Federal Register / Vol. 65, No. 74 / Monday, April 17, 2000 / Proposed Rules 20395

1As noted above, the President’s Working Group

on Financial Markets is comprised of the Secretary

of the Treasury, the Chairman of the Board of

Governors of the Federal Reserve System, the

Chairman of the Securities and Exchange

Commission, and the Chairman of the Commodity

Futures Trading Commission. A number of other

federal agencies participated in the study, including

the Council of Economic Advisers, the Federal

Deposit Insurance Corporation, the National

Economic Council, the Federal Reserve Bank of

New York, the Office of the Comptroller of the

Currency, and the Office of Thrift Supervision.

2PWG Report at 25.

3 Id.

4 Id at 15.

5 Id.

6 Id at 31.

7PWG Report at 32–33.

8 Id at 34.

Locks must be designed to withstand the

maximum output power of the actuators and

maximum expected manual operating forces

treated as a limit load. Under these

conditions, the door must remain closed,

latched and locked.

(5) Power Availability:

All power to the door must be removed in

flight and it must not be possible for the

flight crew to restore power to the door while

in flight.

(6) Powered Lock Systems:

For doors that have powered lock systems,

it must be shown by safety analysis that

inadvertent opening of the door after it is

fully closed, latched and locked, is extremely

improbable.’’

Issued in Renton, Washington, on April 11,

2000.

Donald L. Riggin,

Acting Manager, Transport Airplane

Directorate, Aircraft Certification Service.

[FR Doc. 00–9557 Filed 4–14–00; 8:45 am]

BILLING CODE 4910–13–P

COMMODITY FUTURES TRADING

COMMISSION

17 CFR Part 1

RIN 3038–AB53

Public Reporting by Operators of

Certain Large Commodity Pools

AGENCY: Commodity Futures Trading

Commission.

ACTION: Proposed regulations.

SUMMARY: In April of 1999, the

President’s Working Group on Financial

Markets (comprised of the Secretary of

the Treasury, the Chairman of the Board

of Governors of the Federal Reserve

System, the Chairman of the Securities

and Exchange Commission, and the

Chairman of the Commodity Futures

Trading Commission) (the ‘‘PWG’’)

issued a report entitled ‘‘Hedge Funds,

Leverage, and the Lessons of Long Term

Capital Management: Report of The

President’s Working Group on Financial

Markets’’ (the ‘‘PWG Report’’). This

report reviewed the events surrounding

the near-collapse of Long Term Capital

Portfolio, L.P.

The PWG Report contained eight

recommendations. The first was that

‘‘more frequent and meaningful

information on hedge funds should be

made public’’ and the fourth was that

‘‘regulators should encourage

improvements in the risk management

systems of regulated entities.’’ In

furtherance of the first objective, the

report specifically recommended that

commodity pool operators (‘‘CPOs’’) of

large commodity pools should file

quarterly reports, that these reports

should ‘‘include more meaningful and

comprehensive measures of market

risk’’ such as ‘‘value at risk’’ and that

these reports be published.

Consistent with this unanimous

recommendation of the PWG, the

Commission is proposing new Rule

4.27, which would require the CPOs of

the largest commodity pools to provide

to the Commission the specified

aggregate financial and risk information

on a quarterly basis. In order to provide

context for the evaluation of this

information, these CPOs would also be

required to provide certain summary

information about their risk

management systems and practices.

DATES: Comments must be received on

or before June 16, 2000.

ADDRESSES: Comments should be

mailed to Jean A. Webb, Secretary,

Commodity Futures Trading

Commission, Three Lafayette Centre,

1155—21st Street, NW, Washington, DC

20581; transmitted by facsimile to (202)

418–5521; or transmitted electronically

to (secretary@cftc.gov). Reference

should be made to ‘‘Public Reporting by

Operators of Certain Large Commodity

Pools’’.

FOR FURTHER INFORMATION CONTACT:

Robert B. Wasserman, Associate

Director at rwasserman@cftc.gov, Tobey

Kaczensky, Special Counsel at

tkaczensky@cftc.gov, or James L. Carley,

Attorney at jcarley@cftc.gov, Division of

Trading and Markets, Commodity

Futures Trading Commission, Three

Lafayette Centre, 1155—21st Street,

NW., Washington, DC. 20581,

Telephone (202) 418–5430.

SUPPLEMENTARY INFORMATION:

I. Background

The events in 1998 involving highly

leveraged hedge funds, particularly the

near collapse of Long Term Capital

Portfolio, L.P. (‘‘LTCM’’), raised

concerns that problems at one such

financial institution, under certain

circumstances, could be transmitted to

other financial institutions and pose

material systemic risks to the financial

system of the United States and to

international financial systems. In the

months following these events, the

President’s Working Group on Financial

Markets (the ‘‘PWG’’) conducted a study

of the events and their policy

implications and, in April of 1999,

issued ‘‘Hedge Funds, Leverage, and the

Lessons of Long Term Capital

Management: Report of The President’s

Working Group on Financial Markets’’

(the ‘‘PWG Report’’).1

The PWG Report stated that the

‘‘primary mechanism that regulates risk

taking by firms in a market economy is

the market discipline provided by

creditors, counterparties (including

financial contract counterparties), and

investors.’’ 2 The report observed,

however, that ‘‘market discipline tends

to be effective only when creditors have

the incentives and the means to evaluate

the riskiness of the firm.’’ 3 The report

concluded that investors and

counterparties had ‘‘exercised minimal

scrutiny of its risk management

practices and [its] risk profile’’ and were

‘‘almost certainly not adequately aware’’

of the ‘‘nature of the exposures and risks

[LTCM] had accumulated.’’ 4 The report

attributed this ‘‘insufficient monitoring’’

to ‘‘LTCM’s practice of disclosing only

minimal information’’ about itself that

‘‘did not reveal meaningful details about

[its] risk profile.’’ 5

Thus, the members of the PWG

unanimously recommended that ‘‘more

frequent and meaningful information on

hedge funds should be made public’’ 6

and that the public disclosures should

include risk information. Specifically,

the report recommended that: (i)

registered CPOs operating large funds

begin filing with the Commission

quarterly, rather than annual, reports of

financial information; (ii) in addition to

traditional financial statements, these

reports include more ‘‘meaningful and

comprehensive measures of market risk

(e.g., value at risk or stress test results),

without requiring the disclosure of

proprietary information on strategies or

positions;’’ 7 and (iii) these reports be

published. Separately, the report

recommended that ‘‘regulators should

encourage improvements in the risk

management systems of regulated

entities.’’ 8

With respect to hedge funds that are

not currently registered as CPOs, the

PWG Report recommended that ‘‘a

means for disclosure should be

developed to ensure that similar

financial information is provided to the

public’’ but recognized that ‘‘Congress

20396 Federal Register / Vol. 65, No. 74 / Monday, April 17, 2000 / Proposed Rules

9 Id. at 33.

10H.R. 2924, 106th Cong., 1st Sess. (2000).

11PWG Report at 24.

12 Id.

13Remarks presented to the Futures Industry

Association on March 17, 2000.

14 ‘‘Hedge Funds and Other Highly Leveraged

Institutions—Report of the Technical Committee of

the International Organization of Securities

Commissioners,’’ November 1999 (hereinafter the

‘‘IOSCO Hedge Fund Report’’) at 24–25.

15 ‘‘Report of the Working Group on Highly

Leveraged Institutions’’ (hereinafter the ‘‘FSF

Report’’) at 3.

16 Id. at 31.

17Commission regulations referred to herein are

found at 17 CFR Ch. 1 et. seq. (1999).

would need to enact legislation that

authorizes mechanisms for [such]

disclosure.’’ 9 On September 23, 1999,

Representative Richard Baker of

Louisiana introduced a bill which

would require unregulated hedge funds

to report certain financial and risk

information to the Federal Reserve

Board. As amended on March 16, 2000,

and referred by the Subcommittee on

Capital Markets to the full Committee

on Banking and Financial Services, this

legislation would require each such

hedge fund or family of such hedge

funds with total assets of $3 billion or

net assets of $1 billion to report to the

Board on a quarterly basis both

‘‘[m]eaningful and comprehensive

financial information (such as a

complete set of financial statements

* * *)’’ and ‘‘[m]eaningful and

comprehensive measures of risk (such

as value-at-risk or stress test results).’’ 10

In advocating the reporting of risk, as

well as financial, information, the PWG

report pointed out that financial

leverage, particularly when measured by

balance sheet leverage, does not by itself

provide an adequate measure of risk

because ‘‘for any given balance sheet

leverage ratio, the fragility of a portfolio

depends on the market, credit, and

liquidity risks in the portfolio.’’ 11

Financial information should be

supplemented with a ‘‘statistical

measure’’ such as ‘‘value-at-risk relative

to net worth,’’ which would ‘‘produce a

more meaningful description of leverage

in terms of risk.’’ 12

The PWG believes that improving the

transparency of the risk profiles of

hedge funds would help other market

participants make more informed

judgments about market integrity and

the creditworthiness of borrowers and

counterparties. Secretary of the Treasury

Lawrence Summers recently noted that

the public sector ‘‘can help to enhance

the effectiveness of market discipline by

creating an environment of greater

transparency and disclosure. * * *

[A]gencies should continue to apply the

recommendations of the [PWG Report]

that are designed to enhance the

monitoring of leverage and risk, and to

improve transparency, especially the

steps to increase reporting by the largest

hedge funds. * * *’’ 13

Moreover, the PWG has not been the

only group to recognize these

advantages of greater public disclosure.

The PWG’s recommendations have met

with the approval of international

financial regulators. The International

Organization of Securities

Commissioners (IOSCO) released a

report last November which stated that:

‘‘The [hedge fund] information gap can, in

principle, be addressed through greater

public disclosure to permit market

participants to assess [hedge fund] risks

independently * * * . Market participants

might use additional information * * * for a

number of purposes, including making more

informed decisions with respect to the

pricing of transactions and the proper

assessment of risks and returns inherent in

investment and trading decisions.’’ 14

Similarly, the Financial Stability

Forum, a group consisting of the U.S.

Treasury and the Federal Reserve Bank

of New York as well as the Basel

Committee on Banking Supervision,

IOSCO and financial regulators from the

UK, France, Germany, Australia, Italy,

and Hong Kong, released in March a

report which stated that:

‘‘The [FSF] Working Group firmly supports

the objective of enhancing public disclosure

by HLIs [highly leveraged institutions, or,

hedge funds] and endorses U.S. efforts to

achieve this through both regulation and

legislation.’’ 15

The FSF Report went on to state that

‘‘[t]he Working Group agrees [with the

PWG and IOSCO] that enhanced public

disclosure by HLI’s would be

desirable.16

The regulations proposed today are

intended to implement the PWG Report

recommendations discussed above, and

are consistent with the

recommendations of the IOSCO Hedge

Fund Report and the FSF Report. As

described more fully below, they would

require operators of the largest

commodity pools to file, with respect to

each pooled investment vehicle under

their direct or indirect control,

including vehicles which are not

commodity pools, (1) an initial report

that would provide summary

descriptions of key aspects of their risk

management practices, and (2) quarterly

reports that would disclose both

financial information and information

about the exposure of the pool to market

risk over the course of the quarter (but

that would not reveal positions or

trading strategies).

II. The Hedge Fund Reporting

Regulation—Proposed Regulation 4.27

A. Persons Required To Report

1. Size and Leverage Thresholds

Proposed Section 4.27(b) would

define a reporting person as a

commodity pool operator that controls

one or more pools where, at the end of

a quarter, either (a) the controlled assets

of such pool or pools total three billion

dollars ($3,000,000,000) or greater or (b)

the controlled net assets of such pool or

pools total one billion dollars

($1,000,000,000) or greater. These

thresholds are intended to limit the

reporting requirement to the CPOs of

funds whose activities potentially could

have systemic risk effects. Any person

which has met these thresholds at the

end of any of the past three quarters is

included as a reporting person in order

to ensure a reasonable continuation of

coverage of hedge funds which may be

experiencing problems. Based on

financial filings received pursuant to

existing rules, the Commission believes

that approximately twenty-five pool

operators would be required to report

under the proposed rule.

The Commission requests comment

on whether these criteria for ‘‘reporting

persons’’ are appropriate and whether

other criteria should be applied.

2. The Effect of Current Exemptions

a. Pools Limited to Sophisticated

Investors—Rules 4.7, 4.8 and 4.12(b)

Participation in many of the funds

that would be subject to proposed Rule

4.27 is limited to large, sophisticated

investors that are generally considered

to need less protection than other

customers. Pursuant to Rules 4.7, 4.8,

and 4.12(b), these funds may be

exempted from specified provisions of

other Part 4 rules. 17 In contrast to other

rules under Part 4, however, Rule 4.27

is not intended primarily as a means of

customer protection. Rather, the

regulation is intended to facilitate the

exercise of market discipline by other

market participants in their dealings

with hedge funds that, because of their

size, could potentially have systemic

risk effects. The importance of

facilitating market discipline, to the

benefit of counterparties and the market

at large, is independent of the

sophistication of the investors in any

particular pool. Accordingly, the

proposed rule does not exempt funds

from the provisions of Rule 4.27 on the

grounds that participation in such funds

Federal Register / Vol. 65, No. 74 / Monday, April 17, 2000 / Proposed Rules 20397

18See 50 FR 15868 (April 23, 1985).

19The Employment Retirement Income Security

Act of 1974 (ERISA), 29 U.S.C. 1001–1381 (1982),

as amended by the Multiemployer Pension Plan

Amendments Act of 1980, Pub. L. No 96–364, 94

Stat. 1208 (1980).

20Section 8(a)(1) of the Commodity Exchange

Act, 7 U.S.C. 12(a)(1), provides that ‘‘the

Commission may not publish data and information

that would separately disclose the business

transactions or market positions of any person and

trade secrets or names of customers.’’ The

disclosure called for by proposed Rule 4.27 is of

aggregate information which would not require the

disclosure of information covered by Section

8(a)(1).

21PWG Report at 32.

22 Id.

23Caxton Corporation, Kingdon Capital

Management, LLC, Moore Capital Management,

Inc., Soros Fund Management, LLC, and Tudor

Investment Corporation, ‘‘Sound Practices for

Hedge Fund Managers,’’ February 2000 at l–1 and

l–2 (hereinafter the ‘‘Industry Sound Practices

report’’).

24 Id.

25PWG Report at 24.

26As used herein, the term ‘‘loss’’ means any

adverse change in the value of a pool’s portfolio,

whether realized or unreailzed. See infra at 20.

27 Value-at-risk can, of course, be measured in any

currency.

is limited to large, sophisticated

investors.

b. Pools That Have Received

Exemptions on a Case by Case Basis

Rule 4.12(a) permits the Commission

to ‘‘exempt any person or any class or

classes of persons from any provision of

this Part 4 if it finds that the exemption

is not contrary to the public interest.’’ A

number of persons have received such

exemptions on the grounds that

participants in their pools are not in

need of customer protections provided

by the Part 4 rules. Most of these

persons manage funds that would fall

below the size threshold of Rule 4.27.

However, for the reasons stated above,

no person that controls any pool or

pools that satisfy the thresholds of

Section 4.27(b) and that has obtained

relief pursuant to Rule 4.12(a) prior to

the effective date of these rules will be

exempt from Rule 4.27 by virtue of such

relief. No person that obtains relief

pursuant to Rule 4.12(a) in accordance

with a Commission order or an

exemptive letter issued subsequent to

the effective date of these rules will be

exempt from Rule 4.27 unless such

order or letter expressly exempts such

person from Rule 4.27.

c. Entities Excluded From the Definition

of Commodity Pool

Rule 4.5 excludes certain entities from

the definition of commodity pool

operator on the grounds that they are

otherwise regulated.18 These entities

include investment companies,

insurance companies, banks, trust

companies, and fiduciaries and

employers subject to ERISA.19 Proposed

Rule 4.27, by its terms, would only

apply to commodity pool operators.

Therefore, entities excluded from the

definition of commodity pool operator

pursuant to Rule 4.5 would not be

required to file reports under proposed

Rule 4.27.

B. Reporting Requirements

Each reporting person would file two

types of reports: (i) An initial set of

qualitative descriptions of its risk

management practices and (ii) quarterly

reports disclosing quantitative financial

and risk exposure information. The

initial descriptions would be filed

concurrently with the first quarterly

report; thereafter, revised responses that

reflect material changes, if any, to the

initial descriptions would be filed

concurrently with subsequent quarterly

reports. Each quarterly report would be

filed not later than thirty days after the

end of each quarter.

As noted above, the discipline

exercised by other market participants

can provide a critical means of

controlling excessive leverage and, thus,

constraining the added market, credit,

and funding liquidity risks generated

thereby. Public disclosure of the

information collected under this rule

should help other market participants to

make more informed judgments and to

more effectively exercise market

discipline. This discipline is expected

to both constrain excessive leverage of

reporting persons and encourage

reporting persons to adopt best practices

in risk management as such evolve

within the industry. Accordingly, the

Commission is proposing to disclose

publicly both the initial descriptions

and the quarterly reports.20 Section

4.27(f). The Commission intends to

make this information available over the

Internet within one business day after

receipt. Thus, the Commission

effectively would serve as a conduit for

transmitting this information to the

public.

Discussions of the quantitative

financial and risk information proposed

to be reported on a quarterly basis are

presented in sections 1 and 2 below,

respectively. The qualitative risk

management information to be reported

initially is discussed in section 3.

Specific filing and attestation

requirements are set forth in section 4,

while definitional matters are discussed

in section 5.

1. Quarterly Reporting of Financial

Information Under Rule 4.27

Market discipline can only serve as an

effective check upon excessive leverage

if other market participants can obtain

meaningful information about a

reporting person’s financial condition

on a reasonably timely basis. The PWG

Report observed that ‘‘[c]urrently, the

scope and timeliness of information

made available about the financial

activities of hedge funds are limited.’’ 21

As noted above, the first of its

recommendations was that ‘‘[h]edge

funds should be required to disclose

additional, and more up-to-date,

information to the public’’ and that

CPOs should file ‘‘quarterly reports

rather than annual reports.’’ 22

Accordingly, consistent with the PWG

Report’s recommendations, Section

4.27(d)(1) of the proposed rule would

require each reporting person to report

on a quarterly basis certain key financial

information for each pool under its

control, including statements of income,

financial condition, changes in financial

position, and changes in net asset value.

2. Quarterly Reporting of Risk Exposure

Information Under Rule 4.27

Leverage has been described within

the hedge fund industry not as an

independent source of risk but, rather,

as ‘‘a factor that influences the rapidity

with which changes in market risk,

credit risk or liquidity risk factors’’

create losses.23 It has been noted that

‘‘the market risk inherent in a [hedge

fund], coupled with the constraints

imposed by funding liquidity, make the

amplifying effect of leverage of

particular concern to [hedge fund

managers].’’ 24 The PWG emphasized

that leverage is not an adequate measure

of risk because ‘‘for any given balance

sheet leverage ratio, the fragility of a

portfolio depends on the market, credit,

and liquidity risks in the portfolio.’’ 25

Accordingly, the Commission believes

that, in order to fairly portray the risk

profile of reporting persons, the

quarterly financial information

discussed above should be

supplemented with certain quantitative

risk information. Currently, the most

widely accepted methodology of

calculating exposure to market risk is

value-at-risk (also called ‘‘capital-atrisk’’). Value-at-risk is calculated using

statistical techniques, and represents the

largest dollar loss 26 which is expected

to be suffered over a given investment

horizon or ‘‘holding period’’ (for

example, one day or ten days) with a

given degree of certainty or ‘‘confidence

level’’ (for example, 95% or 99.6%).27

Because it is expressed in dollars, valueat-risk for a particular entity can be

compared over time and, in some

circumstances, across multiple entities

20398 Federal Register / Vol. 65, No. 74 / Monday, April 17, 2000 / Proposed Rules

28See discussion infra at 14–15.

29 Industry Sound Practices repoert at 17.

30 Id. at 3.

31 Id. at 19–20.

32Basel and IOSCO, ‘‘Recommendations for

Public Disclosure of Trading and Derivatives

Activities of Banks and Securities Firms,’’ October

1999, at 6 (hereinafter the ‘‘Basel/IOSCO Disclosure

Recommendations’’).

(for example, when all such entities

compute value-at-risk using the same

confidence level and holding period).

Most importantly, value-at-risk

incorporates correlations among

positions in the portfolio without

revealing the positions themselves; it

does not compromise the confidentiality

of a firm’s trading strategies.

The methodology commonly

understood as ‘‘value-at-risk’’ may, in

the future, be replaced by some other

method of measuring of market risk.

Indeed, one or more reporting persons

may already have developed such an

alternative method. Accordingly, for

purposes of proposed Rule 4.27 and in

the discussion below, the term ‘‘VAR’’

shall mean any measure of exposure to

market risk, including value-at-risk, that

can be expressed in dollars and that

represents the amount that a pool’s

losses during a stated period are

expected not to exceed, with a stated

degree of certainty.

VAR would complement traditional

balance sheet measures of leverage by

giving other market participants insight

into the magnitude of the firm’s

exposure to losses. Under Section

4.27(d)(2)(i), each reporting person

would be required to report for each

pool under its control the highest,

lowest, and ending VAR calculated

during the reporting period at each

confidence level and holding period for

which VAR is normally calculated by

the reporting person. However, as

further discussed below, the proposed

rule would not require disclosure of

stress test results so as not to discourage

reporting persons from conducting the

most rigorous stress tests.28 Some

reporting persons may conduct stress

testing by calculating VAR at extremely

high confidence levels. Accordingly, no

reporting person would be required to

report VAR calculated at a confidence

level in excess of 99.6%. (This is the

confidence level corresponding to a

VAR not expected to be exceeded more

often than once in a year of 250 trading

days).

A matrix of VAR results (e.g., for 95%,

98%, and 99.6% confidence levels)

would be more informative than a single

result. Accordingly, the proposed rule

requires disclosure of the highest,

lowest, and ending VAR at each

confidence level and holding period for

which VAR is calculated by the

reporting person. The Commission is

aware, however, that this approach

might be more burdensome than

requiring, for example, results at the

single highest confidence level for

which VAR is calculated. The

Commission invites comment on the

best approach to take in this regard.

Under Section 4.27(d)(2)(ii), each

reporting person would be required to

report for each holding period for which

it calculates VAR the frequency during

the quarter with which losses for each

pool under its control exceeded the

corresponding VAR for such pool (at the

highest confidence level calculated not

exceeding 99.6%). Each reporting

person would also be required to report

the dollar magnitude of the greatest loss

experienced by each pool during the

quarter. The importance of examining

the magnitude, as well as the frequency,

of losses in excess of VAR is

exemplified by the recommendation of

one group of hedge fund managers that

‘‘[e]ven if the frequency of changes in

value in excess of that generated by the

market risk model is within the

expected range, if the observed change

in the value of the portfolio differs

significantly from the change that would

be expected, given the composition of

the portfolio and the observed changes

in the market factors, [the hedge fund

manager] should reconcile the

difference.’’ 29

Many hedge funds actively seek risk,

and indeed serve the market by acting

as ‘‘risk absorbers;’’ that is, ‘‘by standing

ready to lose capital, [they] act as a

buffer for other market participants in

absorbing ‘shocks.’ ’’ 30 The ratio of VAR

to net asset value (‘‘NAV’’) provides an

indication of the ability of a firm to

absorb the losses that it is likely to

experience during normal market

conditions. This type of ratio very

usefully relates the separate concepts of

leverage and risk to one another. The

Industry Sound Practices report

recommends that hedge fund managers

track the leverage of their funds by

‘‘using ‘risk-based leverage’ measures

reflecting the relationship between the

riskiness of a * * * portfolio and the

capacity * * * to absorb the impact of

that risk.’’ ‘‘VAR/Equity’’ is one of

several such measures mentioned in the

report.31

To be sure, the calculation of VAR is

highly sensitive to the selection of the

confidence level at which it is

measured, and the holding period over

which it is calculated. There is no

widely accepted standard for either of

these parameters. For example, a 95%

one-day VAR for a particular firm may

be a relatively low dollar value that is

expected to be exceeded every month

(95% covering 19 out of 20 trading days

in a month). By contrast, a 99.6% oneday VAR for the same firm might be a

significantly larger dollar value that is

not expected to be exceeded more often

than once a year (99.6% covering 249/

250 trading days). Many firms use each

of these confidence levels and still other

firms use levels of 98%, 99%, and so

forth.

The Commission has considered

whether it would be advisable to ensure

that reported VAR information would

remain directly comparable across

multiple firms. To do so, the

Commission would have to mandate the

confidence level and holding period for

which firms would be required to

calculate and report VAR. This would

mean, however, that some firms might

be compelled to begin calculating VAR

information that they do not already

prepare and that would be inconsistent

with the information used internally to

manage trading activities. The Basel

Committee on Banking Supervision

(‘‘Basel’’) and IOSCO have recognized

that the objectives of comparability

across firms and consistency with

internal risk management systems are

not always compatible. They have

emphasized the latter objective because

‘‘linking public disclosure to internal

risk management processes helps ensure

that disclosure keeps pace with

innovations in risk measurement and

management techniques.’’ 32

The Commission believes that it is

more important to ensure consistency

with internal practices and proposes to

require reporting persons to report VAR

only for confidence levels and holding

periods for which VAR is routinely

calculated for internal purposes. This

approach would provide other market

participants with information which is

consistent with information the pool’s

management utilizes in managing risk

internally, in addition to imposing a

lighter regulatory burden upon reporting

persons.

Nor is the Commission proposing to

specify a particular method or model

that a firm should use to calculate VAR.

To do so could create significant

burdens for reporting persons and, given

the rapid pace of innovation in both

financial engineering and risk

management, would be of questionable

utility. Rather, the Commission is

following the ‘‘internal model’’

approach chosen by Basel and IOSCO.

The Commission does seek to

encourage firms to use accurate, reliable

VAR models, and would do so by

mandating the disclosure of the firms’

Federal Register / Vol. 65, No. 74 / Monday, April 17, 2000 / Proposed Rules 20399

33 ‘‘By comparing actual changes in the value of

the portfolio to the changes generated by the VAR

calculation, the [hedge fund manager] can gain

insight into whether the VAR model is accurately

measuring a [hedge fund’s] risk.’’ Industry Sound

Practices report at I–13.

34 ‘‘[I]f the frequency of changes in value of the

portfolio exceeds the frequency generated by the

market risk model (a statistical expection based on

the confidence level of the market risk model), such

deviation should be scrutinized to determine its

source.’’ Id. at 16.

35Hedge fund managers are advised to ‘‘perform

‘stress tests’ to determine how potential changes in

market conditions could impact the market risk of

[their] portfolio[s]. * * * [and] also consider

conducting ‘scenario analyses’ to benchmark the

risk of the [the fund’s] current portfolio against

various scenarios of market behavior (historical or

prospective) that are relevant to the [manager’s]

trading activities (e.g. the October 1987 stock

market event, the Asian financial crisis * * *).’’

Industry Sound Practices report at 15–16.

36See generally PWG Report; Basel and IOSCO,

‘‘Trading and disclosures of Banks and Securities

Firms—Results of the Survey of Public Disclosures

in 1998 annual Reports,’’ December 1999; the

IOSCO Hedge Fund Report; the Basel/IOSCO

Disclosure Recommendations; Basel, ‘‘Sound

Practices for Banks’ Interactions with Highly

Leveraged Institutions,’’ January 1999; Basel/

IOSCO, ‘‘Framework for Supervisory Information

about Derivatives and Trading Activities,’’

September 1998; IOSCO, ‘‘Principles for the

Supervision of Operators of Collective Investment

Schemes,’’ September 1997; and Basel,

‘‘Supervisory Framework for the Use of

‘Backtesting’ in Conjunction with the Internal

Models Approach to Market Risk Capital

Requirements,’’ January 1996.

37See generally the Industry Sound Practices

Report and the Counterparty Risk Management

Policy Group (or ‘‘CRMPG,’’ a group of major

commercial and investment banks), ‘‘Improving

Counterparty Risk Management Practices,’’ June

1999 (hereinafter the ‘‘CRMPG Report’’).

38See, e.g., CRMPG Report at 2 and Industry

Sound Practices report at 2.

backtesting results. Backtesting is a

process by which the losses implied by

the VAR calculation are compared to the

losses experienced.33 The results of this

comparison provide valuable

information about the validity of a

firm’s VAR model.34 The Commission

believes that market discipline will be

facilitated by disclosing this

information, so that other market

participants may reach their own

conclusions as to the accuracy of the

firm’s VAR, and the reliability of the

firm’s risk management systems. For

example, if a firm calculates VAR at a

95% confidence interval over a one-day

holding period, the expected value for

the number of trading days that the VAR

figure will be exceeded over a quarteryear of approximately 60 trading days is

three (60 trading days × 95% = 57;

60¥57=3). If a firm’s actual one-day

losses exceeded its calculated 95% oneday VAR on ten separate occasions

during a quarter, and no sufficient

explanation is provided, other market

participants might conclude that the

VAR calculated by the firm is of

questionable reliability, and might draw

adverse inferences concerning the firm’s

risk management.

Even when validated by solid backtest

results, however, VAR provides only

part of the information necessary to

fully evaluate a firm’s exposure to

market risk. VAR represents merely the

loss that is not expected to be exceeded

under ‘‘normal’’ market conditions; it

provides no information whatsoever

about the possible extent of losses under

‘‘abnormal’’ market conditions. Even if

VAR accurately predicts the worst loss

that would occur in 99.6% of the

trading days over a year (250 × 99.6%

= 249), it would not provide any

information as to the magnitude of

potential losses on the remaining 0.4%

of the trading days (250 × 0.4% = 1). A

reporting person can only explore the

potential extent of such extraordinary

losses by conducting stress tests.

Stress tests involve subjecting models

of the firm’s positions to various sets of

extreme market conditions and

measuring the losses that would

result.35 These conditions might include

historical circumstances, such as the

1987 stock market drop or the 1998

Russian loan default, or hypothetical

scenarios specifically designed to stress

the firm’s current positions.

Consequently, the results of properly

performed stress tests can show

extraordinarily high hypothetical losses.

For example, a firm with total assets of

$3 billion, a net asset value of $500

million, and a 99.6% one-day VAR of

$100 million (e.g. a VAR-to-NAV ratio of

only 20% which many might consider

quite adequate) could very likely,

through rigorous stress tests, generate

modeled losses well in excess of $500

million.

If reporting persons were compelled

to publicly disclose their stress test

results, they might be discouraged from

performing the most rigorous stress tests

that they could develop and might not

learn of and address potential

weaknesses in their portfolio strategies.

Therefore, the proposed rule would not

require reporting persons to report stress

test results. Rather, reporting persons

would be required simply to report

whether stress tests have been

performed during the quarter and, if so,

whether the results of such tests are

communicated to an appropriate level of

management.

The reporting person would be

permitted (but not required) to provide

any other information with which it

might wish to supplement the reported

VAR information. This information

would be posted publicly along with the

required information.

3. Initial Reporting Concerning Risk

Management Practices Under Rule 4.27

As discussed above, the Commission

is not proposing to mandate use of

specific parameters or methodologies for

monitoring the risk exposures. This

means, however, that for the

quantitative information in the quarterly

reports to be useful to other market

participants, some additional

information must be made available to

enable the quarterly reports to be placed

in context.

The Commission therefore proposes

that each reporting person submit

narrative descriptions of their practices

in five areas set forth in Section

4.27(c)(2). These cover the reporting

person’s policies, procedures, and

systems for supervising, monitoring,

and reviewing market, credit, and

funding liquidity risks generated by its

financing, trading, and investment

activities. Initially, each reporting

person would be required to submit an

entire set of responses. Thereafter, a

revised set of responses would be

required following any material change

in those policies, procedures, or

systems. Such updated responses would

be due concurrently with the

submission of the next quarterly report

required under Section 4.27(d)(2).

The Commission has developed the

topics described below based on a

review of discussions of ‘‘best practices’’

from both governmental organizations 36

and private industry.37 It is important to

note that the Commission is not

proposing to require reporting persons

to use any of the tools that are the

subjects of the inquiries. This is

consistent with the caveats in the

private industry reports, which

emphasize that the best practices they

discuss may not be appropriate for

hedge funds of all sizes.38 Rather, the

Commission is simply proposing that

reporting persons be required to

disclose to the market information about

its use of such tools, along with any

additional information the reporting

person might believe is necessary to put

that disclosure in context. It would then

be up to a reporting person’s

counterparties to determine whether or

not the reporting person’s risk

management efforts are adequate, and

the appropriate steps to take in light of

that determination. Thus, these reports

are expected to lead to improvements in

risk management systems as market

discipline encourages firms to adopt

best practices as they evolve in the

industry.

20400 Federal Register / Vol. 65, No. 74 / Monday, April 17, 2000 / Proposed Rules

39The risk monitoring function ‘‘should report

directly to [s]enior [m]anagement and be staffed

with persons having sufficient experience and

knowledge to understand [the fund’s] trading

strategies and the nature and risk of its

investments.’’ In addition, ‘‘[c]omprehensive and

centralized systems for position and global

exposure reporting and risk analysis should

function independently of risk selection/portfolio

management personnel so that trading activities and

operations may be effectively supervised and

compliance with trading policies and risk limits can

be controlled.’’ Industry Sound Practices report at

10.

40Hedge fund managers ‘‘should evaluate the

stability of sources of liquidity and plan for funding

needs accordingly, including a contingency plan in

periods of stress * * * [including] taking into

account potential investor redemptions and

contractual arrangements that affect [the hedge

fund’s] liquidity (e.g. notice periods for reduction

of credit lines by counterparties).’’ Industry Sound

Practices report at 18.

Topic 1—Approach to Risk

Management

The first topic is the reporting

person’s overall approach to risk

management. A responsive disclosure

would include a discussion of the extent

to which the reporting person has

established an independent risk

monitoring function within its

organization, the extent of that

function’s resources and the nature of

its authority, the types of risk

monitoring techniques the reporting

person employs, and the ways in which

senior management is involved in risk

management.39

The Commission believes this

information would be of particular

value in helping other market

participants to develop an

understanding of the strength of the

reporting person’s commitment to

sound risk management practices. For

example, information about the degree

to which senior management is involved

in risk monitoring, the authority which

the risk monitoring function may

exercise over other functions such as the

trading desk, and the financial and

human resources dedicated to risk

management efforts could assist other

market participants in gauging how

rigorously the firm balances its risk

taking against potential returns.

Topics 2 (Market Risk in Normal

Markets) & 3 (Market Risk in Abnormal

Markets)

The second and third topics both

relate to the reporting person’s approach

to measuring and managing its exposure

to market risk. The second topic is the

method used by the reporting person to

measure market risk during normal

market conditions, how it validates its

models (for example, backtesting), and

whether its practices are tested by

external auditors. These inquiries are

intended to give other market

participants insight into the reliability

of the quantitative market risk

information conveyed quarterly by

reporting persons. The knowledge that a

reporting person is utilizing

contemporary techniques to measure

market risk, has addressed major

problem areas with input data, and

subjects its methodologies to backtesting

and external audits might give other

market participants greater confidence

in these quarterly numbers.

The third topic is the reporting

person’s use of stress tests, its policies

and practices for ensuring that

meaningful and realistic scenarios are

used in stress tests, and the extent of

management involvement in the process

of developing scenarios and evaluating

results. This information is important in

helping other market participants

evaluate the extent to which the

reporting person prepares for abnormal

market conditions. Stress tests are an

essential tool for exploring the potential

extent of extraordinary losses under

such market conditions. The value of

stress testing depends on the

development and use of scenarios that

are meaningful to the unique market

positions of the reporting person.

Ensuring that scenarios are meaningful

requires the involvement of experienced

and seasoned traders and managers.

Topic 4 (Credit Risk)

The fourth topic is credit risk; that is,

the likelihood that trading

counterparties will be unwilling or

unable to perform their obligations to a

reporting person (also sometimes called

‘‘default risk’’). Credit risk is currently

the focus of widespread efforts to

develop quantitative measurement

techniques similar to those that have

been developed to measure market risk.

However, these techniques are not yet as

well developed nor are they as generally

accepted as are the market risk

measurement techniques such as valueat-risk. Accordingly, the Commission

does not propose to require any

disclosure of quantitative credit risk

information in the quarterly reports.

The Commission does believe that

other market participants will benefit

from insight into the extent to and

means by which a reporting person

monitors its credit risk exposures.

Therefore, under the proposal, each

reporting person would be required to

provide information about the basic

processes by which it evaluates the

creditworthiness of potential

counterparties, whether it employs any

of various methodologies to quantify its

credit risk exposures, whether it

monitors the concentration of its

exposures, and whether it uses credit

risk mitigation tools such as netting

agreements.

Topic 5 (Funding Liquidity Risk)

The fifth topic is funding liquidity

risk; that is, the risk that due to its

capital structure or to constraints upon

its ability to access additional external

capital a reporting person will be unable

to fund its operations or to fulfill its

trading obligations without resorting to

the unplanned liquidation of

positions.40

The Commission has concluded that

requiring a reporting person to disclose

detailed information on its access to

additional capital might impinge upon

sensitive relationships and has decided

not to propose requiring the disclosure

of quantitative information about

funding liquidity risk in the quarterly

reports. Each reporting person would,

however, be required to provide a

description of the processes by which it

monitors its funding liquidity,

determines an appropriate limit on

financial leverage, and ensures its

ability to access additional capital when

necessary.

4. Filing and Attestation

Proposed Section 4.27(e) would

provide for the filing of required reports

by mail and concurrently by e-mail. The

Commission believes that electronic

filing would expedite processing and

publication of the data filed, and that

the large, sophisticated entities that

would be required to report under this

regulation are likely to have the

facilities to file reports in this matter

without undue burden. The

Commission proposes to require

attestation of all required filings in a

manner consistent with Section 4.22(h).

5. Definitional Matters

Proposed Sections 4.27(a)(1) and (7)

refer to the definitions of commodity

pool operator and net asset value set

forth in § 4.10 of Part 4.

Section 4.27(a)(2) would define

control as the direct or indirect power

to direct or cause the direction of the

management and policies of the pool,

whether through the ownership of any

share, partnership interest or other

investment in the pool, by contract or

otherwise. This definition is modeled

after that found in regulation 12b–2

under the Securities Exchange Act of

1934, 17 CFR 240.12b–2.

Section 4.27(a)(3) would define

controlled assets as the aggregate of all

assets in one or more pools under

common control. (Investments by one

such pool in another are excluded to

avoid double counting). Section

Federal Register / Vol. 65, No. 74 / Monday, April 17, 2000 / Proposed Rules 20401

41 47 FR 18618–18621 (April 30, 1982).

42 47 FR 18619–18620 (April 30, 1982).

4.27(a)(4) would define controlled net

asset value in a similar manner.

Section 4.27(a)(5) would define

governing authority of a pool to mean

the pool’s Board of Directors, managing

member, general partner, trustee or

similar person with the legal authority

and responsibility to manage the affairs

of the pool, while section 4.27(a)(10)

would define senior management of a

reporting person as the managing

committee, group of executives, or other

body with the authority and

responsibility to direct and oversee the

trading activities of a pool controlled by

the reporting person.

Section 4.27(a)(6) would define loss

as any adverse change, realized or

unrealized, in the value of a pool’s

portfolio, as measured for risk

management purposes. This definition

focuses on losses as actually measured

by the reporting person. This

calculation excludes additions,

withdrawals, and redemptions of

capital.

Section 4.27(a)(8) would define pool

as any investment trust, syndicate or

similar form of enterprise that is

controlled by a commodity pool

operator.

Section 4.27(a)(9) would define

reporting period as each calendar

quarter; however, if all pools controlled

by the same person have a fiscal year

other than the calendar year, and all

such pools have the same fiscal year, it

shall mean each such fiscal quarter. The

latter restriction is intended to avoid

confusion in cases where multiple pools

controlled by the same person have

different fiscal years.

Section 4.27(a)(11) would define VAR

as the amount, stated in U.S. dollars,

which a pool’s losses during a stated

period (the ‘‘holding period’’) are

expected, with a stated degree of

certainty (the ‘‘confidence level’’), not to

exceed. This includes the statistical

measure, ‘‘value-at-risk,’’ currently

calculated by many market participants,

as well as any similar measure of market

risk that may be developed or used.

III. Related Matters

A. Paperwork Reduction Act

Rule 4.27 contains information

collection requirements. As required by

the Paperwork Reduction Act of 1995

(44 U.S.C. 3507(d)), the Commission has

submitted a copy of this section to the

Office of Management and Budget

(OMB) for its review.

Collection of Information

Rules Relating to the Public Reporting

by Operators of Certain Large

Commodity Pools, OMB Control

Number 3038–XXXX.

The burden associated with the

proposed new rule is estimated to be

1,125 hours which will result from new

reporting requirements for certain large

commodity pool operators (CPOs).

The estimated burden of the proposed

new rule with respect to ongoing

quarterly reports required under Section

4.27(d) of each entity that qualifies

under Section 4.27(b) was calculated for

each year in which Rule 4.27 is effective

as follows:

Estimated number of respondents: 25

Annual responses by each

respondent: 4

Total annual responses: 100

Estimated average hours per response:

5

Annual reporting burden: 500 hours

The estimated burden of the proposed

new rule with respect to the initial

report required under Section 4.27(c) of

each entity in the year in which such

entity first qualifies under Section

4.27(b) was calculated for the first year

in which Rule 4.27 is made effective as

follows:

Estimated number of respondents: 25

Annual responses by each

respondent: 1

Total annual responses: 25

Estimated average hours per response:

25

Annual reporting burden: 625 hours

Organizations and individuals

desiring to submit comments on the

information collection requirements

should direct them to the Office of

Information and Regulatory Affairs,

OMB, Room 10235 New Executive

Office Building, Washington, DC 20503,

Attention: Desk Officer for the

Commodity Futures Trading

Commission.

The Commission considers comments

by the public on this proposed

collection of information in—

• Evaluating whether the proposed

collection of information is necessary

for the proper performance of the

functions of the Commission, including

whether the information will have a

practical use;

• Evaluating the accuracy of the

Commission’s estimate of the burden of

the proposed collection of information,

including the validity of the

methodology and assumptions used;

• Enhancing the quality, usefulness,

and clarity of the information to be

collected; and

• Minimizing the burden of collection

of information on those who are to

respond, including through the use of

appropriate automated electronic,

mechanical, or other technological

collection techniques or other forms of

information technology, e.g., permitting

electronic submission of responses.

OMB is required to make a decision

concerning the collection of information

contained in these proposed regulations

between 30 and 60 days after

publication of this document in the

Federal Register. A comment to OMB is

best assured of having its full effect if

OMB receives it within 30 days of

publication. This does not affect the

deadline for the public to comment to

the Commission on the proposed

regulations.

Copies of the information collection

submission to OMB are available from

the CFTC Clearance Officer, 1155—21st

Street, NW, Washington, DC 20581,

(202) 418–5160.

B. Regulatory Flexibility Act

The Regulatory Flexibility Act

(‘‘RFA’’), 5 U.S.C. 601–611, requires that

agencies, in proposing regulations,

consider the impact of those regulations

on small businesses. The Commission

has previously established certain

definitions of ‘‘small entities’’ to be used

by the Commission in evaluating the

impact of its regulations on such entities

in accordance with the RFA.41 The

Commission has previously determined

that FCMs and CPOs are not small

entities for the purpose of the RFA.42

Moreover, the regulations that are the

subject of the present rulemaking apply,

by their terms, only to extraordinarily

large entities. The Chairman, on behalf

of the Commission hereby certifies,

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

proposed regulations will not have a

significant economic impact on a

substantial number of small entities.

Nonetheless, the Commission

specifically requests comment on the

impact these proposed regulations

might have on small entities.

List of Subjects in 17 CFR Part 4

Advertising, Commodity futures,

Commodity interest, Commodity pool

operators, Consumer protection.

In consideration of the foregoing and

pursuant to the authority contained in

the Commodity Exchange Act and, in

particular, section 1a(4), 4l, 4m, 4n, and

8a, 7 U.S.C. 1a(4), 6l, 6m, 6n, and 12a,

the Commission hereby proposes to

amend Chapter I of the Code of Federal

Regulations as follows:

PART 4—COMMODITY POOL

OPERATORS AND COMMODITY

TRADING ADVISORS

1. The authority citation for Part 4

continues to read as follows:

20402 Federal Register / Vol. 65, No. 74 / Monday, April 17, 2000 / Proposed Rules

Authority: 7 U.S.C. 1a.2, 4, 6b, 6c, 6l, 6m,

6n, 6o, 12a and 23.

2. A new § 4.27 is proposed to be

added to subpart B to read as follows:

§ 4.27 Public reporting by operators of

certain large commodity pools.

(a) General definitions. For the

purposes of this section:

(1) Commodity pool operator or CPO

has the same meaning as ‘‘commodity

pool operator’’ defined in section 1a(4)

of the Commodity Exchange Act;

(2) Control means the possession,

direct or indirect, of the power to direct

or cause the direction of the

management and policies of a person,

whether through the ownership of

voting securities, by contract, or

otherwise;

(3) Controlled assets means the sum of

all assets in all pools controlled by the

same person, exclusive of any interest

that any pool controlled by such person

may have in any other pool controlled

by such person;

(4) Controlled net asset value or

CNAV means the sum of the net asset

values for all pools controlled by the

same person, exclusive of any interest

that any pool controlled by such person

may have in any other pool controlled

by such person;

(5) Governing authority means a

pool’s Board of Directors, managing

member, general partner, trustee or

similar person with the legal authority

and responsibility to manage the affairs

of the pool;

(6) Loss means any adverse change,

realized or unrealized, in the value of a

pool’s portfolio, as measured for risk

management purposes. This calculation

excludes any additions, withdrawals, or

redemptions of capital;

(7) Net asset value or NAV has the

same meaning as ‘‘net asset value’’ as

defined in § 4.10(b);

(8) Pool means any investment trust,

syndicate or similar form of enterprise

that is controlled by a commodity pool

operator;

(9) Reporting period means either:

(i) Each quarter ending March 31,

June 30, September 30, or December 31,

or

(ii) In the case of a reporting person

controlling one or more pools of which

each has the same fiscal year that is not

the calendar year, each quarter of such

fiscal year for such pool(s);

(10) Senior management means the

managing committee, group of

executives, or other body of a reporting

person with the authority and

responsibility to direct and oversee the

trading activities of a pool controlled by

such reporting person; and

(11) VAR means the amount, stated in

U.S. dollars, which a pool’s losses

during a stated period (the ‘‘holding

period’’) are expected, with a stated

degree of certainty (the ‘‘confidence

level’’), not to exceed.

(b) Persons required to report. (1) A

reporting person is any commodity pool

operator that:

(i) Controls one or more pools where,

as of the last business day of a reporting

period,

(A) The controlled assets of such pool

or pools are equal to or greater than

three billion dollars ($3,000,000,000); or

(B) The controlled net asset value of

such pool or pools is equal to or greater

than one billion dollars

($1,000,000,000); or

(ii) That qualified as a reporting

person pursuant to this paragraph (b)(1)

as of the last business day of any of the

prior three reporting periods.

(2) For purposes of calculations

pursuant to this paragraph (b), all

amounts shall be converted to U.S.

dollars at the rate in effect on the date

for which such report is made.

(c) Initial reporting. Each reporting

person shall file with the Commission,

not later than 30 days after the end of

the first reporting period during which

such reporting person satisfies the

requirements of paragraph (b) of this

section, a report with respect to each

pool under its control and each such

report shall contain the name and

address of the reporting person, the

name of the pool with respect to which

the report is being filed, and the

following information:

(1) A narrative description of the

strategic approach taken toward the

management of market, credit, and

funding liquidity risk exposures,

including:

(i) The process by which the pool’s

governing authority sets standards for

appropriate risk taking,

(ii) The structure, autonomy, and

authority of the risk monitoring

function,

(iii) The types of tests and tools used

to control risk taking in trading and

investment activities, and

(iv) The extent and frequency of risk

information routinely provided to the

governing authority and senior

management;

(2) A narrative description of the

technique (such as value-at-risk) used to

measure, monitor, and manage the

exposure of the pool to market risk,

including discussions of, as applicable:

(i) Methodology (for example,

historic, parametric, Monte Carlo, or

quasi Monte Carlo),

(ii) Confidence levels and holding

periods,

(iii) The evaluation of correlations

within and among markets,

(iv) How the position liquidity of

portfolios is monitored,

(v) How non-normally distributed

data is handled,

(vi) Whether historic data is weighted,

(vii) How models are backtested or

otherwise validated, and

(viii) How often models are tested by

an external auditor;

(3) A narrative description of the use

of stress tests to determine the

magnitude of potential losses in excess

of VAR, including discussions of:

(i) The methodologies used (for

example, historic events, hypothetical

scenarios, or matrix analysis),

(ii) Stress factors examined,

(iii) The extent of senior

management’s involvement with the

design and construction of stress tests,

(iv) The extent to which stress test

results are communicated to the

governing authority and to senior

management, and

(v) The policies established with

respect to actions that management

should take in response to results

deemed incompatible with its risk

appetite;

(4) A narrative description of the

measurement, monitoring, and

management of the pool’s exposure to

credit risk, including:

(i) How the creditworthiness of

individual counterparties is evaluated,

(ii) Whether value-at-risk-style

techniques for quantifying credit risk

are utilized,

(iii) How the concentration of

exposures to particular counterparties

and sectors is monitored, and

(iv) Whether netting agreements and

other credit risk mitigation tools are

employed; and

(5) A narrative description of the

measurement, monitoring, and

management of the pool’s exposure to

funding liquidity risk, including:

(i) The approach taken toward

managing financial leverage,

(ii) How the level of liquid reserves is

determined, and

(iii) The extent of the authority, if any,

to:

(A) Restrict withdrawals of capital or

other redemptions of interests in the

pool or repayments of subordinated

debt,

(B) Compel additional contributions

of capital, and

(C) Access committed lines of credit.

(6) If any tests, analyses, or practices

discussed in paragraphs (c)(1) through

(5) of this section are not performed, the

reporting person should so state

separately with respect to each item.

(d) Quarterly reporting. Each

reporting person shall file with the

Commission, not later than 30 days after

Federal Register / Vol. 65, No. 74 / Monday, April 17, 2000 / Proposed Rules 20403

the end of each reporting period, a

report with respect to each pool under

its control. Each such report shall

contain the name and address of the

reporting person, the name of the pool

with respect to which the report is being

filed, and the following information:

(1) Financial information:

(i) A statement of financial condition

as of the end of the reporting period;

(ii) A statement of income or loss for

the reporting period;

(iii) A statement of changes in

financial position for the reporting

period; and

(iv) A statement of changes in net

asset value over the reporting period

which shall be prepared in accordance

with § 4.22(a)(2).

(2) Risk information:

(i) The highest, lowest, and last VAR

for the pool during the reporting period

at each confidence level and holding

period for which it was calculated by

the reporting person; provided that VAR

calculated for confidence intervals in

excess of 99.6% need not be reported;

(ii) (A) For each holding period for

which the reporting person calculated

VAR, the number of occasions, if any,

on which losses exceeded the

corresponding VAR calculated for that

holding period at the greatest

confidence interval, not in excess of

99.6%, for which VAR was calculated

by the reporting person and

(B) The dollar amount of the greatest

loss during the reporting period,

whether or not it exceeded the

corresponding VAR;

(iii) A brief discussion of whether,

during the quarter, stress tests were

performed with respect to the pool’s

positions and, if so, whether the results

thereof were reported to senior

management and the governing

authority; and

(iv) Any additional information which

the reporting person wishes to present

to supplement the information in

paragraph (d)(2) of this section.

(3) Changes in risk management

practices: If, for any pool controlled by

the reporting person, there is any

material change to the information

provided pursuant to paragraph (c) of

this section, as modified by previous

submissions pursuant to this paragraph

(d)(3) concerning that pool, the

reporting person shall submit a revised

set of responses pursuant to paragraph

(c) of this section.

(4) All financial information shall be

reported in accordance with generally

accepted accounting principles

consistently applied.

(e) Filing requirements. Each report

required to be filed with the

Commission under this section shall:

(1) Be signed in accordance with the

requirements of § 4.22(h); and

(2) Be sent via first-class mail, postage

prepaid, to: Commodity Futures Trading

Commission, Three Lafayette Centre,

1155—21st Street, NW., Washington, DC

20581, Attention: Managed Funds

Branch, and by attachment to an e-mail

message addressed and sent to

hfreport@cftc.gov with electronic

confirmation of delivery activated.

(3) Copies of reports shall be retained

in accordance with § 1.31.

(f) Public records. Reports filed

pursuant to this section shall be

considered Public Records as defined in

§ 145.0 of this chapter.

* * * * *

Issued in Washington, DC, on April 11,

2000 by the Commission.

Jean A. Webb,

Secretary of the Commission,

Dissenting Remarks of Commissioner

Barbara Pedersen Holum, Proposed Rule

4.27;Reporting by Operators of Certain Large

Commodity Pools

In April 1999, the President’s Working

Group on Financial Markets issued a report

entitled ‘‘Hedge Funds, Leverage, and the

Lessons of Long-Term Capital Management’’

(the ‘‘PWG Report’’). Among other things, the

PWG Report recommended (i) that registered

CPOs operating large funds begin filing with

the Commission quarterly, (ii) that the

reports include more comprehensive

information on market risk, and (iii) that

information in the reports be published.

These recommendations respond to events

occurring twenty months ago. However,

market developments since then call into

question whether a specific prescriptive rule,

such as proposed Rule 4.27, is the

appropriate response at this time.

In my judgement, and in light of the

recommendations of the CFTC staff task force

report entitled ‘‘A New Regulatory

Framework,’’ the Commission should seek

comment on whether the specific

recommendations of the PWG Report remain

current and, if so, how best to achieve them.

For these reasons, I respectfully dissent from

the Commission’s issuance of proposed Rule

4.27.

Commissioner Barbara Pedersen Holum

Date: April 7, 2000.

Concurring Statement of Commissioner

Erickson

I concur with the Commission’s

publication of the proposed rules that would

require commodity pool operators (CPOs) of

the largest commodity pools to file quarterly

reports with the Commission. Given that the

proposed rules are intended to respond to the

events surrounding the near-collapse of

Long-Term Capital Management (LTCM),

comments from the public and especially

from the industry will be instructive in the

Commission’s efforts to craft an approach

that is indeed effective. In addition to

comments limited to the proposed rule, I am

interested in comments that will inform the

Commission about how the industry has

addressed the potential risks posed by certain

highly leveraged institutions since the LTCM

episode. Moreover, I encourage the

submission of comments that provide input

on the following issues:

1. The proposed rules envision a reporting

system whereby the Commission is

essentially a conduit for the public

dissemination of quarterly reports without

any further review by any federal financial

regulator. Is publication alone sufficient?

2. It is not clear that reporting on a

quarterly basis would have been sufficient to

address the events precipitating the private

rescue of LTCM. Assuming that reporting

alone is an adequate response, would

quarterly reporting be effective?

3. The April 1999 report of the President’s

Working Group on Financial Markets

concluded that the ‘‘central public policy

issue raised by the LTCM episode is how to

constrain excessive leverage more

effectively.’’ One possible way to address

leverage concerns would be to require CPOs

to provide the Commission with a

confidential early warning notification

structured similar to the Commission’s

existing notification requirement with

respect to net capital requirements for futures

commission merchants. Such an approach

may address publicly expressed concerns

about the quantity and quality of the

information available to federal financial

regulators in the weeks preceding LTCM.

What are the public policy implications of

such an approach—either in addition to or in

lieu of quarterly reports?

[FR Doc. 00–9463 Filed 4–14–00; 8:45 am]

BILLING CODE 6351–01–P

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG–116048–99]

RIN 1545–AX63

Stock Transfer Rules: Supplemental

Rules; Hearing Cancellation

AGENCY: Internal Revenue Service (IRS),

Treasury.

ACTION: Cancellation of notice of public

hearing on proposed rulemaking.

SUMMARY: This document provides

notice of cancellation of a public

hearing on proposed regulations relating

to supplemental rules for stock

transfers.

DATES: The public hearing originally

scheduled for Thursday, April 20, 2000,

at 10 a.m., is canceled.

FOR FURTHER INFORMATION CONTACT: Guy

Traynor of the Regulations Unit,

Assistant Chief Counsel (Corporate),

(202) 622–7180 (not a toll-free number).

SUPPLEMENTARY INFORMATION: A notice

of proposed rulemaking and notice of