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[Federal Register: August 29, 2001 (Volume 66, Number 168)]
[Rules and Regulations]
[Page 45604-45613]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr29au01-22]

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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: Final rulemaking.

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SUMMARY: The Commodity Futures Trading Commission (``Commission'' or
``CFTC'') is promulgating final rules to implement provisions of the
Commodity Futures Modernization Act of 2000 governing derivatives
clearing organizations. The rules apply to derivatives clearing
organizations that are required to be registered, or which voluntarily
apply to register, with the Commission.

EFFECTIVE DATE: October 29, 2001.

FOR FURTHER INFORMATION CONTACT: Alan L. Seifert, Deputy Director,
Division of Trading and Markets or Lois J. Gregory, Special Counsel,
Division of Trading and Markets, Commodity Futures Trading Commission,
Three Lafayette Centre, 1155 21st Street, NW., Washington, DC 20581.
Telephone (202) 418-5260 or e-mail [email protected]. or
[email protected].

[[Page 45605]]


SUPPLEMENTARY INFORMATION:

I. Background

    On May 14, 2001, the Commission published for comment proposed part
39 of its regulations to implement Section 5b of the Commodity Exchange
Act (``Act''), as added by the Commodity Futures Modernization Act of
2000 (``CFMA''),\1\ governing derivatives clearing organizations.\2\
Section 5b(a) 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,\3\ unless the contracts or options are
in: (i) commodities excluded under the Act, (ii) commodities exempted
under the Act, or (iii) security futures products cleared by a
securities clearing agency. With the exception of security futures
products, which may be cleared by a securities clearing agency,\4\
contracts traded on a designated contract market, if cleared, must be
cleared by a DCO.\5\ Agreements, contracts and transactions in excluded
or exempted commodities that are traded on a derivatives transaction
execution facility, if cleared, may be cleared through clearing
organizations other than DCOs.\6\ However, a clearing organization that
clears these contracts may voluntarily apply, pursuant to section 5b(b)
of the Act, to register with the Commission as a DCO. 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 others, such as
transactions in spot and forward contracts.
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    \1\ See Appendix E of Pub.L. 106-554, 114 Stat. 2763 (2000).
    \2\ 66 FR 24308.
    \3\ For purposes of this release, use of the term ``derivatives
clearing organization'' means a DCO registered, deemed to be
registered, or required to be registered, with the Commission
pursuant to section 5b of the Act.
    \4\ Security futures products traded on a national securities
exchange that is notice-registered with the CFTC as a designated
contract market must be cleared by a securities clearing agency
registered under the Securities Exchange Act of 1934. Securities
Exchange Act section 17A(b)(1). Security futures products traded on
a contract market that is notice-registered with the SEC may be
cleared by either a DCO or a securities clearing agency. See section
5b of the Act.
    \5\ However, the Commission will consider requests for other
types of clearing arrangements pursuant to its exemptive authority
under section 4(c) of the Act.
    \6\ This includes excluded or exempted contracts traded on a
derivatives transaction execution facility pursuant to any of the
sub-provisions of section 5a of the Act.
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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. Part 39
stipulates the form and provides guidance for what should be included
in applications for DCO registration, and sets forth procedures for
processing such applications. It also addresses ongoing compliance by
DCOs with the core principles and other provisions of the Act and
regulations, the enforceability of contracts cleared on DCOs, and
fraud. Part 39 does not apply to the execution of transactions cleared
by DCOs; its provisions apply only to the clearing of transactions by
DCOs.
    The Commission received three comment letters on proposed part
39.\7\ Although the Commission has made various changes in response to
the comments as discussed below, the final rules do not differ
significantly from those that were proposed.
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    \7\ Comment letters (CL) were received from the Board of Trade
Clearing Corporation (``BOTCC''), the Chicago Mercantile Exchange
(``CME''), and the International Swaps and Derivatives Association
(``ISDA'').
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II. Final Part 39

A. Application and Approval Procedures

    As did the proposed rule, final rule 39.1 provides that part 39
applies to any DCO that is registered, is required to be registered, or
which voluntarily applies to be registered with the Commission. The
Commission agrees with comments suggesting that grandfathered DCOs also
be specifically included in this scope provision and has accordingly
amended it to include DCOs that are ``deemed to be registered,'' which
is the language used in the CFMA to refer to grandfathered DCOs.\8\
Thus, the final part 39 rules apply to any DCO, as defined under
section 1a(9) of the Act,\9\ which is registered or deemed to be
registered with the Commission, is required to become so registered, or
which voluntarily seeks to become so registered. Final rule 39.3
provides that an organization meeting all requirements is ``deemed
registered'' sixty days after receipt of an application unless notified
otherwise.\10\
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    \8\ Section 5b(d) provides that a DCO ``shall be deemed to be
registered'' if it acts as the clearing organization for a board of
trade that was designated as a contract market prior to the date of
enactment of the CFMA. See BOTCC CL at 2.
    \9\ As noted in the proposing release, an organization need not
perform a direct credit enhancement function in order to be a DCO
under the Act. See section 1a(9)(ii) (providing that the term DCO
includes entities that provide for the settlement or netting of
agreements, contracts, or transactions executed by participants in
the DCO). Accordingly, and in response to BOTCC's request for
clarification, the term ``clear'' (and all forms of the verb) is
meant to include these other services. See BOTCC CL at 6. An
organization that intends to provide settlement or other clearing-
type services without accompanying credit enhancement must still
demonstrate compliance with all section 5b core principles to obtain
unconditional registration as a DCO. The Commission may grant DCO
registration with conditions when and as appropriate.
    \10\ The Act does not include an express time limit for
Commission consideration of applications to become registered DCOs.
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    Rule 39.3 also sets forth the requirements for registration. As
proposed, the rule required that an applicant meet the definition of a
DCO provided by section 1a(9) of the Act, which in turn, requires that
the entity perform certain functions. As noted by BOTCC, however, an
applicant that has not been grandfathered pursuant to section 5b(d) of
the Act will not have performed the activities envisioned by that
definition. The Commission has modified the rule, therefore, to state
that an applicant need only represent that it will operate in
accordance with the definition of a DCO contained in section 1a(9) of
the Act.\11\
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    \11\ An applicant's representation of how it will operate refers
to the information the applicant must include in its application
describing the operations and functions the applicant will undertake
as a registered DCO.
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    Other requirements of rule 39.3 include submission by an applicant
of its rules and a demonstration that the applicant is able to satisfy
the core principles of the Act to the extent that its ability to do so
is not self evident from the applicant's rules. As proposed, rule 39.3
also would have required applicants to submit ``any'' agreements with
third parties that would enable the applicant to comply with the core
principles and descriptions of ``any'' system test procedures, tests
conducted or test results. BOTCC commented that ``[t]hese materials can
be voluminous. More importantly, these materials frequently will
contain trade secrets of the submitting party or be subject to detailed
confidentiality procedures established by third-party system providers
and other vendors.'' \12\ BOTCC therefore recommended that the rule
``be amended to require an applicant only to submit such information as
is necessary to demonstrate the applicant's compliance with core
principles.'' \13\ The Commission has modified the rule to clarify that
the agreements and descriptions of system tests referred to in rule
39.3 that must be submitted are those that will enable the applicant to
comply, or demonstrate the applicant's ability to comply, with the core
principles.\14\
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    \12\ BOTCC CL at 3.
    \13\ Id.
    \14\ This information is essential to the Commission's oversight
of DCOs. However, trade secrets and other proprietary information
may be entitled to protection under the Freedom of Information Act.
See rule 39.3(a)(7). As has been the case in the past, the staff is
prepared to work with applicants to arrange reasonable
accommodations to address concerns about the relevance of
disclosures or the volume of submissions.

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[[Page 45606]]

    If an applicant does not meet the registration requirements,
Commission staff will inform the applicant of the shortcomings and
notify it that review is being terminated under part 39 and will
continue under section 6 of the Act. Within ten days of being notified,
the applicant may ask the Commission either to register it or to
commence registration denial proceedings. An applicant also may
withdraw its application.
    An applicant may request that the Commission approve any of its
rules pursuant to the procedures and timeframes for approval provided
by rule 40.5. An applicant may request approval of one or more of its
rules at the time it makes its initial application, or thereafter.
Under 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 will review the analysis
submitted by the applicant with respect to the rule or practice in
question and will apply section 15(b) of the Act in a manner consistent
with its previous application of section 15 to contract markets.

B. Existing Derivatives Clearing Organizations

    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
had been designated by the Commission as a contract market for such
agreements, contracts, or transactions prior to enactment of the CFMA.
In response to comments, the Commission clarifies that clearing
organizations that are grandfathered under this provision need not
apply to the Commission to clear new contracts that were not cleared
before the date of enactment of the CFMA.\15\
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    \15\ See CME CL at 1. They would, however, be required under
section 5c(c) of the Act to provide certification that the clearing
of the new contract(s) complies with the Act and the Commission's
regulations. Self-certification procedures for products are provided
under rule 40.2.
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C. Derivatives Clearing Organizations

1. Exemption
    As proposed, rule 39.2 provided that a DCO and the clearing of
transactions on a DCO would be exempt from all Commission regulations
except for those contained in proposed parts 39 and 40,\16\ and certain
select regulations relating to, for example, the segregation of
customer funds and recordkeeping.\17\ In response to comments noting
that only subsection (b) of Commission regulation 1.38 is relevant to
the activities of DCOs, the Commission has amended proposed rule 39.2
to reserve only that subsection.\18\ The Commission also has amended
proposed rule 39.2 to delete reservation of the option anti-fraud
provisions in Commission regulation 33.10, because part 39 contains its
own anti-fraud rule, which applies to the activity of clearing option
contracts otherwise covered by regulation 33.10.\19\ Parts 15 through
18 of the Commission's regulations continue to be reserved in final
rule 39.2 to the extent they are applicable. These provisions are
reserved in connection with the Commission's authority to make special
calls pursuant to rule 39.5(d).\20\
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    \16\ Part 40 of the regulations, which contains provisions
common to contract markets, derivatives transactions execution
facilities and DCOs, was adopted by the Commission on August 1,
2000. See 66 FR 42256 (August 10, 2001).
    \17\ This included Commission Regulation 1.31, which was updated
and amended by the Commission in 1999 to provide broad, flexible
performance standards for recordkeeping. It is substantially similar
to the recordkeeping requirements maintained by the Securities and
Exchange Commission. Notwithstanding the basic non-mandatory nature
of the guidance provided in the appendix to part 39, the Commission
clarifies that, with respect to Core Principle K, a DCO's
recordkeeping must satisfy the performance standards in Regulation
1.31 in order to demonstrate compliance with the core principle,
because that rule has been reserved.
    \18\ See BOTCC CL at 2.
    \19\ Id.
    \20\ Id. See generally the discussion regarding information
needed by the Commission to fulfill its oversight function under
section II. C. 3., infra.
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    Final rule 39.2 continues to provide that the reserved regulations
apply to DCOs as though they were set forth in part 39 and included
specific reference to DCOs. The Commission agrees with BOTCC's
suggestion that this drafting convention be extended so that references
in the regulations to the terms ``clearinghouse'' and ``clearing
organization'' shall be deemed to mean a ``derivatives clearing
organization,'' and has modified rule 39.2 accordingly.\21\
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    \21\ BOTCC CL at 2.
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2. Rules
    Rule 39.4 provides that a DCO may request that the Commission
approve any of its rules either prior to or after implementation of the
rule(s).\22\ Such requests will be processed under the applicable
procedures of part 40. As provided by part 40 and rule 39.4, 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. Also as provided by part 40 and added in final
rule 39.4, a DCO that accepts for clearing a new product that is not
traded on a designated contract market or a registered derivatives
transaction execution facility must submit to the Commission any rules
establishing the terms and conditions of the product that make it
acceptable for clearing with a certification that the clearing of the
product and the rules and terms and conditions comply with the Act and
the rules thereunder. A DCO also may request, at any time, that the
Commission issue an order concerning whether any of its rules or
practices is the least anticompetitive means of achieving the
objectives, purposes, and policies of the Act. As with such requests
accompanying applications, the Commission will review the analysis
submitted with respect to the rule or practice in question and will
apply section 15(b) of the Act in a manner consistent with its previous
application of section 15 to contract markets.
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    \22\ The Act limits a registered entity seeking approval to
request approval only ``prior'' to implementation. The Commission is
using its section 4(c) exemptive authority with respect to this
provision to provide DCOs with greater procedural flexibility.
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3. Information
    Rule 39.5 allows the Commission to request certain information from
DCOs in order to carry out its oversight function. For example, rule
39.5(b) allows the Commission to ask a DCO to submit, in writing,
information deemed necessary to demonstrate that the DCO is operating
in compliance with one or more of the core principles. Such a request
is an informal method of resolving compliance issues and is intended to
be a preferable alternative to the more formal procedures of section
5c(d) of the Act. As proposed in rule 39.3(e), the Commission has
delegated the authority to request information under 39.5(b) to
specified staff. This delegation is consistent with the delegation of
authority in rule 37.8(d) regarding information relating to
transactions on derivatives transaction execution facilities and in
rule 40.7(a)(1) regarding product and rule amendments and supplements.
The authority under rule 39.5(b) is an important complement to the
streamlined and reduced requirements of the CFMA. In response to
concerns expressed by CME, the

[[Page 45607]]

Commission affirms its intent that rule 39.5 be used only when there is
a reasonable basis upon which to request information about the ongoing
compliance by a DCO with one or more core principles.\23\
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    \23\ See CME CL at 2-3. In order to perform properly its
oversight function with respect to the core principles, such a
request may include information related to the DCO's broader
business as a clearing organization in addition to its business as a
registered DCO, because the ability to fulfill the latter function
may potentially be affected by the former. See BOTCC CL at 5.
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    Rule 39.5(c) requires that large trader information be provided to
the Commission by futures commission merchants, clearing members, and
foreign brokers. In response to comments, the Commission does not
believe it is necessary to expand this list to include foreign traders
or participants in a DCO, as in each instance, the report would be
filed through an entity included on the list. Rule 39.5(d) authorizes
the Commission to make special calls for information concerning
customer accounts from futures commission merchants, clearing members,
or foreign brokers. Commission staff will limit special calls as needed
to carry out the Commission's oversight function with respect to DCOs
and their operations.
4. Enforceability
    As proposed, rule 39.6 provided 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. In its
comment letter, ISDA stated that the reference to contracts or
transactions ``cleared pursuant to the rules'' may create ambiguity and
uncertainty in that it does not clearly cover contracts or transactions
cleared by non-registered DCOs. ISDA suggested clarifying the
applicability of the enforceability provision by substituting the words
``submitted to a derivatives clearing organization for clearance'' for
``cleared pursuant to the rules.'' The Commission has considered ISDA's
comment and has amended final rule 39.6 in this manner to clarify the
rule's applicability to DCOs that are required to register, as well as
those that are already registered, with the Commission. The Commission
believes this clarification is appropriate in that enforceability of
contracts extends not only to DCOs properly registered with the
Commission, but to those that should be, but are not, registered with
the Commission and consequently are in violation of Section 5b(a) of
the Act.
    The Commission's substitution of the words ``submitted to a
derivatives clearing organization for clearance'' in final rule 39.6
also addresses BOTCC's suggestion that the Commission clarify that the
enforceability provision applies to cleared transactions and to those
submitted for clearing, but for which the clearing process was delayed
or interrupted.\24\ In addition, in response to BOTCC comments, the
Commission has modified proposed rule 39.6 to apply to violations of
any of the provisions of the Act or of the Commission's regulations,
rather than to violations of section 5b of the Act or part 39 of the
regulations only.\25\
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    \24\ See BOTCC CL at 6, n.9. BOTCC notes that this distinction
could be important in circumstances where the insolvency of a
clearing member or DCO participant interferes with normal clearing
processes.
    \25\ See BOTCC CL at 6.
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5. Anti-fraud
    As proposed, rule 39.7 prohibited fraudulent actions by persons
``in or in connection with'' the clearing of transactions on a DCO.
Both CME and ISDA commented that the proposed rule could be interpreted
to apply to fraud with respect to aspects of a transaction cleared by a
DCO other than the activity of clearing. ISDA asserted that the rule
should be narrowly construed to mean fraud specific to the clearing
function and not in connection with the solicitation or execution of a
transaction merely because the transaction is also cleared.\26\ CME
stated that the rule could be read to apply to the execution of
transactions cleared by a DCO even if the transaction would otherwise
be outside the Commission's jurisdiction.\27\ CME argued that
participants in derivatives markets unregulated by the CFTC will
arrange to have such transactions cleared by non-DCO clearing
organizations if there appears to be any chance that rule 39.7 could
subject their transactions to CFTC jurisdiction.\28\
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    \26\ See ISDA CL at 3-4.
    \27\ See CME CL at 1-2.
    \28\ See CME CL at 2.
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    In response to these comments, the Commission reaffirms that
transactions that are outside the CFTC's jurisdiction do not become
subject to its jurisdiction simply because they are cleared by a DCO.
Thus, rule 39.7 does not govern, cover, or relate to the solicitation
or execution of transactions. This is consistent with rule 39.6, which
provides that a violation of any Commission regulation, which would
include rule 39.7, does not affect the enforceability of transactions
submitted for clearance on a DCO, and with the CFMA's separate
treatment of clearing from the transaction facilities for which
transactions are cleared.
    BOTCC also requested confirmation that proof of scienter is needed
for violations of rule 39.7.\29\ The Commission confirms that
violations of the anti-fraud provision do require proof of
scienter.\30\
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    \29\ See BOTCC CL at 6.
    \30\ This is consistent with other anti-fraud provisions such as
Section 4(b) of the Act, Commission regulation 30.9 (concerning
fraud involving foreign futures contracts) and Commission regulation
33.10 (concerning fraud in connection with domestic exchange-traded
option transactions). The Commission has held that Regulations 30.9
and 33.10 require proof of scienter. See, e.g., In Re Staryk [1996-
1998 Transfer Binder] Comm. Fut. L. Rep. (CCH) para. 27,206 at
45,810 (CFTC Dec. 18, 1997). The Commission also removed the words
``other'' and ``thereof'' twice each from rule 39.7. These words do
not serve a useful purpose in the rule and their removal does not
change the meaning or application of the rule, but does make it
consistent with rule 1.1 recently adopted by the Commission. See 66
FR 42256 (August 10, 2001). Rule 1.1 concerns fraud in or in
connection with transactions in foreign currency subject to the Act.
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D. Application Guidance and Compliance With Core Principles

    In order to become registered, an applicant must demonstrate the
ability to comply with the core principles for DCOs set forth in
Section 5b of the Act. In order to remain registered, a DCO must
continue to comply with the core principles. An applicant or DCO has
reasonable discretion in establishing the manner in which it
demonstrates its ability to comply with the core principles or its
ongoing compliance. Appendix A to part 39 provides guidance that
applicants and DCOs can use to demonstrate initial ability to comply
and continuing compliance with the core principles. The guidance
illustrates the manner in which a clearing organization may meet a core
principle and is not intended to be a mandatory checklist.
    The proposed guidance for Core Principle B--Financial Resources--
addressed the ``amount'' of resources dedicated to supporting the
clearing function. As proposed, this guidance referred to the amount of
resources available and their sufficiency to assure that no break in
clearing operations will occur in a variety of market conditions. In
response to comments, point 1 of the guidance has been modified to
refer to the ``level'' rather than the ``amount'' of resources and
assurance that no ``material adverse'' break in clearing

[[Page 45608]]

operations will occur.\31\ Point 2 continues to refer to the ``nature''
of the resources. The Commission recognizes that it may be difficult to
quantify resource allocations. Thus, in the final guidance it suggests
that applicants or DCOs may provide information describing the level
and nature of resources available to support the clearing function,
rather than the specific or exact amount of resources available at any
one time. In addition, the Commission recognizes that certain temporary
breakdowns that do not materially affect the clearing function do and
will occur. The Commission notes that the guidance relevant to this
issue addresses the allocation of sufficient resources to prevent
breakdowns of a serious and fundamental nature that would materially,
adversely affect an applicant's or DCO's ability to fulfill its basic
clearing services.\32\ Furthermore, reference in the guidance to a
credit enhancement function is not intended to imply a requirement that
a DCO provide that function.\33\
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    \31\ See BOTCC CL at 7.
    \32\ See BOTCC CL at 7.
    \33\ See ISDA CL at 4; see also footnote 9, supra.
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    Point 2 of the proposed guidance under Core Principle B--Financial
Resources--addressed the updating and reporting of certain financial
information. With respect to public disclosure, this guidance has been
amended so as to apply only ``when appropriate.'' Information is not
expected to be made publicly available if it is not appropriate to do
so, as in the case of certain confidential and proprietary financial
and commercial information.\34\ The proposed guidance on Core Principle
L--Public Information--also referred to public disclosure and concerned
rules and operating procedures governing clearing and settlement
systems. This guidance has not been altered from its proposed form and
is consistent with guidance regarding public disclosure of similar
material by contract markets or applicants therefor.\35\
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    \34\See BOTCC CL at 7.
    \35\See the application guidance for designation criterion 7 of
section 5(b) of the Act and the guidance on, and acceptable
practices for, complying with core principles 7 and 10 of section
5(d) of the Act; see also BOTCC CL at 7.
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    As proposed, point 3 of the guidance for Core Principle C--
Participant and Product Eligibility--suggested that an applicant or DCO
describe how it would establish criteria for the transactions it will
clear, and point 2 of the guidance for Core Principle D--Risk
Management--suggested providing a description of how appropriate forms
and levels of collateral would be established and collected. In
response to comments, these points have been reworded to clarify that
the information suggested as relevant to demonstrating compliance
relates to the different factors the applicant or DCO will consider in
carrying out its responsibilities, rather than its internal
procedures.\36\ In addition, the words ``where applicable'' have been
added to subpart (b) of point 2 of the guidance for Core Principle D,
referring to sufficient resources to perform the central counterparty
function, in recognition of the fact that the definition of DCO does
not require the performance of a direct credit enhancement
function.\37\
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    \36\See BOTCC CL at 8.
    \37\ See footnote 9 and text accompanying footnote 33.
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    Point 1 of the guidance under Core Principle G--Default Rules and
Procedures--has been revised to suggest more clearly that relevant
information includes how the applicant or DCO defines default, what
steps would be taken in the event of a default, and steps that would be
taken in situations related to, but which may not constitute,
default.\38\ Point 5 of the guidance for Core Principle G concerning
default rules and procedures suggests that applicants or DCOs address
rules and procedures regarding priority of customer accounts over
proprietary accounts of defaulting members/participants. In response to
comments, the Commission clarifies that this is not meant, and should
not be interpreted, to imply that customer priority procedures are a
necessary element in the structure of all DCOs.\39\ Rules and
procedures regarding priority of customer accounts are only relevant
with respect to a DCO that directly or indirectly clears contracts for
one or more accounts that are customer accounts in the particular
market for which it is clearing, while also clearing non-customer or
proprietary accounts.
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    \38\ See BOTCC CL at 8.
    \39\ See ISDA CL at 4-5.
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    Point 2 of the proposed guidance for Core Principle I--System
Safeguards--suggested that applicants or DCOs provide confirmation that
system testing and review will be performed or assessed by a qualified
independent professional. In response to comments, the Commission has
clarified that a qualified independent professional need not
necessarily be external to the organization to be considered
independent.\40\ An internal reviewer may qualify as independent if he/
she is independent of the activities being audited and is
organizationally able to render an objective assessment.
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    \40\ See BOTCC CL at 8.
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III. Section 4(c) Findings

    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 using its section 4(c) exemptive authority here
to provide registered entities with greater procedural flexibility than
is contained in the Act. Pursuant to 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.\41\ The Commission believes this exercise of
exemptive authority should provide DCOs with greater procedural
flexibility. Accordingly, the Commission finds under section 4(c) of
the Act that the exemption is consistent with the public interest. The
Commission also notes that it will consider, under its section 4(c)
exemptive authority, requests by designated contract markets to use the
clearing services of organizations other than DCOs registered with the
Commission.
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    \41\ See section 5c(c)(2) of the Act.
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IV. Consideration of Costs and Benefits

    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 promulgating a new regulation under the Act. The
Commission has applied 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

[[Page 45609]]

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 may, in its discretion,
give greater weight to any one of the five enumerated areas of concern
and may in its discretion determine that, notwithstanding its costs, a
particular rule is 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 part 39 and the costs and benefits of the related rule
provisions. Significantly, part 39 limits 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. Part 39 also
provides 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 impose reporting, recordkeeping and other
informational requirements on DCOs only when they are mandated by,
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 impose limited costs on DCOs in requiring them to
gather, compile, and submit certain information that the Commission
needs in order to oversee their clearing functions and to enforce their
compliance with the Act. The rules will not increase costs related to
market competitiveness and will not affect the price discovery function
of markets. The Commission believes that the anti-fraud provision of
part 39 benefits market participants and the public interest by
deterring illegal behavior and that the enforceability provision of
part 39 benefits the public interest by furthering legal certainty.
    After considering these factors, the Commission has determined to
promulgate part 39. The Commission notes that it did not receive any
comments in response to the discussion regarding the costs and benefits
of part 39 included in the proposal. Moreover, insofar as the comments
received raised any matters that might be deemed to relate to the costs
and benefits of part 39, the Commission has addressed them in the
foregoing discussion and through modifications to the original
proposal.

V. Implementation Issues; No-action

    In light of Congress's intent to implement the changes of the CFMA
without delay, the Commission determined when it proposed these rules
that it would not bring any enforcement action against any person who
complied with the proposed rules during the transition period between
the effective date of the amendments to the Act (generally December 21,
2000) and the adoption of final implementing regulations. 66 FR at
24310. At that time, the Commission also advised persons relying on
that no-action position that they would be required to bring their
conduct into compliance with the final rules to the extent that the
final rules differed from the proposed rules. Id.
    The rules being adopted today will become effective October 29,
2001. To the extent that the final rules differ from the proposed
rules, persons relying on the no-action position of the proposed rules
will be required to bring their conduct into compliance with the final
rules in order to continue to rely on the no-action. Furthermore, the
Commission will not bring any enforcement action against any person who
complies with the final rules during the period between their adoption
and effective date.

VI. Related Matters

A. Regulatory Flexibility Act

    The Regulatory Flexibility Act (``RFA''), 5 U.S.C. 601-612,
requires that agencies, in promulgating rules, 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 be used by the Commission in
evaluating the impact of its rules on such entities in accordance with
the RFA.\42\ In its previous determinations, the Commission has
concluded that contract markets are not small entities for purposes of
the RFA.\43\ DCOs clear contracts executed on contract markets and
other trading facilities. For reasons similar to those applicable to
contract markets, DCOs, as defined in the CFMA, should not be
considered small entities. In this regard, the Commission notes that it
did not receive any comments regarding the RFA implications of part 39.
Accordingly, the Commission does not expect the rules, as adopted
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
promulgated rules will not have a significant economic impact on a
substantial number of small entities.
---------------------------------------------------------------------------

    \42\ 47 FR 18618 (April 30, 1982).
    \43\ 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 submitted a copy of this part to the Office of Management
and Budget (``OMB'') for its review. No comments were received in
response to the Commission's invitation in the proposing release to
comment on any potential paperwork burden associated with part 39.

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 hereby amends 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 and clearing certain new products.
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 or deemed to be registered with the Commission as a

[[Page 45610]]

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. 1.3, 1.12(f)(1), 1.20, 1.24, 1.25, 1.26, 1.27,
1.29, 1.31, 1.36, 1.38(b), 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. The foregoing reserved regulations 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. Any reference to the
term ``clearinghouse'' or ``clearing organization'' contained in the
regulations shall be deemed to refer to a derivatives clearing
organization.


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 represents that it will operate in accordance
with 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 is able to
satisfy each of the core principles specified in section 5b(c)(2) of
the Act;
    (5) The applicant submits agreements entered into or to be entered
into between or among the applicant, its operator or its participants,
and descriptions of system test procedures, tests conducted or test
results, that will enable the applicant to comply, or demonstrate the
applicant's ability to comply, with the core principles specified in
section 5b(c)(2) of the Act;
    (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;
    (7) The applicant identifies with particularity information in the
application that will be subject to a request for confidential
treatment and supports that request for confidential treatment with
reasonable justification; and
    (8) 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 and clearing certain new products.

    (a) Request for approval of rules. An applicant for registration,
or a registered derivatives clearing organization, may request,
pursuant to the procedures of 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) Acceptance of certain new products for clearing. A derivatives
clearing organization that accepts for clearing a new product that is
not traded on a designated contract market or a registered derivatives
transaction execution facility must submit to the Commission any rules
establishing the terms and conditions of the product that make it
acceptable for clearing with a certification that the clearing of the
product and the rules and terms and conditions comply with the Act and
the rules thereunder pursuant to the procedures of Sec. 40.2 of this
chapter.
    (d) 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.

[[Page 45611]]

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 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 submitted to a derivatives
clearing organization for clearance shall not be void, voidable,
subject to rescission, or otherwise invalidated or rendered
unenforceable as a result of:
    (a) A violation by the derivatives clearing organization of the
provisions of the Act or of Commission regulations; or
    (b) Any Commission proceeding to alter or supplement a rule under
section 8a(7) of the Act, to declare an emergency under section 8a(9)
of the Act, or any other proceeding the effect of which is to alter,
supplement, or require a derivatives clearing organization to adopt a
specific rule or procedure, or to take or refrain from taking a
specific action.


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 person;
    (b) Willfully to make or cause to be made to any person any false
report or statement or cause to be entered for any person any false
record; or
    (c) Willfully to deceive or attempt to deceive any person by any
means whatsoever.

Appendix A to Part 39--Application Guidance and Compliance With Core
Principles

    This appendix provides guidance concerning the core principles
with which applicants must demonstrate the ability to comply and
with which registered derivatives clearing organizations must
continue to comply 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 is able to or does comply 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 resources dedicated to supporting the clearing function:
    a. The level of resources available to the clearing organization
and the sufficiency of those resources to assure that no material
adverse break in clearing operations will 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, if and when appropriate, and to
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

[[Page 45612]]

with changes in a member's/participant's financial status.
    3. Criteria for instruments acceptable for clearing:
    a. The criteria, and the factors considered in establishing the
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. What 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, where
applicable, performing as a central counterparty;
    c. The factors considered in 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.
    3. 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:
    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
funds 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 events that will constitute member or participant
default;
    b. What action the organization would take upon a default and
how the organization would otherwise enforce the definition of
default; and
    c. How the organization would address situations related to but
which may not constitute an event of default, such as 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;

[[Page 45613]]

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 a qualified independent professional.
    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
information regarding 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
    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.

    Issued in Washington, DC on August 22, 2001, by the Commission.
Jean A. Webb,
Secretary of the Commission.
[FR Doc. 01-21670 Filed 8-28-01; 8:45 am]
BILLING CODE 6351-01-P
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