable legal framework that 

addresses each aspect of the activities of 

the derivatives clearing organization. As 

applicable, the framework shall provide 

for: 

(1) The derivatives clearing 

organization to act as a counterparty, 

including novation; 

(2) Netting arrangements; 

(3) The derivatives clearing 

organization’s interest in collateral; 

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(4) The steps that a derivatives 

clearing organization would take to 

address a default of a clearing member, 

including but not limited to, the 

unimpeded ability to liquidate collateral 

and close out or transfer positions in a 

timely manner; 

(5) Finality of settlement and funds 

transfers that are irrevocable and 

unconditional when effected (no later 

than when a derivatives clearing 

organization’s accounts are debited and 

credited); and 

(6) Other significant aspects of the 

derivatives clearing organization’s 

operations, risk management 

procedures, and related requirements. 

(c) Conflict of laws. If a derivatives 

clearing organization provides clearing 

services outside the United States: 

(1) The derivatives clearing 

organization shall identify and address 

any material conflict of law issues. The 

derivatives clearing organization’s 

contractual agreements shall specify a 

choice of law. 

(2) The derivatives clearing 

organization shall be able to 

demonstrate the enforceability of its 

choice of law in relevant jurisdictions 

and that its rules, procedures, and 

contracts are enforceable in all relevant 

jurisdictions. 

Appendix to Part 39—Form DCO 

Derivatives Clearing Organization 

Application for Registrations 

BILLING CODE 6351–01–P 

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BILLING CODE 6351–01–C 

PART 140—ORGANIZATION, 

FUNCTIONS, AND PROCEDURES OF 

THE COMMISSION 

■ 9. The authority citation for part 140 

continues to read as follows: 

Authority: 7 U.S.C. 2 and 12a. 

■ 10. Amend § 140.94 by revising the 

section heading and paragraph (a)(5), 

redesignating paragraph (a)(6) as 

paragraph (a)(7), revise newly 

redesignated paragraph (a)(7), and add 

new paragraphs (a)(6) and (a)(8) through 

(a)(14) to read as follows: 

§ 140.94 Delegation of authority to the 

Director of the Division of Clearing and 

Risk. 

(a) * * * 

(5) All functions reserved to the 

Commission in § 5.14 of this chapter; 

(6) All functions reserved to the 

Commission in §§ 39.3(a)(2) and (a)(3) of 

this chapter; 

(7) All functions reserved to the 

Commission in §§ 39.5(b)(2), (b)(3)(ix), 

and (d)(3) of this chapter; 

(8) All functions reserved to the 

Commission in § 39.10(c)(4)(iv) of this 

chapter; 

(9) All functions reserved to the 

Commission in §§ 39.11(b)(1)(vi), 

(b)(2)(ii), (c)(1), (c)(2), (f)(1) and (f)(4) of 

this chapter; 

(10) All functions reserved to the 

Commission in § 39.12(a)(5)(i)(B) of this 

chapter; 

(11) All functions reserved to the 

Commission in §§ 39.13(g)(8)(ii), 

(h)(1)(i)(C), (h)(1)(ii), (h)(3)(i), (h)(3)(ii), 

and (h)(5)(i)(A) of this chapter; 

(12) The authority to request 

additional information in support of a 

rule submission under 

§ 39.15(b)(2)(iii)(A) of this chapter and 

in support of a petition pursuant to 

section 4d of the Act under 

§ 39.15(b)(2)(iii)(B) of this chapter; 

(13) All functions reserved to the 

Commission in §§ 39.19(c)(3)(iv), 

(c)(5)(i), (c)(5)(ii), and (c)(5)(iii) of this 

chapter; and 

(14) All functions reserved to the 

Commission in § 39.21(d) of this 

chapter. 

Issued in Washington, DC, on October 18, 

2011, by the Commission. 

David A. Stawick, 

Secretary of the Commission. 

Appendices to Derivatives Clearing 

Organization General Provisions and 

Core Principles—Commission Voting 

Summary and Statements of 

Commissioners 

Note: The following appendices will not 

appear in the Code of Federal Regulations 


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Federal Register / Vol. 76, No. 216 / Tuesday, November 8, 2011 / Rules and Regulations 69473 

Appendix 1—Commission Voting 

Summary 

On this matter, Chairman Gensler and 

Commissioners Dunn and Chilton voted 

in the affirmative; Commissioners 

Sommers and O’Malia voted in the 

negative. 

Appendix 2—Statement of Chairman 

Gary Gensler 

I support the final rulemaking on core 

principles for derivatives clearing 

organizations (DCOs). Centralized 

clearing has been a feature of the U.S. 

futures markets since the late-19th 

century. Clearinghouses have 

functioned both in clear skies and 

during stormy times—through the Great 

Depression, numerous bank failures, 

two world wars, and the 2008 financial 

crisis—to lower risk to the economy. 

Importantly, centralized clearing 

protects banks and their customers from 

the risk of either party failing. 

When customers don’t clear their 

transactions, they take on their dealer’s 

credit risk. We have seen over many 

decades, however, that banks do fail. 

Centralized clearing protects all market 

participants by requiring daily mark to 

market valuations and requiring 

collateral to be posted by both parties so 

that both the swap dealer and its 

customers are protected if either fails. It 

lowers the interconnectedness between 

financial entities that helped spread risk 

throughout the economy when banks 

began to fail in 2008. 

Today’s rulemaking will establish 

certain regulatory requirements for 

DCOs to implement important core 

principles that were revised by the 

Dodd-Frank Act. We recognize the need 

for very robust risk management 

standards, particularly as more swaps 

are moved into central clearinghouses. 

We have incorporated the newest draft 

Committee on Payment and Settlement 

Systems (CPSS)-International 

Organization of Securities Commissions 

(IOSCO) standards for central 

counterparties into our final rules. 

First, the financial resources and risk 

management requirements will 

strengthen financial integrity and 

enhance legal certainty for 

clearinghouses. We’re adopting a 

requirement that DCOs collect initial 

margin on a gross basis for its clearing 

member’s customer accounts For 

interest rates and financial index swaps, 

such as credit default swaps, we are 

maintaining, as proposed, a minimum 

margin for a five-day liquidation period. 

This is consistent with current market 

practice, and many commenters 

recommended this as a minimum. For 

the clearing of physical commodity 

swaps, such as on energy, metals and 

agricultural products, we are requiring 

margin that is risk-based but consistent 

with current market practice—a 

minimum of one day. Maintaining a 

minimum five day liquidation period 

for interest rates and credit default 

swaps is appropriate not only as it is 

consistent with current market practice, 

but also as these markets are the most 

systemically relevant for the 

interconnected financial system. History 

shows that, in 2008, it took five days 

after the failure of Lehman Brothers for 

the clearinghouse to transfer Lehman’s 

interest rate swaps positions to other 

clearing members. These financial 

resource requirements, and particularly 

the margin requirements, are critical for 

safety and soundness as more swaps are 

moved into central clearing. 

Second, the rulemaking implements 

the Dodd-Frank Act’s requirement for 

open access to DCOs. The participant 

eligibility requirements promote fair 

and open access to clearing. 

Importantly, the rule addresses how a 

futures commission merchant can 

become a member of a DCO. The rule 

promotes more inclusiveness while 

allowing DCO to scale a member’s 

participation and risk based upon its 

capital. This improves competition that 

will benefit end-users of swaps, while 

protecting DCOs’ ability manage risk. 

Third, the reporting requirements will 

ensure that the Commission has the 

information it needs to monitor DCO 

compliance with the Commodity 

Exchange Act and Commission 

regulations. 

Fourth, the rules formalize the DCO 

application procedures to bring about 

greater uniformity and transparency in 

the application process and facilitate 

greater efficiency and consistency in 

processing applications. 

These reforms will both lower risk in 

the financial system and strengthen the 

market by making many of the processes 

more efficient and consistent. 

Appendix 3—Statement of 

Commissioner Jill Sommers 

The final rules adopted by the 

Commission today for derivatives 

clearing organizations (DCOs) will 

implement a key component of the 

Dodd-Frank Wall Street Reform and 

Consumer Protection Act (Dodd-Frank) 

to facilitate centralized clearing of both 

exchange-traded and over-the-counter 

swaps. While I fully support the 

centralized clearing of swaps, I 

reluctantly cannot support the final 

DCO rules. 

In my opinion, the rules are 

needlessly prescriptive, internally 

inconsistent, and depart from the 

Commission’s time-tested principlesbased oversight regime, with little to no 

explanation of the costs and benefits of 

doing so, or even a rationale other than 

an overarching belief that prescriptive 

rules will increase legal certainty and 

prevent a race to the bottom by 

competing clearinghouses. A few 

examples will illustrate my point. 

Rule 39.11(a)(1) requires a DCO to 

maintain sufficient financial resources 

to cover a default by its largest clearing 

member. Rule 39.11(a)(2) requires a 

DCO to maintain sufficient financial 

resources to cover its operating costs for 

a period of at least one year. Rules 

39.11(b)(1) and (b)(2) list the types of 

financial resources deemed sufficiently 

liquid to meet the requirements of Rules 

39.11(a)(1) and (a)(2). The preamble to 

the rules states that letters of credit are 

not an acceptable financial resource for 

purposes of Rules 39.11(a)(1) or (a)(2), 

but may be allowed on a case-by-case 

basis. Letters of credit are also banned 

for purposes of Rule 39.11(e)(1) (cash 

obligations), and Rule 39.11(e)(3) 

(guaranty fund obligations), neither of 

which allow for a case-by-case 

determination. When it comes to initial 

margin, letters of credit are allowed for 

futures and options without 

qualification, but banned for swaps. 

These distinctions, in my opinion, are 

not legally or factually justifiable. The 

ability to draw on safe, liquid assets is 

critical in all of the situations described 

above. We should treat letters of credit 

the same way unless there is a 

compelling reason not to. This is 

especially true given the fact that 

banning their use as initial margin for 

swaps will have the perverse, 

unintended consequence of 

disincentivizing voluntary clearing by 

commercial end-users who support their 

swaps positions using letters of credit— 

a result that is directly at odds with the 

goals of Dodd-Frank. 

Another example can be found in 

Rule 39.13(g)(2)(ii), which establishes a 

one-day minimum liquidation time for 

calculating initial margin for futures and 

options, a one-day minimum liquidation 

time for swaps on agricultural, metal, 

and energy commodities, and a five-day 

minimum liquidation time for all other 

swaps. In the cost-benefit analysis, the 

Commission states that ‘‘using only one 

criterion—i.e., the characteristic of the 

commodity underlying a swap—to 

determine liquidation time could result 

in less-than-optimal margin 

calculations.’’ The Commission goes on 

to describe the complex nature of 

calculating appropriate margin levels, 

which includes the ability to assess 

quantitative factors such as the risk 

characteristics of the instrument traded, 

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69474 Federal Register / Vol. 76, No. 216 / Tuesday, November 8, 2011 / Rules and Regulations 

289 Derivatives Clearing Organizations (to be 

codified at 17 CFR pts. 1, 21, 39, and 140), available 

at: http://www.cftc.gov/PressRoom/Events/ 

opaevent_cftcdoddfrank101811 (the ‘‘DCO Final 

Rule’’). 

290See Kathryn Chen et al., An Analysis of CDS 

Transactions: Implications for Public Reporting, 

Federal Reserve Bank of New York Staff Report no. 

517 (September 2011), available at: http:// 

www.newyorkfed.org/research/staff_reports/ 

sr517.pdf (stating that ‘‘[c]learing-eligible products 

within our sample traded on more days and had 

more intraday transactions than non-clearing 

eligible products’’). 

291See section 3(b) of the Commodity Exchange 

Act (CEA), 7 U.S.C. 5(b) (stating that ‘‘[i]t is the 

purpose of this Act to serve the public interests 

* * * through a system of effective self-regulation 

of trading facilities, clearing systems, market 

participants and market professionals under the 

oversight of the Commission.’’). 

292The DCO Final Rule, supra note 289, at 387– 

388 (to be codified at 17 CFR 39.12(a)(1)). 

293See letter, dated March 21, 2011, from the 

United Kingdom Financial Services Authority 

(‘‘FSA’’), available at http://comments.cftc.gov/ 

its historical price volatility and 

liquidity in the relevant market, as well 

as ‘‘expert judgment as to the extent to 

which such characteristics and data may 

be an accurate predictor of future 

market behavior with respect to such 

instruments, and [the application of] 

such judgment to the quantitative 

results.’’ We then explain that the 

Commission is not capable of 

determining the risk characteristics, 

price volatility and market liquidity of 

even a sample of swaps for purposes of 

determining an appropriate liquidation 

time for specific swaps. 

In the face of our admitted inability to 

determine appropriate liquidation times 

for particular swaps, we are picking a 

one-day time for some, based on the 

underlying commodity, and a five-day 

time for all others, even though this 

‘‘could result in less-than-optimal 

margin calculations.’’ This defies 

common sense. 

The only reason we give for 

eliminating the long-standing discretion 

of the acknowledged experts, i.e., the 

DCOs, to determine the appropriate 

liquidation times for the transactions 

they clear is to prevent a feared race to 

the bottom by DCOs who will compete 

to clear swaps in the future. We 

acknowledge, however, that DCOs have 

used reasonable and prudent judgment 

in establishing liquidation times in the 

past, including DCOs that currently 

compete in the swaps clearing space. 

The Commission gives no reason for its 

belief that there may be a race to the 

bottom if we do not establish this less 

than ideal methodology. Nor does the 

Commission acknowledge the existence 

of other safeguards in the rules that give 

us strong tools for policing a potential 

race to the bottom. 

With the passage of Dodd-Frank, 

Congress gave the Commission broad 

authority to regulate swap transactions, 

swap markets and swap market 

participants. I do not believe, however, 

that Congress intended for the 

Commission to strip DCOs of the 

flexibility to determine the manner in 

which they comply with core 

principles, as we have done with these 

rules. Our registered DCOs have a strong 

track record of prudent risk 

management, including during the 

financial crisis, and there is no reason 

to believe they will not continue to use 

their expert judgment in a responsible 

fashion. Moreover, unnecessary and 

inflexible rules, such as these, will 

prevent DCOs from quickly adapting to 

changing market conditions for no 

apparent benefit. I therefore dissent. 

Appendix 4—Statement of 

Commissioner Scott O’Malia 

Today, the Commission approved a 

final rulemaking on the operation of 

derivatives clearing organizations (each, 

a ‘‘DCO’’).289 Of the Dodd-Frank 

rulemakings that the Commission has so 

far undertaken, this rulemaking is 

among the most important. I have been 

a strong proponent of clearing. In the 

aftermath of the Enron crisis, I 

witnessed first-hand how the creation of 

ClearPort ameliorated counterparty 

credit fears in the energy merchant 

markets and restored liquidity to those 

markets. I am certain that clearing will 

similarly benefit the swaps market,290

particularly by significantly expanding 

execution on electronic platforms, 

thereby increasing price transparency 

and discovery. Moreover, as we have 

seen in the 2008 financial crisis, 

clearing has the potential to mitigate 

systemic risk, by ensuring that swap 

counterparties—not hardworking 

American taxpayers—post collateral to 

support their exposures. 

The main goal of this final rulemaking 

is to ensure that clearing contributes to 

the integrity of the United States 

financial system by, among other things, 

allowing entities other than the largest 

dealer banks to offer clearing services to 

commercial and financial end-users. I 

fully support this goal. However, in an 

attempt to achieve this goal, this 

rulemaking abandons the principlesbased regulatory regime which 

permitted DCOs to perform so 

admirably in the 2008 financial crisis. 

Instead, the final rulemaking sets forth 

a series of prescriptive requirements. I 

disagree with this approach. DCO risk 

management poses complex and 

multidimensional challenges. One DCO 

may have a significantly different risk 

profile than another. Consequently, each 

DCO must have sufficient discretion to 

match requirements to risks. The role of 

the Commission is to oversee the 

exercise of such discretion, not to 

prevent such exercise.291

Additionally, I am mindful of the cost 

of clearing and want to ensure that such 

cost does not constitute a barrier to 

entry. Certain provisions in this final 

rulemaking may impose substantial 

costs without corresponding benefits. 

Such provisions may discourage market 

participants from executing transactions 

subject to mandatory clearing, even if 

they need such transactions to 

prudently hedge risks, or from clearing 

on a voluntary basis. By creating 

perverse incentives to keep risk outside 

of the regulatory framework, and to 

leave it within our commercial and 

financial enterprises, the DCO rules 

undermine a fundamental purpose of 

the Dodd-Frank Act—namely, the 

expansion of clearing. 

I will elaborate on each concern in 

turn. 

Participant Eligibility: One-Size Does 

Not Fit All 

This final rulemaking prohibits a DCO 

from requiring more than $50 million in 

capital from any entity seeking to 

become a swaps clearing member. This 

number makes a great headline, mainly 

because it is so low. It also sends an 

unequivocal message to DCOs that have 

clearing members that are primarily 

dealer banks. However, in adopting and 

interpreting this requirement, the 

Commission may unwisely limit the 

range of legitimate actions that DCOs 

can take to manage their counterparty 

risks. By imposing such limitations, the 

Commission is introducing costs to 

clearing that it fails to detail and 

explore. 

Let me be plain. I oppose 

anticompetitive behavior. However, an 

entity with $50 million in capitalization 

may not be an appropriate clearing 

member for every DCO. The $50 million 

threshold prevents DCOs from engaging 

in anticompetitive behavior but also 

prohibits DCOs from taking legitimate, 

risk-reducing actions. Instead of 

adopting this prescriptive requirement, 

the Commission should have provided 

principles-based guidance to DCOs on 

the other components of fair and open 

access, such as the standard for less 

restrictive participation 

requirements.292 By taking a more 

principles-based approach, the 

Commission could have been in greater 

accord with international regulators, 

one of which explicitly cautioned 

against the $50 million threshold.293

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Federal Register / Vol. 76, No. 216 / Tuesday, November 8, 2011 / Rules and Regulations 69475 

PublicComments/CommentList.aspx?id=957 

(stating that ‘‘whilst capital thresholds or other 

participation eligibility threshold limitations may 

be a potential tool to help ensure fair and open 

access to [central counterparties (‘‘CCPs’’)], to 

impose them on clearing arrangements for products 

that have complex or unique characteristics could 

lead to increased risk to the system in the short to 

medium term.’’) 

294See Risk Management Requirements for 

Derivatives Clearing Organizations, 76 FR 3698, 

3791 (Jan. 20, 2011). 

295See the DCO Final Rule, supra note 289, at 83 

to 84 (further stating that ‘‘of 126 FCMs, 63 

currently have capital above $50 million and most 

FCMs with capital below that amount are not 

clearing members.’’). 

296 Id. at 83. 

297 Id. at 388 (to be codified at 17 CFR 

39.12(a)(2)(ii)) (further stating that ‘‘[c]apital 

requirements shall be scalable to risks posed by 

clearing members’’.). 

298 Id. (to be codified at 17 CFR 39.12(a)(2)(i)). 

299 Id. Additionally, the notice of proposed 

rulemaking states: ‘‘Proposed §§ 39.12(a)(2)(ii) and 

39.12(a)(2)(iii), considered together, would require 

a DCO to admit any person to clearing membership 

for the purpose of clearing swaps, if the person had 

$50 million in capital, but would permit a DCO to 

require each clearing member to hold capital 

proportional to its risk exposure. Thus, if a clearing 

member’s risk exposure were to increase in a nonlinear manner, the DCO could increase the clearing 

member’s corresponding scalable capital 

requirement in a non-linear manner.’’ 76 FR at 

3701. 

300See Matthew Leising, ‘‘ICE Clear Credit’s 

Member Rules Too Exclusive, Small Firms Say,’’ 

Bloomberg, Aug. 9, 2011, available at: http:// 

www.bloomberg.com/news/2011-08-09/ice-clearcredit-s-member-rules-too-exclusive-small-firmssay.html. 

301The DCO Final Rule, supra note 289, at 85– 

86. 

302The final rulemaking requires DCOs to impose 

risk limits on clearing members. See id. at 399 to 

400 (to be codified at 17 CFR 39.13(h)(1)). 

303See supra note. 

304See the DCO Final Rule, supra note 289, at 399 

to 400 (to be codified at 17 CFR 39.13(h)(1)(i)(C)) 

(stating that ‘‘[t]he Commission may review such 

methods, thresholds, and financial resources and 

require the application of different methods, 

thresholds, or financial resources, as appropriate.’’). 

Basis for the $50 Million? 

How did the Commission determine 

that the $50 million threshold is 

appropriate? It is not really evident from 

the notice of proposed rulemaking.294 In 

the final rulemaking, the Commission 

states that the $50 million threshold was 

derived from the fact that most 

registered futures commission 

merchants (‘‘FCMs’’) that are currently 

DCO clearing members have at least $50 

million in capital.295

The final rulemaking, however, does 

not answer a number of questions that 

are crucial to determining whether the 

$50 million threshold is appropriate for 

all swap transactions. These questions 

include, without limitation: What types 

of products do the referenced FCMs 

currently clear? Are there differences 

between the capital distributions of 

FCMs that clear different products? If 

so, what are such differences? 

The answers to these questions are 

important because FCMs may need 

different amounts of capital to support 

their exposures to different products. 

Assume, for example, that the average 

capitalization of FCMs clearing 

agricultural futures is $50 million. 

Further assume that an FCM has $50 

million in capital, and is seeking to 

become a clearing member. The 

Commission may reasonably conclude 

that such FCM would have the 

resources to clear agricultural futures. It 

may also reasonably conclude that such 

FCM would have the resources to clear 

agricultural swaps that have the same 

terms and conditions as agricultural 

futures. The Commission cannot 

reasonably conclude, however, that 

such FCM would have the resources to 

clear credit default swaps. 

By not setting forth the answers to 

questions such as these, the final 

rulemaking creates the impression that 

the $50 million threshold is arbitrary, 

and renders vulnerable its conclusion 

that the threshold ‘‘captures firms that 

the Commission believes have the 

financial, operational, and staffing 

resources to participate in clearing 

swaps without posing an unacceptable 

level of risk to a DCO.’’ 296

Anticompetitive behavior? Or 

legitimate, risk-reducing action? 

The final rulemaking recognizes that 

DCOs may increase capital requirements 

for legitimate, risk-reducing reasons. In 

fact, the final rulemaking requires a 

DCO to ‘‘set forth capital requirements 

that * * * appropriately match capital 

to risk.’’ 297 Further, the final 

rulemaking mandates DCOs to ‘‘require 

clearing members to have access to 

sufficient financial resources to meet 

obligations arising from participation in 

the [DCO] in extreme but plausible 

market conditions.’’ 298 The final 

rulemaking states that a DCO ‘‘may 

permit such financial resources to 

include, without limitation, a clearing 

member’s capital.’’ 299

The final rulemaking, however, 

provides little insight on how the 

Commission intends to differentiate 

between (i) a required risk-based 

increase in capital requirements and (ii) 

an illegitimate attempt to circumvent 

the $50 million threshold to squash 

competition. To use an example 

grounded in reality—ICE Clear Credit 

recently lowered its minimum capital 

requirement for clearing members to 

$100 million. However, it added a 

requirement that clearing members hold 

excess net capital equal to 5 percent of 

their segregated customer funds. Upon 

learning about the additional 

requirement, at least two existing FCMs 

complained that it violates fair and open 

access.300 The final rulemaking gives 

very little guidance on the criteria that 

the Commission will apply in 

adjudicating a dispute such as this. The 

preamble to the final rulemaking simply 

states: ‘‘A DCO may not * * * [enact] 

some additional financial requirement 

that effectively renders the $50 million 

threshold meaningless for some 

potential clearing members.’’ It further 

states that such a requirement would 

violate the other components of fair and 

open access, such as ‘‘§ 39.12(a)(1)(i) 

(less restrictive alternatives), or 

§ 39.12(a)(1)(iii) (exclusion of certain 

types of firms).’’ 301 This vague 

statement provides no legal certainty or 

bright lines for DCOs and potential 

clearing members to follow. 

If I were running a DCO, I would be 

extremely confused. On the one hand, 

the final rulemaking requires me to 

match capital requirements to risk. On 

the other hand, the preamble suggests 

that I cannot increase capital 

requirements (or any other financial 

requirement), if that would prohibit 

some entities with $50 million in 

capitalization from becoming clearing 

members. How should I resolve this 

conundrum? 

Hidden Costs 

If a DCO took a narrow interpretation 

of the reference to financial 

requirements in the preamble, then it 

has only one alternative: (i) Admit any 

entity with $50 million in capital as a 

clearing member and (ii) impose strict 

risk limits.302 How strict could such 

limits be? To lend some context to this 

$50 million threshold, a recent report 

from the staff of the Federal Reserve 

Bank of New York observed that $50 

million tended to be the notional value 

of one single transaction in a credit 

default swap index with relatively high 

liquidity.303

Assuming that the Commission does 

not require the DCO to increase its risk 

limits,304 where does this situation 

leave the DCO? The DCO would need to 

incur the cost of (i) evaluating 

applications from all entities with $50 

million in capital, (ii) operationally 

connecting to such entities, and (iii) 

potentially defending itself against 

claims from such entities that the risk 

limits or financial requirements are too 

stringent. The DCO may pass on such 

costs to clearing members, which may 

pass on such costs to commercial and 

financial end-users. In the meantime, 

such entities, when admitted, may be 

unable to clear any significant volume 

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69476 Federal Register / Vol. 76, No. 216 / Tuesday, November 8, 2011 / Rules and Regulations 

305 Interestingly, the preamble notes that at least 

two commenters agreed that a DCO may 

legitimately use such increases to moderate the risk 

of a member with only $50 million in capital. 

Specifically, the preamble states: ‘‘Newedge 

commented that the proposed rule should not 

increase risk to a DCO because a DCO can mitigate 

risk by, among other things, imposing position 

limits, stricter margin requirements, or stricter 

default deposit requirements on lesser capitalized 

clearing members.’’ The preamble also states: ‘‘J.P. 

Morgan, however, commented that a cap on a 

member’s minimum capital requirement would not 

impact the systemic stability of a DCO as long as 

* * * DCOs hold a sufficient amount of margin and 

funded default guarantee funds.’’ Id. at 80 to 82. It 

is therefore unclear why the cost-benefit analysis 

did not address the potential for such increases. 

306See id. at 387 (to be codified at 17 CFR 

39.12(a)(1)(iii)) (stating that ‘‘[a] derivatives clearing 

organization shall not exclude or limit clearing 

membership of certain types of market participants 

unless the derivatives clearing organization can 

demonstrate that the restriction is necessary to 

address credit risk or deficiencies in the 

participants’ operational capabilities that would 

prevent them from fulfilling their obligations as 

clearing members.’’ The regulation contains no 

further detail regarding what type of demonstration 

would be sufficient.). 

307 In legal parlance, the $50 million threshold is 

neither necessary nor sufficient to determining 

whether a DCO has violated fair and open access. 

The threshold is not necessary because a DCO can 

set an even lower minimum capital requirement 

and still violate fair and open access if another 

requirement ‘‘excludes or limits clearing 

membership of certain types of market 

participants.’’ Id. (to be codified at 17 CFR 

39.12(a)(1)(iii)). The threshold is not sufficient 

because, even if the DCO accepts all entities with 

$50 million in capital as clearing members, the 

Commission may still hold that DCO violated fair 

and open access if it imposes ‘‘some additional 

financial requirement that effectively renders the 

$50 million threshold meaningless.’’ Id. at 85–86. 

308 In such guidance, the Commission could have 

detailed the information that a DCO would need to 

provide in order to demonstrate that it could not 

adopt a less restrictive participation requirement 

without materially increasing its own risk. The 

Commission could have also discussed the weight 

that DCOs should accord to a particular level of 

capitalization, depending on whether the relevant 

clearing member (i) engages in businesses other 

than the intermediation of futures or swaps, or (ii) 

participates at multiple DCOs rather than one DCO. 

309See supra note. I note that the Commission 

and FSA share jurisdiction over three DCOs 

clearing swaps—namely, LCH.Clearnet Limited, ICE 

Clear Europe Limited, and CME Clearing Europe. 

How the Commission and FSA will resolve 

conflicting regulation remains to be seen. 

310See Bank for International Settlements’ 

Committee on Payment and Settlement Systems and 

Technical Committee of the International 

Organization of Securities Commissions (‘‘CPSS– 

IOSCO’’), ‘‘Recommendations for Central 

Counterparties,’’ CPSS Publ’n No. 64 (November 

2004), available at: http://www.bis.org/publ/ 

cpss64.pdf (the ‘‘CPSS–IOSCO Recommendations’’). 

Section 4.2.2 of the CPSS–IOSCO 

Recommendations state: ‘‘To reduce the likelihood 

of a participant’s default and to ensure timely 

performance by the participant, a CCP should 

establish rigorous financial requirements for 

participation. Participants are typically required to 

meet minimum capital standards. Some CCPs 

impose more stringent capital requirements if 

exposures of or carried by a participant are large or 

if the participant is a clearing participant. Capital 

requirements for participation may also take 

account of the types of products cleared by a CCP. 

In addition to capital requirements, some CCPs 

impose standards such as a minimum credit rating 

or parental guarantees.’’ 

311See CPSS–IOSCO, ‘‘Principles for financial 

market infrastructures: Consultative report,’’ CPSS 

Publ’n No. 94 (March 2011), available at: http:// 

www.bis.org/publ/cpss94.pdf (the ‘‘CPSS–IOSCO 

Consultation’’). The CPSS–IOSCO Consultation, 

which CPSS–IOSCO has not adopted as final, does 

not set forth any requirement or suggestion that 

resembles the $50 million threshold. Instead, the 

Consultation, like the Recommendations, 

emphasizes the importance of ‘‘risk-based’’ CCP 

participation criteria that are not unduly 

discriminatory. Specifically, Section 3.16.6 of the 

CPSS–IOSCO Consultation states: ‘‘Participation 

requirements based solely on a participant’s size are 

typically insufficiently related to risk and deserve 

careful scrutiny.’’ Whereas the Consultation may 

have intended to comment on restrictively high 

CCP participation requirements, the same logic 

applies to restrictively low CCP participation 

requirements. Neither are risk-based. 

312See Core Principles and Other Requirements 

for Designated Contract Markets, 75 FR 80572 (Dec. 

22, 2010). 

313See the DCO Core Principles, supra note 289, 

at 393–394 (to be codified at 17 CFR 39.13(g)(2)(ii)). 

of transactions, for themselves or for 

customers, especially in asset classes 

such as credit default swaps. Under this 

scenario, rather than leading to fair and 

open access, the $50 million threshold 

may actually impede access to clearing 

by commercial and financial end-users, 

because the threshold would increase 

their costs without introducing 

meaningful competition among FCMs 

offering clearing services. 

If, on the other hand, a DCO took a 

more aggressive interpretation of the 

reference to financial requirements in 

the preamble, then it may have other 

alternatives to mitigate risks that 

admitting an entity with $50 million in 

capital may introduce. For example, it 

may increase margin requirements. It 

may also increase guaranty fund 

contributions for all clearing members, 

in proportion to their clearing activity. 

In other words, a DCO may increase the 

overall cost of clearing in order to 

compensate for the risks of having lesser 

capitalized new clearing members. 

What are the potential effects of such 

increases? It is difficult to determine 

from our cost-benefit analysis. The 

analysis does not identify increases in 

margin or guaranty fund contributions 

as potential costs, much less attempt to 

quantify such costs.305 However, if the 

increases in costs are significant, and if 

such increases apply to a wide range of 

clearing members (because the DCO 

fears being accused of unjustified 

discrimination),306 then such increases 

would most definitely influence 

whether commercial and financial 

entities voluntarily clear or even enter 

into hedges in the first place. 

Principles-Based Regulation Is a Better 

Solution 

I propose a simple solution that 

would have addressed the confusion 

and hidden costs resulting from the $50 

million threshold. The Commission 

should have eliminated the threshold. 

The threshold adds no value to the other 

components of fair and open access.307

Given that the final rulemaking 

rightfully requires a DCO to properly 

manage its risks, one or more DCOs 

would inevitably impose some sort of 

financial requirement that would 

prevent entities with $50 million (or 

more) in capital from directly 

participating in clearing. At that point, 

the Commission would not be able to 

opine on such a requirement without 

looking to the other components of fair 

and open access. As a result, it would 

have served the Commission well to 

have focused in the first instance on 

setting forth principles-based guidance 

on such components.308 Moreover, 

principles-based guidance would have 

brought the Commission into greater 

accord with certain international 

regulators,309 current international 

standards on CCP regulation,310 as well 

as the proposed revisions to such 

standards.311

Costs Without Benefits: Minimum 

Liquidation Time Requirements 

I have consistently highlighted that 

our rulemakings are interconnected and 

that the Commission has an obligation 

to analyze the cost impact across 

rulemakings. In this instance, I am 

concerned about the relationship 

between this final rulemaking and our 

proposal interpreting core principle 9 

for designated contract markets (DCMs), 

which may be finalized in the future.312

Although this relationship may result in 

significant costs for the market, this 

final rulemaking fails to disclose such 

costs. 

Specifically, this final rulemaking 

requires a DCO to calculate margin 

using different minimum liquidation 

times for different products. A DCO 

must calculate margin for (i) futures 

based on a one-day minimum 

liquidation time, (ii) agricultural, 

energy, and metals swaps based on a 

one-day minimum liquidation time, and 

(iii) all other swaps based on a five-day 

minimum liquidation time.313

No Policy Basis for Minimum 

Liquidation Times 

As a preliminary matter, this final 

rulemaking creates the impression that 

these requirements are arbitrary, like the 

$50 million threshold. Although the 

final rulemaking characterizes these 

requirements as ‘‘prudent,’’ it sets forth 

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314See id. at 126–127. 

315According to the final rulemaking, such 

factors are: ‘‘(i) Average daily trading volume in a 

product; (ii) average daily open interest in a 

product; (iii) concentration of open interest; (iv) 

availability of a predictable basis relationship with 

a highly liquid product; and (v) availability of 

multiple market participants in related markets to 

take on positions in the market in question.’’ Id. at 

129. 

316 Instead of considering the five factors, the 

Commission appears to have simply codified the 

minimum liquidations times that certain DCOs 

currently use for swaps. For example, the 

Commission justifies setting a minimum liquidation 

time of five days for swaps referencing non-physical 

commodities as follows: ‘‘The longer liquidation 

time, currently five days for credit default swaps at 

ICE Clear Credit LLC and CME, and for interest rate 

swaps at LCH and CME, is based on their 

assessment of the higher risk associated with these 

products.’’ Id. at 127–128. Given that this 

justification appears to focus on credit default 

swaps and interest rate swaps, it is unclear how the 

Commission concluded that a five-day minimum 

liquidation time is appropriate for swaps that 

reference financial commodities but are neither 

credit default swaps nor interest rate swaps. 

317 75 FR at 80616. 

318According to information that I have received 

from one DCM, the proposal would force 

conversion of 628 futures and options contracts to 

swap contracts. Moreover, according to the OffMarket Volume Study (May-2010 through July2010) prepared by Commission staff, the proposal 

would force conversion of approximately 493 

futures and options contracts. See Off-Market 

Volume Study, available at: http://www.cftc.gov/ 

LawRegulation/DoddFrankAct/Rulemakings/ 

DF_12_DCMRules/index.htm. 

319See 75 FR at 80589–90. 

320See letter, dated February 22, 2011, from 

NYSE Liffe U.S., available at: http:// 

comments.cftc.gov/PublicComments/ 

ViewComment.aspx?id=27910&SearchText=. See 

also letter, dated February 22, 2011, from ELX 

Futures, L.P., available at: http://comments.cftc.gov/ 

PublicComments/ 

ViewComment.aspx?id=27873&SearchText=. See 

further letter, dated February 22, 2011, from Eris 

Exchange, LLC, available at: http:// 

comments.cftc.gov/PublicComments/ 

ViewComment.aspx?id=27853&SearchText=. 

321See section 3(b) of the CEA, 7 U.S.C. 5(b). 

322See the DCO Final Rule, supra note 289, at 394 

(to be codified at 17 CFR 39.13(g)(2)(ii)(D)). 

323The petition is available at: http:// 

www.cftc.gov/PressRoom/PressReleases/pr5724-09. 

The petition was filed on July 28, 2009. The 

Commission issued an order granting the petition 

on September 16, 2011. The order does not appear 

on the Commission Web site. 

no justification for this 

characterization.314 According to the 

final rulemaking, DCOs should consider 

at least five factors in establishing 

minimum liquidation times for its 

products, including trading volume, 

open interest, and predictable 

relationships with highly liquid 

products.315 In setting forth such 

factors, the Commission is holding 

DCOs to a higher standard than it holds 

itself. The final rulemaking presents no 

evidence that the Commission 

considered any of the five factors in 

determining minimum liquidation 

times.316

Negative Implications for Competition 

More importantly, when these 

requirements are juxtaposed against our 

proposal interpreting DCM core 

principle 9, the potential of these 

requirements to disrupt already 

established futures markets becomes 

apparent. In the proposal, which is 

entitled Core Principles and Other 

Requirements for Designated Contract 

Markets, the Commission proposed, in a 

departure from previous interpretations 

of DCM core principle 9, to prohibit a 

DCM from listing any contract for 

trading unless an average of 85 percent 

or greater of the total volume of such 

contract is traded on the centralized 

market, as calculated over a twelve (12) 

month period.317 If the Commission 

finalizes such proposal, then DCMs may 

need to delist hundreds of futures 

contracts.318 Financial contracts may be 

affected, along with contracts in 

agricultural commodities, energy 

commodities, and metals. 

According to the proposal, DCMs may 

convert delisted futures contracts to 

swap contracts.319 However, if the 

futures contracts reference financial 

commodities, then this final rulemaking 

would require that a DCO margin such 

swap contracts using a minimum 

liquidation time of five days instead of 

one day for futures. If nothing 

substantive about the contracts change 

other than their characterization (i.e., 

futures to swaps), then how can the 

Commission justify such a substantial 

increase in minimum liquidation time 

and margin? An increase of this 

magnitude may well result in a chilling 

of activity in the affected contracts. 

Such chilling would be an example of 

the type of market disruption that the 

CEA was intended to avoid. 

I believe this has severe implications 

for competition. As commenters to the 

DCM proposal noted, market 

participants generally execute new 

futures contracts outside the DCM 

centralized market until the contracts 

attract sufficient liquidity. Attracting 

such liquidity may take years.320 Let us 

assume that an established DCM already 

lists a commercially viable futures 

contract on a financial commodity that 

meets the 85 percent threshold. Even 

without the DCM proposal and this final 

rulemaking, a DCM seeking to compete 

by listing a futures contract with the 

same terms and conditions already faces 

an uphill battle. Now with the DCM 

proposal, the competitor DCM would 

have to also face the constant threat of 

being required to convert the futures 

contract into a swap contract. 

With this final rulemaking, the 

competitor DCM (or a competitor swap 

execution facility (SEF)) faces the 

additional threat that, by virtue of such 

conversion, the contract would be 

margined using a five-day minimum 

liquidation time. In contrast, the 

incumbent futures contract—which may 

have the same terms and conditions as 

the new ‘‘swap’’ contract—would still 

be margined using a one-day minimum 

liquidation time. It is difficult to 

imagine a DCM (or a competitor SEF) 

willing to compete given the twin 

Swords of Damocles that it would need 

to confront. By dissuading such 

competition, this final rulemaking and 

the DCM proposal undermine the 

‘‘responsible innovation and fair 

competition among boards of trade’’ that 

the CEA was intended to promote.321

Some may argue that this final 

rulemaking would not have the negative 

effects that I articulated because it 

explicitly permits the Commission to 

establish, either sua sponte or upon 

DCO petition, longer or shorter 

liquidation times for particular products 

or portfolios.322 I would argue that 

requiring market participants, during 

the pendency of such a petition, to pay 

margin calculated using a five-day 

minimum liquidation time would likely 

cause a substantial number of market 

participants to withdraw from the 

market, thereby chilling activity— 

perhaps irrevocably—in the contract. I 

would further argue that the additional 

cost that (i) a DCM would incur to 

persuade a DCO to file a petition with 

the Commission and (ii) a DCM or DCO 

would incur to prepare such a petition, 

when coupled with the possibility that 

the Commission may deny such 

petition, would likely deter a DCM from 

seeking to compete with an incumbent 

futures contract. After all, the 

Commission may take a long time to 

consider any DCO petition. For 

example, the Commission took 

approximately two years to approve a 

petition to reduce the minimum 

liquidation time for certain contracts on 

the Dubai Mercantile Exchange from 

two days to one day.323 Thus, this 

power to petition the Commission for 

relief may be of little value to offset the 

likely stifling of competition. 

Return to Principles-Based Regulation 

What should the Commission have 

done to avoid market disruption and a 

curtailment in competition? Again, the 

Commission should have retained a 

principles-based regime, and should 

have permitted each DCO to determine 

the appropriate minimum liquidation 

time for its products, using the five 

factors articulated above. Determining 

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69478 Federal Register / Vol. 76, No. 216 / Tuesday, November 8, 2011 / Rules and Regulations 

324See the DCO Final Rule, supra note 289, at 

315–316 (stating that ‘‘[i]n addition to the 

liquidation time frame, the margin requirements for 

a particular instrument depend upon a variety of 

characteristics of the instrument and the markets in 

which it is traded, including the risk characteristics 

of the instrument, its historical price volatility, and 

liquidity in the relevant market. Determining such 

margin requirements does not solely depend upon 

such quantitative factors, but also requires expert 

judgment as to the extent to which such 

characteristics and data may be an accurate 

predictor of future market behavior with respect to 

such instruments, and applying such judgment to 

the quantitative results * * * Determining the risk 

characteristics, price volatility, and market liquidity 

of even a sample for purposes of determining a 

liquidation time specifically for such instrument 

would be a formidable task for the Commission to 

undertake and any results would be subject to a 

range of uncertainty.’’). 

325See supra note 310. With respect to minimum 

liquidation times, Section 4.4.3 of the CPSS–IOSCO 

Recommendations simply state: ‘‘Margin 

requirements impose opportunity costs on CCP 

participants. So, a CCP needs to strike a balance 

between greater protection for itself and higher 

opportunity costs for its participants. For this 

reason, margin requirements are not designed to 

cover price risk in all market conditions. 

Nonetheless, a CCP should estimate the interval 

between the last margin collection before default 

and the liquidation of positions in a particular 

product, and hold sufficient margin to cover 

potential losses over that interval in normal market 

conditions.’’ 

326See also supra note 311. Like the CPSS– 

IOSCO Recommendations, the CPSS–IOSCO 

Consultation also advocates a principles-based 

model for estimating minimum liquidation times. 

Section 3.6.7 of the CPSS–IOSCO Consultation 

states: ‘‘A CCP should select an appropriate closeout period for each product cleared by the CCP, and 

document the close-out periods and related analysis 

for each product type. A CCP should base its closeout period upon historical price and liquidity data 

when developing its initial margin methodology. 

Historical data should include the worst events that 

occurred in the selected time period for the product 

cleared as well as simulated data projections that 

would capture potential events outside of the 

historical data. In certain instances, a CCP may 

need to determine margin levels using a shorter 

historical period to reflect better new or current 

volatility in the market. Conversely, a CCP may 

need to determine margin levels based on a longer 

period in order to reflect past volatility. The closeout period should be set based on anticipated closeout times in stressed market conditions. Close-out 

periods should be set on a product-specific basis, 

as less-liquid products might require significantly 

longer close-out periods. A CCP should also 

consider and address position concentrations, 

which can lengthen close-out timeframes and add 

to price volatility during close outs.’’ 

327The Commission acknowledged as much in its 

cost-benefit analysis. The analysis states: ‘‘The 

Commission anticipates that using only one 

criterion—i.e., the characteristic of the commodity 

underlying a swap—to determine liquidation time 

could result in less-than-optimal margin 

calculations. For some products, a five-day 

minimum may prove to be excessive and tie up 

more funds than are strictly necessary for risk 

management purposes. For other products, a oneday or even a five-day period may be insufficient 

and expose a DCO and market participants to 

additional risk.’’ The DCO Final Rule, supra note 

289, at 315. 

328 Id. at 127 to 128 (stating ‘‘ * * * the final rule 

provides that the minimum liquidation time for 

swaps based on certain physical commodities, i.e., 

agricultural commodities, energy, and metals, is one 

day. For all other swaps, the minimum liquidation 

time is five days. This distinction is based on the 

differing risk characteristics of these product groups 

and is consistent with existing requirements that 

reflect the risk assessments DCOs have made over 

the course of their experience clearing these types 

of swaps. The longer liquidation time, currently five 

days for credit default swaps at ICE Clear Credit, 

LLC, and CME, and for interest rate swaps at LCH 

and CME, is based on their assessment of the higher 

risk associated with these products.’’). 

329 Id. at 396 (to be codified at 17 CFR 

39.13(g)(6)). 

330 Id. at 396–397 (to be codified at 17 CFR 

39.13(g)(7)). 

331 Id. at 383–387 (to be codified at 17 CFR 

39.11(c)(1) and (f)). 

332See United States Commodity Futures Trading 

Commission, International Monetary Fund— 

Financial Sector Assessment Program: SelfAssessment of IOSCO Objectives and Principles of 

Securities Regulation, August 2009, available at: 

http://www.treasury.gov/resource-center/ 

international/standards-codes/Documents/ 

Securities%20CFTC%20Self%20Assessment%208– 

28–09.pdf (the ‘‘FSAP Assessment’’) (describing the 

capabilities of the Risk Surveillance Group within 

the Division of Clearing and Risk (formerly known 

as the Division of Clearing and Intermediary 

Oversight): ‘‘After identifying traders or FCMs at 

risk, the RSG estimates the magnitude of the risk. 

The SRM system enables RSG staff to calculate the 

current performance bond requirement for any 

trader or FCM. This amount is generally designed 

to cover approximately 99% of potential one-day 

moves * * * SRM also enables RSG staff to conduct 

stress tests. RSG staff can determine how much a 

position would lose in a variety of circumstances 

such as extreme market moves. This is a 

particularly important tool with respect to option 

positions. As noted, the non-linear nature of 

options means that the loss resulting from a given 

price change may be many multiples greater for an 

option position than for a futures position in the 

same market. Moreover, the complexity of option 

positions can result in situations where the greatest 

loss does not correspond to the most extreme price 

move.’’). 

The FSAP Assessment also describes the ability 

of the RSG to check DCO stress testing of its default 

resources: ‘‘The RSG compares the risk posed by the 

largest clearing member to a DCO’s financial 

resource package. The RSG analyzes not only the 

size of the DCO package but also its composition. 

In the event of a default, a DCO must have access 

to sufficient liquidity to meet its obligations as a 

central counterparty on very short notice.’’ 

333See Exec. Order No. 13,563, 76 Fed. Reg. 3821 

(Jan. 21, 2011); Exec. Order No. 13,579, 76 Fed. Reg. 

41,587 (July 14, 2011). 334See, e.g., Business Roundtable and the United 

States Chamber of Commerce vs. SEC, No. 10–1305, 

2011 U.S. App. LEXIS 14988 (July 22, 2011). 

appropriate margin requirements 

involves quantitative and qualitative 

expertise. Such expertise resides in the 

DCOs and not in the Commission. In its 

cost-benefit analysis, the final 

rulemaking admits as much.324

Returning to a principles-based regime 

would have also better aligned with 

current international standards on CCP 

regulation,325 as well as the revisions to 

such standards.326

The ‘‘Race to the Bottom’’ Argument 

Simply Cannot Withstand Scrutiny 

Some may argue that, by not imposing 

minimum liquidation times, the 

Commission may enable a ‘‘race to the 

bottom,’’ where DCOs would compete 

by offering the lowest margin. As a 

conceptual matter, given that the 

Commission has not demonstrated that 

the minimum liquidation times that it 

has decided to mandate are ‘‘prudent,’’ 

it cannot demonstrate that the one-day 

or five-day period would prevent a 

‘‘race to the bottom.’’ 327 As an empirical 

matter, the Commission must have 

decided that DCOs currently competing 

to clear interest rate swaps and credit 

default swaps have not entered into a 

‘‘race to the bottom,’’ because the final 

rulemaking codifies the existing fiveday minimum liquidation time that 

such competing DCOs voluntarily 

adopted.328

Finally, the Commission has more 

effective tools to prevent any ‘‘race to 

the bottom.’’ First, this final rulemaking 

requires a DCO to determine the 

adequacy of its initial margin 

requirements on a daily basis.329

Second, this final rulemaking requires a 

DCO to conduct back testing of its initial 

margin requirements on a daily or 

monthly basis.330 Third, this final 

rulemaking requires a DCO to stress test 

its default resources at least once a 

month, and to report to the Commission 

the results of such stress testing at least 

once every fiscal quarter.331 Fourth, the 

Commission has the ability to 

independently back test and stress test 

DCO initial margin requirements.332

Consequently, the Commission would 

be able to detect any ‘‘race to the 

bottom’’ that would cause any DCO to 

have insufficient initial margin to cover 

its risks. 

Cost-Benefit Analysis: We Can Do Better 

I have always emphasized that the 

Commission must engage in more 

rigorous cost-benefit analyses of its 

rulemakings. At various points in my 

speeches and writings, I have urged the 

Commission to (i) focus on the 

economic effects of its rulemakings, 

both cumulative and incremental, (ii) 

quantify the costs and benefits of its 

rulemakings, both cumulative and 

incremental, and (iii) better justify the 

choice of a prescriptive requirement 

when a less-costly and equally effective 

principles-based alternative is available. 

Only by engaging in more rigorous costbenefit analyses would the Commission 

fulfill the mandates of two Executive 

Orders 333 and render our rulemakings 

less vulnerable to legal challenge.334

I have read the cost-benefit analysis in 

this final rulemaking with great interest. 

I can confirm that such analysis is 

longer than previous analyses. 

Unfortunately, increased length does 

not ensure an improvement in analysis 

and content. 

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335See the DCO Final Rule, supra note 289, at 

315–316. 

336See supra note 318. The Off-Market Volume 

Survey does not include contracts listed on new 

DCMs, such as NYSE Liffe U.S., ELX Futures, L.P., 

or Eris Exchange, LLC. However, the existence of 

such survey is proof that the Commission has the 

ability to identify contracts that DCM core principle 

9 may affect. 

337See supra note 332. See pages 252 to 268 of 

the FSAP Assessment for a full description of the 

capabilities of the RSG. 

338The DCO Final Rule, supra note 289, at 344. 

339See supra note 310. 

340See supra note 311. 

341See, e.g., id. at 132 (stating that requiring 

DCOs to calibrate margin to cover price movements 

at a 99 percent confidence interval accords with 

Principle 6 of the CPSS–IOSCO Consultation). 

Although I have numerous concerns 

with the cost-benefit analysis, my 

primary concern relates to its failure to 

attempt meaningful quantification. In 

multiple places in the cost-benefit 

analysis, the Commission concludes 

that the costs of a particular requirement 

are difficult or impossible to estimate. In 

certain instances, the statement may be 

accurate. If the Commission truly cannot 

quantify the costs in those instances, 

then that fact alone should cause the 

Commission to proceed with caution if 

it is going to abandon the existing 

principles-based regime. In other 

instances, however, I find the statement 

to be puzzling, given the capabilities 

and expertise of the Risk Surveillance 

Group (‘‘RSG’’) and the DCO Review 

Group (‘‘DRG’’) in our Division of 

Clearing and Risk (formerly known as 

the Division of Clearing and 

Intermediary Oversight). 

I would like to highlight two such 

instances where the Commission has 

not utilized its own data to quantify the 

costs associated with its policy 

decisions. First, with respect to the 

minimum liquidation time 

requirements, the Commission states 

that ‘‘it is not feasible to estimate or 

quantify these costs reliably.’’ The 

Commission justifies such conclusion 

by stating that (i) ‘‘reliable data is not 

available for many swaps that prior to 

the Dodd-Frank Act were executed in 

unregulated markets,’’ and (ii) it would 

be too difficult for the Commission to 

estimate margin using either a one-day 

or five-day minimum liquidation time 

for any particular product.335 Whereas 

these statements may be accurate for 

certain swaps, they are not accurate for 

futures contracts currently listed on a 

DCM that will be converted to swap 

contracts under the pending DCM 

proposal. However potentially 

incomplete, the Off-Market Volume 

Study (May 2010 through July 2010) 

accompanying the DCM proposal 

entitled Core Principles and Other 

Requirements for Designated Contract 

Markets 336 demonstrates that the 

Commission has the ability to identify at 

least a sample of the futures contracts 

that may be potentially converted to 

swap contracts. It is true that the DCO 

usually impounds the minimum 

liquidation time in the risk arrays that 

it uses to calculate margin, and the RSG 

cannot change such risk arrays easily. 

However, the RSG can ask the DCO to 

provide the assumptions underlying the 

risk arrays, including the minimum 

liquidation time (usually one day). Then 

the RSG can modify such assumptions 

to estimate margin calculations using a 

five-day minimum liquidation time.337

Would these calculations be imperfect? 

Yes. However, any attempt, even an 

imperfect one, undertaken by the 

Commission to understand the cost of 

our rulemakings or to justify our policy 

decisions is better than no attempt at all. 

Another instance that I would like to 

highlight pertains to letters of credit. 

This final rulemaking prohibits DCOs 

from accepting letters of credit as (i) 

initial margin for swaps contracts (but 

not futures contracts) or (ii) as guarantee 

fund contributions. In the cost-benefit 

analysis, the Commission states that, ‘‘it 

is not possible to estimate or quantify 

[the] cost’’ of the prohibition.338 In 

response to questions from me and 

certain of my colleagues, however, the 

DRG prepared a memorandum on the 

use of letters of credit as initial margin. 

Although this memorandum is nonpublic, it is part of the administrative 

record for this final rulemaking. This 

memorandum details, among other 

things: (i) the number and identity of 

certain DCOs accepting and/or holding 

letters of credit as initial margin; (ii) the 

percentage of total initial margin on 

deposit across all DCOs that letters of 

credit constitute; and (iii) the potential 

disproportionate impact on energy and 

agricultural end-users of disallowing 

letters of credit. Whereas the 

memorandum may focus on the use of 

letters of credit as initial margin for 

futures contracts, the Commission 

proposal for DCM core principle 9 may 

force conversion of numerous energy 

and agricultural futures contracts into 

swaps contracts. Yet, the cost-benefit 

analysis contains none of the 

information in the memorandum, even 

in aggregate and anonymous form. In 

the interests of transparency, the 

Commission should have found a way 

to share this information with the 

public. 

The Commission (or its predecessor) 

has regulated the futures markets since 

the 1930s. The Commission has 

overseen DCOs clearing swaps since at 

least 2001. We can do better than this. 

If the Commission needs to re-propose 

a rulemaking to provide quantitative 

estimates of its costs and benefits, so be 

it. Given the foundational nature of this 

rulemaking, as well as other 

rulemakings that are forthcoming, it is 

more important for the Commission to 

achieve the most reasonable balance 

between costs and benefits, rather than 

to finish the rulemaking fast. 

International Coordination: We Must Do 

Better. 

In closing, I would mention my strong 

desire for the Commission to ensure that 

its policies do not create disadvantages 

for United States businesses and that 

our rules comport with international 

standards. It is becoming increasingly 

clear that the schedule for financial 

reform is converging among the G–20 

nations. It is less clear that the 

substantive policies underlying 

financial reform are experiencing the 

same convergence. We must be more 

cognizant of the effects of such lack of 

convergence on dually-registered 

entities, and the incentives created by 

such divergence for regulatory arbitrage. 

This final rulemaking illustrates the 

inconsistent approach that the 

Commission has taken towards 

international coordination to date. First, 

although the final rulemaking notes that 

the CPSS–IOSCO Recommendations 

embody the current international 

standards on CCP regulation, the final 

rulemaking does not attempt to comport 

with the CPSS–IOSCO 

Recommendations.339 Instead, the final 

rulemaking attempts to comport with 

the CPSS–IOSCO Consultation, which 

has not been finalized.340 In general, 

both the CPSS–IOSCO 

Recommendations and the CPSS– 

IOSCO Consultation are less 

prescriptive than the final rulemaking. 

Second, while the final rulemaking 

does note the rare instance where its 

prescriptive requirements comport with 

the CPSS–IOSCO Consultation,341 it 

does not reveal where its prescriptive 

requirements depart from the CPSS– 

IOSCO Consultation. For example, as I 

stated above, the CPSS–IOSCO 

Consultation actually sets forth 

principles-based considerations for 

participant eligibility and margin 

calculation. 

Finally, the final rulemaking states 

that the Commission will review a 

number of its provisions after CPSS and 

IOSCO finish their work, which is likely 

to occur in 2012. Whereas I support 

such a review, the statement begs the 

following questions: What legal 

certainty are these regulations offering 

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69480 Federal Register / Vol. 76, No. 216 / Tuesday, November 8, 2011 / Rules and Regulations 

DCOs, clearing members, and market 

participants if the Commission changes 

such regulations in 2012? Also, what are 

the implications of requiring DCOs to 

incur costs to comport with prescriptive 

requirements now when the 

Commission might change such 

requirements next year? If changes are 

foreseeable, shouldn’t the Commission 

adopt a phasing or delayed 

implementation plan to allow the 

international coordination process to 

reach completion before our rules and 

their costs become effective? If, in the 

alternative, the Commission will not be 

influenced by international standards, 

what are the costs of such nonconvergence? 

As we are finalizing foundational 

rulemakings, we can no longer rely on 

an inconsistent approach. We need to 

produce a more coherent plan for 

international coordination. 

Conclusion 

Due to the above concerns, I 

respectfully dissent from the decision of 

the Commission to approve this final 

rulemaking for publication in the 

Federal Register. 

[FR Doc. 2011–27536 Filed 11–7–11; 8:45 am] 

BILLING CODE 6351–01–P 

mstockstill on DSK4VPTVN1PROD with RULES2