[Federal Register Volume 66, Number 93 (Monday, May 14, 2001)]
[Proposed Rules]
[Pages 24308-24315]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 01-12084]


=======================================================================
-----------------------------------------------------------------------

COMMODITY FUTURES TRADING COMMISSION

17 CFR Part 39

RIN 3038-AB66


A New Regulatory Framework for Clearing Organizations

AGENCY: Commodity Futures Trading Commission.

ACTION: Proposed rulemaking.

-----------------------------------------------------------------------

SUMMARY: The Commodity Futures Trading Commission (Commission or CFTC) 
is proposing rules to implement various provisions of the Commodity 
Futures Modernization Act of 2000 (``CFMA''), which fundamentally 
alters the regulation of derivatives clearing organizations. These 
proposed rules apply to derivatives clearing organizations that are, 
are required to, or seek to become registered with the Commission and 
implement the statutory framework in the CFMA governing those entities.

DATES: Comments must be received by June 13, 2001.

ADDRESSES: Comments should be sent to the Commodity Futures Trading 
Commission, Three Lafayette Centre, 1155 21st Street, N.W., Washington, 
D.C. 20581, attention: Office of the Secretariat. Comments may be sent 
by facsimile transmission to (202) 418-5521 or, by e-mail to 
<a href="/cdn-cgi/l/email-protection#9eedfbfdecfbeaffece7defdf8eafdb0f9f1e8"><span class="__cf_email__" data-cfemail="ee9d8b8d9c8b9a8f9c97ae8d889a8dc0898198">[email protected]</span></a>. Reference should be made to ``Clearing 
Organizations.''

FOR FURTHER INFORMATION CONTACT: Alan L. Seifert, Deputy Director, 
Division of Trading and Markets, Lois J. Gregory, Special Counsel, or 
David P. Van Wagner, Associate Director, Division of Trading and 
Markets, Commodity Futures Trading Commission, Three Lafayette Centre, 
1155 21st Street, N.W., Washington, D.C. 20581. Telephone (202) 418-
5260 or e-mail <a href="/cdn-cgi/l/email-protection#763725131f10130402361510021558111900"><span class="__cf_email__" data-cfemail="99d8cafcf0fffcebedd9faffedfab7fef6ef">[email protected]</span></a>., <a href="/cdn-cgi/l/email-protection#39757e4b5c5e564b40795a5f4d5a175e564f"><span class="__cf_email__" data-cfemail="ade1eadfc8cac2dfd4edcecbd9ce83cac2db">[email protected]</span></a>, or 
<a href="/cdn-cgi/l/email-protection#d89c8eb9b68fb9bfb6bdaa98bbbeacbbf6bfb7ae"><span class="__cf_email__" data-cfemail="d39785b2bd84b2b4bdb6a193b0b5a7b0fdb4bca5">[email protected]</span></a>.

SUPPLEMENTARY INFORMATION:

I. Background

    Congress on December 15, 2000, passed, and the President on 
December 21, 2000, signed into law, the CFMA,\1\ which substantially 
amended the Commodity Exchange Act, 7 U.S.C. 1 et seq. (``Act''). New 
Section 5b(a) of the Act, added by the CFMA, requires that contracts of 
sale of a commodity for future delivery, options on such contracts, and 
options on a commodity be cleared only by a derivatives clearing 
organization (``DCO'') registered with the Commission,\2\ unless the 
contracts are: (i) Excluded under the Act, (ii) exempted under the Act, 
or (iii) security futures products cleared by a securities clearing 
agency. Contracts traded on a designated contract market, if cleared, 
must be cleared by a DCO.\3\ Excluded or exempted contracts, including 
those elected pursuant to section 5a(g) to be traded on a registered 
derivatives transaction execution facility, are not required to be 
cleared by a DCO, although a clearing organization that clears these 
contracts may voluntarily apply, pursuant to section 5b(b), to register 
with the Commission as a DCO.\4\ In addition, a DCO may clear other 
contracts, agreements, or transactions, including, but not limited to, 
certain over-the-counter (``OTC'') derivative instruments referenced in 
section 5b(b) of the Act and transactions in spot and forward 
contracts.\5\
---------------------------------------------------------------------------

    \1\ See Commodity Futures Modernization Act of 2000, Appendix E 
of Pub. L. 106-554, 114 Stat. 2763 (2000).
    \2\ For purposes of this release, use of the term ``derivatives 
clearing organization'' means an applicant seeking registration as a 
DCO, or a DCO registered or required to be registered, with the 
Commission pursuant to section 5b of the Act.
    \3\ The Commission will consider, however, under the exemptive 
authority provided by section 4(c) of the Act, requests to clear 
transactions through alternative means.
    \4\ Thus, under the CFMA, DCOs are treated as entities that are 
separate and distinct from the markets for which they provide 
clearing services.
    \5\ Under section 409 of the Federal Deposit Insurance 
Corporation Act of 1991, as amended by section 112 of the CFMA, OTC 
derivatives also may be cleared by a multilateral clearing 
organization supervised by federal banking authorities, a clearing 
agency registered under the Securities Exchange Act of 1934, or a 
clearing organization supervised by a foreign financial regulator 
that satisfies appropriate standards as determined by the 
Comptroller of the Currency, the Board of Governors of the Federal 
Reserve System, the Federal Deposit Insurance Corporation, the 
Securities and Exchange Commission, or the CFTC. This approach to 
clearing is consistent with the Report of the President's Working 
Group on Financial Markets (``PWG''), which encouraged the 
development of clearing systems for OTC derivatives to reduce 
systemic risk. See Over-the-Counter Derivatives Markets and the 
Commodity Exchange Act, Report of the PWG (Nov. 1999). The 
Commission believes that appropriate standards referred to above 
include regulating and overseeing the organization pursuant to 
principles comparable to the core principles set forth in section 5b 
of the Act and a requirement to participate in appropriate and 
adequate information sharing arrangements.
---------------------------------------------------------------------------

    To be registered as a DCO, an applicant must demonstrate that it 
complies with fourteen core principles set forth in the CFMA. Section 
5b requires any person desiring to so register to submit to the 
Commission an application in such form and containing such information 
as the Commission may require for the purpose of determining whether 
the applicant meets the core principles.
    The Commission is now proposing rules to implement section 5b of 
the Act. This proposal follows the Commission's proposal of regulations 
to implement the CFMA's provisions governing trading facilities, which 
was published for comment on March 9, 2001.\6\ Part 39 would stipulate 
the form and provide guidance for the content of applications for DCO 
registration, as well as procedures for processing such applications. 
Other provisions would assist the Commission in carrying out its 
oversight responsibilities with respect to the operations and 
activities of DCOs, enforcing compliance by DCOs with the core 
principles and other provisions of the Act and regulations, protecting 
clearing participants from fraud, and ensuring the enforceability of 
contracts cleared on DCOs. Part 39 does not apply to the execution of 
transactions cleared by DCOs; its provisions apply specifically and 
only to the clearing of transactions by DCOs.\7\
---------------------------------------------------------------------------

    \6\ 66 FR 14262. That release, when it is published as a final 
rulemaking, will be conformed to this release insofar as this 
release clarifies the application of the DCO-related provisions of 
the CFMA.
    \7\ Section 1a(9) of the Act defines the term DCO to encompass 
entities that, ``with respect to an agreement, contract, or 
transaction--(i) enables each party to the agreement * * * to 
substitute, through novation or otherwise, the credit of the [DCO] 
for the credit of the parties; (ii) arranges or provides, on a 
multilateral basis, for the settlement or netting of obligations 
resulting from such agreements * * * executed by participants in the 
[DCO]; or (iii) otherwise provides clearing services or arrangements 
that mutualize or transfer among participants in the [DCO] the 
credit risk arising from such agreements * * * executed by the 
participants.''
---------------------------------------------------------------------------

II. Proposed Part 39

A. Application and Approval Procedures

    Proposed part 39 would apply to any DCO, as defined under section 
1a(9) of the Act,\8\ that is registered with the

[[Page 24309]]

Commission, is required to become so registered, or which voluntarily 
seeks to become so registered. If certain conditions were met, an 
organization would be deemed to be registered with the Commission as a 
DCO under part 39 or, as determined by Commission order, registered 
upon conditions, sixty days after receipt by the Commission of an 
application for registration, unless notified otherwise.\9\ This would 
include submission of the applicant's rules, a demonstration that the 
applicant satisfies the core principles of the Act, submission of any 
agreements with third parties that enable the applicant to meet one or 
more of the core principles, and descriptions of any system test 
procedures and results.
---------------------------------------------------------------------------

    \8\ The CFMA's definition of DCO does not necessitate the 
performance of a direct credit enhancement function. See section 
1a(9)(ii). Thus, the provision of certain settlement or netting 
services in the absence of direct credit enhancement would generally 
meet the definition of a DCO. An organization that intends to 
provide settlement or other clearing-type services to a designated 
contract market without accompanying credit enhancement must still 
demonstrate compliance with all section 5b core principles to obtain 
unconditional registration as a DCO. Otherwise, the Commission may 
grant DCO registration with conditions when and as appropriate.
    \9\ The Act does not include an express time limit for 
Commission consideration of applications to become registered DCOs.
---------------------------------------------------------------------------

    Appendix A to part 39 would provide guidance that applicants could 
use to meet the core principles. The CFMA provides that an applicant 
shall have reasonable discretion in establishing the manner in which it 
complies with the core principles. The guidance in proposed Appendix A 
is intended merely to illustrate the manner in which a clearing 
organization may meet a core principle and is not intended to be a 
mandatory checklist.
    If an applicant did not meet registration requirements, Commission 
staff would inform the applicant of the shortcomings and notify it that 
the Commission was terminating review under part 39 and would continue 
review of its application under section 6 of the Act. Within ten days 
of being notified, the applicant could ask the Commission to either 
register it or commence registration denial proceedings. An applicant 
also could withdraw its application.
    An applicant may request that the Commission approve any of its 
rules. If an applicant requests approval of one or more of its rules, 
it would be required to do so pursuant to the applicable provisions of 
proposed Sec. 40.5 in proposed part 40 governing the procedures and 
timeframes for rule approval.\10\ An applicant may request approval of 
one or more of its rules at the time it makes its initial application 
or thereafter. In accordance with new section 5b(c)(3) of the Act, an 
applicant also may request that the Commission issue an order 
concerning whether a rule or practice of the applicant is the least 
anticompetitive means of achieving the objectives, purposes, and 
policies of the Act. In considering any requests for such orders, the 
Commission intends to apply section 15(b) of the Act in a manner 
consistent with its previous application of section 15(b) to contract 
markets.
---------------------------------------------------------------------------

    \10\ 66 FR 14262 (March 9, 2001).
---------------------------------------------------------------------------

B. Existing Derivatives Clearing Organizations

    New section 5b(d) of the Act provides that existing DCOs shall be 
deemed to be registered with the Commission to the extent that the DCO 
clears agreements, contracts, or transactions for a board of trade that 
has been designated by the Commission as a contract market for such 
agreements, contracts, or transactions prior to enactment of the CFMA. 
This provision captures all futures clearing organizations regulated by 
the Commission that have ever cleared any futures contracts for 
designated contract markets prior to December 21, 2000, the effective 
date of the CFMA. This language does not capture any organization 
approved to clear futures in connection with a pre-CFMA contract market 
designation which has not yet cleared any contracts.\11\ However, since 
review and approval of such an organization took place pursuant to 
criteria comparable to that contained in the fourteen core principles 
set forth in the amended Act, the Commission clarifies that any such 
organization will be deemed by the Commission to be registered with the 
Commission as a DCO upon receipt by the Commission of a certification 
that the organization currently meets and will continue to meet the 
core principles and all applicable requirements of the Act and 
Commission regulations.
---------------------------------------------------------------------------

    \11\ This includes one organization, namely, FutureCom Commodity 
Exchange, Ltd.
---------------------------------------------------------------------------

C. Derivatives Clearing Organizations

    Under proposed part 39, a DCO and the clearing of transactions on a 
DCO are exempt from all Commission regulations except for proposed 
parts 39 and 40, and certain select regulations relating to, for 
example, the segregation of customer funds and recordkeeping.\12\ To 
maintain registration as a DCO, part 39 would require DCOs to remain in 
compliance at all times with the core principles. The Commission could 
ask a DCO to submit in writing at any time, any information that the 
Commission deemed necessary to demonstrate that the DCO is in 
compliance with one or more of the core principles.\13\ The guidance in 
Appendix A with respect to applicants may be used by registrants as 
well, for guidance on ongoing compliance with the core principles. A 
DCO may request that the Commission approve any of its rules either 
prior to or after implementation of the rule(s).\14\ Such requests 
would be handled under the applicable procedures of proposed part 40. 
Any new or amended rule not voluntarily submitted to the Commission for 
approval must be submitted with a certification that the new rule or 
amendment complies with the Act, pursuant to applicable procedures of 
proposed part 40. As noted above, a DCO also may request that the 
Commission issue an order concerning whether a rule or practice of the 
applicant is the least anticompetitive means of achieving the 
objectives, purposes, and policies of the Act. The Commission intends 
to apply section 15(b) of the Act in a manner consistent with its 
previous application of section 15(b) to contract markets.
---------------------------------------------------------------------------

    \12\ Commission Regulation 1.31 is reserved in part 39. 
Regulation 1.31 was updated and amended by the Commission in 1999 so 
as to provide broad, flexible performance standards for 
recordkeeping. In addition, Regulation 1.31 is substantially similar 
to the recordkeeping requirements maintained by the Securities and 
Exchange Commission. Pursuant to the guidance provided in the 
appendix to part 39, a DCO's recordkeeping has to satisfy the 
performance standards in Regulation 1.31.
    \13\ Section 5c(d) of the Act provides a mechanism for notifying 
DCOs (and other registered entities) that they are violating a core 
principle. The request for a demonstration of compliance operates 
independently of the section 5c(d) procedure. Indeed, the request 
for such a demonstration from a registered entity, and the 
Commission's consideration of the entity's response may constitute a 
useful alternative to the more formal procedures of section 5c(d) of 
the Act. It would be the Commission's intent to explore such 
informal methods of resolving issues of compliance with core 
principles by DCOs prior to invoking more formal mechanisms.
    \14\ The Act limits a registered entity seeking approval to 
request approval only ``prior'' to implementation. Thus, the 
Commission is proposing to use its section 4(c) exemptive authority 
with respect to this provision. The Commission believes that this 
exercise of exemptive authority should provide DCOs with greater 
procedural flexibility and would be consistent with the public 
interest.
---------------------------------------------------------------------------

    In addition to the information requests relevant to demonstrating 
compliance with core principles, proposed rule 39.5 requires that large 
trader information be provided to the Commission by futures commission 
merchants, clearing members and foreign brokers. This requirement 
complements the rules relating to large trader position reports for 
transaction execution facilities. The Commission has also proposed 
special call authority parallel to that proposed for transaction 
execution facilities.
    Proposed part 39 also contains an antifraud provision. This 
provision

[[Page 24310]]

would be specifically limited to prohibit fraudulent actions by persons 
in or in connection with the clearing of transactions on a DCO. Part 
39's antifraud provision is proposed pursuant to the authority provided 
by section 8a(5) of the Act to make such rules, as in the judgment of 
the Commission, are reasonably necessary to effectuate the provisions 
of the Act. Section 5b of the Act grants new authority to the 
Commission to regulate DCOs, which is separate from the authority to 
regulate the trading facilities for which they clear. In this context, 
the proposed antifraud provision is necessary to address fraud in or in 
connection with clearing, which might not be covered by any other 
antifraud provision or by one of the core principles. As is the case 
with the other provisions of part 39, the antifraud rule would apply 
specifically and only to the activity of clearing.
    Proposed part 39 would not interfere with the enforceability of 
contracts cleared on DCOs. It provides that a contract or transaction 
cleared pursuant to the rules of a DCO shall not be void, voidable, 
subject to rescission, or otherwise invalidated or rendered 
unenforceable as a result of a violation by the DCO of the provisions 
of section 5b of the Act or part 39, or as a result of any Commission 
proceeding to alter, supplement, or require the DCO to adopt a specific 
rule or procedure or refrain from taking a specific action.

III. Section 4(c) Findings

    One of the provisions of the proposal contained in this Federal 
Register notice is being proposed under section 4(c) of the Act, which 
grants the Commission broad exemptive authority. Section 4(c) of the 
Act provides that, in order to promote responsible economic or 
financial innovation and fair competition, the Commission may by rule, 
regulation or order exempt any class of agreements, contracts, or 
transactions, either unconditionally or on stated terms or conditions, 
from any of the requirements of any provision of the Act (except 
certain provisions governing a group or index of securities and 
security futures products). As relevant here, when granting an 
exemption pursuant to section 4(c), the Commission must find that the 
exemption would be consistent with the public interest.
    The Commission is proposing to use its section 4(c) exemptive 
authority here to provide registered entities with greater procedural 
flexibility than is contained in the Act. Pursuant to proposed rule 
39.4, a DCO may request that the Commission approve its rules or rule 
amendments prior to their implementation or any time thereafter, 
notwithstanding the Act's limitation on registered entities seeking 
approval to do so only prior to implementation. The Commission believes 
that this exercise of exemptive authority should provide DCOs with 
greater procedural flexibility and would be consistent with the public 
interest.

IV. Cost-Benefit Analysis

    Section 15 of the Act, as amended by section 119 of the CFMA, 
requires the Commission to consider the costs and benefits of its 
action before issuing a new regulation under the Act. The Commission is 
applying the cost-benefit provisions of section 15 in this rulemaking 
and understands that, by its terms, section 15 as amended does not 
require the Commission to quantify the costs and benefits of a new 
regulation or to determine whether the benefits of the proposed 
regulation outweigh its costs. Rather, section 15 simply requires the 
Commission to ``consider the costs and benefits'' of its action.
    The amended section 15 further specifies that costs and benefits 
shall be evaluated in light of five broad areas of market and public 
concern: protection of market participants and the public; efficiency, 
competitiveness, and financial integrity of futures markets; price 
discovery; sound risk management practices; and other public interest 
considerations. Accordingly, the Commission could, in its discretion, 
give greater weight to any one of the five enumerated areas of concern 
and could in its discretion determine, that, notwithstanding its costs, 
a particular rule was necessary or appropriate to protect the public 
interest or to effectuate any of the provisions or to accomplish any of 
the purposes of the Act.
    Part 39 is part of a package of related rule provisions 
implementing the CFMA. The Commission has considered the costs and 
benefits of proposed part 39 and the costs and benefits of the related 
rule provisions. Significantly, part 39 would limit the period of time 
for Commission review of DCO applications to 60 days, thereby providing 
the important benefit of an expedited review, even though the Act does 
not specify any time limit for review of DCO applications. The rules 
also provide the benefit of substantial additional, non-binding 
guidance to DCO applicants and DCOs as to how they may comply with the 
statutory core principles. The rules only impose reporting, 
recordkeeping and other informational requirements on DCOs that either 
are mandated by or carry out, or are fully consistent with the new 
provisions of the CFMA concerning DCOs.
    The Commission has considered the costs and benefits of this rule 
package in light of the specific areas of concern identified in the 
CFMA. The rules would impose limited costs on the entities in requiring 
them to gather, compile, and submit certain information that the 
Commission needs in order to perform its function of overseeing futures 
and clearing and enforcing compliance by DCOs with the provisions of 
the Act. The proposed rules would not increase costs related to market 
competitiveness and would not affect the price discovery function of 
markets. The Commission believes that part 39's antifraud provision 
would benefit market participants and the public interest by deterring 
illegal behavior and that its enforceability provision would benefit 
the public interest by furthering legal certainty.
    After considering these factors, the Commission has determined to 
propose part 39. Commenters are invited to submit any data that they 
may have quantifying the costs and benefits of the proposed rules.

V. Implementation

    The provisions of the Act governing DCOs contained in the CFMA 
became effective on December 21, 2000, the same date that the CFMA was 
signed into law. In light of the need to promulgate implementing 
regulations without delay, the Commission encourages commenters to 
submit their comments on the proposed rulemaking as early as possible 
during the comment period, but in any event, by the end of the comment 
period. The Commission believes at this time that any extension of the 
comment period would be contrary to the public interest. The Commission 
will not bring any enforcement action against any person who complies 
with the rules proposed herein. Persons who do comply with the proposed 
rules, however, will be required to bring their conduct into compliance 
with the final rules to the extent that the final rules differ from the 
proposed rules.

VI. Related Matters

A. Regulatory Flexibility Act

    The Regulatory Flexibility Act (``RFA''), 5 U.S.C. 601-612, 
requires that agencies, in proposing regulations, consider the impact 
of those regulations on small entities. The rules adopted herein would 
affect DCOs. The Commission has previously established certain 
definitions of ``small entities'' to

[[Page 24311]]

be used by the Commission in evaluating the impact of its rules on such 
entities in accordance with the RFA.\15\ In its previous 
determinations, the Commission has concluded that contract markets are 
not small entities for the purpose of the RFA.\16\ DCOs clear contracts 
executed on contract markets and other trading facilities. DCOs, as 
defined in the CFMA, should not be considered small entities. 
Accordingly, the Commission does not expect the rules, as proposed 
herein, to have a significant economic impact on a substantial number 
of small entities. Therefore, the Acting Chairman, on behalf of the 
Commission, hereby certifies, pursuant to 5 U.S.C. 605(b), that the 
proposed amendments will not have a significant economic impact on a 
substantial number of small entities. The Commission invites the public 
to comment on whether DCOs covered by these rules should be considered 
small entities for purposes of the RFA.
---------------------------------------------------------------------------

    \15\ 47 FR 18618 (April 30, 1982).
    \16\ 47 FR 18618, 18619 (discussing contract markets).
---------------------------------------------------------------------------

B. Paperwork Reduction Act

    Part 39 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 part to the Office of 
Management and Budget (``OMB'') for its review.

    Collection of Information: Clearing Organizations, OMB Control 
Number 3038-0051.

    The proposed rules will not change the burden previously approved 
by OMB. The burden associated with the proposed new rules is estimated 
to be 2,000 hours that will result from new submission requirements for 
first-time applicants for registration as DCOs. The estimated burden of 
the new part 39 was calculated as follows:
    Estimated number of respondents: 10.
    Reports annually by each respondent: 1.
    Total annual responses: 10.
    Estimated Average number of hours per response: 200.
    Annual burden in fiscal year: 2,000.
    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 10202 New Executive 
Office Building, 725 17th Street, NW., 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:
    <bullet> 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;
    <bullet> 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;
    <bullet> Enhancing the quality, usefulness, and clarity of the 
information to be collected; and
    <bullet> 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.

List of Subjects in 17 CFR Part 39

    Commodity futures, Consumer protection.
    In consideration of the foregoing, and pursuant to the authority 
contained in section 7b of title 7 of the U.S.C., as added by the 
Commodity Futures Modernization Act of 2000, Appendix E of Pub. L. 106-
554, 114 Stat. 2763 (2000), the Commission proposes to amend Chapter I 
of Title 17 of the Code of Federal Regulations by adding part 39 to 
read as follows:

PART 39--DERIVATIVES CLEARING ORGANIZATIONS

Sec.
39.1   Scope.
39.2   Exemption.
39.3   Procedures for registration.
39.4   Procedures for implementing derivatives clearing organization 
rules.
39.5   Information relating to derivatives clearing organization 
operations.
39.6   Enforceability.
39.7   Fraud in connection with the clearing of transactions on a 
derivatives clearing organization.
Appendix A to Part 39--Application Guidance and Compliance With Core 
Principles

    Authority: 7 U.S.C. 7b as added by the Commodity Futures 
Modernization Act of 2000, Appendix E of Pub. L. 106-554, 114 Stat. 
2763 (2000).


Sec. 39.1  Scope.

    The provisions of this part apply to any derivatives clearing 
organization as defined under section 1a(9) of the Act which is 
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.


Sec. 39.2  Exemption.

    A derivatives clearing organization and the clearing of agreements, 
contracts and transactions on a derivatives clearing organization are 
exempt from all Commission regulations except for the requirements of 
this part 39 and Secs. 1.12(f)(1), 1.3, 1.20, 1.24, 1.25, 1.26, 1.27, 
1.29, 1.31, 1.36, 1.38, 33.10, part 40 and part 190 of this chapter, 
and as applicable to the agreement, contract or transaction cleared, 
parts 15 through 18 of this chapter, which are applicable to a 
derivatives clearing organization and its activities as though they 
were set forth in this section and included specific reference to 
derivatives clearing organizations.


Sec. 39.3  Procedures for registration.

    (a) Registration by application. An organization shall be deemed to 
be registered as a derivatives clearing organization sixty days after 
receipt by the Commission of an application for registration as a 
derivatives clearing organization unless notified otherwise during that 
period, or, as determined by Commission order, registered upon 
conditions, if:
    (1) The application is labeled as being submitted pursuant to this 
part 39;
    (2) The applicant meets the definition of derivatives clearing 
organization contained in section 1a(9) of the Act;
    (3) The application includes a copy of the applicant's rules;
    (4) To the extent it is not self evident from the applicant's 
rules, the application demonstrates how the applicant satisfies each of 
the core principles specified in section 5b(c)(2) of the Act;
    (5) The applicant submits any agreements entered into or to be 
entered into between or among the applicant, its

[[Page 24312]]

operator or its participants that enable or empower the applicant to 
comply with the core principles specified in section 5b(c)(2) of the 
Act, and descriptions of any system test procedures, tests conducted or 
test results;
    (6) The applicant does not amend or supplement the application 
except as requested by the Commission or for correction of 
typographical errors, renumbering or other nonsubstantive revisions, 
during that period; and
    (7) The applicant has not instructed the Commission in writing 
during the review period to review the application pursuant to the time 
provisions of and procedures under section 6 of the Act.
    (b) Termination of part 39 review. If, during the sixty-day period 
for review provided by paragraph (a) of this section, it appears that 
the application's form or substance fails to meet the requirements of 
this part, the Commission shall notify the applicant seeking 
registration that the Commission is terminating review under this 
section and will review the proposal under the time period and 
procedures of section 6 of the Act. This termination notification will 
state the nature of the issues raised and the specific condition of 
registration that the applicant would violate, appears to violate, or 
the violation of which cannot be ascertained from the application. 
Within ten days of receipt of this termination notification, the 
applicant seeking registration may request that the Commission render a 
decision whether to register the applicant or to institute a proceeding 
to deny the proposed application under procedures specified in section 
6 of the Act by notifying the Commission that the applicant views its 
submission as complete and final as submitted.
    (c) Withdrawal of application for registration. An applicant for 
registration may withdraw its application by filing with the Commission 
such a request. 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) Guidance for applicants and registrants. Appendix A to this 
part provides guidance to applicants and registrants on how the core 
principles specified in section 5b(c)(2) of the Act may be satisfied.
    (e) Delegation of authority. (1) The Commission hereby delegates, 
until it orders otherwise, to the Director of the Division of Trading 
and Markets or the Director's delegatees, with the concurrence of the 
General Counsel or the General Counsel's delegatees, the authority to 
exercise the functions under paragraphs (a) and (b) of this section and 
under Sec. 39.5.
    (2) The Director of the Division of Trading and Markets may submit 
to the Commission for its consideration any matter which has been 
delegated in this paragraph.
    (3) Nothing in this paragraph prohibits the Commission, at its 
election, from exercising the authority delegated in paragraph (e)(1) 
of this section.


Sec. 39.4  Procedures for implementing derivatives clearing 
organization rules.

    (a) Request for approval of rules. An applicant for registration, 
or a registered derivatives clearing organization, may request, 
pursuant to the procedures of Sec. 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 Sec. 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 Sec. 40.6 of this chapter.
    (c) Orders regarding competition. An applicant 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.


Sec. 39.5  Information relating to derivatives clearing organization 
operations.

    (a) 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 form and manner and within the 
time as specified by the Commission in the request.
    (b) Upon request by the Commission, a derivatives clearing 
organization shall file with the Commission a written demonstration, 
containing such supporting data, information and documents, in the form 
and manner and within such time as the Commission may specify that the 
derivatives clearing organization is in compliance with one or more 
core principles as specified in the request.
    (c) Information regarding transactions by large traders cleared by 
a derivatives clearing organization shall be filed with the Commission, 
in a form and manner acceptable to the Commission, by futures 
commission merchants, clearing members, foreign brokers or registered 
entities other than a derivatives clearing organization, as applicable. 
Provided, however, that if no such person or entity is required to file 
large trader information with the Commission, such information must be 
filed with the Commission by a derivatives clearing organization.
    (d) Upon special call by the Commission, each person registered as 
a 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 or 
other multilateral clearing organization in the form and manner and 
within the time specified by the Commission in the special call.


Sec. 39.6  Enforceability.

    An agreement, contract or transaction cleared pursuant to the rules 
of a derivatives clearing organization 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 section 5b of the Act or this part 39; 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.


Sec. 39.7  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 other 
person;
    (b) Willfully to make or cause to be made to any other person any 
false

[[Page 24313]]

report or statement thereof or cause to be entered for any person any 
false record thereof; or
    (c) Willfully to deceive or attempt to deceive any other person by 
any means whatsoever.

Appendix A to Part 39--Application Guidance and Compliance With Core 
Principles

    This appendix provides guidance concerning the core principles 
with which a clearing organization must demonstrate compliance to be 
granted and to maintain registration as a derivatives clearing 
organization under section 5b of the Act and Sec. 39.3 and Sec. 39.5 
of the Commission's regulations. The guidance follows each core 
principle and can be used to demonstrate core principle compliance 
under Sec. 39.3(a)(iv) and Sec. 39.5(d). The guidance for each core 
principle is illustrative only of the types of matters a clearing 
organization may address, as applicable, and is not intended to be a 
mandatory checklist. Addressing the criteria set forth in this 
appendix would help the Commission in its consideration of whether 
the clearing organization is in compliance with the core principles. 
To the extent that compliance with, or satisfaction of, a core 
principle is not self-explanatory from the face of a clearing 
organization's rules, an application pursuant to Sec. 39.3 or a 
submission pursuant to Sec. 39.5 should include an explanation or 
other form of documentation demonstrating that the clearing 
organization complies with the core principles.
    Core Principle A: In General--To be registered and to maintain 
registration as a derivatives clearing organization, an applicant 
shall demonstrate to the Commission that the applicant complies with 
the core principles specified in this paragraph. The applicant shall 
have reasonable discretion in establishing the manner in which it 
complies with the core principles.
    An entity preparing to submit to the Commission an application 
to operate as a derivatives clearing organization is encouraged to 
contact Commission staff for guidance and assistance in preparing 
its application. Applicants may submit a draft application for 
review prior to the submission of an actual application without 
triggering the application review procedures of Sec. 39.3 of the 
Commission's regulations. The Commission also may require a 
derivatives clearing organization to demonstrate to the Commission 
that it is operating in compliance with one or more core principles.
    Core Principle B: Financial Resources--The applicant shall 
demonstrate that the applicant has adequate financial, operational, 
and managerial resources to discharge the responsibilities of a 
derivatives clearing organization.
    In addressing Core Principle B, applicants and registered 
derivatives clearing organizations may describe or otherwise 
document:
    1. The amount of resources dedicated to supporting the clearing 
function:
    a. The amount of resources available to the clearing 
organization and the sufficiency of those resources to assure that 
no break in clearing operations would occur in a variety of market 
conditions; and
    b. The level of member/participant default such resources could 
support as demonstrated through use of hypothetical default 
scenarios that explain assumptions and variables factored into the 
illustrations.
    2. The nature of resources dedicated to supporting the clearing 
function:
    a. The type of the resources, including their liquidity, and how 
they could be accessed and applied by the clearing organization 
promptly;
    b. How financial and other material information will be updated 
and reported to members, the public, and the Commission on an 
ongoing basis; and
    c. Any legal or operational impediments or conditions to access.
    Core Principle C: Participant and Product Eligibility--The 
applicant shall establish (i) appropriate admission and continuing 
eligibility standards (including appropriate minimum financial 
requirements) for members of and participants in the organization; 
and (ii) appropriate standards for determining eligibility of 
agreements, contracts, or transactions submitted to the applicant. 
    In addressing Core Principle C, applicants and registered 
derivatives clearing organizations may describe or otherwise 
document:
    1. Member/participant admission criteria:
    a. How admission standards for its clearing members/participants 
would contribute to the soundness and integrity of operations; and
    b. Matters such as whether these criteria would be in the form 
of organization rules that apply to all clearing members/
participants, whether different levels of membership/participation 
would relate to different levels of net worth, income, and 
creditworthiness of members/participants, and whether margin levels, 
position limits and other controls would vary in accordance with 
these levels.
    2. Member/participant continuing eligibility criteria:
    a. A program for monitoring the financial status of its members/
participants; and
    b. Whether and how the clearing organization would be able to 
change continuing eligibility criteria in accordance with changes in 
a member's/participant's financial status.
    3. Criteria for instruments acceptable for clearing:
    a. How the clearing organization would establish specific 
criteria for the types of agreements, contracts, or transactions it 
will clear; and
    b. How those criteria take into account the different risks 
inherent in clearing different agreements, contracts, or 
transactions and how they affect maintenance of assets to support 
the guarantee function in varying risk environments.
    4. The clearing function for each instrument the organization 
undertakes to clear.
    Core Principle D: Risk Management--The applicant shall have the 
ability to manage the risks associated with discharging the 
responsibilities of a derivatives clearing organization through the 
use of appropriate tools and procedures. 
    In addressing Core Principle D, applicants and registered 
derivatives clearing organizations may describe or otherwise 
document:
    1. Use of risk analysis tools and procedures:
    a. How the adequacy of the overall level of financial resources 
would be tested on an ongoing periodic basis in a variety of market 
conditions;
    b. How the organization would use specific risk management tools 
such as stress testing and value at risk calculations; and
    c. What contingency plans the applicant has for managing extreme 
market events.
    2. Use of collateral:
    a. How appropriate forms and levels of collateral would be 
established and collected;
    b. How amounts would be adequate to secure prudentially 
obligations arising from clearing transactions and performing as a 
central counterparty;
    c. The process for determining appropriate margin levels for an 
instrument cleared and for clearing members/participants;
    d. The appropriateness of required or allowed forms of margin 
given the liquidity and related requirements of the clearing 
organization;
    e. How the clearing organization would value open positions and 
collateral assets; and
    f. The proposed margin collection schedule and how it would 
relate to changes in the value of market positions and collateral 
values.
    1. Use of credit limits:
    If systems would be implemented that would prevent members/
participants and other market participants from exceeding credit 
limits and how they would operate.
    Core Principle E: Settlement Procedures--The applicant shall 
have the ability to (i) complete settlements on a timely basis under 
varying circumstances; (ii) maintain an adequate record of the flow 
of funds associated with each transaction that the applicant clears; 
and (iii) comply with the terms and conditions of any permitted 
netting or offset arrangements with other clearing organizations.
    In addressing Core Principle E, applicants and registered 
derivatives clearing organizations may describe or otherwise 
document:
    1. Settlement timeframe:
    a. Procedures for completing settlements on a timely basis 
during times of normal operating conditions; and
    b. Procedures for completing settlements on a timely basis in 
varying market circumstances including during a period when one or 
more significant members/participants have defaulted.
    2. Recordkeeping:
    a. The nature and quality of the information collected 
concerning the flow of funds involved in clearing and settlement; 
and
    b. How such information would be recorded, maintained and 
accessed.
    3. Interfaces with other clearing organizations:

[[Page 24314]]

    How compliance with the terms and conditions of netting or 
offset arrangements with other clearing organizations would be met, 
including, among others, common banking or common clearing programs.
    Core Principle F: Treatment of Funds--The applicant shall have 
standards and procedures designed to protect and ensure the safety 
of member and participant funds.
    In addressing Core Principle F, applicants and registered 
derivatives clearing organizations may describe or otherwise 
document:
    1. Safe custody:
    a. The safekeeping of funds, whether in accounts, in 
depositories, or with custodians, and how it would meet industry 
standards of safety;
    b. Any written terms regarding the legal status of the funds and 
the specific conditions or prerequisites for movement of the funds; 
and
    c. The extent to which the deposit of funds in accounts in 
depositories or with custodians would limit concentration of risk.
    2. Segregation between customer and proprietary funds:
    Requirements or restrictions regarding commingling customer with 
proprietary funds, obligating customer funds for any purpose other 
than to purchase, clear, and settle the products the clearing 
organization is clearing, or procedures regarding customer funds 
which are subject to cross-margin or similar agreements, and any 
other aspects of customer fund segregation.
    3. Investment standards:
    a. How customer funds would be invested consistent with high 
standards of safety; and
    b. How the organization will gather and keep associated records 
and data regarding the details of such investments.
    Core Principle G: Default Rules and Procedures--The applicant 
shall have rules and procedures designed to allow for efficient, 
fair, and safe management of events when members or participants 
become insolvent or otherwise default on their obligations to the 
derivatives clearing organization. 
    In addressing Core Principle G, applicants and registered 
derivatives clearing organizations may describe or otherwise 
document:
    1. Definition of default:
    a. The definition of default and how it would be established and 
enforced; and
    b. How the organization would address failure to meet margin 
requirements, the insolvent financial condition of a member/
participant, failure to comply with certain rules, failure to 
maintain eligibility standards, actions taken by other regulatory 
bodies, or other events.
    2. Remedial action:
    The authority pursuant to which, and how, the clearing 
organization may take appropriate action in the event of the default 
of a member/participant which may include, among other things, 
closing out positions, replacing positions, set-off, and applying 
margin.
    3. Process to address shortfalls:
    Procedures for the prompt application of clearing organization 
and/or member/participant financial resources to address monetary 
shortfalls resulting from a default.
    4. Use of cross-margin programs:
    How cross-margining programs would provide for clear, fair, and 
efficient means of covering losses in the event of a program 
participant default.
    5. Customer priority rule:
    Rules and procedures regarding priority of customer accounts 
over proprietary accounts of defaulting members/participants and, 
where applicable, in the context of specialized margin reduction 
programs such as cross-margining or trading links with other 
exchanges.
    Core Principle H: Rule Enforcement--The applicant shall (i) 
maintain adequate arrangements and resources for the effective 
monitoring and enforcement of compliance with rules of the applicant 
and for resolution of disputes; and (ii) have the authority and 
ability to discipline, limit, suspend, or terminate a member's or 
participant's activities for violations of rules of the applicant.
    In addressing Core Principle H, applicants and registered 
derivatives clearing organizations may describe or otherwise 
document:
    1. Surveillance:
    Arrangements and resources for the effective monitoring of 
compliance with rules relating to clearing practices and financial 
surveillance.
    2. Enforcement:
    Arrangements and resources for the effective enforcement of 
rules and authority and ability to discipline and limit or suspend a 
member's/participant's activities pursuant to clear and fair 
standards.
    3. Dispute resolution:
    Where applicable, arrangements and resources for resolution of 
disputes between customers and members/participants, and between 
members/participants.
    Core Principle I: System Safeguards--The applicant shall 
demonstrate that the applicant (i) has established and will maintain 
a program of oversight and risk analysis to ensure that the 
automated systems of the applicant function properly and have 
adequate capacity and security; and (ii) has established and will 
maintain emergency procedures and a plan for disaster recovery, and 
will periodically test backup facilities sufficient to ensure daily 
processing, clearing, and settlement of transactions. 
    In addressing Core Principle I, applicants and registered 
derivatives clearing organizations may describe or otherwise 
document:
    1. Oversight/risk analysis program:
    a. Whether a program addresses appropriate principles and 
procedures for the oversight of automated systems to ensure that its 
clearing systems function properly and have adequate capacity and 
security. The Commission believes that the guidelines issued by the 
International Organization of Securities Commissions (IOSCO) in 1990 
and adopted by the Commission on November 21, 1990 (55 FR 48670), as 
supplemented in October 2000, are appropriate guidelines for an 
automated clearing system to apply.
    b. Emergency procedures and a plan for disaster recovery; and
    c. Periodic testing of back-up facilities and ability to provide 
timely processing, clearing, and settlement of transactions.
    2. Appropriate periodic objective system reviews/testing:
    a. Any program for the periodic objective testing and review of 
the system, including tests conducted and results; and
    b. Confirmation that such testing and review would be performed 
or assessed by qualified independent professionals.
    Core Principle J: Reporting--The applicant shall provide to the 
Commission all information necessary for the Commission to conduct 
the oversight function of the applicant with respect to the 
activities of the derivatives clearing organization. 
    In addressing Core Principle J, applicants and registered 
derivatives clearing organizations may describe or otherwise 
document:
    1. Information available to or generated by the clearing 
organization that will be made routinely available to the 
Commission, upon request and/or as appropriate, to enable the 
Commission to perform properly its oversight function, including 
counterparties and their positions, stress test results, internal 
governance, legal proceedings, and other clearing activities;
    2. Information the clearing organization will make available to 
the Commission on a non-routine basis and the circumstances which 
would trigger such action;
    3. The information the organization intends to make routinely 
available to members/participants and/or the general public; and
    4. Provision of information:
    a. The manner in which all relevant routine or non-routine 
information will be provided to the Commission whether by electronic 
or other means; and
    b. The manner in which any information will be made available to 
members/participants and/or the general public.
    Core Principle K: Recordkeeping--The applicant shall maintain 
records of all activities related to the business of the applicant 
as a derivatives clearing organization in a form and manner 
acceptable to the Commission for a period of 5 years.
    In addressing Core Principle K, applicants and registered 
derivatives clearing organizations may describe or otherwise 
document:
    1. The different activities related to the entity as a clearing 
organization for which it must maintain records; and
    2. How the entity would satisfy the performance standards of 
Commission Regulation 1.31 (17 CFR 1.31), reserved in this part 39 
and applicable to derivatives clearing organizations, including:
    a. What ``full'' or ``complete'' would encompass with respect to 
each type of book or record that would be maintained;
    b. The form and manner in which books or records would be 
compiled and maintained with respect to each type of activity for 
which such books or records would be kept;
    c. Confirmation that books and records would be open to 
inspection by any representative of the Commission or of the U.S. 
Department of Justice;
    d. How long books and records would be readily available and how 
they would be made readily available during the first two years; and

[[Page 24315]]

    e. How long books and records would be maintained (and 
confirmation that, in any event, they would be maintained for at 
least five years).
    Core Principle L: Public Information--The applicant shall make 
information concerning the rules and operating procedures governing 
the clearing and settlement systems (including default procedures) 
available to market participants. 
    In addressing Core Principle L, applicants and registered 
derivatives clearing organizations may describe or otherwise 
document:
    Disclosure of information regarding rules and operating 
procedures governing clearing and settlement systems:
    a. Which rules and operating procedures governing clearing and 
settlement systems should be disclosed to the public, to whom they 
would be disclosed, and how they would be disclosed;
    b. What other information would be available regarding the 
operation, purpose and effect of the clearing organization's rules;
    c. How members/participants may become familiar with such 
procedures before participating in operations; and
    d. How members/participants will be informed of their specific 
rights and obligations preceding a default and upon a default, and 
of the specific rights, options and obligations of the clearing 
organization preceding and upon the member's/participant's default.
    Core Principle M: Information Sharing--The applicant shall (i) 
enter into and abide by the terms of all appropriate and applicable 
domestic and international information-sharing agreements; and (ii) 
use relevant information obtained from the agreements in carrying 
out the clearing organization's risk management program. 
    In addressing Core Principle M, applicants and registered 
derivatives clearing organizations may describe or otherwise 
document:
    1. Applicable appropriate domestic and international 
information-sharing agreements and arrangements including the 
different types of domestic and international information-sharing 
arrangements, both formal and informal, which the clearing 
organization views as appropriate and applicable to its operations.
    2. How information obtained from information-sharing 
arrangements would be used to carry out risk management and 
surveillance programs:
    a. How information obtained from any information-sharing 
arrangements would be used to further the objectives of the clearing 
organization's risk management program and any of its surveillance 
programs including financial surveillance and continuing eligibility 
of its members/participants;
    b. How accurate information is expected to be obtained and the 
mechanisms or procedures which would make timely use and application 
of all information; and
    c. The types of information expected to be shared and how that 
information would be shared.
    Core Principle N: Antitrust Considerations--Unless appropriate 
to achieve the purposes of this Act, the derivatives clearing 
organization shall avoid (i) adopting any rule or taking any action 
that results in any unreasonable restraint of trade; or (ii) 
imposing any material anticompetitive burden on trading on the 
contract market. 
    Pursuant to section 5b(c)(3) of the Act, a registered 
derivatives clearing organization or an entity seeking registration 
as a 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. The Commission 
intends to apply section 15(b) of the Act to its consideration of 
issues under this core principle in a manner consistent with that 
previously applied to contract markets.

    Dated: May 8, 2001.
    By the Commission.
Jean A. Webb,
Secretary.

[FR Doc. 01-12084 Filed 5-11-01; 8:45 am]
BILLING CODE 6351-01-P


</pre><script data-cfasync="false" src="/cdn-cgi/scripts/5c5dd728/cloudflare-static/email-decode.min.js"></script></body>
</html>