Federal Register, Volume 77 Issue 25 (Tuesday, February 7, 2012)[Federal Register Volume 77, Number 25 (Tuesday, February 7, 2012)]
[Rules and Regulations]
[Pages 6336-6409]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2012-1033]
[[Page 6335]]
Vol. 77
Tuesday,
No. 25
February 7, 2012
Part III
Commodity Futures Trading Commission
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17 CFR Parts 22 and 190
Protection of Cleared Swaps Customer Contracts and Collateral;
Conforming Amendments to the Commodity Broker Bankruptcy Provisions;
Final Rule
Federal Register / Vol. 77 , No. 25 / Tuesday, February 7, 2012 /
Rules and Regulations
[[Page 6336]]
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COMMODITY FUTURES TRADING COMMISSION
17 CFR Parts 22 and 190
RIN Number 3038-AC99
Protection of Cleared Swaps Customer Contracts and Collateral;
Conforming Amendments to the Commodity Broker Bankruptcy Provisions
AGENCY: Commodity Futures Trading Commission.
ACTION: Final rule.
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SUMMARY: The Commodity Futures Trading Commission (the ``Commission'')
is adopting final regulations to implement new statutory provisions
enacted by Title VII of the Dodd-Frank Wall Street Reform and Consumer
Protection Act (the ``Dodd-Frank Act''). Specifically, these
regulations impose requirements on futures commission merchants
(``FCMs'') and derivatives clearing organizations (``DCOs'') regarding
the treatment of cleared swaps customer contracts (and related
collateral), and make conforming amendments to bankruptcy provisions
applicable to commodity brokers under the Commodity Exchange Act (the
``CEA'').
DATES: The rules will become effective April 9, 2012. All parties must
comply with the Part 22 rules by November 8, 2012. All parties must
comply with the Part 190 rules by April 9, 2012. Prior to the
compliance date for the Part 22 rules, the definition of 190.01(pp)
(``Cleared Swap'') shall be limited to transactions where the rules or
bylaws of a derivatives clearing organization require that such
transactions, along with the money, securities, and other property
margining, guaranteeing or securing such transactions, be held in a
separate account for Cleared Swaps only.
FOR FURTHER INFORMATION CONTACT: Robert B. Wasserman, Chief Counsel,
Division of Clearing and Risk (DCR), at 202-418-5092 or
[email protected]; M. Laura Astrada, Associate Chief Counsel, DCR, at
202-418-7622 or [email protected]; Alicia Lewis, Special Counsel, DCR,
at 202-418-5862 or [email protected]; or Martin White, Assistant General
Counsel, Office of the General Counsel, at 202-418-5129 or
[email protected], in each case, at the Commodity Futures Trading
Commission, Three Lafayette Centre, 1155 21st Street, NW., Washington,
DC 20581.
SUPPLEMENTARY INFORMATION:
Table of Contents
I. Background
A. Segregation Requirements.
B. Overview of the Clearing Process as it Relates to the
Segregation Requirements.
C. Segregation Alternatives.
D. Operation of the Segregation Models in an FCM Bankruptcy.
E. Solicitation of Public Input.
F. Clarification of the Application of Financial and Segregation
Interpretation No. 10 to Cleared Swaps.
II. The Final Rules
III. Segregation Model for Cleared Swaps Customer Collateral
A. Summary of the Comments.
B. Discussion of the Comments.
IV. Section by Section Analysis: Regulation Part 22
A. Regulation 22.1: Definitions.
B. Regulation 22.2--Futures Commission Merchants: Treatment of
Cleared Swaps Customer Collateral.
C. Regulation 22.3--Derivatives Clearing Organizations:
Treatment of Cleared Swaps Customer Collateral.
D. Regulation 22.4--Futures Commission Merchants and Derivatives
Clearing Organizations: Permitted Depositories.
E. Regulation 22.5--Futures Commission Merchants and Derivatives
Clearing Organizations: Written Acknowledgment.
F. Regulation 22.6--Futures Commission Merchants and Derivatives
Clearing Organizations: Naming of Cleared Swaps Customer Accounts.
G. Regulation 22.7--Permitted Depositories: Treatment of Cleared
Swaps Customer Collateral.
H. Regulation 22.8--Situs of Cleared Swaps Customer Accounts.
I. Regulation 22.9--Denomination of Cleared Swaps Customer
Collateral and Location of Depositories.
J. Regulation 22.10--Application of other Regulatory Provisions.
K. Regulation 22.11--Information to be Provided Regarding
Customers and Their Cleared Swaps.
L. Regulation 22.12--Information to be Maintained Regarding
Cleared Swaps Customer Collateral.
M. Regulation 22.13--Additions to Cleared Swaps Customer
Collateral.
N. Regulation 22.14--Futures Commission Merchant Failure to Meet
a Customer Margin Call in Full.
O. Regulation 22.15--Treatment of Cleared Swaps Customer
Collateral on an Individual Basis.
P. Regulation 22.16--Disclosures to Customers.
V. Section by Section Analysis: Amendments to Regulation Part 190
A. Background.
B. Definitions.
C. Amendments to Regulation 190.02--Operation of the Debtor's
Estate Subsequent to the Filing Date and Prior to the Primary
Liquidation Date.
D. Amendments to Regulation 190.03--Operation of the Debtor's
Estate Subsequent to the Primary Liquidation Date.
E. Amendments to Regulation 190.04--Operation of the Debtor's
Estate--General.
F. Amendments to Regulation 190.05--Making and Taking Delivery
on Commodity Contracts.
G. Amendments to Regulation 190.06--Transfers.
H. Amendments to Regulation 190.07--Calculation of Allowed Net
Equity.
I. Amendments to Regulation 190.09--Member Property.
J. Amendments to Regulation 190.10--General.
K. Amendments to Appendix A to Part 190--Bankruptcy Forms,
Bankruptcy.
L. Amendments to Appendix B to Part 190--Special Bankruptcy
Distributions.
VI. Effective Date
VII. Consideration of Costs and Benefits
A. Introduction.
B. Benefits and Costs of Complete Legal Segregation Model
Relative to Futures Model.
C. Conclusion.
VIII. Related Matters.
A. Paperwork Reduction Act.
B. Regulatory Flexibility Act.
IX. Text of Proposed Rules
I. Background
A. Segregation Requirements
On July 21, 2010, President Obama signed the Dodd-Frank Act.\1\
Title VII of the Dodd-Frank Act \2\ amended the CEA \3\ to establish a
comprehensive new regulatory framework for swaps and certain security-
based 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;
\4\ (2) imposing mandatory clearing and trade execution requirements on
clearable swap contracts; (3) creating rigorous recordkeeping and real-
time reporting regimes; 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.
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\1\ See Dodd-Frank Act, Public Law 111-203, 124 Stat. 1376
(2010). The text of the Dodd-Frank Act may be accessed at http://www.cftc.gov./LawRegulation/OTCDERIVATIVES/index.htm.
\2\ Pursuant to section 701 of the Dodd-Frank Act, Title VII may
be cited as the ``Wall Street Transparency and Accountability Act of
2010.''
\3\ 7 U.S.C. 1 et seq.
\4\ In this release, the terms ``swap dealer'' and ``major swap
participant'' shall have the meanings set forth in section 721(a) of
the Dodd-Frank Act, which added sections 1a(49) and (33) of the CEA.
However, as directed by section 721(c) of the Dodd-Frank Act, the
Commission is in the process of promulgating rules to further
define, among other terms, ``swap dealer'' and ``major swap
participant.'' See 75 FR 80173, Dec. 21, 2010.
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Section 724 of the Dodd-Frank Act prescribes the manner in which
Cleared
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Swaps (and related collateral) \5\ must be treated prior to and after
bankruptcy. Section 724(a) of the Dodd-Frank Act amends section 4d of
the CEA to add a new paragraph (f), which imposes the following
requirements on an FCM, as well as any depository thereof (including,
without limitation, a DCO):
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\5\ Regulation 22.1 defines ``Cleared Swap'' and ``Cleared Swaps
Customer Collateral.''
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1. The FCM must treat and deal with all collateral (including
accruals thereon) deposited by a customer \6\ to margin its Cleared
Swaps as belonging to such customer;
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\6\ Regulation 22.1 defines ``Cleared Swaps Customer.''
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2. The FCM must separately account for and may not commingle such
collateral with its own property and may not, with certain exceptions,
use such collateral to margin the Cleared Swaps of any person other
than the customer depositing such collateral;
3. A DCO may not hold or dispose of the collateral that an FCM
receives from a customer to margin Cleared Swaps in any manner that
would indicate that such collateral belonged to the FCM or any person
other than the customer; and
4. The FCM and the DCO may only invest such collateral in
enumerated investments.
In other words, the FCM and the DCO (i) must hold such customer
collateral in an account (or location) that is separate from the
property belonging to the FCM or DCO, and (ii) must not use the
collateral of one customer to (A) cover the obligations of another
customer or (B) the obligations of the FCM or DCO. These basic
requirements that Cleared Swaps Customer Collateral be treated as the
property of customers and maintained in segregated accounts (or
locations) are imposed by the statute and have the force of law
regardless of the Commission's particular implementing regulations.
Moreover, by the terms of the statute, these requirements would apply
even if the Commission promulgated no implementing regulations.
Section 724(b) of the Dodd-Frank Act governs bankruptcy treatment
of Cleared Swaps by clarifying that Cleared Swaps are ``commodity
contracts'' within the meaning of section 761(4)(F) of the Bankruptcy
Code.\7\ Therefore, in the event of an FCM or DCO insolvency, Cleared
Swaps Customers may invoke the protections of Subchapter IV of Chapter
7 of the Bankruptcy Code (``Subchapter IV''). Such protections include:
(i) protected transfers of Cleared Swaps and related collateral; \8\
and (ii) if Cleared Swaps are subject to liquidation, preferential
distribution of remaining collateral.\9\ However, section 766(h) of the
Bankruptcy Code (``Section 766(h)'') subjects customers to mutualized
risk by requiring that customer property be distributed ``ratably to
customers on the basis and to the extent of such customers' allowed net
equity claims.'' This requirement, in turn, limits the Commission's
flexibility in designing a model for the protection of customer
collateral.
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\7\ 11 U.S.C. 761(4)(F).
\8\ See, e.g., 11 U.S.C. 764.
\9\ See, e.g., 11 U.S.C. 766(h) and (i).
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B. Overview of the Clearing Process as It Relates to the Segregation
Requirements
1. Central Counterparties/Derivatives Clearing Organizations
One of the primary objectives of the Dodd-Frank Act was to promote
the central clearing of swaps and to establish the regulatory
infrastructure for the clearing of swaps.\10\ Clearing is the process
by which transactions in derivatives are processed, guaranteed, and
settled by a central counterparty, also known as a DCO. In accordance
with this overall Congressional purpose, section 724 of the Dodd-Frank
Act amends the CEA to provide the statutory foundation for the
protection of Cleared Swaps Customer Collateral.
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\10\ See supra n. 1; S. Rep. No. 111-176, at 33 (2010) (``[w]ith
appropriate collateral and margin requirements, a central clearing
organization can substantially reduce counterparty risk and provide
an organized mechanism for clearing transactions''); Process for
Review of Swaps for Mandatory Clearing, 76 FR 44464, July 26, 2011
(final rule); Derivatives Clearing Organizations General Provisions
and Core Principles, 76 FR 69334, Nov. 8, 2011 (final rule).
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A DCO has members (``Clearing Members'') who clear derivatives
transactions (e.g., swaps) through the DCO and who are subject to the
DCO's rules. Clearing Members may clear transactions on their own
behalf (i.e., ``proprietary transactions'') or on behalf of customers
(i.e., ``customer transactions''). Clearing members that clear swaps
for customers must be registered as futures commission merchants
(``FCMs'').\11\
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\11\ Section 4d(f)(1) of the CEA, 7 U.S.C. 6d(f)(1).
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The term ``central counterparty'' means, conceptually, that the DCO
becomes the seller to every buyer, and the buyer to every seller. More
specifically, the DCO novates swap transactions initially entered into
between various market participants, such as swaps users, dealers, or
end users, and cleared either directly (if the market participant is
itself a Clearing Member) or indirectly (through an FCM that is a
Clearing Member) . The contractual obligations between the original
parties (``A'' and ``B'') \12\ are replaced by sets of equivalent
obligations: between the Clearing Member FCMs acting for the original
parties and the DCO and between the Clearing Member FCMs and their
individual customers. Thus, if the original swap agreement would
require a certain payment from A to B, as a result of the clearing
process this obligation becomes (1) a duty by A's clearing FCM to pay
the DCO, (2) a corresponding claim by A's FCM to recompense from A, (3)
a duty by the DCO to pay B's clearing FCM, and (4) a corresponding duty
by B's FCM to pay B.
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\12\ For purposes of this example, neither A nor B is a Clearing
Member.
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In economic effect, the DCO serves as a guarantor that every
Clearing Member party to a cleared swap receives performance according
to the terms of the swap, while the clearing FCM serves as a guarantor
of its customers' swaps obligations to the DCO.
2. Variation
To avoid the accumulation of large obligations, the DCO conducts a
variation payment and collection cycle at least once a day, and in the
case of many DCOs, twice a day. The DCO will first calculate the gain
(and corresponding loss) on each contract through a process known as
``marking to market,'' using reported market prices where available, or
other means (such as surveys of Clearing Members). The DCO will then
aggregate and net the gains and losses for each Clearing Member
(separately for proprietary and customer accounts), collect from those
Clearing Members with net losses, and pay those Clearing Members with
net gains. This process is highly time sensitive: The Clearing Member
typically has only one or a few hours between the demand for payment
and the time payment is due. Similarly, the Clearing Member FCMs will
debit the accounts of those customers who have losses on their
transactions, and credit the accounts of those customers who have
gained.
3. Margin (Collateral)
To secure the prompt payment of variation obligations, the DCO will
require each Clearing Member to post collateral (often referred to as
``margin'') for the transactions it clears (separately for customer
positions and proprietary positions). If the Clearing Member does not
promptly make a variation payment to the DCO--referred to as a
default--the collateral may immediately be liquidated and applied to
the obligation. Margin may only be used to meet the
[[Page 6338]]
default of the Clearing Member posting that margin. While proprietary
margin may be used to meet obligations in either the Clearing Member's
proprietary account or customer account, the reverse is not true: A
Clearing Member's customer margin may not be used to meet a default in
the Clearing Member's proprietary account.
Similarly, FCMs will--indeed, are required to--collect collateral
from each of their customers, based on each customer's portfolio of
positions, to secure the prompt payment of the customer's variation
obligations.\13\ If a customer fails to fulfill an obligation to the
FCM arising out of a swap agreement the FCM clears for the customer,
the FCM may use some or all of the value of the collateral that
customer has posted to meet that obligation--that is the purpose of the
collateral.
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\13\ See regulation 39.13(g)(8)(ii) (stating that ``[a]
derivatives clearing organization shall require its clearing members
to collect customer initial margin, as defined in Sec. 1.3 of this
chapter, from their customers, for nonhedge positions, at a level
that is greater than 100 percent of the derivatives clearing
organization's initial margin requirements with respect to each
product and swap portfolio.''). 76 FR at 69439.
The purpose of this rulemaking is to protect Cleared Swaps
Customer Collateral in the event that an FCM defaults to a DCO due
to ``Fellow-Customer Risk'' (as such term is defined in section
I(B)(6) herein). However, as section III(B) explores in greater
detail, the segregation model selected in this rulemaking provides
limited protection from operational and investment risks.
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The DCO will generally set minimum collateral levels for each type
of swap, and will prescribe a ``margin methodology'' to determine the
minimum margin level for portfolios of swaps. The DCO's margin
methodology will be designed to estimate the amount of loss a portfolio
of swap positions may incur, calculated at a statistical confidence
level no less than 99%, over a holding period generally between one and
ten days, depending on the time it is estimated to take to liquidate
the swaps in the portfolio.\14\ The FCM will, in turn, use the same or
similar methodology in determining the minimum level of collateral it
must collect from each customer.\15\
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\14\ See generally, 76 FR 69334. See specifically regulation
39.13(g)(2)(ii) (setting forth a one-day minimum liquidation time
for agricultural, energy, and metals swaps, and a five-day minimum
liquidation time for all other swaps). 76 FR 69438.
\15\ The FCM is required to collect a higher level of collateral
from its customers than that prescribed for Clearing Members (see
id.) and may, in its discretion, collect a yet higher level. See
regulation 22.13(a)(1).
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4. Default Resources
As noted above, the margin collateral collected by a DCO is
designed to cover most (e.g., 99%), but not all, potential losses
incurred by a Clearing Member. DCOs cover the ``tail risk'' (i.e., the
risk that a Clearing Member will incur, and default on, a loss in
excess of the margin collected) by means of what is sometimes referred
to as a default resources package, or ``waterfall.'' Elements of the
waterfall may include a contribution of a specified amount of the DCO's
own capital, pre-funded contributions from Clearing Members (a
``guaranty fund''),\16\ or (to a limited extent), a power by the DCO to
assess additional contributions from Clearing Members. Unlike margin, a
Clearing Member's contribution to the guaranty fund will generally be
usable to meet the default of another Clearing Member. In other words,
the guaranty fund is ``mutualized.'' Elements of the waterfall are
applied in an order pre-determined by the DCO's rules. Such rules will
often apply the guaranty fund contribution of the defaulter before the
DCO's own capital, and the remainder of the guaranty fund (i.e., the
guaranty fund contributions of the non-defaulting Clearing Members)
thereafter.
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\16\ See also infra at n. 250.
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Though seemingly complex, centralized clearing has important
advantages in terms of transparency, risk management, netting out of
countervailing obligations, and reduced exposure of market participants
to each other's credit risk (by effectively substituting the DCO's
credit risk).
5. Customer Accounts
Generally, a clearing FCM will have two different types of Cleared
Swaps Customer Accounts in connection with collateral provided to it by
Cleared Swaps Customers. One account is maintained (generally at a
bank) by the FCM on behalf of its Cleared Swaps Customers (the ``FCM
Customer Account''). The FCM Customer Account holds assets provided by
customers, or other assets of equivalent value, that are not currently
posted with the DCO to support swaps positions cleared by the FCM on
behalf of its Cleared Swaps Customers. The other account is maintained
by the DCO for the FCM on behalf of the FCM's Cleared Swaps Customers
(the ``DCO Customer Account''). The DCO Customer Account holds customer
assets, or assets of equivalent value, that the FCM has posted to the
DCO as collateral for swaps positions that have been established and
cleared by the FCM for its Cleared Swaps Customers.
The collateral posted by each Cleared Swaps Customer is, however,
potentially exposed to risks that do not arise out of the obligations
that a Cleared Swaps Customer has directly incurred by assuming his or
her swaps position. \17\ The most important impact of such risks would
occur in the case of an insolvency on the part of the FCM through which
the Cleared Swaps Customer clears. As discussed in more detail below,
the new CEA section 4d(f), and the Commission's implementing
regulations, are designed to provide protection for Cleared Swaps
Customer Collateral against certain risks that may arise during an
insolvency on the part of the FCM through which the Cleared Swaps
Customer clears.
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\17\ Examples of other risks include the possibility of misuse
or misallocation of a Cleared Swaps Customer's assets by a dishonest
or negligent FCM.
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6. Fellow-Customer Risk
``Fellow-Customer Risk'' is the risk that a DCO would need to
access the collateral of non-defaulting Cleared Swaps Customers to cure
an FCM default. Fellow-Customer Risk arises in circumstances in which a
Cleared Swaps Customer (the ``defaulting customer'') of a clearing FCM
suffers a (significant) loss in connection with a cleared swap.\18\ The
loss will result in a call by the DCO for a variation payment from the
clearing FCM that carries that Cleared Swaps Customer's Cleared
Swaps.\19\ The clearing FCM may demand expedited payment from the
defaulting Cleared Swaps Customer, but is in any event directly
obligated promptly to meet the payment obligation to the DCO.
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\18\ See also supra n. 13.
\19\ As noted above, the amount the DCO will call for or pay to
the FCM in respect of its Cleared Swaps Customers is the net of the
gains and losses computed on a customer-by-customer basis.
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If the loss is great enough, it may exceed the sum of the FCM's
available liquid assets, the swaps collateral posted by the Cleared
Swaps Customer, and any additional payments immediately available from
the Cleared Swaps Customer. In this situation, sometimes called a
``double default,'' the defaulting Cleared Swaps Customer will have
defaulted on its obligation to the clearing FCM which, in turn, will
default on its obligation to the DCO. In such circumstances, the FCM
will likely have to file for protection in bankruptcy. Meanwhile, the
defaulting Cleared Swaps Customer's loss will translate to a gain by
one or more other market participants. Notwithstanding the default by
the clearing FCM, the DCO, in its capacity as central counterparty, is
required to pay out these gains. The DCO will thus be faced with a
potentially significant loss.
A potential resource for the DCO to apply to this loss in a double
default
[[Page 6339]]
situation is the collateral held in the Cleared Swaps Customer Account
maintained by the DCO for the defaulting FCM on behalf of the FCM's
Cleared Swaps Customers. Under the current rules applicable to futures
clearing, a DCO is permitted to use all of the collateral in the
Clearing Member's customer account to meet a loss in that account,
without regard to which customer(s) in fact supplied that collateral.
Thus, in this case, the non-defaulting customers of the defaulting FCM
clearing member would be exposed to loss due to ``Fellow-Customer
Risk.''
C. Segregation Alternatives
In implementing new CEA section 4d(f), the Commission considered
five alternative segregation models for Cleared Swaps Customer
Collateral in the notice of proposed rulemaking issue by the Commission
on June 9, 2011 (the ``NPRM'').\20\
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\20\ See Notice of Proposed Rulemaking on the Protection of
Cleared Swaps Customer Contracts and Collateral; Conforming
Amendments to the Commodity Broker Bankruptcy Provisions, 76 FR
33818, 33822, June 9, 2011.
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1. Legal Segregation With Operational Commingling Model
The first alternative explored by the Commission was legal
segregation with operational commingling (the ``LSOC Model'' or
``Complete Legal Segregation Model''). Under the LSOC Model, each FCM
and DCO would enter (or ``segregate''), in its books and records, the
Cleared Swaps of each individual customer and relevant collateral. Each
FCM and DCO would ensure that such entries are separate from entries
indicating (i) FCM or DCO obligations, or (ii) the obligations of non-
cleared swaps customers. Operationally, however, each FCM and DCO would
be permitted to hold (or ``commingle'') the relevant collateral in one
account. Each FCM and DCO would ensure that such account is separate
from any account holding FCM or DCO property or holding property
belonging to non-cleared swaps customers.
Prior to the simultaneous default of an FCM and one of its Cleared
Swaps Customers (as discussed above, a ``double default''), the FCM
would ensure that the DCO does not use the collateral of one Cleared
Swaps Customer to support the obligations of another customer by making
certain that the value of the Cleared Swaps Customer Collateral that
the DCO holds equals or exceeds the value of all Cleared Swaps Customer
Collateral that it has received to secure the contracts of the FCM's
customers. Following a double default, the DCO would be permitted to
access the collateral of the defaulting Cleared Swaps Customers, but
not the collateral of the non-defaulting Cleared Swaps Customers. Thus
while, even under the LSOC Model, Section 766(h) requires the pro rata
distribution of customer property, the collateral attributable to the
non-defaulting Cleared Swaps Customers would be available to be
distributed.
2. Legal Segregation With Recourse Model
Second, the Commission contemplated the Legal Segregation with
Recourse Model (together with the LSOC Model, the ``Legal Segregation
Models''). As with the LSOC Model, under the Legal Segregation with
Recourse Model, each FCM and DCO would segregate the Cleared Swaps of
each individual customer and relevant collateral in its books and
records. However, each FCM and DCO would be permitted to commingle the
relevant collateral in one account, provided that such account is
separate from any proprietary accounts or accounts property belonging
to non-cleared swaps customers.
Again, as with the LSOC Model, prior to a double default, the FCM
would ensure that the DCO does not use the collateral of one Cleared
Swaps Customer to support the obligations of another customer by making
certain that the value of the Cleared Swaps Collateral that the DCO
holds equals or exceeds the value of all Cleared Swaps Collateral that
it has received to secure the contracts of the FCM's customers.
However, unlike the LSOC Model, following a double default, the Legal
Segregation with Recourse Model would not prohibit a DCO from accessing
the collateral of the non-defaulting Cleared Swaps Customers, after the
DCO applies its own capital to cure the default, as well as the
guaranty fund contributions of its non-defaulting FCM members.
3. Physical Segregation Model
The Commission also explored the possibility of full physical
segregation (the ``Physical Segregation Model'') for Cleared Swaps
Customer Collateral. The Physical Segregation Model primarily differs
from the Legal Segregation Models operationally. In the ordinary course
of business (i.e., prior to a double default), as with the Legal
Segregation Models, each FCM and DCO would enter (or ``segregate''), in
its books and records, the Cleared Swaps of each individual customer
and relevant collateral. However, unlike the Legal Segregation Models,
each FCM and DCO would maintain separate individual accounts for the
relevant collateral. Hence, the FCM would ensure that the DCO does not
use the collateral of one Cleared Swaps Customer to support the
obligations of another customer by making certain that the DCO does not
mistakenly transfer collateral in (i) the account belonging to the
former to (ii) the account belonging to the latter.
Following a double default, the Physical Segregation Model would
lead to the same result as the Complete Legal Segregation Model.
Specifically, the DCO would be permitted to access the collateral of
the defaulting Cleared Swaps Customers, but not the collateral of the
non-defaulting customers.
As discussed above, one important limitation on the effectiveness
of the Physical Segregation Model is section 766(h) of the Bankruptcy
Code, which requires that customer property be distributed ratably.
Thus, if because of Physical Segregation, certain Cleared Swaps
Customer Collateral was better protected than the property of other
Cleared Swaps Customers, it would not be permissible to pay Cleared
Swaps Customers in the first group a higher proportion (i.e., a higher
cents-on-the-dollar distribution) of their net equity claims than
Cleared Swaps Customers in the second group. Rather, Cleared Swaps
Customers in both groups would receive the same proportion of their
allowed net equity claims. In other words, in spite of incurring
greater cost under the Physical Segregation Model, a Cleared Swaps
Customer would essentially receive the same level of protection for its
Cleared Swaps Customer Collateral under the Physical Segregation Model
as it would under the LSOC Model.
4. Futures Model
The Commission also considered replicating the segregation
requirement currently applicable to futures (the ``Futures Model'').
Under this model, DCOs treat each FCM's customer account on an omnibus
basis, that is, as belonging to an undifferentiated group of customers.
Prior to a double default, the Futures Model shares certain
similarities with the Legal Segregation Models. Specifically, each FCM
would enter (or ``segregate''), in its books and records, the Cleared
Swaps of each individual customer and relevant collateral. Each DCO,
however, would recognize, in its books and records, the Cleared Swaps
that an FCM intermediates on a collective (or ``omnibus'') basis. Each
FCM and DCO would be permitted to hold (or ``commingle'') all Cleared
Swaps Customer Collateral in one account.
[[Page 6340]]
Following a double default, the Futures Model shares certain
similarities with the Legal Segregation with Recourse Model.
Specifically, the Futures Model would not prohibit a DCO from accessing
the collateral of the non-defaulting Cleared Swaps Customers. However,
unlike the Legal Segregation with Recourse Model, under the Futures
Model the DCO would be permitted to access such collateral before
applying its own capital or the guaranty fund contributions of non-
defaulting FCM members.\21\
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\21\ For a more detailed discussion regarding the operation of
the segregation models in an FCM bankruptcy, see section I.D.
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5. Optionality
Finally, the Commission explored permitting a DCO to choose between
(i) the Legal Segregation Models (whether Complete or with Recourse),
(ii) the Physical Segregation Model, and (iii) the Futures Model,
rather than mandating any particular alternative.
D. Operation of the Segregation Models in an FCM Bankruptcy
When discussing the issues surrounding an FCM bankruptcy under the
Bankruptcy Code, analytically there are several scenarios to consider:
(1) The bankruptcy is unrelated to the loss of customer funds, and
there is no such loss; (2) The bankruptcy involves shortfalls in
customer funds due to operational risks; (3) The bankruptcy involves
losses due to customer risk (i.e., a customer incurs a loss in excess
of the FCM's financial ability to cover); or (4) the bankruptcy
involves shortfalls in customer funds due to operational risk and
losses due to customer risk.
1. Bankruptcy Unrelated to Loss of Customer Funds
An FCM bankruptcy that is unrelated to the loss of customer funds
may arise because of financial difficulties in the FCM, financial
difficulties in the proprietary accounts, or because of the impact of
difficulties at a corporate parent or affiliate. Under this scenario,
all models share important characteristics: Customer positions and
related collateral, whether at a DCO or at the FCM, can be transferred
to one or more willing transferee FCMs, or may be liquidated and
returned to the trustee. With respect to fostering transfer, however,
the Legal Segregation Models (whether Complete or with Recourse) and
the Physical Segregation Model do have a significant advantage compared
to the Futures Model: In each of them, information about the customers
as a whole, and about each individual customer's positions, are
transmitted to the DCO every day, an information flow (and store) that
is not present in the Futures Model. Thus, each DCO will have important
customer information on a customer by customer basis that can be used
to facilitate and implement transfers, and is thus less reliant upon
the FCM for that information.
2. Bankruptcy With Shortfalls Due to Operational Risks or Investment
Risks
An FCM bankruptcy with shortfalls due to operational risks would
arise because of a shortfall in segregated funds due to, e.g.,
negligence, theft or other mishap. An FCM may also have shortfalls due
to investment risks resulting from extraordinary losses on the set of
investments permitted under regulation 1.25 (as included in new
regulation 22.2(e)(3)). Under this scenario, all models again share
important characteristics: Customer positions and related collateral at
a DCO may be delivered to the Trustee, or may transferred by the DCO,
but only to the extent of each customer's pro rata share. Under all of
the segregation models, to the extent there is a shortfall, each
customer will ultimately receive the same cents-on-the-dollar
proportion of the value of the customer's account.
However, with respect to fostering transfer, the other models again
have a significant advantage compared to the Futures Model: In each of
them, information about the customers as a whole, and about each
individual customer's positions, are transmitted to the DCO every day,
an information flow (and store) that is not present in the Futures
Model. Thus, each DCO will have important customer information on a
customer by customer basis that can be used to facilitate and implement
transfers, and accordingly is less reliant upon the FCM for that
information.
3. Bankruptcy With Shortfalls Due to Customer Risk
An FCM bankruptcy with shortfalls due to customer risk would arise
because a customer incurs a loss that exceeds both the customer's
collateral and the FCM's ability to pay.
Under the Futures Model, the DCO could use the entirety of the
FCM's customer account (or as much of it as necessary) to meet the
entire loss created by the default. Transfer of customer positions
would be difficult, in that the DCO would lack information as to which
customers were in default, and which positions belonged to defaulting
customers (and, presumably, would not be transferred) and which did
not.\22\ The DCO would be permitted to liquidate customer positions, a
process that might take between one and ten days.\23\ Once the loss was
crystalized, the DCO would be able to turn over the collateral (less
that used to meet the default) to the Trustee for use in the pro rata
distribution.
---------------------------------------------------------------------------
\22\ See generally, CME Group, Inc. (``CME'') at 14-15
(discussing information deficits at bankrupt FCM).
\23\ See 76 FR at 69366-68.
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Under the LSOC Model, the DCO could only use the collateral
attributable to defaulting customers (those whose positions suffered
losses) to meet the loss. Thus, all collateral attributable to
customers whose net positions gained or were ``flat'' (neither gained
nor lost), and much of the collateral attributable to customers whose
net positions lost, would be immediately available for transfer.
Moreover, the DCO would have information that is no more than one
business day old tying customers to portfolios of positions, and the
DCO itself would maintain the margining methodology that would tie such
portfolios of positions to the collateral requirement associated with
such portfolios. Even if the DCO decided to liquidate all customer
positions, the collateral of non-defaulting customers would be exposed
to less loss than under the Futures Model because the DCO would not
have the right to access it.
The Physical Segregation Model would work in a manner similar to
the LSOC Model. Again, all collateral attributable to customers whose
net positions gained or were ``flat'' (neither gained nor lost), and
the remaining collateral attributable to customers whose net positions
lost, would be immediately available for transfer. The DCO would have
specific information on how much collateral was, in fact, attributable
to each customer. However, because of the ratable distribution
requirement, any losses that did exist would be shared ratably among
all customers.
Under the Legal Segregation with Recourse, the DCO could only use
the collateral attributable to defaulting customers (those whose
positions suffered losses) to meet the loss--at first. It would also
use the defaulting clearing member FCM's own contribution to the
guaranty fund, its own contribution to the guaranty fund, as well as
the contributions of non-defaulting clearing members. However, if those
resources were insufficient to cover the default, the DCO would have
``recourse'' to the collateral of non-defaulting customers. While such
[[Page 6341]]
recourse is much less likely under the Legal Segregation with Recourse
Model than under the Futures Model--because the fellow-customer
collateral would not be reached unless the loss was great enough to
consume the entire guaranty fund--until the amount of loss from the
default was crystalized (through liquidation or transfer), the DCO
might be reluctant or unable to release the collateral of non-
defaulting customers. Accordingly, while Legal Segregation with
Recourse would (in most cases) provide customers superior recovery in a
liquidation, it would be much less well-suited to a prompt transfer of
positions.
E. Solicitation of Public Input
The Commission sought public comment on the segregation
alternatives mentioned above, and on the advisability of permitting the
DCO to choose between alternatives. First, the Commission, through its
staff, held extensive external meetings with three segments of
stakeholders (i.e., DCOs, FCMs, and swaps customers).\24\ Second, on
October 22, 2010, the Commission, through its staff, held a roundtable
(the ``First Roundtable'').\25\ Third, on November 19, 2010, the
Commission issued an Advance Notice of Proposed Rulemaking for
Protection of Cleared Swaps Customers Before and After Commodity Broker
Bankruptcies (the ``ANPR''). Fourth, on June 3, 2011, the Commission,
through its staff, held a second roundtable (the ``Second
Roundtable'').\26\ Fifth, after careful consideration of the comments
the Commission received on the ANPR, the Commission issued the NPRM.
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\24\ A list of external meetings is available at: http://www.cftc.gov/LawRegulation/DoddFrankAct/Rulemakings/DF_6_SegBankruptcy/index.htm.
\25\ The transcript from the First Roundtable (the ``First
Roundtable Tr.'') is available at: http://www.cftc.gov/idc/groups/public/@swaps/documents/dfsubmission/dfsubmission6_102210-transcrip.pdf.
\26\ The transcript from the Second Roundtable (the ``Second
Roundtable Tr.'') is available at: http://www.cftc.gov/idc/groups/public/@swaps/documents/dfsubmission/dfsubmission6_060311-transcri.pdf.
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1. First Roundtable
As the ANPR describes, the First Roundtable revealed that
stakeholders had countervailing concerns regarding the alternative
segregation models that the Commission set forth. On the one hand, a
number of swaps customers argued that the Commission should focus on
effectively eliminating Fellow-Customer Risk \27\ and Investment
Risk.\28\ Such swaps customers emphasized that (i) They currently
transact in uncleared swaps, (ii) they are able to negotiate for
individual segregation at independent third parties for collateral
supporting such uncleared swaps, and therefore (iii) they are currently
subject to neither Fellow-Customer Risk nor Investment Risk. Such
customers found it inappropriate that, under certain alternatives set
forth by the Commission, they should be subject to Fellow-Customer Risk
and Investment Risk when they transact in Cleared Swaps.
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\27\ As noted in section I.B.1, an FCM functions as a guarantor
of customer transactions with a DCO. Section 4d(f) of the CEA
prohibits an FCM from using the collateral deposited by one Cleared
Swaps Customer to support the swap transactions of another Cleared
Swaps Customer. Therefore, if one Cleared Swaps Customer owes money
to the FCM (i.e., the Cleared Swaps Customer has a debit balance),
the FCM, acting as guarantor, must deposit its own capital with the
DCO to settle obligations attributable to such customer. If the
Cleared Swaps Customer defaults to the FCM, and the Cleared Swaps
Customer's obligations are so significant that the FCM does not have
sufficient capital to meet them, then the FCM would default to the
DCO.
As discussed in Section I.B.4, the financial resources DCOs
maintain to cover Clearing Member defaults with respect to customer
positions in excess of collateral provided by the Clearing Member
include property of the defaulting Clearing Member (i.e., collateral
deposited to support FCM proprietary transactions and contributions
to the DCO guaranty fund). Other elements of such packages may
include: (i) The collateral that the FCM deposited to support the
transactions of non-defaulting customers; (ii) a portion of the
capital of the DCO; and (iii) contributions to the guaranty fund
from other DCO Clearing Members. Typically, a DCO would exhaust one
element before moving onto the next element. Therefore, the risk
that the DCO would use any one element depends on the position of
that element in the package.
\28\ ``Investment Risk'' is the risk that each Cleared Swaps
Customer would share pro rata in any decline in the value of FCM or
DCO investments of Cleared Swaps Customer Collateral. Section 4d(f)
of the CEA permits an FCM to invest Cleared Swaps Customer
Collateral in certain enumerated instruments. The Commission is
proposing to expand such instruments to include those referenced in
regulation 1.25 (as it may be amended from time to time). Even
though (i) such investments are ``consistent with the objectives of
preserving principal and maintaining liquidity,'' and (ii) both the
FCM, as well as the DCO, value such investments conservatively (by,
e.g., applying haircuts), the value of such investments may decline
to less than the value of the collateral originally deposited. See
regulation 1.25(b) (as amended in Investment of Customer Funds and
Funds Held in an Account for Foreign Futures and Foreign Options
Transactions, 76 FR 78776, December 19, 2011). In such a situation,
all customers would share in the decline pro rata, even if the
invested collateral belonged to certain customers and not others.
---------------------------------------------------------------------------
On the other hand, a number of FCMs and DCOs argued that the
benefits of effectively eliminating Fellow-Customer Risk and Investment
Risk are outweighed by the costs. With respect to benefits, these FCMs
and DCOs noted that the Futures Model has served the futures industry
well for many decades. With respect to costs, these FCMs and DCOs
described two potential sources. First, FCMs and DCOs stated that,
depending on the manner in which the Commission proposes to eliminate
or mitigate Fellow-Customer Risk and Investment Risk, they may
experience substantial increases to operational costs (e.g., costs
associated with transaction fees, reconciliations, recordkeeping,
reporting). Second, and more significantly, FCMs and DCOs stated that
they may incur additional risk costs due to proposed financial
resources requirements.\29\
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\29\ As described below, the term ``Risks Costs'' refers to the
costs associated with the allocation of loss in the event of a
default under the Complete Legal Segregation Model relative to the
Futures Model. For a more detailed explanation of these costs, see
the discussion in section VII.B.2.b., under the heading titled
```Risk Costs' and potential effects on margin levels and DCO
guaranty fund levels in response to complete legal segregation.''
---------------------------------------------------------------------------
In addition, some DCOs may have anticipated including collateral
from non-defaulting Cleared Swaps Customers as an element in their
financial resources packages. If DCOs no longer have access to such
collateral, then those DCOs would need to obtain additional financial
resources to meet proposed Commission requirements. Both FCMs and DCOs
averred that the costs associated with obtaining such additional
financial resources may be substantial, and would ultimately be borne
by Cleared Swaps Customers.\30\
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\30\ 75 FR at 75163. For example, one DCO estimated that it
would have to increase the amount of collateral that each Cleared
Swaps Customer must provide by 60 percent, if it could no longer
access the collateral of non-defaulting Cleared Swaps Customers to
cure certain defaults. See infra n. 258.
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2. ANPR
Given the concerns that stakeholders expressed at the First
Roundtable, the Commission decided to seek further comment through the
ANPR on the potential benefits and costs of (i) The Legal Segregation
Models (whether Complete or with Recourse), (ii) the Physical
Segregation Model, and (iii) the Futures Model. As the ANPR explicitly
stated, ``[t]he Commission [was] seeking to achieve two basic goals:
Protection of customers and their collateral, and minimization of costs
imposed on customers and on the industry as a whole.'' \31\ In
addition, the Commission requested comment on the impact of each model
on behavior, as well as whether Congress evinced intent for the
Commission to adopt any one or more of these models.
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\31\ Id.
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[[Page 6342]]
As described in the NPRM, the Commission received thirty-one
comments from twenty-nine commenters.\32\ The comments were generally
divided by the nature of the commenter: Most (though not all) of the
comments from current or potential Cleared Swaps Customers favored
either the Legal Segregation Models (whether Complete or with Recourse)
or the Physical Segregation Model, manifesting a willingness to bear
the added costs.\33\ Most of the FCMs and DCOs favored the Futures
Model, though one commenter favored the Complete Legal Segregation
Model.\34\ Finally, another commenter, in its supplemental comment,
opined that the most important factor that the Commission should
consider is the extent to which a model fostered the portability \35\
of Cleared Swaps belonging to non-defaulting customers.\36\ This
commenter noted that the Physical Segregation Model and what is now
referred to as the Complete Legal Segregation Model were most conducive
to that goal.\37\
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\32\ All comment letters are available through the Commission's
Web site at: http://www.cftc.gov/LawRegulation/FederalRegister/ProposedRules/2010-29836.
\33\ See id.
\34\ See id.
\35\ The terms ``portability,'' ``port,'' and ``porting'' refer
to the ability to reliably transfer the swaps (and related
collateral) of a non-defaulting customer from an insolvent FCM to a
solvent FCM, without the necessity of liquidating and re-
establishing the swaps.
\36\ See ISDA comment letters on ANPR.
\37\ See id.
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After careful consideration of the First Roundtable discussion and
the comments received in response to the ANPR, the Commission issued
the NPRM on June 9, 2011.
3. Second Roundtable
Discussions during the Second Roundtable generally reflected the
conflicting concerns expressed by market participants regarding the
alternative segregation models set forth by the Commission. Swaps
customers continued to state that the Commission should focus on
mitigating Fellow-Customer Risk, with some also advocating for the
elimination of Investment Risk, while FCMs and DCOs reiterated that the
Commission should select the Futures Model as the segregation model for
Cleared Swaps Customer Collateral because the Futures Model has served
the futures industry well for many decades. Pension funds, and a few
investment managers, remained concerned about their potential exposure
to Fellow-Customer Risk and Investment Risk and continued to press the
Commission to adopt the Physical Segregation Model either outright or
on an optional basis.
In addition, participants discussed various cost and benefits
issues arising in relation to the Futures and the Legal Segregation
Models. Specifically, several participants believed that the
operational costs would not be significantly different between the
Futures Model and the Complete Legal Segregation Model.\38\ Moreover,
although some participants projected that risk costs would
significantly increase if the Commission were to select the Complete
Legal Segregation Model,\39\ one participant argued that these risk
costs would not be incremental risk costs; rather they are risk costs
that exist in the Futures Model that would most likely ultimately be
borne by customers.\40\ Finally, one participant argued that any model
that facilitates the ability to port ``is superior to one that
doesn't'' because ``the closeout cost in the future's model was the
most expensive,'' meaning that ``closing out a client account and rates
could be extremely devastating to the market, and * * * be really
significant losses * * * [and] any way [the losses] can be avoided
would be beneficial to every participant in the market.'' \41\
---------------------------------------------------------------------------
\38\ See Second Roundtable Tr. at 250, l.2 (In response to
whether the Complete Legal Segregation Model would impose
operational costs over the Futures Model, Ms. Bregasi stated that
``[t]here is no additional cost between LSOC and the futures
model;'' Mr. Prager stated that ``[w]e don't see them incurring
other than the start-up costs, the one time that everyone will have
to incur to set up, the running cost. We don't see any incremental
cost;'' and Mr. MacFarlane stated that ``I would agree there are no
additional operational costs.''). See also, Second Roundtable Tr. at
239, l.8 (Mr. Frankel explaining that operational costs resulting
from passing ``the client identity and * * * some other multiplier
that explains how much excess there is in the seg account for the
client * * * [is] a small build.''); Second Roundtable Tr. at 243,
l.22 (Mr. Kahn stating that ``in terms of the cost, the fact is OTC
is a little different than futures because there is a tremendous
build that everyone is doing in the case of OTC so if we need to
build LSOC which in essence we've done in the LCH European model,
there is a cost of that but I can't really define what it is. It's
relatively small and not material.'').
\39\ See Second Roundtable Tr. at 255, l.12 (Mr. Frankel arguing
that ``Moving to a 99.9 percent confidence of coverage we think will
increase margins by about 60 percent [for rates] * * * I think for
CDS it could be more than double.''). See also Second Roundtable Tr.
at 262, l.2 (Mr. Diplas arguing that ``not having the additional
pool of funds that are associated with the fellow customers means
that we definitely need to actually margin from a CCP perspective,
the higher confidence interval. That will differ depending on the
asset class we're looking at. Some of them, at least based on the
existing pool of trades, it could be manageable like at 60, 70
percent in rates. We'll talk about three to four times the amount
that--in credit--and the more we get to instruments with fatter
tails the higher the number is going to be. I think that is
something that clients need to be cognizant of.'').
\40\ See, e.g., Second Roundtable Tr. at 257, l.6 (Mr.
MacFarlane stating that ``what's being said, if our transactions had
to be margined on an individual basis it would require that we put
up 60 to 70 percent more, which says that then the real risk of that
transaction is 75 percent more than what we're collateralizing. So
in the event of a default, not by us but by another counterparty
potentially, they will be under-collateralized relative to what
their individual transaction would require, and then that
potentially could work its way back to us.'').
\41\ See, e.g., Second Roundtable Tr. at 259, l.6 (quoting Mr.
Frankel). For a more detailed discussion of cost and benefit
considerations, please see discussion below in section VII.
---------------------------------------------------------------------------
4. NPRM
After carefully considering all comments to the ANPR and statements
made during the First Roundtable discussion, the Commission proposed in
the NPRM the Complete Legal Segregation Model as the segregation model
for Cleared Swaps Collateral because the Complete Legal Segregation
Model provided the best balance between benefits and costs in order to
protect market participants and the public. Nonetheless, due in part to
the strong opposing views expressed by market participants, the NPRM
made clear that the Commission was still considering whether to adopt,
in the alternative, the Legal Segregation with Recourse Model, and was
continuing to assess the feasibility of an optional approach and the
Futures Model.
Commenters to the ANPR generally observed that customers ultimately
would bear the costs of implementing whatever segregation model was
selected by the Commission. Nonetheless, most (though not all) of the
buy-side commenters favored individual protection for Cleared Swaps
Customer Collateral. These commenters generally viewed the Complete
Legal Segregation Model as the minimum level of protection necessary
for Cleared Swaps Customer Collateral. Because it was largely
recognized that customers would ultimately bear the costs of
implementing the selected segregation model, the Commission believed it
appropriate to give weight to the views of market participants who
would bear those costs, and found it compelling that most buy-side
commenters favored adoption of either the LSOC Model or the Physical
Segregation Model. The Commission noted that the Legal Segregation
Models and the Physical Segregation Model would provide greater
individualized protection to Cleared Swaps Customer Collateral than the
Futures Model, and was in accordance with section 4d(f) of the CEA. In
addition, the Commission noted that the LSOC Model and the Physical
Segregation Model may provide substantial benefits in the form of (i)
[[Page 6343]]
Decreased Fellow-Customer Risk, (ii) increased likelihood of
portability, (iii) decreased systemic risk, and (iv) positive impact on
portfolio margining, and asked for comment as to whether and why
commenters favor or oppose adoption of the Futures Model.
In choosing between the Legal Segregation Models and the Physical
Segregation Model, the Commission noted that the operational costs for
the Physical Segregation Model would be substantially higher than the
operational costs for the Legal Segregation Models (whether Complete or
with Recourse). With respect to benefits, the Commission believed that
the Physical Segregation Model would provide only incremental
advantages over the Complete Legal Segregation Model with respect to
the mitigation of Fellow-Customer Risk. In addition, the Commission
noted that while the Physical Segregation Model does eliminate
Investment Risk, (i) the Commission was in the process of further
addressing Investment Risk by proposing amendments to regulation 1.25,
and (ii) each FCM and DCO already values investments conservatively.
Finally, the Commission observed that the Physical Segregation Model
would generally enhance portability to the same extent as the Complete
Legal Segregation Model, and therefore would have similar effects on
systemic risk. In addition, the Commission stated that the Physical
Segregation Model and the Complete Legal Segregation Model would likely
enhance portfolio margining to the same extent. Therefore, the
Commission chose not to propose the Physical Segregation Model in the
NPRM.
In choosing between the Complete Legal Segregation Model and the
Legal Segregation with Recourse Model, the Commission noted that
commenters argued that implementing the former would result in
significant Risk Costs,\42\ whereas implementing the latter would
result in no Risk Costs. In addition, the Commission believes that
comments to the ANPR that question the assumptions underlying the upper
estimates of Risk Costs for the Complete Legal Segregation Model have
raised credible issues regarding the accuracy of those estimates.
Nevertheless, the Commission recognized that such assumptions formed an
area of divergence between commenters, and therefore asked for
additional comment on the Risk Costs for the Complete Legal Segregation
Model. The Commission also observed that operational costs for the
Complete Legal Segregation Model and the Legal Segregation with
Recourse Model were approximately the same. With respect to benefits,
the Commission noted that the Complete Legal Segregation Model would
(i) Mitigate Fellow-Customer Risk even in extreme FCM defaults, unlike
the Legal Segregation with Recourse Model, (ii) enhance portability
(and therefore mitigate systemic risk) to a significantly greater
extent than the Legal Segregation with Recourse Model, and (iii) have
an incremental advantage over the Legal Segregation with Recourse Model
with respect to impact on portfolio margining.\43\ Consequently, the
Commission chose not to propose the Legal Segregation with Recourse
Model in the NPRM, but stated that it was still considering this model
as an alternative.
---------------------------------------------------------------------------
\42\ For a more detailed discussion regarding risk costs, see
section VII.B.2.b., infra.
\43\ See 33818 FR at 33828.
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F. Clarification of the Application of Financial and Segregation
Interpretation No. 10 to Cleared Swaps
In response to the Commission's NPRM, clarification was requested
\44\ regarding the applicability to the cleared swaps market of the
Commission's 2005 Amendment to Financial and Segregation Interpretation
No. 10 on the Treatment of Funds Deposited in Safekeeping Accounts
(``Segregation Interpretation 10-1'').\45\ The commenter noted that
``[u]ntil 2005, the CFTC permitted the use of third-party custodial
accounts for futures margin by pension plans and investment companies
registered under the 1940 Act * * *. In 1984, the CFTC issued Financial
and Segregation Interpretation No. 10 * * *, permitting the use of
third party custodial accounts for the holding of customer property
subject to certain conditions ensuring that an FCM would have immediate
and unfettered access to customer funds.'' \46\ However, Segregation
Interpretation 10-1 made it clear that, with limited exceptions, FCMs
would not be in compliance with the requirements of section 4d(a)(2) of
the CEA if they hold customer funds in a third-party custodial account.
---------------------------------------------------------------------------
\44\ See Committee on Investment of Employee Benefit Assets
(``CIEBA'') December 22, 2011 letter (``CIEBA Supplemental'') at 2.
\45\ Amendment of Interpretation, 70 FR 24768, May 11, 2005
(Notice) The underlying Financial and Segregation Interpretation No.
10 (``Segregation Interpretation 10'') was issued on May 23, 1984,
and can be found at Comm. Fut. L. Rep. (CCH) ]7120.
\46\ CIEBA Supplemental at 4.
---------------------------------------------------------------------------
The Commission agrees that Segregation Interpretation 10-1 does not
apply to Cleared Swaps. Accordingly, and subject to the conditions
described below, Cleared Swaps Customer Collateral may be deposited at
a bank in a third-party safekeeping account, in lieu of posting such
collateral directly to the FCM, without the FCM being deemed in
violation of section 4d(f) of the CEA, and FCMs are permitted to
allowed Cleared Swaps Customers to elect to have their Cleared Swaps
Customer Collateral held in such accounts.
However, if an FCM uses, or allows the use of, a third-party
safekeeping account, that FCM must comply with all of the conditions
for such accounts set forth in Segregation Interpretation 10 as
originally issued in 1984.\47\ In addition, as noted in Segregation
Interpretation 10, though the use of third-party safekeeping accounts
is not prohibited, such collateral constitutes customer property within
the meaning of the Bankruptcy Code. As such, positions and collateral
held in third-party custodial accounts are subject to the U.S.
Bankruptcy Code and applicable provisions in the CEA, which provide for
the pro rata share of available customer property.
---------------------------------------------------------------------------
\47\ These conditions include limitations regarding the titling
and location of the third-party safekeeping account, and
requirements concerning the FCM's rights to promptly liquidate
positions and access collateral.
---------------------------------------------------------------------------
The commenter also requested that the Commission revise or repeal
Segregation Interpretation 10-1 to allow futures and options customers
to have their collateral held in third-party safekeeping accounts.\48\
However, while the Commission does not believe it would be appropriate
to address this request at this time, as it is beyond the scope of this
rulemaking, the Commission may address this concern in the future.
---------------------------------------------------------------------------
\48\ See CIEBA Supplemental at 12
---------------------------------------------------------------------------
The Commission also notes that a number of commenters\49\ have
proposed alternative arrangements that would provide individual
protection for collateral belonging to cleared swaps market
participants (and, in some cases, futures customers) that are willing
and able to bear the associated costs. However, these proposals raise
important risk management and cost externality issues, particularly
with respect to ensuring that collateral is promptly available to DCOs
in the event of a default, ensuring proper capital treatment for the
relevant market participants, and protecting all customers.
---------------------------------------------------------------------------
\49\ See generally CIEBA August 8, 2011 letter (``CIEBA
Original'') at 1-5; Salzman at 1-9; CME at 18; State Street at 2-4.
---------------------------------------------------------------------------
The Commission has directed staff to carefully analyze these
proposals with the goal of developing proposed rules that provide
additional protection for
[[Page 6344]]
collateral belonging to market participants.\50\
---------------------------------------------------------------------------
\50\ The Commission also notes that any market participant may
become a clearing member of a DCO, consistent with the DCO's
membership eligibility requirements and the CEA and Commission
regulations, with all the rights and responsibilities associated
therewith.
---------------------------------------------------------------------------
The Commission agrees with the comment that ``swap margin is not
meant to enhance the swap dealers' bottom line, but to protect the
system against counterparty failure,'' \51\ and remains committed to
protecting the market and market participants.
---------------------------------------------------------------------------
\51\ See CIEBA Supplemental at 14.
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II. The Final Rules
In determining the scope and content of the final rules, the
Commission has taken into account issues raised by commenters,
including those issues with respect to the costs and benefits
associated with the proposed segregation model for Cleared Swaps
Customer Collateral. The Commission received twenty-eight (28) comment
letters on the proposed rules,\52\ twenty-five (25) of which addressed
the issue of which segregation model the Commission should adopt for
Cleared Swaps Customer Collateral. Of these twenty-five (25), the
strong weight of the commenters rested in favor of individual
protection for Cleared Swaps Customer Collateral, with twenty (20)
comment letters supporting implementation of the Complete Legal
Segregation Model, the Physical Segregation Model or some combination
thereof.\53\ Four (4) comment letters supported adoption of the current
Futures Model,\54\ with one (1) comment letter, from the FIA, showing
support for both the Complete Legal Segregation Model and the Futures
Model.
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\52\ All comment letters are available through the Commission's
Web site at: http://comments.cftc.gov/PublicComments/CommentList.aspx?id=1038. Comments addressing the proposed rules
were received from: APG Algemene Pensioen Groep N.V. and the
European Federation Retirement Provision (``APG/EFRP''), American
Council of Life Insurers (``ACLI''), Association of Institutional
Investors (``AII''), Bank of America, N.A., BlackRock, Inc.
(``BlackRock''), Chris Barnard, CME, CIEBA, Federal Home Loan Banks
(``FHLB''), Fidelity Management & Research Co. (``Fidelity''),
Freddie Mac, Futures Industry Association (``FIA''),
IntercontinentalExchange, Inc. (``ICE''), Investment Company
Institute (``ICI''), International Swaps and Derivatives
Association, Inc. (``ISDA''), LCH.Clearnet Group Limited (``LCH''),
Managed Funds Association (``MFA''), Natural Gas Exchange, Inc.
(``NGX''), Newedge USA, LLC (``Newedge''), Och-Ziff Capital
Management Group (``Och-Ziff''), Jerrold E. Salzman, Securities
Industry and Financial Markets Association (``SIFMA''), Tudor
Investment Corporation (``Tudor''), and Vanguard. Note, CIEBA,
Fidelity and the MFA each submitted two comment letters.
\53\ The following commenters support the Complete Legal
Segregation Model outright: ACLI, AII, BlackRock, Mr. Barnard,
Freddie Mac, ICI, ISDA, LCH, SIFMA, and Vanguard. APG/EFRP, CIEBA,
Fidelity, MFA, Tudor and FHLB support implementation of the Physical
Segregation Model.
\54\ The commenters in favor of adoption of the Futures Model
were CME, ICE, Newedge, and Mr. Salzman.
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After carefully considering all comments, the Commission has
selected the Complete Legal Segregation Model as the most appropriate
segregation model for Cleared Swaps Customer Collateral under section
4d(f) of the CEA. The Commission believes this model provides the best
balance between benefits and costs in order to protect market
participants and the public. The Commission has adopted a number of
clarifications and corrections suggested in the comment letters. In
other cases the final rules are adopted as proposed. The discussion
below provides a more detailed analysis of the issues raised by the
comment letters.
III. Segregation Model for Cleared Swaps Customer Collateral
In the NPRM, the Commission proposed the Complete Legal Segregation
Model but made clear that, because the costs and benefits associated
with the Complete Legal Segregation Model were still being evaluated,
the Commission was considering whether to adopt the Legal Segregation
with Recourse Model as an alternative, and was continuing to assess the
feasibility of the Futures Model and a clearinghouse-by-clearinghouse
Optional Approach. Below is a summary of the comments the Commission
received regarding the alternative segregation models for Cleared Swaps
Customer Collateral.
A. Summary of the Comments
1. Complete Legal Segregation Model
As mentioned above, the majority of the comment letters supported
adoption of the Complete Legal Segregation Model either outright or as
a viable alternative to the Physical Segregation Model, with most
arguing that the Complete Legal Segregation Model presents the best
balance between costs and adequacy of collateral protections,\55\ and
several calling it a ``significant improvement over the'' Futures
Model.\56\ Several commenters also opined that the Complete Legal
Segregation Model is supported by the statutory language and purposes
of the Dodd-Frank Act.\57\
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\55\ See ACLI at 2; AII at 1; BlackRock at 1; Barnard at 2;
Fidelity at 2; Freddie Mac at 2; LCH at 1-2; SIFMA at 3; Vanguard at
8.
\56\ CIEBA at 1; and FHLB at 1.
\57\ See BlackRock at 3; Fidelity at 5-6; FIA at 3, n. 10; ICI
at 2; Mr. Barnard at 1; and SIFMA at 3, n. 7.
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In addition, many of the comment letters asserted that the Complete
Legal Segregation Model largely mitigates Fellow-Customer Risk and
enhances the portability of cleared swap positions and associated
collateral.\58\ One commenter stated that the Complete Legal
Segregation Model is ``the most cost effective framework to adequately
protect the margin customers post to cleared swap transactions''
because it effectively mitigates Fellow-Customer Risk, avoids the costs
associated with establishing the Physical Segregation Model by allowing
margin to be held in an omnibus account, and enhances the portability
of cleared swap positions and related margin.\59\ Another commenter
stated that the Complete Legal Segregation Model ``provides the most
operationally efficient framework to manage risk on a daily basis or
port portfolios especially in periods of stress.'' \60\ And yet other
commenters argued that there has been little substantiation of the
``increased costs'' that would arise from implementation of the
Complete Legal Segregation Model, especially with respect to costs
surrounding the reporting requirements associated with maintaining
separate legal accounts given that ``other regulatory rulemakings that
require similar reporting will likely result in many of these
incremental operational costs being incurred regardless of which model
is chosen.'' \61\
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\58\ See, e.g., AII at 3 (stating that the Complete Legal
Segregation Model effectively eliminates Fellow-Customer Risk,
enhances portability of positions and related margin, and largely
avoids the costs associated with establishing individually
segregated accounts); BlackRock at 2 (arguing that the Complete
Legal Segregation Model ``eliminates Fellow-Customer Risk and
facilitates `immediate' portability of customer positions if
required''); CIEBA Original at 5 (acknowledging that the Complete
Legal Segregation Model could eliminate Fellow-Customer Risk); FHLB
at 3 (agreeing that the Complete Legal Segregation Model greatly
reduces Fellow-Customer Risk); ICI at 3 (stating that the Complete
Legal Segregation Model mitigates Fellow-Customer Risk); ISDA at 1-2
(agreeing that Complete Legal Segregation Model facilitates post-
default portability); MFA at 3-4 (stating that the Complete Legal
Segregation Model eliminates Fellow-Customer Risk and enhances the
portability of customer positions); Vanguard at 4-6 (arguing that
the Complete Legal Segregation Model addresses counterparty risk and
Fellow-Customer Risk); and SIFMA at 5 (stating that Complete Legal
Segregation Model minimizes Fellow-Customer Risk and facilitates the
ability of Cleared Swaps Customers to port their positions to a non-
defaulting FCM).
\59\ AII at 1.
\60\ BlackRock at 6.
\61\ Fidelity at 6. See also LCH at 2-3. The Commission has
adopted a gross margining requirement. See 76 FR at 69374-76.
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[[Page 6345]]
Several commenters also argued that, in selecting a segregation
model for Cleared Swaps Customer Collateral, the Commission should take
into account the differences between the risk profiles of futures and
over the counter (``OTC'') swaps.\62\
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\62\ BlackRock at 2-4; Fidelity at 4; SIFMA at 2; Vanguard at 3-
4.
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Furthermore, commenters argued that, unlike the Futures Model, the
Complete Legal Segregation Model would not degrade the collateral
protections that currently exist in the OTC swaps market.\63\ In
addition, one commenter indicated that the Complete Legal Segregation
Model is ``the model that most closely parallels the protections that
[LCH] understand[s] will be required in Europe under the European
Commission's proposal for a European Market Infrastructure Regulation
(``EMIR'').'' \64\
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\63\ See Fidelity at 2-4; Freddie Mac at 1; and LCH at 1. See
also Tudor at 2 (arguing that the segregation model selected by the
Commission should not provide a lesser degree of protection for
Cleared Swaps Customer Collateral).
\64\ LCH at 1.
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Commenters who did not support adoption of the Complete Legal
Segregation Model largely argued that (1) The costs of implementing the
Complete Legal Segregation Model outweigh any of the purported benefits
of such model; \65\ (2) the Complete Legal Segregation Model would, in
the view of the commenter, fail to work operationally or legally,\66\
and does not take into account the operational complexities of multi-
tiered and multi-DCO clearing; \67\ (3) individualized segregation
potentially introduces systemic costs because it impedes timely market
settlements during periods of market stress; \68\ (4) since the Futures
Model has served the industry well during times of stress in the
futures market, it should be the segregation model for Cleared Swaps
Customer Collateral; \69\ (5) the Complete Legal Segregation Model
introduces moral hazard; \70\ or (6) the Complete Legal Segregation
Model does not provide enough protection of Cleared Swaps Customer
Collateral because there is some residual Fellow-Customer Risk,\71\ and
it does not protect against fraud-related risks,\72\ record-keeping/
operational risk, and Investment Risks.\73\ Moreover, several
commenters disagreed with the Commission's interpretation of the
statutory language in the Dodd-Frank Act, and argued that the statutory
language cited by the Commission does not indicate Congressional intent
for individual protection for Cleared Swaps Customer Collateral.\74\
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\65\ See, e.g., ICE at 11.
\66\ See CME at 5 (stating that ``the framework established by
the [Complete Legal Segregation Model] concept and the proposed
regulations will be wholly inadequate to achieve the Commission's
desired objectives: Namely, in an FCM default, the preservation of
non-defaulting cleared swaps customers' collateral and the ability
to port their positions and collateral to another FCM.'').
\67\ See, e.g., CME at 6-8. See also Mr. Salzman at 7 (stating
that ``the benefits promised by the proponents of the [Complete
Legal Segregation Model] are illusory,'' and arguing that the
Commission's authority to adopt, and a bankruptcy court's
willingness to respect, such model are questionable).
\68\ See ICE at 3.
\69\ See, e.g., Newedge at 8; and CME at 23.
\70\ See, e.g., Newedge at 4-5.
\71\ See, e.g., CME at 7.
\72\ Fraud-related risks are risks associated to an FCM's
fraudulent activity with respect to the cleared swap margin account.
\73\ See, e.g., Tudor at 4; CIEBA Original at 1; and FHLB at 3-6
(each advocating for the adoption and implementation, either
outright or on an optional basis, of the Physical Segregation Model,
though acknowledging that the Complete Legal Segregation Model is
preferable to the Futures Model).
\74\ See CME at 21-22 (arguing that if Congress intended to
change the framework for the protection of customer collateral it
would have explicitly done so); FIA at 3, n. 10 (agreeing that the
complete legal segregation model is permitted by the language of
section 4d(f), but arguing that Commission reliance on the
differences between sections 4d(a) and 4d(b) are misplaced); and ICE
at 5 (arguing that the Commission should not rely on the language in
section 4d(f) because there is no legislative history interpreting
the statutory language).
---------------------------------------------------------------------------
2. Physical Segregation Model
Comments with respect to the Physical Segregation Model were mixed,
with some commenters advocating the adoption of the Physical
Segregation Model outright,\75\ others advocating for its adoption on
an optional basis,\76\ and others arguing that the Physical Segregation
Model should not be adopted because the increased costs and operational
burdens associated with adoption of the Physical Segregation Model
outweigh the benefits.\77\
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\75\ FHLB at 1; Tudor at 1-2.
\76\ ACLI at 2; CIEBA at 2; MFA at 2; Mr. Salzman at 8.
\77\ BlackRock at 6; Vanguard at 6.
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Two commenters requested that the Commission reconsider adoption of
the Physical Segregation Model on the basis that (i) Customer
collateral should be individually segregated at both the FCM and the
DCO to provide the same level of customer collateral protection that
currently exists in the OTC swaps market, (ii) none of the other models
are sufficient to fully protect customer collateral from recordkeeping/
operational, investment and fraud-related risks, (iii) the Physical
Segregation Model facilitates porting more than the other models, and
(iv) the commenters would be willing to bear any increased costs
associated with the adoption of the Physical Segregation Model.\78\
---------------------------------------------------------------------------
\78\ See, e.g., ICI at 2 and 9.
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In addition, though several commenters supported the Complete Legal
Segregation Model as the best alternative under consideration, these
commenters urged the Commission to develop a framework for the adoption
of the Physical Segregation Model because (i) The protections offered
by the Physical Segregation Model are greater than those offered by the
Complete Legal Segregation Model, (ii) the Physical Segregation Model
facilitates porting more than the other models, and (iii) the costs
assertions resulting from implementing the Physical Segregation Model
have either not been substantiated or are costs that the commenters are
willing to bear.\79\
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\79\ See, e.g., ACLI at 2; BlackRock at 5.
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Commenters that opposed adoption of the Physical Segregation Model
generally did so on the basis that implementation of the model would
give rise to substantial increased costs with little increased benefit,
as compared with the Complete Legal Segregation Model.\80\
---------------------------------------------------------------------------
\80\ See, e.g., AII at 2; ICE at 9; FIA at 6; SIFMA at 4 n. 9;
and Vanguard at 6.
---------------------------------------------------------------------------
3. Futures Model
As mentioned above, four comment letters supported adoption of the
Futures Model, with one commenter supporting adoption of both the
Complete Legal Segregation Model and the Futures Model.
CME argued that the Futures Model provides the best balance of
costs versus industry risk as a whole and is ``the only approach that
provides both legal and operational certainty to all parties in the
event of an FCM default.'' \81\ According to CME, the Complete Legal
Segregation Model imperfectly protects customer collateral and thus,
``the Commission [should] not rush [sic] to implement a `solution' that
gives superficial comfort, but may not work either operationally or
legally in the event of an actual default.'' \82\ CME encouraged the
Commission to ``engage in further study, and establish a review process
that includes a representative group of interested parties with
expertise in the area, in order to evaluate alternative approaches.''
\83\ Because the Futures Model has effectively protected customer
interests in the futures market, CME recommended that, in the interim,
the Commission implement swaps clearing employing the Futures
[[Page 6346]]
Model.\84\ Moreover, CME suggests that the Commission support a new
industry effort to, at some point in the future, develop and implement
a guaranteed clearing participant relationship that would allow a
client, on an optional basis, to have a direct relationship with a DCO,
with the client's positions guaranteed by a guaranteeing clearing
member of the DCO and the client's Cleared Swaps Customer Collateral
held in an outside account by a third party custodian.
---------------------------------------------------------------------------
\81\ CME at 23.
\82\ Id. at 2.
\83\ Id.
\84\ See id. at 23.
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Mr. Salzman supported adoption of the Futures Model with optional
full physical segregation of Cleared Swaps Customer Collateral.
ICE advocated adoption of the Futures Model, arguing against
fundamentally changing a clearinghouse's existing operations, and
positing that customers that wish to avoid Fellow-Customer Risk might
explore becoming direct clearing participants once they ``fully
appreciate[e] the substantial costs * * * associated with implementing
and maintaining [the Complete Legal Segregation Model].'' \85\ However,
ICE also proposed, as a middle ground, a model that appears to be based
on the Futures Model but that provides some protection against Fellow-
Customer Risk. ICE explained that its ICE Clear Credit affiliate had
adopted a model under which, ``customers are exposed to `fellow-
customer risk' only with respect to the customer's pro-rata share of
the net customer-related margin requirement of its clearing member.''
\86\ ICE Clear Credit considers ``the difference between a customer's
gross margin requirement and the customer's net margin requirement'' to
be ``Excess Margin.'' \87\ ICE stated that a customer's Excess Margin
is segregated and held by ICE Clear Credit on a custodial basis and is
therefore not exposed to Fellow-Customer Risk. ICE argued that this
model would provide some protection against Fellow-Customer Risk but
would be more cost-effective than the proposed Complete Legal
Segregation Model. In addition, ICE stated that individual segregation
should be offered to customers at the option of a DCO, and also
advanced the notion that the Commission should ``carefully consider and
weigh the costs and benefits of potential customer-related OTC clearing
models by asset class * * *.'' \88\
---------------------------------------------------------------------------
\85\ ICE at 3.
\86\ Id.
\87\ Id. at 3, n. 3.
\88\ ICE at 1-2.
---------------------------------------------------------------------------
Newedge, which submitted a comment on behalf of itself, DRW Trading
Group and nine ``Customers,'' supported adoption of the Futures Model
on the basis that the Futures Model ``is the model most consistent with
the general purposes of Title VII of Dodd-Frank as well as least likely
to add moral hazard to the industry.'' \89\ Newedge argued that Title
VII is about the reduction of systemic risk through the mutualization
of risk, and that by mutualizing credit risk the Futures Model promotes
the purpose of the Dodd-Frank Act because such mutualization encourages
the creation and maintenance of well-capitalized FCMs. In addition,
Newedge argued that the loss of customer off-sets would increase moral
hazard because it would encourage FCMs to maintain less excess capital.
Furthermore, Newedge suggested that, as an alternative to the adoption
of the Complete Legal Segregation Model, the Commission should require
greater FCM disclosure to allow customers to better assess Fellow-
Customer Risk.\90\
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\89\ Newedge at 2.
\90\ Newedge argues that such disclosure be provided in ``plain
English'' on an annual basis, and include the following data:
The FCM's total equity, regulatory capital and net worth;
The dollar value of the FCM's proprietary margin requirements as
a percentage of its segregated and secured customer margin
requirements;
What number of the FCM's customers comprise an agreed
significant percentage of its customer segregated funds;
The aggregate notional value of non-hedged, principal OTC
transactions into which the FCM has entered;
The amount, generic source and purpose of any unsecured and
uncommitted short-term funding the FCM is using;
The aggregate amount of financing the FCM provides for customer
transactions involving illiquid financial products for which it is
difficult to obtain timely and accurate prices;
The percentage of customer ``bad debts'' the FCM had during the
prior year compared to its year-end segregated and secured customer
funds; and
A summary of the FCM's current risk practices, controls and
procedures.
Newedge at 7. See also FHLB at 7, n. 14 (encouraging the
Commission, in response to a question in the NPRM regarding
additional disclosure of FCM financial information, to make such
information publicly available on a real time basis); and MFA at 5
(arguing that ``if the Commission mandates the disclosure by FCMs of
certain financial information, customers will be in a better
position than they are today to evaluate the financial strength of
their FCM.'').
---------------------------------------------------------------------------
Comment letters supporting individual protection for customer
collateral over the Futures Model generally did so on the basis that
the Futures Model (i) does not protect Cleared Swaps Customer
Collateral from Fellow-Customer Risk, Investment Risk, operational risk
or fraud-related risk, and (ii) does not facilitate the portability of
customer positions and associated collateral in the event of an FCM's
default.\91\
---------------------------------------------------------------------------
\91\ See, e.g., AII at 1-2; BlackRock at 2, 7-8; CIEBA Original
at 5; FHLB at 6-7; Fidelity at 3; Freddie Mac at 1-2; SIFMA at 5;
and Vanguard at 4-5.
---------------------------------------------------------------------------
BlackRock argued that not only does the Futures Model fail to
address the core risk differences between futures and OTC swaps, but
because of the buffer created by the mutualized risk provided by the
customer collateral, the Futures Model may result in less stringent
selection and oversight of customers by FCMs.\92\ In addition,
BlackRock argued that the moral hazard argument advocated by proponents
of the Futures Model presumes that futures customers have access to
information that allows them to make informed decisions regarding their
fellow customers. However, BlackRock stated that access to such
information is currently lacking, there are no requirements or
incentives for a DCO or FCM to inform a customer when a fellow customer
is in a stress or potential default situation and, as a result,
customers are forced to rely on DCOs and regulators for protection.\93\
---------------------------------------------------------------------------
\92\ Blackrock at 8.
\93\ Id.
---------------------------------------------------------------------------
Freddie Mac argued that by allowing DCOs to access the collateral
of non-defaulting customers to cover the losses of defaulting
customers, the Futures Model provides a ``subsidy to DCOs, FCMs and
their riskiest customers at the expense of customers that present less
risk[, and] this non-transparent shifting of risk would create moral
hazard and inefficient credit decisions.'' \94\
---------------------------------------------------------------------------
\94\ Freddie Mac at 2.
---------------------------------------------------------------------------
Similarly, FHLB argued that DCOs and FCMs should bear all Fellow-
Customer Risk as they are in a superior position to conduct analyses of
other cleared swap customers.\95\ In addition, FHLB indicated that if
the Commission adopts the Futures Model as the segregation model for
Cleared Swaps Customer Collateral, it would be anomalous for market
participants to have the initial margin they post for Cleared Swaps
face greater risk than the initial margin they post for uncleared
swaps.\96\ Moreover, the Futures Model would impede portability because
the collateral posted for Cleared Swaps ``could be tied up in the
omnibus account indefinitely.'' \97\
---------------------------------------------------------------------------
\95\ FHLB at 6-7.
\96\ FHLB at 7. FHLB also states that market participants have a
statutory right to segregate initial margin they post for uncleared
swaps with an independent custodian. Id. at 6.
\97\ FHLB at 7.
---------------------------------------------------------------------------
SIFMA stated that avoiding Fellow-Customer Risk presented by the
Futures Model should be the most important
[[Page 6347]]
objective in selecting a segregation model for Cleared Swaps Customer
Collateral and, as such, none of the members of the Asset Management
Group supports the Futures Model.\98\ In addition, SIFMA argued that
the Futures Model does not facilitate portability to the same extent as
the Complete Legal Segregation Model and, therefore, is not as
effective at reducing systemic risk.\99\
---------------------------------------------------------------------------
\98\ SIFMA at 3.
\99\ See SIFMA at 4-6.
---------------------------------------------------------------------------
Vanguard asserted that the Futures Model exposes market
participants to Fellow-Customer Risk and because this risk is not a
factor in the OTC swaps markets, the magnitude of such risk is not
something that a customer could ever assess, especially given the
``complete lack of transparency with respect to [an] FCM's other
customers and their trading positions.'' \100\ Furthermore, Vanguard
stated that mutualization of customer losses effectively allows ``less
sophisticated analysis of the risk presented by individual customers
and their trading portfolios as such individual risk can ultimately be
covered by the overall pool of margin posted by all of the FCM's
customers,'' with the result that ``riskier customers (and trading
portfolios) [are] likely to be under margined and safer clients (and
trading portfolios) [are] likely to be over margined relative to their
actual level of risk presented to the system.'' \101\ In sum, Vanguard
stated that, given the differences between the swaps and futures
markets, the Futures Model could expose a Cleared Swaps Customer to
significantly greater and potentially unlimited risk.\102\
---------------------------------------------------------------------------
\100\ Vanguard at 5.
\101\ Id.
\102\ Id.
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4. Legal Segregation With Recourse Model
None of the comment letters received by the Commission appeared to
support the Legal Segregation with Recourse Model. Commenters that
discussed this model generally stated that the Commission should not
adopt the Legal Segregation with Recourse Model because either (1) by
failing to mitigate Fellow-Customer Risk, it is substantially inferior
to the Complete Legal Segregation Model \103\ or (2) it suffers from
the same shortcomings as the Complete Legal Segregation Model since it
is costly to implement and fails to mitigate investment and operational
risks.\104\
---------------------------------------------------------------------------
\103\ See BlackRock at 7; FHLB at 7; Freddie Mac at 2; FIA at 6-
7; MFA at 2; and Vanguard at 4.
\104\ See, e.g., CME at 16.
---------------------------------------------------------------------------
5. Optional Approach
Though some commenters expressed a desire to have optional full
physical segregation of Cleared Swaps Customer Collateral, none of the
commenters supported the Optional Approach outlined by the
Commission.\105\ Under this approach, each DCO would choose the level
of customer collateral protection it chooses to offer.\106\ The
Commission noted that this approach might be reconciled with section
766(h) of the Bankruptcy Code by permitting DCOs to require that FCMs
establish separate legal entities, each of which is limited to clearing
at DCOs that use only the same customer collateral protection
model.\107\
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\105\ See, e.g., MFA at 3 n. 11 (stating ``[t]he Commission
should allow market participants to elect the Physical Segregation
Model but only to the extent that it is compatible with the Complete
Legal Segregation Model. We are not advocating that the Commission
adopt the ``Optional Approach'' set forth in the Proposing Release,
because we believe that approach would be very difficult to
implement.''); ACLI at 2 (supporting the option to negotiate and
select the Physical Segregation Model); BlackRock at 5 (stating that
BlackRock would support an optional approach if the Commission
believes such an approach would be prudent, but cautions that
optionality may present implementation challenges and result in
portability delays); CIEBA Original at 1 (promoting optional
individual segregation of Cleared Swaps Customer Collateral); CME at
17-20 (arguing that the Commission should support efforts to
establish programs that would permit individuals to physically
segregate the collateral associated with their Cleared Swaps
positions on an optional basis); and Tudor at 6 (arguing that if the
Commission does not adopt the Physical Segregation Model, the
Commission should ``require DCOs to offer various segregation models
to their cleared swaps customers, including full physical
segregation.'').
\106\ See 76 FR at 33825.
\107\ See 76 FR at 33829.
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One commenter stated that it is ``likely that the benefits of
creating such a regulatory structure would be illusory,'' \108\ while
another argued that ``[o]ptionality will produce complexity and expense
that might be tolerable when the cleared swaps market is well
established, but that will be burdensome to a developing market.''
\109\ In addition, one commenter expressed concern regarding the
appropriateness of the Commission adopting a segregation regime ``that
provides protection to customers based on their ability and willingness
to pay.'' \110\
---------------------------------------------------------------------------
\108\ CME at 20.
\109\ ISDA at 2.
\110\ FIA at 6.
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B. Discussion of the Comments
After careful analysis of the issues raised by the comment letters
with respect to the selection of a segregation model for Cleared Swaps
Customer Collateral, the Commission is adopting the Complete Legal
Segregation Model. As described above, the majority of market
participants supported adoption of either the Complete Legal
Segregation Model or the Physical Segregation Model. In addition, while
certain technical corrections/clarifications were requested, none of
the commenters identified material new information with respect to
costs or benefits associated with the adoption of the Complete Legal
Segregation Model or any other model under consideration. Some
commenters did, however, re-iterate their view that their business
model depended upon receiving stronger protection for their Cleared
Swaps Customer Collateral than what exists under the Futures Model.
These commenters are accustomed to paying for the higher costs implicit
in separate accounting in the current bilateral market.
On the other hand, CME, ICE, and Mr. Salzman identified a number of
issues with the Complete Legal Segregation Model, including a number of
limitations on the protection it provides to customers. They did not,
however, provide reason to reject the conclusion that the Complete
Legal Segregation Model provides substantially greater protection
against Fellow-Customer Risk than the Futures Model.
CME notes \111\ that a portion of the Cleared Swaps Customer
Collateral will be held at the FCM, not the DCO, and that this
collateral will not be protected by Complete Legal Segregation in the
event that an FCM becomes insolvent. This proposition is true \112\ but
is of little or no relevance to the comparison of Complete Legal
Segregation with the Futures Model favored by these commenters.
Complete Legal Segregation is intended to protect against Fellow-
Customer Risk. As discussed in the NPRM and above,\113\ Fellow-Customer
Risk is the risk that the collateral of one customer will be used to
compensate a DCO for market losses resulting from the swaps of another
customer.\114\ In other words, Fellow-Customer Risk arises in
connection with collateral maintained in an FCM's customer account
posted with a DCO because, under the Futures Model, the DCO is
potentially entitled to take all of the collateral in this account to
cover losses created by the swaps of any customer. However, Cleared
Swaps Customer Collateral held at the FCM (or at a location other than
at the DCO, such as a bank) is not accessible to the DCO. Thus, such
[[Page 6348]]
collateral is not subject to Fellow-Customer Risk.\115\ While Cleared
Swaps Customer Collateral in the customer account at the FCM is
available to meet customers' swaps-related obligations to the FCM, the
FCM is prohibited by statute from using one customer's Cleared Swaps
Customer Collateral as margin or security for another customer's
swaps.\116\
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\111\ CME at 6.
\112\ See supra note 13.
\113\ See supra at Section 1.B.6.
\114\ 76 FR at 33821 n. 21.
\115\ As explained above, FCMs typically maintain two separate
Cleared Swaps Customer Accounts. One is maintained at the DCO and
contains collateral required by the DCO to secure current swaps
positions. The second is maintained by the FCM itself, typically at
a bank, and contains collateral provided to the FCM by customers but
not currently posted to the account at the DCO.
\116\ Section 4d(f)(2)(B) of the CEA, 7 U.S.C. 6d(f)(2)(B).
---------------------------------------------------------------------------
To be sure, Cleared Swaps Customer Collateral is subject to
operational risk--the risk that, due to fraud, incompetence, or other
mishap, customer funds that are required to be segregated are lost.
Operational risk, however, is common to all of the segregation models
for Cleared Swaps Customer Collateral, including the Physical
Segregation Model.\117\ Collateral at the FCM is also subject to a
modicum of Investment Risk. But Commission regulation 1.25, upon which
regulation 22.2(e)(1) is based, is designed to ensure that customer
segregated funds are invested in a manner that minimizes their exposure
to credit, liquidity, and market risks both to preserve their
availability to customers and DCOs and to enable investments to be
quickly converted to cash at a predictable value in order to avoid
systemic risk. Towards these ends, regulation 1.25 establishes a
general prudential standard by requiring that all permitted investments
be ``consistent with the objectives of preserving principal and
maintaining liquidity.'' \118\
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\117\ Moreover, as noted above (see supra section I.D.2), while
the LSOC Model does not protect against operational risk any more
than the Futures Model, it is superior in that it enhances the
ability to transfer collateral after an insolvency caused by
operational risk.
\118\ See regulation 1.25(b).
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CME also provides a detailed description of how, due to the ``the
extended operational timeline for derivatives clearing and the netting
of payments,'' a customer could default on a payment on Tuesday, but
the DCO would, due to a countervailing gain by a different customer or
customers of the same clearing member, not see such a default until
after Wednesday's clearing cycle (payments for which may not be due
until Thursday morning).\119\ This analysis elides the fact that,
pursuant to the calculations required under regulation 22.2(f), an FCM
with a customer who incurred a loss in excess of that customer's
Cleared Swaps Customer Collateral would, unless and until that customer
posted additional collateral, be required to have covered such loss
with the FCM's own capital deposited into the Cleared Swaps Customer
Account. If, at any moment, such customer loss was not covered by the
FCM's own capital, then the FCM would be in violation of its
segregation requirements. Pursuant to Commission regulation 1.12(h),
---------------------------------------------------------------------------
\119\ CME at 9.
[w]henever a person registered as a futures commission merchant
knows or should know that the total amount of its funds on deposit
in segregated accounts on behalf of customers * * * is less than the
total amount of such funds required by the Act and the Commission's
rules to be on deposit in segregated * * * accounts on behalf of
such customers, the registrant must report such deficiency
immediately by telephonic notice * * * to the registrant's
designated self-regulatory organization and the principal office of
the Commission in Washington, DC * * *.\120\
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\120\ Commission regulation 1.12(h) emphasis added.
Thus, an FCM whose customer suffers such a loss which is not
covered by the FCM's own capital on deposit in the Cleared Swaps
Customer Account will certainly know of such deficiency no later than
noon the next day (Wednesday in CME's example), when it will be
required, pursuant to regulation 22.2(g), to compute its segregated
funds requirements and the amount of segregated funds it has on deposit
to meet such requirements. Moreover, the Commission believes that an
FCM carrying a customer account that suffers losses in excess of that
firm's ability to cover ``should know'' of such losses by the end of
that trading day (Tuesday in CME's example).
Such notice will permit the Commission to act to notify the
relevant clearing organizations and to ensure that prompt action is
taken to either bring capital in to enable the FCM to meet its
segregated funds requirements or to otherwise act to minimize customer
losses.
CME implies that a successful porting of customer accounts requires
information that is ``100% accurate,'' \121\ and that an FCM is
unlikely to meet that standard each day. CME also notes that there may
be portfolio changes in customer accounts on the day of default.\122\
Moreover, CME notes that a defaulting FCM may have systems that
fail.\123\ CME notes that in the case of Lehman Brothers,\124\ there
was a ``rushed, confused, uncertain and near-panic atmosphere,'' as
described in the report of the SIPA Trustee.\125\
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\121\ CME at 13.
\122\ Id. at 12.
\123\ Id. at 14.
\124\ The Lehman Brothers FCM was placed into a Securities
Investor Protection Corporation liquidation on Friday, September 19,
2008.
\125\ CME at 14 (citation omitted).
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Recent experience demonstrates, however, that transfers can occur
despite less than perfect information. For example, in the case of the
bankruptcy of Lehman Brothers the commodity customer accounts were
effectively transferred to Barclays over the weekend of September 20-
21, 2008, immediately following the commencement of the liquidation of
the firm,\126\ and any discrepancies were resolved, despite the
difficulties described. Indeed, the key issue will be to identify the
collateral attributable to the defaulting customer, as distinguished
from the collateral attributable to all other customers, as
discrepancies between non-defaulting customers can be resolved either
as transferred accounts are reconciled, or through the claims process.
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\126\ This transfer was authorized in the hours immediately
following the commencement of Lehman's liquidation, and was
implemented in the hours immediately thereafter.
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Thus, while CME is correct in stating that ``the risk of ultimate
financial loss to customers due to a fellow-customer default is reduced
but certainly not eliminated under CLSM,'' \127\ the Commission
concludes, based on its experience with its rules in general and with
FCM bankruptcies in particular, that the probability and probable
amount of such loss is far less than CME implies.
---------------------------------------------------------------------------
\127\ CME at 15.
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Moreover, the swift portability of collateral associated with
customer positions in the event of an FCM's default remains problematic
under the Futures Model where there is a customer default. Furthermore,
many of the imperfections of the Complete Legal Segregation Model and
the residual Fellow-Customer Risk associated therewith that were
highlighted by CME arise from the ``last-day risk'' that results from
the fact that information about each customer's positions is only
provided once each day. However, the NPRM made clear in relevant
portions of sections 22.11 and 22.12, and the Commission reiterates
herein, that information must be provided and calculations must be made
at least once a business day. In other words, many of the imperfections
discussed by CME are not inherent to the Complete Legal Segregation
Model. Rather, each DCO is free to make improvements to that
[[Page 6349]]
minimum regulatory standard if the DCO finds such improvements to be
technologically feasible and economically justifiable. For example, a
DCO could require its clearing members to identify the customer
associated with each swap as it is cleared, and the DCO could use this
information to associate gains and losses more tightly with each
customer, thereby minimizing ``last-day risk.'' The NPRM and this final
rule simply set a minimum threshold for daily tracking.
With respect to costs associated with evaluating the credit risks
of individual customers, CME noted that it calculates, ``at the end of
each trading day * * * for each FCM's cleared swaps customer account *
* * the net position of each customer in the account [and] the net
margin requirement for each customer in the account.'' \128\ Thus,
based on CME's description of its current clearing practices, it would
appear that CME already undertakes an individualized evaluation of the
sufficiency of the collateral posted by each customer of an FCM.\129\
In addition, as CME notes, ``FCMs are subject to compliance audits that
are conducted for each FCM by the DCO serving as its ``designated self-
regulatory organization.'' \130\ It would therefore seem that at least
some of the costs associated with evaluating the credit risk of
individual customers are already being incurred by DCOs.
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\128\ Id. at 9 (emphasis supplied).
\129\ In addition, during the Second Roundtable, Ms. Taylor of
CME stated that with respect to risk management, CME is ``set up to
do it in the over-the-counter business at the individual customer
level.'' See Second Roundtable Tr. at168, l. 10.
\130\ See also Second Roundtable Tr. at 171, l. 18 (Ms. Taylor
stating that ``on a day-to-day basis we don't see the collateral
that's in the account of a customer at an FCM, but we do have
transparency into the efficacy of the practices of holding margin
and holding it in segregated accounts through the financial
supervision and audit functions so that there is ongoing monitoring
of that * * *'').
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With respect to ICE's proposal, the Commission notes that it would
provide less Fellow-Customer Risk protection than the Complete Legal
Segregation Model. The fact that swap customers seem to overwhelmingly
favor at least as much Fellow-Customer Risk protection as afforded to
them under the Complete Legal Segregation Model, notwithstanding the
potential costs, weighs in favor of the Complete Legal Segregation
Model rather than ICE's proposal.
With respect to Newedge's suggestion for increased disclosure of
FCM information, additional disclosure is often beneficial, and the
Commission will consider additional disclosure requirements as a means
of enhancing protection for collateral belonging to market
participants. However, because of confidentiality concerns, any
feasible enhanced disclosure is insufficient for quantifying risk
exposure to Fellow-Customer Risk and, thus, insufficient for providing
Cleared Swaps Customers with the ability to effectively manage such
exposure.\131\ Moreover, even if it were practical to provide Cleared
Swaps Customers with information sufficient to assess Fellow-Customer
Risk, that task is better left to the DCO since (1) DCOs have a
concentrated ability to ensure adequate risk mitigation, and (2) having
each Cleared Swaps Customer effectively risk-manage each FCM would
likely entail duplication with resulting cost.
---------------------------------------------------------------------------
\131\ See Second Roundtable at p. 183, 1.12-p. 184, 1.10 (In
reference to the disclosure of additional FCM information, Mr. Kahn
stating ``Barclays does agree and would be willing to show our risk-
management procedures and policies, and we do talk to our buy side
clients about that * * * [but] if Barclays is providing clearing
services for any of the individual firms on the other side of the
table, we do not say that, nor would we ever give out any position
level information. It is very important to us that in whatever
paradigm it's set up and how you evaluate from a risk-management
standpoint that the buy side and their trades that they've put on
that we are serving remains confidential and does not leak to the
market in any side.''); and Second Roundtable at p. 185, 1.6 (Ms.
Taylor stating that ``when we know when people clear, that's very
confidential information and I'm very sympathetic to the fear about
fellow customer risk, but I'm also very sympathetic to the fact that
none of you would want your information disclosed so that there is a
balance on the other side * * *''). See also In re Stotler and Co.,
144 B.R. 385, 393 (Bankr.N.D.Ill. 1992) (``[T]he legislative history
of 11 U.S.C. 766 emphasizes that the risk of a broker's bankruptcy
is not to be borne by the customer * * *.'' Individual customers
``face a formidable task in researching the relative solvency,
reputation, and success of competing FCMs.'').
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Thus, after careful analysis of the comments, the Commission
believes that the Complete Legal Segregation Model provides the most
appropriate framework for the protection of Cleared Swaps Customer
Collateral at this time. None of the segregation models the Commission
considered provides perfect protection for Cleared Swaps Customer
Collateral, and the degree of imperfection of any of the models is
influenced by ``the facts and circumstances'' of an FCM default.
However, as CME notes, the Complete Legal Segregation Model ``would, on
its face, lead to greater protection of cleared swaps customer
collateral against Fellow-Customer Risk than the Futures Model'' \132\
and is ``more likely to facilitate portability of cleared swaps
customer positions than the Futures Model, in the event of an FCM
default in its cleared swaps customer account * * *.'' \133\
Furthermore, the Complete Legal Segregation Model provides the best
balance between benefits and costs in order to protect market
participants and the public.
---------------------------------------------------------------------------
\132\ CME at 16.
\133\ Id.
---------------------------------------------------------------------------
Finally, while the Complete Legal Segregation Model is a critical
step in the efforts to protect customers and their collateral, as noted
above, the Commission is actively considering seeking notice and
comment on a proposal to allow individual protection of client assets.
In addition, the Commission is directing staff to look into the
possibility of adopting the Complete Legal Segregation Model for the
futures market. The Commission remains committed to protecting market
participants.
IV. Section by Section Analysis: Regulation Part 22
A. Regulation 22.1: Definitions
Proposed regulation 22.1 established definitions for, inter alia,
the following terms: ``cleared swap,'' ``cleared swaps customer,''
``cleared swaps customer account,'' ``cleared swaps customer
collateral,'' ``cleared swaps proprietary account,'' ``clearing
member,'' \134\ ``collecting futures commission merchant,''
``commingle,'' ``customer,'' ``depositing futures commission
merchant,'' ``permitted depository,'' \135\ and ``segregate.''
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\134\ Under the Commission's proposal, the term ``clearing
member'' means ``any person that has clearing privileges such that
it can process, clear and settle trades through a derivatives
clearing organization on behalf of itself or others. The derivatives
clearing organization need not be organized as a membership
organization.''
\135\ The Commission proposed to define ``permitted depository''
as a depository that is a bank located in the United States, a trust
company located in the United States, a Collecting Futures
Commission Merchant registered with the Commission (but only with
respect to a Depositing Futures Commission Merchant providing
Cleared Swaps Customer Collateral), or a derivatives clearing
organization registered with the Commission. In addition, the FCM or
the DCO must hold a written acknowledgment letter from the
depository as required by proposed regulation 22.5.
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1. ``Segregate'' and ``Commingle''
Regulation 22.1 proposed definitions for the terms ``segregate''
and ``commingle'' that are intended to codify the common meaning of
such terms under the part 1 of the Commission's regulations (the ``Part
1 Provisions''). Pursuant to the proposal, to ``segregate'' two or more
items means to keep them in separate accounts and to avoid combining
them in the same transfer between accounts. In contrast, ``commingle''
means to hold two or more items in the same account, or to combine such
items in a transfer between accounts. The Commission did not receive
comments on these
[[Page 6350]]
proposed definitions and is, therefore, adopting them as proposed.
2. ``Cleared Swap''
Regulation 22.1 proposed a definition of the term ``Cleared Swap''
that (i) excludes, for purposes of Part 22 only, cleared swaps (and
related collateral) that, pursuant either to a Commission rule,
regulation, or order (including an order under section 4d(a) of the
CEA) or to a DCO rule approved in accordance with regulation
39.15(b)(2),\136\ are commingled with futures contracts (and related
collateral) in a customer account established for the futures
contracts, but (ii) includes, for purposes of Part 22 only, futures
contracts or foreign futures contracts (and, in each case, related
collateral) that, pursuant to either a Commission rule, regulation, or
order (including an order under section 4d(f) of the CEA) or to a DCO
rule approved in accordance with regulation 39.15(b)(2),\137\ are
commingled with cleared swaps (and related collateral) in a customer
account established for the cleared swaps. The Commission did not
receive comments on the proposed definition of ``Cleared Swap'' and is
adopting it as proposed with one change. The Commission finalized
regulation 39.15 on October 18, 2011.\138\ That final regulation
requires a DCO seeking to commingle Cleared Swaps (and related
collateral) with futures contracts (and related collateral) in a
futures account to petition for a Commission order under section 4d(a)
of the CEA. Thus, the final definition of ``Cleared Swap'' in this
rulemaking removes the reference to DCO rule approval procedures
relevant to such commingling.
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\136\ Section 4d(a) of the CEA, 7 U.S.C. 6d(a).
\137\ Section 4d(f) of the CEA, 7 U.S.C. 6d(f).
\138\ 76 FR 69441.
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3. ``Cleared Swaps Customer'' and ``Customer''
Regulation 22.1 proposed definitions of ``Cleared Swaps Customer''
and ``Customer.'' The Commission is adopting the definitions of
``Cleared Swaps Customer'' and ``Customer'' essentially as proposed,
except that a technical amendment is made to the definition of Cleared
Swaps Customer to clarify that a clearing member of a DCO is not a
Cleared Swaps Customer with respect to Cleared Swaps cleared on that
DCO.
4. ``Cleared Swaps Customer Collateral''
Proposed regulation 22.1 defined Cleared Swaps Customer Collateral
to include (i) money, securities, or other property that an FCM or a
DCO receives, from, for, or on behalf of a Cleared Swaps Customer that
is intended to or does margin, guarantee, or secure a Cleared Swap
\139\ or, if the Cleared Swap is in the form or nature of an option,
constitutes the settlement value of such option and (ii) ``accruals,''
which are the money, securities, or other property that an FCM or DCO
receives, either directly or indirectly, as incident to or resulting
from a Cleared Swap that the FCM intermediates for a Cleared Swaps
Customer. The proposed definition explicitly included a Cleared Swap in
the form or nature of an option as Cleared Swaps Customer Collateral,
but did not explicitly include option premiums as Cleared Swaps
Customer Collateral. The proposed definition also explicitly included
in ``accruals'' the money, securities, or other property that a DCO may
receive relating to the Cleared Swap that an FCM intermediates for a
Cleared Swap Customer.
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\139\ Proposed regulation 22.1 provides that ``Cleared Swaps
Customer Collateral'' includes collateral that an FCM or a DCO
receives from, for, or on behalf of a Cleared Swaps Customer that
either (i) is actually margining, guaranteeing, or securing a
Cleared Swap or (ii) is intended to margin, guarantee, or secure a
Cleared Swap. This provision is a clarification of ``customer
funds'' as defined in regulation 1.3, which includes ``all money,
securities, and property received by a futures commission merchant
or by a clearing organization from, for, or on behalf of, customers
or option customers * * * to margin, guarantee, or secure futures
contracts.''
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FIA suggested that the Commission confirm that the term Cleared
Swaps Customer Collateral includes all assets provided by a Cleared
Swaps Customer, including any sums required by an FCM to margin a
Cleared Swap, even if that sum is in excess of the amount required by
the relevant DCO, as well as collateral ``voluntarily'' deposited by a
Cleared Swaps Customer in a Cleared Swaps Customer Account.\140\ In
response, the Commission is clarifying that the definition of Cleared
Swaps Customer Collateral includes any sums required by an FCM that is
intended to, or does, margin a Cleared Swap as well as collateral
``voluntarily'' deposited by, or on behalf of, a Cleared Swaps Customer
in a Cleared Swaps Customer Account. Moreover, in response to this
comment, the Commission is adding a new section 22.13(c), which states
that collateral posted by a Cleared Swaps Customer in excess of the
amount required by a DCO (the ``excess collateral'') may be transmitted
by the Cleared Swaps Customer's FCM to the DCO if, but only if, (i) the
FCM is permitted to do so by DCO rule and (ii) the DCO provides a
mechanism by which the FCM can identify the amount of such excess
collateral attributable to each Cleared Swaps Customer, and such
mechanism is employed effectively to accomplish that goal.
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\140\ See FIA at 7-8.
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5. ``Cleared Swaps Customer Account'' and ``Cleared Swaps Proprietary
Account''
As proposed, regulation 22.1 defined a ``Cleared Swaps Customer
Account'' as (i) an account that an FCM maintains at a Permitted
Depository for the Cleared Swaps (and related collateral) of its
Cleared Swaps Customers, or (ii) an account that a DCO maintains at a
Permitted Depository for collateral related to Cleared Swaps that the
FCM members intermediate for their Cleared Swaps Customers. Regulation
22.1 also proposed a definition for ``Cleared Swaps Proprietary
Account'' that is substantially similar to regulation 1.3, which
defines ``Proprietary Account'' for futures contracts. The Commission
requested comment on whether the proviso in paragraph (b)(8), which
states that ``an account owned by any shareholder or member of a
cooperative association of producers, within the meaning of section 6a
of the Act, which association is registered as an FCM and carries such
account on its records, shall be deemed to be a Cleared Swaps Customer
Account and not a Cleared Swaps Proprietary Account of such
association, unless the shareholder or member is an officer, director,
or manager of the association,'' remains relevant, particularly with
respect to Cleared Swaps. The Commission did not receive comments on
these proposed definitions and is, therefore, adopting the definitions
of ``Cleared Swaps Customer Account'' and ``Cleared Swaps Proprietary
Account'' as proposed.
6. ``Clearing Member''
Regulation 22.1 proposed a definition of ``Clearing Member.'' The
Commission did not receive comments on this proposed definition.
Therefore, the Commission is adopting the definition of ``Clearing
Member'' as proposed.
7. ``Collecting Futures Commission Merchant'' and ``Depositing Futures
Commission Merchant''
Proposed regulation 22.1 defined a ``Collecting Futures Commission
Merchant'' or ``Collecting FCM'' as one that carries Cleared Swaps on
behalf of another FCM and the Cleared Swaps Customers of that other FCM
and, as part of doing so, collects Cleared Swaps
[[Page 6351]]
Customer Collateral.\141\ In contrast, a ``Depositing Futures
Commission Merchant'' or ``Depositing FCM'' was defined as one that
carries Cleared Swaps on behalf of its Cleared Swaps Customers through
a Collecting FCM, and, as part of doing so, deposits Cleared Swaps
Customer Collateral with such Collecting FCM. The Commission did not
receive comments on these proposed definitions and is adopting the
definitions of ``Collecting Futures Commission Merchant'' and
``Depositing Futures Commission Merchant'' as proposed.
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\141\ For the avoidance of doubt, an FCM does not become a
Collecting FCM simply by intermediating the proprietary transactions
of another FCM. An FCM only becomes a Collecting FCM by
intermediating, on behalf of another FCM, Cleared Swaps belonging to
Cleared Swaps Customers (and the relevant collateral).
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8. ``Permitted Depository''
Regulation 22.1 proposed a definition of ``Permitted Depository.''
The Commission did not receive comments on this proposed definition and
is, therefore, adopting the definition of ``Permitted Depository'' as
proposed.
B. Regulation 22.2--Futures Commission Merchants: Treatment of Cleared
Swaps Customer Collateral
Regulation 22.2 proposed requirements for an FCM's treatment of
Cleared Swaps Customer Collateral, as well as the associated Cleared
Swaps.
1. In General
Proposed regulation 22.2(a) required an FCM to treat and deal with
the Cleared Swaps of Cleared Swaps Customers, as well as associated
Cleared Swaps Customer Collateral, as belonging to the Cleared Swaps
Customers. The Commission did not receive any comments on regulation
22.2(a) and is therefore adopting regulation 22.2(a) as proposed.
2. Location of Collateral
Proposed regulation 22.2(b) required that an FCM segregate all
Cleared Swaps Customer Collateral that it receives. Additionally,
proposed regulation 22.2(b) required that an FCM adopt one of two
methods to hold segregated Cleared Swaps Customer Collateral, which
parallel either implicit assumptions or explicit provisions of
regulation 1.20(a).
The Commission did not receive any comments on regulation 22.2(b)
and is therefore adopting regulation 22.2(b) as proposed.
3. Commingling
Proposed regulation 22.2(c) permitted an FCM to commingle the
Cleared Swaps Customer Collateral of multiple Cleared Swaps Customers,
while prohibiting the FCM from commingling Cleared Swaps Customer
Collateral with:
FCM property, except as permitted under proposed
regulation 22.2(e) (as discussed below); or
``customer funds'' (as regulation 1.3 defines such term)
for futures contracts or the ``foreign futures or foreign options
secured amount'' (as regulation 1.3 defines such term), except as
permitted by a Commission rule, regulation or order (or a derivatives
clearing organization rule approved pursuant to regulation
39.15(b)(2)).\142\
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\142\ As the discussion on the proposed definition of ``Cleared
Swaps'' highlights, if the Commission adopts a rule or regulation or
issues an order pursuant to section 4d(a) of the CEA, or if the
Commission approves DCO rules pursuant to regulation 39.15(b)(2)
permitting such commingling, the Commission would apply the
corresponding provisions and Part 190 to the Cleared Swap (and
related collateral) as if the swap constituted a futures contract
(and related collateral).
In contrast, if the Commission adopts a rule or regulation or
issues an order pursuant to section 4d(f) of the CEA, or if the
Commission approves DCO rules pursuant to regulation 39.15(b)(2)
permitting such commingling, the proposed definition of ``Cleared
Swap'' would operate to apply Part 22 and Part 190 to (i) the
futures contract (and related collateral) or (ii) the foreign
futures contract (and related collateral) as if such contracts
constituted Cleared Swaps (and related collateral).
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The Commission did not receive any comments on regulation 22.2(c)
and is therefore adopting regulation 22.2(c) as proposed.
4. Limitations on Use
Proposed regulation 22.2(d) prohibited an FCM from (i) using, or
permitting the use of, the Cleared Swaps Customer Collateral of one
Cleared Swaps Customer to purchase, margin, or settle the Cleared
Swaps, or any other transaction, of a person other than the Cleared
Swaps Customer; (ii) using Cleared Swaps Customer Collateral to margin,
guarantee, or secure the non-Cleared Swap contracts (e.g., futures or
foreign futures contracts) of the entity constituting the Cleared Swaps
Customer; \143\ (iii) imposing, or permitting the imposition of, a lien
on Cleared Swaps Customer Collateral, including on any FCM residual
financial interest therein; and (iv) claiming that any of the following
constitutes Cleared Swaps Customer Collateral:
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\143\ As mentioned above, an entity may simultaneously transact
(i) Futures contracts, (ii) foreign futures contracts, (iii) Cleared
Swaps, and (iv) uncleared swaps. Such entity would constitute a
Cleared Swaps Customer only with respect to its Cleared Swaps.
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Money invested in the securities, memberships, or
obligations of any DCO, designated contract market (``DCM''), swap
execution facility (``SEF''), or swap data repository (``SDR''); or
Money, securities, or other property that any DCO holds
and may use for a purpose other than to margin, guarantee, secure,
transfer, adjust or settle the obligations incurred by the FCM on
behalf of its Cleared Swaps Customers.
ISDA argued that these proposed rules could prevent or inhibit
portfolio margining, even where netting itself is legally enforceable,
and stated that the Commission should ``acknowledge in rule that excess
collateral may be managed and applied so as to facilitate portfolio
based-margining (including to the benefit of uncleared swaps).'' \144\
FIA requested that the Commission confirm that regulation 22.2(d) will
permit FCMs to take security interests in their Cleared Swaps
Customers' Cleared Swaps Customer Accounts in support of other
positions held by such customers at the FCM, or for other entities
(including affiliates of FCMs) to take such security interests in
support of financing the Cleared Swaps Customer's margin obligations.
MFA asked the Commission to ensure that Cleared Swaps Customers are
able to grant liens on Cleared Swaps Customer Collateral (subordinate
to a DCO's rights) to be able to continue entering into cross-product,
and other multilateral, netting agreements. MFA also argued that the
Commission should either (i) modify proposed regulation 22.2(d)(2) to
limit application of the rule to ``prohibiting an FCM's creditors from
obtaining a lien on [Cleared Swaps Customer Collateral]'' or (ii)
clarify in the final rule release or in interpretive guidance that the
language of proposed regulation 22.2(d) is not intended to limit a
Cleared Swaps Customer's ability ``to grant liens on entitlements to
cleared swap positions and related collateral as contemplated by UCC 9-
102(14), 102(15), 9-102(16), 9-102(17), 9-102(49);'' provided such lien
does not impair a DCO's first priority interests to such
collateral.\145\
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\144\ ISDA at 4-5.
\145\ See MFA at 5-6.
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As explained above, ``excess'' collateral refers to the collateral
that a Cleared Swaps Customer deposits with an FCM or DCO that is more
than the amount required by the FCM or DCO to margin such customer's
Cleared Swaps portfolio. Since the ``excess'' collateral belongs to the
Cleared Swaps Customer, and is not required by the FCM or DCO, it is
entirely proper for the Cleared Swaps Customer to manage the
collateral. The Cleared Swaps Customer may manage ``excess'' collateral
by giving instructions to the FCM to,
[[Page 6352]]
among other things, transfer such collateral from one account (e.g., a
Cleared Swaps Customer Account) to another account (e.g., a futures
account).\146\ However, it is less clear how collateral that is not
``excess''--namely, collateral margining cleared positions (for which
the counterparty is the DCO, through the FCM)--can also be used to
margin uncleared positions (for which the counterparty is, by
definition, other than a DCO). Accordingly, while the Commission
supports the benefits of portfolio margining, the Commission does not
believe it would be prudent to permit collateral margining cleared
positions to simultaneously be used to margin uncleared positions.
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\146\ Regulation Part 22 creates the presumption that all money,
securities, and other property deposited in a Cleared Swaps Customer
Account constitutes Cleared Swaps Customer Collateral. Therefore, in
order for a Cleared Swaps Customer to use ``excess'' collateral to
margin, e.g., uncleared swaps, such customer must direct the
transfer of such collateral from the Cleared Swaps Customer Account.
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In addition, the Commission clarifies that an FCM may not, under
any circumstances, grant a lien to any person (other than to a DCO) on
its Cleared Swaps Customer Account, or on the FCM's residual interest
in its Cleared Swaps Customer Account. On the other hand, a Cleared
Swaps Customer may grant a lien on the Cleared Swaps Customer's
individual cleared swaps account (an ``FCM customer account'') that is
held and maintained at the Cleared Swaps Customer's FCM.\147\ The
Commission notes that by permitting a Cleared Swaps Customer to grant a
lien on that Cleared Swaps Customer's FCM customer account, an FCM is
not permitting the grant of a lien on Cleared Swaps Customer
Collateral. Furthermore, the Commission confirms that regulation
22.2(d) permits (i) FCMs to take a security interest in a Cleared Swaps
Customer's FCM customer account in support of other positions held by
such customer at the FCM, and (ii) other entities (including affiliates
of FCMs) to take a security interest in a Cleared Swaps Customer's FCM
customer account in support of financing the Cleared Swaps Customer's
margin obligations.
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\147\ An FCM customer account is an account maintained by the
FCM on behalf of a specific Cleared Swaps Customer that holds assets
provided by that Cleared Swaps Customer, or other assets of
equivalent value, that are not currently posted with the DCO to
support swaps positions cleared by the FCM on behalf of such Cleared
Swaps Customer. Typically, an FCM customer account constitutes a
notation in the books and records of the FCM, and not a separate
account at a depository. For a more detailed discussion of FCM
customer accounts, see the discussion in section I.B.5.
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5. Exceptions
Regulation 22.2(e) proposed certain exceptions to the
abovementioned requirements and limitations. Specifically, proposed
regulation 22.2(e)(1) allowed an FCM to invest Cleared Swaps Customer
Collateral in accordance with regulation 1.25, as such regulation may
be amended from time to time. Proposed regulation 22.2(e)(2) permitted
an FCM to withdraw Cleared Swaps Customer Collateral for such purposes
as meeting margin calls at a DCO or a Collecting FCM, or to meet
charges lawfully accruing in connection with a cleared swap, such as
brokerage or storage charges. Proposed regulation 22.2(e)(3) permitted
an FCM (i) to place its own property in an FCM Physical Location or
(ii) to deposit its own property in a Cleared Swaps Customer
Account.\148\ Finally, as proposed, regulation 22.2(e)(4) clarified
that, if an FCM places or deposits its own property in an FCM Physical
Location or a Cleared Swaps Customer Account, as applicable, then that
property becomes Cleared Swaps Customer Collateral. However, an FCM
would be permitted to retain a residual financial interest in property
in excess of that necessary.
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\148\ Regulation 22.2(e)(3) proposes to permit an FCM to deposit
only those securities that are unencumbered and are of the types
specified in regulation 1.25. Such proposal accords with regulation
1.23. See regulation 1.23. The Commission notes, however, that this
proposal does not, and is not meant to, require a DCO to accept all
of the types of securities or other property specified in regulation
1.25.
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SIFMA and Vanguard argued that the Commission should require an FCM
to identify when it has used its own capital to meet a Cleared Swap
Customer's margin obligation and whether such capital can be used by a
DCO to cure a defaulting Cleared Swap Customer's margin
obligations.\149\ To address this comment, the Commission is amending
regulation 22.2(e)(3) to distinguish between (a) cases where an FCM
uses its own capital to cure a Cleared Swaps Customer's undermargined
or deficit account and (b) cases where an FCM uses its own capital to
create a ``buffer'' in the Cleared Swaps Customer Account. The
Commission notes that in case (a), the FCM has, in essence, provided an
advance to the Cleared Swaps Customer, and the DCO should be able to
use such collateral to meet a default by that Cleared Swaps Customer to
the same extent as if that Cleared Swaps Customer provided the
collateral. However, in case (b) the FCM has provided collateral that
does not belong to any specific Cleared Swaps Customer, and thus there
is no reason to restrict the use of that collateral to any specific
Cleared Swaps Customer. The Commission also notes that, to the extent
the DCO permits the FCM to post ``excess'' collateral, the DCO must,
through its own rules, require that the FCM separately account for the
separately identified ``buffer collateral'' (which originated from the
FCM's own capital) and the collateral attributed (at the DCO) to the
FCM's Cleared Swaps Customers (which belongs to those customers).
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\149\ See SIFMA at 10; and Vanguard at 7.
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ISDA noted that the use of ``such'' in regulation 22.2(e)(4)(ii) is
ambiguous and could imply that an FCM has a residual interest only in
the particular account (i.e., cash versus securities) into which it has
deposited property. ISDA argued that this might cause unintended
consequences if the customer deposits a security and the FCM, faced
with a need to advance variation margin on behalf such customer in
cash, does not liquidate the security but rather deposits cash secured
by that security. ISDA suggested that the Commission clarify the
language by making clear that the FCM has a residual interest in all
property in Cleared Swaps Customer Accounts in excess of that required
by the regulation 22.2(f)(4) segregation requirement.\150\ In response,
the Commission clarifies that an FCM has a residual interest in all
property in Cleared Swaps Customer Accounts in excess of that required
by the regulation 22.2(f)(4) segregation requirements.
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\150\ See ISDA at 8-9.
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e. Requirements As to Amount
As proposed, regulation 22.2(f) set forth an explicit calculation
for the amount of Cleared Swaps Customer Collateral that an FCM must
maintain in segregation, which did not materially differ in the Form 1-
FR-FCM from the calculation for ``customer funds'' of futures
customers. First, proposed regulation 22.2(f) defined ``account'' to
reference an FCM's books and records pertaining to the Cleared Swaps
Customer Collateral of a particular Cleared Swaps Customer. Second,
proposed regulation 22.2(f) required an FCM to reflect in its account
for each Cleared Swaps Customer the market value of any Cleared Swaps
Collateral that it receives from such customer, as adjusted for:
Any uses that proposed regulation 22.2(d) permits;
Any accruals or losses on investments permitted by
proposed regulation 22.2(e) that, pursuant to the applicable FCM
customer agreement,
[[Page 6353]]
are creditable or chargeable to such Cleared Swaps Customer;
Any charges lawfully accruing to the Cleared Swaps
Customer, including any commission, brokerage fee, interest, tax, or
storage fee; and
Any appropriately authorized distribution or transfer of
the Cleared Swaps Collateral.
Third, proposed regulation 22.2(f) categorized accounts of Cleared
Swaps Customers as having credit or debit balances. Accounts where the
market value of Cleared Swaps Customer Collateral is positive after
adjustments have credit balances. Conversely, accounts where the market
value of Cleared Swaps Customer Collateral is negative after
adjustments have debit balances. Fourth, proposed regulation 22.2(f)
required an FCM to maintain in segregation, in its FCM Physical
Location and/or its Cleared Swaps Customer Accounts at Permitted
Depositories, an amount equal to the sum of any credit balances that
Cleared Swaps Customers have in their accounts, excluding from such sum
any debit balances that Cleared Swaps Customers have in their accounts
(the ``Collateral Requirement''). Finally, regulation 22.2(f) proposed
an exception to the exclusion of debit balances. Specifically, to the
extent that a Cleared Swaps Customer deposited ``readily marketable
securities'' with the FCM to secure a debit balance in its account,
then the FCM must include such balance in the Collateral Requirement.
``Readily marketable'' was defined as having a ``ready market'' as such
latter term is defined in rule 15c3-1(c)(11) of the Securities and
Exchange Commission (Sec. 241.15c3-1(c)(11) of this title). Proposed
regulation 22.2(f) deemed a debit balance ``secured'' only if the FCM
maintains a security interest in the ``readily marketable securities,''
and holds a written authorization to liquidate such securities in its
discretion. To determine the amount of the debit balance that the FCM
must include in the Collateral Requirement, proposed regulation 22.2(f)
required the FCM (i) to determine the market value of such securities,
and (ii) to reduce such market value by applicable percentage
deductions (i.e., ``securities haircuts'') as set forth in rule 15c3-
1(c)(2)(vi) of the Securities and Exchange Commission. The FCM would
include in the Collateral Requirement that portion of the debit
balance, not exceeding 100 percent, which is secured by such reduced
market value. The Commission requested comment on the Collateral
Requirement proposed in regulation 22.2(f). Specifically, the
Commission requested comment on whether the explicit calculation of
such Collateral Requirement materially differs from the implicit
calculation in the Part 1 Provisions for segregated ``customer funds''
of futures customers.
ISDA expressed concern that the definition of Cleared Swaps
Customer Collateral may sweep in investment returns, which may be
inconsistent with regulation 22.10 that allows DCOs and FCMs to keep
investment returns unless otherwise agreed and regulation
22.2(f)(2)(ii) that refers to investment returns creditable to a
customer by agreement.\151\ FIA asked the Commission to clarify whether
the definition of Cleared Swaps Customer Collateral included the
interest earned on investments of customer funds, which FCMs have
traditionally been permitted to retain.\152\ In addition, FIA stated
that because an FCM is required to include accruals or losses on
investments of customer collateral under proposed regulation 22.3, the
provision appears to state that customers can agree to assume all or a
portion of the losses incurred in connection with the investment of
customer collateral. FIA ``does not believe that a customer may agree
to share in losses incurred in connection with investments under Rule
1.25.'' \153\ The Commission confirms that investment returns are
includable in Cleared Swaps Customer Collateral only to the extent
creditable pursuant to the customer agreement. As such, the Commission
is deleting the words ``or losses'' and ``or chargeable,'' from
regulation Sec. 22.2(f)(2)(ii). To be clear, Cleared Swaps Customers
are not responsible for losses on investments made pursuant to, and in
accordance with, regulation 1.25.
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\151\ ISDA at 6-7.
\152\ See FIA at 7-8 & nn. 25-30.
\153\ The FIA cited to a number of cases where courts have
stated that ``Congress intended that futures commission merchants be
entitled to any and all interest on their investment of customer
margin funds.'' See id. at n. 29 (citing Marchese v. Shearson Hayden
Stone, Inc. 644 F.Supp. 1381 (C.D. Cal. 1986), aff'd, 822 F.2d 876
(9th Cir. 1987); Craig v. Refco, 624 F.Supp 944 (N.D. Ill. 1983),
aff'd. 816 F.2d 347 (7th Cir. 1987) (confirming that ``the FCM, not
the customer, bears the risk of any decline in the value of
investments purchased with customer funds''); and Bibbo v. Dean
Witter Reynolds, Inc., 151 F.3d 559 (6th Cir. 1998). See also id. at
8-9 & n. 31.
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AII requested that the Commission ``ensure that swaps customers may
direct the investments in which initial margin is invested, as is done
today through bilateral agreements with dealer counterparties.'' \154\
While Cleared Swaps Customers in the Cleared Swaps Customer Account
Class would share in Investment Risk, the Commission notes that these
comments are beyond the limited scope of these regulations, and it will
consider how to address them outside of this rulemaking. However,
nothing contained herein would limit an FCM from adopting as a policy--
and commit itself by contract with its customers--to further limit its
investments of customer funds for all customers of one or more account
classes (i.e., futures, foreign futures, Cleared Swaps).\155\
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\154\ AII at 4. The term ``initial margin'' is defined in
regulation 1.3(ccc) and means ``money, securities, or property
posted by a party to a futures, option, or swap as performance bond
to cover potential future exposures arising from changes in the
market value of the position.'' The term ``variation margin'' is
defined in regulation 1.3(fff) and means ``a payment made by a party
to a futures, option, or swap to cover the current exposure arising
from changes in the market value of the position since the trade was
executed or the previous time the position was marked to market.''
\155\ Because of pro rata distribution, limiting the investments
of customer funds attributable to individual customers would be
insufficient to protect such customers from Investment Risk
attributable to the investment of customer funds attributable to
other customers within the same account class.
---------------------------------------------------------------------------
FIA argued that the calculation requirements set forth in
regulation 22.2 pose an excessive burden because an FCM cannot offset
negative and positive balances in different currencies. Thus, if a
Cleared Swaps Customer has a positive balance in USD but a negative
balance in Euro, the FCM would need to deposit its own capital to cover
the negative balance in Euro without respect to the Cleared Swaps
Customer's positive balance in USD. FIA noted that though proposed
regulation 22.2(g) mirrors existing regulation 1.32(a), there is an
important difference in circumstances that warrants different treatment
of the two cases: while relatively few futures contracts traded on U.S.
DCMs are denominated in a foreign currency, a significant number of
Cleared Swaps are expected to be denominated in foreign
currencies.\156\ In response, the Commission recognizes the concerns
expressed by the FIA. However, efforts to provide that an FCM may, in
making its segregation calculations, include a debit balance to the
extent such balance is secured by funds in other currencies, subject to
appropriate haircuts, are beyond the limited scope of this rulemaking.
The Commission will, therefore, consider how to address these issues
outside of this rulemaking.
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\156\ See FIA at 10-11.
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f. Segregated Account; Daily Computation and Record
Proposed regulation 22.2(g) required an FCM to compute, as of the
close of
[[Page 6354]]
each business day, on a currency-by-currency basis:
The aggregate market value of the Cleared Swaps Customer
Collateral in all FCM Physical Locations and all Cleared Swaps Customer
Accounts at Permitted Depositories (the ``Collateral Value'');
The Collateral Requirement; and
The amount of the residual financial interest that the FCM
holds in such Cleared Swaps Customer Collateral (i.e., the difference
between the Collateral Value and the Collateral Requirement).
Proposed regulation 22.2(g) also required the FCM to complete the
abovementioned computation prior to noon\157\ on the next business day,
and to keep all computations, together with supporting data, in
accordance with regulation 1.31.
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\157\ ``Noon'' refers to noon in the time zone where the FCM's
principal office is located.
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The Commission did not receive any comments on regulation 22.2(g)
and is therefore adopting regulation 22.2(g) as proposed.
C. Regulation 22.3--Derivatives Clearing Organizations: Treatment of
Cleared Swaps Customer Collateral
Regulation 22.3 proposed requirements for DCO treatment of Cleared
Swaps Customer Collateral from FCMs, as well as the associated Cleared
Swaps. Specifically, regulation 22.3(a) required a DCO to treat Cleared
Swaps Customer Collateral deposited by an FCM as belonging to the
Cleared Swaps Customers of that FCM and not other persons. Moreover,
regulation 22.3(b) required DCOs to segregate all Cleared Swaps
Customer Collateral either with itself or a Permitted Depository.
Proposed regulation 22.3(c) allowed a DCO to commingle the Cleared
Swaps Customer Collateral that it receives from multiple FCMs on behalf
of their Cleared Swaps Customers, while prohibiting the DCO from
commingling Cleared Swaps Customer Collateral with (i) The money,
securities, or other property belonging to the DCO, (ii) the money,
securities, or other property belonging to any FCM, or (iii) other
categories of funds that it receives from an FCM on behalf of
Customers, including ``customer funds'' (as regulation 1.3 defines such
term) for futures contracts or the ``foreign futures or foreign options
secured amount'' (as regulation 1.3 defines such term), except as
permitted by a Commission rule, regulation or order (or by a
derivatives clearing organization rule approved pursuant to regulation
39.15(b)(2)).\158\ Regulations 22.3(d) and (e), on the other hand,
proposed certain exceptions to the abovementioned requirements and
limitations. Regulation 22.3(d) as proposed (i) allowed a DCO to place
money, securities, or other property belonging to an FCM in a DCO
Physical Location, or deposit such money, securities, or other property
in the relevant Cleared Swaps Customer Account, pursuant to an
instruction from the FCM, and (ii) to permit FCM withdrawals of money,
securities, or other property from a DCO Physical Location or Cleared
Swaps Customer Account. Proposed regulation 22.3(d) is being deleted
consistent with the changes to regulation 22.2(e)(3), which require
delineation between cases where an FCM posts collateral on behalf of a
particular customer and cases where an FCM posts collateral on behalf
of its customer account in general. Proposed regulation 22.3(e) (now,
regulation 22.3(d)) allowed a DCO to invest Cleared Swaps Customer
Collateral in accordance with regulation 1.25, as such regulation may
be amended from time to time.
---------------------------------------------------------------------------
\158\ See 76 FR at 69390-92.
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The Commission requested comment on what, if any, changes to
proposed regulation 22.3 may be appropriate to accommodate the
possibility that a depository registered with either domestic or
foreign banking regulators may seek to become a DCO, and that such
depository may seek to hold Cleared Swaps Customer Collateral, as well
as other forms of customer property. Specifically, the Commission
requested comment on (i) whether a DCO that is also a registered
depository should be permitted to hold both tangible and intangible
forms of Cleared Swaps Customer Collateral from FCMs itself, (ii) the
challenges that a DCO holding tangible and intangible forms of Cleared
Swaps Customer Collateral pose to the protection (including effective
segregation) of Cleared Swaps Customer Collateral (as well as other
forms of customer property), and (iii) how any challenges identified in
(ii) might be addressed.
ISDA stated that the definition of Cleared Swaps Customer
Collateral does not distinguish between initial and variation margin.
Both FIA and ISDA expressed concerns that, if variation margin is
considered as collateral, regulations 22.3(a) and 22.3(b) would prevent
a DCO from taking Cleared Swaps Customer Collateral received from one
FCM as variation margin ``and transferring it to an FCM whose customers
are on the opposite side of the relevant trades.'' \159\ FIA asked the
Commission to confirm that a DCO may pass variation margin to the
receiving party ``if such variation is characterized as collateral and
not as a settlement payment by the parties to the swap.'' \160\
Similarly, ICE requested clarification that a DCO that has received
``variation or mark-to-market margin (as opposed to initial margin)''
may be used to settle variation for offsetting swaps. ICE argues that
without an amendment permitting DCOs to treat ``variation or mark-to-
market'' margin as a pass-through, ``clearinghouses could effectively
be prohibited from clearing much of the OTC swaps market as it
transacts today.'' \161\ The Commission is adopting regulation 22.3 as
proposed. The Commission recognizes the concerns expressed by
commenters and confirms that regulation 22.3 is intended to permit DCOs
to use variation margin collected from Cleared Swaps Customers to pay
variation margin to, among others, Cleared Swaps Customers.
---------------------------------------------------------------------------
\159\ ISDA at 5. See FIA at 9.
\160\ FIA at 9 (emphasis supplied).
\161\ ICE at 10.
---------------------------------------------------------------------------
ISDA also observed that a variation margin payment ``may be
considered as a settlement payment--a realized profit/loss--as in the
case of listed futures; or as collateralizing current exposure, a
payment representing unrealized profit/loss, as in the case of
bilateral (uncleared) swap contracts.'' \162\ ISDA argued that Cleared
Swaps Customers would be subject to a ``mark-to-market'' tax regime,
paying ordinary income on swap returns, if a DCO were to treat as a
contract settlement, a variation margin payment made with respect to a
Cleared Swap.\163\ Accordingly, ISDA noted that recording daily mark-
to-market income on swaps would poorly match the periodic realized
coupon income on the bonds hedged by such swaps.\164\ Similarly, FIA
noted that it has ``been advised that, because cleared swaps are not
subject to section 1256 of the Internal Revenue Code, the
characterization of such payments as settlement payments may have tax
consequences that may impair the ability of certain financial end-users
* * * to enter into cleared swaps transactions.'' \165\ ISDA suggested
that Congress did not intend to change the tax treatment of swaps,
because section 1601 of the Dodd-Frank Act explicitly exempts Cleared
Swaps from being treated as ``section 1256 contracts.'' \166\ As such,
ISDA requested that the
[[Page 6355]]
Commission clarify that DCOs can treat variation margin as collateral
rather than settlement payments.\167\ These comments are beyond the
limited scope of these regulations and outside the scope of the
Commission's authority. The Commission does not take any view on the
proper treatment of variation margin associated with swaps for tax
purposes. Rather, the Commission believes that the Internal Revenue
Service is the regulatory body best equipped to address the identified
taxation issue.
---------------------------------------------------------------------------
\162\ ISDA at 5.
\163\ Id.
\164\ Id. at 6.
\165\ FIA at 9, n. 33.
\166\ ISDA at 6.
\167\ Id.
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D. Regulation 22.4--Futures Commission Merchants and Derivatives
Clearing Organizations: Permitted Depositories
Proposed regulation 22.4 listed depositories permitted to hold
Cleared Swaps Customer Collateral (the ``Permitted
Depositories''),\168\ and noted that an FCM could serve as a Permitted
Depository, but only if it is a Collecting FCM carrying the Cleared
Swaps (and related Cleared Swaps Customer Collateral) of a Depositing
FCM. The Commission sought public comment regarding the appropriateness
of allowing an FCM to serve as a Permitted Depository only if the FCM
is a ``Collecting FCM.'' The Commission did not receive any comments in
response thereto or on regulation 22.4 generally. The Commission is,
therefore, adopting regulation 22.4 as proposed.
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\168\ As proposed, for a DCO or an FCM, a Permitted Depository
must (subject to regulation 22.9) be: (i) A bank located in the
United States; (ii) a trust company located in the United States; or
(iii) a DCO.
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E. Regulation 22.5--Futures Commission Merchants and Derivatives
Clearing Organizations: Written Acknowledgement
As proposed, regulation 22.5 required a DCO or FCM to obtain
written acknowledgement letters from depositories (including, by
implication, depositories located outside the United States) before
opening a Cleared Swaps Customer Account.\169\ Proposed regulation 22.5
also set forth substantive requirements for such acknowledgement
letter. The Commission requested comment on the appropriateness of the
following: (i) the addition of regulation 1.20 (as the Commission may
choose to amend such regulation) in proposed regulation 22.5, and (ii)
the adaptation of any form letter that the Commission may choose to
promulgate under regulation 1.20 to accommodate Cleared Swaps Customer
Collateral under regulation 22.5.
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\169\ The function of a written acknowledgment letter is to
ensure and provide evidence that a potential Permitted Depository is
aware that (i) The FCM or DCO is opening a Cleared Swaps Customer
Account, (ii) the funds deposited in such account constitute Cleared
Swaps Customer Collateral, and (iii) such Cleared Swaps Customer
Collateral is subject to the requirements of section 4d(f) of the
CEA and Part 22 (when finalized).
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ISDA stated that an acknowledgement letter from a foreign
depository ``may be difficult to get and of little purpose, if
obtained'' because the letter would not alter the fact that the foreign
depository would be subject to local bankruptcy jurisdiction.\170\ The
Commission is adopting regulation 22.5 as proposed. The Commission
notes that under regulation 1.49(d)(1) depositories in the futures
market must provide the depositing FCM or DCO with the appropriate
written acknowledgements required under regulations 1.20 and 1.26. The
requirements set forth in regulation 22.5 parallel the requirements set
forth under regulations 1.20 and 1.26. The Commission has no reason to
believe that written acknowledgements from foreign depositories would
be any more difficult to obtain in the swaps market than they would be
in the futures market. Moreover, the written acknowledgment is intended
to clearly establish the commercial expectations of the parties before
a bankruptcy or insolvency event. In addition, the written
acknowledgements could aid a bankruptcy judge's or trustee's allocation
of assets to the extent a bankruptcy court or other insolvency regime
finds the commercial expectations of the parties to be helpful
information.
---------------------------------------------------------------------------
\170\ ISDA at 8.
---------------------------------------------------------------------------
F. Regulation 22.6--Futures Commission Merchants and Derivatives
Clearing Organizations: Naming of Cleared Swaps Customer Accounts
Proposed regulation 22.6 required an FCM or DCO to ensure that the
name of each Cleared Swaps Customer Account that it maintains with a
Permitted Depository (i) clearly identifies the account as a ``Cleared
Swaps Customer Account,'' and (ii) clearly indicates that the
collateral therein is ``Cleared Swaps Customer Collateral'' subject to
segregation in accordance with section 4d(f) of the CEA and Part 22.
The Commission did not receive any comments on this regulation and is,
therefore, adopting regulation 22.6 as proposed.
G. Regulation 22.7--Permitted Depositories: Treatment of Cleared Swaps
Customer Collateral
As proposed, under regulation 22.7 a Permitted Depository is (i)
required to treat all funds in a Cleared Swaps Customer Account as
Cleared Swaps Customer Collateral and (ii) prohibited from holding,
disposing of, or using any Cleared Swaps Customer Collateral as
belonging to any person other than the Cleared Swaps Customers of the
FCM maintaining such Cleared Swaps Customer Account or the Cleared
Swaps Customers of the FCMs for which the DCO maintains such Cleared
Swaps Customer Account. The Commission did not receive any comments on
this proposed rule and is adopting regulation 22.7 as proposed.
H. Regulation 22.8--Situs of Cleared Swaps Customer Accounts
1. Proposed Requirements
Proposed regulation 22.8 required (i) each FCM to designate the
United States as the site (i.e., the legal situs) of the FCM Physical
Location and the ``account'' (as regulation 22.2(f)(1) defines such
term) that the FCM maintains for each Cleared Swaps Customer, and (ii)
each DCO to designate the United States as the site (i.e., the legal
situs) of the DCO Physical Location and the Cleared Swaps Customer
Account that the DCO maintains on its books and records for the Cleared
Swaps Customers of each FCM. The Commission sought comment on whether,
as proposed, regulation 22.8 ensured that Cleared Swaps Customer
Collateral be treated in accordance with the U.S. Bankruptcy Code, to
the extent possible, and if it did not achieve this purpose, what
alternatives the Commission should consider to achieve such purpose.
Additionally, the Commission requested comment on the benefits and
costs of proposed regulation 22.8, as well as any alternatives.
NGX states that the requirement of U.S. situs for a customer
account may increase legal uncertainty with respect to the insolvency
regime that would apply to a bankruptcy, and such uncertainty may slow
down resolution of a clearing participant's default and bankruptcy.
Moreover, NGX argues that ``it is unclear how the U.S. account situs
requirement will interact with the choice of law provision'' \171\ of a
non-U.S. DCO that chooses to apply its home country insolvency regime.
In light of this uncertainty, NGX recommends that the Commission adopt
the approach it proposed for foreign non-U.S. clearinghouses seeking
DCO registration; namely, that the DCO registration application include
a ``memorandum of local law analyzing
[[Page 6356]]
insolvency issues in the [relevant] foreign jurisdiction * * * and
describing how the applicant has addressed any conflict of law issues,
which jurisdiction's law is intended to apply to each aspect of the
applicant's clearing house's operations, and the enforceability of the
choice of law in the relevant jurisdictions.'' \172\ However, NGX
requested that the Commission provide greater guidance regarding the
operation of the proposed rule if it opts to retain the account situs
requirements, specifically making clear that ``a DCO choice of law rule
should be able to include both choice of forum as well as the
substantive law to be applied'' with respect to a clearinghouse's
insolvency and the remedies available to a clearinghouse in the event
of a clearing member's default or insolvency.\173\
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\171\ NGX at 4.
\172\ Id. at 5 (citing to the ``Risk Management Requirements for
Derivative Clearing Organizations,'' 76 FR. 3698, 3742, Jan. 20,
2011).
\173\ Id. at 4-5.
---------------------------------------------------------------------------
The Commission notes that, in the event of an FCM's bankruptcy, the
legal situs provision is intended to make clear that the insolvency
regime that will apply to the customers of the FCM is the U.S.
insolvency regime embodied in Subchapter IV of Chapter 7 of the U.S.
Bankruptcy Code and Part 190 of the Commission's regulations.\174\
While a DCO is free to make the choice that local law applies to all
other aspects of a DCO's relationships with its members, the Commission
has historically required, and intends to continue requiring, that
customers of FCMs in bankruptcy be treated in accordance with U.S.
bankruptcy law.
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\174\ As discussed in the NPRM, the Commission does not intend
for regulation 22.8 to affect the actual location in which an FCM or
DCO may keep Cleared Swaps Customer Collateral. Though the legal
situs of an ``account'' (as regulation 22.2(f)(1) defines the term)
and a Cleared Swaps Customer Account must be in the United States,
the Commission recognizes that Cleared Swaps Customer Collateral
may, in actuality, be kept outside the United States in certain
circumstances. However, the Commission notes that regulation 22.8
does not override other Commission regulations regarding the
location of customer funds. Specifically, regulation 22.9, which
applies regulation 1.49 to Cleared Swaps, requires, among other
things, FCMs and DCOs to hold, in a segregated account on behalf of
Cleared Swaps Customers, sufficient United States dollars in the
United States to meet all United States dollar obligations.
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I. Regulation 22.9--Denomination of Cleared Swaps Customer Collateral
and Location of Depositories
Proposed regulation 22.9 applies regulation 1.49 to Cleared Swaps
Customer Collateral. Regulation 1.49 sets forth rules determining the
permitted denominations of customer funds (i.e., permitted currencies
and amounts in each currency), permitted locations of customer funds
(i.e., permitted countries and amounts in each country), and
qualifications that entities outside of the United States must meet to
become Permitted Depositories (e.g., minimum regulatory capital).
Specifically, regulation 1.49(b)(1)(iii) permits an FCM's obligations
to a customer to be denominated in ``a currency in which funds have
accrued to the customer as a result of trading conducted on a
designated contract market or registered derivatives transaction
execution facility,'' while regulation 1.49(d)(3) requires depositories
that are located outside the United States to be (i) A bank or trust
company that meets certain financial requirements, (ii) an FCM, or
(iii) a DCO. In addition, regulation 22.9 proposed to allow an FCM to
serve as a Permitted Depository only if the FCM was a Collecting FCM
carrying the Cleared Swaps, and associated Cleared Swaps Customer
Collateral, for the Cleared Swaps Customers of a Depositing FCM.
ISDA stated that regulation 1.49(b)(1)(iii) should be amended to
reflect the wider scope of execution methods available for Cleared
Swaps.\175\ In response, the Commission is amending regulation 22.9 to
allow the FCM's obligations to a Cleared Swaps Customer to be
denominated in the currency in which funds have accrued to the Cleared
Swaps Customer as a result of a Cleared Swap carried through such FCM,
to the extent of such accruals. However, the Commission notes that it
cannot amend regulation 1.49(b)(1)(iii) at this time because such an
amendment was not part of the NPRM.
---------------------------------------------------------------------------
\175\ ISDA at 8.
---------------------------------------------------------------------------
ISDA also requested that the Commission make plain that central
securities depositories are acceptable depositories.\176\ Similarly,
FIA argued that Euroclear, a central securities depository for Euro-
denominated securities, should be permitted to act as a depository
under Commission regulations.\177\ The Commission notes that although
the notion of a central securities depository as an acceptable
depository for securities has considerable intuitive appeal, CEA Sec.
4d(f)(3)(A)(i) limits acceptable depositories for commingled funds to
``any bank or trust company or * * * a derivatives clearing
organization.'' \178\ Because these comments are beyond the limited
scope of these regulations, the Commission will consider how to address
them outside of this rulemaking.
---------------------------------------------------------------------------
\176\ Id.
\177\ See FIA at 11.
\178\ Section 4d(f)(3)(A)(ii) of the CEA permits customer
property to be used to margin a cleared swap with a member of a DCO,
i.e., a collecting FCM. However, the Commission notes that a foreign
bank that meets the requirements of regulation 1.49(d)(3)(i) is a
good depository, and such a foreign bank may itself hold foreign
securities in an account at a foreign central securities depository.
---------------------------------------------------------------------------
Finally, FHLB argued that ``customer collateral should only be held
in banks or trust companies located in the United States.'' \179\ The
Commission does not believe it would be appropriate to address this
comment at this time, as it is beyond the scope of this rulemaking.
---------------------------------------------------------------------------
\179\ FHLB at 9.
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J. Regulation 22.10--Application of Other Regulatory Provisions
Proposed regulation 22.10 applies 1.27 (Record of
investments),\180\ 1.28 (Appraisal of obligations purchased with
customer funds),\181\ 1.29 (Increment or interest resulting from
investment of customer funds),\182\ and 1.30 (Loans by futures
commission merchants; treatment of proceeds) \183\ to Cleared Swaps
Customers and Cleared Swaps Customer Collateral.
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\180\ Regulation 1.27 requires FCMs and DCOs investing customer
funds to maintain specified records concerning such investments.
\181\ Regulation 1.28 requires FCMs investing customer funds to
record and report such investment at no greater than market value.
\182\ Regulation 1.29 permits FCMs and DCOs investing customer
funds to receive and retain any increment or interest thereon.
\183\ Regulation 1.30 permits FCMs to loan their own funds to
customers on a secured basis, and to repledge or sell such security
pursuant to agreement with such customers. However, regulation 1.30
does make clear that the proceeds of such loans, when used to
purchase, margin, guarantee, or secure futures contracts, shall be
treated as customer funds.
---------------------------------------------------------------------------
While several commenters cited regulation 22.10, they did so in the
context of discussion of other regulations. Because the Commission did
not receive any comments regarding the substance of regulation 22.10,
it is adopting regulation 22.10 as proposed.
K. Regulation 22.11--Information To Be Provided Regarding Customers and
Their Cleared Swaps
Proposed regulation 22.11 required that (i) each Depositing FCM
provide to its Collecting FCM and (ii) each FCM member provide to its
DCO, in each case, information sufficient to identify Cleared Swaps
Customers on a one-time basis, and information sufficient to identify
the portfolio of rights and obligations belonging to such customers
with respect to their Cleared Swaps ``at least once each business
day.'' If a Depositing FCM or FCM member also serves as a Collecting
FCM, then it must
[[Page 6357]]
provide the specified information with respect to each individual
Cleared Swaps Customer for which it acts (on behalf of a Depositing
FCM) as a Collecting FCM. As proposed, regulation 22.11 also held the
DCO responsible for taking appropriate steps to confirm that the
information that it receives is accurate and complete, and ensure that
the information is being produced on a timely basis. However, because
the DCO may not have a direct relationship with, e.g., a Depositing
FCM, the regulation required the DCO to take ``appropriate steps'' to
ensure that its FCM members enter into suitable arrangements with,
e.g., a Depositing FCM to verify the accuracy and timeliness of
information. The Commission requested comment on whether (i) The
proposed requirement in regulation 22.11 for a Depositing FCM to
provide a Collecting FCM with information sufficient to identify its
Cleared Swaps Customers raises any competitive concerns, (ii) such
concerns, if any, could be resolved if the identities of the Cleared
Swaps Customers are coded, with the DCO, but not the Collecting FCM,
receiving a copy of such code, and (iii) other methods were available
to resolve any such concerns.
ISDA requested that the Commission further clarify the language of
regulation 22.11 to make explicit that an FCM must provide identifying
information to the DCO or to the Collecting FCM the first time the FCM
intermediates a swap for a Cleared Swaps Customer with the particular
relevant DCO or collecting FCM.\184\ In response, the Commission is
amending the language of regulation 22.11 to make clear that an FCM
must provide identifying information to a DCO or Collecting FCM the
first time it intermediates a Cleared Swap with that DCO or Collecting
FCM.
---------------------------------------------------------------------------
\184\ See ISDA at 9.
---------------------------------------------------------------------------
In addition, a number of commenters raised concerns regarding the
need for specific recordkeeping and reporting requirements.\185\ These
commenters requested that the Commission mandate reporting and
recordkeeping requirements for DCOs and require DCOs to implement rules
requiring their clearing members to comply with such reporting and
recordkeeping requirements. FHLB argued that, at a minimum, an FCM
should have to identify (i) collateral posted by an individual customer
as cash or securities and (ii) with respect to identifiable securities,
which customer posted such securities.\186\ CME, by contrast, stated
that auditing for accuracy of ``a full breakdown of all forms of
collateral at all levels of clearing for each end customer, allocated
specifically to each DCO * * * will increase costs exponentially.''
\187\ CIEBA, CME, ICE, FHLB, SIFMA, BlackRock, and Vanguard stated that
it is important to be able to ensure that an FCM's books and records
are accurate in order to support implementation of Cleared Swaps
Customer Collateral in bankruptcy. The preferred means of addressing
this problem ranged from increasing recordkeeping and monitoring
burdens on FCMs and DCOs to abandoning the Complete Legal Segregation
Model. On the other hand, CME complained that the phrase ``portfolio of
rights and obligations arising from the Cleared Swaps that such futures
commission merchant intermediates for such customer'' is unclear as to
whether it covers the collateral supporting such positions.\188\ CME
stated that it ``read[s] the proposed regulations as requiring a DCO to
allocate to each non-defaulting customer its specific required margin
only * * *,'' and that it intends to ``allocate to any defaulting
customer the difference between its specific required margin and the
collateral within the DCO's access and control * * * .''\189\
---------------------------------------------------------------------------
\185\ See, e.g., ICI at 5; SIFMA at 8; and FHLB at 4.
\186\ FHLB also argues that this information should be provided
to Cleared Swaps Customers on a daily basis so that they can correct
any discrepancies in the records, which would, in turn, reduce
operational risk. See FHLB at 4.
\187\ CME at 15, n. 30. Cf. FHLB at 3, n. 2 (stating FHLB's
understanding that LCH has the technology necessary to track
individual customer collateral on a real-time basis, but
acknowledging that it is ``not in a position to calculate the costs
associated with such technology.'').
\188\ CME at 6-7.
\189\ Id. at 7 (emphasis in original).
---------------------------------------------------------------------------
AII, SIFMA, and Vanguard requested that the Commission require DCOs
to carefully monitor clearing member compliance with DCO rules,
including through periodic audits, by amending regulation 22.11(e) to
provide specific and concrete examples of the steps a DCO must take to
confirm that information from an FCM is accurate, complete and timely.
In addition, AII, SIFMA, and Vanguard requested that the words
``appropriate steps'' in regulation 22.11(e) be replaced with ``all
steps necessary.'' \190\ CME argued that regulation 22.11 should
specify the contents of the daily FCM report to the DCO,\191\ and that
the Commission should clarify the intent behind the language ``take
additional steps,'' specifically with respect to what the Commission
``intends each DCO to accomplish under the verification requirement.''
\192\
---------------------------------------------------------------------------
\190\ See AII at 3; SIFMA at 8; and Vanguard at 6.
\191\ See CME at 3-4, and 13-15.
\192\ CME at 15.
---------------------------------------------------------------------------
FIA noted that the proposed rule does not require the information
to be provided by any specific time each business day, and recommended
that the Commission specify such a deadline.\193\ Vanguard, SIFMA and
AII also suggested that the Commission consider requiring information
to be provided ``as frequently as necessary'' rather than ``at least
once each business day.'' \194\ Finally, CME stated that it
``presume[d] that the Commission's intention is to continue to treat
omnibus accounts of a foreign broker clearing through an FCM as a
single `customer' for purposes of the requirements of Part 22.''\195\
---------------------------------------------------------------------------
\193\ See FIA at 12. FIA cites to ``Proposed Rule 22.12,'' but
it is regulation Sec. 22.11 that requires FCMs to provide
information to a clearing FCM or DCO.
\194\ AII at 3; SIFMA at 8; and Vanguard at 6-7.
\195\ CME at 8, n. 20.
---------------------------------------------------------------------------
The Commission notes that under the Complete Legal Segregation
Model, DCOs must, in the event of the insolvency of a clearing member
carrying Cleared Swaps Customer positions, either return to the
Trustee, or transfer to another FCM, the value of the collateral
associated with each Cleared Swaps Customer's positions (as adjusted in
accordance with Commission regulations). This requirement corresponds
to the margin required for the Cleared Swaps Customer's swaps cleared
through that DCO, including any individualized surcharge or voluntary
contribution.\196\ Thus, a DCO has no responsibility to monitor the
nature or amount of collateral each Cleared Swaps Customer actually
posts with the FCM, or the provenance of the specific items of
collateral the DCO receives from the FCM. Rather, the DCO should take
the steps appropriate, in the professional judgment of its staff, to
verify that FCM members have and are using systems and appropriate
procedures to track accurately, and to provide to the DCO accurately,
the positions of each customer. Furthermore, the Commission is
clarifying that the responsibilities of a DCO under Part 22 are
analogous to the responsibilities of a DCM under regulation 1.52 with
respect to margin (the calculation of which requires an accurate
accounting of the customer's positions). As noted by one commenter,
FCMs are already subject to DSRO
[[Page 6358]]
audits on an approximately annual basis.\197\
---------------------------------------------------------------------------
\196\ See regulation 22.13(a)(1)(C).
\197\ See CME at 15.
---------------------------------------------------------------------------
At this time, the Commission is not requiring that information be
provided ``as frequently as necessary'' or by a specific time.
Regulation 22.11 requires information to be provided ``at least once a
day,'' thereby permitting DCOs to require by rule the collection of
this information more frequently. If more frequent collection of such
information becomes an industry standard at a later point in time, the
Commission might then consider increasing the frequency of this
reporting requirement. In addition, the Commission notes that a DCO may
set, by rule, the time or times by which such information must be
provided.
Finally, the Commission confirms the presumption ``that the
Commission's intention is to continue to treat omnibus accounts of a
foreign broker clearing through an FCM as a single `customer' for
purposes of the requirements of Part 22.'' \198\ However, to the extent
a foreign broker is required to provide individual protection for swaps
customer collateral under the laws of another jurisdiction, the
Commission intends that the regulations under Part 22 foster compliance
with such other laws.
---------------------------------------------------------------------------
\198\ See id. at 8, n. 20.
---------------------------------------------------------------------------
L. Regulation 22.12--Information To Be Maintained Regarding Cleared
Swaps Customer Collateral
As proposed, regulation 22.12 required DCOs and Collecting FCMs to
use the information provided pursuant to proposed regulation 22.11 to
calculate and record, no less frequently than once each business day,
the amount of collateral required (i) for each relevant Cleared Swaps
Customer (including each such customer of a Depositing FCM), based on
the portfolio of rights and obligations arising from its Cleared Swaps;
and (ii) for all relevant Cleared Swaps Customers.
SIFMA argued that DCOs and FCMs should be required to perform the
calculations specified in regulation 22.12 ``as frequently as
technologically possible'' rather than ``no less frequently than once
each business day.'' \199\ The Commission is adopting regulation 22.12
as proposed. The calculations required by regulation 22.12 are based on
information provided under regulation 22.11, which is sent to the DCOs
and FCMs ``at least once each business day.'' It would be anomalous for
the Commission to require a more frequent calculation of collateral
requirements when the information on which such calculation is based is
only required to be provided once each business day. However, if more
frequent collection of such information becomes an industry standard at
a later point in time, the Commission might then consider requiring
more frequent calculation of collateral requirements by regulation.
---------------------------------------------------------------------------
\199\ SIFMA at 9. See also AII at 3.
---------------------------------------------------------------------------
FIA and ISDA observed that the reference in the NPRM in the
discussion of regulation 22.12 to an advance by the FCM to a Cleared
Swaps Customer as a ``loan'' combined with regulation 22.10, which,
among other things, prohibits an FCM from granting unsecured loans to
customers, could be read to prohibit unsecured short-term advances of
margin funds to Cleared Swaps Customers by FCMs. They asked that the
Commission clarify that unsecured short term advances of margin are
permissible.\200\ The Commission clarifies that, consistent with
current practice, unsecured short term advances of margin are not
considered ``loans'' for purposes of existing regulation 1.30, or new
regulation 22.10. The Commission notes, however, that such advances
should be either promptly repaid or promptly replaced with a secured
loan.
---------------------------------------------------------------------------
\200\ See ISDA at 9; FIA at 11-12.
---------------------------------------------------------------------------
M. Regulation 22.13--Additions to Cleared Swaps Customer Collateral
Regulation 22.13 proposed two tools that DCOs or Collecting FCMs
may use to manage the risk they incur with respect to individual
Cleared Swaps Customers. Because the proposed tools were not intended
to be mandatory or exclusive, the Commission sought comment on how it
could enable DCOs or Collecting FCMs to use other tools to manage such
risk. In addition, proposed regulation 22.13(a) clarified that a DCO or
Collecting FCM could increase the collateral required of a particular
Cleared Swaps Customer or group of such customers, based on an
evaluation of the credit risk posed by such customer(s). The proposed
clarification was not intended to interfere with the right of any FCM
to increase the collateral requirements with respect to any of its
customers, and the Commission requested comment regarding whether a DCO
or a Collecting FCM wished to increase the collateral required for any
reason other than credit risk. Similarly, proposed regulation 22.13(b)
provided that collateral deposited by an FCM that is identified as
collateral in which such FCM has a residual financial interest (i.e.,
the FCM's own funds) may, to the extent of such residual financial
interest, be used by the DCO or Collecting FCM to secure the Cleared
Swaps of any or all Cleared Swaps Customers.
ISDA suggests that the final rule attribute the collateral
deposited by an FCM that is identified as collateral in which such FCM
has a residual financial interest to individual Cleared Swaps Customers
to determine which Cleared Swaps Customers have a credit balance and
which have a debit balance.\201\ The Commission notes that collateral
attributable to an FCM's residual financial interest is, by definition,
not the property of any Cleared Swaps Customer. Accordingly, there is
no customer-protection-based reason to deny a DCO or Collecting FCM the
ability to use such collateral to meet the default of any Cleared Swaps
Customer. In addition, as mentioned above, the Commission is adding a
new section 22.13(c), which states that, subject to certain
requirements, collateral posted by a Cleared Swaps Customer in excess
of the amount required by a DCO (the ``excess collateral'') may be
transmitted by the Cleared Swaps Customer's FCM to the DCO.\202\
---------------------------------------------------------------------------
\201\ See ISDA at 9-10.
\202\ For further detail, see the discussion above in section
IV.A.4. under the definition of ``Cleared Swaps Customer
Collateral.''
---------------------------------------------------------------------------
N. Regulation 22.14--Futures Commission Merchant Failure To Meet a
Customer Margin Call in Full
Proposed regulation 22.14 required a defaulting FCM to transmit to
the DCO or Collecting FCM, as applicable, Cleared Swaps Customer
Collateral on deposit at the FCM for each Cleared Swaps Customer whose
swaps contributed to the call, and the identity and the amount
transmitted on behalf of, each such customer. Regulation 22.14 also
proposed a detailed sequence of events following an FCM's default.
Specifically, proposed regulations 22.14(e) and (f) addressed the issue
of allocation of the loss of value of collateral (also known as
Investment Risk) \203\ despite the application of haircuts. The
Commission sought comment on the proposed allocation of Investment
Risk.
---------------------------------------------------------------------------
\203\ See supra at n. 28.
---------------------------------------------------------------------------
FIA suggested that the regulations make clear that the DCO or
Collecting FCM may reasonably rely on the information provided by the
defaulting FCM (or on information previously provided if the defaulting
FCM does not promptly provide information on the day of the
default).\204\ In response, the Commission is amending regulation 22.14
to add subsection (2) to specifically permit such reliance on
[[Page 6359]]
information provided by a defaulting FCM.
---------------------------------------------------------------------------
\204\ See FIA at 12; SIFMA at 10.
---------------------------------------------------------------------------
Vanguard and SIFMA requested clarification regarding how a DCO
should handle simultaneous defaults in a futures and Cleared Swaps
Customer Account, and how the FCM and DCO resources should be allocated
between the two accounts.\205\ The Commission notes that defaults in
multiple accounts are already addressed in the Commission's regulations
and, in particular, Part 190, which treats account classes separately.
For example, in the event of a default in a futures customer account,
the default would be treated in accordance with the Futures Model, and
the FCM would be permitted to apply all customer collateral to meet
that default and would, after liquidation of positions, return any
remaining customer collateral to the Trustee for distribution as above.
A default in the Cleared Swaps Customer Account, on the other hand,
would be treated in accordance with the Complete Legal Segregation
Model, with remaining positions and collateral either transferred to
another FCM or returned to the Trustee. Thus, swaps customer accounts
and futures customer accounts are treated separately by the DCO, with
balances that are not transferred being returned to the Trustee for
distribution.\206\ The Trustee would distribute customer property,
including collateral received from a DCO, pari passu within each
account class. Any surplus in any account class would be re-distributed
in accordance with regulation 190.08. In addition, the Commission notes
that a separate proprietary account for swaps is not required under
Commission regulations. Thus, a clearing member's own swaps and futures
(and related collateral) may be held together in a proprietary account
and a default in such account should proceed in accordance with
existing Commission regulations. For example, if there is a default
only in the proprietary account, property in either customer account
will not be liable for that default, and such customer property will
either be transferred along with customer positions to another FCM or,
after the liquidation of customer positions, would be returned to the
Trustee for distribution as part of the appropriate account classes
pursuant to regulation 190.08.
---------------------------------------------------------------------------
\205\ See Vanguard at 7.
\206\ Pursuant to regulation 190.06(b)(3)(iii), for a particular
customer, a negative equity balance in one account class must be
offset against a positive equity balance in any other account class.
---------------------------------------------------------------------------
With respect to the application of DCO resources, the Commission
notes that if there is a shortfall in more than one account class,
after the application of collateral as permitted in the proposed and
existing rules, the DCO would apply its default resources to the
remaining shortfalls in each account in accordance with its then-
existing rules.
O. Regulation 22.15: Treatment of Cleared Swaps Customer Collateral on
an Individual Basis
As proposed, regulation 22.15 set forth the basic principle of
individual collateral protection. It required each DCO and each
Collecting FCM to treat the amount of collateral required with respect
to the portfolio of rights and obligations arising out of the Cleared
Swaps intermediated for each Cleared Swaps Customer as belonging to
that customer, which amount could not be used to margin, guarantee or
secure the Cleared Swaps, or any other obligations, of an FCM, or of
any other customer.
FIA urged the Commission to confirm that, in the event of an FCM
default, clearing FCMs and DCOs have flexibility to liquidate all
positions in an omnibus account (with the restriction that proceeds of
positions of non-defaulting customers may not be used to offset sums
owed by defaulting customers to the FCM or by the clearing FCM to the
DCO).\207\ SIFMA stated that proposed regulation 22.15 required that
``any temporary misallocation of non-defaulting customer property due
to [intra-day price movements on the day of a default] * * * be
rectified as promptly as possible so that the property of non-
defaulting customers is fully restored.'' \208\ ICI argued that if at
the time of an FCM default there is a misallocation of Cleared Swaps
Customer Collateral, the Commission should require such misallocation
to be corrected as soon as practicable.\209\ Similarly, Vanguard
requested that the Commission clarify that any initial misallocation
related to delayed recordkeeping be rectified as promptly as possible
such that the property of the non-defaulting parties is fully
restored.\210\ CME cautioned that errors in the Sec. 22.11 information
from an FCM could heighten the risk of misallocating Cleared Swaps
Customer Collateral in a default scenario, because a DCO will not have
the time or legal ability to resolve discrepancies in a portfolio.\211\
CME asked the Commission to clarify the allocation of this risk among
Cleared Swaps Customers.\212\ In addition, CME questioned how to
allocate excess collateral that is posted to a DCO for purposes of
daily reporting and in response to customer default, \213\ and sought
confirmation that the Commission intended to preserve the finality of
the clearing cycle.\214\
---------------------------------------------------------------------------
\207\ See FIA at 12-13.
\208\ SIFMA at 10.
\209\ See ICI at 5.
\210\ See Vanguard at 7.
\211\ See CME at 14.
\212\ See id.
\213\ See id. at 7-8.
\214\ See id. at 9.
---------------------------------------------------------------------------
The Commission has amended regulation 22.15 to make clear that
clearing FCMs and DCOs have the flexibility to liquidate all positions
in an omnibus account in the event of the default of a depositing FCM
or clearing member respectively. In addition, the Commission notes that
there will not be any unallocated excess collateral because such
collateral is either collateral in which the FCM has a residual
interest and does not belong to a customer, or collateral that must be
attributed to individual Cleared Swaps Customers. Furthermore, any
temporary misallocation of non-defaulting Cleared Swaps Customer
property or excess collateral would be resolved by the Trustee, in
computing the claims by such customers against the estate (or, where
appropriate, by the estate against such customers). In addition, these
discrepancies would not be the responsibility of the DCO, even if the
DCO transferred an amount on behalf of a Cleared Swaps Customer that
was later found to be too much, nor would such a transfer be subject to
avoidance.\215\ Finally, it is not the Commission's intent to disrupt
or unwind a complete and final settlement cycle, and northing in these
regulations should be construed to do so.
---------------------------------------------------------------------------
\215\ Cf. 11 U.S.C. 764(b).
---------------------------------------------------------------------------
P. Regulation 22.16--Disclosures to Customers
As proposed, regulation 22.16 requires each FCM to disclose, to
each of its Cleared Swaps Customers, the governing provisions of each
DCO (or the provisions of the customer agreement with respect to a
Collecting FCM) relating to use of Cleared Swaps Customer Collateral
and related matters.
The FIA advocated that these FCM disclosures be the subject of a
uniform disclosure document prepared by the industry, subject to
Commission approval.\216\ Given the diversity of industry practice in
the swaps market, the Commission is reluctant to mandate the use of a
uniform disclosure document. Nonetheless, the Commission sees no reason
to object to an FCM's use of a document prepared
[[Page 6360]]
by a committee, so long as the document accurately provides the
required information for each DCO on which the customer's positions are
cleared.
---------------------------------------------------------------------------
\216\ See FIA at 12.
---------------------------------------------------------------------------
V. Section by Section Analysis: Amendments to Regulation Part 190
A. Background
In April of 2010, prior to the enactment of the Dodd-Frank Act, the
Commission promulgated rules to establish an account class for cleared
OTC derivatives (and related collateral).\217\ At that time, there were
questions concerning the Commission's authority to require the
segregation of cleared OTC derivatives (and related collateral) or to
establish a separate account class for cleared OTC derivatives in a DCO
insolvency. As a result, protection for cleared OTC derivatives (and
related) collateral was limited to those cases where such derivatives
and collateral were required to be segregated pursuant to the rules of
a DCO, and the reach of the account class was limited to cases of the
bankruptcy of a commodity broker that is an FCM. Moreover, while
section 4d(a)(2) of the CEA permitted the inclusion in the domestic
futures account class of transactions and related collateral from
outside that class, there was no similar provision permitting the
inclusion in the cleared OTC account class of transactions and related
collateral from outside that latter class.
---------------------------------------------------------------------------
\217\ See Account Class, 75 FR 17297, Apr. 6, 2010.
---------------------------------------------------------------------------
Section 724 of the Dodd-Frank Act has resolved these questions. As
mentioned above, section 4d(f) of the CEA, as amended by the Dodd-Frank
Act, requires, among other things, segregation of Cleared Swaps and
Cleared Swaps Customer Collateral. Section 4d(f)(3)(B) of the CEA
permits the inclusion of positions in other contracts (such as
exchange-traded futures) and related collateral with Cleared Swaps and
Cleared Swaps Customer Collateral. Section 724(b) of the Dodd-Frank Act
amends the Bankruptcy Code to include in the definition of ``commodity
contracts'' Cleared Swaps with respect to both FCMs and DCOs. Thus,
this section V proposes amendments to regulation Part 190, pursuant to
Commission authority under section 20 of the CEA, in order to give
effect to section 724 of the Dodd-Frank Act, to implement Public Law
111-16, the Statutory Time-Periods Technical Amendments Act of 2009,
and to provide technical clarifications. Such amendments conform to
proposed Part 22.
B. Definitions
1. Proposed Amendment to Regulation 190.01(a)--Account Class
The Commission proposed amendments to regulation 190.01(a) to
change the definition of account class to include a class for cleared
swaps accounts, delete commodity option accounts from the definition,
make clear that options on futures and options on commodities should
not be grouped into one account class, clarify that Commission orders
putting futures contracts and related collateral in the cleared swaps
account class (pursuant to new section 4d(f)(3)(B) of the CEA) are
treated, for bankruptcy purposes, in a manner analogous to orders
putting Cleared Swaps and related collateral in the futures account
class (pursuant to CEA section 4d(a)(2)), and clarify that if, pursuant
to a Commission rule, regulation or order (or a DCO rule approved
pursuant to regulation 39.15(b)(2)), positions or transactions that
would otherwise belong to one class are associated with positions and
related collateral in commodity contracts in another account class,
then the former positions and related collateral shall be treated as
part of the latter account class. The Commission did not receive any
comments on proposed regulation 190.01(a) and is adopting regulation
190.01(a) as proposed.
2. Proposed New Regulation 190.01(e)--Calendar Day
The Commission proposed defining the term ``calendar day'' to
include the time from midnight to midnight. The Commission did not
receive any comments on proposed regulation 190.01(e) and is adopting
regulation 190.01(e) as proposed.
3. Proposed Amendment to Regulation 190.01(f)--Clearing Organization
The Commission proposed to amend the definition of clearing
organization to remove, as unnecessary, the reference to commodity
options traded on or subject to the rules of a contract market or board
of trade. The Commission did not receive any comments on proposed
regulation 190.01(f) and is adopting regulation 190.01(f) as proposed.
4. Proposed Amendment to Regulation 190.01(cc)--Non-Public Customer
The Commission proposed to amend the definition of non-public
customer to include references to non-public customers under regulation
30.1(c) (with respect to foreign futures and options customers) and in
the definition of Cleared Swaps Proprietary Aaccount. The Commission
did not receive any comments on proposed regulation 190.01(cc) and is
adopting regulation 190.01(cc) as proposed.
5. Proposed Amendment to Regulation 190.01(hh)--Principal Contract
The Commission proposed to amend the definition of principal
contract to include an exclusion for cleared swaps contracts. The
Commission did not receive any comments on proposed regulation
190.01(hh) and is adopting regulation 190.01(hh) as proposed.
6. Proposed Amendment to Regulation 190.01(ll)--Specifically
Identifiable Property
The Commission proposed to amend the definition of specifically
identifiable property to update references and change terms to conform
to other proposed changes to Part 190 and other business practices. The
Commission did not receive any comments on proposed regulation
190.01(ll) and is adopting regulation 190.01(ll) as proposed.
7. Proposed Amendment to Regulation 190.01 (pp)--Cleared Swap
Proposed regulation 190.01(pp) replaced the definition of ``Cleared
OTC Derivative'' that the Commission previously adopted with a
definition of cleared swap that includes the definition of that term in
regulation 22.1. The Commission did not receive any comments on
proposed regulation 190.01(pp) and is adopting regulation 190.01(pp) as
proposed.
C. Proposed Amendments to Regulation 190.02--Operation of the Debtor's
Estate Subsequent to the Filing Date and Prior to the Primary
Liquidation Date
The Commission proposed certain clarifications as well as technical
amendments to Sec. 190.02 to (1) expand the regulation to apply to
Cleared Swaps (and related collateral) and (2) change references to
``business days'' to ``calendar days,'' and require transfer
instructions by the sixth calendar day after the order for relief and
instruct transfers to be completed by the seventh calendar day after
the order for relief, in order to fall within the protection of section
764(b) of the U.S. Bankruptcy Code. The Commission did not receive any
comments on proposed regulation 190.02. However, in light of a recent
demonstration of the efficiency of transfer arrangements, it appears
that a full calendar day may not be necessary to execute such
instructions. Accordingly, the Commission is changing the amendment to
require transfer instructions to be provided by the seventh calendar
day after the order
[[Page 6361]]
for relief, at an hour to be specified by the trustee.
D. Proposed Amendments to Regulation 190.03--Operation of the Debtor's
Estate Subsequent to the Primary Liquidation Date
The Commission proposed certain technical amendments to regulation
190.03 to clarify that maintenance margin refers to the maintenance
margin requirements of the applicable designated contract market or
swap execution facility. The Commission did not receive any comments on
proposed regulation 190.03 and is adopting regulation 190.03 as
proposed.
E. Proposed Amendments to Regulation 190.04--Operation of the Debtor's
Estate--General
Proposed amendments to regulation 190.04 would extend the
liquidation of open commodity contracts to commodity contracts traded
on swap execution facilities.\218\ These commodity contracts would be
liquidated in accordance with the rules of the relevant SEF or DCM.
Open commodity contracts that are liquidated by book entry may also be
offset using the settlement price as calculated by the relevant
clearing organization pursuant to its rules, which rules are required
to be submitted to the Commission for approval pursuant to section
5c(c) of the CEA, or approved by the Commission (or its delegate)
pursuant to regulation 190.10(d). The Commission did not receive any
comments on proposed regulation 190.04 and is adopting regulation
190.04 as proposed.
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\218\ Open commodity contracts traded on a designated contract
market would continue to be liquidated in accordance with the rules
of the relevant designated contract market.
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F. Proposed Amendments to Regulation 190.05--Making and Taking Delivery
on Commodity Contracts
The Commission proposed technical amendments to regulation 190.05
to change a reference to ``contract market'' to ``designated contract
market, swap execution facility, or clearing organization,'' and
require the submission of rules for approval subject to section 5c(c)
of the CEA. The Commission did not receive any comments on proposed
regulation 190.05 and is adopting regulation 190.05 as proposed.
G. Proposed Amendments to Regulation 190.06--Transfers
The Commission proposed amendments to regulation 190.06 to (i)
Clarify that nothing in subparagraph (a) would constrain the
contractual right of the DCO to liquidate open commodity contracts,
(ii) permit the trustee to transfer accounts with no open commodity
contracts, as the Commission has permitted in a number of recent FCM
bankruptcies, (iii) prohibit the trustee from avoiding pre-petition
transfers made by a clearing organization as long as the money,
securities, or other property accompanying such transfer would not
exceed the funded balance of accounts held for or on behalf of
customers based on information available as of the close of business on
the calendar day immediately preceding such transfer minus the value on
the date of return or transfer of any property previously returned or
transferred thereto, and (iv) change ``business day'' to ``calendar
day.'' The Commission did not receive any comments on proposed
regulation 190.06 and is adopting regulation 190.06 as proposed.
H. Proposed Amendments to Regulation 190.07--Calculation of Allowed Net
Equity
Proposed amendments to regulation 190.07 clarify that individual
Cleared Swaps Customer Accounts within an omnibus account are to be
treated individually, correct a typographical error, change the
valuation of an open commodity contract so that the value of the
commodity contract would be derived from the settlement price as
calculated by the relevant clearing organization pursuant to its rules,
and change references to securities traded over-the-counter pursuant to
the National Association of Securities Dealers Automated Quotation
System to securities not traded on an exchange. The Commission did not
receive any comments on proposed regulation 190.07. However, the
Commission is adding ``paragraph (c)'' before ``(1)(ii)'' in regulation
190.7(c)(1)(i)(A) to clarify the cross reference.
I. Proposed Amendments to Regulation 190.09--Member Property
The Commission proposed amendments to regulation 190.09 to include
references to an account excluded pursuant to the proviso in regulation
30.1(c) (referring to proprietary accounts in the context of foreign
futures and options) and to the Cleared Swaps Proprietary Account. The
Commission did not receive any comments on proposed regulation 190.09
and is adopting regulation 190.09 as proposed.
J. Proposed Amendments to Regulation 190.10--General
Proposed amendments to regulation 190.10 have been made to require
notice by email and overnight mail. The Commission did not receive any
comments on proposed regulation 190.10. However, the Commission is
changing the reference to the ``Division of Clearing and Intermediary
Oversight'' to the ``Division of Clearing and Risk'' in regulation
190.10(a) to reflect changes based on a structural reorganization
within the Commission.
K. Proposed Amendments to Appendix A to Part 190--Bankruptcy Forms,
Bankruptcy
The Commission proposed changes to appendix A, form 1 to include
references to ``transfers'' generally, and to make certain technical
amendments to (i) Reflect the addition of section 4d(f) of the CEA by
section 724 of the Dodd-Frank Act, (ii) clarify that Commission
approval with respect to the rules of a registered entity that require
Commission approval means Commission approval under section 5c(c) of
the CEA, and (iii) conform certain time periods to the proposed changes
made by the Commission to implement Public Law 111-16, the Statutory
Time-Periods Technical Amendments Act of 2009. The Commission did not
receive any comments on the proposed amendments to appendix A and is
adopting appendix A as proposed.
L. Proposed Amendments to Appendix B to Part 190--Special Bankruptcy
Distributions
The Commission proposed amendments to Framework 1 of Appendix B to
clarify that the cross margining program is intended to apply only to
futures customers and customer funds for futures contracts, and to
Framework 2 of Appendix B to address shortfalls in Cleared Swaps
Customer Collateral. The Commission did not receive any comments on the
proposed amendments to appendix B. However, the Commission is making
certain technical corrections to bring the language of the appendix in
line with current statutory language.
VI. Effective Date
The Commission asked for comment, in the NPRM and at the Second
Roundtable, on the appropriate timing of effectiveness for the final
rules, and whether six months after the promulgation of final rules
would be sufficient.
At the Second Roundtable, several panelists stated that it would
take
[[Page 6362]]
approximately 18 months to 2 years after finalization of the
segregation rules to complete all of the documentation and other
infrastructure work that would be necessary to implement the
segregation regime selected by the Commission.\219\ These commenters
indicated that this lead time would be the same for the Legal
Segregation Models and the Full Physical Segregation Model, but may be
longer if the Commission were to select the Futures Model.\220\ In
other words, this 18 month to 2 year time period is ``a cost of moving
to the cleared world regardless of how it's done.'' Another panelist,
however, did state that six months did not seem to provide sufficient
time to complete all of the work that would need to be completed,\221\
though this commenter acknowledged that ``the real constraining factor
* * * is getting that final documentation with the clients.'' \222\
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\219\ Second Roundtable Tr. at 58, 1.14 to 61, 1.17.
\220\ Id.
\221\ Second Roundtable Tr. at 62, 1.11 to 62, 1.19 (Mr. Diplas
stating that six months ``seems to live within the low side from the
standpoint in terms of the work, the IT work that needs to take
place between, like, FCMs and DCOs, the testing, et cetera, and also
even the agreements that we might have to do in terms of
consistency, of how these reports should look, and how the client
IDs should be done, et cetera, so that we don't have--each DCO have
a different methodology in that respect.'').
\222\ Second Roundtable Tr. at 63, 1.2 to 63, 1.4.
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Comments to the NPRM generally reinforced the need for additional
time. ISDA recommended that there be a minimum of 18 months between
final promulgation of the rules and effectiveness.\223\ In addition,
FIA stated that, according to certain representatives from investment
management firms, it would take one to two years to implement whatever
model is chosen by the Commission.\224\ ICE requested that, if a model
other than the Futures Model is adopted, the Commission provide
sufficient time to FCMs and DCOs to allow them ``to analyze, develop
and implement the necessary systems and processes relating to'' the
selected segregation model.\225\ In addition, ICI stated that market
participants need time to develop ``the operational and systems
infrastructure necessary to facilitate a smooth transition to
clearing.'' \226\
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\223\ See ISDA at 11.
\224\ See FIA at 6.
\225\ ICE at 11.
\226\ ICI at 2.
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As acknowledged by some commenters, the 18 month to 2 year time
period is the time period needed to transition to clearing. It is not
the time period necessary to implement the Complete Legal Segregation
Model. Because the Commission did not receive any specific comments
regarding the time period needed to implement the Complete Legal
Segregation model, the Commission considered adopting the effective
date that was proposed in the NPRM. However, given representations from
market participants regarding the amount and tenor of the work that
would need to be completed to implement clearing, the Commission is
extending the compliance date for the Part 22 rules to November 8,
2012, the compliance date set forth in the rules implementing DCO Core
Principles for the gross margining requirement of Regulation
39.13(g)(8)(i).
Given the importance of implementing the time period changes in
Part 190 as soon as possible, and because the implementation issues
raised by Part 22 do not apply to Part 190, which imposes obligations
primarily on bankruptcy trustees, the compliance date for the Part 190
rules is the effective date of these rules. However, during the period
between the compliance date for Part 190 and the compliance date for
Part 22, Commission rules will not require segregation of Cleared Swaps
or Cleared Swaps Collateral. Accordingly, consistent with the approach
applicable under current Part 190, where protection for cleared OTC
derivatives (and related) collateral is limited to those cases where
such derivatives and collateral are required to be segregated pursuant
to the rules of a DCO, during that period, the definition of 190.01(pp)
(``Cleared Swap'') shall be limited to transactions where the rules or
bylaws of a derivatives clearing organization require that such
transactions, along with the money, securities, and other property
margining, guaranteeing or securing such transactions, be held in a
separate account for Cleared Swaps only.
VII. Consideration of Costs and Benefits
A. Introduction
Section 15(a) of the CEA \227\ requires the Commission to consider
the costs and benefits of its actions before issuing a rulemaking under
the CEA. Section 15(a) further specifies that the costs and benefits
shall be evaluated in light of five broad areas of market and public
concern: (1) Protection of market participants and the public; (2)
efficiency, competitiveness, and financial integrity of futures
markets; (3) price discovery; (4) sound risk management practices; and
(5) other public interest considerations. To the extent that these new
rules reflect the statutory requirements of the Dodd-Frank Act, they
will not create costs and benefits beyond those mandated by Congress in
passing the legislation. However, the rules may generate costs and
benefits attributable to the Commission's determinations regarding
implementation of the Dodd-Frank Act's statutory requirements. The
costs and benefits of the Commission's determinations are considered in
light of the five factors set forth in CEA section 15(a).
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\227\ 7 U.S.C. 19(a).
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1. Business and Legal Context of the Segregation Requirement for
Cleared Swaps Customer Collateral
The Commission's Part 22 rules are one component of the regulatory
infrastructure for clearing \228\ swaps transactions mandated by the
Dodd-Frank Act. Though a significant fraction of swaps transactions may
be required to be cleared through DCOs, many swaps transactions may
voluntarily be cleared though DCOs. Swaps users and some swap dealers
transact with the DCO through FCMs that the DCO admits as ``clearing
members'' and who are subject to DCO rules. As described above in
detail, for every transaction received by or matched through its
facilities, a DCO acts as the buyer to every seller and the seller to
every buyer, essentially guaranteeing financial performance.\229\
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\228\ As described above, clearing is the process by which
transactions in derivatives are processed, guaranteed, and settled
by a central clearing organization, the DCO. See section I.B.
\229\ For a detailed discussion of clearing as it pertains to
swap transactions, see section I.B.
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2. Overview of the Statute and Regulation
Proposed Part 22 implements the requirement of the newly enacted
CEA section 4d(f) that property provided by Cleared Swaps Customers to
FCMs to serve as collateral for Cleared Swaps transactions be treated
as the property of the customers, not the FCM or DCO; and that such
property be maintained in accounts separate from the property of the
FCM or DCO, although such accounts can hold the commingled collateral
of more than one Cleared Swaps Customer ``for convenience.'' \230\
These basic requirements that Cleared
[[Page 6363]]
Swaps Customer Collateral be treated as the property of customers and
maintained in segregated accounts are imposed by the statute
independently of the Commission's particular implementing regulations
and, by the terms of the statute, would apply even if the Commission
promulgated no implementing regulations. Generally, the core statutory
segregation requirements serve two functions: (1) They help ensure that
FCMs, DCOs, and other depositories of assets deposited by swaps
customers to serve as collateral for their Cleared Swaps transactions
treat such customer collateral as the property of the customers and not
use it for their own proprietary business purposes; and (2) in
conjunction with Subchapter IV of Chapter 7 of the Bankruptcy Code,
they provide protection of Cleared Swaps Customer Collateral from the
claims of other creditors in the event of the bankruptcy of an FCM.
---------------------------------------------------------------------------
\230\ Though treating futures customer collateral on a
collective basis may, at one time, have been practically necessary
``for convenience,'' such practice is not standard in the current
swaps market nor is it as critical in an era where account
information is stored and processed on an automated basis. For
example, and as noted above, DCOs are already assessing risks posed
by clearing members' customers at the individual customer level. See
supra n.122.
---------------------------------------------------------------------------
Sections 22.2 through 22.10 implement the basic architecture of a
system of segregation for swaps customer funds roughly comparable to
the system used for customer funds for futures contracts under CEA
sections 4d(a)(2) and 4d(b) and Commission regulations 1.20 through
1.30 and 1.49.\231\ Some provisions of sections 22.2 through 22.10
essentially restate the statutory requirements. Other provisions of
these sections set forth requirements intended to (a) ensure that the
objectives of the statute are met and (b) clarify FCMs' and DCOs'
duties under the statute and facilitate carrying out those duties in an
efficient manner.\232\ The basic architecture established by sections
22.2 through 22.10 is supplemented by section 22.16, a disclosure
requirement designed to inform swaps customers of DCO and FCM policies
regarding the handling of their collateral in case of default and by
amendments to part 190 of the Commission's rules intended to ensure
that cleared swaps customer accounts of the sort required by Part 22
are treated as a separate account class under bankruptcy law in the
event the relevant FCM files for bankruptcy.\233\
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\231\ See discussion in sections IV.B through IV.J.
\232\ See id.
\233\ See discussion above in section IV.P and section V.B.1.
---------------------------------------------------------------------------
Proposed sections 22.11 through 22.15 add to this basic segregation
architecture provisions designed to implement the Complete Legal
Segregation Model for protecting swaps customer funds against Fellow-
Customer Risk.\234\ Proposed sections 22.11, 22.12, and 22.14 are
intended to ensure that DCOs have available information that will
enable them to attribute the value of assets in an FCM's customer
account to individual customers in the event of an FCM's default on
obligations to the DCO arising in connection with swaps transactions
cleared for customers.\235\ Section 22.14 also requires certain
transfers of customer collateral among FCMs in response to margin
calls.\236\ Section 22.5 prohibits the DCO from using asset value in an
FCM's customer account attributable to one customer to margin,
guarantee, or secure the Cleared Swaps or other obligations of the
relevant FCM or of other customers.\237\ Section 22.13 clarifies that
DCO's have the right, at their election, to require (on the grounds of
risk management) larger amounts of collateral from selected
customers.\238\
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\234\ See discussion above in section IV.K through section IV.O.
\235\ See discussion above in sections IV.K., IV.L. and IV.N.
Having such information at the DCO can be quite valuable in a
situation where the FCM is bankrupt.
\236\ See discussion above in section IV.N.
\237\ See discussion above in section IV.E.
\238\ See discussion above in section IV.M.
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3. Organization and Focus of the Consideration of Costs and Benefits
Section VII.B presents the Commission's considerations regarding
the costs and benefits arising from the Commission's choice of the
Complete Legal Segregation Model as set forth in sections 22.11 through
22.15.\239\ The costs and benefits of the Commission's choice of model
for addressing Fellow-Customer Risk are, in the view of the Commission,
the most significant cost-benefit issues in this final rulemaking, as
is reflected in the fact that discussions of cost-benefit issues in
comments to the NPRM focused almost exclusively on the choice of model.
This section of the discussion employs the Futures Model--in essence,
the rule without sections 22.11 through 22.15--as a baseline for
comparison because this model was favored by several commenters and
because comparison with this model provides a useful and appropriate
methodology for isolating, to the extent possible, the relative costs
and benefits of the alternative models presented by the commenters and
considered by the Commission.\240\
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\239\ As discussed above, in addition to the Futures Model and
the Complete Legal Segregation Model, the Commission gave
consideration to other alternatives: the Legal Segregation with
Recourse Model and the Physical Segregation Model. No commenters
supported the Legal Segregation with Recourse Model on grounds that
it involved the same costs as the Legal Segregation Model, but with
fewer benefits. Accordingly, its costs and benefits are not
considered further in this analysis. Several commenters did support
the Physical Segregation Model; however, as noted above, the
effectiveness of the Physical Segregation Model is limited due to
the application of the ratable distribution requirements of section
766(h) of the Bankruptcy Code. As such, these limitations were
disqualifying.
\240\ CIEBA, FHLB, SIFMA, and Fidelity argue that the correct
baseline for making cost and benefit comparisons should be the
current practice in the uncleared swaps markets rather than the
Futures Model (See CIEBA Original at 12; FHLB at 9; SIFMA at 7; and
Fidelity at 7). In principle, using this benchmark rather than the
Futures Model would change the absolute level of costs and benefits
of the alternatives under consideration but would not change the
relative ranking of those alternatives so long as comparisons to the
benchmark were made in a consistent fashion. There are, however,
practical advantages to using the Futures Model as a benchmark
because current practice with regard to protection of collateral in
the uncleared swaps market is unregulated and the level of
protection provided varies considerably across transactions.
Moreover, CEA, as amended by the Dodd-Frank Act, does not permit the
Commission to retain the current practice regarding uncleared swaps.
Because the appropriate baseline for the consideration of costs and
benefits is the Futures Model rather than the uncleared swaps model,
the costs and benefits of the basic requirement that swaps customer
collateral be kept in segregated accounts and treated as the
property of customers rather than the property of FCMs or DCOs are
included within the baseline and not evaluated separately.
---------------------------------------------------------------------------
Notably, this comparative analysis pivots, in the first instance,
on who bears the cost of the most significant cost driver--Fellow-
Customer Risk. Where the risk is assigned to one constituency (e.g.,
swap users in the Futures Model baseline) a virtually mirror image risk
mitigation benefit is conferred on others (e.g., DCOs and clearing
members in the Futures Model baseline).
Under any model, however, once such risks are initially assigned,
the affected entities and market participants, may then attempt to re-
allocate or shift such assigned risks or costs to other entities or
market participants. The LSOC Model, in the first instance places
fellow risk on DCOs and clearing members with corresponding mitigation
of risk to swaps users. However, as explained in detail below, market
participants can be expected to adapt to the direct allocation of risk
associated with one or another of the models in a variety of ways, and
the ultimate costs and benefits of the rule will reflect both its
direct allocation of risk and the effect of adaptations to that
allocation.
For example, as described below, some, though not all, DCOs
commented that they would be likely to adapt to the LSOC Model by
increasing margin levels. To the extent that this occurs, the rule
would have the effect of reducing the risks of losses to the DCO and
the FCM because there would be a reduced
[[Page 6364]]
likelihood of any given customer incurring losses that exceed the
margin posted by that customer. In return for the benefit of reduced
fellow customer risk and legal allocation of the residual risk to DCOs
and their members, swaps users would incur the opportunity cost of
having to use more capital as collateral for their Cleared Swaps. Thus,
to the extent that DCOs adapt to the LSOC Model in this fashion, the
rule would function in a manner analogous to insurance, with swaps
users incurring somewhat higher costs in their routine use of swaps in
return for a lower risk of wholesale loss of collateral as a result of
some other swaps user's market losses. As also described below, the
LSOC Model is expected to alter behavioral incentives for market
participants relative to the Futures Model in variety of other ways
that will create costs and benefits but that the Commission believes
will lead to a net increase in monitoring of risky behavior by FCMs and
that, on balance, will facilitate transfer of customer positions and
collateral in the event of the simultaneous default of an FCM and one
or more customers.
B. Benefits and Costs of Complete Legal Segregation Model Relative to
Futures Model
1. Introduction
As noted above, the Complete Legal Segregation Model is intended to
provide swaps customers with protection against Fellow-Customer
Risk.\241\
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\241\ For a discussion of Fellow-Customer Risk, see supra
section I.B.6.
---------------------------------------------------------------------------
The basic difference between the Complete Legal Segregation Model
and the Futures Model thus relates to a difference in the allocation of
loss arising out of a double default of both a customer and the
customer's FCM. Under the Futures Model, this risk is borne by
customers in the form of ``Fellow-Customer Risk''-- the risk that a
customer will lose some or all of the value of its collateral due to
the default of some other swaps customer or customers of the clearing
FCM. Under the LSOC Model, this risk to customers is substantially,
though not completely, eliminated. However, the corresponding loss, in
the event of a double default, falls on the DCO and, through the
guaranty fund, its non-defaulting members. In practice, under the LSOC
Model, DCOs can be expected to take measures to protect themselves
against the risk of loss from a double default, and some of the
material benefits and costs are likely to flow from a DCO's adaptations
to the rule.
The next section reviews, respectively, the material benefits and
costs that the Commission believes will arise from the Commission's
selection of the LSOC Model.
2. Material Benefits and Costs Arising From the Complete Legal
Segregation Model
a. Benefits to Customers of Protection Against Fellow-Customer Risk
The primary benefit of the Complete Legal Segregation Model to
customers is the protection of non-defaulting Cleared Swaps Customers
against loss of the value of their collateral due to the use of such
value by the relevant DCO in the event of a double default.\242\ The
associated cost to those customers is the payment they will be required
to make for protection against this risk, where this payment will
likely originate from some combination of the capital cost of posting
higher initial margins and/or higher fees for swaps transactions (see
subsection b below).
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\242\ According to comments on the ANPR, the direct benefit to
customers in the form of reduced risk of loss of collateral stemming
from the activities of fellow customers may generate indirect
benefits. For example, commenters indicated that increased security
for collateral could increase their ability to use swaps for
business purposes, although this effect could be counterbalanced by
increased dollar costs. Commenters also stated that the increased
protection against Fellow-Customer Risk would reduce their need to
incur costs to protect against the effects of loss of Cleared Swaps
Customer Collateral.
---------------------------------------------------------------------------
Comments regarding this rulemaking have indicated that, as a result
of the statutory clearing requirements in the Dodd-Frank Act, once the
cleared swaps market has matured, Cleared Swaps Customers would be
posting upwards of $500 billion in collateral to secure their Cleared
Swaps positions.\243\ The Commission notes that the precise amount will
depend on how the market evolves and can be expected to change over
time.\244\ Under the Futures Model, the value of this collateral will
be exposed to greater Fellow-Customer Risk than under the other models
considered. In addition, it does not appear possible to reliably
quantify the probability of the actual loss of value of collateral by a
given customer due to Fellow-Customer Risk for a number of reasons. By
their nature, double defaults are rare events, though potentially
important if they involve major FCMs. Because the mandatory clearing of
swaps under the Dodd-Frank Act has not yet gone into effect, there is,
as yet no body of experience with such clearing in practice, and a
fortiori no experience with FCM defaults under the Dodd-Frank clearing
regime.\245\ There has been experience with FCM default in the futures
industry, but the numbers are too small to permit reliable
extrapolation.\246\ In addition, a number of commenters suggested that
Fellow-Customer Risk may be greater in the cleared swaps market than in
the futures market because swaps are less liquid than exchange-traded
futures (thereby resulting in greater volatility of prices,
particularly in times of financial stress) and because the aggregate
value of transactions in the swaps market is many times greater than
the aggregate value of transactions in the futures market.\247\ The
Commission notes these commenters requested increased protection for
their funds to guard against Fellow-Customer Risk.
---------------------------------------------------------------------------
\243\ CME Comment on ANPR at 7 (estimated $500 billion in
collateral for swaps expected to be cleared by CME); ISDA February
16, 2011 Comment on ANPR at 2 (estimated $833 billion industry-
wide).
\244\ Id.
\245\ Several clearing houses do, however, have experience
clearing swaps on a voluntary basis. For example, LCH has been
clearing interest rate swaps for over a decade, and ICE actively
clears credit default swaps. In addition, while there are examples
of FCM defaults related to clearing futures (e.g., Griffin Trading
Co., Klein Futures, Inc. and Lehman Brothers, Inc.), there have been
no FCM failures related to the clearing of swaps transactions.
\246\ In the past two decades, there have been only two cases of
double defaults in the futures markets: Griffin Trading Co. and
Klein Futures, Inc. See Trustee v. Griffin, 440 B.R. 148 (2010);
CFTC Division of Trading and Markets, Report on Lessons Learned from
the Failure of Klein & Co. Futures, Inc., July 2001, available at
http://www.cftc.gov/files/tm/tmklein_report071101.pdf. With respect
to FCM defaults generally in the futures markets, one commenter
observed, ``The United States, fortunately has seen only a handful
of FCM failures in recent decades. As a result, the FCM liquidation
process, including the availability of porting, has not been tested
under a wide variety of circumstances.'' ISDA at 3.
\247\ See, e.g., Second Roundtable Tr. at 165, 283-84
(characteristics of swaps may make it more difficult to liquidate or
transfer customer positions in case of an FCM insolvency than for
futures).
---------------------------------------------------------------------------
Notwithstanding its inability to reasonably quantify the value of
benefits associated with Fellow-Customer Risk elimination, the
Commission, in light of comments received in response to both the ANPR
and NPRM, believes that the Complete Legal Segregation Model confers
benefits to swaps users. In fact, buy-side commenters represented that
they desired the protection afforded through the Complete Legal
Segregation Model, notwithstanding the costs associated with that
protection.\248\ The
[[Page 6365]]
ability of a swaps customer to determine Fellow-Customer Risk at a
particular FCM is limited, because confidentiality restraints
inherently limit the amount of information that an FCM can provide
customers with respect to the creditworthiness, swaps positions, and,
in some cases, even identity of its other customers.\249\ This, in
turn, impairs (if not completely precludes) the customer's ability to
evaluate Fellow-Customer Risk, hindering their ability to manage it,
insure against it, or appropriately account for it in business
decision-making.\250\
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\248\ E.g. MFA at 7-8; BlackRock at 7; Fidelity at 6; LCH at 2.
The numerical estimates of higher margin and guaranty fund levels
for Complete Legal Segregation relative to the Futures Model
described in the text below were also described in the NPRM so swaps
users who commented in response to the NPRM presumably were aware of
them. However, some commenters who supported Complete Legal
Segregation indicated that they did not give full credence to the
higher of the cost estimates. E.g., MFA at 7-8.
\249\ Id. See also Second Roundtable Tr. at 183-185.
\250\ E.g., Tudor at 2; Fidelity at 3; MFA at 3-8. See also
supra at 50-51.
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Both the benefit to customers of greater protection for their
collateral provided under the Complete Legal Segregation Model as well
as the associated costs depends, to an extent, on customer behavior in
advance of a double default. Prior to an FCM insolvency, customers have
the right to find another FCM to carry their accounts, and to have
their existing FCM transfer their positions and collateral to that
clearing FCM.\251\ Under the extreme assumption that all customers
costlessly anticipate the default and move their positions to another
FCM before the default occurs, the Complete Legal Segregation Model
offers no apparent greater benefit to customers over the Futures Model.
However, on this assumption the Complete Legal Segregation model also
imposes no additional losses to the DCO compared with the Futures Model
since, in this instance, under neither model is the collateral of non-
defaulting customers available to the DCO to cure the default. As a
result, the extent to which customers can anticipate a fellow-customer
default will tend to decrease both the benefits and the costs of the
Complete Legal Segregation Model.
---------------------------------------------------------------------------
\251\ See 76 FR at 69442.
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b. ``Risk Costs'' and Potential Effects on Margin Levels and DCO
Guaranty Fund Levels in Response To Complete Legal Segregation.
Risk Costs refer to the costs associated with the allocation of
loss in the event of a default under the Complete Legal Segregation
Model relative to the Futures Model. This can usefully be divided into
direct and indirect costs (and associated benefits). The direct cost of
the Complete Legal Segregation Model is the increased risk the DCO will
face when a Cleared Swaps Customer and its FCM default, which equals
the probability of a default by a Cleared Swaps Customer and its FCM,
multiplied by the expected contribution that fellow customers would
have provided toward the uncovered loss. (As discussed in the previous
section, there is a corresponding gain to Cleared Swaps Customers which
is the value they place on avoiding this same cost, i.e., the value of
having the equivalent of insurance against Fellow-Customer Risk.) \252\
Thus, the Complete Legal Segregation Model will potentially result in a
decrease in the financial resources package available to the DCO in the
event of default. Maintaining the same assurance of performance of the
DCO's function as central counterparty in the circumstances of a double
default may require the DCO to, therefore, raise additional financial
resources.\253\ The comments submitted to the Commission by DCOs and
others have suggested two possible ways by which DCO's default resource
structure under the Complete Legal Segregation Model might differ from
the Futures Model: Either through higher initial customer margins or by
increasing the size of the DCO's guaranty fund.\254\ Of course, actual
DCOs could use a mixture of adjustments to margins and guaranty funds.
Commenters who estimated higher costs resulting from Complete Legal
Segregation therefore estimated potential effects on margins and
guaranty funds in isolation, while generally recognizing that this is a
simplification of what actual practice is likely to be.\255\
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\252\ In addition, as discussed in section VII.B.3.b.iv., there
are efficiency gains in centralizing FCM monitoring in a small
number of parties. Moreover, because of confidentiality
considerations, among other things, DCOs have greater access to
information from their Clearing Members than Cleared Swaps Customers
do. As a result of this greater access to information and because of
the increased incentive on DCOs to actively monitor the risks posed
by their Clearing Member FCMs and Cleared Swaps Customers, the
overall effectiveness of risk management may be increased.
\253\ Section 725(c)(2)(B)(ii) of the Dodd-Frank Act requires
that a DCO possess financial resources that, at a minimum, would
allow the DCO to meet its financial obligations notwithstanding a
default by the member or participant creating the largest financial
exposure for that organization in extreme but plausible market
conditions. See also 76 FR at 69344-45. In determining what
financial resources are needed to comply with section
725(c)(2)(B)(ii) and its implementing regulations, a DCO will need
to evaluate and take into consideration the effect of Complete Legal
Segregation. However, within limits, the statute and regulations
permit the exercise of judgment by the DCO as to the methods it will
use to do this. As is indicated in the discussion in the text below,
in comments to the proposed rulemaking, different DCOs have
suggested that they may differ in their evaluation of the practical
effects of Complete Legal Segregation, in the value they ascribe to
fellow-customer collateral as a resource, and in the steps they will
take to maintain adequate financial resources in light of their
evaluation.
\254\ A guaranty fund is a fund created by a DCO to which the
clearing members contribute, in proportion generally set by DCO
rule. See supra section I.B.4 and n. 27. The assets in the fund are
then available to cover losses resulting from defaults by one or
more clearing members, whether in their proprietary capacity or due
to customer accounts, to the extent those losses are not covered by
available collateral provided by the defaulting Clearing Member
(limited to proprietary collateral for a default in the clearing
member's proprietary account, or including customer collateral for a
customer default). In addition, a DCO may retain by rule the right
to call upon the members to contribute additional assets, up to a
defined amount, if the pre-funded default resources are insufficient
(referred to as an ``assessment power'').
\255\ ICE contends that DCOs will choose to adjust to Complete
Legal Segregation entirely by increasing margins rather than
guaranty funds because Complete Legal Segregation increases the risk
that assets in guaranty funds will actually be used to cover losses
in the event of a double default. According to ICE, excessive
reliance on margin is undesirable because guaranty funds offer the
DCO more flexibility in responding to defaults and may be more
liquid than assets used as margin. See ICE at 6-7. However, while
ICE may be correct that clearing member FCMs, all other things being
equal, would prefer less risk of loss of assets contributed to
guaranty funds, there may be counterbalancing factors. For example,
clearing customers may prefer a DCO with a larger guaranty fund and
lower margin levels. Similarly, if a structure of default resources
with an excessive ratio of margin to guaranty fund is, in fact, less
effective or efficient for dealing with FCM defaults, a DCO that
employs such a structure might be at a competitive disadvantage.
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Assuming no change in guaranty fund levels, ISDA suggested that the
Complete Legal Segregation Model would require an increase of roughly
60% in initial margins relative to the Futures Model.\256\ A number of
other participants in the Commission's roundtables thought that the
method used to arrive at the estimate was a reasonable way to roughly
model the effect of Complete Legal Segregation on margin levels.\257\
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\256\ ISDA January 18, 2011 Comment on ANPR at 9. The assumption
that DCOs would use a 99.9% confidence level under Complete Legal
Segregation was based on ``suggestions'' made at the Commission's
First Roundtable. See First Roundtable Tr. at 110-111.
\257\ See, e.g., First Roundtable Tr. at 110-114; Second
Roundtable Tr. at 255-57.
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CME estimated that Complete Legal Segregation would require an
increase in margin in the range of 60% to 90%.\258\ CME did not specify
the quantitative assumptions underlying its estimate.\259\ To
illustrate effects on margin in dollar terms, CME made the assumption
that, in a mature swaps market, it might expect to clear interest rate
swaps with a notional value of $200 trillion. On this assumption, CME
projected required margin from
[[Page 6366]]
customers clearing through CME of $500 billion under the Futures Model
and $800-900 billion under Complete Legal Segregation.\260\ ISDA
estimated that, industry-wide, Complete Legal Segregation would require
$581 billion more margin than the Futures Model (a 69.75% increase over
a baseline, for the Futures Modal, of $833 billion). ISDA made clear
that this estimate was based on a number of assumptions about future
market activity and on data obtained from only four FCMs. Therefore,
this figure is best construed as an estimate of the general magnitude
of the effects expected by ISDA and not as a precise predicted dollar
figure.\261\ Nonetheless and notwithstanding this estimate of higher
initial margin, ISDA concluded that Complete Legal Segregation was
``the most appropriate choice of holding model for cleared swaps
collateral'' of the models proposed in the NPRM and supported this
approach because it facilitated porting of customer positions in the
event of an FCM default.\262\
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\258\ CME Comment on ANPR at 7-8.
\259\ See CME Comment on ANPR at 8 (describing methodology used
in general terms).
\260\ CME Comment on ANPR at 7-8.
\261\ ISDA January 18, 2011 Comment on ANPR at 10.
\262\ ISDA at 1. For a more detailed discussion of the benefits
of Complete Legal Segregation for porting, see section VII.B.3.b.ii.
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Although the above estimates were based on data for interest rate
swaps, commenters and participants in roundtable discussions indicated
that somewhat higher margin levels might be needed to maintain adequate
default resources in connection with credit default swaps because of
the high volatility and idiosyncratic risks associated with this type
of swap.\263\ Using data concerning credit default swaps it currently
clears, albeit not under the Dodd-Frank legal regime, ICE estimated
that the required initial margin increases would range from 40% to
371%.
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\263\ Second Roundtable Tr. at 255.
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These estimates assume that the entire default resource shortfall
resulting from the DCO's lost reliance on collateral posted as margin
by non-defaulting customers is reflected in higher initial margins. To
illustrate the other extreme, CME estimated the cost of responding to
Complete Legal Segregation purely by means of an increase in its
guaranty fund. According to CME, it would be necessary to double the
size of the guaranty fund using this approach, although their comment
indicates that this should be taken as a rough estimate likely to be
adjusted based on experience in the future.\264\ Under its assumption
that in the future it might clear a notional value of $200 trillion in
interest rate swaps, CME estimates that it would require a guaranty
fund of $50 billion under the Futures Model and $100 billion under
Complete Legal Segregation. CME also stated that it might prove
possible to adapt to Complete Legal Segregation using ``what is
traditionally called `concentration' margin whereby the DCO sets a
level of risk at which it would begin to charge higher margins based on
indicative stress-test levels.'' According to CME, if it proved
possible to implement such a system, likely ``concentration charges''
would fall in the range of $50-$250 billion.\265\ However, CME stated
that it currently lacked sufficient information to precisely assess an
appropriate methodology using this approach and that this approach
could have disadvantages which would need to be addressed before it was
considered as a practical approach.\266\ ISDA estimated that industry-
wide guaranty funds under the Futures Model would come to $128
billion.\267\ ISDA apparently did not independently estimate the effect
of Complete Legal Segregation on guaranty funds, but, relying upon DCO
estimates that they would approximately double, estimated an increment
of an additional $128 billion for Complete Legal Segregation industry-
wide.\268\ If guaranty funds are larger as a result of Complete Legal
Segregation, it is likely that some or all of the cost would be passed
on by FCMs to their customers in the form of higher fees. However, in
the absence of more information about future competitive conditions in
the cleared swaps market and similar matters, it is not possible to
reliably estimate the extent to which this would occur.
---------------------------------------------------------------------------
\264\ CME Comment on ANPR at 7-8. The comment states that under
Complete Legal Segregation CME, in determining the size of the
guaranty fund ``would likely change [from an approach treating
customer margin accounts as diversified unitary pools] to an
approach geared toward assessing the largest loss associated with a
certain number of the largest individual customer accounts.
Currently, we presume that five such customer accounts would be our
target, although experience and prudence would be our guide. In any
event, our stress-test loss profile of the largest customer accounts
would almost certainly generate larger `worst loss' results [under
Complete Legal Segregation] than under [the Futures Model].'' Id.
\265\ Id. at 8-9.
\266\ Id.
\267\ ISDA January 18, 2011 Comment on ANPR at 10. ISDA stated
that this estimate referred to the funded component of guaranty
funds and did not include DCO's right to call for more assets from
member FCMs when needed.
\268\ ISDA January 18, 2011 Comment on ANPR at 9-10 and n.8
(referring to CME estimate).
---------------------------------------------------------------------------
By contrast to CME, ICE, and ISDA, LCH stated that it is not
appropriate to attribute higher margins and/or guaranty funds to the
Complete Legal Segregation Model than to the Futures Model and that the
appropriate level of default resources for DCOs, is the same under both
models.\269\ LCH has a more than a decade's worth of experience
clearing OTC swaps. LCH states that a methodology in which no
diversification of customer collateral is assumed represents their
current practice, and is appropriately ``conservative'' in terms of
capital adequacy.\270\ LCH maintains that, even if it is legally
permissible for a DCO to take advantage of fellow customer collateral,
it is imprudent to assume that any funds in the omnibus Cleared Swaps
Customer Account will remain at the time of default.\271\ In the event
that default occurs not as a sudden shock, but rather, as the end of a
process of credit deterioration taking place over a number of days
(potentially a number of weeks), the Cleared Swaps Customers may have
time (and, if subject to Fellow-Customer Risk, strong incentive) to
port (i.e., transfer) their Cleared Swaps Contracts and associated
collateral away from the defaulting FCM.\272\ CME also has noted that
an FCM default is likely to be preceded by a period of financial
turmoil: ``In a situation where an FCM has defaulted on its obligations
to one or more DCOs, it is entirely possible that the FCM or its parent
company has been under severe financial stress for some period of
time.'' \273\
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\269\ Evaluating the Costs of Complete Legal Segregation, Aug.
2011, at 6-11 (``LCH White Paper'').
\270\ 76 FR at 33847, n. 177.
\271\ LCH White Paper at 8.
\272\ LCH at 3.
\273\ CME at 14. See also id. (describing a situation where ``an
increasing number of customers were removing their assets and
accounts.'').
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Thus, according to the logic of LCH's approach, the size of the
guaranty fund and/or initial margin levels would need to be as high
under the Futures Model as under the Complete Legal Segregation
Model.\274\
---------------------------------------------------------------------------
\274\ LCH White Paper at 8.
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The divergence in the approaches of LCH and the other two
clearinghouse commenters is due in part to different implicit
assumptions about fellow customer behavior, and how such behavior
should affect a DCO's design of default resources. Under Complete Legal
Segregation, such an approach likely requires an assessment of the
largest stressed loss on a small (or concentrated) number of the
largest customers of the given FCM since, in this instance, the DCO
would not have access to the collateral of non-defaulting customers.
Under the Futures Model, by contrast, consideration of the largest
[[Page 6367]]
stressed loss might occur over an expanded (and, to a degree, more
diversified) pool of customers because the DCO is permitted to use the
mutualized pool of customer collateral. Hence, the Complete Legal
Segregation Model effectively prohibits the DCO from using the
mutualized pool of customer deposits as a resource in the event of
double default. It follows that the extent to which the Complete Legal
Segregation Model actually affects the DCO's resources relative to the
Futures Model depends upon the degree to which non-defaulting Cleared
Swaps Customers collateral will be present following a default. If all
Cleared Swaps Customer Contracts remained with the defaulting FCM
through the default, then the DCO could potentially measure the
adequacy of guaranty funds based on a fully diversified pool of
customer positions. Conversely, if all customers would transfer their
positions to a different FCM in anticipation of the default, then the
diversification (and its consequence for the DCO's financial resources
package) would be eliminated.
More generally, the extent to which the Complete Legal Segregation
Model leads to a higher guaranty fund or higher levels of margin per
customer than the Futures Model depends on the extent to which Cleared
Swaps Customer Contracts can be expected to remain with the defaulting
FCM during the period immediately preceding a default. Since the
circumstances of particular FCM defaults will vary, DCOs, in
determining their financial resources package, should be expected to
take into consideration the possibility that, at least for some FCM
defaults, there will be warning signs, resulting in a portion of
Cleared Swaps Customer Collateral being transferred out of the Cleared
Swaps Customer Account maintained by the defaulting FCM.
While determining the appropriate assumptions regarding customer
behavior under the Futures Model is central to the issue of the
adequacy of a DCO's default resources, it may prove less central to the
consideration of relative costs and benefits under this rule, since
both of those costs and benefits depend on the extent to which Cleared
Swaps Customers will transfer their Cleared Swaps Contracts. In
general, the greater the extent to which customers will move their
positions, the lower the benefits of the Complete Legal Segregation
Model over the Futures Model. However, this benefit afforded the
customer needs to be balanced against the cost to the DCO of insuring
against the uncertainty.\275\ Both the capital costs and associated
benefits of the LSOC Model relative to the Futures Model will tend to
be lower to the extent customers are likely to move their positions in
advance of an FCM default and higher to the extent customers are
unlikely to be able to do so. Differing assumptions about customer
mobility in advance of default are, therefore, likely to have smaller
implications for the relative costs and benefits between approaches
than they do for the Risk Costs considered in isolation.
---------------------------------------------------------------------------
\275\ In addition, and as discussed above, section 724(a) of the
Dodd-Frank Act added a new paragraph (f) to section 4(d) of the CEA,
which requires that neither an FCM nor a DCO may not use the
collateral of one customer to cover the obligations of another
customer or the obligations of the FCM or the DCO.
---------------------------------------------------------------------------
A distinct question in evaluating Risk Cost is how to translate a
margin or guaranty fund increase into a cost increase. A customer that
is required to post an additional $100 of margin is not adversely
affected in the amount of $100. Moreover, the cost to the customer is,
at least in part, offset by the benefit to the DCO. The cost to a
customer of a margin increase of $100 is the difference between the
gain he or she would have received by retaining that $100, and the
return he or she will receive on the asset while it is on deposit with
the FCM or DCO. For example, the customer might invest the $100 in
buying and holding grain over the pendency of the swap if the initial
margin were not increased, while he or she is limited to the return on
assets the DCO will accept as margin payment (e.g., the T-bill rate)
under the new, higher margins. The exact difference in rate of returns
is dependent on the individual customer's investment options as well as
his/her risk tolerance, and hence is difficult to calculate precisely.
Offsetting this cost are the statutory goal of protecting customer
funds and the gain to the DCO of having additional assets available in
the event of a combined Cleared Swaps Customer and FCM default, which
may enable it to obtain a higher rate of return on some of its other
assets.\276\ Similarly, the cost to an FCM of a guaranty fund
contribution increase is equal to the difference in return between
acceptable instruments for deposit to the guaranty fund and the FCM's
potential return on those additional funds if they were not deposited
to the guaranty fund.\277\
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\276\ An additional offset to this cost is the value that
customers assign to the increased safety of their collateral from
Fellow-Customer Risk, as discussed in section VII.B.2.
\277\ There will also be an implicit cost to the FCM reflecting
the risk that the contributed assets will need to be used by the DCO
to cover losses in a default situation.
---------------------------------------------------------------------------
c. Effects on Likelihood That Customer Swaps Positions Will Be
``Ported'' to New FCMs Rather Than Liquidated in the Event of an FCM
Default
According to several commenters, a central issue to consider when
designing a customer collateral protection regime is the ability of
customers to ``port,'' i.e., transfer, their swaps positions to a
solvent FCM in the event that their current FCM defaults.\278\
Following a default by an FCM, the swaps positions of the FCM's
customers either have to be moved to another FCM, or closed. Moving a
position to another FCM allows the DCO to maintain its net position in
that contract at zero, which is generally a goal of a DCO. It also
relieves the customer of the necessity of reestablishing a position,
which potentially can be costly, especially in a stressed economic
state.\279\ Finally, according to commenters, the ability to port
rather than liquidate customer positions can have important systematic
benefits for the market at large, because the forced liquidation of the
swaps cleared by a major FCM could have severe disruptive effects on
prices and market conditions.\280\
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\278\ Black Rock at 2; Fidelity at 5; FIA at 4; MFA at 4.
\279\ See ISDA February 16, 2011 Comment on ANPR at 2.
\280\ See, e.g., id. at 2-4; and MFA at 4.
---------------------------------------------------------------------------
Rules governing customer collateral accounts have an indirect, but
potentially important, effect on the likelihood of successful porting
in the event of an FCM default. If swaps positions are transferred to a
new FCM, the new FCM will have to add to its customer account with the
DCO enough collateral to secure the ``ported'' swaps. The most ready
source of such collateral is the customer account of the defaulting
FCM, which already contains collateral securing the relevant swaps.
However, if collateral from the defaulting FCM's customer account
cannot be transferred, then porting of market positions requires
customers to, at least temporarily, provide the new FCM with new
collateral. This is, at best, a burden, and may, in some cases, make
porting infeasible--particularly the prompt porting of numerous
customers with varied financial resources and liquidity.
From the perspective of porting, the Complete Legal Segregation
Model has several related advantages over the Futures Model in
circumstances of a double default. As discussed above, under the
Futures Model, if even a
[[Page 6368]]
single customer is in default, the DCO is entitled to as much of the
customer account as is necessary to make up its loss. As a result, the
DCO has incentives to postpone transfer of the customer account until
the full ramifications of the customer default--and thus the size of
the DCO's claim against the account--are resolved. By contrast, under
Complete Legal Segregation, the DCOs claim against the customer account
is limited by law to that portion of the account attributable to
individual customers in default. The DCO will therefore have little or
no incentive to resist transfer of that portion of the account
attributable to other customers. At the same time, the Complete Legal
Segregation Model, unlike the Futures Model, provides a legal framework
for attributing the value of the customer account to individual
customers. Further, it requires that FCMs provide DCOs with the
necessary information and that DCOs make the attribution at least once
daily, so as to be prepared for a possible FCM default. As a result,
the Complete Legal Segregation Model, has clear advantages over the
Futures Model in terms of facilitating the transfer of the collateral
of non-defaulting customers in circumstances where one or more
customers have defaulted.\281\
---------------------------------------------------------------------------
\281\ For a more detailed discussion of the operation of the
segregation models in an FCM bankruptcy, see supra section I.D.
---------------------------------------------------------------------------
Because of the infrequent occurrence of double default situations
it is not possible to predict how frequently Complete Legal Segregation
will permit porting in circumstances where porting would not be
possible, or would be delayed, under the Futures Model. Nevertheless,
the structural advantages of Complete Legal Segregation for purposes of
facilitating porting, and the analysis in ISDA's comment, imply that
this is an important benefit of this model.
d. Effects on Incentives for DCOs and Customers to Monitor and Control
Risky Behavior by FCMs
CME and other commenters have argued that the Complete Legal
Segregation Model could potentially reduce the incentives of individual
customers to carefully evaluate clearing FCMs and only do business with
the least risky.\282\ In effect, they argue that because the financial
condition of the FCM, and of the FCM's other customers, will be less
relevant to the customer's exposure to loss in the event of a fellow
customer's default than under the Futures Model, the customer will
devote less effort to monitoring the FCM and its other customers.
---------------------------------------------------------------------------
\282\ Second Roundtable Tr. at 253, l.17; FIA at 5; Newedge at
4. Cf. MFA at 4-5; BlackRock at 8.
---------------------------------------------------------------------------
However, while it is possible that the protection against Fellow-
Customer Risk provided by the Complete Legal Segregation Model may
cause customers, on average, to devote less effort to monitoring the
activities of their respective FCMs than under the Futures Model, that
incentive is not removed. For example, customers remain exposed to
Operational Risk.
Moreover, the Complete Legal Segregation Model creates offsetting
increased monitoring incentives on the DCO and its member FCMs, to the
benefit of customers. Because of the increased likelihood that a
customer default would impact the guaranty fund under the Complete
Legal Segregation Model, increased incentives exist to protect that
fund through more careful monitoring by the suppliers of the guaranty
fund and their agent (the DCO). Indeed, commenters observe that the
availability of fellow-customer collateral as a buffer reduces the
incentives of DCOs to provide vigorous oversight.\283\ The net effect
of these incentive changes on the incentive to monitor is difficult to
quantify. However, the basic economics of monitoring suggest that there
are efficiency gains to centralizing monitoring in a small number of
parties.\284\ This is because of ``free rider'' effects associated with
diffuse exposure to risk of loss. When the risk of loss from the
activities of a firm, such as an FCM, is spread over a large number of
agents, each individual agent gains little from devoting resources to
monitoring the firm relative to the total potential benefit of
monitoring to the affected agents as a group.\285\ This effect is
compounded by an information effect; even if the incentive exists, it
is difficult for individual customers to gain access to real-time
information about the financial condition of the FCM, and even more so
to gain real-time information about the financial condition of their
fellow customers. In contrast, the DCO is in a position to obtain good
information about the financial condition of FCMs and customers since,
via its rules, it can require FCMs to provide such information as a
condition for becoming and remaining clearing members. Based on these
considerations, there is reason to believe that, while Complete Legal
Segregation may reduce incentives for customers to monitor their FCMs,
it will increase incentives for monitoring of FCMs by DCOs and, on
balance is likely to increase the effectiveness and efficiency with
which risk taking by clearing FCMs is monitored.
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\283\ Blackrock at 8; Freddie Mac at 2; Vanguard at 5.
\284\ See e.g., Kevin Dowd, Re-Examining the Case for Government
Deposit Insurance, 59 S. Econ. J. 363, 370 (1993).
\285\ See, e.g., Andrei Shleifer and Robert W. Vishny, A Survey
of Corporate Governance, 52 J. Fin. 737, 753 (1997) (discussing
effect of ``free rider'' issues on monitoring in context of
corporate governance).
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e. Operational Costs
As discussed above, in order for the Complete Legal Segregation
Model to work better than the Futures Model in the event of a double
default, the DCO must have information that will enable it to attribute
the assets in the defaulting FCM's customer account to individual
customers of the FCM.\286\ Moreover, because the occurrence of a double
default is rare, and because an FCM in the process of default may not
(despite its regulatory obligations) be able to provide a DCO with
accurate and timely information on its customers, section 22.11
requires clearing FCMs to provide the necessary information to DCOs on
at least a daily basis. The Commission notes that section 22.12
similarly requires DCOs to use this information to calculate and record
the amount of collateral required to support each customer's Cleared
Swaps transactions on at least a daily basis. This daily information
processing is not provided under the Futures Model and will add to the
operational costs of clearing.
---------------------------------------------------------------------------
\286\ See discussion at section VII.A.2; supra n.224.
---------------------------------------------------------------------------
The NPRM discussed the likely magnitude of increased operational
costs associated with the more extensive information requirement.\287\
The Commission noted there that one estimate suggested the operational
costs of the Complete Legal Segregation Model (relative to the Futures
Model) were likely to be slightly less than $1 million per year per
FCM, with one-time costs of about $700,000.\288\ A DCO's cost of
accommodating this additional information was estimated to be of the
same general magnitude. Another comment observed that the operational
costs would be the same across all models being considered given a
requirement for DCOs to collect margin on a gross basis.\289\ The
Commission
[[Page 6369]]
received no alternative quantitative estimates in response to the
NPRM,\290\ although Fidelity suggested that some of the operational
costs associated with Complete Legal Segregation will be incurred
regardless of the segregation model that is chosen because other CFTC
rulemakings (i.e., the real time reporting rulemaking and the reporting
of certain post-enactment swap transactions rulemaking) require similar
reporting.\291\
---------------------------------------------------------------------------
\287\ 76 FR at 33845-33846.
\288\ Id. (citing ISDA estimates for operational costs received
in response to the ANPR).
\289\ LCH at 2 (``If the Commission adopts [the gross margining
requirement for DCOs], any DCO offering any swaps clearing service
under any of the models outlined by the Commission in the Proposed
Rulemaking will be required to track margin on an individual client
basis and FCMs will be required to do the same.''). See also 76 FR
at 69374-76. In addition, some individual customer information
already resides at the DCO. See CME at 9 (``At the end of each
trading day, CME Clearing calculates, for each FCM's cleared swaps
customer account* * * the net margin requirement for each customer
in the account.'').
\290\ In fact, FHLB states that the costs and risks associated
with the additional operational complexity ``may be difficult to
quantify.'' FHLB at 4.
\291\ Fidelity at 6.
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Based on estimates by CME and ISDA described above, the expected
scale of the cleared swaps market will require hundreds of billions of
dollars of collateral to adequately secure swaps positions under any
segregation model, and will thus potentially expose this collateral to
some degree of Fellow-Customer Risk. In light of the projected
magnitude of the customer funds at stake, the Commission believes that
operational costs of the Complete Legal Segregation Model are a
relatively minor factor in choosing a model that would protect customer
funds consistent with section 4d(f) of the CEA, and that this would be
true even if operational costs proved to be considerably higher than
the estimate described in the NPRM.
f. Additional Potential Sources of Costs and Benefits Arising From
Complete Legal Segregation
As discussed in section I.D.1 above, the Complete Legal Segregation
Model provides a significant advantage compared to the Futures Model
with respect to fostering transfer. Specifically, under the Complete
Legal Segregation Model, information about the Cleared Swaps Customers
as a whole, and about each individual Cleared Swaps Customer's
positions, are transmitted to the DCO every day, an information flow
(and store) that is not present in the Futures Model. Thus, in the
event of an FCM bankruptcy, each DCO will have important information on
a customer by customer basis that can be used to facilitate and
implement transfers, thereby making the DCO less reliant upon the FCM
for that information.
3. Application to CEA Section 15(a) Considerations
a. Protection of Market Participants
As discussed above, the primary benefit of the Complete Legal
Segregation Model is the protection of Cleared Swaps Customers from the
risk of losing the value of their collateral as a result of a double
default. Based on estimates by CME and ISDA, the cleared swaps market
is likely to require upwards of $500 billion in customer collateral
regardless of the segregation model chosen by the Commission.\292\
These assets will be potentially exposed to Fellow-Customer Risk. It is
not possible to reliably quantify the likelihood of fellow customer
losses in the absence of Complete Legal Segregation for reasons
discussed in section VII.B.2.a. above. In addition, the magnitude of
Fellow-Customer Risk in particular default situations will be affected
by the extent to which customers foresee or anticipate a default and
accordingly move their accounts to other FCMs; and the extent to which
a default is foreseeable or anticipated will vary in different
defaults. The risk cost imposed on DCOs and their members by Complete
Legal Segregation will be affected by the foreseeability of default in
a roughly parallel way.
---------------------------------------------------------------------------
\292\ See supra n. 243.
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Notwithstanding these uncertainties, swaps users who participated
in this rulemaking process, with only limited exceptions, consistently
placed great value on protection against Fellow-Customer Risk and
supported either Complete Legal Segregation or stronger measures to
provide such protection despite estimates of high dollar costs in the
form of the capital cost of higher margins or guaranty funds.\293\
Since swaps users most likely ultimately will bear, directly or
indirectly, most of the dollar costs of protection against Fellow-
Customer Risk, the Commission places substantial weight on their
valuation of such protection.
---------------------------------------------------------------------------
\293\ See, e.g., Second Roundtable Tr. at 245-249; Second
Roundtable Tr. at 140, l.12 (Mr. MacFarlane stating that ``Tudor
would happily pay the incremental costs, both in terms of collateral
and operational costs [for greater protection].'').
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b. Efficiency, Competitiveness, and Financial Integrity of Markets
i. Dollar Costs and Swaps Usage
Complete Legal Segregation could add materially to the dollar cost
of clearing swaps, affecting competitiveness in particular.\294\
Moreover, there were estimates (albeit somewhat speculative estimates)
that Complete Legal Segregation might require on the order of 70%
higher margins, 100% higher DCO guaranty funds, or some combination of
smaller increases in both. In light of the expected large scale of the
cleared swaps market, these estimates imply industry wide increments in
margin on the order of $500 billion or more, increments in guaranty
funds of over $100 billion, or a combination of smaller increments of
both.\295\ The cost of these measures would not be the dollar amount of
margin or guaranty fund contributions, but, rather, the opportunity
cost of using capital for these purposes rather than other business
purposes. Considerable uncertainty is added to the evaluation of these
estimates of the dollar cost of Complete Legal Segregation by the fact
that DCOs do not yet have experience clearing under the Dodd-Frank
regime (although they do currently clear swaps pursuant to the rules of
the exchanges) and by LCH's observation that, under the method it uses
to determine needed financial resources to protect against default, the
same level of resources is required under both Complete Legal
Segregation and the Futures Model.\296\
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\294\ This analysis is also informed by the extent to which
clearing certain types of swaps is mandatory, as well as by the cost
already incurred in the uncleared swaps market.
\295\ See supra n. 243.
\296\ See supra n. 269.
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If Complete Legal Segregation results in higher dollar costs to
swaps users, this may discourage some use of swaps for hedging or other
beneficial economic uses. The Commission does not have precise
information about the price responsiveness of swaps usage that would
make it possible to quantify this effect. A countervailing
consideration is that comments to this rulemaking indicate that
customers are already transacting in uncleared swaps, and are paying
for full segregation of the collateral they are posting because of the
importance to them of protection of that collateral against the
defaults of others. Moreover, as some commenters noted, concern over
exposure to Fellow-Customer Risk that they currently pay for and
receive could discourage swaps usage in the absence of Complete Legal
Segregation or other protection against such risk.\297\ Comments by
swaps users indicated that such effects would occur though they did not
provide quantitative estimates. The evidence from the comments,
specifically the statements of swap users regarding their willingness
to pay for legal segregation, suggests that the demand-enhancing
[[Page 6370]]
effects of the increased safety associated with Complete Legal
Segregation are larger than the demand-reducing effects of higher
margins and/or fees associated with it.\298\
---------------------------------------------------------------------------
\297\ See e.g., Second Roundtable at 141, l.3 (Mr. MacFarlane
stating''the uncertainty that's created by not knowing who we're
sharing risk in the omnibus pool would cause us to pull our capital
back from the market.'').
\298\ See e.g., Second Roundtable Tr. at 245 (Mr. Thum stating
that ``we're prepared to bear the cost to provide for the margin
protection that our clients need.'').
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ii. Financial Integrity of Markets
Complete Legal Segregation is likely to have several effects on the
financial integrity of markets, the specifics of which are discussed in
more detail under other headings.\299\ As explained above, Complete
Legal Segregation is expected to lead to a net improvement in the
monitoring of risky behavior by FCMs, with the effects of increased
incentives for such monitoring by DCOs outweighing the effects of
reduced incentives for such monitoring by customers. This net
improvement in monitoring of FCMs can be expected to enhance the
financial integrity of the markets in which clearing FCMs participate.
---------------------------------------------------------------------------
\299\ See discussion at sections VII.B.2.b, VII.B.2.c,
VII.B.2.d, and VII.B.3.b.i.
---------------------------------------------------------------------------
By facilitating porting, Complete Legal Segregation is expected to
enhance the financial integrity of cleared swaps markets in financial
stress situations involving FCMs by reducing the likelihood that a
double default will result in the need to liquidate large volumes of
swaps positions with resulting costs to customers and the DCO and the
potential to seriously disrupt the market at large.
By prohibiting DCOs from using the collateral of non-defaulting
customers in a double default situation, Complete Legal Segregation
potentially could have a negative effect on the financial integrity of
DCOs by reducing the financial resources available to apply to losses
arising from double defaults. However, the record indicates that DCOs
would substitute additional resources in the form of higher margin
levels, larger guaranty funds, or a combination of both as need to
maintain the ability to cover losses from FCM and customer
defaults.\300\ Importantly, prohibiting DCOs from using the collateral
of non-defaulting customers to protect a DCO from risks within a DCO's
control is consistent with the statute's goal of protecting customer
funds. As a result, the loss of the ability to rely on the collateral
of non-defaulting customers would be expected to translate to higher
dollar costs than under the Futures Model rather than reduced financial
integrity.
---------------------------------------------------------------------------
\300\ See supra n. 255.
---------------------------------------------------------------------------
c. Price Discovery
Complete Legal Segregation is not expected to have a significant
effect on price discovery under normal market conditions. In
circumstances of a double default involving a large FCM, Complete Legal
Segregation may help protect price discovery in the swaps markets by
reducing the likelihood of the need for a large scale liquidation of
swaps positions that would disrupt normal pricing.
d. Sound Risk Management Practices
As discussed above,\301\ Complete Legal Segregation is expected to
produce a net improvement in the monitoring of risky behavior by FCMs.
While there may be some reduction in the incentives to Cleared Swaps
Customers to monitor their FCMs, there is a corresponding increase in
the incentives by DCOs to do so. There are efficiency gains in
centralizing this responsibility in a small number of parties, and the
DCOs (as membership organizations) have greater access to information
from their Clearing Members, in contrast to Cleared Swaps Customers,
who (due to considerations of confidentiality) may have little ability
to obtain information about an FCM's activities with respect to fellow-
customers.
---------------------------------------------------------------------------
\301\ See supra section VII.B.2.d.
---------------------------------------------------------------------------
e. Other Public Interest Considerations
By better protecting Cleared Swaps Customer Collateral against
fellow-customer risk, the LSOC Model will enhance compliance with the
values of CEA Section 4d(f), which requires that the property of each
individual customer be protected.
C. Conclusion
The Commission has carefully considered the available evidence
regarding the costs and benefits of Complete Legal Segregation Model
and has concluded that the Complete Legal Segregation Model best
accomplishes the statutory objective of protecting customer deposits.
In terms of benefits, customers have much greater assurance of the
safety of their margin deposits against Fellow-Customer Risk under the
Complete Legal Segregation Model than under the Futures Model. In
addition, Complete Legal Segregation will facilitate porting rather
than liquidation of customer positions in double default situations
with associated benefits to customers and, for defaults of large FCMs,
reduced risk of disruption of markets as a result of large volumes of
customer positions. Complete Legal Segregation also will increase
incentives for DCOs to monitor risky behavior by member FCMs and that
this effect can be expected to outweigh reduced incentives for
customers to monitor their FCMs. In determining that Complete Legal
Segregation is the appropriate model, the Commission has placed weight
on, among other considerations, the comments of many swaps users that
they place great value on assurance of their margins and their
positions and are willing to incur substantial costs to achieve such
assurance and on comments by a range of market participants placing
great importance on porting of customer positions as a response to FCM
defaults.
On the cost side, several DCOs that employ the Futures Model for
the futures-side of their business and other commenters argued that
Complete Legal Segregation will require some combination of
substantially higher margin levels and guaranty fund contributions than
the Futures Model. However, one major DCO reported that, under the
approach it uses to establish margin and guaranty fund level, these
levels would be the same under Complete Legal Segregation and the
Futures Model. Complete Legal Segregation will impose some operational
costs but such costs are small enough to be a minor consideration
relative to the other aspects of cost; e.g., the potential increases in
margins and guaranty funds.
The Commission notes that, as discussed above, there are a number
of sources of uncertainty in evaluating the costs and benefits of
Complete Legal Segregation, such as market participants not yet having
experience clearing swaps under the Dodd-Frank legal regime and the
infrequency of double defaults. However, the costs and benefits of all
the models considered by the Commission are subject to similar
uncertainties as to the probability of double defaults and customer
behavior in anticipation of such defaults. Accordingly, such
uncertainties do not militate against the selection of the Complete
Legal Segregation Model as the preferred alternative.
VIII. Related Matters
A. Paperwork Reduction Act
1. Introduction
Sections 22.2(g), 22.5(a), 22.11, 22.12, and 22.16 of these rules
impose new information disclosure and recordkeeping requirements that
constitute the collection of information
[[Page 6371]]
within the meaning of the Paperwork Reduction Act of 1995
(``PRA'').\302\ Under the PRA, 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.\303\ The
Commission therefore has requested that the Office of Management and
Budget (``OMB'') assign a control number for this collection of
information. The Commission has also submitted the NPRM, this final
rule release, and supporting documentation to 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 ``Disclosure and Retention of Certain
Information Relating to Cleared Swaps Customer Collateral,'' OMB
Control Number 3038-0091. This collection of information will be
mandatory. The information in question will be held by private entities
and, to the extent it involves consumer financial information, may be
protected under Title V of the Gramm-Leach-Bliley Act as amended by the
Dodd-Frank Act.\304\ OMB has not yet approved the collection of this
information.
---------------------------------------------------------------------------
\302\ 44 U.S.C. 3501 et seq.
\303\ Id.
\304\ See generally, Notice of Proposed Rulemaking, Privacy of
Consumer Financial Information; Conforming Amendments Under Dodd-
Frank Act, 75 FR 66014, Oct. 27, 2010.
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2. Comments Received on Collection of Information Proposed in NPRM
Sections 22.2(g), 22.5(a), 22.11, 22.12, and 22.16 and estimates of
the expected information collection burden were published for comment
in the NPRM. The collection of information required by the final
versions of these rules and the associated information collection
burden is identical to that of the rules as proposed. Comments were
received regarding proposed sections 22.5(a), 22.11, 22.12, and 22.16.
The substance of these comments and the Commission's response to them
is set forth above in sections IV.E, IV.K, IV.L., and IV.P of this
preamble.
In addition, in response to a comment on the definition of
``Cleared Swaps Customer Collateral'' by the FIA requesting that the
Commission confirm that the term ``Cleared Swaps Customer Collateral''
includes all assets provided to an FCM by a Cleared Swaps Customer,
including amounts in excess of the amount required to margin a Cleared
Swap by the relevant DCO, the Commission has included in the final rule
a new permissive provision, subsection 22.13(c)(2). Subsection
22.13(c)(2) provides that an FCM may transmit to a DCO collateral
posted by a Cleared Swaps Customer in excess of the amount required by
the DCO if (1) the rules of the DCO permit such transmission; and (2)
the DCO provides a mechanism by which the FCM is able to, and maintains
rules requiring the FCM to, identify each business day, for each
Cleared Swaps Customer, the amount of collateral posted in excess of
the amount required by the DCO. This rule subsection may have the
effect of causing some FCMs to perform a daily computation of the
amount of collateral posted in excess of the amount required by the
relevant DCO. In the view of the Commission, this provision does not
materially change, or add to the burden of, the information collection
required by the Part 22 rules as proposed. This is so because the
computation of the amount of collateral posted in excess of the amount
required by the relevant DCO will be performed using same data sources
that would be used for the information collections required by
subsections 22.2(g), 22.11, and 22.12. Moreover, this burden would only
be imposed (and enforced) by voluntary action of the DCO in permitting,
and the FCM in transmitting, such additional collateral.
There were no comments specifically addressing the Commission's
numerical estimates of information collection burden in section VII.B.2
of the NPRM.
B. Regulatory Flexibility Act
The Regulatory Flexibility Act (``RFA'') \305\ requires that
agencies consider whether their rules will have a significant economic
impact on a substantial number of small entities and, if so, provide a
regulatory flexibility analysis of that impact. These Part 22 rules and
amendments to Part 190 apply to DCOs and FCMs. In the NPRM, the
Chairman, pursuant to section 605(b) of the RFA, 5 U.S.C. 605(b),
certified on behalf of the Commission that these rules and amendments
will not have a significant economic impact on a substantial number of
small entities based on previous determinations by the Commission that
DCOs and FCMs are not small entities for purposes of the RFA.\306\
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\305\ 5 U.S.C. 601 et seq.
\306\ See 66 FR 45605, 45609 (Aug. 29, 2001) (DCOs); 47 FR
18618, 18619-20 (April 30, 1982) (FCMs).
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List of Subjects
17 CFR Part 22
Brokers, Clearing, Consumer protection, Reporting and recordkeeping
requirements, Swaps.
17 CFR Part 190
Bankruptcy, Brokers, Commodity futures, Reporting and recordkeeping
requirements, Swaps.
IX. Text of Final Rules
For the reasons stated in this release, the Commission hereby
amends Chapter 17 as follows:
0
1. Add Part 22 to read as follows:
PART 22--CLEARED SWAPS
Sec.
22.1 Definitions.
22.2 Futures Commission Merchants: Treatment of Cleared Swaps
Customer Collateral.
22.3 Derivatives Clearing Organizations: Treatment of Cleared Swaps
Customer Collateral.
22.4 Futures Commission Merchants and Derivatives Clearing
Organizations: Permitted Depositories.
22.5 Futures Commission Merchants and Derivatives Clearing
Organizations: Written Acknowledgement.
22.6 Futures Commission Merchants and Derivatives Clearing
Organizations: Naming of Cleared Swaps Customer Accounts.
22.7 Permitted Depositories: Treatment of Cleared Swaps Customer
Collateral.
22.8 Situs of Cleared Swaps Customer Accounts.
22.9 Denomination of Cleared Swaps Customer Collateral and Location
of Depositories.
22.10 Application of other Regulatory Provisions.
22.11 Information to be Provided Regarding Customers and their
Cleared Swaps.
22.12 Information to be Maintained Regarding Cleared Swaps Customer
Collateral.
22.13 Additions to Cleared Swaps Customer Collateral.
22.14 Futures Commission Merchant Failure to Meet a Customer Margin
Call in Full.
22.15 Treatment of Cleared Swaps Customer Collateral on an
Individual Basis.
22.16 Disclosures to Customers.
Authority: 7 U.S.C. 1a, 6d, 7a-1 as amended by Pub. L. 111-203,
124 Stat. 1376.
Sec. 22.1 Definitions.
For the purposes of this part:
Cleared Swap. This term refers to a transaction constituting a
``cleared swap'' within the meaning of section 1a(7) of the Act.
(1) This term shall exclude any swap (along with money, securities,
or other property received to margin, guarantee, or secure such a swap)
that, pursuant to a Commission rule, regulation, or order, is (along
with such money, securities, or other property) commingled with a
commodity future or option (along with money, securities, or other
property
[[Page 6372]]
received to margin, guarantee, or secure such a future or option) that
is segregated pursuant to section 4d(a) of the Act.
(2) This term shall include any trade or contract (along with
money, securities or other property received to margin, guarantee, or
secure such a trade or contract), that
(i) Would be required to be segregated pursuant to section 4d(a) of
the Act, or
(ii) Would be subject to Sec. 30.7 of this chapter, but which is,
in either case, pursuant to a Commission rule, regulation, or order (or
a derivatives clearing organization rule approved in accordance with
Sec. 39.15(b)(2) of this chapter), commingled with a swap (along with
money, securities, or other property received to margin, guarantee, or
secure such a swap) in an account segregated pursuant to section 4d(f)
of the Act.
Cleared Swaps Customer. This term refers to any person entering
into a Cleared Swap, but shall exclude:
(1) Any owner or holder of a Cleared Swaps Proprietary Account with
respect to the Cleared Swaps in such account; and
(2) A clearing member of a derivatives clearing organization with
respect to Cleared Swaps cleared on that derivatives clearing
organization. A person shall be a Cleared Swaps Customer only with
respect to its Cleared Swaps.
Cleared Swaps Customer Account. This term refers to any account for
the Cleared Swaps of Cleared Swaps Customers and associated Cleared
Swaps Customer Collateral that:
(1) A futures commission merchant maintains on behalf of Cleared
Swaps Customers (including, in the case of a Collecting Futures
Commission Merchant, the Cleared Swaps Customers of a Depositing
Futures Commission Merchant) or
(2) A derivatives clearing organization maintains for futures
commission merchants on behalf of Cleared Swaps Customers thereof.
Cleared Swaps Customer Collateral. (1) This term means all money,
securities, or other property received by a futures commission merchant
or by a derivatives clearing organization from, for, or on behalf of a
Cleared Swaps Customer, which money, securities, or other property:
(i) Is intended to or does margin, guarantee, or secure a Cleared
Swap; or
(ii) Constitutes, if a Cleared Swap is in the form or nature of an
option, the settlement value of such option.
(2) This term shall also include accruals, i.e., all money,
securities, or other property that a futures commission merchant or
derivatives clearing organization receives, directly or indirectly,
which is incident to or results from a Cleared Swap that a futures
commission merchant intermediates for a Cleared Swaps Customer.
Cleared Swaps Proprietary Account. (1) This term means an account
for Cleared Swaps and associated collateral that is carried on the
books and records of a futures commission merchant for persons with
certain relationships with that futures commission merchant,
specifically:
(i) Where such account is carried for a person falling within one
of the categories specified in paragraph (2) of this definition, or
(ii) Where ten percent or more of such account is owned by a person
falling within one of the categories specified in paragraph (2) of this
definition, or
(iii) Where an aggregate of ten percent or more of such account is
owned by more than one person falling within one or more of the
categories specified in paragraph (2) of this definition.
(2) The relationships to the futures commission merchant referred
to in paragraph (1) of this definition are as follows:
(i) Such individual himself, or such partnership, corporation or
association itself;
(ii) In the case of a partnership, a general partner in such
partnership;
(iii) In the case of a limited partnership, a limited or special
partner in such partnership whose duties include:
(A) The management of the partnership business or any part thereof;
(B) The handling, on behalf of such partnership, of:
(1) The Cleared Swaps of Cleared Swaps Customers or
(2) The Cleared Swaps Customer Collateral;
(C) The keeping, on behalf of such partnership, of records
pertaining to
(1) the Cleared Swaps of Cleared Swaps Customers or
(2) the Cleared Swaps Customer Collateral; or
(D) The signing or co-signing of checks or drafts on behalf of such
partnership;
(iv) In the case of a corporation or association, an officer,
director, or owner of ten percent or more of the capital stock of such
organization;
(v) An employee of such individual, partnership, corporation or
association whose duties include:
(A) The management of the business of such individual, partnership,
corporation or association or any part thereof;
(B) The handling, on behalf of such individual, partnership,
corporation, or association, of the Cleared Swaps of Cleared Swaps
Customers or the Cleared Swaps Customer Collateral;
(C) The keeping of records, on behalf of such individual,
partnership, corporation, or association, pertaining to the Cleared
Swaps of Cleared Swaps Customers or the Cleared Swaps Customer
Collateral; or
(D) The signing or co-signing of checks or drafts on behalf of such
individual, partnership, corporation, or association;
(vi) A spouse or minor dependent living in the same household of
any of the foregoing persons;
(vii) A business affiliate that, directly or indirectly, controls
such individual, partnership, corporation, or association; or
(viii) A business affiliate that, directly or indirectly, is
controlled by or is under common control with, such individual,
partnership, corporation or association. Provided, however, that an
account owned by any shareholder or member of a cooperative association
of producers, within the meaning of section 6a of the Act, which
association is registered as a futures commission merchant and carries
such account on its records, shall be deemed to be a Cleared Swaps
Customer Account and not a Cleared Swaps Proprietary Account of such
association, unless the shareholder or member is an officer, director,
or manager of the association.
Clearing Member. This term means any person that has clearing
privileges such that it can process, clear and settle trades through a
derivatives clearing organization on behalf of itself or others. The
derivatives clearing organization need not be organized as a membership
organization.
Collecting Futures Commission Merchant. A futures commission
merchant that carries Cleared Swaps on behalf of another futures
commission merchant and the Cleared Swaps Customers of the latter
futures commission merchant, and as part of carrying such Cleared
Swaps, collects Cleared Swaps Customer Collateral.
Commingle. To commingle two or more items means to hold such items
in the same account, or to combine such items in a transfer between
accounts.
Customer. This term means any customer of a futures commission
merchant, other than a Cleared Swaps Customer, including, without
limitation:
(1) Any ``customer'' or ``commodity customer'' within the meaning
of Sec. 1.3 of this chapter; and
[[Page 6373]]
(2) Any ``foreign futures or foreign options customer'' within the
meaning of Sec. 30.1(c) of this chapter.
Depositing Futures Commission Merchant. A futures commission
merchant that carries Cleared Swaps on behalf of its Cleared Swaps
Customers through another futures commission merchant and, as part of
carrying such Cleared Swaps, deposits Cleared Swaps Customer Collateral
with such futures commission merchant.
Permitted Depository. This term shall have the meaning set forth in
Sec. 22.4 of this part.
Segregate. To segregate two or more items is to keep them in
separate accounts, and to avoid combining them in the same transfer
between two accounts.
Sec. 22.2 Futures Commission Merchants: Treatment of Cleared Swaps
and Associated Cleared Swaps Customer Collateral.
(a) General. A futures commission merchant shall treat and deal
with the Cleared Swaps of Cleared Swaps Customers and associated
Cleared Swaps Customer Collateral as belonging to Cleared Swaps
Customers.
(b) Location of Cleared Swaps Customer Collateral. (1) A futures
commission merchant must segregate all Cleared Swaps Customer
Collateral that it receives, and must either hold such Cleared Swaps
Customer Collateral itself as set forth in paragraph (b)(2) of this
section, or deposit such collateral into one or more Cleared Swaps
Customer Accounts held at a Permitted Depository, as set forth in
paragraph (b)(3) of this section.
(2) If a futures commission merchant holds Cleared Swaps Customer
Collateral itself, then the futures commission merchant must:
(i) Physically separate such collateral from its own property;
(ii) Clearly identify each physical location in which it holds such
collateral as a ``Location of Cleared Swaps Customer Collateral'' (the
``FCM Physical Location'');
(iii) Ensure that the FCM Physical Location provides appropriate
protection for such collateral; and
(iv) Record in its books and records the amount of such Cleared
Swaps Customer Collateral separately from its own funds.
(3) If a futures commission merchant holds Cleared Swaps Customer
Collateral in a Permitted Depository, then:
(i) The Permitted Depository must qualify pursuant to the
requirements set forth in Sec. 22.4 of this part, and
(ii) The futures commission merchant must maintain a Cleared Swaps
Customer Account with each such Permitted Depository.
(c) Commingling. (1) A futures commission merchant may commingle
the Cleared Swaps Customer Collateral that it receives from, for, or on
behalf of multiple Cleared Swaps Customers.
(2) A futures commission merchant shall not commingle Cleared Swaps
Customer Collateral with either of the following:
(i) Funds belonging to the futures commission merchant, except as
expressly permitted in paragraph (e)(3) of this section; or
(ii) Other categories of funds belonging to Customers of the
futures commission merchant, including customer funds (as Sec. 1.3 of
this chapter defines such term) and the foreign futures or foreign
options secured amount (as Sec. 1.3 of this chapter defines such
term), except as expressly permitted by Commission rule, regulation, or
order, or by a derivatives clearing organization rule approved in
accordance with Sec. 39.15(b)(2) of this chapter.
(d) Limitations on Use. (1) No futures commission merchant shall
use, or permit the use of, the Cleared Swaps Customer Collateral of one
Cleared Swaps Customer to purchase, margin, or settle the Cleared Swaps
or any other trade or contract of, or to secure or extend the credit
of, any person other than such Cleared Swaps Customer. Cleared Swaps
Customer Collateral shall not be used to margin, guarantee, or secure
trades or contracts of the entity constituting a Cleared Swaps Customer
other than in Cleared Swaps, except to the extent permitted by a
Commission rule, regulation or order.
(2) A futures commission merchant may not impose or permit the
imposition of a lien on Cleared Swaps Customer Collateral, including
any residual financial interest of the futures commission merchant in
such collateral, as described in paragraph (e)(4) of this section.
(3) A futures commission merchant may not include, as Cleared Swaps
Customer Collateral,
(i) Money invested in the securities, memberships, or obligations
of any derivatives clearing organization, designated contract market,
swap execution facility, or swap data repository, or
(ii) Money, securities, or other property that any derivatives
clearing organization holds and may use for a purpose other than those
set forth in Sec. 22.3 of this part.
(e) Exceptions. Notwithstanding the foregoing:
(1) Permitted Investments. A futures commission merchant may invest
money, securities, or other property constituting Cleared Swaps
Customer Collateral in accordance with Sec. 1.25 of this chapter,
which section shall apply to such money, securities, or other property
as if they comprised customer funds or customer money subject to
segregation pursuant to section 4d(a) of the Act and the regulations
thereunder.
(2) Permitted Withdrawals. Such share of Cleared Swaps Customer
Collateral as in the normal course of business shall be necessary to
margin, guarantee, secure, transfer, adjust, or settle a Cleared Swaps
Customer's Cleared Swaps with a derivatives clearing organization, or
with a Collecting Futures Commission Merchant, may be withdrawn and
applied to such purposes, including the payment of commissions,
brokerage, interest, taxes, storage, and other charges, lawfully
accruing in connection with such Cleared Swaps.
(3) Deposits of Own Money, Securities, or Other Property.
(i) In order to ensure that it is always in compliance with
paragraph (f) of this section, a futures commission merchant may place
in an FCM Physical Location or deposit in a Cleared Swaps Customer
Account its own money, securities, or other property (provided, that
such securities or other property are unencumbered and are of the types
specified in Sec. 1.25 of this chapter).
(ii) Money, securities, or other property deposited by a futures
commission merchant pursuant to 22.13(b) and available to a derivatives
clearing organization or Collecting Futures Commission Merchant to meet
the obligations of the futures commission merchant's Cleared Swaps
Customers collectively, shall be maintained in an account separate from
the Cleared Swaps Customer Account.
(4) Residual Financial Interest. (i) If, in accordance with
paragraph (e)(3)(i) of this section, a futures commission merchant
places in an FCM Physical Location or deposits in a Cleared Swaps
Customer Account its own money, securities, or other property, then
such money, securities, or other property (including accruals thereon)
shall constitute Cleared Swaps Customer Collateral.
(ii) The futures commission merchant shall have a residual
financial interest in any portion of such money, securities, or other
property in excess of that necessary for compliance with paragraph
(f)(4) of this section.
(iii) The futures commission merchant may withdraw money,
securities, or other property from the FCM Physical
[[Page 6374]]
Location or Cleared Swaps Customer Account, to the extent of its
residual financial interest therein. At the time of such withdrawal,
the futures commission merchant shall ensure that the withdrawal does
not cause its residual financial interest to become less than zero.
(f) Requirements as to Amount. (1) For purposes of this Sec.
22.2(f), the term ``account'' shall reference the entries on the books
and records of a futures commission merchant pertaining to the Cleared
Swaps Customer Collateral of a particular Cleared Swaps Customer.
(2) The futures commission merchant must reflect in the account
that it maintains for each Cleared Swaps Customer the market value of
any Cleared Swaps Customer Collateral that it receives from such
customer, as adjusted by:
(i) Any uses permitted under Sec. 22.2(d) of this part;
(ii) Any accruals on permitted investments of such collateral under
Sec. 22.2(e) of this part that, pursuant to the futures commission
merchant's customer agreement with that customer, are creditable to
such customer;
(iii) Any charges lawfully accruing to the Cleared Swaps Customer,
including any commission, brokerage fee, interest, tax, or storage fee;
and
(iv) Any appropriately authorized distribution or transfer of such
collateral.
(3) If the market value of Cleared Swaps Customer Collateral in the
account of a Cleared Swaps Customer is positive after adjustments, then
that account has a credit balance. If the market value of Cleared Swaps
Customer Collateral in the account of a Cleared Swaps Customer is
negative after adjustments, then that account has a debit balance.
(4) The futures commission merchant must maintain in segregation,
in its FCM Physical Locations and/or its Cleared Swaps Customer
Accounts at Permitted Depositories, an amount equal to the sum of any
credit balances that the Cleared Swaps Customers of the futures
commission merchant have in their accounts, excluding from such sum any
debit balances that the Cleared Swaps Customers of the futures
commission merchant have in their accounts.
(5) Notwithstanding the foregoing, the futures commission merchant
must include, in calculating the sum referenced in paragraph (f)(4) of
this section, any debit balance that a Cleared Swaps Customer may have
in its account, to the extent that such balance is secured by ``readily
marketable securities'' that the Cleared Swaps Customer deposited with
the futures commission merchant.
(i) For purposes of this section, ``readily marketable'' shall be
defined as having a ``ready market'' as such latter term is defined in
Rule 15c3-1(c)(11) of the Securities and Exchange Commission (Sec.
241.15c3-1(c)(11) of this title).
(ii) In order for a debit balance to be deemed secured by ``readily
marketable securities,'' the futures commission merchant must maintain
a security interest in such securities, and must hold a written
authorization to liquidate the securities at the discretion of the
futures commission merchant.
(iii) To determine the amount secured by ``readily marketable
securities,'' the futures commission merchant shall:
(A) Determine the market value of such securities; and
(B) Reduce such market value by applicable percentage deductions
(i.e., ``securities haircuts'') as set forth in Rule 15c3-1(c)(2)(vi)
of the Securities and Exchange Commission (Sec. 240.15c3-1(c)(2)(vi)
of this title). The portion of the debit balance, not exceeding 100 per
cent, that is secured by the reduced market value of such readily
marketable securities shall be included in calculating the sum referred
to in paragraph (f)(4) of this section.
(g) Segregated Account; Daily Computation and Record. (1) Each
futures commission merchant must compute as of the close of each
business day, on a currency-by-currency basis:
(i) The aggregate market value of the Cleared Swaps Customer
Collateral in all FCM Physical Locations and all Cleared Swaps Customer
Accounts held at Permitted Depositories (the ``Collateral Value'');
(ii) The sum referenced in paragraph (f)(4) of this section (the
``Collateral Requirement''); and
(iii) The amount of the residual financial interest that the
futures commission merchant holds in such Cleared Swaps Customer
Collateral, which shall equal the difference between the Collateral
Value and the Collateral Requirement.
(2) The futures commission merchant must complete the daily
computations required by this section prior to noon on the next
business day and must keep such computations, together with all
supporting data, in accordance with the requirements of Sec. 1.31 of
this chapter.
Sec. 22.3 Derivatives Clearing Organizations: Treatment of Cleared
Swaps Customer Collateral.
(a) General. A derivatives clearing organization shall treat and
deal with the Cleared Swaps Customer Collateral deposited by a futures
commission merchant as belonging to the Cleared Swaps Customers of such
futures commission merchant and not other persons, including, without
limitation, the futures commission merchant.
(b) Location of Cleared Swaps Customer Collateral. (1) The
derivatives clearing organization must segregate all Cleared Swaps
Customer Collateral that it receives from futures commission merchants,
and must either hold such Cleared Swaps Customer Collateral itself as
set forth in paragraph (b)(2) of this section, or deposit such
collateral into one or more Cleared Swaps Customer Accounts held at a
Permitted Depository, as set forth in paragraph (b)(3) of this section.
(2) If a derivatives clearing organization holds Cleared Swaps
Customer Collateral itself, then the derivatives clearing organization
must:
(i) Physically separate such collateral from its own property, the
property of any futures commission merchant, and the property of any
other person that is not a Cleared Swaps Customer of a futures
commission merchant;
(ii) Clearly identify each physical location in which it holds such
collateral as ``Location of Cleared Swaps Customer Collateral'' (the
``DCO Physical Location'');
(iii) Ensure that the DCO Physical Location provides appropriate
protection for such collateral; and
(iv) Record in its books and records the amount of such Cleared
Swaps Customer Collateral separately from its own funds, the funds of
any futures commission merchant, and the funds of any other person that
is not a Cleared Swaps Customer of a futures commission merchant.
(3) If a derivatives clearing organization holds Cleared Swaps
Customer Collateral in a Permitted Depository, then:
(i) The Permitted Depository must qualify pursuant to the
requirements set forth in Sec. 22.4 of this part; and
(ii) The derivatives clearing organization must maintain a Cleared
Swaps Customer Account with each such Permitted Depository.
(c) Commingling. (1) A derivatives clearing organization may
commingle the Cleared Swaps Customer Collateral that it receives from
multiple futures commission merchants on behalf of their Cleared Swaps
Customers.
(2) A derivatives clearing organization shall not commingle the
Cleared Swaps Customer Collateral that it receives from a futures
commission merchant on behalf of Cleared Swaps Customers with any of
the following:
[[Page 6375]]
(i) The money, securities, or other property belonging to the
derivatives clearing organization;
(ii) The money, securities, or other property belonging to any
futures commission merchant; or
(iii) Other categories of funds that it receives from a futures
commission merchant on behalf of Customers, including customer funds
(as Sec. 1.3 of this chapter defines such term) and the foreign
futures or foreign options secured amount (as Sec. 1.3 of this chapter
defines such term), except as expressly permitted by Commission rule,
regulation or order, (or a derivatives clearing organization rule
approved in accordance with Sec. 39.15(b)(2) of this chapter).
(d) Exceptions; Permitted Investments. Notwithstanding the
foregoing and Sec. 22.15 of this part, a derivatives clearing
organization may invest the money, securities, or other property
constituting Cleared Swaps Customer Collateral in accordance with Sec.
1.25 of this chapter, which section shall apply to such money,
securities, or other property as if they comprised customer funds or
customer money subject to segregation pursuant to section 4d(a) of the
Act and the regulations thereunder.
Sec. 22.4 Futures Commission Merchants and Derivatives Clearing
Organizations: Permitted Depositories.
In order for a depository to be a Permitted Depository:
(a) The depository must (subject to Sec. 22.9) be one of the
following types of entities:
(1) A bank located in the United States;
(2) A trust company located in the United States;
(3) A Collecting Futures Commission Merchant registered with the
Commission (but only with respect to a Depositing Futures Commission
Merchant providing Cleared Swaps Customer Collateral); or
(4) A derivatives clearing organization registered with the
Commission; and
(b) The futures commission merchant or the derivatives clearing
organization must hold a written acknowledgment letter from the
depository as required by Sec. 22.5 of this part.
Sec. 22.5 Futures Commission Merchants and Derivatives Clearing
Organizations: Written Acknowledgement.
(a) Before depositing Cleared Swaps Customer Collateral, the
futures commission merchant or derivatives clearing organization shall
obtain and retain in its files a separate written acknowledgment letter
from each depository in accordance with Sec. Sec. 1.20 and 1.26 of
this chapter, with all references to ``customer funds'' modified to
apply to Cleared Swaps Customer Collateral, and with all references to
section 4d(a) or 4d(b) of the Act and the regulations thereunder
modified to apply to section 4d(f) of the Act and the regulations
thereunder.
(b) The futures commission merchant or derivatives clearing
organization shall adhere to all requirements specified in Sec. Sec.
1.20 and 1.26 of this chapter regarding retaining, permitting access
to, filing, or amending the written acknowledgment letter, in all cases
as if the Cleared Swaps Customer Collateral comprised customer funds
subject to segregation pursuant to section 4d(a) or 4d(b) of the Act
and the regulations thereunder.
(c) Notwithstanding paragraph (a) of this section, an
acknowledgement letter need not be obtained from a derivatives clearing
organization that has made effective, pursuant to section 5c(c) of the
Act and the regulations thereunder, rules that provide for the
segregation of Cleared Swaps Customer Collateral, in accordance with
all relevant provisions of the Act and the regulations thereunder.
Sec. 22.6 Futures Commission Merchants and Derivatives Clearing
Organizations: Naming of Cleared Swaps Customer Accounts.
The name of each Cleared Swaps Customer Account that a futures
commission merchant or a derivatives clearing organization maintains
with a Permitted Depository shall:
(a) Clearly identify the account as a ``Cleared Swaps Customer
Account'' and
(b) Clearly indicate that the collateral therein is ``Cleared Swaps
Customer Collateral'' subject to segregation in accordance with the Act
and this part.
Sec. 22.7 Permitted Depositories: Treatment of Cleared Swaps Customer
Collateral.
A Permitted Depository shall treat all funds in a Cleared Swaps
Customer Account as Cleared Swaps Customer Collateral. A Permitted
Depository shall not hold, dispose of, or use any such Cleared Swaps
Customer Collateral as belonging to any person other than:
(a) The Cleared Swaps Customers of the futures commission merchant
maintaining such Cleared Swaps Customer Account or;
(b) The Cleared Swaps Customers of the futures commission merchants
for which the derivatives clearing organization maintains such Cleared
Swaps Customer Account.
Sec. 22.8 Situs of Cleared Swaps Customer Accounts.
The situs of each of the following shall be located in the United
States:
(a) Each FCM Physical Location or DCO Physical Location;
(b) Each ``account,'' within the meaning of Sec. 22.2(f)(1), that
a futures commission merchant maintains for each Cleared Swaps
Customer; and
(c) Each Cleared Swaps Customer Account on the books and records of
a derivatives clearing organization with respect to the Cleared Swaps
Customers of a futures commission merchant.
Sec. 22.9 Denomination of Cleared Swaps Customer Collateral and
Location of Depositories.
(a) Subject to paragraph (b) of this section, futures commission
merchants and derivatives clearing organizations may hold Cleared Swaps
Customer Collateral in the denominations, at the locations and
depositories, and subject to the same segregation requirements
specified in Sec. 1.49 of this chapter, which section shall apply to
such Cleared Swaps Customer Collateral as if it comprised customer
funds subject to segregation pursuant to section 4d(a) of the Act.
(b) Notwithstanding the requirements set forth in Sec. 1.49 of
this chapter, a futures commission merchant's obligations to a Cleared
Swaps Customer may be denominated in a currency in which funds have
accrued to the customer as a result of a Cleared Swap carried through
such futures commission merchant, to the extent of such accruals.
(c) Each depository referenced in paragraph (a) of this section
shall be considered a Permitted Depository for purposes of this part.
Provided, however, that a futures commission merchant shall only be
considered a Permitted Depository to the extent that it is acting as a
Collecting Futures Commission Merchant (as Sec. 22.1 of this part
defines such term).
Sec. 22.10 Application of other Regulatory Provisions.
Sections 1.27, 1.28, 1.29, and 1.30 of this chapter shall apply to
the Cleared Swaps Customer Collateral held by futures commission
merchants and derivatives clearing organizations to the same extent as
if such sections referred to:
(a) ``Cleared Swaps Customer Collateral'' in place of ``customer
funds;''
(b) ``Cleared Swaps Customers'' instead of ``commodity or option
customers'' or ``customers or option customers;''
[[Page 6376]]
(c) ``Cleared Swaps Contracts'' instead of ``trades, contracts, or
commodity options;'' and
(d) ``Section 4d(f) of the Act'' instead of ``section 4d(a)(2) of
the Act.''
Sec. 22.11 Information To Be Provided Regarding Customers and Their
Cleared Swaps.
(a) Each Depositing Futures Commission Merchant shall:
(1) The first time that the Depositing Futures Commission Merchant
intermediates a Cleared Swap for a Cleared Swaps Customer with a
Collecting Futures Commission Merchant, provide information sufficient
to identify such customer to the relevant Collecting Futures Commission
Merchant; and
(2) At least once each business day thereafter, provide information
to the relevant Collecting Futures Commission Merchant sufficient to
identify, for each Cleared Swaps Customer, the portfolio of rights and
obligations arising from the Cleared Swaps that the Depositing Futures
Commission Merchant intermediates for such customer.
(b) If an entity serves as both a Depositing Futures Commission
Merchant and a Collecting Futures Commission Merchant, then:
(1) The information that such entity must provide to its Collecting
Futures Commission Merchant pursuant to paragraph (a)(1) of this
section shall also include information sufficient to identify each
Cleared Swaps Customer of the Depositing Futures Commission Merchant
for which such entity serves as a Collecting Futures Commission
Merchant; and
(2) The information that such entity must provide to its Collecting
Futures Commission Merchant pursuant to paragraph (a)(2) of this
section shall also include information sufficient to identify, for each
Cleared Swaps Customer referenced in paragraph (b)(1) of this section,
the portfolio of rights and obligations arising from the Cleared Swaps
that such entity intermediates as a Collecting Futures Commission
Merchant, on behalf of its Depositing Futures Commission Merchant, for
such customer.
(c) Each futures commission merchant that intermediates a Cleared
Swap for a Cleared Swaps Customer, on or subject to the rules of a
derivatives clearing organization, directly as a Clearing Member shall:
(1) The first time that such futures commission merchant
intermediates a Cleared Swap for a Cleared Swaps Customer, provide
information to the relevant derivatives clearing organization
sufficient to identify such customer; and
(2) At least once each business day thereafter, provide information
to the relevant derivatives clearing organization sufficient to
identify, for each Cleared Swaps Customer, the portfolio of rights and
obligations arising from the Cleared Swaps that such futures commission
merchant intermediates for such customer.
(d) If the futures commission merchant referenced in paragraph (c)
of this section is a Collecting Futures Commission Merchant, then:
(1) The information that it must provide to the derivatives
clearing organization pursuant to paragraph (c)(1) of this section
shall also include information sufficient to identify each Cleared
Swaps Customer of any entity that acts as a Depositing Futures
Commission Merchant in relation to the Collecting Futures Commission
Merchant (including, without limitation, each Cleared Swaps Customer of
any Depositing Futures Commission Merchant for which such entity also
serves as a Collecting Futures Commission Merchant); and
(2) The information that it must provide to the derivatives
clearing organization pursuant to paragraph (c)(2) of this section
shall also include information sufficient to identify, for each Cleared
Swaps Customer referenced in paragraph (d)(1) of this section, the
portfolio of rights and obligations arising from the Cleared Swaps that
the Collecting Futures Commission Merchant intermediates, on behalf of
the Depositing Futures Commission Merchant, for such customer.
(e) Each derivatives clearing organization shall:
(1) Take appropriate steps to confirm that the information it
receives pursuant to paragraphs (c)(1) or (c)(2) of this section is
accurate and complete, and
(2) Ensure that the futures commission merchant is providing the
derivatives clearing organization the information required by
paragraphs (c)(1) or (c)(2) of this section on a timely basis.
Sec. 22.12 Information To Be Maintained Regarding Cleared Swaps
Customer Collateral.
(a) Each Collecting Futures Commission Merchant receiving Cleared
Swaps Customer Funds from an entity serving as a Depositing Futures
Commission Merchant shall, no less frequently than once each business
day, calculate and record:
(1) the amount of collateral required at such Collecting Futures
Commission Merchant for each Cleared Swaps Customer of the entity
acting as Depositing Futures Commission Merchant (including, without
limitation, each Cleared Swaps Customer of any Depositing Futures
Commission Merchant for which such entity also serves as a Collecting
Futures Commission Merchant); and
(2) the sum of the individual collateral amounts referenced in
paragraph (a)(1) of this section.
(b) Each Collecting Futures Commission Merchant shall calculate the
collateral amounts referenced in paragraph (a) of this section with
respect to the portfolio of rights and obligations arising from the
Cleared Swaps that the Collecting Futures Commission Merchant
intermediates, on behalf of the Depositing Futures Commission Merchant,
for each Cleared Swaps Customer referenced in paragraph (a)(1) of this
section.
(c) Each derivatives clearing organization receiving Cleared Swaps
Customer Funds from a futures commission merchant shall, no less
frequently than once each business day, calculate and record:
(1) the amount of collateral required at such derivatives clearing
organization for each Cleared Swaps Customer of the futures commission
merchant; and
(2) the sum of the individual collateral amounts referenced in
paragraph (c)(1) of this section.
(d) If the futures commission merchant referenced in paragraph (c)
of this section is a Collecting Futures Commission Merchant, then the
derivatives clearing organization shall also perform and record the
results of the calculation required in paragraph (c) of this section
for each Cleared Swaps Customer of an entity acting as a Depositing
Futures Commission Merchant in relation to the Collecting Futures
Commission Merchant (including, without limitation, any Cleared Swaps
Customer for which such entity is also acting as a Collecting Futures
Commission Merchant).
(e) Each futures commission merchant shall calculate the collateral
amounts referenced in paragraph (c) of this section with respect to the
portfolio of rights and obligations arising from the Cleared Swaps that
the futures commission merchant intermediates (including, without
limitation, as a Collecting Futures Commission Merchant on behalf of a
Depositing Futures Commission Merchant), for each Cleared Swaps
Customer referenced in paragraphs (c)(1) and (d) of this section.
(f) The collateral requirement referenced in paragraph (a) of this
[[Page 6377]]
section with respect to a Collecting Futures Commission Merchant shall
be no less than that imposed by the relevant derivatives clearing
organization with respect to the same portfolio of rights and
obligations for each relevant Cleared Swaps Customer.
Sec. 22.13 Additions to Cleared Swaps Customer Collateral.
(a)(1) At the election of the derivatives clearing organization or
Collecting Futures Commission Merchant, the collateral requirement
referred to in Sec. Sec. 22.12(a), (c), and (d) of this part
applicable to a particular Cleared Swaps Customer or group of Cleared
Swaps Customers may be increased based on an evaluation of the credit
risk posed by such customer or group, in which case the derivatives
clearing organization or Collecting Futures Commission Merchant shall
collect and record such higher amount as provided in Sec. 22.12 of
this part.
(2) Nothing in paragraph (a)(1) of this section is intended to
interfere with the right of a futures commission merchant to increase
the collateral requirements at such futures commission merchant with
respect to any of its Cleared Swaps Customers or Customers.
(b) Any collateral deposited by a futures commission merchant
(including a Depositing Futures Commission Merchant) pursuant to Sec.
22.2(e)(3)(ii) of this part, which collateral is identified as such
futures commission merchant's own property may be used by the
derivatives clearing organization or Collecting Futures Commission
Merchant, as applicable, to margin, guarantee or secure the Cleared
Swaps of any or all of such Cleared Swaps Customers.
(c) A futures commission merchant may transmit to a derivatives
clearing organization any collateral posted by a Cleared Swaps Customer
in excess of the amount required by the derivatives clearing
organization if:
(1) the rules of the derivatives clearing organization expressly
permit the futures commission merchant to transmit collateral in excess
of the amount required by the derivatives clearing organization; and
(2) the derivatives clearing organization provides a mechanism by
which the futures commission merchant is able to, and maintains rules
pursuant to which the futures commission merchant is required to,
identify each Business Day, for each Cleared Swaps Customer, the amount
of collateral posted in excess of the amount required by the
derivatives clearing organization.
Sec. 22.14 Futures Commission Merchant Failure To Meet a Customer
Margin Call in Full.
(a) A Depositing Futures Commission Merchant which receives a call
for either initial margin or variation margin with respect to a Cleared
Swaps Customer Account from a Collecting Futures Commission Merchant,
which call such Depositing Futures Commission Merchant does not meet in
full, shall, with respect to each Cleared Swaps Customer of such
Depositing Futures Commission Merchant whose Cleared Swaps contribute
to such margin call,
(1) Transmit to the Collecting Futures Commission Merchant an
amount equal to the lesser of
(i) The amount called for; or
(ii) The remaining Cleared Swaps Collateral on deposit at such
Depositing Futures Commission Merchant for that Cleared Swaps Customer;
and
(2) Advise the Collecting Futures Commission Merchant of the
identity of each such Cleared Swaps Customer, and the amount
transmitted on behalf of each such customer.
(b) If the entity acting as Depositing Futures Commission Merchant
referenced in paragraph (a) of this section is also a Collecting
Futures Commission Merchant, then:
(1) Such entity shall include in the transmission required in
paragraph (a)(1) of this section any amount that it receives, pursuant
to paragraph (a)(1) of this section, from a Depositing Futures
Commission Merchant for which such entity acts as a Collecting Futures
Commission Merchant; and
(2) Such entity shall present its Collecting Futures Commission
Merchant with the information that it receives, pursuant to paragraph
(a)(2) of this section, from a Depositing Futures Commission Merchant
for which such entity acts as a Collecting Futures Commission Merchant.
(c) A futures commission merchant which receives a call for either
initial or variation margin with respect to a Cleared Swaps Customer
Account from a derivatives clearing organization, which call such
futures commission merchant does not meet in full, shall, with respect
to each Cleared Swaps Customer of such futures commission merchant
whose Cleared Swaps contribute to such margin call:
(1) Transmit to the derivatives clearing organization an amount
equal to the lesser of
(i) The amount called for; or
(ii) The remaining Cleared Swaps Collateral on deposit at such
futures commission merchant for each such Cleared Swaps Customer; and
(2) Advise the derivatives clearing organization of the identity of
each such Cleared Swaps Customer, and the amount transmitted on behalf
of each such customer.
(d) If the futures commission merchant referenced in paragraph (c)
is a Collecting Futures Commission Merchant, then:
(1) Such Collecting Futures Commission Merchant shall include in
the transmission required in paragraph (c)(1) of this section any
amount that it receives from a Depositing Futures Commission Merchant
pursuant to paragraph (a)(1) of this section; and
(2) Such Collecting Futures Commission shall present the
derivatives clearing organization with the information that it receives
from a Depositing Futures Commission Merchant pursuant to paragraph
(a)(2) of this section.
(e) If,
(1) On the business day prior to the business day on which the
Depositing Futures Commission Merchant fails to meet a margin call with
respect to a Cleared Swaps Customer Account, such Collecting Futures
Commission Merchant referenced in paragraph (a) of this section held,
with respect to such account, Cleared Swaps Collateral of a value no
less than the amount specified in Sec. 22.12(a)(2) of this part, after
the application of haircuts specified by policies applied by such
Collecting Futures Commission Merchant in its relationship with the
Depositing Futures Commission Merchant, and
(2) As of the close of business on the business day on which the
margin call is not met, the market value of the Cleared Swaps
Collateral held by the derivatives clearing organization or Collecting
Futures Commission Merchant is, due to changes in such market value,
less than the amount specified in Sec. 22.12(a)(2) of this part, then
the amount of such collateral attributable to each Cleared Swaps
Customer pursuant to Sec. 22.12(a)(1) of this part shall be reduced by
the percentage difference between the amount specified in Sec.
22.12(a)(2) of this part and such market value.
(f) If:
(1) On the business day prior to the business day on which the
futures commission merchant fails to meet a margin call with respect to
a Cleared Swaps Customer Account, the derivatives clearing organization
referenced in paragraph (c) of this section held, with respect to such
account, Cleared Swaps Collateral of a value no less than the amount
specified in Sec. 22.12(c)(2) of this part, after the application of
haircuts specified by the
[[Page 6378]]
rules and procedures of such derivatives clearing organization, and
(2) As of the close of business on the business day on which the
margin call is not met, the market value of the Cleared Swaps
Collateral held by the derivatives clearing organization is, due to
changes in such market value, less than the amount specified in Sec.
22.12(c)(2) of this part, then the amount of collateral attributable to
each Cleared Swaps Customer pursuant to Sec. 22.12(c)(1) of this part
shall be reduced by the percentage difference between the amount
specified in Sec. 22.12(c)(2) and such market value.
(g) A derivatives clearing organization or Collecting Futures
Commission Merchant is entitled to reasonably rely upon any information
provided by a defaulting futures commission merchant under Sec. 22.14.
If the defaulting futures commission merchant does not provide such
information on the date of the futures commission merchant's default, a
derivatives clearing organization or Collecting Futures Commission
Merchant may rely on the information previously provided to it by the
defaulting futures commission merchant.
Sec. 22.15 Treatment of Cleared Swaps Customer Collateral on an
Individual Basis.
Subject to Sec. 22.3(d) of this part, each derivatives clearing
organization and each Collecting Futures Commission Merchant receiving
Cleared Swaps Customer Collateral from a futures commission merchant
shall treat the value of collateral required with respect to the
portfolio of rights and obligations arising out of the Cleared Swaps
intermediated for each Cleared Swaps Customer, and collected from the
futures commission merchant, as belonging to such customer, and such
amount shall not be used to margin, guarantee, or secure the Cleared
Swaps or other obligations of the futures commission merchant or of any
other Cleared Swaps Customer or Customer. Nothing contained herein
shall be construed to limit, in any way, the right of a derivatives
clearing organization or Collecting Futures Commission Merchant to
liquidate any or all positions in a Cleared Swaps Customer Account in
the event of default of a clearing member or Depositing Futures
Commission Merchant.
Sec. 22.16 Disclosures to Customers.
(a) A futures commission merchant shall disclose, to each of its
Cleared Swaps Customers, the governing provisions, as described in
paragraph (c) of this section, relating to use of Cleared Swaps
Customer Collateral, transfer, neutralization of the risks, or
liquidation of Cleared Swaps in the event of a default by the futures
commission merchant relating to the Cleared Swaps Customer Account, as
well as any change in such governing provisions.
(b) If the futures commission merchant referenced in paragraph (a)
of this section is a Depositing Futures Commission Merchant, then such
futures commission merchant shall disclose, to each of its Cleared
Swaps Customers, the governing provisions, as described in paragraph
(c) of this section, relating to use of Cleared Swaps Customer
Collateral, transfer, neutralization of the risks, or liquidation of
Cleared Swaps in the event of a default by:
(1) Such futures commission merchant or
(2) Any relevant Collecting Futures Commission Merchant relating to
the Cleared Swaps Customer Account, as well as any change in such
governing provisions.
(c) The governing provisions referred to in paragraphs (a) and (b)
of this section are the rules of each derivatives clearing
organization, or the provisions of the customer agreement between the
Collecting Futures Commission Merchant and the Depositing Futures
Commission Merchant, on or through which the Depositing Futures
Commission Merchant will intermediate Cleared Swaps for such Cleared
Swaps Customer.
PART 190--BANKRUPTCY
0
2. The authority citation for part 190 continues to read as follows:
Authority: 7 U.S.C. 1a, 2, 4a, 6c, 6d, 6g, 7a, 12, 19, and 24,
and 11 U.S.C. 362, 546, 548, 556, and 761-766, unless otherwise
noted.
Sec. Sec. 190.01, 190.02, 190.03, 190.05, 190.06, 190.07,
190.10 [Amended]
0
3. In 17 CFR part 190:
0
a. Remove the words ``commodity account'' and add, in their place, the
words ``commodity contract account'' in:
0
i. Sections 190.01(w), (y), and (kk)(6);
0
ii. Sections 190.02(d)(1), (6), and (7);
0
iii. Section 190.06(g)(3); and
0
iv. Section 190.10(d)(1).
0
b. Remove the words ``commodity futures account'' and add, in their
place, the words ``commodity contract account'' in:
0
i. Section 190.03(a)(2); and
0
ii. Section 190.10(h).
0
c. Remove the words ``commodity transactions'' and add, in their place,
the words ``commodity contract transactions'' in Sec. 190.02(d)(3).
0
d. Remove the words ``commodity futures contract'' and add, in their
place, the words ``commodity contract'' in Sec. 190.05(a)(1) and
(b)(1).
0
e. Remove the words ``commodity accounts'' and add, in their place, the
words ``commodity contract accounts'' in Sec. 190.06(g)(1)(i) and
(ii).
0
f. Remove the words ``board of trade'' and add, in their place, the
words ``designated contract market'' in Sec. 190.07(e)(1).
0
g. Remove the words ``contract market'' and add, in their place, the
words ``designated contract market'' in Sec. 190.07(e)(2)(ii)(B).
0
4. In Sec. 190.01,
0
a. Redesignate paragraphs (e) through (oo) as (f) through (pp);
0
b. Add a new paragraph (e); and
0
c. Revise paragraphs (a), and newly redesignated paragraphs (f), (cc),
(hh), (ll)(2)(ii), (ll)(4), (ll)(5), and (pp) to read as follows:
Sec. 190.01 Definitions.
* * * * *
(a)(1) Account class means each of the following types of customer
accounts which must be recognized as a separate class of account by the
trustee: futures accounts, foreign futures accounts, leverage accounts,
delivery accounts as defined in Sec. 190.05(a)(2) of this part, and
cleared swaps accounts.
(2)(i) To the extent that the equity balance, as defined in Sec.
190.07 of this part, of a customer in a commodity option, as defined in
Sec. 1.3 of this chapter, may be commingled with the equity balance of
such customer in any domestic commodity futures contract pursuant to
regulations under the Act, the aggregate shall be treated for purposes
of this part as being held in a futures account.
(ii) To the extent that such equity balance of a customer in a
commodity option may be commingled with the equity balance of such
customer in any cleared swaps account pursuant to regulations under
this act, the aggregate shall be treated for purposes of this part as
being held in a cleared swaps account.
(iii) If positions or transactions in commodity contracts that
would otherwise belong to one account class (and the money, securities,
or other property margining, guaranteeing, or securing such positions
or transactions), are, pursuant to a Commission rule, regulation, or
order (or a derivatives clearing organization rule approved in
accordance with Sec. 39.15(b)(2) of this chapter), held separately
from other positions and transactions in that account class, and are
commingled with positions or transactions in commodity
[[Page 6379]]
contracts of another account class (and the money, securities, or other
property margining, guaranteeing, or securing such positions or
transactions), then the former positions (and the relevant money,
securities, or other property) shall be treated, for purposes of this
part, as being held in an account of the latter account class.
* * * * *
(e) Calendar day. A calendar day includes the time from midnight to
midnight.
(f) Clearing organization shall have the same meaning as that set
forth in section 761(2) of the Bankruptcy Code.
* * * * *
(cc) Non-public customer means any person enumerated in the
definition of Proprietary Account in Sec. 1.3 or Sec. 31.4(e) of this
chapter, any person excluded from the definition of ``foreign futures
or foreign options customer'' in the proviso to section 30.1(c) of this
chapter, or any person enumerated in the definition of Cleared Swaps
Proprietary Account in Sec. 22.1 of this chapter, in each case, if
such person is defined as a ``customer'' under paragraph (k) of this
section.
* * * * *
(hh) Principal contract means a contract which is not traded on a
designated contract market, and includes leverage contracts and dealer
options, but does not include:
(1) Transactions executed off the floor of a designated contract
market pursuant to rules approved by the Commission or rules which the
designated contract market is required to enforce, or pursuant to rules
of a foreign board of trade located outside the United States, its
territories or possessions; or
(2) Cleared swaps contracts.
* * * * *
(ll) * * *
(2) * * *
(ii) Is a bona fide hedging position or transaction as defined in
Sec. 1.3 of this chapter or is a commodity option transaction which
has been determined by the registered entity to be economically
appropriate to the reduction of risks in the conduct and management of
a commercial enterprise pursuant to rules which have been approved by
the Commission pursuant to section 5c(c) of the Commodity Exchange Act;
and
* * * * *
(4) Any cash or other property deposited prior to the entry of the
order for relief to pay for the taking of physical delivery on a long
commodity contract or for payment of the strike price upon exercise of
a short put or a long call option contract on a physical commodity,
which cannot be settled in cash, in excess of the amount necessary to
margin such commodity contract prior to the notice date or exercise
date, which cash or other property is identified on the books and
records of the debtor as received from or for the account of a
particular customer on or after three calendar days before the first
notice date or three calendar days before the exercise date
specifically for the purpose of payment of the notice price upon taking
delivery or the strike price upon exercise, respectively, and such
customer takes delivery or exercises the option in accordance with the
applicable designated contract market rules.
(5) The cash price tendered for any property deposited prior to the
entry of the order for relief to make physical delivery on a short
commodity contract or for exercise of a long put or a short call option
contract on a physical commodity, which cannot be settled in cash, to
the extent it exceeds the amount necessary to margin such contract
prior to the notice date or exercise date, which property is identified
on the books and records of the debtor as received from or for the
account of a particular customer on or after three calendar days before
the first notice date or three calendar days before the exercise date
specifically for the purpose of a delivery or exercise, respectively,
and such customer makes delivery or exercises the option in accordance
with the applicable contract market rules.
* * * * *
(pp) Cleared Swap. This term shall have the same meaning as set
forth in Sec. 22.1 of this chapter.
0
5. In Sec. 190.02, revise paragraphs (a), (b)(1), (b)(2), (d)(11),
(e), (f)(1)(i), (f)(1(ii) and (g)(2)(i) to read as follows:
Sec. 190.02 Operation of the debtor's estate subsequent to the filing
date and prior to the primary liquidation date.
* * * * *
(a) Notices to the Commission and Designated Self-Regulatory
Organizations.
(1) General. Each commodity broker which files a petition in
bankruptcy shall, at or before the time of such filing, and each
commodity broker against which such a petition is filed shall, as soon
as possible, but no later than one calendar day after the receipt of
notice of such filing, notify the Commission and such broker's
designated self-regulatory organization, if any, in accordance with
Sec. 190.10(a) of the filing date, the court in which the proceeding
has been filed, and the docket number assigned to that proceeding by
the court.
(2) Of transfers under section 764(b) of the Bankruptcy Code. As
soon as possible, but in no event later than the close of business on
third calendar day after the order for relief, the trustee, the
applicable self-regulatory organization, or the commodity broker must
notify the Commission in accordance with Sec. 190.10(a) whether such
entity or organization intends to transfer or to apply to transfer open
commodity contracts on behalf of the commodity broker in accordance
with section 764(b) of the Bankruptcy Code and Sec. 190.06 (e) or (f).
(b) Notices to customers. (1) Specifically identifiable property
other than commodity contracts. The trustee must use its best efforts
to promptly, but in no event later than two calendar days after entry
of the order for relief, commence to publish in a daily newspaper or
newspapers of general circulation approved by the court serving the
location of each branch office of the commodity broker, for two
consecutive days a notice to customers stating that all specifically
identifiable property of customers other than open commodity contracts
which has not otherwise been liquidated will be liquidated commencing
on the sixth calendar day after the second publication date if the
customer has not instructed the trustee in writing on or before the
fifth calendar day after the second publication date to return such
property pursuant to the terms for distribution of specifically
identifiable property contained in Sec. 190.08(d)(1) and, on the
seventh calendar day after such second publication date, if such
property has not been returned in accordance with such terms on or
prior to that date. Such notice must describe specifically identifiable
property in accordance with the definition in this part and must
specify the terms upon which that property may be returned. Publication
of the form of notice set forth in the appendix to this part will
constitute sufficient notice for purposes of this paragraph (b)(1).
(2) Request for instructions regarding transfer of open commodity
contracts. The trustee must use its best efforts to request promptly,
but in no event later than two calendar days after entry of an order
for relief, customer instructions concerning the transfer or
liquidation of the specifically identifiable open commodity contracts,
if any, not required to be liquidated under paragraph (f)(1) of this
section. The request for customer instructions required by this
paragraph (b)(2) must state that the trustee is required to liquidate
any such commodity contract for which transfer instructions have not
[[Page 6380]]
been received on or before the seventh calendar day after entry of the
order for relief, at an hour specified by the trustee, and any such
commodity contract for which instructions have been received which has
not been transferred in accordance with Sec. 190.08(d)(2) on or before
the seventh calendar day after entry of the order for relief. A form of
notice is set forth in the appendix to this part.
* * * * *
(d) * * *
(11) Whether the claimant's positions in security futures products
are held in a futures account or a securities account, as these terms
are defined in Sec. 1.3 of this chapter;
* * * * *
(e) Transfers--(1) All cases. The trustee for a commodity broker
must immediately use its best efforts to effect a transfer in
accordance with Sec. 190.06 (e) and (f) no later than the seventh
calendar day after the order for relief of the open commodity contracts
and equity held by the commodity broker for or on behalf of its
customers.
(2) Involuntary cases. A commodity broker against which an
involuntary petition in bankruptcy is filed, or the trustee if a
trustee has been appointed in such case, must use its best efforts to
effect a transfer in accordance with Sec. 190.06 (e) and (f) of all
open commodity contracts and equity held by the commodity broker for or
on behalf of its customers and such other property as the Commission in
its discretion may authorize, on or before the seventh calendar day
after the filing date, and immediately cease doing business: Provided,
however, That the commodity broker may trade for liquidation only,
unless otherwise directed by the Commission, by any applicable self-
regulatory organization or by the court: And, Provided further, That if
the commodity broker demonstrates to the Commission within such period
that it was in compliance with the segregation and financial
requirements of this chapter on the filing date, and the Commission
determines, in its sole discretion, that such transfer or liquidation
is neither appropriate nor in the public interest, the commodity broker
may continue in business subject to applicable provisions of the
Bankruptcy Code and of this chapter.
(f) * * *
(1) * * *
(i) Dealer option contracts, if the dealer option grantor is not
the debtor, which cannot be transferred on or before the seventh
calendar day after the order for relief; and
(ii) Specifically identifiable commodity contracts as defined in
Sec. 190.01(kk)(2) for which an instruction prohibiting liquidation is
noted prominently in the accounting records of the debtor and timely
received under paragraph (b)(2) of this section. Notwithstanding the
foregoing, an open commodity contract must be offset if: such contract
is a futures contract or a Cleared Swaps contract which cannot be
settled in cash and which would otherwise remain open either beyond the
last day of trading (if applicable), or the first day on which notice
of intent to deliver may be tendered with respect thereto, whichever
occurs first; such contract is a long option on a physical commodity
which cannot be settled in cash and would be automatically exercised,
has value and would remain open beyond the last day for exercise; such
contract is a short option on a physical commodity which cannot be
settled in cash; or, as otherwise specified in these rules.
* * * * *
(g) * * *
(2) * * *
(i) 100% of the maintenance margin requirements of the applicable
designated contact market or swap execution facility, if any, with
respect to the open commodity contracts in such account; or
* * * * *
0
6. In Sec. 190.03, revise paragraphs (a)(3), (b)(3), (b)(4), (b)(5),
and (c) to read as follows:
Sec. 190.03 Operation of the debtor's estate subsequent to the
primary liquidation date.
* * * * *
(a) * * *
(3) Margin calls. The trustee must promptly issue margin calls with
respect to any account referred to under paragraph (a)(1) of this
section in which the balance does not equal or exceed 100% of the
maintenance margin requirements of the applicable designated contact
market or swap execution facility, if any, with respect to the open
commodity contracts in such account, or if there are no such
maintenance margin requirements, 100% of the clearing organization's
initial margin requirements applicable to the open commodity contracts
in such account, or if there are no such maintenance margin
requirements or clearing organization initial margin requirements, then
50% of the customer initial margin applicable to the commodity
contracts in such account: Provided, That no margin calls need be made
to restore customer initial margin.
* * * * *
(b) * * *
(3) The trustee has received no customer instructions with respect
to such contract by the sixth calendar day after entry of the order for
relief;
(4) The commodity contract has not been transferred in accordance
with Sec. 190.08(d)(2) on or before the seventh calendar day after
entry of the order for relief; or
(5) The commodity contract would otherwise remain open (e.g.,
because it cannot be settled in cash) beyond the last day of trading in
such contract (if applicable) or the first day on which notice of
delivery may be tendered with respect to such contract, whichever
occurs first.
(c) Liquidation of specifically identifiable property other than
open commodity contracts. All specifically identifiable property other
than open commodity contracts which have not been liquidated prior to
the primary liquidation date, and for which no customer instructions
have been timely received must be liquidated, to the extent reasonably
possible, no later than the sixth calendar day after final publication
of the notice referred to in Sec. 190.02(b)(1). All other specifically
identifiable property must be liquidated or returned, to the extent
reasonably possible, no later than the seventh calendar day after final
publication of such notice.
0
7. In Sec. 190.04, revise paragraph (d)(1) to read as follows:
Sec. 190.04 Operation of the debtor's estate--general.
* * * * *
(d) Liquidation -- (1) Order of Liquidation. (i) In the Market.
Liquidation of open commodity contracts held for a house account or
customer account by or on behalf of a commodity broker which is a
debtor shall be accomplished pursuant to the rules of a clearing
organization, a designated contract market, or a swap execution
facility, as applicable. Such rules shall ensure that the process for
liquidating open commodity contracts, whether for the house account or
the customer account, results in competitive pricing, to the extent
feasible under market conditions at the time of liquidation. Such rules
must be submitted to the Commission for approval, pursuant to section
5c(c) of the Act, and be approved by the Commission. Alternatively,
such rules must otherwise be submitted to and approved by the
Commission (or its delegate pursuant to Sec. 190.10(d) of this part)
prior to their application.
(ii) Book entry. Notwithstanding paragraph (d)(1) of this section,
in appropriate cases, upon application by
[[Page 6381]]
the trustee or the affected clearing organization, the Commission may
permit open commodity contracts to be liquidated, or settlement on such
contracts to be made, by book entry. Such book entry shall offset open
commodity contracts, whether matched or not matched on the books of the
commodity broker, using the settlement price for such commodity
contracts as determined by the clearing organization. Such settlement
price shall be determined by the rules of the clearing organization,
which shall ensure that such settlement price is established in a
competitive manner, to the extent feasible under market conditions at
the time of liquidation. Such rules must be submitted to the Commission
for approval pursuant to section 5c(c) of the Act, and be approved by
the Commission. Alternatively, such rules must otherwise be approved by
the Commission (or its delegate pursuant to Sec. 190.10(d) of this
part) prior to their application.
* * * * *
0
8. In Sec. 190.05, revise paragraph (b) introductory text to read as
follows:
Sec. 190.05 Making and taking delivery on commodity contracts.
* * * * *
(b) Rules for deliveries on behalf of a customer of a debtor.
Except in the case of a commodity contract which is settled in cash,
each designated contract market, swap execution facility, or clearing
organization shall adopt, maintain in effect and enforce rules which
have been submitted in accordance with section 5c(c) of the Act for
approval by the Commission, which:
* * * * *
0
9. In Sec. 190.06,
0
a. Remove paragraph (e)(1)(iv) and redesignate paragraph (e)(1)(v) as
(e)(1)(iv);
0
b. Revise paragraphs (a), (e)(1)(iii), (e)(2), (f)(3)(i), (g)(2) and
0
c. Add paragraph (g)(1)(iii) to read as follows:
Sec. 190.06 Transfers.
(a) Transfer rules. No clearing organization or other self-
regulatory organization may adopt, maintain in effect or enforce rules
which:
(1) Are inconsistent with the provisions of this part;
(2) Interfere with the acceptance by its members of open commodity
contracts and the equity margining or securing such contracts from
futures commission merchants, or persons which are required to be
registered as futures com-mission merchants, which are required to
transfer accounts pursuant to Sec. 1.17(a)(4) of this chapter; or
(3) Prevent the acceptance by its members of transfers of open
commodity contracts and the equity margining or securing such contracts
from futures commission merchants with respect to which a petition in
bankruptcy has been filed, if such transfers have been approved by the
Commission. Provided, however, that this paragraph shall not limit the
exercise of any contractual right of a clearing organization or other
registered entity to liquidate open commodity contracts.
* * * * *
(e) * * *
(1) * * *
(iii) Dealer option accounts, if the debtor is the dealer option
grantor with respect to such accounts; or
* * * * *
(2) Amount of equity which may be transferred. In no case may
money, securities or property be transferred in respect of any eligible
account if the value of such money, securities or property would exceed
the funded balance of such account based on available information as of
the calendar day immediately preceding transfer less the value on the
date of return or transfer of any property previously returned or
transferred with respect thereto.
(f) * * *
(3) * * *
(i) Of the customer estate. If all eligible customer accounts held
by a debtor cannot be transferred under this section, a partial
transfer may nonetheless be made. The Commission will not disapprove
such a transfer for the sole reason that it was a partial transfer if
it would prefer the transfer of accounts, the liquidation of which
could adversely affect the market or the bankrupt estate. Any dealer
option contract held by or for the account of a debtor which is a
futures commission merchant from or for the account of a customer which
has not previously been transferred, and is eligible for transfer, must
be transferred on or before the seventh calendar day after entry of the
order for relief.
* * * * *
(g) * * *
(1) * * *
(iii) The transfer prior to the order for relief by a clearing
organization of one or more accounts held for or on behalf of customers
of the debtor, provided that (I) the money, securities, or other
property accompanying such transfer did not exceed the funded balance
of each account based on available information as of the close of
business on the business day immediately preceding such transfer less
the value on the date of return or transfer of any property previously
returned or transferred thereto, and (II) the transfer is not
disapproved by the Commission.
(2) Post-relief transfers. On or after the entry of the order for
relief, the following transfers to one or more transferees may not be
avoided by the trustee:
(i) The transfer of a customer account eligible to be transferred
under paragraph (e) or (f) of this section made by the trustee of the
commodity broker or by any self-regulatory organization of the
commodity broker:
(A) On or before the seventh calendar day after the entry of the
order for relief; and
(B) The Commission is notified in accordance with Sec.
190.02(a)(2) prior to the transfer and does not disapprove the
transfer; or
(ii) The transfer of a customer account at the direction of the
Commission on or before the seventh calendar day after the order for
relief upon such terms and conditions as the Commission may deem
appropriate and in the public interest.
* * * * *
0
10. In Sec. 190.07,
0
a. Redesignate paragraph (b)(2)(xiii) as paragraph (b)(2)(xiv);
0
b. Add a new paragraph (b)(2)(xiii); and
0
c. Revise paragraphs (b)(2)(viii), (b)(2)(ix), (b)(3)(v), (c)(1)(i),
(e) introductory text, (e)(1) and (e)(4) to read as follows:
Sec. 190.07 Calculation of allowed net equity.
* * * * *
(b) * * *
(2) * * *
(viii) Subject to paragraph (b)(2)(ix) of this section, the futures
accounts, leverage accounts, options accounts, foreign futures
accounts, delivery accounts (as defined in Sec. 190.05(a)(2)), and
cleared swaps accounts of the same person shall not be deemed to be
held in separate capacities: Provided, however, that such accounts may
be aggregated only in accordance with paragraph (b)(3) of this section.
(ix) An omnibus customer account of a futures commission merchant
maintained with a debtor shall be deemed to be held in a separate
capacity from the house account and any other omnibus customer account
of such futures commission merchant.
* * * * *
(xiii) With respect to the cleared swaps account class, each
individual customer account within each omnibus customer account
referred to in
[[Page 6382]]
paragraph (ix) of this section shall be deemed to be held in a separate
capacity from each other such individual customer account; subject to
the provisions of paragraphs (b)(2)(i) through (xii) of this paragraph
(b)(2).
* * * * *
(3) * * *
(v) The rules pertaining to separate capacities and permitted
setoffs contained in this section must be applied subsequent to the
entry of an order for relief; prior to the filing date, the provisions
of Sec. 1.22 of this chapter and of sections 4d(a)(2) and 4d(f) of the
Act (and, in each case, the regulations promulgated thereunder) shall
govern what setoffs are permitted.
* * * * *
(c) * * *
(1) * * *
(i) Multiplying the ratio of the amount of the net equity claim
less the amounts referred to in paragraph (c)(1)(ii) of this section of
such customer for any account class bears to the sum of the net equity
claims less the amounts referred to in paragraph (c)(1)(ii) of this
section of all customers for accounts of that class by the sum of:
(A) The value of the money, securities or property segregated on
behalf of all accounts of the same class less the amounts referred to
in paragraph (c)(1)(ii) of this section;
(B) The value of any money, securities or property which must be
allocated under Sec. 190.08 to customer accounts of the same class;
and
(C) The amount of any add-back required under paragraph (b)(4) of
this section; and
* * * * *
(e) Valuation. In computing net equity, commodity contracts and
other property held by or for a commodity broker must be valued as
provided in this paragraph (e): Provided, however, that for all
commodity contracts other than those listed in paragraph (e)(1) of this
section, if identical commodity contracts, securities, or other
property are liquidated on the same date, but cannot be liquidated at
the same price, the trustee may use the weighted average of the
liquidation prices in computing the net equity of each customer holding
such contracts, securities, or property.
(1) Commodity Contracts. Unless otherwise specified in this
paragraph (e), the value of an open commodity contract shall be equal
to the settlement price as calculated by the clearing organization
pursuant to its rules: Provided, that such rules must either be
submitted to the Commission, pursuant to section 5c(c)(4) of the Act
and be approved by the Commission, or such rules must be otherwise
approved by the Commission (or its delegate pursuant to Sec. 190.10(d)
of this part) prior to their application; Provided, further, that if
such contract is transferred its value shall be determined as of the
end of the settlement cycle in which it is transferred; and Provided,
finally, that if such contract is liquidated, its value shall be equal
to the net proceeds of liquidation.
* * * * *
(4) Securities. The value of a listed security shall be equal to
the closing price for such security on the exchange upon which it is
traded. The value of all securities not traded on an exchange shall be
equal in the case of a long position, to the average of the bid prices
for long positions, and in the case of a short position, to the average
of the asking prices for the short positions. If liquidated prior to
the primary liquidation date, the value of such security shall be equal
to the net proceeds of its liquidation. Securities which are not
publicly traded shall be valued by the trustee, subject to approval of
the court, using such professional assistance as the trustee deems
necessary in its sole discretion under the circumstances.
* * * * *
0
11. In Sec. 190.09, revise paragraph (b) to read as follows:
Sec. 190.09 Member property.
* * * * *
(b) Scope of Member Property. Member property shall include all
money, securities and property received, acquired, or held by a
clearing organization to margin, guarantee or secure, on behalf of a
clearing member, the proprietary account, as defined in Sec. 1.3 of
this chapter, any account not belonging to a foreign futures or foreign
options customer pursuant to the proviso in Sec. 30.1(c), and any
Cleared Swaps Proprietary Account, as defined in Sec. 22.1: Provided,
however, that any guaranty deposit or similar payment or deposit made
by such member and any capital stock, or membership of such member in
the clearing organization shall also be included in member property
after payment in full of that portion of the net equity claim of the
member based on its customer account and of any obligations due to the
clearing organization which may be paid therefrom in accordance with
the by-laws or rules of the clearing organization, including
obligations due from the clearing organization to customers or other
members.
0
12. In Sec. 190.10, revise paragraph (a) to read as follows:
Sec. 190.10 General.
(a) Notices. Unless instructed otherwise by the Commission, all
mandatory or discretionary notices to be given to the Commission under
this part shall be directed by electronic mail to
[email protected], with a copy sent by overnight mail to
Director, Division of Clearing and Risk, Commodity Futures Trading
Commission, Three Lafayette Centre, 1155 21st Street NW., Washington,
DC 20581. For purposes of this part, notice to the Commission shall be
deemed to be given only upon actual receipt.
* * * * *
0
13. Revise appendix A to part 190 to read as follows:
Appendix A to Part 190--Bankruptcy Forms
Bankruptcy Appendix Form 1--Operation of the Debtor's Estate--Schedule
of Trustee's Duties
For the convenience of a prospective trustee, the Commission has
constructed an approximate schedule of important duties which the
trustee should perform during the early stages of a commodity broker
bankruptcy proceeding. The schedule includes duties required by this
part, subchapter IV of chapter 7 of the Bankruptcy Code as well as
certain practical suggestions, but it is only intended to highlight
the more significant duties and is not an exhaustive description of
all the trustee's responsibilities. It also assumes that the
commodity broker being liquidated is an FCM. Moreover, it is
important to note that the operating facts in a particular
bankruptcy proceeding may vary the schedule or obviate the need for
any of the particular activities.
All Cases
Date of Order for Relief
1. Assure that the commodity broker has notified the Commission,
its designated self-regulatory organization (``DSRO'') (if any), and
all applicable clearing organizations of which it is a member that a
petition or order for relief has been filed (Sec. 190.02(a)(1)).
2. Attempt to effectuate the transfer of entire customer
accounts wherein the commodity contracts are transferred together
with the money, securities, or other property margining,
guaranteeing, or securing the commodity contracts (hereinafter the
``transfer'').
3. Attempt to estimate shortfall of customer funds segregated
pursuant to sections 4d(a) and (b) of the Act; customer funds
segregated pursuant to section 4f of the Act; and the foreign
futures or foreign options secured amount, as defined in Sec. 1.3
of this chapter.
a. The trustee should:
i. Contact the DSRO (if any) and the clearing organizations and
attempt to effectuate a transfer with such shortfall under section
764(b) of the Code; notify the Commission for assistance (Sec.
190.02(a)(2) and
[[Page 6383]]
(e)(1), Sec. 190.06(b)(2), (e), (f)(3), (g)(2), and (h)) but
recognize that if there is a substantial shortfall, a transfer of
such funds or amounts is highly unlikely.
ii. If a transfer cannot be effectuated, liquidate all customer
commodity contracts that are margined, guaranteed, or secured by
funds or amounts with such shortfall, except dealer options and
specifically identifiable commodity contracts which are bona fide
hedging positions (as defined in Sec. 190.01(kk)(2)) with
instructions not to be liquidated. (See Sec. Sec. 190.02(f) and
190.06(d)(1)). (In this connection, depending upon the size of the
debtor and other complications of liquidation, the trustee should be
aware of special liquidation rules, and in particular the
availability under certain circumstances of book-entry liquidation
(Sec. 190.04(d)(1)(ii)).
b. If there is a small shortfall in any of the funds or amounts
listed in paragraph 2, negotiate with the clearing organization to
effect a transfer; notify the Commission (Sec. Sec. 190.02(a)(2)
and (e)(1), 190.06(b)(2), (e), (f)(3), (g)(2), and (h)).
4. Whether or not a transfer has occurred, liquidate or offset
open commodity contracts not eligible for transfer (e.g., deficit
accounts) (Sec. 190.06(e)(1)).
5. Offset all futures contracts and Cleared Swaps contracts
which cannot be settled in cash and which would otherwise remain
open either beyond the last day of trading (if applicable) or the
first day on which notice of intent to deliver may be tendered with
respect thereto, whichever occurs first; offset all long options on
a physical commodity which cannot be settled in cash, have value and
would be automatically exercised or would remain open beyond the
last day of exercise; and offset all short options on a physical
commodity which cannot be settled in cash (Sec. 190.02(f)(1)).
6. Compute estimated funded balance for each customer commodity
contract account containing open commodity contracts (Sec.
190.04(b)) (daily thereafter).
7. Make margin calls if necessary (Sec. 190.02(g)(1)) (daily
thereafter).
8. Liquidate or offset any open commodity contact account for
which a customer has failed to meet a margin call (Sec.
190.02(f)(1)) (daily thereafter).
9. Commence liquidation or offset of specifically identifiable
property described in Sec. 190.02(f)(2)(i) (property which has lost
10% or more of value) (and as appropriate thereafter).
10. Commence liquidation or offset of property described in
Sec. 190.02(f)(3) (``all other property'').
11. Be aware of any contracts in delivery position and rules
pertaining to such contracts (Sec. 190.05).
First Calendar Day After the Entry of an Order for Relief
1. If a transfer occurred on the date of entry of the order for
relief:
a. Liquidate any remaining open commodity contracts, except any
dealer option or specifically identifiable commodity contract
[hedge] (See Sec. 190.01(kk)(2) and Sec. 190.02(f)(1)), and not
otherwise transferred in the transfer.
b. Primary liquidation date for transferred or liquidated
commodity contracts (Sec. 190.01(ff)).
2. If no transfer has yet been effected, continue attempt to
negotiate transfer of open commodity contracts and dealer options
(Sec. 190.02(c)(1)).
3. Provide the clearing organization or Collecting Futures
Commission Merchant (as such term is defined in Sec. 22.1) with
assurances to prevent liquidation of open commodity contract
accounts available for transfer at the customer's instruction or
liquidate all open commodity contracts except those available for
transfer at a customer's instruction and dealer options.
Second Calendar Day After the Entry of an Order for Relief
If no transfer has yet been effected, request directly customer
instructions regarding transfer of open commodity contracts and
publish notice for customer instructions regarding the return of
specifically identifiable property other than commodity contracts
(Sec. Sec. 190.02(b) (1) and (2)).
Third Calendar Day After the Entry of an Order for Relief
1. Second publication date for customer instructions (Sec.
190.02(b)(1)) (publication is to be made on two consecutive days,
whether or not the second day is a business day).
2. Last day on which to notify the Commission with regard to
whether a transfer in accordance with section 764(b) of the
Bankruptcy Code will take place (Sec. 190.02(a)(2) and Sec.
190.06(e)).
Sixth Calendar Day After the Entry of an Order for Relief
Last day for customers to instruct the trustee concerning open
commodity contracts (Sec. 190.02(b)(2)).
Seventh Calendar Day After the Entry of an Order for Relief
1. If not previously concluded, conclude transfers under Sec.
190.06(e) and (f). (See Sec. 190.02(e)(1) and Sec.
190.06(g)(2)(i)(A)).
2. Transfer all open dealer option contracts which have not
previously been transferred (Sec. 190.06(f)(3)(i)).
3. Primary liquidation date (Sec. 190.01(ff)) (assuming no
transfers and liquidation effected for all open commodity contracts
for which no customer instructions were received by the sixth
calendar day).
4. Establishment of transfer accounts (Sec. 190.03(a)(1))
(assuming this is the primary liquidation date); mark such accounts
to market (Sec. 190.03(a)(2)) (daily thereafter until closed).
5. Liquidate or offset all remaining open commodity contracts
(Sec. 190.02(b)(2)).
6. If not done previously, notify customers of bankruptcy and
request customer proof of claim (Sec. 190.02(b)(4)).
Eighth Calendar Day After the Entry of an Order for Relief
Customer instructions due to trustee concerning specifically
identifiable property (Sec. 190.02(b)(1)).
Ninth Calendar Day After the Entry of an Order for Relief
Commence liquidation of specifically identifiable property for
which no arrangements for return have been made in accordance with
customer instructions (Sec. Sec. 190.02(b)(1), 190.03(c)).
Tenth Calendar Day After the Entry of an Order for Relief
Complete liquidation to the extent reasonably possible of
specifically identifiable property which has yet to be liquidated
and for which no customer instructions have been received (Sec.
190.03(c)).
Separate Procedures for Involuntary Petitions for Bankruptcy
1. Within one calendar day after notice of receipt of filing of
the petition in bankruptcy, the trustee should assure that proper
notification has been given to the Commission, the commodity
broker's designated self-regulatory organization (Sec.
190.02(a)(1)) (if any), and all applicable clearing organizations;
margin calls should be issued if necessary (Sec. 190.02(g)(2)).
2. On or before the seventh calendar day after the filing of a
petition in bankruptcy, the trustee should use his best efforts to
effect a transfer in accordance with Sec. 190.06(e) and (f) of all
open commodity contracts and equity held for or on behalf of
customers of the commodity broker (Sec. 190.02(e)(2)) unless the
debtor can provide certain assurances to the trustee.
Bankruptcy Appendix Form 2-- Request for Instructions Concerning Non-
Cash Property Deposited With (Commodity Broker)
Please take notice: On (date), a petition in bankruptcy was
filed by [against] (commodity broker). Those customers of (commodity
broker) who deposited certain kinds of non-cash property (see below)
with (commodity broker) may instruct the trustee of the estate to
return their property to them as provided below.
As no customer may obtain more than his or her proportionate
share of the property available to satisfy customer claims, if you
instruct the trustee to return your property to you, you will be
required to pay the estate, as a condition to the return of your
property, an amount determined by the trustee. If your property is
not margining an open contract, this amount will approximate the
difference between the market value of your property and your pro
rata share of the estate, as estimated by the trustee. If your
property is margining an open commodity contract, this amount will
be approximately the full fair market value of the property on the
date of its return.
Kinds of Property to Which This Notice Applies
1. Any security deposited as margin which, as of (date petition
was filed), was securing an open commodity contract and is:
--registered in your name,
--not transferrable by delivery, and
--not a short-term obligation.
2. Any fully-paid, non-exempt security held for your account in
which there were no open commodity contracts as of (date
[[Page 6384]]
petition was filed). (Rather than the return, at this time, of the
specific securities you deposited with (commodity broker), you may
instead request now, or at any later time, that the trustee purchase
``like-kind'' securities of a fair market value which does not
exceed your proportionate share of the estate).
3. Any warehouse receipt, bill of lading or other document of
title deposited as margin which, as of (date petition was filed),
was securing an open commodity contract and--can be identified in
(commodity broker)'s records as being held for your account, and--is
neither in bearer form nor otherwise transferable by delivery.
4. Any warehouse receipt bill of lading or other document of
title, or any commodity received, acquired or held by (commodity
broker) to make or take delivery or exercise from or for your
account and which--can be identified in (commodity broker)'s records
as received from or for your account as held specifically for the
purpose of delivery or exercise.
5. Any cash or other property deposited to make or take delivery
on a commodity contract may be eligible to be returned. The trustee
should be contacted directly for further information if you have
deposited such property with (commodity broker) and desire its
return.
Instructions must be received by (the 5th calendar day after 2d
publication date) or the trustee will liquidate your property. (If
you own such property but fail to provide the trustee with
instructions, you will still have a claim against (commodity broker)
but you will not be able to have your specific property returned to
you).
Note: Prior to receipt of your instructions, circumstances may
require the trustee to liquidate your property, or transfer your
property to another broker if it is margining open commodity
contracts. If your property is transferred and your instructions
were received within the required time, your instructions will be
forwarded to the new broker.
Instructions should be directed to: (Trustee's name, address,
and/or telephone).
Even if you request the return of your property, you must also
pay the trustee the amount he specifies and provide the trustee with
proof of your claim before (the 7th calendar day after 2d
publication date) or your property will be liquidated. (Upon receipt
of customer instructions to return property, the trustee will mail
the sender a form which describes the information he must provide to
substantiate his claim).
Note: The trustee is required to liquidate your property despite
the timely receipt of your instructions, money, and proof of claim
if, for any reason, your property cannot be returned by (close of
business on the 7th calendar day after 2d publication date).
Bankruptcy Appendix Form 3--Request for Instructions Concerning
Transfer of Your Hedge Contracts Held by (Commodity Broker)
United States Bankruptcy Court ----District of ----In re ----,
Debtor, No. ----.
Please take notice: On (date), a petition in bankruptcy was filed by
[against] (commodity broker).
You indicated when your hedge account was opened that the
commodity contracts in your hedge account should not be liquidated
automatically in the event of the bankruptcy of (commodity broker),
and that you wished to provide instructions at this time concerning
their disposition.
Instructions to transfer your commodity contracts and a cash
deposit (as described below) must be received by the trustee by (the
6th calendar day after entry of order for relief) or your commodity
contracts will be liquidated.
If you request the transfer of your commodity contracts, prior
to their transfer, you must pay the trustee in cash an amount
determined by the trustee which will approximate the difference
between the value of the equity margining your commodity contracts
and your pro rata share of the estate plus an amount constituting
security for the nonrecovery of any overpayments. In your
instructions, you should specify the broker to which you wish your
commodity contracts transferred.
Be further advised that prior to receipt of your instructions,
circumstances may, in any event, require the trustee to liquidate or
transfer your commodity contracts. If your commodity contracts are
so transferred and your instructions are received, your instructions
will be forwarded to the new broker.
Note also that the trustee is required to liquidate your
positions despite the timely receipt of your instructions and money
if, for any reason, you have not made arrangements to transfer and/
or your contracts are not transferred by (7 calendar days after
entry of order for relief).
Instructions should be sent to: (Trustee's or designee's name,
address, and/or telephone). [Instructions may also be provided by
phone].
Bankruptcy Appendix Form 4--Proof of Claim
[Note to trustee: As indicated in Sec. 190.02(d), this form is
provided as a guide to the trustee and should be modified as
necessary depending upon the information which the trustee needs at
the time a proof of claim is requested and the time provided for a
response.]
Proof of Claim
United States Bankruptcy Court ----District of ----In re ----,
Debtor, No. ----.
Return this form by ---- or your claim will be barred (unless
extended, for good cause only).
I. [If claimant is an individual claiming for himself] The
undersigned, who is the claimant herein, resides at ----.
[If claimant is a partnership claiming through a member] The
undersigned, who resides at ----, is a member of ----, a
partnership, composed of the undersigned and ----, of ----, and
doing business at ----, and is duly authorized to make this proof of
claim on behalf of the partnership.
[If claimant is a corporation claiming though a duly authorized
officer] The undersigned, who resides at ---- is the ---- of ----, a
corporation organized under the laws of ---- and doing business at
----, and is duly authorized to make this proof of claim on behalf
of the corporation.
[If claim is made by agent] The undersigned, who resides at ----
, is the agent of ----, and is duly authorized to make this proof of
claim on behalf of the claimant.
II. The debtor was, at the time of the filing of the petition
initiating this case, and still is, indebted to this claimant for
the total sum of $ ----.
III. List EACH account on behalf of which a claim is being made
by number and name of account holder[s], and for EACH account,
specify the following information:
a. Whether the account is a futures, foreign futures, leverage,
option (if an option account, specify whether exchange-traded,
dealer or cleared swap), ``delivery'' account, or a cleared swaps
account. A ``delivery'' account is one which contains only documents
of title, commodities, cash, or other property identified to the
claimant and deposited for the purposes of making or taking delivery
on a commodity underlying a commodity contract or for payment of the
strike price upon exercise of an option.
b. The capacity in which the account is held, as follows (and if
more than one is applicable, so state):
1. [The account is held in the name of the undersigned in his
individual capacity];
2. [The account is held by the undersigned as guardian,
custodian, or conservator for the benefit of a ward or a minor under
the Uniform Gift to Minors Act];
3. [The account is held by the undersigned as executor or
administrator of an estate];
4. [The account is held by the undersigned as trustee for the
trust beneficiary];
5. [The account is held by the undersigned in the name of a
corporation, partnership, or unincorporated association];
6. [The account is held as an omnibus customer account of the
undersigned futures commission merchant];
7. [The account is held by the undersigned as part owner of a
joint account];
8. [The account is held by the undersigned in the name of a plan
which, on the date the petition in bankruptcy was filed, had in
effect a registration statement in accordance with the requirements
of Sec. 1031 of the Employee Retirement Income Security Act of 1974
and the regulations thereunder]; or
9. [The account is held by the undersigned as agent or nominee
for a principal or beneficial owner (and not described above in
items 1-8 of this II, b)].
10. [The account is held in any other capacity not described
above in items 1-9 of this II, b. Specify the capacity].
c. The equity, as of the date the petition in bankruptcy was
filed, based on the commodity contracts in the account.
d. Whether the person[s] (including a general partnership,
limited partnership, corporation, or other type of association) on
whose behalf the account is held is one of the following persons OR
whether one of the following persons, alone or jointly, owns 10% or
more of the account:
1. [If the debtor is an individual--
A. Such individual;
B. Relative (as defined below in item 8 of this III.d) of the
debtor or of a general partner of the debtor;
[[Page 6385]]
C. Partnership in which the debtor is a general partner;
D. General partner of the debtor; or
E. Corporation of which the debtor is a director, officer, or
person in control];
2. [If the debtor is a partnership--
A. Such partnership;
B. General partner in the debtor;
C. Relative (as defined in item 8 of this III.d) of a general
partner in, general partner of, or person in control of the debtor;
D. Partnership in which the debtor is a general partner;
E. General partner of the debtor; or
F. Person in control of the debtor];
3. [If the debtor is a limited partnership--
A. Such limited partnership;
B. A limited or special partner in such partnership whose duties
include:
i. The management of the partnership business or any part
thereof;
ii. The handling of the trades or customer funds of customers of
such partnership;
iii. The keeping of records pertaining to the trades or customer
funds of customers of such partnership; or
iv. The signing or co-signing of checks or drafts on behalf of
such partnership];
4. [If the debtor is a corporation or association (except a
debtor which is a futures commission merchant and is also a
cooperative association of producers)--
A. Such corporation or association;
B. Director of the debtor;
C. Officer of the debtor;
D. Person in control of the debtor;
E. Partnership in which the debtor is a general partner;
F. General partner of the debtor;
G. Relative (as defined in item 8 of this III.d) of a general
partner, director, officer, or person in control of the debtor;
H. An officer, director or owner of ten percent or more of the
capital stock of such organization];
5. [If the debtor is a futures commission merchant which is a
cooperative association of producers--
Shareholder or member of the debtor which is an officer,
director or manager];
6. [An employee of such individual, partnership, limited
partnership, corporation or association whose duties include:
A. The management of the business of such individual,
partnership, limited partnership, corporation or association or any
part thereof;
B. The handling of the trades or customer funds of customers of
such individual, partnership, limited partnership, corporation or
association;
C. The keeping of records pertaining to the trades or funds of
customers of such individual, partnership, limited partnership,
corporation or association; or
D. The signing or co-signing of checks or drafts on behalf of
such individual, partnership, limited partnership, corporation or
association];
7. [Managing agent of the debtor];
8. [A spouse or minor dependent living in the same household of
ANY OF THE FOREGOING PERSONS, or any other relative, regardless of
residency, (unless previously described in items 1-B, 2-C, or 4-G of
this III.d) defined as an individual related by affinity or
consanguinity within the third degree as determined by the common
law, or individual in a step or adoptive relationship within such
degree];
9. [``Affiliate'' of the debtor, defined as:
A. Entity that directly or indirectly owns, controls, or holds
with power to vote, 20 percent or more of the out-standing voting
securities of the debtor, other than an entity that holds such
securities--
i. In a fiduciary or agency capacity without sole discretionary
power to vote such securities; or
ii. Solely to secure a debt, if such entity has not in fact
exercised such power to vote;
B. Corporation 20 percent or more of whose outstanding voting
securities are directly or indirectly owned, con-trolled, or held
with power to vote, by the debtor, or by an entity that directly or
indirectly owns, controls, or holds with power to vote, 20 percent
or more of the outstanding voting securities of the debtor, other
than an entity that holds such securities--
i. In a fiduciary or agency capacity without sole discretionary
power to vote such securities; or
ii. Solely to secure a debt, if such entity has not in fact
exercised such power to vote;
C. Person whose business is operated under a lease or operating
agreement by the debtor, or person substantially all of whose
property is operated under an operating agreement with the debtor;
D. Entity that otherwise, directly or indirectly, is controlled
by or is under common control with the debtor];
E. Entity that operates the business or all or substantially all
of the property of the debtor under a lease or operating agreement;
or
F. Entity that otherwise, directly or indirectly, controls the
debtor; or
10. [Any of the persons listed in items 1-7 above of this III.d
if such person is associated with an affiliate (see item 9 above) of
the debtor as if the affiliate were the debtor].
e. Whether the account is a discretionary account. (If it is,
the name in which the ``attorney in fact'' is held).
f. If the account is a joint account, the amount of the
claimant's percentage interest in the account. (Also specify whether
participants in a joint account are claiming separately or jointly).
g. Whether the claimant's positions in security futures products
are held in a futures account or securities account, as those terms
are defined in Sec. 1.3 of this chapter.
IV. Describe all claims against the debtor not based upon a
commodity contract account of the claimant (e.g., if landlord, for
rent; if customer, for misrepresentation or fraud).
V. Describe all claims of the DEBTOR against the CLAIMANT not
already included in the equity of a commodity contract account[s] of
the claimant (see III.c above).
VI. Describe any deposits of money, securities or other property
held by or for the debtor from or for the claimant, and indicate if
any of this property was included in your answer to III.c above.
VII. Of the money, securities, or other property described in VI
above, identify any which consists of the following:
a. With respect to property received, acquired, or held by or
for the account of the debtor from or for the account of the
claimant to margin, guarantee or secure an open commodity contract,
the following:
1. Any security which as of the filing date is:
A. Held for the claimant's account;
B. Registered in the claimant's name;
C. Not transferable by delivery; and
D. Not a short term obligation; or
2. Any warehouse receipt, bill of lading or other document of
title which as of the filing date:
A. Can be identified on the books and records of the debtor as
held for the account of the claimant; and
B. Is not in bearer form and is not otherwise transferable by
delivery.
b. With respect to open commodity contracts, and except as
otherwise provided below in item g of this VII, any such contract
which:
1. As of the date the petition in bankruptcy was filed, is
identified on the books and records of the debtor as held for the
account of the claimant;
2. Is a bona fide hedging position or transaction as defined in
Rule 1.3 of the Commodity Futures Trading Commission (``CFTC'') or
is a commodity option transaction which has been determined by a
registered entity to be economically appropriate to the reduction of
risks in the conduct and management of a commercial enterprise
pursuant to rules which have been approved by the CFTC pursuant to
section 5c(c) of the Commodity Exchange Act;
3. Is in an account designated in the accounting records of the
debtor as a hedging account.
c. With respect to warehouse receipts, bills of lading or other
documents of title, or physical commodities received, acquired, or
held by or for the account of the debtor for the purpose of making
or taking delivery or exercise from or for the claimant's account,
any such document of title or commodity which as of the filing date
can be identified on the books and records of the debtor as received
from or for the account of the claimant specifically for the purpose
of delivery or exercise.
d. Any cash or other property deposited prior to bankruptcy to
pay for the taking of physical delivery on a long commodity contract
or for payment of the strike price upon exercise of a short put or a
long call option contract on a physical commodity, which cannot be
settled in cash, in excess of the amount necessary to margin such
commodity contract prior to the notice date or exercise date which
cash or other property is identified on the books and records of the
debtor as received from or for the account of the claimant within
three or less days of the notice date or three or less days of the
exercise date specifically for the purpose of payment of the notice
price upon taking delivery or the strike price upon exercise.
e. The cash price tendered for any property deposited prior to
bankruptcy to make physical delivery on a short commodity contract
or for exercise of a long put or a short call option contract on a
physical commodity, which cannot be settled in cash,
[[Page 6386]]
to the extent it exceeds the amount necessary to margin such
contract prior to the notice exercise date which property is
identified on the books and records of the debtor as received from
or for the account of the claimant within three or less days of the
notice date or of the exercise date specifically for the purpose of
a delivery or exercise.
f. Fully paid, non-exempt securities identified on the books and
records of the debtor as held by the debtor for or on behalf of the
commodity contract account of the claimant for which, according to
such books and records as of the filing date, no open commodity
contracts were held in the same capacity.
g. Open commodity contracts transferred to another futures
commission merchant by the trustee.
VIII. Specify whether the claimant wishes to receive payment in
kind, to the extent possible, for any claim for securities.
IX. Attach copies of any documents which support the information
provided in this proof of claim, including but not limited to
customer confirmations, account statements, and statements of
purchase or sale.
This proof of claim must be filed with the trustee no later than
----, or your claim will be barred unless an extension has been
granted, available only for good cause.
Return this form to:
(Trustee's name (or designee's) and address)
-----------------------------------------------------------------------
Dated:-----------------------------------------------------------------
(Signed)---------------------------------------------------------------
Penalty for Presenting Fraudulent Claim. Fine of not more than
$5,000 or imprisonment for not more than five years or both--Title
18, U.S.C. 152.
(Approved by the Office of Management and Budget under control
number 3038-0021)
0
14. Revise appendix B to part 190 to read as follows:
Appendix B to Part 190--Special Bankruptcy Distributions
Framework 1--Special Distribution of Customer Funds for Futures
Contracts When FCM Participated in Cross-Margining
The Commission has established the following distributional
convention with respect to ``customer funds'' (as Sec. 1.3 of this
chapter defines such term) for futures contracts held by a futures
commission merchant (FCM) that participated in a cross-margining
(XM) program which shall apply if participating market professionals
sign an agreement that makes reference to this distributional rule
and the form of such agreement has been approved by the Commission
by rule, regulation or order:
All customer funds for futures contracts held in respect of XM
accounts, regardless of the product that customers holding such
accounts are trading, are required by Commission order to be
segregated separately from all other customer segregated funds. For
purposes of this distributional rule, XM accounts will be deemed to
be commodity interest accounts and securities held in XM accounts
will be deemed to be received by the FCM to margin, guarantee or
secure commodity interest contracts. The maintenance of property in
an XM account will result in subordination of the claim for such
property to certain non-XM customer claims and thereby will operate
to cause such XM claim not to be treated as a customer claim for
purposes of the Securities Investors Protection Act and the XM
securities to be excluded from the securities estate. This creates
subclasses of futures customer accounts, an XM account and a non-XM
account (a person could hold each type of account), and results in
two pools of segregated funds belonging to futures customers: An XM
pool and a non-XM pool. In the event that there is a shortfall in
the non-XM pool of customer class segregated funds and there is no
shortfall in the XM pool of customer segregated funds, all futures
customer net equity claims, whether or not they arise out of the XM
subclass of accounts, will be combined and will be paid pro rata out
of the total pool of available XM and non-XM customer funds for
futures contracts. In the event that there is a shortfall in the XM
pool of customer segregated funds and there is no shortfall in the
non-XM pool of customer segregated funds, then futures customer net
equity claims arising from the XM subclass of accounts shall be
satisfied first from the XM pool of customer segregated funds, and
futures customer net equity claims arising from the non-XM subclass
of accounts shall be satisfied first from the non-XM customer
segregated funds. Furthermore, in the event that there is a
shortfall in both the non-XM and XM pools of customer segregated
funds: (1) If the non-XM shortfall as a percentage of the
segregation requirement in the non-XM pool is greater than or equal
to the XM shortfall as a percentage of the segregation requirement
in the XM pool, all futures customer net equity claims will be paid
pro rata; and (2) if the XM shortfall as a percentage of the
segregation requirement in the XM pool is greater than the non-XM
shortfall as a percentage of the segregation requirement of the non-
XM pool, non-XM futures customer net equity claims will be paid pro
rata out of the available non-XM segregated funds, and XM futures
customer net equity claims will be paid pro rata out of the
available XM segregated funds. In this way, non-XM customers will
never be adversely affected by an XM shortfall.
The following examples illustrate the operation of this
convention. The examples assume that the FCM has two customers, one
with exclusively XM accounts and one with exclusively non-XM
accounts. However, the examples would apply equally if there were
only one customer, with both an XM account and a non-XM account.
BILLING CODE 6351-01-P
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Issued in Washington, DC on January 11, 2012, by the Commission.
David A. Stawick,
Secretary of the Commission.
Appendices to Protection of Cleared Swaps Customer Contracts and
Collateral; Conforming Amendments to the Commodity Broker Bankruptcy
Provisions--Commission Voting Summary and Statements of Commissioners
Note: The following appendices will not appear in the Code of
Federal Regulations
Appendix 1--Commission Voting Summary
On this matter, Chairman Gensler and Commissioners Chilton,
O'Malia and Wetjen voted in the affirmative; Commissioner Sommers
voted in the negative
Appendix 2--Statement of Chairman Gary Gensler
I support the final rules on segregation of customer funds for
cleared swaps. These rules are an important step forward in
protecting customers and reducing the risk of swaps trading. The
rules carry out the Dodd-Frank Wall Street Reform and Consumer
Protection Act (Dodd-Frank Act) mandate that futures commission
merchants (FCMs) and derivatives clearing organizations (DCOs)
segregate customer collateral supporting cleared swaps. FCMs and
DCOs must hold customer collateral in a separate account from that
belonging to the FCM or DCO. It prohibits clearing organizations
from using the collateral of non-defaulting, innocent customers to
protect themselves and their clearing members. For the first time,
customer money must be protected individually all the way to the
clearinghouse.
We received a tremendous amount of public input on this rule,
including through two roundtables, as well as through comments on an
advanced notice of proposed rulemaking and a proposal. This rule
builds on customer protections included in the clearinghouse core
principles rule we finalized in October requiring DCOs to collect
initial margin on a gross basis for their clearing members' customer
accounts.
Appendix 3--Statement of Commissioner Scott D. O'Malia
Today, the Commodity Futures Trading Commission (the
``Commission'') is voting to finalize a rulemaking on protection of
cleared swaps customer collateral.\307\ Whereas I support this
rulemaking, I believe that it is important to detail its
limitations, so that we do not offer market participants a
misleading sense of comfort in light of the collapse of MF Global,
Inc. (``MF Global''). As I will explain further, the Commission has
much more work to do to increase confidence in the customer
protections that our regulations offer.
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\307\ Protection of Cleared Swaps Customer Contracts and
Collateral; Conforming Amendments to the Commodity Broker Bankruptcy
Provisions (to be codified at 17 CFR parts 22 and 190) (referenced
herein as the ``rulemaking''), available at: http://www.cftc.gov/PressRoom/Events/opaevent_cftcdoddfrank011112.
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This rulemaking does not address MF Global.
First, this rulemaking does not address MF Global. The
rulemaking is entitled, in part, Protection of Cleared Swaps
Customer Contracts and Collateral. Therefore, it benefits cleared
swaps customers, and not futures customers (who are bearing the
brunt of MF Global). This rulemaking would not have prevented a
shortfall in the customer funds of the ranchers and farmers that
transact daily in the futures market. Nor would it have expedited
the transfer of positions and collateral belonging to such customers
in the event of a collapse similar to that of MF Global.
This rulemaking may expose swaps customers to more risk.
Second, this rulemaking only addresses one of three categories
of risk that an intermediary--like MF Global--can pose to its
customers. The three categories of risk are (i) ``fellow-customer''
risk, (ii) operational risk, and (iii) investment risk. By its own
admission, this rulemaking only protects against ``fellow-customer''
risk. It does not protect against operational risk--namely, the risk
that an intermediary improperly segregates cleared swaps customer
collateral.\308\ Moreover, it does not protect against investment
risk--namely, the risk that an intermediary experiences losses on
its investment of cleared swaps customer collateral, which it cannot
cover using its capital.\309\ To be plain, I support limiting
intermediaries from investing customer collateral in risky
instruments--regardless of whether such collateral margins futures
or swaps contracts.\310\ However, I am not na[iuml]ve enough to
believe that such limitations--without additional Commission
oversight or action--would be sufficient. I have warned against
complacency in the past.\311\ I reiterate such warning here.
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\308\ See section I(D)(2) of the preamble to this rulemaking.
\309\ Id.
\310\ See sections 22.2(e)(1) and 22.3(d) of the rule text to
this rulemaking (to be codified at 17 CFR 22.2(e)(1) and 22.3(d))
(limiting an FCM and a DCO to investing cleared swaps customer
collateral in instruments enumerated in regulation 1.25).
\311\ See ``Opening Statement of Commissioner Scott D.
O'Malia'', dated December 5, 2011, available at: http://www.cftc.gov/PressRoom/SpeechesTestimony/omaliastatement120511.
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Under this rulemaking, what happens if an intermediary--like MF
Global--becomes insolvent as operational or investment
irregularities are revealed? Basically, under the Bankruptcy
Code,\312\ cleared swaps customers would share pro rata in any
shortfall. A shortfall would complicate the porting of cleared swaps
customer contracts and associated collateral, notwithstanding the
enhanced recordkeeping and reporting requirements of this
rulemaking.
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\312\ See section 766(h) of the Bankruptcy Code, 11 U.S.C.
766(h).
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By not protecting against operational and investment risk, this
rulemaking may have the effect of exposing some swaps customers to
more risk than they currently bear in the over-the-counter markets.
Since December 2, 2011, we have received eight comment letters from
end-users, many of which explicitly asked the Commission to not
finalize this rulemaking until it explores other alternatives that
may provide greater protection.\313\ These end-users include
Fidelity Investments, the Committee on Investment of Employee
Benefit Assets (``CIEBA''), and the Federal Home Loan Banks.
According to many of these comment letters, swaps customers in the
over-the-counter markets currently have the option to enter into
tri-party custody agreements. In general, these agreements may
provide superior protection to this rulemaking against not only
fellow-customer risk, but also operational and investment risk.\314\
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\313\ See comment letters from (i) Managed Funds Association,
dated December 2, 2011; (ii) Fidelity Investments, dated December 8,
2011; (iii) Och-Ziff Capital Management Group, dated circa December
12, 2011; (iv) State Street Corporation, dated December 14, 2011;
(v) the Committee on Investment of Employee Benefit Assets, dated
December 22, 2011; (vi) the European Federation for Retirement
Provision (``EFRP'') and APG Algemene Pensioen Groep, N.V.
(``APG''), dated December 23, 2011; (vii) the Federal Home Loan
Banks, dated January 9, 2012; and (viii) BlueMountain Capital
Management, LLC, Elliot Management Corporation, Moore Capital
Management, LP, Paulson & Co. Inc., and Tudor Investment
Corporation, dated January 9, 2012 (the ``Moore et. al. letter'').
In each case, the comment letters were filed in answer to the notice
of proposed rulemaking on the Protection of Cleared Swaps Customer
Contracts and Collateral; Conforming Amendments to the Commodity
Broker Bankruptcy Provisions, 76 FR 33818, Jun. 9, 2011. All comment
letters to such notice are available at: http://www.cftc.gov/idc/groups/public/@lrfederalregister/documents/file/2011-10737a.pdf.
\314\ See, e.g., comment letters from (i) Fidelity Investments,
dated December 8, 2011; (ii) Och-Ziff Capital Management Group,
dated circa December 12, 2011; and (iii) CIEBA, dated December 22,
2011.
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I understand that staff has been directed to ``carefully
analyze'' various proposals that commenters have advanced ``with the
goal of developing proposed rules that provide additional protection
for collateral belonging to market participants.'' \315\ This is a
laudable goal. I only hope that we achieve this goal before
mandatory clearing becomes effective.\316\ Otherwise, we may be
subjecting
[[Page 6408]]
a substantial portion of cleared swaps customer collateral to
operational risk and investment risk. To provide some context, such
collateral--in the aggregate--may amount to anywhere from $500
billion to $833 billion.\317\ As one commenter stated, ``[i]t would
seem to be a perverse result that, because of rulemaking promulgated
under the Dodd-Frank * * * Act, which was * * * meant to enhance the
safety of the over-the-counter markets by reducing systemic and
counterparty risks, market participants were to be placed [in] [sic]
a worse position with regard to risk than they are currently.''
\318\ Other commenters supported this statement.\319\
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\315\ Section I(F) of the preamble to this rulemaking.
\316\ See comment letter from CIEBA, dated December 22, 2011
(stating that ``* * * the Commission should not permit mandatory
clearing of swaps to become effective until a physical segregation
option, such as the individual settlement account * * * or another
satisfactory structure, has been made available to swaps
customers.'' [emphasis original]).
This rulemaking does attempt to resolve one request repeated in
the comment letters filed since December 2, 2011. In section I(F) of
the preamble, the rulemaking makes clear that the Commission's 2005
Amendment to Financial and Segregation Interpretation No. 10, 70 FR
24768, May 11, 2005 (``Segregation Interpretation 10-1''), does not
apply to cleared swaps. Therefore, Segregation Interpretation 10-1
would not prohibit an intermediary from entering into a tri-party
custody agreement with a cleared swaps customer. However, this
rulemaking similarly makes clear that Segregation Interpretation No.
10, which the Commission issued in 1984, would continue to apply to
collateral segregated according to a tri-party custody agreement. In
other words, cleared swaps customers could not avoid the pro rata
distribution provisions of the Bankruptcy Code (as well as
regulation Part 190). Therefore, the resolution in this rulemaking
may provide commenters with cold comfort.
\317\ Section VII(B)(2) of the preamble to this rulemaking
(citing estimates provided by CME Group, Inc. and the International
Swaps and Derivatives Association, Inc.).
\318\ Comment letter from Och-Ziff Capital Management Group,
dated circa December 12, 2011.
\319\ See the Moore et. al. letter (stating ``[g]iven the
crucial role that central clearing will play in reducing systemic
risk in the swaps market, we see no valid argument to suggest that
customers to cleared swaps should be subject to weaker regulatory
protections than those afforded counterparties to uncleared
swaps.''); and comment letter from EFRP and APG, dated December 23,
2011 (stating ``EFRP and APG support the CFTC's efforts to reduce
risk, enhance transparency, and promote market integrity, as the
U.S. Congress intended by enacting Title VII of the Dodd-Frank * * *
Act. It should be clear though that such reform will only improve
financial stability, if it is prudent from the perspective of end
users, such as pension funds. However, as currently framed the
Proposed Rules subject us to increased risks.'').
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This rulemaking may imperfectly address fellow-customer risk.
Let me now say a few words on ``fellow-customer'' risk.
Preliminarily, what is it? According to this rulemaking, it is the
risk that a derivatives clearing organization (``DCO'') will access
the collateral of non-defaulting cleared swaps customers to cure the
default of an intermediary.\320\ Under what circumstances could a
DCO access such collateral? Under this rulemaking, there are two
circumstances and they have to occur simultaneously. First, a swaps
customer would need to default to an intermediary. Second, as a
result of such default, the intermediary must be unable to meet its
DCO obligations. In short, swaps customer losses must exceed the
capitalization of the intermediary.\321\ As this rulemaking
acknowledges, ``fellow-customer'' risk is rare.\322\ In comparison,
according to notices received by the Commission, operational risk is
far more prevalent.\323\
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\320\ Section I(B)(6) of the preamble to this rulemaking.
\321\ Id.
\322\ Section VII(B)(2) of the preamble to this rulemaking
(stating that ``double defaults are rare events.'').
\323\ Regulation 1.12(h) requires an intermediary that knows or
should know that it is under-segregated to report to the Commission
and its designated self-regulatory organization. Usually, under-
segregation results from minor operational failure, and does not
lead to the collapse of an intermediary. However, a pattern of
operational failure would draw greater attention and inquiry.
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Of course, just because a risk is rare does not mean that the
Commission should not protect against it. But let us take a closer
look at the protection that this rulemaking is offering. First,
although it is close to 230 pages, with nearly 100 pages in rule
text, only a couple of the provisions of this rulemaking address
``fellow-customer'' risk. They are regulations 22.11 to 22.16.\324\
The remainder of regulation Part 22, as well as the majority of
changes to regulation Part 190 (Bankruptcy), simply aligns the
cleared swaps segregation regime with the existing futures
segregation regime.\325\ As MF Global reveals, the futures
segregation regime may have some vulnerabilities. In this
rulemaking, the Commission is unthinkingly replicating these
vulnerabilities.
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\324\ Sections 22.11 to 22.16 of the rule text to this
rulemaking (to be codified at 17 CFR 22.11 (Information to be
Provided Regarding Customers and Their Cleared Swaps), 22.12
(Information to be Maintained Regarding Cleared Swaps Customer
Collateral), 22.13 (Additions to Cleared Swaps Customer Collateral),
22.14 (Futures Commission Merchant Failure to Meet a Customer Margin
Call in Full), 22.15 (Treatment of Cleared Swaps Collateral on an
Individual Basis), 22.16 (Disclosures to Customers)).
\325\ See, e.g., section 22.10 to the rule text of this
rulemaking (to be codified at 17 CFR 22.10 Application of other
Regulatory Provisions).
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Second, this rulemaking only offers protection to a portion of
the cleared swaps customer collateral that an intermediary holds. In
general, cleared swaps customer collateral may fall within two
categories: (i) collateral needed to support contracts; and (ii)
collateral in excess of that needed to support contracts (``Excess
Collateral''). The Commission, in its final rulemaking on
Derivatives Clearing Organization General Provisions and Core
Principles, states that a DCO must require its clearing members to
collect Excess Collateral.\326\ However, as certain commenters have
astutely observed, and as this rulemaking readily admits, this
rulemaking does not protect Excess Collateral deposited outside of
the DCO.\327\ So, the Commission has required cleared swaps
customers to provide collateral that it then does not protect.
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\326\ See Derivatives Clearing Organization General Provisions
and Core Principles, 76 FR 69334, 69438, Nov. 8, 2011 (to be
codified at 17 CFR 39.13(g)(8)).
\327\ See section III(B) of the preamble to this rulemaking
(stating ``CME notes that a portion of the Cleared Swaps Customer
Collateral will be held at the FCM, not the DCO, and that this
collateral will not be protected by Complete Legal Segregation in
the event that an FCM becomes insolvent. This proposition is true
but is of little or no relevance to the comparison of Complete Legal
Segregation with the Futures Model favored by these commenters.'').
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Third, this rulemaking cites, as a major benefit, the
possibility of enhanced portability of cleared swaps customer
contracts, as well as associated collateral, after an intermediary
defaults due to ``fellow-customer'' risk.\328\ The rulemaking sets
forth more stringent recordkeeping and reporting requirements as a
foundation for enhanced portability. As commenters have identified,
these requirements have two significant weaknesses.
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\328\ Section I(D)(2) of the preamble to this rulemaking. To be
fair, this rulemaking does make the point that enhanced
recordkeeping and reporting requirements may also foster portability
in the event of operational or investment risk.
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Preliminarily, to maximize portability, each intermediary must
(i) keep complete and accurate records and (ii) comply with
reporting requirements. As MF Global and earlier intermediary
collapses have demonstrated, a distressed intermediary may not
prioritize recordkeeping and reporting.\329\
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\329\ See, e.g., comment letters from (i) the Federal Home Loan
Banks, dated January 9, 2012 and (ii) CIEBA, dated December 22,
2011. See also the Moore et. al. letter.
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Secondarily, despite requests from various commenters (including
the Association of Institutional Investors and Vanguard), this
rulemaking does not provide guidance on the concrete steps that a
DCO should take to ensure that an intermediary is providing accurate
and complete information. Instead, the rulemaking states: ``* * *
the DCO should take the steps appropriate, in the professional
judgment of its staff, to verify that [intermediaries] have and are
using systems and appropriate procedures to track accurately, and to
provide to the DCO accurately, the positions of each customer.''
\330\ In light of MF Global, the Commission should give this
provision--and the requests of commenters--more thought.
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\330\ Section IV(K) of the preamble to this rulemaking.
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Finally, this rulemaking is silent on one important factor that
may affect the portability of cleared swaps customer contracts, as
well as associated collateral--namely, whether the intermediary is
both a futures commission merchant and a securities broker-dealer. I
am touching on this issue in the interest of full disclosure.
A comprehensive solution is needed.
Despite its limitations, I ultimately support this rulemaking.
As I have stated previously, the Commission must immediately take
action to renew public confidence in our customer protection
regime.\331\ Although this rulemaking largely replicates futures
segregation, this rulemaking--if it works as promised in an
intermediary bankruptcy--may enhance portability for cleared swaps
customers in the event of ``fellow-customer'' risk. Even the
possibility of such enhancement is non-negligible--especially in the
volatile economic environment that exists today.
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\331\ See Statement on MF Global: Next Steps, dated November 16,
2011, available at: http://www.cftc.gov/PressRoom/SpeechesTestimony/omaliastatement111611.
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However, this rulemaking also vividly illustrates some of my
concerns regarding our Dodd-Frank rulemaking process. First, the
Commission has a duty to regulate the swaps market. It also owes a
duty to futures customers. Right now, it is unclear from this
rulemaking how the Commission means to address futures customer
concerns. I understand that the investigation into the MF Global
collapse is ongoing. However, the Commission could examine the
manner in
[[Page 6409]]
which operational and investment risks contribute to
undersegregation. Our undersegregation reports would help us with
such an examination, as well as the detection of potential causal
patterns for undersegregation.\332\
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\332\ See supra note 17.
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Second, instead of rushing to complete this rulemaking, I would
have preferred that the Commission focus on providing a more
comprehensive solution to operational, investment, and ``fellow-
customer'' risk. Moreover, I would have preferred that the
Commission more fully explore the alternatives that various
commenters have advanced, which may provide greater protection for
futures, as well as cleared swaps customer, collateral. Further, it
would have been helpful for the Commission to have weighed, in one
analysis, the benefits and costs of offering a combination of (i)
this rulemaking and (ii) one or more alternatives.
Finally, the Commission needs to contemplate whether any
alternative would be workable in light of the pro rata distribution
provisions of the Bankruptcy Code. If not, the Commission should
contemplate recommending to Congress changes to the Bankruptcy Code.
After MF Global, the Commission needs to provide market
participants with real, fully developed reforms. I look forward to
the Commission taking such action.
[FR Doc. 2012-1033 Filed 2-6-12; 8:45 am]
BILLING CODE 6351-01-P
Last Updated: February 7, 2012