Source: https://www.federalregister.gov/documents/2011/08/01/2011-19365/customer-clearing-documentation-and-timing-of-acceptance-for-clearing
Timestamp: 2019-02-16 15:19:27
Document Index: 229268053

Matched Legal Cases: ['§\u2009145', '§\u20091', '§\u200923', '§\u200923', '§\u200939', '§\u20091', '§\u20091', '§\u200923', '§\u200939', '§\u200939', '§\u200939', '§\u200939', '§\u20091', '§\u200939', '§\u200939', '§\u200939', '§\u200939', '§\u20091', '§\u200923', '§\u20091', '§\u20091', '§\u200939', '§\u200939', '§\u200939', '§\u20091', 'art 1', '§\u20091', '§\u200923', '§\u200939', '§\u20091', 'art 1', '§\u200923', 'art 23', '§\u200923', '§\u200923', 'art 23', '§\u200923', '§\u200939', '§\u200939', '§\u200939', '§\u200923', '§\u2009155']

Federal Register :: Customer Clearing Documentation and Timing of Acceptance for Clearing
A Proposed Rule by the Commodity Futures Trading Commission on 08/01/2011
45730-45738 (9 pages)
2011-19365
https://www.federalregister.gov/d/2011-19365 https://www.federalregister.gov/d/2011-19365
Please submit your comments using only one method. RIN number, 3038-AD51, must be in the subject field of responses submitted via e-mail, and clearly indicated on written submissions. All comments must be submitted in English, or if not, accompanied by an English translation. Comments will be posted as received to http://www.cftc.gov. You should submit only information that you wish to make available publicly. If you wish the CFTC to consider information that you believe is exempt from disclosure under the Freedom of Information Act, a petition for confidential treatment of the exempt information may be submitted according to the procedures established in § 145.9 of the CFTC's regulations.[1]
On July 21, 2010, President Obama signed the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act).[2] Title VII of the Dodd-Frank Act amended the Commodity Exchange Act (CEA or Act) [3] to establish a comprehensive new regulatory framework for swaps. The legislation was enacted to reduce risk, increase transparency, and promote market integrity within the financial system by, among other things: (1) Providing for the registration and comprehensive regulation of swap dealers and major swap participants; (2) imposing clearing and trade execution requirements on standardized derivative products; (3) creating rigorous recordkeeping and real-time reporting Start Printed Page 45731regimes; and (4) enhancing the Commission's rulemaking and enforcement authorities with respect to, among others, all registered entities and intermediaries subject to the Commission's oversight. Title VII also includes amendments to the federal securities laws to establish a similar regulatory framework for security-based swaps under the authority of the Securities and Exchange Commission (SEC).
A fundamental premise of the Dodd-Frank Act is that the use of properly regulated central clearing can reduce systemic risk. Another tenet of the Dodd-Frank Act is that open access to clearing by market participants will increase market transparency and promote market efficiency by enabling market participants to reduce counterparty risk and by facilitating offset of open positions. The Commission has proposed extensive regulations addressing open access at the derivatives clearing organization (DCO) level.[4]
Pursuant to these provisions, the Commission has proposed § 1.71(d)(1) relating to FCMs and § 23.605(d)(1) relating to SDs and MSPs.[5] These regulations would prohibit SDs and MSPs from interfering or attempting to influence the decisions of affiliated FCMs with regard to the provision of clearing services and activities and would prohibit FCMs from permitting them to do so.
Section 4s(j)(6) of the CEA prohibits an SD or MSP from adopting any process or taking any action that results in any unreasonable restraint on trade or imposes any material anticompetitive burden on trading or clearing, unless necessary or appropriate to achieve the purposes of the Act. The Commission has proposed § 23.607 to implement this provision.[6]
Section 2(h)(1)(B)(ii) of the CEA requires that DCO rules provide for the non-discriminatory clearing of swaps executed bilaterally or through an unaffiliated designated contract market (DCM) or swap execution facility (SEF). The Commission has proposed § 39.12(b)(2) to implement this provision.[7]
On June 16, 2011, the Futures Industry Association (FIA) and the International Swap and Derivatives Association (ISDA), published an FIA-ISDA Cleared Derivatives Execution Agreement (Agreement) as a template for use by swap market participants in negotiating execution-related agreements with counterparties to swaps that are intended to be cleared.[8] The Agreement was developed with the assistance of a committee comprised of representatives of certain FIA and ISDA member firms which included both swap dealers and buy-side firms. More than 60 organizations provided input during the development of the document.[9]
FIA and ISDA emphasized that the use of the agreement is voluntary and may not be necessary and appropriate under all circumstances.[10] FIA and ISDA recognized that many of the provisions in the Agreement will be superseded by new regulatory requirements and the rules of swap execution venues and clearing organizations.[11]
The Agreement includes optional annexes that make the clearing member to one or both of the executing parties a party to the Agreement (the Tri-party annexes). Some of the participants in the process, as well as some market participants that were not included, have expressed concern to the Commission that aspects of the Tri-party annexes may be inconsistent with certain principles of the Dodd-Frank Act.[12]
Specifically, concerns arise in connection with certain provisions that would permit a customer's FCM, in consultation with the SD, to establish specific credit limits for the customer's swap transactions with the SD, and to declare that with regard to trades with that SD, the FCM will only accept for clearing those transactions that fall within these specific limits.[13] The limits set for trades with the SD might be less than the overall limits set for the customer for all trades cleared through the FCM. The result would be to create a “sublimit” for the customer for trades with that SD. Some market participants have stated that the setting of such “sublimits” would result in restrictions of customer counterparties because, without such “sublimits,” the customer may enter into transactions with whomever it chooses, up to its overall limit with the FCM.[14]
Generally, in cleared markets, an FCM does not know the identity of its customer's executing counterparty. Another effect of such sublimits would be to disclose the identity of the customer's counterparty to the FCM. In many instances, the FCM and the customer's counterparty—the SD—might be affiliated entities. Some market participants have stated that such disclosure may lead to “greater information exchange” between the FCM and the affiliated SD, which would Start Printed Page 45732“force the customer to execute with the clearing member's trading desk affiliate.” [15] A third effect of such sublimits could be to delay acceptance of the trades into clearing while the FCM verifies compliance with the sublimits.
Arrangements with these effects potentially conflict with the concepts of open access to clearing and execution of customer transactions on a DCM or SEF on terms that have a reasonable relationship to the best terms available. More specifically, they potentially conflict with proposed §§ 1.71(d)(1), 23.605(d)(1), 23.608, and 39.12. As certain market participants have stated, tri-party agreements of the type described above could lead to undue influence by FCMs on a customer's choice of counterparties (or, conversely, undue influence by SDs on a customer's choice of clearing member). Therefore, they could constrain a customer's opportunity to obtain execution of the trade on the terms that have a reasonable relationship to the best terms available by limiting the number of potential counterparties.[16]
To address these concerns and to provide further clarity in this area, the Commission is now proposing § 1.72 relating to FCMs, § 23.608 relating to SDs and MSPs, and § 39.12(a)(1)(vi) relating to DCOs. These new regulations would prohibit arrangements involving FCMs, SDs, MSPs, or DCOs that would (a) disclose to an FCM, SD, or MSP the identity of a customer's original executing counterparty; (b) limit the number of counterparties with whom a customer may enter into a trade; (c) restrict the size of the position a customer may take with any individual counterparty, apart from an overall credit limit for all positions held by the customer at the FCM; (d) impair a customer's access to execution of a trade on terms that have a reasonable relationship to the best terms available; or (e) prevent compliance with specified time frames for acceptance of trades into clearing.
As noted above, a goal of the Dodd-Frank Act is to reduce risk by increasing the use of central clearing. Minimizing the time between trade execution and acceptance into clearing is an important risk mitigant. The Commission recently proposed § 39.12(b)(7) regarding time frames for clearing.[17] Upon review of the comments received, the Commission is now proposing a revised version of that provision.[18]
As previously proposed, § 39.12(b)(7)(i) required DCOs to coordinate with designated contract markets (DCMs) and swap execution facilities (SEFs) to facilitate prompt and efficient processing of trades. In response to a comment, the Commission now proposes to require prompt, efficient, and accurate processing of trades.[19]
Recognizing the key role clearing members play in trade processing and submission of trades to central clearing, the Commission is also now proposing parallel provisions for coordination among DCOs and clearing members. Proposed § 39.12(b)(7)(i)(B) would require DCOs to coordinate with clearing members to establish systems for prompt processing of trades. Proposed §§ 1.74(a) and 23.610(a) would require reciprocal coordination with DCOs by FCMs, SDs, and MSPs that are clearing members.
As previously proposed, § 39.12(b)(7)(ii) required DCOs to accept immediately upon execution all transactions executed on a DCM or SEF. A number of DCOs and other commenters expressed concern that this requirement could expose DCOs to unwarranted risk because DCOs need to be able to screen trades for compliance with applicable clearinghouse rules related to product and credit filters.[20] The Commission recognizes that while immediate acceptance for clearing upon execution currently occurs in some futures markets, it might not be feasible for all cleared markets at this time. For example, where the same cleared product is traded on multiple execution venues, a DCO needs to be able to aggregate the risk of trades coming in to ensure that a clearing member or customer has not exceeded its credit limits. Accordingly, the Commission is proposing to modify § 39.12(b)(7)(ii) to permit DCOs to screen trades against applicable product and credit criteria before accepting or rejecting them. Consistent with principles of open access, the proposal would require that such criteria be non-discriminatory with respect to trading venues and clearing participants.
The Commission continues to believe that acceptance or rejection for clearing in close to real time is crucial both for effective risk management and for the Start Printed Page 45733efficient operation of trading venues.[21] Rather than prescribe a specific length of time, the Commission is proposing as a standard that action be taken “as quickly as would be technologically practicable if fully automated systems were used.” The Commission anticipates that this standard would require action in a matter of milliseconds or seconds or, at most, a few minutes, not hours or days.[22]
As previously proposed, §§ 39.12(b)(7)(iii) and 39.12(b)(7)(iv) distinguished between swaps subject to mandatory clearing and swaps not subject to mandatory clearing. Upon review of the comments, the Commission believes that this distinction is unnecessary with regard to processing time frames. If a DCO lists a product for clearing, it should be able to process it regardless of whether clearing is mandatory or voluntary. Therefore, newly proposed § 39.12(b)(7)(iii) would cover all trades not executed on a DCM or SEF. It would require acceptance or rejection by the DCO as quickly after submission as would be technologically practicable if fully automated systems were used.
Proposed § 1.74(b) would set up a parallel requirement for clearing FCMs; proposed § 23.610(b) would set up a parallel requirement for SDs and MSPs that are clearing members. These rules, again, would apply a performance standard, not a prescribed method for achieving it.
The Regulatory Flexibility Act (RFA) requires that agencies consider whether the regulations they propose will have a significant economic impact on a substantial number of small entities.[23] The Commission previously has established certain definitions of “small entities” to be used in evaluating the impact of its regulations on small entities in accordance with the RFA.[24] The proposed regulations would affect FCMs, DCOs, SDs, and MSPs.
The Commission previously has determined, however, that FCMs should not be considered to be small entities for purposes of the RFA.[25] The Commission's determination was based, in part, upon the obligation of FCMs to meet the minimum financial requirements established by the Commission to enhance the protection of customers' segregated funds and protect the financial condition of FCMs generally.[26] The Commission also has previously determined that DCOs are not small entities for the purpose of the RFA.[27]
The Commission also has previously determined that large traders are not “small entities” for RFA purposes.[28] In that determination, the Commission considered that a large trading position was indicative of the size of the business. MSPs, by statutory definition, maintain substantial positions in swaps or maintain outstanding swap positions that create substantial counterparty exposure that could have serious adverse effects on the financial stability of the United States banking system or financial markets. Accordingly, for purposes of the RFA for this rulemaking, the Commission is hereby proposing that MSPs not be considered “small entities” for essentially the same reasons that large traders have previously been determined not to be small entities.
The Paperwork Reduction Act (PRA) [29] imposes certain requirements on Federal agencies (including the Commission) in connection with their conducting or sponsoring any collection of information as defined by the PRA. This proposed rulemaking would result in new collection of information requirements within the meaning of the PRA. The Commission therefore is submitting this proposal to the Office of Management and Budget (OMB) for review in accordance with 44 U.S.C. 3507(d) and 5 CFR 1320.11. The title for this collection of information is Start Printed Page 45734“Customer Clearing Documentation and Timing of Acceptance for Clearing.” An agency may not conduct or sponsor, and a person is not required to respond to, a collection of information unless it displays a currently valid control number. The OMB has not yet assigned this collection a control number.
Proposed §§ 1.72 and 23.608 would require each FCM, SD, and MSP to ensure compliance with the proposed regulations. Maintenance of contracts is prudent business practice and the Commission anticipates that SDs and MSPs already maintain some form of this documentation. Additionally, the Commission believes that much of the existing customer clearing documentation already complies with the proposed rules, and therefore that compliance will require a minimal burden.
In addition to the above, the Commission anticipates that FCMs, SDs, and MSPs will spend an average of 16 hours per year drafting and, as needed, updating customer clearing documentation to ensure compliance required by proposed §§ 1.72 and 23.608.
For each DCO, the annual burden associated with these proposed regulations is estimated to be 40 hours, at an annual cost of $4,000. Burden means the total time, effort, or financial resources expended by persons to generate, maintain, retain, disclose, or provide information to or for a federal agency. The Commission has characterized the annual costs as initial costs as the Commission anticipates that the cost burdens will be reduced dramatically over time as once the documentation and procedures required by the proposed regulations are implemented, any additional expenditure related to § 39.12 likely would be limited to the time required to review and, as needed, amend, existing documentation and procedures.
Proposed 39.12(b)(7) would require each DCO to coordinate with clearing members to establish systems for prompt processing of trades. The Commission believes that this is currently a practice of DCOs. Accordingly, any additional expenditure related to § 39.12(b)(7) likely would be limited to the time initially required to review and, as needed, amend, existing trade processing procedures to ensure that they conform to all of the required elements and to coordinate with FCMs, SDs, and MSPs to establish reciprocal procedures.
The Commission anticipates that DCOs will spend an average of 20 hours per year drafting and, as needed, updating the written policies and procedures to ensure compliance required by proposed § 39.12, and 20 hours per year coordinating with FCMs, SDs, and MSPs on reciprocal procedures.
According to recent Bureau of Labor Statistics, the mean hourly wage of an employee under occupation code 11-3031, “Financial Managers,” (which includes operations managers) that is employed by the “Securities and Commodity Contracts Intermediation and Brokerage” industry is $74.41.[30] Because SDs, MSPs, FCMs, and DCOs include large financial institutions whose operations management employees' salaries may exceed the mean wage, the Commission has estimated the cost burden of these proposed regulations based upon an average salary of $100 per hour.
Developing Written Procedures for Compliance, and Maintaining Records Documenting Compliance for SDs and MSPs. This hourly burden arises from the proposed requirement that SDs and MSPs make and maintain records documenting compliance related to client clearing documentation.Start Printed Page 45735
As far as costs are concerned, the possibility of “breakage” remains for SDs and other counterparties. However, this concern is mitigated by the timelines required in the second section of this rule, which reduce the likelihood that a SD would have time to enter into other transactions before the one in view is accepted or rejected for clearing. Similarly, if a SD has to enter into a replacement trade, the costs will be mitigated by the tight timeline, because the SD would know quickly whether the trade was accepted or rejected for clearing. As noted above, the process of evaluating individual transactions against counterparty sub-limits could Start Printed Page 45736delay notification of acceptance or rejection for clearing. In the absence of this rule, the cost to trade will have to account for these factors and additional market risk during that time.
Start Part Start Printed Page 45737
2. Add § 1.72 to part 1 to read as follows:
Restrictions on customer clearing arrangements.
(e) Prevents compliance with the time frames set forth in § 1.73(a)(9)(ii), § 23.609(a)(9)(ii), or § 39.12(b)(7) of this chapter.
3. Add § 1.74 to part 1 to read as follows:
5. Add § 23.608 to part 23, subpart J, to read as follows:
§ 23.608
6. Add § 23.610 to part 23, subpart J, to read as follows:
§ 23.610
Authority: 7 U.S.C. 1a, 2, 5, 6, 6d, 7a-1, 7a-2, and 7b as amended by the Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. 111-203, 124 Stat. 1376.
8. In § 39.12, add paragraph (a)(1)(vi) to read as follows:
(C) Restricts the size of the position a customer may take with any individual counterparty, apart from an overall limit for all positions held by the customer at the futures commission merchant;Start Printed Page 45738
9. Amend § 39.12 by:
b. Revising § 39.12(b)(7) to read as follows:
(A) That are submitted by the parties to the derivatives clearing organization, in accordance with § 23.506 of this chapter;
12. See, e.g., letter dated April 11, 2011 from Stuart J. Kaswell, Executive Vice President, Managing Director, and General Counsel, Managed Funds Association; letter dated April 19, 2011 from James Cawley, Swaps & Derivatives Market Association. These letters can be found in the Commission's comment file for 76 FR 13101.
16. The Commission previously proposed § 155.7, an execution standard that would apply to swaps available for trading on a DCM or SEF to ensure fair dealing and protect against fraud and other abusive practices. 75 FR 80638, 80648 (Dec. 22, 2010). The proposed rule would require Commission registrants to execute swaps available for trading on a DCM or SEF on terms that have a reasonable relationship to the best terms available.
30. http://www.bls.gov/​oes/​current/​oes113031.htm.