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[Federal Register: May 14, 2001 (Volume 66, Number 93)]
[Proposed Rules]
[Page 24308-24315]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr14my01-14]

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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.

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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
[email protected]. 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 [email protected]., [email protected], or
[email protected].

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\
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    \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.
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    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\
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    \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.''
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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.
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    \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.
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    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.
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    \10\ 66 FR 14262 (March 9, 2001).
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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.
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    \11\ This includes one organization, namely, FutureCom Commodity
Exchange, Ltd.
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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.
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    \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.
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    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.
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    \15\ 47 FR 18618 (April 30, 1982).
    \16\ 47 FR 18618, 18619 (discussing contract markets).
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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:
    � 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.

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
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