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[Federal Register: December 13, 2000 (Volume 65, Number 240)]
[Rules and Regulations]
[page 78020-78030]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr13de00-29]

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COMMODITY FUTURES TRADING COMMISSION

17 CFR Part 39

RIN 3038-AB57


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 a new regulatory framework to apply to clearing
organizations. These regulations for clearing organizations are part of
an initiative that would also establish a new regulatory framework for
multilateral transaction execution facilities (MTEF) and market
intermediaries. The final new framework in its entirety is
simultaneously announced today in companion releases. The new
framework, including these regulations are centered on broad, flexible,
core principles and are designed to ``promote innovation, maintain U.S.
competitiveness, and at the same time reduce systemic risk and protect
customers.'' The Commission has fashioned these regulations so that it
can fairly and efficiently carry out the important duty of overseeing
clearing organizations in a changing, dynamic industry pursuant to a
transparent codified framework.

EFFECTIVE DATE: February 12, 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],
[email protected], or [email protected].

SUPPLEMENTARY INFORMATION:

[[page 78021]]

I. Background

    On June 22, 2000, the Commission published for comment proposed new
Part 39, a regulatory framework for the oversight of clearing
organizations. 65 FR 39027. Part 39 is part of an initiative that would
also establish a new regulatory framework for MTEFs and market
intermediaries. The final new framework in its entirety is
simultaneously announced today in companion releases. The new
framework, including Part 39, is centered on broad, flexible, core
principles and is designed to ``promote innovation, maintain U.S.
competitiveness, and at the same time reduce systemic risk and protect
customers.'' 65 FR 38986.
    The futures and option markets are undergoing changes in market
structure and technology. Clearing organizations for these markets
perform valuable functions by mitigating counterparty risk,
facilitating the netting and offsetting of contractual obligations, and
decreasing systemic risk. Clearing organizations should be subject to
continuing regulatory oversight to ensure that they have sufficient
financial resources and that they establish and implement prudential
risk management programs designed to control concentration risks
associated with centralized clearing.\1\ The Commission has fashioned
new Part 39 so that it can fairly and efficiently carry out the
important duty of overseeing clearing organizations in a changing,
dynamic industry pursuant to a transparent codified framework.
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    \1\ See Over-the-Counter Derivatives Markets and the Commodity
Exchange Act, Report of the President's Working Group, November
1999.
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    Part 39 requires that transactions effected on recognized futures
exchanges (RFEs) under Part 38 and derivatives transaction facilities
(DTFs) under Part 37 be cleared only by clearing organizations that
have been recognized by the Commission under Part 39--recognized
clearing organizations (RCOs). RCOs are also permitted to clear
transactions that are exempt under Part 35--Exemption of Bilateral
Agreements and Part 36--Exemption of Transactions on Multilateral
Transaction Execution Facilities.\2\ In addition, nothing in Part 39
prohibits an RCO from clearing any other type of instrument such as
cash or forward delivery contracts.\3\
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    \2\ In addition to RCOs, certain other enumerated entities also
are authorized to clear transactions exempt under Parts 35 and 36.
These include a clearing agency or system regulated by the
Securities and Exchange Commission (SEC), the Federal Reserve, or
the Comptroller of the Currency, and certain foreign clearing
organizations.
    \3\ Further, nothing in Part 39 prohibits an entity that clears
only exempt transactions from applying to the Commission for RCO
status. An entity may want to apply for recognition as an RCO for
its own business purposes.
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    Current futures clearing organizations may self-certify and
automatically qualify as RCOs under Part 39. New entities could apply
for RCO status by demonstrating that their rules, procedures, and
operations would be consistent with the 13 broad and flexible core
principles set forth in Part 39. Appendix A to Part 39 would provide
guidance to applicant RCOs as to how to make such a demonstration.
Certain provisions of Part 39 and Appendix A have been modified from
their proposed versions in light of comments received from participants
in the industry. These modifications, as discussed herein, provide
additional clarity and are consistent with the new regulatory
framework's goal of promoting innovation and maintaining U.S.
competitiveness, while also reducing systemic risk and protecting
customers.

II. Overview

    The Commission received comment letters on Part 39 from a number of
SROs and other interested entities.\4\ Commenters overwhelmingly
supported the Part 39 requirement that all transactions executed on a
designated contract market, an RFE, or a DTF, if cleared, be cleared by
an RCO. Commenters also supported the proposition that nothing in Part
39 prohibits RCOs from clearing transactions other than those effected
pursuant to Parts 35-38. Other comments concerned the definition of
clearing organization, the jurisdiction of the Commission, the
applicable provisions of the Commodity Exchange Act (Act) and
regulations, and the guidance in Appendix A to Part 39. In response to
the comments, the Commission has made changes to the definition of
clearing organization and changes that clarify the jurisdiction of the
Commission under Part 39. Other changes to Part 39 limit the
applicability of sections of the Act and the regulations, and address
the illustrative purpose of the guidance in Appendix A.
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    \4\ In this and three companion Notices of Final Rulemaking
which are being published in this edition of the Federal Register,
comment letters (CL) are referenced by file number, letter number
and page. These letters are available through the Commission's
internet web site. Comments filed in response to the notice of
proposed rulemaking on clearing organizations are contained in file
No. 23. Comments filed predominantly in response to the notice of
proposed rulemaking on Parts 36-38, but which also had comments on
clearing organizations, are contained in file No. 21. Those
commenting upon Part 39 include: Board of Trade Clearing Corporation
(BOTCC); California Power Exchange; Chicago Board of Trade; Chicago
Mercantile Exchange (CME); Federal Reserve Bank of Chicago (FRB of
Chicago); Financial Markets Lawyers Group; Futures Industry
Association (FIA); Global TeleExchange; Government Securities
Clearing Corporation (GSCC); New York Independent System Operator;
JP Morgan; Kiodex, Inc.; Mercatus Center at George Mason University;
New York Clearing Corporation (NYCC); New York Mercantile Exchange;
Options Clearing Corporation (OCC); Oxy Energy Services, Inc.;
PetroCosm Corporation; Securities Industry Association; and Cleary,
Gottlieb, Steen & Hamilton, on behalf of a coalition of investment
banks consisting of Chase Manhattan Bank, Citigroup Inc., Credit
Suisse First Boston Inc., Goldman Sachs & Co., Merrill Lynch & Co.
Inc., and Morgan Stanley Dean Witter & Co. (Coalition).
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III. Discussion

A. Purpose

    The Part 39 core principles reflect standards that the Commission
takes into account in overseeing the clearing of futures and option
contracts without imposing new regulatory requirements. Certain
commenters contended that Part 39 as proposed would impose a new
regulatory framework on entities already successfully regulated, and
that the Commission had not fully articulated why Part 39 was being
imposed at this time. See, e.g., CL 21-51 at 11 and CL 23-40 at 2.
    The Commission currently oversees the clearing organizations that
are associated or affiliated with U.S. futures and option exchanges. As
a practical matter, the Commission generally has regulated clearing
organizations in connection with its oversight of contract markets
which heretofore have had close affiliations with their clearing
organizations. Among other things, the Commission has reviewed clearing
organization rules, audited clearing organizations for compliance with
the Commission's segregation, recordkeeping, and customer funds
investment rules, monitored the clearing process in times of major
market moves to identify potential systemic risks, and conducted
oversight of the liquidation of positions and transfer of customer
accounts in cases where clearing members encounter financial
difficulty.
    The Commission's oversight of clearing organizations also has been
guided by standards not expressly set forth in the Act or the
Commission's regulations for contract markets. For example, the
Commission has taken into account, among other standards and
procedures, the standards set forth in the Bank for International
Settlements' (BIS) 1993 Lamfalussy Report on multilateral netting
systems and other BIS reports, the recommendations with respect to
clearing and settlement of

[[page 78022]]

securities transactions of the Group of Thirty, and the recommendations
of the President's Working Group in response to the market break of
October 1987. Part 39's core principles reflect these various standards
and existing futures clearing organizations currently meet these
standards. Thus, Part 39 represents the Commission's intention to put
into a logical and coherent regulatory form the same principles that
the Commission now applies to clearing organizations. This approach is
a natural accompaniment to the new regulatory framework.
    Recently, there has been an increase in the number of new
electronic markets that do not have their own clearing capacity. This
trend has resulted in an increase in the opportunity for clearing
organizations independent of transaction facilities to clear for
multiple markets, which in turn magnifies the importance of clearing in
the management of systemic risk. Clearing organizations unaffiliated
with the transaction facilities for which they clear necessarily will
have rules, procedures, and practices separate and independent from the
transaction facilities. Thus, the Commission will oversee the clearing
function pursuant to a framework separate from, but related to, the
framework for the oversight of the transaction facilities.

B. Definition of Clearing Organization

    In its final Part 39 rules, the Commission has clarified the
definition of ``clearing organization'' to mean, with respect to
transactions executed on a designated contract market or pursuant to
Parts 35-38, a person that provides credit enhancement to its members
or participants in connection with netting and/or settling the payments
and payment obligations of such members or participants, by becoming a
universal counterparty to such members or participants, or
otherwise.\5\ Providing credit enhancement in connection with, or as a
byproduct of, providing settlement services is the critical attribute
of a clearing organization.
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    \5\ The definition continues to exclude those netting
arrangements specified in Sec. 35.2 (d)(1) and (d)(2) and an entity
that is a single counterparty offering to enter into, or entering
into, bilateral transactions with multiple counterparties.
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    Some of the comments raised concerns about the proposed definition
in that they stated certain activities should not constitute the
activity of clearing. See, e.g., BOTCC CL 21-20 at 10. These activities
include the netting of payment obligations and entitlements and the
performance of trade processing services such as trade comparison,
margin calculation, and reporting services.\6\ In response to these
comments, the revised definition captures only organizations whose
services enhance the credit of the members or participants that are
parties to the contracts cleared by the organization.
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    \6\ It also includes, where applicable, the scheduling or
netting of physical delivery obligations and related bookkeeping
functions such as those performed by operators of physical delivery
points for certain energy-related products. See CL 21-56 at 2.
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    One method of credit enhancement is to be the counterparty to every
cleared transaction. The clearing organization substitutes itself for
each original counterparty and becomes legally bound to every party to
a transaction. This is known as legal novation. However, a clearing
organization can provide credit enhancement in ways other than strict
legal novation. It can agree with its members and participants that it
will be legally bound to guarantee payment flows associated with
transactions in connection with or as a byproduct of the provision of
netting services, that is, the netting of all payment obligations and
entitlements. A clearing organization also could provide credit
enhancement in any legal agreement to guarantee payment flows in
connection with other settlement services.
    The provision of one or more clearing services absent credit
enhancement, however, will not, as a general matter, constitute the
activity of clearing for purposes of Part 39. Therefore, for purposes
of Part 39, the term ``clearing organization'' does not encompass the
sole provision of netting services in the absence of any type of credit
enhancement.

C. Scope of Part 39

    The language of the scope provision, Sec. 39.1, the enforceability
provision, Sec. 39.5, and the antifraud provision, Sec. 39.6, in their
final form, all apply to an RCO's clearing of transactions effected
pursuant to the enumerated parts. The final language of Sec. 39.2
clarifies:
    (1) what must be cleared by an RCO (any transaction effected on a
contract market or pursuant to Parts 37 and 38 that is cleared);
    (2) that the clearing of transactions by an RCO is regulated under
Part 39;
    (3) that transactions effected pursuant to Parts 35 or 36 may be
cleared by an RCO or by other authorized clearing organizations;\7\
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    \7\ Transactions pursuant to Part 34 are not included in 39.2 or
otherwise referred to in Part 39 as these instruments have
consistently been subject to other regulatory schemes, whether under
the jurisdiction of the SEC as securities, or regulated pursuant to
federal banking laws as depository instruments.
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    (4) that the clearing of transactions effected pursuant to Parts 35
or 36 by an RCO is regulated under Part 39;
    (5) that the clearing of transactions effected pursuant to Parts 35
or 36 by authorized clearing organizations other than an RCO is not
regulated under Part 39; and
    (6) that transactions not specified in 39.1(a) may also be cleared
by an RCO.
    The changes to the scope, enforceability and antifraud provisions
address commenters' concerns that: (1) proposed Part 39 could be
interpreted to apply the Act and the Commission's regulations to
transactions outside the appropriate scope of Part 39, such as cash
products or other products beyond the authority of the Act, see, e.g.,
CME CL 21-51 at 9-10; (2) it may appear as if the Commission is
attempting to expand its jurisdiction to include any over-the-counter
transaction that is submitted to an RCO for clearing, id.; (3) the new
part should clarify that transactions effected pursuant to Parts 35 or
36 do not become subject to the jurisdiction of the Commission simply
because they are submitted to a Part 39 clearing organization and that
clearing does not, by itself, make an exempt transaction subject to the
Act, see BOTCC CLs 21-6 at 4 and 21-20 at 8; and (4) the effect of
Sec. 39.6 would not be the assertion of the Commission's enforcement
authority over otherwise-exempt transactions simply because those
transactions are submitted to clearing. As proposed, Sec. 39.6
prohibited fraud in connection with any transaction cleared by an RCO.
The final section prohibits fraud in connection with the activity of
clearing. See BOTCC CL 21-6 at 4, FRB of Chicago CL 23-25 at 7 and GSCC
CL 23-19 at 4.
    As discussed, the final Part 39 rules address these comments. The
Commission is not hereby asserting jurisdiction over transactions in
cash and other products not subject to the Act. Commission oversight of
an RCO under Part 39 addresses the clearing process only and does not
include regulation or oversight of the transactions or the traders. The
Commission, however, notes that it must monitor for the potential that
clearing of cash and other products not subject to the Act could
adversely affect the viability, risk exposure, and management of the
entity as an RCO.\8\
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    \8\ An analogy can be drawn to the interest the Commission has
in assessing risk presented to futures commission merchants (FCMs)
by their non-futures activities. Thus, for example, the Commission's
net capital rule has provisions relating to the capital treatment of
securities and other non-futures inventory held by an FCM in the
normal course of its business. See Commission Regulation 1.17. See
also Commission Regulations 1.14 and 1.15 that assess risk to a
registered FCM from affiliates in its holding company system.

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[[page 78023]]

D. Treatment as Contract Market

    As proposed, Sec. 39.1(b)(2) provided that an RCO would be deemed
to be a contract market for purposes of the Act and the regulations,
but would be exempt from all such provisions except as reserved in
Sec. 39.5. In its final rules, the Commission has combined the language
of proposed Sec. 39.1(b)(2) with proposed Sec. 39.5. Section 39.5 now
provides that an RCO is deemed to be a contract market to the extent it
clears transactions specified in Sec. 39.1(a) (the scope provision),
but is exempt from all provisions of the Act and regulations except, as
applicable, certain enumerated sections of the Act and the Commission's
regulations which would continue to apply.
    Combining the separate provisions and amending the resulting
Sec. 39.5 as indicated, limits the purpose for which RCOs are deemed to
be contract markets and addresses commenters' concern that the
provision would subject clearing organizations to provisions of the Act
and the Commission's regulations that do not now apply. See, e.g.,
BOTCC CL 21-6 at 4. Pursuant to the final rule, an RCO is deemed to be
a contract market only to the extent it clears those transactions
specified in Sec. 39.1(a). Further, even though an RCO is deemed to be
a contract market to this limited extent, Sec. 39.5 exempts it from all
provisions of the Act and regulations, except the sections enumerated,
and only to the extent those enumerated sections are applicable to the
activity of clearing Sec. 39.1(a) transactions.
    In reserving the sections of the Act and the regulations enumerated
in Sec. 39.5, the Commission is not asserting that any of those
sections or regulations would be applicable to an RCO under any
particular circumstances. The Commission only seeks, conservatively, to
reserve those sections of the Act and regulations that may need to be
applied to an RCO in order to achieve compliance with the core
principles set forth in Part 39. The reservations in Sec. 39.5 of
Sections 4b and 4o of the Act and Rule 33.10 will subject RCOs to the
same standard with respect to fraud and manipulation in connection with
the clearing of transactions to which clearing organizations are
currently subject. See FIA CL 23-26 at 5. Reservation of the enumerated
sections of the Act or regulations, including specifically Section 4i
of the Act and Rule 1.38(a), will not render RCOs responsible for the
enforcement of any new or additional regulatory requirements, nor
increase the liability of clearing organizations under Section 22 of
the Act. See BOTCC CLs 21-20 at 7 and 21-6 at 4.

E. Competitive Issues

    Commenters strongly agreed with the requirement in Sec. 39.2 that
all transactions effected on a contract market, RFE, or DTF, if
cleared, must be cleared by an RCO. For example, the CME expressed its
agreement with the result that a clearing organization that either is
governed by another regulator, or has no regulator, is prohibited from
clearing such products. CL 21-51 at 10. However, many commenters raised
concerns regarding the effect of Part 39 on the ability of RCOs to
compete with other types of clearing organizations. The commenters
stated that allowing clearing organizations other than RCOs, including
clearing organizations regulated by the SEC, to clear transactions
effected pursuant to Parts 35 or 36, will give clearing organizations
other than RCOs the ability to clear the full spectrum of financial
transactions--cash, securities, options, futures (if traded on an
exempt MTEF) and other derivatives. They further stated that the SEC,
however, will not allow an RCO that is not also registered as a
clearing agency with the SEC to clear transactions in securities. Id.
Commenters thought the proposal grants an unfair exemption to
securities clearinghouses, banks, bank affiliates, and foreign
clearinghouses from the substantive requirements that otherwise would
apply to RCOs. CLs 21-6 at 5, 21-20 at 5, 23-26 at 7, and 21-36 at 6.
    In authorizing particular clearing organizations in addition to
RCOs to clear transactions pursuant to Parts 35 and 36, the Commission
is adopting the unanimous recommendations made in the report of the
President's Working Group.\9\ The Commission notes that it has made
revisions elsewhere in its new regulatory framework (i.e., the final
rules under Parts 35-38) that lessen the impact of these concerns in
some instances. Under final rules adopted by the Commission in response
to comments made by the U.S. Department of the Treasury, transactions
based on U.S. government securities are not eligible for trading on
exempt MTEFs.\10\ Under part 39, only RCOs can clear transactions
effected on DTFs or RFEs.
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    \9\ Over-the-Counter Derivatives Markets and the Commodity
Exchange Act, Report of the President's Working Group, November
1999. The group, whose members were signatories to the report,
includes the Secretary of the Treasury, the Chairman of the Board of
Governors of the Federal Reserve System, the Chairman of the
Securities and Exchange Commission, and the Chairman of the
Commodity Futures Trading Commission.
    \10\ Specifically, the Commission has removed the reference to
exempt securities and indexes thereof previously included in
proposed Rule 36.2(b)(4) and has amended final Rule 36.2(b)(1) to
make clear that eligible debt instruments do not include such exempt
securities.
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F. Application of Core Principles and Appendix A

1. General
    RCO applicants must demonstrate compliance with each of the core
principles of Part 39 as a condition of recognition. These principles
will not subject RCOs to any regulatory requirement not now applicable
to futures clearing organizations under the Commission's current
oversight. Each of the core principles must be addressed, but the
guidance in Appendix A to Part 39 is intended only to be illustrative
of the types of matters an applicant may address in order to
satisfactorily demonstrate that it meets the core principles.
    The final appendix clarifies the purpose of the guidance in
response to commenters' concerns regarding the level of specificity in
Appendix A. Commenters were concerned that the guidance would take on
the force of law, applicants would have to affirmatively demonstrate
compliance with each provision, and clearing organizations would be
subject to far greater regulatory compliance burdens than before. See,
e.g., FIA CL 23-26 at 4 and BOTCC CL 21-20 at 10. Appendix A expressly
makes clear that it is neither a checklist of issues that an applicant
is required to address nor an exclusive list of matters from which an
applicant can choose applicable components to address. Rather, the
appendix provides detailed non-binding guidance that applicants can use
as a tool in demonstrating satisfaction of the core principles.
    In order to become recognized under Part 39, current futures
clearing organizations need only submit a certification that their
rules, procedures and operations fulfill the conditions for recognition
under Part 39.\11\ All of the current futures clearing organizations
could become recognized in this

[[page 78024]]

manner. They are not required to address affirmatively any of the
separate core principles (and none of the suggested guidance in
Appendix A).
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    \11\ Although Sec. 39.4(a) allows only nondormant entities, as
defined, to self-certify, the Commission is prepared to accept the
certification of the Intermarket Clearing Corporation (ICC) under
this provision. ICC is a wholly-owned subsidiary of the Options
Clearing Corporation. Commission staff is familiar with ICC's rules
and operations. ICC has maintained its clearing systems, rules, and
banking and other arrangements in place and remains fully prepared
operationally to clear transactions in futures contracts in
accordance with its rules.
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2. The Core Principles
    The final rules contain changes that address commenters' views
concerning the wording and applicability of particular core principles.
Commenters requested that Core Principle 2, which deals with
participant and product eligibility, be revised to eliminate product
eligibility criteria for instruments that an RCO will accept for
clearing. Commenters contended that this requirement was impractical,
would require an extraordinary degree of prognostication and would best
be dealt with on a case-by-case basis by an RCO, considering all
relevant circumstances. BOTCC CL 21-20 at 13. The Commission has
revised the final core principle and the accompanying appendix guidance
accordingly.
    Several commenters thought that Core Principle 7 on enforcement
inappropriately required arrangements and resources for resolution of
disputes and encouraged the Commission to eliminate it from the
principle. See, e.g., NYCC CL 23-40 at 4 and GSCC 23-19 at 4. The
Commission has considered the commenters' concerns that this
requirement would impose a new and inappropriate burden on RCOs, but
has determined to retain it in the core principle with the added
qualification of ``as applicable.'' The Commission does not wish to
rule out the possible appropriateness of some form of dispute
resolution at RCOs as the industry continues to evolve. By qualifying
the item with its applicability, RCO applicants can choose to address
whether and why they do or do not have a dispute resolution program in
demonstrating that they will be able to effectively enforce their
rules.
    The final version of the other core principles contains
modifications that serve to increase their intended breadth and
flexibility. For example, Core Principle 1, which deals with financial
resources, as proposed, required adequate capital resources to fulfill
its guarantee function without interruption in various market
conditions. At the suggestion of one of the commenters, the final
version of Core Principle 1 requires adequate financial resources to
fulfill its guarantee function without interruption in reasonably
foreseeable market conditions. See Coalition CL 23-41 at 24. In
addition, Core Principle 14 concerning competition has been revised.
The Commission does not want to inadvertently impose duties on an
applicant that differ in form or degree from the antitrust statutes and
court decisions construing federal antitrust laws. See BOTCC CL 21-20
at 13. Thus, final Core Principle 14 simply requires RCOs to operate in
a manner consistent with the public interest to be protected by the
antitrust laws. This language comes directly from Section 15 of the Act
which the Commission has reserved in Sec. 39.5. The requirements of
Section 15 remain the responsibility of the Commission and the
Commission intends to apply Section 15 to antitrust issues in the same
manner as previously applied.
    Core Principle 12 regarding public disclosure of certain operating
procedures of an RCO was not revised in response to concerns regarding
confidentiality. An RCO, however, will not be required under this core
principle to disclose trade secrets.
3. The Guidance in Appendix A
    Commenters also expressed opinions about the applicability and
wording of particular proposed guidance in Appendix A. Many of these
concerns are addressed by language in the final appendix that states
the guidance is only illustrative of the types of matters an applicant
may address in order to demonstrate that it meets the core principles
and is not intended to be a mandatory checklist of issues to address.
If particular guidance does not apply to an RCO applicant, it may
either not address it or explain why it does not apply. Applicants also
are strongly encouraged to address relevant matters other than those
contained in the guidance suggested in the appendix if doing so would
assist the applicant in demonstrating compliance with a particular core
principle.
    The Commission has modified certain of the guidance in response to
commenters' concerns regarding the appropriateness or applicability of
particular guidance language. In response to comments that the
Commission does not have the authority to review the setting of levels
of margin, the Commission revised guidance regarding the determination
of appropriate margin levels for a cleared contract and the clearing
member clearing the contract. See, e.g., FIA CL 23-26 at 4. The final
version of this guidance suggests that an applicant may describe the
process by which it would determine appropriate margin levels for an
instrument that it clears and its clearing members. This information is
highly relevant and could be used by an applicant for RCO status to
assist in demonstrating that it meets the third core principle
concerning the ability to manage risks associated with carrying out the
guarantee function.
    Several comments addressed the appropriateness of the proposed
guidance under Core Principle 6 concerning default rules and
procedures. The guidance suggested that applicants describe rules and
procedures regarding priority of customer accounts over proprietary
accounts and, where applicable, in the context of other programs such
as specialized margin reduction programs like cross-margining.
Commenters argued that given the successful operation of cross-
margining programs, it is inappropriate for the accounts of cross-
margining participants to be subordinated to the accounts of market
participants not participating in cross-margining programs. OCC CL 23-
23 at 2, 3. The Commission has considered this argument and although it
recognizes that cross-margining programs have been successful and can
operate to reduce risks, including risk of participant default, it has
determined to retain this guidance in the final Appendix A. The
guidance is appropriate in that it only suggests that an applicant RCO
that is proposing or contemplating being a party to a margin reduction
program such as cross-margining address in its application whether and
why a priority rule would or would not be present in any particular
margin reduction program. It does not require such a priority rule.
This information will provide relevant and useful information to the
Commission in assessing the applicant's overall compliance with all
aspects of Core Principle 6.
    The Commission modified other guidance under various core
principles in response to comments received. For example, the final
guidance under Core Principle 8 dealing with system safeguards suggests
that an applicant may confirm that system testing and review has been
performed by a qualified independent professional, and not specifically
by a member of the Information Systems Audit and Control Association. A
professional that is a certified member of the Information Systems
Audit and Control Association experienced in the industry, however, is
referred to as an example of an acceptable party to carry out such
testing and review. See CL 21-20 at 10. In addition, the Commission has
modified the guidance for Core Principle 9 relating to governance to
note that an RCO, consistent with longstanding Commission policy, may
not limit liability for violation of the Act or Commission rules,
fraud, or wanton or willful misconduct. This requirement

[[page 78025]]

currently applies to designated contract markets.

G. Other Comments

    Certain commenters suggested that the Commission restrict the
length of time that a proposed RCO rule could be stayed under
Commission Regulation 1.41. See e.g., CL 21-20 at 12. The Commission
anticipates that it only will impose a stay of an RCO rule in limited
and potentially egregious situations. In fact, the Commission would
only be able to stay a proposed rule incident to disapproval
proceedings and the stay determination would not be delegable to
Commission staff. Since a rule only would be stayed incident to a
disapproval proceeding, the length of any stay would not be
indeterminate in any event.
    Certain commenters raised questions as to whether bankruptcy
provisions that are currently applicable to transactions conducted on a
contract market could also be applicable to all transactions cleared by
an RCO. See, e.g., CL 21-65 at 23. Part 39 reserves the applicability
of Part 190 to the activity of clearing Sec. 39.1(a) transactions, if
applicable. Part 190 in conjunction with the commodity broker
liquidation provisions of Subchapter IV of Chapter 7, Title 11 of the
Federal Bankruptcy Code, apply to an insolvency when the insolvent
party is a ``commodity broker'' (typically an FCM or clearing
organization that has any futures accounts), as defined under Title 11.
If an RCO does not have open futures accounts it would not be covered
by SubChapter IV.

IV. Section 4(c) Findings

    These final rules are being promulgated 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, including any person or class of persons offering,
entering into, rendering advice or rendering other services with
respect to, the agreement, contract, or transaction, from the contract
market designation requirement of Section 4(a) of the Act, or any other
provision of the Act other than Section 2(a)(1)(B), if the Commission
determines that the exemption would be consistent with the public
interest. Furthermore, Section 4(c)(2) of the Act provides that the
Commission may not grant an exemption from the contract market
designation requirement of Section 4(a) of the Act unless the
Commission also finds that: (i) the contract market designation
requirement should not be applied to the agreement, contract, or
transaction for which the exemption is requested and the exemption
would be consistent with the public interest and the purposes of the
Act; (ii) the exempted transaction will be entered into solely between
``appropriate persons''; and (iii) the agreement, contract, or
transaction in questions will not have a material adverse effect on the
ability of the Commission or any contract market to discharge its
regulatory or self-regulatory duties under the Act.
    As explained above, Part 39 is part of a new regulatory framework.
The new framework is intended to promote innovation and competition in
the trading of derivatives and to permit the markets the flexibility to
respond to technological and structural changes. Specifically, Part 39
replaces Commission regulation of clearing organizations through the
current more formal designation and regulation of contract markets. It
provides for a streamlined procedure for clearing organizations to
obtain recognition by meeting broad, non-prescriptive core principles.
It permits recognized clearing organizations the flexibility to clear
regulated, exempt, and unregulated transactions. It also authorizes
clearing organizations regulated by other regulatory bodies to clear
certain transactions. The core principle approach set forth in Part 39
strikes an appropriate balance between applying necessary regulatory
protections to the critical market functions of clearing and
facilitating the development of varied clearing mechanisms and
structures. Accordingly, the Commission believes that Part 39 is
consistent with the public interest, is consistent with the purposes of
the Act, will be applicable only to appropriate persons, and would have
no adverse effect on the regulatory or self-regulatory responsibilities
imposed by the Act.

V. Related Matters

A. Regulatory Flexibility Act

    The Regulatory Flexibility Act (RFA), 5 U.S.C. 601 et seq.,
requires that agencies, in promulgating rules, consider the impact of
those regulations on small entities. The rules adopted herein would
affect certain clearing organizations. The Commission has stated that
it is appropriate to evaluate within the context of a particular rule
whether some or all of affected entities should be considered small
entities and, if so, to analyze the economic impact on them of any
rule. In this regard, the rules being adopted herein would not require
any current futures clearing organization to change any aspect of its
operation or take any action other than to submit a certification. The
rules being adopted replace regulation of clearing organizations
through the formal designation and regulation of contract markets with
a streamlined procedure for clearing organizations, regardless of size,
to obtain recognition by meeting broad, non-prescriptive core
principles. Accordingly, the Chairman, on behalf of the Commission,
hereby certifies, pursuant to 5 U.S.C. 605(b), that the action taken
herein will not have a significant economic impact on a substantial
number of small entities. In this regard, the Commission notes that it
did not receive any comments regarding the RFA implications of Part 39.

B. Paperwork Reduction Act

    Part 39 contains information collection requirements. As required
by the Paperwork Reduction Act of 1995, 44 U.S.C. 3501 et seq., the
Commission submitted a copy of this part to the Office of Management
and Budget (OMB) for its review. See 44 U.S.C. Sec. 3507(d). No
comments were received in response to the Commission's invitation in
the proposing release to comment on any potential paperwork burden
associated with this regulation.

List of Subjects in 17 CFR Part 39

    Clearing, Clearing Organizations, Commodity Futures, Consumer
Protection.

    In consideration of the foregoing, and pursuant to the authority
contained in Sections 2, 6(c), 7a, and 12a(5) of the U.S.C., 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--RECOGNIZED CLEARING ORGANIZATIONS

Sec.
39.1  Scope and definitions.
39.2  Permitted clearing.
39.3  Conditions for recognition as a recognized clearing
organization.
39.4  Procedures for recognition.
39.5  Enforceability.
39.6  Fraud in connection with the clearing of transactions by a
recognized clearing organization.
Appendix A to Part 39--Application Guidance

    Authority: 7 U.S.C. 2, 6(c), 6d(2), 6g, 7a, 12a(5).

[[page 78026]]

Sec. 39.1  Scope and definitions.

    (a) Scope. The provisions of this part 39 apply to a recognized
clearing organization that clears transactions effected on or through a
designated contract market, a recognized futures exchange under part 38
of this chapter, a derivatives transaction facility under part 37 of
this chapter, an exempt multilateral transaction execution facility
under part 36 of this chapter, and to exempt bilateral transactions
under part 35 of this chapter.
    (b) Definitions. For purposes of this part:
    (1) Clearing organization means a person that provides a credit
enhancement function with respect to transactions executed on a
designated contract market or pursuant to Parts 35 through 38 of this
chapter in connection with netting and/or settling the payments and
payment obligations of such members or participants, by becoming a
universal counterparty to such members or participants, or otherwise;
but does not include those netting arrangements specified in
Sec. 35.2(d)(1) and (d)(2), nor does it include an entity that is a
single counterparty offering to enter into, or entering into bilateral
transactions with multiple counterparties.
    (2) Recognized clearing organization means a clearing organization
that has been recognized by the Commission under Sec. 39.3.


Sec. 39.2  Permitted clearing.

    (a) Any transaction effected on a designated contract market,
recognized futures exchange, or derivatives transaction facility, if
cleared, shall be cleared by a recognized clearing organization. The
clearing of transactions by a recognized clearing organization shall be
governed by the provisions of this part.
    (b) A transaction effected pursuant to part 35 or part 36 of this
chapter, if cleared, shall meet the requirements of Sec. 35.2(c) or
Sec. 36.2(c) of this chapter, as applicable, if the transaction is
cleared by one of the following authorized clearing organizations:
    (1) A recognized clearing organization;
    (2) A securities clearing agency subject to the supervisory
jurisdiction of the Securities and Exchange Commission;
    (3) A clearing system organized as a bank, bank subsidiary,
affiliate of a bank, or Edge Act corporation established under the
Federal Reserve Act authorized to engage in international banking or
financial activities, and subject to the jurisdiction of the Federal
Reserve or Comptroller of the Currency; or
    (4) A foreign clearing organization that demonstrates to the
Commission that it:
    (i) Is subject to home country regulation and oversight comparable
to the standards set forth by the Commission for recognition of
clearing organizations under this part; and
    (ii) Is a party to and abides by appropriate and adequate
information-sharing arrangements.
    (c) The clearing of transactions effected pursuant to part 35 or
part 36 of this chapter by a recognized clearing organization shall be
governed by the provisions of this part. The provisions of this part
shall not apply to the clearing of transactions effected pursuant to
part 35 or part 36 by an authorized clearing organization other than a
recognized clearing organization.
    (d) Nothing in this part prohibits clearing by a recognized
clearing organization of transactions not specified in Sec. 39.1(a).


Sec. 39.3  Conditions for recognition as a recognized clearing
organization.

    To be recognized by the Commission under this part 39 as a
recognized clearing organization, an entity:
    (a) Need not be affiliated with a designated contract market or
recognized futures exchange under part 38 of this chapter, derivatives
transaction facility under part 37 of this chapter, or exempt
multilateral transaction execution facility under part 36 of this
chapter;
    (b) Must have rules and procedures relating to its governance and
to the operation of its clearing function; and
    (c) Must initially, and on a continuing basis, meet and adhere to
the following core principles:
    (1) Financial resources: Have adequate financial resources to
fulfill its guarantee function without interruption in reasonably
foreseeable market conditions.
    (2) Participant eligibility: Have appropriate admission and
continuing eligibility standards for members or participants of the
organization.
    (3) Risk management: Have the ability to manage the risks
associated with carrying out its guarantee function through the use of
tools and procedures appropriate under the circumstances.
    (4) Settlement procedures: Have the ability to complete settlements
on a timely basis under varying circumstances, to maintain an adequate
record of the flow of funds associated with the transactions it clears,
and, to the extent applicable, to comply with the terms and conditions
of any netting or offset arrangements with other clearing
organizations.
    (5) Treatment of member and participant funds: Have adequate
procedures designed to protect the safety of member and participant,
and as applicable, customer funds held by the clearing organization.
    (6) Default rules and procedures: Have rules and procedures
designed to allow for the effective and fair management of events when
members or participants become insolvent or otherwise default on their
obligations to the clearing organization.
    (7) Rule enforcement: Have arrangements and resources for the
effective monitoring and enforcement of compliance with its rules and,
as applicable, for resolution of disputes.
    (8) System safeguards: Have a program of testing, oversight, and
risk analysis to ensure that its automated systems function properly
and have adequate capacity, security, emergency, and disaster recovery
procedures.
    (9) Governance: Have appropriate fitness standards for owners or
operators with greater than ten percent interest or an affiliate of
such an owner, and for members of the governing board, and a means to
address conflicts of interest in making decisions.
    (10) Reporting: Provide all information requested by the Commission
for it to conduct its oversight function of the clearing organization's
activities.
    (11) Recordkeeping: Keep full books and records of all activities
relating to its business as a recognized clearing organization in a
form and manner acceptable to the Commission for a period of five
years, during the first two of which the books and records are readily
available, and which shall be open to inspection by any representative
of the Commission or the U.S. Department of Justice.
    (12) Public information: Publicly disclose information concerning
the rules and operating procedures governing its clearing and
settlement systems, including default procedures.
    (13) Information sharing: Participate in domestic and international
information-sharing agreements as appropriate and use information
obtained from such agreements in carrying out the clearing
organization's risk management program.
    (14) Competition: Operate in a manner consistent with the public
interest to be protected by the antitrust laws.


Sec. 39.4  Procedures for recognition.

    (a) Recognition by certification. A clearing organization that
cleared for at least one nondormant contract market

[[page 78027]]

within the meaning of Sec. 5.3 of this chapter on February 12, 2001,
will be recognized by the Commission as a recognized clearing
organization upon receipt by the Commission at its Washington, DC,
headquarters of a copy of the clearing organization's current rules and
a certification by the clearing organization that it meets the
conditions for recognition under this part.
    (b) Recognition by application. A clearing organization shall be
recognized by the Commission as a recognized clearing organization
sixty days after receipt by the Commission of an application for
recognition unless notified otherwise during that period, if:
    (1) The application demonstrates that the applicant satisfies the
conditions for recognition under this part;
    (2) The submission is labeled as being submitted pursuant to this
part;
    (3) The submission includes a copy of the applicant's rules and, to
the extent that compliance with the conditions of recognition is not
self-evident, a brief explanation of how the rules satisfy each of the
conditions for recognition under Sec. 39.3;
    (4) The applicant does not amend or supplement the application for
recognition, except as requested by the Commission or for correction of
typographical errors, renumbering or other nonsubstantive revisions,
during that period; and
    (5) The applicant has not instructed the Commission in writing
during the review period to review the application pursuant to
procedures under section 6 of the Act.
    (6) Appendix A to this part is guidance to applicants concerning
how the core principles set forth in this paragraph (b) could be
satisfied.
    (c) Termination of part 39 review. During the sixty-day period for
review pursuant to paragraph (b) of this section, the Commission shall
notify the applicant seeking recognition that the Commission is
terminating review under this section and will review the proposal
under the procedures of section 6 of the Act, if it appears that the
application fails to meet the conditions for recognition under this
part. This termination notification will state the nature of the issues
raised and the specific condition of recognition that the application
appears to violate, is contrary to, or fails to meet. Within ten days
of receipt of this termination notification, the applicant seeking
recognition may request that the Commission render a decision whether
to recognize the clearing organization or to institute a proceeding to
disapprove the proposed submission under procedures specified in
section 6 of the Act by notifying the Commission that the applicant
seeking recognition views its submission as complete and final as
submitted.
    (d) Delegation of authority. (1) The Commission hereby delegates to
the Director of the Division of Trading and Markets or the Director's
delegatee, with the concurrence of the General Counsel or the General
Counsel's delegatee, authority to notify an entity seeking recognition
under paragraph (b) of this section that review under those procedures
is being terminated.
    (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 the paragraph prohibits the Commission, at its
election, from exercising the authority delegated in paragraph (d)(1)
of this section.
    (e) Request for Commission approval of rules. (1) An applicant for
recognition as a recognized clearing organization may request that the
Commission approve any or all of its rules and subsequent amendments
thereto, at the time of recognition or thereafter, under section
5a(a)(12) of the Act and Sec. 1.41 of this chapter. The recognized
clearing organization may label such rules as having been approved by
the Commission.
    (2) Rules of a recognized clearing organization that have not been
submitted pursuant to paragraph (a) or (b)(3) of this section shall be
submitted to the Commission pursuant to Sec. 1.41 of this chapter.
    (3) An applicant seeking recognition as a recognized clearing
organization may request that the Commission consider under the
provisions of section 15 of the Act any of the entity's rules or
policies at the time of recognition or thereafter.
    (f) Request for withdrawal of recognition. A recognized clearing
organization may withdraw from Commission recognition by filing with
the Commission at its Washington, DC headquarters such a request.
Withdrawal from recognition 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 clearing organization was recognized
by the Commission.


Sec. 39.5  Enforceability.

    To the extent it clears transactions specified in Sec. 39.1(a), a
recognized clearing organization shall be deemed to be a contract
market for purposes of the Act and the Commission rules thereunder;
provided, however, a recognized clearing organization shall be exempt
from all provisions of the Act and Commission regulations except, as
applicable, sections 1a, 2(a)(1), 4, 4b, 4c, 4d, 4g, 4i, 4o, 5(6),
5(7), 5a(a)(1), 5a(a)(2), 5a(a)(8), 5a(a)(9), the rule disapproval
procedures of section 5a(a)(12), 5a(a)(16), 5a(a)(17), 6(a), 6(c) to
the extent it prohibits manipulation of the market price of any
commodity in interstate commerce or for future delivery on or subject
to the rules of any contract market, 8a(7), 8a(9), 8c(a), 8c(b), 8c(c),
8c(d), 9(a), 9(f), 14, 15, 20 and 22 of the Act and Secs. 1.3, 1.20,
1.24, 1.25, 1.26, 1.27, 1.29, 1.31, 1.36, 1.38, 1.41, parts 15 through
21, Sec. 33.10, this part 39, and part 190 of this chapter, which
continue to apply.


Sec. 39.6  Fraud in connection with the clearing of transactions by a
recognized clearing organization.

    It shall be unlawful for any person, directly or indirectly, in or
in connection with the clearing of any transaction specified in
Sec. 39.1(a) by a recognized 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 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

    This appendix provides guidance to applicants for recognition as
recognized clearing organizations in connection with satisfying each
of the core principles of Sec. 39.4. This appendix is only
illustrative of the types of matters an applicant may address, as
applicable, in order to demonstrate satisfactorily that it meets the
core principles and is not intended to be a mandatory checklist of
issues to address.

Core Principle 1--Financial Resources. Have adequate financial
resources to fulfill its guarantee function without interruption in
reasonably foreseeable market conditions.

    In addressing core principle 1, applicants 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

[[page 78028]]

accessed and applied by the clearing organization promptly; and
    b. Any legal or operational impediments or conditions to access.

Core Principle 2--Participant Eligibility. Have appropriate admission
and continuing eligibility standards for members or participants of the
organization.

    In addressing core principle 2, applicants may describe or
otherwise document:
    1. Member/participant admission criteria:
    a. How admission standards for its clearing members 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, whether
different levels of membership would relate to different levels of
net worth, income, and creditworthiness of members, 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;
and
    b. Whether and how the clearing organization would be able to
change continuing eligibility criteria in accordance with changes in
a member's financial status.
    3. The clearing function for each instrument the organization
undertakes to clear.

Core Principle 3--Risk Management. Have the ability to manage the risks
associated with carrying out its guarantee function through the use of
tools and procedures appropriate under the circumstances.

    In addressing core principle 3, applicants 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; and
    b. How the organization would use specific risk management tools
such as stress testing and value at risk calculations.
    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;
    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 and how systems would be implemented
that would prevent members and other market participants from
exceeding credit limits.
    4. Use of cross-margin programs: How collateral assets subject
to cross-margining programs would provide, where applicable, for
clear, fair, and efficient loss-sharing arrangements in the event of
a program participant default.

Core Principle 4--Settlement Procedures. Have the ability to complete
settlements on a timely basis under varying circumstances, to maintain
an adequate record of the flow of funds associated with the
transactions it clears, and, to the extent applicable, to comply with
the terms and conditions of any netting or offset arrangements with
other clearing organizations.

    In addressing core principle 4, applicants 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 a
significant participant or member has 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 5--Treatment of Member and Participant Funds. Have
adequate procedures designed to protect the safety of member and
participant, and as applicable, customer funds held by the clearing
organization.

    In addressing core principle 5, applicants 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 which are subject to cross-margin or
similar agreements, and any other aspects of customer fund
segregation.
    3. Investment standards: How customer funds would be invested
consistent with high standards of safety and associated
recordkeeping regarding the details of such investments.

Core Principle 6--Default Rules and Procedures. Have rules and
procedures designed to allow for the effective and fair management of
events when members or participants become insolvent or otherwise
default on their obligations to the clearing organization.

    In addressing core principle 6, applicants 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 applicant would address failure to meet margin
requirements, the insolvent financial condition of a member or
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 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 financial
resources to address monetary shortfalls resulting from a default.
    4. Customer priority rule: Rules and procedures regarding
priority of customer accounts over proprietary accounts of
defaulting members or participants and, where applicable, in the
context of specialized margin reduction programs such as cross-
margining or trading links with other exchanges.

Core Principle 7--Rule Enforcement. Have arrangements and resources for
the effective monitoring and enforcement of compliance with its rules
and, as applicable, for resolution of disputes.

    In addressing core principle 7, applicants 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 effective
enforcement of rules and authority and ability to discipline and
limit or suspend a member's or 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,
and between members.

Core Principle 8--System Safeguards. Have a program of testing,
oversight and risk analysis to ensure that its automated systems
function properly and have adequate capacity, security, emergency, and
disaster recovery procedures.

    In addressing core principle 8, applicants may describe or
otherwise document:
    1. Oversight/risk analysis program:
    a. Whether a program addresses appropriate principles for the
oversight of automated systems to ensure that its clearing systems
function properly and have adequate capacity and security;

[[page 78029]]

    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. A professional
that is a certified member of the Information Systems Audit and
Control Association experienced in the industry is an example of an
acceptable party to carry out such testing and review.

Core Principle 9--Governance. Have appropriate fitness standards for
owners or operators with greater than ten percent interest or an
affiliate of such an owner, and for members of the governing board, and
a means to address conflicts of interest in making decisions.

    In addressing core principle 9, applicants may describe or
otherwise document:
    1. Standards for fitness for clearing organization owners,
operators, affiliates of owners or operators, and members of the
governing board based on disqualification standards under section
8a(2) of the Act and a history of serious disciplinary offenses,
such as those which would be disqualifying under Sec. 1.63 of this
chapter.
    2. Collection and verification of information supporting
compliance with standards: Verification information could be
registration information or certification of fitness or affidavit of
fitness by outside counsel based on other verified information.
    3. Methods to ascertain presence of conflicts of interest and
methods of making decisions in that event.
    4. A recognized clearing organization may not limit its
liability or the liability of any of its officers, directors,
employees, licensors, contractors and/or affiliates where such
liability arises from such person's violation of the Act or
Commission rules, fraud, or wanton or willful misconduct.

Core Principle 10--Reporting. Provide all information requested by the
Commission for it to conduct its oversight function of the clearing
organization's activities.

    In addressing core principle 10, applicants may describe or
otherwise document:
    1. Information necessary for the Commission to perform its
oversight activities of the recognized clearing organization's
activities:
    a. Information available to or generated by the clearing
organization that will be made 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;
    b. The types of information which are not believed to be
necessary to provide to the Commission and why; and
    c. The information the organization intends to make routinely
available to members/participants or the general public.
    2. Provision of information:
    a. The manner in which all relevant 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 11--Recordkeeping. Keep full books and records of all
activities relating to its business as a recognized clearing
organization in a form and manner acceptable to the Commission for a
period of five years, during the first two of which the books and
records are readily available, and which shall be open to inspection by
any representative of the Commission or the U.S. Department of Justice.

    In addressing core principle 11, applicants may describe or
otherwise document:
    1. Maintenance of records related to the function of a clearing
organization in a form and manner acceptable to the Commission:
    a. The different activities related to the function of the
clearing organization for which the organization intends to keep
books or records; and
    b. Any activity related to the function of a clearing
organization for which the organization does not intend to keep
books or records and why this is not viewed as necessary.
    2. How the entity would satisfy the requirements of Sec. 1.31 of
this chapter including:
    a. What ``full'' or ``complete'' would encompass with respect to
each type of book or record that would be maintained;
    b. How 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 12--Public Information. Publicly disclose information
concerning the rules and operating procedures governing its clearing
and settlement systems, including default procedures.

    In addressing core principle 12, applicants 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 rules;
    c. How member/participants may become familiar with such
procedures before participating in operations; and
    d. How member/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 participant's default.

Core Principle 13--Information Sharing. Participate in domestic and
international information-sharing agreements as appropriate, and use
information obtained from such agreements in carrying out the clearing
organization's risk management program.

    In addressing core principle 13, applicants 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. Using information obtained from information-sharing
arrangements in carrying 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 14--Competition. Operate in a manner consistent with the
public interest to be protected by the antitrust laws.

    Pursuant to Core Principle 14, an entity seeking recognition as
a recognized clearing organization may request the Commission
consider under the provisions of section 15 of the Act any of the
entity's rules or policies at the time of application for
recognition or thereafter. The Commission intends to apply section
15 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, D.C., this 21st day of November, 2000, by
the Commission.
Jean A. Webb,
Secretary of the Commission.

[This statement will not appear in the Code of Federal Regulations.]

Concurrence of Commissioner Thomas J. Erickson Regarding Final
Rules for a New Regulatory Framework for Clearing Organizations

    I concur with the adoption of the final rules relating to
clearing organizations. Increasingly, clearing is being de-coupled
from the exchange. More electronic

[[page 78030]]

exchanges are choosing to contract with new or existing clearing
organizations for this aspect of traditional exchange activity. From
what the Commission heard at the public hearing on the proposed
framework, this trend is expected to continue and accelerate.
Accordingly, this proposal represents a first step toward providing
clearing organizations with the flexibility they will need to adapt
to this new environment.
    Nevertheless, I am sympathetic to the concerns of domestic
clearing organizations regarding competition, jurisdiction and
scope. Specifically, the final rule's treatment of securities
clearinghouses, banks, bank affiliates, and foreign clearinghouses
with regard to the requirements of Part 39 would appear to subject
futures clearinghouses to a significant competitive disadvantage.
The Commission's final rules justify this approach with little more
than the observation that it is consistent with the ``unanimous
recommendations of the President's Working Group.'' \1\ Much more
needs to be done so that one segment of the industry is not
disproportionately affected and unfairly hamstrung by these
regulations. Therefore, while I support the final rules to the
extent they represent the Commission's willingness to meet the
evolving marketplace with innovative approaches, I do so with the
caveat that Part 39 will clearly need the Commission's full
attention in order to ensure that the Commission is not picking
winners and losers. At a minimum, since these reforms follow so
closely the recommendations of the President's Working Group, I hope
that the members of the PWG will respond swiftly to today's action
by making parallel changes to their own regulatory schemes
implementing the PWG's recommendations.
---------------------------------------------------------------------------

    \1\ See Final Rules for a New Regulatory Framework for Clearing
Organizations, p.12.

    Date: November 20, 2000.
Thomas J. Erickson,
Commissioner.
[FR Doc. 00-30269 Filed 12-12-00; 8:45 am]
BILLING CODE 6351-01-P
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